FORM 10-K

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

(Mark One)

  |X|           ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                    OF THE SECURITIES EXCHANGE ACT OF 1934

                      For fiscal year ended December 31, 1997

                                      OR

  |_|         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                    OF THE SECURITIES EXCHANGE ACT OF 1934

                       For the transition period from ______to____

                         Commission File Number: 1-1414

                                  PACIFIC BELL
             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

Securities registered pursuant to Section 12(b) of the Act: (See attached
Schedule A)

Securities registered pursuant to Section 12(g) of the Act: None.

THE   REGISTRANT,   AN   INDIRECTLY   HELD   WHOLLY-OWNED   SUBSIDIARY   OF  SBC
COMMUNICATIONS,  INC.,  MEETS THE  CONDITIONS  SET FORTH IN GENERAL  INSTRUCTION
I(1)(a)  AND (b) OF FORM 10-K AND IS  THEREFORE  FILING  THIS FORM WITH  REDUCED
DISCLOSURE FORMAT PURSUANT TO GENERAL INSTRUCTION I(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

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K is not contained  herein,  and will not be contained,  to the
best of registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [Not Applicable]

<PAGE>



                                  SCHEDULE A

          Securities Registered Pursuant To Section 12(b) Of The Act:


                                                  Name of each exchange
        Title of each Class                       on which registered

           -------------                            ---------------

 7.250%     Note Due 07/01/02                  New York Stock Exchange
 6.250%     Note Due 03/01/05                  New York Stock Exchange
 7.125%     Debenture due 03/15/26             New York Stock Exchange
 7.500%     Debenture due 02/01/33             New York Stock Exchange
 6.875%     Debenture due 08/15/23             New York Stock Exchange
 6.625%     Debenture due 10/15/34             New York Stock Exchange

<PAGE>


                               TABLE OF CONTENTS




Item                                                                  Page
----                                                                  ----

                                  PART I

 1.  Business.......................................................
 2.  Properties.....................................................
 3.  Legal Proceedings..............................................
 4.  Submission of Matters to a Vote of Security Holders............


                                    PART II

 5.  Market for Registrant's Common Equity and Related
       Stockholder Matters..........................................
 6.  Selected Financial and Operating Data..........................
 7.  Management's Discussion and Analysis of Results of Operations
     (Abbreviated pursuant to General Instruction I(2)).............
 7A. Quantitative and Qualitative Disclosures about Market Risk.....
 8.  Financial Statements and Supplementary Data....................
 9.  Changes in and Disagreements with Accountants on Accounting
       and Financial Disclosure.....................................


                                   PART III

10.  Directors and Executive Officers of the Registrant.............
11.  Executive Compensation.........................................
12.  Security Ownership of Certain Beneficial Owners and
       Management...................................................
13.  Certain Relationships and Related Transactions.................


                                    PART IV

14.  Exhibits, Financial Statement Schedules, and Reports on Form 8-K




__________

*Omitted pursuant to General Instruction I(2).



<PAGE>
                                     PART I

ITEM 1. BUSINESS

GENERAL

Pacific Bell (PacBell,  which includes its subsidiaries) is a telecommunications
company  whose  subsidiaries  and  affiliates   operate   predominantly  in  the
communications  services  industry.  PacBell  is a  wholly-owned  subsidiary  of
Pacific  Telesis Group (PAC),  a wholly-owned  subsidiary of SBC  Communications
Inc.   (SBC).    PacBell's    subsidiaries   provide   landline   and   wireless
telecommunications services and equipment, directory advertising and publishing.
Pacific   Bell's   telephone   operations   (Telephone   Operations),    provide
telecommunications  services  over  approximately  17 million  access  lines  in
California.  The Telephone  Operations operate within California providing local
exchange  services  and are  subject  to  regulation  by the  California  Public
Utilities Commission (CPUC) and by the Federal Communications  Commission (FCC).
PacBell was  incorporated  under the laws of the State of California in 1906 and
has  its  principal  executive  offices  at 140 New  Montgomery,  San Francisco,
California 94105-3705 (telephone number 415-542-9000).

PAC was one of the original seven regional  holding  companies  (RHCs) formed to
hold AT&T Corp.'s (AT&T) local telephone  companies.  AT&T divested PAC, and its
subsidiary,  PacBell,  by means of a  spin-off  of stock to its  shareowners  on
January  1,  1984  (divestiture).  As a result,  PAC  became a  publicly  traded
company.  The divestiture was made pursuant to a consent decree,  referred to as
the  Modification of Final Judgment (MFJ),  issued by the United States District
Court for the District of Columbia (District Court). With the mergers of SBC and
PAC, and Bell Atlantic  Corporation  and NYNEX  Corporation,  there are now five
RHCs.

COMPLETION OF MERGER OF SBC AND PAC

On April 1, 1997,  SBC and PAC  completed the merger of an SBC  subsidiary  with
PAC, in a transaction  in which each  outstanding  share of PAC common stock was
exchanged for 1.4629  shares of SBC common stock  (equivalent  to  approximately
626 million shares; both the exchange ratio and shares issued have been restated
to  reflect  SBC's  two-for-one  stock  split,  effected  in the form of a stock
dividend,  declared January 30, 1998 with a record date of February 20, 1998 and
distribution date of March 19, 1998). With the merger, PAC became a wholly-owned
subsidiary  of SBC. The  transaction  was  accounted  for by SBC as a pooling of
interests and a tax-free reorganization.

Post-merger initiatives

Several strategic  decisions resulted from the merger integration  process.  The
decisions resulted from an extensive review of operations  throughout the merged
company and included significant  integration of operations and consolidation of
some administrative and support functions.

Reorganization

SBC is  centralizing  several key  functions  that will  support  the  Telephone
Operations and two other SBC  subsidiaries,  Southwestern Bell Telephone Company
(SWBell) and Nevada Bell,  including network planning,  strategic  marketing and
procurement.  It is  also  consolidating  a  number  of  corporate-wide  support
activities,   including  research  and  development,   information   technology,
financial  transaction  processing and real estate management.  PacBell,  Nevada
Bell and SWBell will continue as separate legal entities. These initiatives will
result in the  creation  of some jobs and the  elimination  and  realignment  of
others, with many of the affected employees changing job responsibilities and in
some cases assuming positions in other locations.

PacBell recognized charges during 1997 in connection with these initiatives. The
charges were comprised mainly of postemployment  benefits,  primarily related to
severance,   and  costs  associated  with  closing  down  duplicate  operations,
primarily  contract  cancellations.  Other  charges  arising  out of the  merger
relating to relocation,  retraining and other effects of  consolidating  certain
operations  are being  recognized  in the periods  those  charges are  incurred.
Additional  information on these charges is contained in Note 3 of the Financial
Statements.

FEDERAL LEGISLATION AND THE MFJ

On February 8, 1996, the Federal Government enacted the  Telecommunications  Act
of 1996 (the Telecom Act), a major, wide-ranging amendment to the Communications
Act of 1934.

By its  specific  terms,  the Telecom Act  supersedes  the  jurisdiction  of the
District Court with regard to activities  occurring after the date of enactment.
The FCC is given  authority for all  post-enactment  conduct,  with the District
Court retaining jurisdiction of pre-enactment conduct for a five-year period. As
a result of these  provisions,  on April 11, 1996 the District  Court issued its
Opinion and Order  terminating  the MFJ and  dismissing  all pending  motions as
moot, thereby effectively ending 13 years of RHCs regulation under the MFJ.

In July 1997,  SBC  brought  suit in the U.S.  District  Court for the  Northern
District of Texas (U.S. District Court), seeking a declaration that a portion of
the  Telecom  Act  is   unconstitutional  on  the  grounds  that  it  improperly
discriminates against SBC's telephone subsidiaries including PacBell, by name by
imposing  restrictions  that prohibit SBC from offering  interLATA (Local Access
Transport Area)  long-distance and other services in California that other Local
Exchange  Carriers  (LECs) are free to provide.  The suit  challenged  only that
portion of the Telecom Act that excluded SBC from  competing in certain lines of
business. On December 31, 1997 the U.S. District Court issued a ruling declaring
unconstitutional,   among  other  things,  the  prohibitions  on  SBC  providing
interLATA long-distance.  The FCC and competitor intervenors sought and received
a stay of the decision by the U.S.  District Court, and SBC anticipates  further
opposition to this ruling from the Justice Department and interexchange carriers
(IXCs), but is unable to predict the outcome of subsequent  appeals.  Additional
information  relating to the Telecom Act is  contained  in Item 7,  Management's
Discussion  and  Analysis  of Results of  Operations  of this  report  under the
heading "Competitive Environment" beginning on page 17.

BUSINESS OPERATIONS

The  Telephone   Operations  provide   telecommunication   services  by  serving
approximately  17 million  access lines in the  nation's  most  populous  state,
California  as well as two of the  country's  five largest  metropolitan  areas.
PacBell's  broad  operations  offer customers an expansive range of services and
products,  varying by  market,  including:  local  exchange  services,  wireless
communications,  long-distance, Internet services, telecommunications equipment,
enhanced  services,  and  directory  advertising  and  publishing.  Services and
products  are  provided  by  the  Telephone   Operations  and  through   several
wholly-owned  subsidiaries,  which include: Pacific Bell Mobile Services (PBMS),
Pacific Bell Directory  (PBDirectory),  Pacific Bell Information Services (PBIS)
and Pacific Bell Internet Services (PBI). These services and products (which are
described  more fully below)  include  landline and wireless  telecommunications
services,  sales of  advertising  for and  publication of yellow pages and white
pages directories,  sales of customer premises,  private business exchange (PBX)
and  wireless  equipment,  enhanced  services and  Internet  services.  Personal
Communication  Services  (PCS) are  provided by PBMS in  California  and Nevada.
Landline telecommunications services are provided to California by the Telephone
Operations.

PacBell's  revenues are  categorized for financial  reporting  purposes as local
service (substantially all of which was provided by the Telephone Operations and
PBMS),  network  access  (provided by the Telephone  Operations),  long-distance
service (substantially all of which was provided by the Telephone Operations and
PBMS),  directory  advertising  (principally  provided by PBDirectory) and other
(including equipment sales at PBMS,  nonregulated products and services provided
by the Telephone  Operations,  billing and collection services for IXCs provided
by the Telephone  Operations and Internet  services  provided by PBI).  With the
passage of the Telecom Act, PBMS offers wireless  long-distance services between
Local Access Transport Areas (interLATA) and within Local Access Transport Areas
(intraLATA). The Telephone Operations provide intraLATA long-distance service.

The following  table sets forth for PacBell the  percentage  of total  operating
revenues  by any  class  of  service  which  accounted  for 10% or more of total
operating revenues in any of the last three fiscal years.

------------------------------------------------------------------------------
                                                     Percentage of Total
                                                      Operating Revenues
------------------------------------------------------------------------------

                                                     1997      1996      1995
------------------------------------------------------------------------------
Local service                                         44%       42%       42%
Network access                                        25%       27%       27%
Long-distance service                                 12%       13%       14%
Directory advertising                                 11%       11%       11%
------------------------------------------------------------------------------

      Communication Services

Communication services include local, long-distance and network access services.
Local services involve the transport of landline and wireless telecommunications
traffic between  telephones and other customer premises  equipment (CPE) located
within the same local service calling area. Local services include:  basic local
exchange service, certain extended area service, dedicated private line services
for voice and  special  services,  directory  assistance  and  various  vertical
services,  including custom calling services, call control options and Caller ID
services.  Until the  passage of the  Telecom  Act,  the  Telephone  Operations'
long-distance  services  involved the transport of intraLATA  telecommunications
traffic,  except for  certain  wireless  service  areas that cover more than one
LATA, for which PacBell had obtained MFJ waivers. In addition to these services,
beginning  in  1996,  PBMS  provided  both  interLATA  and  intraLATA   wireless
long-distance services to its PCS customers. Long-distance services also include
other  services  such as  Wide  Area  Telecommunications  Service  (WATS  or 800
services)  and  other  special  services.  Network  access  services  connect  a
subscriber's  telephone or other  equipment to the  transmission  facilities  of
other  carriers that provide  long-distance  (principally  interLATA)  and other
communications services.  Network access services are either switched, which use
a switched communications path between the carrier and the customer, or special,
which use a direct nonswitched path.

      Landline Network Services

During  the  latter  half of 1996 and over the  course  of 1997,  the  Telephone
Operations have been offering certain services on a "wholesale" basis as well as
providing elements of the Telephone Operations' networks on an "unbundled" basis
to competitors. These services are being offered as specified by the Telecom Act
and state  actions  and  agreements.  Such  federal  and state  regulation  have
resulted in the Telephone Operations facing increased competition in significant
portions of its business. At December 31, 1997 the Telephone Operations provided
wholesale  services to more than 200 thousand  access lines.  Management  cannot
quantify  the impact to the  Telephone  Operations'  business in 1998 from local
exchange competition,  because uncertainty exists as to the breadth and scope of
competitors'  offering of local exchange services to all portions of the market,
and as certain regulations,  tariffs and negotiations governing such competition
are not yet finalized.

The  Telephone  Operations  provided  approximately  86% of PacBell's  operating
revenues in 1997. The Telephone Operations provide  telecommunications  services
to approximately  10.5 million residential and 6.7 million business access lines
in California. During 1997 total access lines grew by 4.7%.

The Telephone  Operations continue to expand their offering of vertical services
throughout their operating areas.  These services  include,  among other things,
Caller ID,  a feature which displays the telephone number of the person calling;
Call Return,  a feature that redials the number of the last incoming  call;  and
Call Blocker,  a feature which allows  customers to  automatically  reject calls
from a designated list of telephone numbers.

PBIS  provides  voice  messaging  services  under several  registered  trademark
products,  which  include  residential  voice  messaging  services  (The Message
Center),  business  messaging  services  (Pacific Bell Voice Mail), and business
call management  services (Pacific Bell Call Management).  PBI provides Internet
services in selected metropolitan areas in California.

      Wireless

In 1993,  the FCC adopted an order  allocating  radio spectrum and outlining the
development  of  licenses  for  new  PCS  deployment.   PCS  utilizes   wireless
telecommunications  digital technology at a higher frequency radio spectrum than
cellular  using lower  powered  transmission  equipment.  Like  cellular,  it is
designed to permit access to a variety of communications  services regardless of
subscriber  location.  In an FCC auction,  which  concluded  in March 1995,  PCS
licenses were awarded in 51 major markets.  PAC affiliates acquired PCS licenses
in the Major Trading Areas (MTAs) of Los Angeles-San  Diego,  California and San
Francisco-San Jose, California.  The California licenses cover substantially all
of California and Nevada.

PBMS was formed to offer PCS services  across  California  and Nevada.  The PBMS
network incorporates the Global System for Mobile Communications (GSM) standard,
which is widely used  internationally,  and its phones  feature a built-in pager
and  answering  machine.  PBMS began  trials in August  1996 and began  offering
services in January 1997, and by mid-1997 provided  widespread  offerings of PCS
services to all of the major  markets in  California  and Nevada.  At the end of
1997, PBMS provided  wireless  services to approximately  340,000 customers over
its PCS networks.

      Directory Advertising

PBDirectory,  the  publisher of Pacific Bell SMART  Yellow  Pages,  publishes 35
million  books,  representing  approximately  112  directories in California and
Nevada.  PacBell recognizes all directory  advertising  revenues and expenses in
the month the related directory is published.  PBDirectory's publishing schedule
is spread throughout the year for its directories. PBDirectory's directories are
printed by World Color Press.

      Customer Premises Equipment and Other Equipment Sales

Equipment   offerings  range  from   single-line  and  cordless   telephones  to
sophisticated  digital PBX systems. PBX is a private telephone switching system,
usually located on a customer's premises, which provides intra-premise telephone
services as well as access to the public switched network.

     Video Services

As part of the change in strategic direction of the post-merger initiatives, SBC
announced during 1997 that it is scaling back its limited direct investment in a
number of video services.  Additional  information on these matters is contained
in Note 3 of the  Financial  Statements.  As part of this  curtailment,  PacBell
halted construction on the Advanced  Communications Network (ACN) in California.
As part of an agreement with the ACN vendor, PacBell paid the liabilities of the
ACN trust that owned and financed ACN  construction  and incurred  costs to shut
down all construction  previously  conducted under the trust and receive certain
consideration from the vendor.

GOVERNMENT REGULATION

The  Telephone  Operations  are subject to  regulation by the CPUC which has the
power to regulate, in varying degrees, intrastate rates and services,  including
local,  long-distance  and network access (both  intraLATA and interLATA  access
within the state)  services.  The Telephone  Operations  are also subject to the
jurisdiction of the FCC with respect to interstate rates and services, including
interstate  access  charges.  Access  charges  are  designed to  compensate  the
Telephone  Operations  for the use of their  facilities  for the  origination or
termination of long-distance and other  communications by other carriers.  There
are currently no access charges for the Internet.

Additional information relating to federal and state regulation of the Telephone
Operations  is  contained  in Item 7,  Management's  Discussion  and Analysis of
Results of Operations of this report under the heading "Regulatory  Environment"
on page 15.

IMPORTANCE, DURATION AND EFFECT OF LICENSES

Under the auction  process of an FCC order  outlining  the  development  of PCS,
licenses  with  durations  of ten years were  awarded in 51 major  markets.  The
licenses for Los  Angeles-San  Diego,  California  and San  Francisco-San  Jose,
California  expire in 2005.  These licenses,  upon  application and a showing of
compliance with FCC use and conduct standards, may be renewed.

MAJOR CUSTOMER

No customer  accounted for more than 10% of PacBell's  consolidated  revenues in
1997 or 1996.  Approximately  10% of PacBell's  consolidated  revenues were from
services provided to AT&T for 1995.

COMPETITION

      Communication Services

Information relating to competition in the communications  industry is contained
in Item 7, Management's Discussion and Analysis of Results of Operations of this
report under the heading "Competitive Environment" beginning on page 17.

      Directory Advertising and Publishing

PBDirectory faces competition from over 50 publishers of printed  directories in
its  operating  areas.  Direct and  indirect  competition  also exist from other
advertising media,  including  newspapers,  radio,  television,  and direct mail
providers, as well as from directories offered over the Internet.

      Customer Premises Equipment and Other Equipment Sales

PacBell faces significant  competition from numerous  companies in marketing its
telecommunications equipment.

RESEARCH AND DEVELOPMENT

Certain  company-sponsored  basic and applied  research  was  conducted  at Bell
Communications  Research,  Inc.  (Bellcore).  The Telephone  Operations  owned a
one-seventh   interest  in  Bellcore  and  another  affiliate  of  SBC  owned  a
one-seventh interest, with the remainder owned by the other four remaining RHCs.
In November 1997, the sale of Bellcore was completed. The RHCs have retained the
activities   of   Bellcore   that    coordinate    the   Federal    Government's
telecommunications    requirements   for   national   security   and   emergency
preparedness.

Applied research is also conducted at SBC Technology Resources, Inc. and Telesis
Technology Laboratories,  subsidiaries of SBC. They provide research, technology
planning and evaluation services to PacBell and its subsidiaries.

EMPLOYEES

As  of  December 31,   1997,  PacBell  employed  approximately  50,030  persons.
Approximately 70% of the employees are represented by the Communications Workers
of America (CWA).  Contracts  covering an estimated 33,340 employees between the
CWA and the Telephone Operations end in August 1998. New contracts are scheduled
to be negotiated in 1998. In 1995,  PBDirectory  negotiated  two new  three-year
contracts  with the  International  Brotherhood  of Electrical  Workers  (IBEW),
covering  approximately  1,300  employees in northern  and southern  California.
PBDirectory also is scheduled to negotiate new contracts with the IBEW in 1998.

ITEM 2.  PROPERTIES

The properties of PacBell do not lend themselves to description by character and
location of principal  units.  At December 31, 1997, 96% of the property,  plant
and equipment of PacBell was related to the Telephone Operations. Network access
lines  represented  41% of the  Telephone  Operations'  investment  in telephone
plant; central office equipment  represented 38%; land and buildings represented
10%; other miscellaneous property, comprised principally of furniture and office
equipment and vehicles and other work equipment, represented 5%; and information
origination/termination equipment represented 6%.

ITEM 3.  LEGAL PROCEEDINGS

There are no legal proceedings to report.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Omitted pursuant to General Instruction I(2).

<PAGE>

                                     PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Not applicable.

ITEM 6.  SELECTED FINANCIAL AND OPERATING DATA


  -----------------------------------------------------------------------------
                                          At December 31, or for the year ended
                                                   1997           1996
  ------------------------------------------------------------------------------
  Return on Weighted Average Total                  4.42%         16.92%
  Capital (1)
  Debt Ratio (debt, including current
      maturities, as a percentage of               65.82%         59.00%
      total capital) (2)
  Network access lines in  service (000)           17,369         16,585
  Access minutes of use (000,000)                  69,100         63,338
  Long-distance messages billed (000,000)           5,638          5,158
  Number of employees                              50,030         45,589
  ------------------------------------------------------------------------------

Operating  data  may be  periodically  revised  to  reflect  the  most  current
information   available.

(1)   Calculated using income before changes in accounting principles.  These
      impacts are included in shareowner's equity.

(2)   Shareowners equity used in these calculations includes changes in
      accounting principles.
<PAGE>
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
Dollars in millions

This discussion should be read in conjunction with the financial  statements and
the accompanying notes.

RESULTS OF OPERATIONS

Summary

Financial  results,  including  percentage  changes  from the  prior  year,  are
summarized as follows:

--------------------------------------------------------------------------------
                                                                  Percent Change
                                                1997        1996   1997 vs.1996
--------------------------------------------------------------------------------
Operating revenues                          $  9,938    $  9,446          5.2%
Operating expenses                          $  9,429    $  7,142         32.0%
Income before cumulative effect of          $      8    $  1,170        -99.3%
accounting changes
Cumulative effect of accounting changes     $    342    $     85          -
Net income                                  $    350    $  1,255          -
--------------------------------------------------------------------------------

PacBell  recognized the cumulative effect of accounting changes in 1997 relating
to conforming accounting  methodologies between PacBell and SBC for, among other
items, pensions and postretirement  benefits.  PacBell recognized the cumulative
effect  of a  change  in  accounting  in 1996  relating  to the  recognition  of
directory publishing revenues and related expenses.

PacBell's  income  before  cumulative  effect  of  accounting  changes  includes
after-tax charges of approximately $1.2 billion reflecting strategic initiatives
resulting from SBC's  comprehensive  review of operations of the merged company,
the  impact of several  regulatory  rulings  during the second  quarter of 1997,
costs incurred for customer number  portability since the merger and charges for
ongoing merger integration costs. Excluding these items, PacBell reported income
before  cumulative  effect of accounting  changes of $1,171 for 1997. Net income
for  1997  was  favorably  affected  by the $18  after-tax  gain on the  sale of
PacBell's interest in Bellcore and a first quarter 1997 $87 after-tax settlement
gain  associated  with  lump-sum  pension  payments  that exceeded the projected
service and interest  costs for 1996  retirements.  Excluding  these  additional
items,   PacBell  reported  an  adjusted  income  before  cumulative  effect  of
accounting  changes of $1,066 for 1997,  8.9% lower than the 1996 income  before
cumulative  effect  of  accounting   changes  of  $1,170.  The  primary  factors
contributing to this decrease were increased  expenses,  including  expenses for
the introduction of PCS operations in California and Nevada, partially offset by
growth in demand for wireline and non-regulated services and products.

Items  affecting the comparison of the operating  results  between 1997 and 1996
are discussed in the following sections.


<PAGE>
Management's Discussion and Analysis, continued
Dollars in millions

Operating Revenues

PacBell's  operating  revenues  for  1997  reflect  reductions  of $114  related
primarily to the impact of several  regulatory rulings during the second quarter
of 1997.  Excluding these reductions,  PacBell's  operating  revenues  increased
$606,  or 6.4%,  in 1997.  Components  of total  operating  revenues,  including
percentage changes from the prior year, are as follows:

-------------------------------------------------------------------------------
                                                               Percent Change
                                            1997        1996      1997 vs.1996
-------------------------------------------------------------------------------
Local service                           $  4,386    $  3,956           10.9%
Network access
  Interstate                               1,714       1,805           -5.0%
  Intrastate                                 790         718           10.0%
Long-distance service                      1,182       1,274           -7.2%
Directory advertising                      1,125       1,051            7.0%
Other                                        741         642           15.4%
================================================================
                                        $  9,938    $  9,446            5.2%
===============================================================================

     Local  service  revenues  increased  in 1997 due  primarily to increases in
     demand,  including  increases in residential  and business access lines and
     vertical services  revenues.  Total access lines increased by 4.7% in 1997,
     with approximately 32% of access line growth due to the sales of additional
     access lines to existing residential customers. Vertical services revenues,
     which  include  custom  calling  options,  Caller  ID  and  other  enhanced
     services,  increased by  approximately  15%.  Local  service  revenues also
     reflect the  implementation  of the California  High Cost Fund (CHCFB) that
     went into effect  February  1, 1997.  The CPUC has stated that the CHCFB is
     intended to directly  subsidize the provision of service to high cost areas
     and  allow  PacBell  to set  competitive  rates  for  other  services.  The
     rebalancing  provisions of the CHCFB resulted in a shift from long-distance
     revenues  of $84 and  intrastate  network  access  revenues of $26 to local
     service  revenues  in 1997.  This shift is subject to final CPUC  approval,
     expected in the second or third quarter of 1998. For further information on
     the  operations  of  the  CHCFB,  see  the  discussion  under  the  heading
     "Regulatory  Environment".   Additionally,  Federal  payphone  deregulation
     increased  local  service  revenues  and  decreased  long-distance  service
     revenues and interstate  network access revenues;  the overall impact was a
     slight increase in total operating revenues. Rate reductions in 1997 due to
     CPUC price cap orders partially offset increases in local service revenues.
     Wireless  revenues  also  contributed  to the  increase  in  local  service
     revenues due to introduction of PCS in 1997.

     Network Access Interstate  network access revenues decreased in 1997 due to
     $134 in charges. These charges include billing claim settlements related to
     the Percentage Interstate Usage (PIU) factor and several federal regulatory
     issues  including  end-user  charges,  800 data base  charges,  recovery of
     certain  employee-related  expenses  and  the  retroactive  effect  of  the
     productivity  factor adjustment  mandated in the July 1, 1997 Federal price
     cap  filing.  While the  change in PIU  factor,  which is used to  allocate
     network access revenues  between  interstate and intrastate  jurisdictions,
     also had the effect of increasing  intrastate  network access revenues,  it
     resulted in a slight  decline in total network access  revenues.  Excluding
     these impacts,  interstate  network access  revenues  increased in 1997 due
     largely  to  increases  in demand for access  services  by IXCs.  Growth in
     revenues from end-user  charges  attributable to an increasing  access line
     base also contributed to the increase. Partially offsetting these increases
     were the effects of rate  reductions  of  approximately  $22 related to the
     FCC's productivity  factor adjustment and revenue sharing  adjustments made
     in 1996.

     Intrastate  network access  revenues in 1997 reflect an increase due to the
     PIU  settlements  and a decrease due to the effects of the CHCFB  described
     above.   Excluding  these  impacts,   intrastate  network  access  revenues
     increased in 1997 as increases in demand,  including  usage by  alternative
     intraLATA toll carriers,  were partially  offset by state  regulatory  rate
     orders.

     Long-Distance  Service revenues  decreased in 1997 due to the effect of the
     CHCFB discussed above,  federal payphone  deregulation  discussed above and
     rate reductions due to CPUC price cap orders  partially offset by increases
     in demand resulting from California's growing economy.

     Directory  Advertising  revenues  increased in 1997 due mainly to increased
     demand at  PBDirectory  and the  publication of books in 1997 that were not
     published in 1996.

     Other operating  revenues  increased in 1997 due primarily to revenues from
     new business  initiatives,  primarily Internet services and equipment sales
     at PBMS.  Revenues also increased due to demand for  nonregulated  products
     and services including voice messaging services.

Operating Expenses

PacBell's  operating  expenses  for 1997 reflect  approximately  $1.7 billion of
charges related to strategic  initiatives  resulting from a comprehensive review
of operations of the merged company,  the impact of several  regulatory  rulings
during the  second  quarter  of 1997 (see Note 3 to the  Financial  Statements),
costs incurred for customer number  portability since the merger and charges for
ongoing merger integration costs.  Excluding these charges,  PacBell's operating
expenses  increased  $587,  or 8.2%,  in  1997.  Components  of total  operating
expenses including percentage changes from the prior year, are as follows:

-------------------------------------------------------------------------------
                                                                  Percent Change
                                            1997        1996      1997 vs. 1996
--------------------------------------------------------------------------------
Cost of services and products           $  4,218    $  3,713           13.6%
Selling, general and administrative        3,190       1,603           99.0%
Depreciation and amortization              2,021       1,826           10.7%
----------------------------------------------------------------
                                        $  9,429    $  7,142           32.0%
===============================================================================

     Cost of Services and Products  reflects charges of $190 in 1997 relating to
     SBC's  strategic  initiatives,  operational  reviews,  costs  incurred  for
     customer number portability since the merger and ongoing merger integration
     costs; excluding these charges, expenses increased $315, or 8.5% in 1997. A
     significant  part of this  increase was caused by the  introduction  of PCS
     operations  during 1997.  Other major factors  contributing to the increase
     included  increases in  interconnection  costs and  employee  compensation,
     including  increases  related to force additions and contract labor.  These
     increases were partially offset by decreased  employee benefit expenses due
     to  conforming  of  accounting  methodologies  between  PacBell and SBC for
     pensions and postretirement benefits.

     Selling,  General and  Administrative  expense in 1997  reflects  $1,352 of
     charges relating to SBC's strategic  initiatives,  operational  reviews and
     ongoing merger  integration  costs. As discussed in Note 3 to the Financial
     Statements,  the most significant of these charges included the shutdown of
     ACN,  regulatory  costs  related to the  approval of the merger with SBC by
     California  regulators  and  reorganization  initiatives.  Excluding  these
     charges,   expenses  increased  $235,  or  14.7%,  in  1997.  Significantly
     increasing expenses was caused by the introduction of PCS operations during
     1997.  Other major factors  contributing to the increase were due primarily
     to  other  business  ventures,   primarily  voice  messaging  and  Internet
     services, and increases in employee compensation and uncollectibles.  These
     increases  were  partially  offset by a first quarter 1997 $146  settlement
     gain associated with lump-sum  pension payments that exceeded the projected
     service  and  interest  costs for 1996  retirements  and  reduced  expenses
     resulting  from  conforming  of accounting  methodologies  for pensions and
     postretirement benefits (see Note 3 to the Financial Statements).

     Depreciation  and  Amortization in 1997 reflects  charges  totaling $158 to
     record  impairment of plant and intangibles.  As discussed in Note 3 to the
     Financial Statements,  the most significant of these impairments related to
     certain analog switching  equipment and cable within commercial  buildings.
     Excluding these charges,  depreciation and  amortization  increased $37, or
     2.0%  in 1997  due  primarily  to  overall  higher  plant  levels.  Reduced
     depreciation  beginning with the second quarter of 1997 on analog switching
     equipment partially offset this increase.

     Interest Expense  increased $98 or 27.0% in 1997 due primarily to increased
     average debt levels during the year. Also  contributing to the increase was
     interest   associated  with  the  second  quarter  1997  one-time  charges,
     primarily interest on merger-approval costs.

     Other  Income  (Expense)  - Net  increased  income  by $2 in 1997.  Results
     reflect $36 in charges  related to SBC's strategic  initiatives,  primarily
     writeoffs  of  nonoperating   plant.  These  charges  were  offset  by  the
     recognition  of  investment  returns  on funds  held in trust for  deferred
     compensation and the gain recognized from the sale of PacBell's interest in
     Bellcore.

     Income Taxes expense  decreased  $729,  or 94.1% in 1997.  Income taxes for
     1997 reflect the tax effect of charges for strategic  initiatives resulting
     from SBC's  comprehensive  review of operations of the merged company,  the
     impact of several  regulatory  rulings  during the second  quarter of 1997,
     costs incurred for customer number portability since the merger and charges
     for ongoing merger integration costs.  Excluding these items,  income taxes
     for 1997 were lower due to reduced income before income tax.

     Income  taxes  paid,  net of refunds  reflect  the  impact of  reduced  tax
     payments  due to  merger-related  and  integration  costs  incurred and the
     application of the SBC tax sharing agreement.

     Cumulative  Effect of  Accounting  Changes,  as  discussed in Note 3 to the
     Financial  Statements,  were  recorded  in  the  second  quarter  of  1997,
     retroactive  to January 1, 1997.  The  changes  were to conform  accounting
     methodologies  between  PacBell and SBC,  primarily  the  adoption of SBC's
     methodology  of  amortizing  gains and  losses on assets  held  within  the
     pension and postretirement  plans. The cumulative  after-tax effect of this
     one-time gain is $342, net of deferred taxes of $238.

     As discussed in Note 1 to the Financial Statements, PBDirectory changed its
     method of recognizing  directory  publishing  revenues and related expenses
     effective January 1, 1996. The cumulative  after-tax effect of applying the
     new  method  to prior  years  was  recognized  as of  January  1, 1996 as a
     one-time non-cash gain of $85. Management believes this change to the issue
     basis method is preferable  because it is the method generally  followed in
     the  publishing  industry,  including  Southwestern  Bell Yellow  Pages,  a
     wholly-owned  subsidiary of SBC, and better reflects the operating activity
     of  the  business.  This  accounting  change  is  not  expected  to  have a
     significant effect on net income of future periods.


Operating Environment and Trends of the Business

Regulatory Environment

The  telecommunications  industry  is in  transition  from a  tightly  regulated
industry  overseen by multiple  regulatory  bodies,  to a more  incentive-based,
market driven industry  monitored by state and federal  agencies.  The Telephone
Operations remain subject to regulation by the CPUC for intrastate  services and
by the FCC for interstate  services.  The Telephone  Operations  under price cap
regulation  may establish and modify prices for some services as long as they do
not  exceed  the price caps and may  change  prices  for some  services  without
regulatory approval.

      Federal Regulation

During 1997, the FCC issued an Access Reform Order restructuring  access charges
paid for IXCs access to the Telephone Operations' networks. The order raises the
flat  monthly  end user  charge  for  primary  business  lines,  and  additional
residence  and business  lines,  and lowers the price caps on per minute  access
charges for interstate long distance  carriers.  The Access Reform Order,  which
took effect in January  1998 and other  price cap  changes  which took effect in
1997,  are  supposed  to shift  sources of revenue  from  carriers  to end users
without changing the total amount of revenue received by the LECs.

The FCC's price cap plan for the LECs  provides for changes to be made  annually
to the price caps for  inflation,  productivity  and changes in other costs.  In
1997 the Telephone  Operations  were ordered to begin using a 6.5%  productivity
offset, with no sharing.  Prior to 1997, there were three productivity  offsets,
two of which provided for a sharing of profits above a specified  earnings level
with the Telephone  Operations' customers and a higher productivity offset which
did not include sharing.  The Telephone  Operations have elected the higher 5.3%
productivity offset without sharing.

With  the  passage  of the  Telecom  Act,  the FCC has been  conducting  further
proceedings in conjunction with access reform to address a number of pricing and
productivity  issues, and is performing a broader review of price cap regulation
in  the  context  of  the  increasingly   more  competitive   telecommunications
environment.  The Chairman of the FCC has indicated  that the FCC intends to act
on these proceedings in 1998. The Telecom Act and FCC actions taken to implement
provisions  of  the  Telecom  Act  are  discussed   further  under  the  heading
"Competitive Environment."

Pursuant to the Telecom Act,  the local coin rate in the  payphone  industry was
deregulated  by the FCC in October  1997,  and LECs were  required to remove any
direct  or  indirect   subsidy  of  payphone   service   from  their   regulated
telecommunications  operations.  Removal of the  subsidy  caused  the  Telephone
Operations to raise the local coin rates  throughout its operating  territory in
1997.

      State Regulation

The CPUC's form of price caps  requires the  Telephone  Operations  to submit an
annual price cap filing to determine  prices for categories of services for each
new year. The  productivity  factor used in calculating  price caps has been set
equal to the  inflation  factor  for the  period  1996-1998.  The price cap plan
includes a sharing mechanism that requires the Telephone Operations to share its
earnings  with  customers  above  certain  earnings  levels but no  sharing  has
occurred under the sharing mechanism.  The CPUC includes PBDirectory earnings in
the sharing  mechanism  calculation  for the Telephone  Operations.  In December
1997,  the CPUC adopted a decision on the Telephone  Operations'  1997 price cap
filing resulting in a revenue  reduction in 1998 of approximately  $86 effective
January 1, 1998.  The  reduction  reflects  items accrued in the 1997 results of
operations,  including,  among other things,  the rate reduction  ordered in the
CPUC  decision  approving  the  SBC/PAC  merger  and the gain on the sale of the
Telephone Operations' interest in Bellcore.  Because of the accruals,  the order
will not materially  affect the Telephone  Operations'  results of operations in
1998.

In an April 1997 ruling, the CPUC reaffirmed that  postretirement  benefit costs
were appropriately recoverable in the Telephone Operations' price cap filings as
exogenous  costs.  In its December 1997  decision,  the CPUC  continued to allow
recovery  in  1998  consistent  with  the  amount  requested  by  the  Telephone
Operations in an October 1997 filing.  Concurrent  with the approval of recovery
for 1998,  the CPUC  ordered a further  proceeding  to  address  procedures  and
amounts for future recovery.

In May 1997, the FCC adopted new  separations  rules that shifted  recovery of a
substantial   amount  of  billing  and   collection   costs  to  the  interstate
jurisdiction. The Telephone Operations filed for a waiver of the requirement and
were denied the waiver in December 1997. As a result,  the Telephone  Operations
could be  required  to  refund an  annualized  amount  of  approximately  $21 to
customers since July 1997, with refunds commencing in 1999.

In 1996, the CPUC issued an order on universal service and established the CHCFB
to subsidize  telephone  service in California's  high cost areas. The estimated
$352 cost of the program is  expected  to be  collected  from  customers  of all
telecommunications  providers  who will  contribute  to the fund through a 2.87%
surcharge on all bills for  telecommunications  services provided in California.
The  surcharge  became  effective  February  1, 1997 and PacBell  collected  the
surcharge  from its customers  during 1997; the surcharge will continue in 1998.
To  maintain  revenue  neutrality,  the  Telephone  Operations  will  reduce its
revenues  dollar for dollar for  amounts  it will  receive  from the fund.  This
reduction  will occur through an across the board  surcredit on all products and
services  (except for  residential  basic  exchange  services and  contracts) or
through permanent price reductions for those services that previously subsidized
universal service.  The Telephone Operations filed to reduce permanently certain
toll and access rates.  Hearings  were held in October  1997,  and a decision is
expected in the second or third quarter of 1998.

The Telephone Operations expect to receive  approximately $305 annually from the
CHCFB fund based on CPUC estimates of the cost of providing  universal  service.
The  Telephone  Operations  believe the new program  underestimates  the cost of
providing universal service and that the average cost of providing service is up
to 33% higher per line, per month than the CPUC estimate. As a result, subsidies
for universal  service will remain in the prices for the  Telephone  Operations'
competitive services, which may place it at a competitive disadvantage.

In a 1988 CPUC decision,  the Telephone Operations received a rate increase as a
result  of  expensing  items  that were  previously  capitalized.  The  decision
required an annual  incremental  rate  reduction  of $23,  but did not address a
termination  date for the rate  reduction.  The  Telephone  Operations  filed an
application in 1995 to terminate the rate  reductions.  With CPUC approval,  the
Telephone Operations halted rate reductions for 1996, 1997 and 1998, pending the
outcome of the hearings.  An adverse decision may restore all or some portion of
the revenue reductions.  The deferred rate reductions are subject to refund plus
interest.  Revenues subject to refund as of December 31, 1997 were approximately
$69 plus  interest.  The revenues  subject to refund are expected to continue to
increase at the rate of $23 per year plus interest until the matter is resolved.

In 1992, the Telephone Operations entered into a settlement with tax authorities
and others which fixed a specific  methodology for valuing utility  property for
tax  purposes  for a period  of eight  years.  As a result,  the CPUC  opened an
investigation  to determine  if any  resulting  property  tax savings  should be
returned by the Telephone Operations to its customers. Intervenors have asserted
that as much as $20 of annual  property  tax  savings  should be  treated  as an
exogenous cost reduction in the Telephone  Operations'  annual price cap filings
and that as much as $90 in past  property  tax savings as of December  31, 1997,
plus interest, should be returned to customers. The Telephone Operations believe
that, under the CPUC's  regulatory  framework,  any property tax savings qualify
only as a component of shareable  earnings and not as an exogenous  cost.  In an
interim opinion issued in June 1995, the CPUC ruled in favor of intervenors, but
decided to defer a final decision on the matter pending resolution in a separate
proceeding of the criteria for exogenous  cost  treatment  under its  regulatory
framework. To date, the CPUC has taken no further action on the issue.

More than 120  applications  for  certification  to  provide  competitive  local
service have been approved by the CPUC, with over 25 more  applications  pending
approval.  As a result, the Telephone  Operations expect competition to continue
to develop for local  service,  but the  financial  impacts of this  competition
cannot be reasonably estimated at this time.

Competitive Environment

Competition   continues  to  increase  for   telecommunication  and  information
services.  Recent  changes in  legislation  and  regulation  have  increased the
opportunities  for alternative  service  providers  offering  telecommunications
services.  Technological  advances  have expanded the types and uses of services
and products  available.  As a result,  PacBell faces increasing  competition in
significant portions of its business.

On  February 8,  1996,  the Telecom Act was enacted into law. The Telecom Act is
intended to address  various aspects of competition  within,  and regulation of,
the   telecommunications   industry.   The   Telecom  Act   provides   that  all
post-enactment  conduct or  activities  which were  subject to the MFJ,  are now
subject to the  provisions of the Telecom Act. In April 1996, the District Court
issued its  Opinion and Order  terminating  the MFJ and  dismissing  all pending
motions  related to the MFJ as moot. This ruling  effectively  ended 13 years of
RHC regulation  under the MFJ. Among other things,  the Telecom Act also defines
conditions the Telephone  Operations  must comply with before being permitted to
offer  interLATA   long-distance  service  and  establishes  certain  terms  and
conditions intended to promote  competition for the Telephone  Operations' local
exchange services.

Under the Telecom Act,  PacBell may immediately  offer  interLATA  long-distance
outside  California  and over its  wireless  network  both  inside  and  outside
California.  Before being  permitted to offer landline  interLATA  long-distance
service in California, PacBell must apply for and obtain state-specific approval
from the FCC. The FCC's approval,  which involves  consultation  with the United
States  Department  of  Justice  and  appropriate  state  commission,   requires
favorable  determinations  that  the  Telephone  Operations  have  entered  into
interconnection  agreement(s)  that satisfy a 14-point  "competitive  checklist"
with  predominantly  facilities-based  carrier(s)  that  serve  residential  and
business  customers  or,  alternatively,  that the Telephone  Operations  have a
statement of terms and conditions  effective in California under which it offers
the  "competitive  checklist"  items.  The FCC must also make  favorable  public
interest  and  structural  separation  determinations  in  connection  with such
applications.

In July 1997, SBC brought suit in the U.S. District Court, seeking a declaration
that parts of the Telecom  Act are  unconstitutional  on the  grounds  that they
improperly  discriminate against PacBell by imposing  restrictions that prohibit
PacBell,  among others, by name from offering interLATA  long-distance and other
services  that other LECs are free to provide.  The suit  challenged  only those
portions of the Telecom Act that exclude PacBell from competing in certain lines
of  business.  On December  31,  1997 the U.S.  District  Court  issued a ruling
declaring  unconstitutional,   among  other  things,  the  prohibitions  on  SBC
providing  interLATA  long-distance  in  California.  If upheld,  this ruling is
expected  to  speed  competition  in  the  interLATA  long-distance  markets  in
California.  The FCC and competitor  intervenors have sought and received a stay
of the decision by the U.S. District Court.

In August 1996, the FCC issued rules by which competitors could connect with the
LECs' networks, including those of the Telephone Operations. Among other things,
the rules addressed unbundling of network elements,  pricing for interconnection
and unbundled elements,  and resale of retail  telecommunications  services. The
FCC rules were appealed by numerous parties, including SBC.

In July 1997,  the United States Court of Appeals for the Eighth  Circuit in St.
Louis (8th Circuit) held that the FCC did not have authority to promulgate rules
related to the pricing of local intrastate telecommunications and that its rules
in that regard were  invalid.  The 8th Circuit also  overturned  the FCC's rules
which allowed competitors to "pick and choose" among the terms and conditions of
approved interconnection  agreements.  In October 1997, the 8th Circuit issued a
subsequent  decision  clarifying  that the  Telecom  Act does  not  require  the
incumbent LECs to deliver network elements to competitors in anything other than
completely unbundled form.

In September 1997, a number of parties including SBC, filed petitions to enforce
the July 1997  ruling of the  8th Circuit  that the right to set local  exchange
prices,  including the pricing methodology used, is reserved  exclusively to the
states.   The   petitions   responded  to  the  FCC's   rejection  of  Ameritech
Corporation's interLATA  long-distance  application in Michigan in which the FCC
stated  it  intended  to  apply  its  own  pricing  standards  to RHC  interLATA
applications. The petitioners asserted the FCC was violating state authority. On
January  22,  1998 the 8th  Circuit  ordered  the FCC to abide by the July  1997
ruling  and  reiterated   that  the  FCC  cannot  use  interLATA   long-distance
applications made by SBC and other RHC wireline  subsidiaries wishing to provide
interLATA  long-distance  to attempt to re-impose  the pricing  standards  ruled
invalid in July 1997 by the 8th Circuit.  On January 26, 1998, the U.S.  Supreme
Court agreed to hear all appeals of the July 1997 8th Circuit decision.

The effects of the FCC rules are  dependent on many factors  including,  but not
limited  to: the  ultimate  resolution  of the pending  appeals;  the number and
nature of competitors requesting interconnection,  unbundling or resale; and the
results of the state  regulatory  commissions'  review and  handling  of related
matters within their jurisdictions.  Accordingly,  PacBell is not able to assess
the impact of the FCC rules at this time.

      Landline Local Service

Recent  state  legislative  and  regulatory  developments  also allow  increased
competition  for  local  exchange   services.   Companies   wishing  to  provide
competitive  local service have filed numerous  applications  with the CPUC, and
the CPUC has been  approving  these  applications  since  late  1995.  Under the
Telecom Act,  companies  seeking to  interconnect  to the Telephone  Operations'
networks and  exchange  local calls must enter into  interconnection  agreements
with the Telephone Operations.  These agreements are then subject to approval by
the CPUC. The Telephone Operations have reached approximately 40 interconnection
and resale  agreements with competitive local service  providers,  and most have
been  approved  by the  CPUC.  AT&T and  other  competitors  are  reselling  the
Telephone Operations local exchange services, and as of December 31, 1997, there
were  more than 200  thousand  Telephone  Operations'  access  lines  supporting
services by resale  competitors  throughout  California.  Many  competitors have
placed facilities in service, and have begun advertising  campaigns and offering
services.

The  CPUC  authorized  facilities-based  local  services  competition  effective
January 1996 and resale  competition  effective  March 1996.  While the CPUC has
established  local  competition  rules and interim prices,  several issues still
remain to be resolved, including final rates for resale and LEC provisioning and
pricing of certain network elements to competitors. In order to provide services
to resellers, the Telephone Operations use established operating support systems
and has  implemented  electronic  ordering  systems and a customer  care/billing
center. Costs to implement local competition, especially number portability, are
substantial.  The CPUC has set a schedule  to review the  Telephone  Operations'
recovery of its local competition implementation costs incurred since January 1,
1996.

The CPUC has issued orders regarding the  implementation of competition in 1997.
Some of the key ones  include  permitting  the  resale of  Centrex  services  to
businesses only, prohibiting  aggregation of customers to obtain toll discounts,
enforcing   optional  calling  plans  retail  tariff   restrictions  on  resale,
prohibiting  sharing of  certain  Centrex  features  to route  intraLATA  calls,
adopting no discount on private  line resale,  ordering  resale of voice mail to
competitors,  and allowing  collection of intrastate access charges on unbundled
network elements.  The CPUC order on resale of voice mail service was stayed and
is being reviewed.

As a result of the Telecom Act and conforming  interconnection  agreements,  the
Telephone  Operations expect increased  competitive  pressure in 1998 and beyond
from  multiple   providers  in  various   markets   including   facilities-based
Competitive Local Exchange Carriers, IXCs and resellers. At this time management
is unable to assess the effect of  competition  on the  industry as a whole,  or
financially on PacBell, but expects both losses of market share in local service
and gains  resulting from new business  initiatives,  vertical  services and new
service areas.

      Wireless Local Service

In 1993,  the FCC adopted an order  allocating  radio  spectrum and licenses for
PCS. PCS utilizes  wireless  telecommunications  digital  technology at a higher
frequency radio spectrum than cellular.  Like cellular, it is designed to permit
access  to  a  variety  of  communications  services  regardless  of  subscriber
location.  In an FCC auction,  which  concluded in March 1995, PCS licenses were
awarded in 51 major markets. PAC or affiliates acquired PCS licenses in the MTAs
of  Los  Angeles-San  Diego,  California  and  San  Francisco-Oakland-San  Jose,
California.  The California  licenses cover  substantially all of California and
Nevada.  PBMS is  currently  operational  in all of its major  California-Nevada
markets.

In  November  1996,  PBMS  conducted  an  extensive  PCS  trial  in  San  Diego,
California.  Service was formally  launched in San Diego,  California in January
1997, in Las Vegas, Nevada in February 1997, in Sacramento,  California in March
1997,  in  San  Francisco  in  May 1997,  in Los  Angeles  in  July 1997  and in
Bakersfield,  California  in  October 1997.  The  network  incorporates  the GSM
standard which is widely used in Europe. PBMS is selling PCS as an off-the-shelf
product in retail stores across California and Nevada.  Significant  competition
exists, particularly from the two established cellular companies in each market.

PacBell also has state approved interconnection agreements to receive reciprocal
compensation  from  IXCs and other  LECs  accessing  its  wireless  networks  in
California and Nevada.

Companies  granted  licenses in MTAs where PBMS also  provides  service  include
subsidiaries  and  affiliates  of  AT&T,  Sprint  Corporation  and  other  RHCs.
Significant  competition  from PCS  providers  exists  in  PBMS  major  markets.
Competition has been based upon both price and product marketing.

      Long-distance

Competition  continues  to  intensify  in the  Telephone  Operations'  intraLATA
long-distance  markets.  It is estimated that  providers  other than PacBell now
serve  more than  half of the  business  intraLATA  long-distance  customers  in
California.

Since the Telecom Act, PBMS has entered the wireless  long-distance markets, and
offers wireless long-distance service in all of its wireless service areas.

      Other

In the  future,  it is likely  that  additional  competitors  will emerge in the
telecommunications  industry.  Cable television companies and electric utilities
have  expressed  an interest in, or already  are,  providing  telecommunications
services.  As a result of recent and prospective mergers and acquisitions within
the industry,  PacBell may face competition from entities offering both cable TV
and telephone services in California.  IXCs have been certified to provide local
service,  and a number of other major  carriers  have publicly  announced  their
intent  to  provide  local  service  in  certain  markets,  some of which are in
California. Public communications services such as public payphone services will
also face  increased  competition  as a result of  federal  deregulation  of the
payphone industry.

PacBell is aggressively  representing its interests regarding competition before
federal and state regulatory bodies,  courts,  Congress and the California state
legislature.  PacBell  will  continue to evaluate the  increasingly  competitive
nature of its business,  and develop  appropriate  competitive,  legislative and
regulatory strategies.

OTHER BUSINESS MATTERS

Restructuring  Reserve In December 1993, PacBell established a reserve to record
the incremental cost of force reductions associated with restructuring PacBell's
business processes, of $977 in expenses, which impacted net income by $576. This
restructuring   was  expected  to  allow  PacBell  to  eliminate   approximately
10,000 employee positions through 1997, net of approximately 4,000 new positions
expected to be created.  For the  three-year  period 1994 through 1996 net force
reductions totaled 9,168.

This table sets forth the status and activity of this  reserve  during the three
year period:

----------------------------------------------------------------------
                                          1996     1995       1994
----------------------------------------------------------------------
  Balance - beginning of year         $    219  $   819    $ 1,097
   Charges: cash outlays                  (190)    (381)      (216)
            Non-cash                        64     (219)       (62)
----------------------------------------------------------------------
  Balance - end of year               $     93  $   219    $   819
======================================================================

The  remaining  1996 reserve of $93 was used during 1997. As a result of the new
initiatives  from the merger  with SBC,  net force  changes  during 1997 are not
meaningful to the restructuring reserve.

Commitments PacBell has purchase  commitments of approximately $190 remaining in
connection  with its previously  announced  program for deploying an all-digital
switching platform with ISDN and SS-7 capabilities.


Local  Number  Portability/interconnection  Over the next few  years,  the Local
Number  Portability/Interconnection  Over  the  next few  years,  the  Telephone
Operations  expect to incur  significant  capital and software  expenditures for
customer  number  portability,   which  allows  customers  to  switch  to  local
competitors and keep the same phone number, and interconnection. PacBell expects
capital costs and expenses  associated with customer number portability to total
up to $600 on a  pre-tax  basis  over the next  four  years.  Full  recovery  of
customer number  portability  costs is required under the Telecom Act;  however,
the FCC has not yet  determined  when or how  those  significant  costs  will be
recovered. PacBell has filed a tariff for recovery of these costs. No action has
been  taken by the FCC on this  tariff,  pending  the  issuance  of its order on
customer number portability.  PacBell is unable to predict the likelihood of the
FCC  permitting  the tariffs to become  effective.  Capital  costs and  expenses
associated  with  interconnection  will vary based on the number of  competitors
seeking  interconnection,  the  particular  markets  entered  and the  number of
customers served by those competitors.  Accordingly, PacBell is currently unable
to reasonably  estimate the future costs that will be incurred  associated  with
interconnection.

Year 2000 Costs PacBell  currently  operates  numerous  date-sensitive  computer
applications  and  systems  throughout  its  business.  As  the  century  change
approaches,  it will be  essential  for  PacBell to ensure  that  these  systems
properly  recognize the year 2000 and continue to process  critical  operational
and financial information.  PacBell has established processes for evaluating and
managing  the  risks  and  costs  associated  with  preparing  its  systems  and
applications for the year 2000 change. Total expenses for this project have been
estimated  to be less than $100 over the next three  years.  PacBell  expects to
substantially  complete  modifications and incur most of these costs during 1998
to allow for thorough testing before the year 2000.


ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Quantitative Information about Market Risk

--------------------------------------------------------------------------------
                   Foreign Exchange Risk Sensitivity Analysis
--------------------------------------------------------------------------------
                US Dollar Value   Net Underlying   Net Exposed  Foreign Exchange
 December 31,    of Net Foreign      Foreign       Long/Short    Loss from a 10%
     1997           Exchange         Currency       Currency     Depreciation of
(millions of $)    Contracts       Transaction      Position      the US dollar
                                    Exposures
--------------------------------------------------------------------------------
Japanese Yen          142              142             -                  -
--------------------------------------------------------------------------------

The  preceding  table  describes  the  effects  of a change  in the value of the
Japanese yen as it relates to leases entered into by PBMS.  Since the identified
exposure is fully covered with forward contracts, changes in the value of the US
dollar which affect the value of the underlying foreign currency  commitment are
fully offset by changes in the value of the foreign currency contract.  Were the
underlying currency transaction exposure to change, the resulting mismatch would
expose the company to currency risk of the foreign exchange  contract.  For this
reason,  all contracts are related to firm  commitments  and matched by maturity
and currency.

Qualitative Information about Market Risk

PacBell follows SBC's policy on foreign  exchange risk. From time to time SBC is
required to make  investments,  receive  dividends,  or borrow  funds in foreign
currency. To maintain the dollar cost of the investment or limit the dollar cost
of the funding,  SBC will enter into forward  foreign  exchange  contracts.  The
contracts  are used to provide  currency  at a fixed  rate.  SBC's  policy is to
measure the risk of adverse  currency  fluctuations by calculating the potential
dollar losses  resulting  from changes in exchange  rates that have a reasonable
probability  of occurring.  Changes that exceed  acceptable  loss limits require
that SBC cover the exposure. SBC does not speculate in foreign exchange markets,
and does not hedge all foreign exchange  exposures due to uncertainty in foreign
cash flows.

<PAGE>
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


                        Report of Independent Auditors


The Board of Directors
Pacific Bell

We have audited the accompanying  consolidated  balance sheet of Pacific Bell (a
wholly-owned  subsidiary of Pacific Telesis Group, a wholly-owned  subsidiary of
SBC Communications  Inc.) as of December 31, 1997, and the related  consolidated
statements  of  income,  shareowner's  equity  and cash  flows for the year then
ended. Our audit also included the financial  statement  schedules listed in the
Index  at  Item  14(a).  These  financial   statements  and  schedules  are  the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these  consolidated  financial  statements and schedules based on our
audit.

We conducted our audit in accordance with generally accepted auditing standards.
Those standards  require that we plan and perform the audit to obtain reasonable
assurance   about  whether  the  financial   statements  are  free  of  material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

In our opinion the consolidated  financial  statements referred to above present
fairly, in all material respects, the consolidated financial position of Pacific
Bell at December 31, 1997,  and the  consolidated  results of its operations and
its cash flows for the year then ended,  in conformity  with generally  accepted
accounting  principles.  Also, in our opinion,  the related financial  statement
schedules,  when considered in relation to the basic financial  statements taken
as a whole,  present fairly in all material  respects the  information set forth
therein.

As discussed in Note 3 to the  consolidated  financial  statements,  in 1997 the
Company  changed  its  method of  accounting  for  pensions  and  postretirement
benefits.




                                                ERNST & YOUNG LLP


San Antonio, Texas
February 20, 1998

<PAGE>

                        REPORT OF INDEPENDENT AUDITORS


The Board of Directors and Shareowner of Pacific Bell:

We have audited the accompanying  consolidated  balance sheet of Pacific Bell (a
wholly owned  subsidiary  of the Pacific  Telesis  Group,  which became a wholly
owned  subsidiary  of SBC  Communications  Inc.  effective  April 1,  1997)  and
Subsidiaries (the "Company"),  as of December 31, 1996, the related consolidated
statements  of  income,  shareowners'  equity and cash flows for each of the two
years in the  period  ended  December  31,  1996,  and the  financial  statement
schedule as of and for the two years ended December 31, 1996. These consolidated
financial statements and the financial statement schedule are the responsibility
of management.  Our  responsibility  is to express an opinion on these financial
statements and the financial statement schedule based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards  require that we plan and perform an audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Pacific
Bell and Subsidiaries as of December 31, 1996, and the  consolidated  results of
their  operations  and their  cash flows for each of the two years in the period
ended  December  31,  1996 in  conformity  with  generally  accepted  accounting
principles.  In  addition,  in our opinion,  the  financial  statement  schedule
referred to above, when considered in relation to the basic financial statements
taken as a whole,  presents fairly,  in all material  respects,  the information
required to be included  therein as of and for the two years ended  December 31,
1996.

As discussed in Note 1 to the Consolidated  Financial Statements,  the Company's
Pacific Bell Directory  subsidiary  changed its method of recognizing  directory
publishing revenues and related expenses effective January 1, 1996. As discussed
in Note 2 to the Consolidated Financial Statements, the Company discontinued its
application of Statement of Financial  Accounting  Standards No. 71, "Accounting
for the Effects of Certain Types of Regulation" in 1995.




                                                COOPERS & LYBRAND L.L.P.

San Francisco, California
February 27, 1997

<PAGE>

PACIFIC BELL AND SUBSIDIARIES
-------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
Dollars in millions
-------------------------------------------------------------------------------
                                                         1997    1996     1995
-------------------------------------------------------------------------------
Operating Revenues
Local service                                         $ 4,386 $  3,956 $  3,742
Network access:
  Interstate                                            1,714    1,805    1,682
  Intrastate                                              790      718      707
Long-distance service                                   1,182    1,274    1,210
Directory advertising                                   1,125    1,051    1,012
Other                                                     741      642      509
-------------------------------------------------------------------------------
Total operating revenues                                9,938    9,446    8,862
-------------------------------------------------------------------------------

Operating Expenses
Cost of services and products                           4,218    3,713    3,596
Selling, general and administrative                     3,190    1,603    1,512
Depreciation and amortization                           2,021    1,826    1,831
-------------------------------------------------------------------------------
Total operating expenses                                9,429    7,142    6,939
-------------------------------------------------------------------------------
Operating Income                                          509    2,304    1,923
-------------------------------------------------------------------------------

Other Income (Expense)
Interest expense                                         (461)    (363)    (410)
Other income - net                                          6        4       25
-------------------------------------------------------------------------------
Total other income (expense)                             (455)    (359)    (385)
-------------------------------------------------------------------------------
Income Before Income Taxes, Extraordinary Loss
  and Cumulative Effect of Accounting Changes              54    1,945    1,538
-------------------------------------------------------------------------------
Income Taxes                                               46      775      569
-------------------------------------------------------------------------------
Income Before Extraordinary Loss and
  Cumulative Effect of Accounting Changes                   8    1,170      969
-------------------------------------------------------------------------------
Extraordinary Loss from Discontinuance of
  Regulatory Accounting, net of tax                         -        -   (3,360)
-------------------------------------------------------------------------------
Cumulative Effect of Accounting Changes, net of tax       342       85        -
-------------------------------------------------------------------------------
Net Income (Loss)                                     $   350 $  1,255 $ (2,391)
-------------------------------------------------------------------------------
The accompanying notes are an integral part of the financial statements.
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
-------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
Dollars in millions except per share data
-------------------------------------------------------------------------------
                                                              1997        1996
-------------------------------------------------------------------------------
Assets
Current Assets
Cash and cash equivalents                                $     43     $     58
Accounts receivable - net of allowances for
  uncollectibles of $237 and $161                           2,199        2,133
Prepaid expenses                                               54           37
Deferred charges                                               22           45
Deferred income taxes                                         329          119
Other current assets                                           56           37
-------------------------------------------------------------------------------
Total current assets                                        2,703        2,429
-------------------------------------------------------------------------------
Property, Plant and Equipment - at cost                    29,681       28,372
  Less: Accumulated depreciation and amortization          17,606       16,699
-------------------------------------------------------------------------------
Property, Plant and Equipment - Net                        12,075       11,673
-------------------------------------------------------------------------------
Other Assets                                                  725          547
-------------------------------------------------------------------------------
Total Assets                                             $ 15,503     $ 14,649
-------------------------------------------------------------------------------

Liabilities and Shareowner's Equity
Current Liabilities
Debt maturing within one year                            $    716     $    287
Accrued taxes                                                 340           95
Accounts payable and accrued liabilities                    2,955        2,451
-------------------------------------------------------------------------------
Total current liabilities                                   4,011        2,833
-------------------------------------------------------------------------------
Long-Term Debt                                              5,588        5,364
-------------------------------------------------------------------------------

Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes                                         952          476
Postemployment benefit obligation                             917          671
Unamortized investment tax credits                            188          236
Other noncurrent liabilities                                  574        1,142
-------------------------------------------------------------------------------
Total deferred credits and other noncurrent                 2,631        2,525
liabilities
-------------------------------------------------------------------------------

Shareowner's Equity
Common shares ($1 par value, 300,000,000 authorized:
issued 224,504,982 at December 31, 1997 and 1996)             225          225
Capital in excess of par value                              5,096        6,100
Retained earnings (deficit)                                (2,048)      (2,398)
-------------------------------------------------------------------------------
Total shareowner's equity                                   3,273        3,927
-------------------------------------------------------------------------------
Total Liabilities and Shareowner's Equity                $ 15,503     $ 14,649
-------------------------------------------------------------------------------
The accompanying notes are an integral part of the financial statements.
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
-------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
Dollars in millions, increase (decrease) in cash and cash equivalents
-------------------------------------------------------------------------------
                                                         1997     1996     1995
-------------------------------------------------------------------------------
Operating Activities
Net income (loss)                                     $   350 $  1,255 $ (2,391)
Adjustments to reconcile net income (loss) to net cash
  provided by operating activities:
   Depreciation and amortization                        2,021    1,826    1,831
   Provision for uncollectible accounts                   245      167      166
   Amortization of investment tax credits                 (48)     (47)     (52)
   Deferred income taxes                                  158      250       93
   Extraordinary loss, net of tax                           -        -    3,360
   Cumulative effect of accounting change, net of tax    (342)     (85)       -
   Changes in operating assets and liabilities:
     Accounts receivable                                 (312)    (719)    (125)
     Other current assets                                 (13)     294       (2)
     Accounts payable and accrued liabilities             749     (114)    (121)
Other - net                                              (209)    (305)     (98)
-------------------------------------------------------------------------------
Total adjustments                                       2,249    1,267    5,052
-------------------------------------------------------------------------------
Net Cash Provided by Operating Activities               2,599    2,522    2,661
-------------------------------------------------------------------------------

Investing Activities
Construction and capital expenditures                  (2,312)  (2,334)  (1,964)
Dispositions                                               65        -        -
Other                                                     (14)     (29)      19
-------------------------------------------------------------------------------
Net Cash Used in Investing Activities                  (2,261)  (2,363)  (1,945)
-------------------------------------------------------------------------------

Financing Activities
Net change in short-term borrowings with original
  maturities of three months or less                      406     (504)     526
Issuance of other short-term borrowings                   610        -        -
Repayment of other short-term borrowings                 (610)       -        -
Issuance of long-term debt                                253      770        6
Repayment of long-term debt                                (8)      (4)    (501)
Equity received from parent                               156      713      218
Dividends paid                                         (1,160)  (1,151)    (943)
Other                                                       -        7      (16)
--------------------------------------------------------------------------------
Net Cash Used in Financing Activities                    (353)    (169)    (710)
--------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents      (15)     (10)       6
-------------------------------------------------------------------------------
Cash and cash equivalents beginning of year                58       68       62
-------------------------------------------------------------------------------
Cash and Cash Equivalents End of Period               $    43 $     58 $     68
-------------------------------------------------------------------------------
The accompanying notes are an integral part of the financial statements.
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
---------------------------------------------------------------------------
STATEMENTS OF SHAREOWNER'S EQUITY
Dollars in millions
---------------------------------------------------------------------------
                                                                 Retained
                                           Common      Paid-in   Earnings
                                            Stock      Surplus   (Deficit)
---------------------------------------------------------------------------
Balance, December 31, 1994               $     225   $   5,169  $     830
Net income (loss)                                -           -     (2,391)
Dividend to shareowner                           -           -       (943)
Equity from parent                               -         218          -
Other                                            -           -          3
---------------------------------------------------------------------------
Balance, December 31, 1995                     225       5,387     (2,501)
---------------------------------------------------------------------------
Net income                                       -           -      1,255
Dividend to shareowner                           -           -     (1,151)
Equity from parent                               -         713          -
Other                                            -           -         (1)
---------------------------------------------------------------------------
Balance, December 31, 1996                     225       6,100     (2,398)
---------------------------------------------------------------------------
Net income                                       -           -        350
Dividend to shareowner                           -      (1,160)         -
Equity from parent                               -         156          -
---------------------------------------------------------------------------
Balance, December 31, 1997               $     225   $   5,096 $   (2,048)
---------------------------------------------------------------------------
The accompanying notes are an integral part of the financial statements.
<PAGE>
Notes to Financial Statements, continued
Dollars in millions

NOTES TO FINANCIAL STATEMENTS
Dollars in millions

1.  Summary of Significant Accounting Policies

    Basis of Presentation - The consolidated  financial  statements  include the
    accounts of Pacific Bell (PacBell, which includes its subsidiaries). PacBell
    is a wholly-owned  subsidiary of Pacific Telesis Group (PAC), a wholly-owned
    subsidiary of SBC Communications Inc. (SBC). PacBell operates  predominantly
    in the  telecommunications  services  industry  in  California  and  Nevada,
    providing   landline  services  in  California  and  wireless  services  and
    equipment in California and Nevada, and directory advertising services.

    PacBell provides telephone operations (Telephone Operations) and has several
    subsidiaries  including Pacific Bell Directory  (PBDirectory),  Pacific Bell
    Information  Services (PBIS),  Pacific Bell Mobile Services (PBMS),  Pacific
    Bell Internet Services (PBI),  Pacific Bell Network  Integration (PBNI), and
    others.

    All   significant   intercompany   transactions   are   eliminated   in  the
    consolidation process.

    Certain amounts in prior period financial  statements have been reclassified
    to conform to the current year's presentation.

    The  preparation  of  financial  statements  in  conformity  with  generally
    accepted accounting  principles (GAAP) requires management to make estimates
    and assumptions that affect the amounts reported in the financial statements
    and accompanying notes. Actual results could differ from those estimates.

    Income Taxes - PacBell is included in SBC's consolidated  federal income tax
    return.  Federal  income  taxes  are  provided  for in  accordance  with the
    provisions  of the Tax  Allocation  Agreement  (SBC Tax  Agreement)  between
    PacBell and SBC. In general,  PacBell's  income tax provision  under the SBC
    Tax Agreement reflects the financial consequences of income,  deductions and
    credits which can be utilized on a separate return basis or in consolidation
    with SBC and which are assured of realization.

    Deferred  income taxes are provided for  temporary  differences  between the
    carrying amounts of assets and liabilities for financial  reporting purposes
    and the amounts used for tax purposes.

    Investment tax credits earned prior to their repeal by the Tax Reform Act of
    1986 are amortized as reductions in income tax expense over the lives of the
    assets which gave rise to the credits.

    Cash  Equivalents - Cash equivalents  include all highly liquid  investments
    with original maturities of three months or less.

    Deferred  Charges  -  Directory  advertising  costs are  deferred  until the
    directory is published and advertising  revenues  related to these costs are
    recognized.

    Directory  Accounting  Change  -  Prior  to  January  1,  1996,  PBDirectory
    recognized  revenues  and  expenses  related to  publishing  directories  in
    California  using  the  "amortization"  method,  under  which  revenues  and
    expenses were  recognized over the lives of the  directories,  generally one
    year.  Effective January 1, 1996,  PBDirectory  changed to the "issue basis"
    method of accounting  which recognizes the revenues and expenses at the time
    the related  directory  is  published.  The change in  methodology  was made
    because  the issue basis  method is  generally  followed  in the  publishing
    industry,   including   Southwestern   Bell  Yellow  Pages,  a  wholly-owned
    subsidiary  of SBC,  and  better  reflects  the  operating  activity  of the
    business.

    The  cumulative  after-tax  effect of applying the change in method to prior
    years is recognized as of  January 1,  1996 as a one-time,  non-cash gain of
    $85. The gain is net of deferred  taxes of $58. Had the current  method been
    applied during 1995, income before  extraordinary loss and accounting change
    would not have been materially affected.

    Property,  Plant and Equipment - Property,  plant and equipment is stated at
    cost. The cost of additions and substantial  betterments of property,  plant
    and  equipment  is  capitalized.  The cost of  maintenance  and  repairs  of
    property,  plant and equipment is charged to operating  expenses.  Property,
    plant and equipment is depreciated  using  straight-line  methods over their
    estimated economic lives, generally ranging from 3 to 50 years. Prior to the
    discontinuance  of  regulatory  accounting  in the  third  quarter  of 1995,
    PacBell computed  depreciation using certain straight-line methods and rates
    as prescribed by regulators. In accordance with composite group depreciation
    methodology,  when a portion of PacBell's  depreciable  property,  plant and
    equipment  is retired in the  ordinary  course of  business,  the gross book
    value is charged to accumulated depreciation;  no gain or loss is recognized
    on the disposition of this plant.

    Software Costs - The costs of computer  software  purchased or developed for
    internal use are expensed as incurred.  However,  initial  operating  system
    software  costs  are  capitalized  and  amortized  over  the  lives  of  the
    associated hardware.

    Advertising Costs - Costs for advertising products and services or corporate
    image are expensed as incurred.

    Derivative   Financial   Instruments  -  PacBell  does  not  invest  in  any
    derivatives  for  trading  purposes.  From time to time  PacBell  invests in
    immaterial  amounts of foreign currency forward exchange  contracts in order
    to manage exposure to changes in foreign currency rates.  Amounts related to
    derivative  contracts  are  recorded  using the hedge  accounting  approach.
    PacBell  currently  does not recognize  the fair values of these  derivative
    financial  investments  or their  changes  in fair  value  in its  financial
    statements.  At December  31, 1997,  PacBell's  forward  exchange  contracts
    related to leases entered into by PBMS.

2.  Discontinuance of Regulatory Accounting

    In the third  quarter  of 1995,  PacBell  discontinued  its  application  of
    Statement of Financial  Accounting  Standards  No. 71,  "Accounting  for the
    Effects  of  Certain  Types  of  Regulation,"   (FAS 71).  FAS  71  requires
    depreciation  of  telephone  plant using lives set by  regulators  which are
    generally  longer  than those  established  by  unregulated  companies,  and
    deferral  of  certain  costs and  obligations  based on  regulatory  actions
    (regulatory assets and liabilities). As a result of competition,  management
    determined  that  PacBell  no longer met the  criteria  for  application  of
    FAS 71.

    Upon  discontinuance  of FAS 71, PacBell recorded a non-cash,  extraordinary
    charge to net income of $3,360 (after a net deferred tax benefit of $2,421).
    This charge is comprised of an after-tax  charge of $2,842 to reduce the net
    carrying value of telephone  plant,  and an after-tax charge of $518 for the
    elimination  of net regulatory  assets.  The components of the charge are as
    follows:

     --------------------------------------------------------------------------
                                                         Pre-tax     After-tax
     --------------------------------------------------------------------------
     Increase telephone plant accumulated depreciation  $  4,819    $  2,842
     Elimination of net regulatory assets                    962         518
     --------------------------------------------------------------------------
     Total                                             $   5,781    $  3,360
     ==========================================================================

    The increase in accumulated  depreciation of $4,819 reflected the effects of
    adopting depreciable lives for PacBell's plant categories which more closely
    reflect the economic and  technological  lives of the plant.  The adjustment
    was supported by a discounted  cash flow analysis that estimated  amounts of
    telephone  plant that may not be  recoverable  from future  discounted  cash
    flows.  These analyses included  consideration of the effects of anticipated
    competition and technological changes on plant lives and revenues.

    Following is a comparison of new lives to those prescribed by regulators for
    selected plant categories:

     -------------------------------------------------------------------------
                                                    Average Lives (in Years)
     -------------------------------------------------------------------------
                                                    Regulator-    Estimated
                                                    Prescribed     Economic
     -------------------------------------------------------------------------
     Digital switch                                     17            10
     Digital circuit                                  10-12           8
     Copper cable                                     19-26           14
     Fiber cable                                      28-30           20
     Conduit                                            59            50
     -------------------------------------------------------------------------

    The discontinuance of FAS 71 for external financial  reporting purposes also
    required the elimination of net regulatory assets of $962. Regulatory assets
    and  liabilities  are  related  primarily  to  accounting  policies  used by
    regulators in the ratemaking  process which are different from those used by
    non-regulated   companies.   The  differences  arose  predominantly  in  the
    accounting for income taxes,  deferred compensated  absences,  pension costs
    and debt redemption  costs.  These items were required to be eliminated with
    the  discontinuance  of accounting  under  FAS 71.  PacBell  accounting  and
    reporting for regulatory  purposes are not affected by the discontinuance of
    FAS 71 for external financial reporting purposes.

    With the  discontinuance of FAS 71, PacBell began accounting for interest on
    funds borrowed to finance construction as an increase in property, plant and
    equipment and a reduction of interest  expense.  Under the provisions of FAS
    71, PacBell capitalized both interest and equity costs allowed by regulators
    during  periods of  construction  as other  income and as an addition to the
    cost of  plant  constructed.  Additionally,  PacBell  began  accounting  for
    pension  costs under  Statement of Financial  Accounting  Standards  No. 87,
    "Employers'  Accounting for  Pensions,"  (FAS 87) and Statement of Financial
    Accounting  Standards No. 88,  "Employers'  Accounting for  Settlements  and
    Curtailments of Defined Benefit Pension Plans and for Termination  Benefits"
    (FAS 88).

3.  Merger of SBC and PAC

    On April 1, 1997, SBC and PAC completed the merger of an SBC subsidiary with
    PAC, in a transaction  in which each  outstanding  share of PAC common stock
    was  exchanged  for  1.4629  shares  of  SBC  common  stock  (equivalent  to
    approximately  626 million shares; both the exchange ratio and shares issued
    have been restated to reflect SBC's two-for-one stock split, effected in the
    form of a stock  dividend,  declared  January 30, 1998 with a record date of
    February 20, 1998 and distribution date of March 19, 1998). With the merger,
    PAC became a wholly-owned  subsidiary of SBC. The  transaction was accounted
    for by SBC as a pooling of interests and a tax-free reorganization.

    Conforming accounting changes and merger transaction costs PacBell's results
    include  merger  transaction  costs and the  effects  of  changes to conform
    accounting  methodologies  between SBC and PacBell  for,  among other items,
    pensions and postretirement benefits. These changes were recorded by PacBell
    in the  second  quarter  of  1997,  retroactive  to  January 1,  1997,  as a
    cumulative  effect of  accounting  changes of $342 net of deferred  taxes of
    $238,  and increased  income before  income taxes and  cumulative  effect of
    accounting changes and net income for 1997 by $77 and $45. Had these changes
    been  adopted  January  1, 1996 and 1995 they would  have  increased  income
    before income taxes and cumulative effect of accounting  changes by $142 and
    $79 and net income by $84 and $47. The changes in accounting for pension and
    postretirement  benefits were to adopt SBC's methodology of amortizing gains
    and losses on assets  held within  those  benefit  plans.  Among other costs
    relating to the close of the merger,  PacBell  recorded the present value of
    amounts to be returned to California ratepayers as a condition of the merger
    of $276 ($173 net of tax).

    Post-merger  initiatives
    During the second quarter of 1997,  PacBell  recorded  after-tax  charges of
    $943  related  to SBC's June 19,  1997  announcement  of  several  strategic
    decisions  resulting from the merger integration process that began with the
    April 1 closing of the SBC/PAC  merger,  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.  Following is a discussion of
    the most significant of these charges.

    Reorganization - SBC is centralizing several key functions that will support
    the Telephone  Operations  and two other SBC  subsidiaries,  Nevada Bell and
    Southwestern Bell Telephone  Company  (SWBell),  including network planning,
    strategic  marketing and procurement.  It is also  consolidating a number of
    corporate-wide  support  activities,  including  research  and  development,
    information  technology,  financial  transaction  processing and real estate
    management.  PacBell, Nevada Bell and SWBell will continue as separate legal
    entities. These initiatives will result in the creation of some jobs and the
    elimination and realignment of others,  with many of the affected  employees
    changing job  responsibilities and in some cases assuming positions in other
    locations.

    PacBell  recognized a charge of  approximately  $154 ($97 net of tax) during
    the second quarter of 1997 in connection with these initiatives. This charge
    was  comprised  mainly of  postemployment  benefits,  primarily  related  to
    severance,  and costs  associated  with closing down  duplicate  operations,
    primarily  contract  cancellations.  Other charges arising out of the merger
    related to relocation, retraining and other effects of consolidating certain
    operations  are being  recognized in the periods those charges are incurred.
    During the second half of 1997,  PacBell  incurred $252 ($149 net of tax) of
    merger-related charges.

    Impairments/asset valuation - As a result of SBC's merger integration plans,
    strategic  review of  domestic  operations  and  organizational  alignments,
    PacBell  reviewed the carrying  values of related  long-lived  assets.  This
    review  included  estimating  remaining  useful  lives  and cash  flows  and
    identifying assets to be abandoned.  Where this review indicated impairment,
    discounted cash flows related to those assets were analyzed to determine the
    amount of the  impairment.  As a result of these reviews,  PacBell wrote off
    some assets and  recognized  impairments to the value of other assets with a
    combined  charge of $416 ($262 after tax) recorded in the second  quarter of
    1997. These  impairments and write-offs  related to certain analog switching
    equipment,  selected wireless  equipment,  duplicate or obsolete  equipment,
    cable within commercial  buildings and certain  nonoperating plant and other
    assets.

    Video  curtailment/purchase  commitments  - SBC  also  announced  that it is
    scaling back its limited  direct  investment in video  services.  As part of
    this curtailment, PacBell halted construction on the Advanced Communications
    Network (ACN). As part of an agreement with the ACN vendor, PacBell paid the
    liabilities  of the ACN trust  that  owned and  financed  ACN  construction,
    incurred costs to shut down all construction  previously conducted under the
    trust and  received  certain  consideration  from the vendor.  In the second
    quarter of 1997, PacBell recognized its net expense of $553 ($346 after tax)
    associated with these activities.

4.  Property, Plant and Equipment

    Property, plant and equipment, which is stated at cost, is summarized as
    follows at December 31:
     --------------------------------------------------------------------------
                                                           1997          1996
     --------------------------------------------------------------------------
     Property, plant and equipment
        In service                                     $  28,886     $  27,075
        Under construction                                   795         1,297
     --------------------------------------------------------------------------
                                                          29,681        28,372
     Accumulated depreciation and amortization           (17,606)      (16,699)
     --------------------------------------------------------------------------
     Property, plant and equipment-net                 $  12,075     $  11,673
     ==========================================================================

    PacBell's  depreciation expense as a percentage of average depreciable plant
    was 7.3% for 1997, 6.9% for 1996 and 7.1% for 1995.

5.  Leases

    Certain  facilities and equipment used in operations are under  operating or
    capital leases.  Rental  expenses under operating  leases for 1997, 1996 and
    1995 were $158,  $138 and $84. At December 31, 1997,  the aggregate  minimum
    rental commitments under noncancelable leases were as follows:

    ---------------------------------------------------------------------------
                                                       Operating      Capital
    Year                                                Leases         Leases
    ----------------------------------------------------------------------------
    1998                                            $     37       $     38
    1999                                                  34             40
    2000                                                  31             42
    2001                                                  27             45
    2002                                                  19             46
    Thereafter                                            37            123
    =============================================================
    Total Minimum Lease Payments                    $    185            334
    =============================================================
    Amount representing interest                                        (47)
    ---------------------------------------------------------------------------
    Present value of minimum lease payments                        $    287
    ===========================================================================

<PAGE>

6.  Debt

    Long-term debt,  including  interest rates and maturities,  is summarized as
    follows at December 31:
    ----------------------------------------------------------------------------
                                                          1997           1996
    ----------------------------------------------------------------------------
    Debentures
      4.62%-5.88%     1999-2006                       $    475      $     475
      6.00%-6.88%     2002-2034                          1,194          1,194
      7.12%-7.75%     2008-2043                          2,250          2,150
      8.50%           2031                                 225            225
    --------------------------------------------------------------------------
                                                         4,144          4,044
    Unamortized discount--net of premium                   (89)           (89)
    ----------------------------------------------------------------------------
    Total debentures                                     4,055          3,955
    ----------------------------------------------------------------------------
    Notes
      6.25%-8.70%     2001-2009                          1,300          1,150
    Unamortized discount                                   (18)           (18)
    ----------------------------------------------------------------------------
    Total notes                                          1,282          1,132
    ----------------------------------------------------------------------------
    Capitalized leases                                     287            291
    ----------------------------------------------------------------------------
    Total long-term debt, including current maturities   5,624          5,378
    Current maturities                                     (36)           (14)
    ----------------------------------------------------------------------------
    Total long-term debt                              $  5,588      $   5,364
    ============================================================================

    In February 1998, PacBell called $175 of debentures and notes. Estimated net
    income impact from unamortized  discounts and call premiums is approximately
    $(2). During 1995, PacBell  refinanced  long-term  debentures.  Costs of $18
    associated with  refinancing  are included in other income  (expense) - net,
    with  related  income  tax  benefits  of $7  included  in income  taxes,  in
    PacBell's Consolidated Statements of Income.

    At December 31, 1997,  the  aggregate  principal  amounts of long-term  debt
    scheduled  for  repayment  for the years 1998 through  2002 were $36,  $138,
    $166, $241 and $468. As of December 31, 1997, PacBell was in compliance with
    all covenants and conditions of instruments governing its debt.

    Debt maturing within one year consists of the following at December 31:
    ----------------------------------------------------------------------------
                                                         1997         1996
    ----------------------------------------------------------------------------
    Commercial paper                                   $      -     $    200
    Intercompany loans                                      680           73
    Current maturities of long-term debt                     36           14
    ============================================================================
    Total                                              $    716     $    287
    ============================================================================

    The weighted average interest rate on debt maturing with one year, excluding
    current maturities of long-term debt, at December 31, 1997 and 1996 was 6.0%
    and 6.64%.


<PAGE>
7.  Financial Instruments

    The carrying amounts and estimated fair values of PacBell's long-term debt,
    including current maturities, are summarized as follows at December 31:
    ----------------------------------------------------------------------------
                                                 1997               1996
    ----------------------------------------------------------------------------
                                           Carrying   Fair    Carrying   Fair
                                            Amount    Value    Amount    Value
    ----------------------------------------------------------------------------
    Debentures                              $4,055   $4,337    $3,955   $3,917
    Notes                                    1,282    1,342     1,132    1,171
    ----------------------------------------------------------------------------

    The fair values of PacBell's  long-term debt were estimated  based on quoted
    market  prices,  where  available,  or on the net  present  value  method of
    expected  future cash flows  using  current  interest  rates.  The  carrying
    amounts of commercial paper debt approximated fair values.

    PacBell  does  not hold or  issue  any  financial  instruments  for  trading
    purposes.  PacBell's  cash  equivalents  are recorded at cost.  The carrying
    amounts of cash and cash equivalents and customer deposits  approximate fair
    values.

8.  Income Taxes

    Significant  components of PacBell's deferred tax assets and liabilities are
    as follows at December 31:
    ----------------------------------------------------------------------------
                                                             1997      1996
    ----------------------------------------------------------------------------
    Deferred tax (assets)/liabilities due to:
    Depreciation and amortization                        $      962  $      947
    Employee benefits                                          (138)       (420)
    Unamortized investment tax credits                          (82)        (99)
    Other, net                                                 (286)       (357)
    ----------------------------------------------------------------------------
    Net deferred tax liabilities                         $      456  $       71
    ----------------------------------------------------------------------------
    Amounts recorded in consolidated balance sheets:
    Deferred tax assets*                                 $      329  $      405
    ============================================================================
    Deferred tax liabilities*                            $      785  $      476
    ============================================================================

    * Reflects reclassification of certain current and noncurrent amounts by
      federal and state tax jurisdictions to a net presentation.  Amounts
      include both current and noncurrent portions.

    As a result of implementing  Statement of Financial Accounting Standards No.
    109, "Accounting for Income Taxes" in 1993, PacBell recorded a net reduction
    in its deferred tax liability.  This reduction was  substantially  offset by
    the establishment of a net regulatory  liability,  which was eliminated with
    the discontinued application of FAS 71 in September 1995 (see Note 2).
<PAGE>
    The components of income tax expense (benefit) are as follows:
    ----------------------------------------------------------------------------
                                                  1997        1996         1995
    ----------------------------------------------------------------------------
    Federal
     Current                                  $    (46)   $    442    $    406
     Deferred-net                                  142         184          66
     Amortization of investment tax credits        (48)        (47)        (52)
    ----------------------------------------------------------------------------
                                                    48         579         420
    ----------------------------------------------------------------------------
    State and local
     Current                                       (18)        130         122
     Deferred-net                                   16          66          27
    ----------------------------------------------------------------------------
                                                    (2)        196         149
    ----------------------------------------------------------------------------
    Total                                     $     46    $    775    $    569
    ============================================================================

    A  reconciliation  of income tax expense and the amount computed by applying
    the statutory  federal  income tax rate (35%) to income before income taxes,
    extraordinary loss and cumulative effect of changes in accounting principles
    is as follows:
<TABLE>
<CAPTION>
    -------------------------------------------------------------------------------
                                                   1997       1996        1995
    -------------------------------------------------------------------------------
    <S>                                            <C>        <C>        <C>
    Taxes computed at federal statutory rate       $     19   $    681   $    538
    Increases (decreases) in taxes resulting from:
     Amortization of investment tax credits
     over the life of the plant that gave rise          (31)       (31)       (52)
     to the credits
    Excess deferred taxes due to rate change              -          -        (45)
    Depreciation of telephone plant
     construction costs previously deducted
     for tax purposes-net                                 -          -         32
    State and local income taxes-net of                  (1)       127         97
     federal tax benefit
    1997 implementation of the SBC Tax                   56          -          -
     Agreement
    Other-net                                             3         (2)        (1)
    -------------------------------------------------------------------------------
    Total                                          $     46   $    775   $    569
    ===============================================================================
</TABLE>

9.  Employee Benefits

    Pensions  -   Substantially   all   employees  of  PacBell  are  covered  by
    noncontributory  defined  pension and death benefit plans, as defined by PAC
    and sponsored by SBC. The pension benefit formula used in the  determination
    of pension cost for nonmanagement employees is based on a flat dollar amount
    per year of service according to job classification.  For managers, benefits
    accrue in separate  account  balances  based on a fixed  percentage  of each
    employee's  monthly  salary with interest,  or are  determined  based upon a
    stated percentage of adjusted career income.

    PacBell's  objective in funding the plans, in combination with the standards
    of the Employee  Retirement Income Security Act of 1974 (as amended),  is to
    accumulate  funds  sufficient to meet its benefit  obligations  to employees
    upon their  retirement.  Contributions  to the plans are made to a trust for
    the benefit of plan  participants.  Plan assets consist primarily of stocks,
    U.S. government and domestic corporate bonds, index funds and real estate.

<PAGE>
    Significant assumptions used by SBC in developing pension information
    include:
    ----------------------------------------------------------------------------
                                                  1997        1996        1995
    ----------------------------------------------------------------------------
    Discount rate for determining projected       7.25%       7.5%        7.25%
        benefit obligation
    Long-term rate of return on plan assets       8.5%        9.0%        9.0%
    Composite rate of compensation increase       4.3%        4.0%        4.0%
    ----------------------------------------------------------------------------

    GAAP require  certain  disclosures  to be made of components of net periodic
    pension cost for the period and a reconciliation of the funded status of the
    plans with amounts  reported in the balance sheets.  Since the funded status
    of plan assets and  obligations  relates to the plans as a whole,  which are
    sponsored by SBC, this  information  is not  presented for PacBell.  PacBell
    recognized pension cost (benefit) for 1997, 1996 and 1995 of $(246),  $(174)
    and $76. As of December 31,  1997, the amount of PacBell's cumulative amount
    of contributions  recognized in excess of its pension cost made to the trust
    were $395 and as of December 31, 1996, the cumulative amount of pension cost
    recognized in excess of its cumulative  contributions made to the trust were
    $814.

    During 1997, the significant amount of lump sum pension payments resulted in
    a partial  settlement of PacBell's pension plans. In accordance with FAS 88,
    net settlement  gains in the amount of $286 were recognized in 1997. Of this
    amount,  $146 was  recognized  in the  first  quarter  of 1997  and  related
    primarily to managers who terminated employment in 1996. These gains are not
    included in the net pension benefit presented above.

    Postretirement  Benefits -  Under  PAC's  benefit  plans,  PacBell  provides
    certain medical,  dental and life insurance  benefits to  substantially  all
    retired  employees  and their  dependents  under  various  plans and accrues
    actuarially determined postretirement benefit costs as active employees earn
    these benefits.  Employees  retiring after certain dates will pay a share of
    the costs of medical  coverage  that exceeds a defined  dollar  medical cap.
    Such future cost  sharing  provisions  have been  reflected  in  determining
    PacBell's postretirement benefit costs.

    GAAP require  certain  disclosures  to be made of components of net periodic
    postretirement benefit cost and a reconciliation of the funded status of the
    plans to amounts reported in the balance sheets.  Since the funded status of
    assets and obligations  relates to the plans as a whole, this information is
    not presented for PacBell. In addition, at the time of adoption of Statement
    of  Financial  Accounting  Standards  No. 106,  "Employers'  Accounting  for
    Postretirement  Benefits Other Than  Pensions,"  PacBell elected to amortize
    its transition  benefit  obligation (TBO) over 20 years.  PacBell recognized
    amortization of the TBO was $95 in 1997, 1996 and 1995.  PacBell  recognized
    postretirement  benefit cost for 1997, 1996 and 1995 of $260, $257 and $327.
    At December  31,  1997 and 1996,  the amount  included  in the  Consolidated
    Balance Sheets for accrued  postretirement  benefit  obligation was $613 and
    $568.  Significant  assumptions  for the discount  rate,  long-term  rate of
    return on plan assets and composite  rate of  compensation  increase used by
    SBC, in developing the accumulated  postretirement benefit, were the same as
    those used in developing the pension information.

    PAC maintains  Voluntary Employee  Beneficiary  Association (VEBA) trusts to
    fund postretirement benefits. During 1997 and 1996, PAC contributed $295 and
    $129  into  the  VEBA  trusts  to be  ultimately  used  for the  payment  of
    postretirement  benefits.  Assets  consist  principally  of stocks  and U.S.
    government and corporate bonds.

    The assumed medical cost trend rate in 1998 is 7.5%, decreasing gradually to
    5.5% in 2002 prior to adjustment for cost-sharing provisions of the plan for
    active and certain recently retired employees. The assumed dental cost trend
    rate in 1998 is 6.0%,  reducing to 5.0% in 2002.  Raising the annual medical
    and dental  cost  trend  rates by one  percentage  point  increases  the net
    periodic postretirement benefit cost for the year ended December 31, 1997 by
    approximately 8%.

    Postemployment  Benefits  - Under  PAC's  benefit  plans,  PacBell  provides
    employees  varying  levels  of  severance  pay,   disability  pay,  workers'
    compensation and medical benefits under specified  circumstances and accrues
    these postemployment  benefits at the occurrence of an event that renders an
    employee inactive or, if the benefits ratably vest, over the vesting period.

    Savings Plans -  Substantially  all employees are eligible to participate in
    contributory  savings plans  defined by PAC and sponsored by SBC.  Under the
    savings  plans,  PacBell  matches a stated  percentage of eligible  employee
    contributions, subject to a specified ceiling.

10. Stock Option Plans

    Management  employees of PacBell  participate  in various stock option plans
    sponsored by SBC.  Options issued  through  December 31, 1997 carry exercise
    prices  equal to the market price of the stock at the date of grant and have
    maximum  terms  ranging  from five to ten  years.  Depending  upon the plan,
    vesting of options occurs up to four years from the date of grant. Up to 156
    million shares may be issued to SBC employees under these plans.

    In 1996, PacBell elected to continue  measuring  compensation cost for these
    plans using the intrinsic value-based method of accounting prescribed in the
    Statement of Financial  Accounting  Standards No. 123, "Accounting for Stock
    Based  Compensation" (FAS 123).  Accordingly,  no compensation cost has been
    recognized  for the stock  option  plans.  Had  compensation  cost for stock
    option plans been recognized using the fair-value based method of accounting
    at the date of grant  for  awards  in 1997 and 1996 as  defined  by FAS 123,
    PacBell's net income would have been $336 and $1,254.

    For purposes of these pro forma disclosures, the estimated fair value of the
    options granted after 1994 is amortized to expense over the options' vesting
    period.  Because most employee options vest over a two to three year period,
    these  disclosures  will not be indicative of future pro forma amounts until
    the FAS 123 rules are  applied to all  outstanding  non-vested  awards.  SBC
    estimates  the fair  value of stock  options  at the date of grant,  using a
    Black-Scholes  option  pricing  model  with the  following  weighted-average
    assumptions  used for grants in 1997 and 1996:  risk-free  interest  rate of
    6.57% and  6.26%;  dividend  yield of 2.99% and 4.92%;  expected  volatility
    factor of 15% and 18%;  and  expected  option life of 5.8 and 4.7 years.  As
    options are  exercisable in SBC common stock,  separate  assumptions are not
    developed for subsidiaries of SBC.

    FAS 123  requires  certain  disclosures to be made about the outstanding and
    exercisable  options,  option activity,  weighted average exercise price per
    option and option  exercise  price range for each income  statement  period.
    Since the stock option activity relates only to SBC's  shareowners'  equity,
    this information in not presented for PacBell.

<PAGE>
11. Additional Financial Information

    ----------------------------------------------------------------------------
                                                                December 31,
                                                         -----------------------
    Balance Sheets                                           1997         1996
    ----------------------------------------------------------------------------
    Accounts payable and accrued liabilities
       Accounts payable                                  $  1,797     $  1,543
       Advance billing and customer deposits                  303          253
       Compensated future absences                            279          258
       Accrued interest                                       147          131
       Accrued payroll                                         84           55
       Other                                                  345          211
    ============================================================================
    Total                                                $  2,955     $  2,451
    ============================================================================

    ----------------------------------------------------------------------------
    Statements of Income                       1997          1996         1995
    ----------------------------------------------------------------------------
    Interest expense incurred              $    518      $    411     $    421
    Capitalized interest                        (57)          (48)         (11)
    ----------------------------------------------------------------------------
    Total interest expense                 $    461      $    363     $    410
    ============================================================================
    Allowance for funds used during
     construction                                 -             -     $     36
    ============================================================================

    ----------------------------------------------------------------------------
    Statements of Cash Flows                   1997          1996         1995
    ----------------------------------------------------------------------------
    Cash paid during the year for:
       Interest                            $    445      $    352     $    417
       Income taxes, net of refunds        $   (359)     $    574     $    550
    ----------------------------------------------------------------------------

    No customer accounted for more than 10% of PacBell's  consolidated  revenues
    in 1997 and 1996.  Approximately 10% of PacBell's 1995 consolidated revenues
    were from services provided to AT&T Corp.

    Approximately   70%  of  PacBell's   employees   are   represented   by  the
    Communications  Workers of America  (CWA).  A  three-year  contract and a 20
    month  contract were  negotiated  between the CWA and PacBell,  effective in
    August 1995 and December  1996.  PBDirectory  also is scheduled to negotiate
    new contracts with the  International  Brotherhood of Electrical  Workers in
    1998. These contracts will be subject to renegotiation in mid-1998.

<PAGE>
12. Quarterly Financial Information (Unaudited)

<TABLE>
<CAPTION>
    -------------------------------------------------------------------------------
      Calendar      Total Operating      Operating Income
      Quarter          Revenues               (Loss)           Net Income (Loss)
                     --------------------------------------------------------------
                        1997       1996      1997      1996       1997       1996
    -------------------------------------------------------------------------------
    <S>    <C>      <C>        <C>        <C>       <C>        <C>        <C>
    First  (2)      $  2,489   $  2,327   $   714   $   605    $   715    $   393
    Second (1)         2,354      2,364      (860)      629       (647)       314
    Third              2,481      2,315       423       530        195        262
    Fourth             2,614      2,440       232       540         87        286
    ===============================================================================
    Annual (2)      $  9,938   $  9,446   $   509   $ 2,304    $   350    $ 1,255
    ===============================================================================
<FN>

    (1) Includes after-tax charges of $943 of second quarter charges related to
        post-merger initiatives (see Note 3) and customer number portability, $19
        and $194 of third and fourth quarter merger integration costs and customer
        number portability and $18 fourth quarter gain on sale of PacBell's
        interest in Bell Communications Research, Inc.

    (2) 1996 Net Income amounts reflect a cumulative effect of accounting change of
        $85 from change in accounting for directory operations (see Note 1).
        1997 Net Income amounts reflect a cumulative effect of accounting change of
        $342 for merger conforming adjustments, primarily related to pensions and
        postretirement benefits (see Note 3).
</FN>
</TABLE>

<PAGE>
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

Effective  April 1, 1997,  Coopers & Lybrand  L.L.P were  replaced  with Ernst &
Young LLP,  however  Coopers & Lybrand had been engaged to perform a review,  as
defined by the American Institute of Certified Public Accountants standards,  of
the March 31, 1997 interim financial statements of Pacific Bell.

No  disagreements  with  accountants on any  accounting or financial  disclosure
matters occurred during the period covered by this report.



                                    PART III


ITEMS 10 THROUGH 13.

Omitted pursuant to General Instruction I(2).




                                     PART IV


ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)  Documents filed as a part of the report:                             Page

     (1) Report of Independent Auditors...................................
         Financial Statements Covered by Report of Independent Auditors:
         Statements of Income.............................................
         Balance Sheets...................................................
         Statements of Cash Flows.........................................
         Statements of Shareowner's Equity................................
         Notes to the Financial Statements................................

     (2) Financial Statement Schedules:
         II - Valuation and Qualifying Accounts...........................

     Financial statement schedules other than those listed above have been
     omitted because the required information is contained in the financial
     statements and notes thereto, or because such schedules are not required
     or applicable.
<PAGE>

     (3) Exhibits:


 Exhibit
 Number
     4      Pursuant to Regulation S-K, Item 601(b)(4)(iii)(A), no instrument
            that defines the rights of holders of long-term debt of the
            registrant is filed herewith.  Pursuant to this regulation, the
            registrant hereby agrees to furnish a copy of any such instrument
            to the SEC upon request.

     12     Computation of Ratios of Earnings to Fixed Charges.

     23a    Consent of Ernst & Young LLP.

     23b    Consent of Coopers & Lybrand L.L.P.

     24     Powers of Attorney.

     27     Financial Data Schedule.

(b)  Reports on Form 8-K:

     On October 22, 1997,  PacBell filed a Current Report on Form 8-K, reporting
     on Item 5. Other Events.  The Report contained  selected PacBell  financial
     statement   information  for  three-month  and  nine-month   periods  ended
     September 30, 1997 and 1996.

     On October 23, 1997,  Pacific Bell (PacBell) filed a Current Report on Form
     8-K, reporting on Item 5. Other Events and Item 7. Financial Statements and
     Exhibits.  The  Report  discussed  a pending  California  Public  Utilities
     Commission (CPUC) case regarding  charging of cross-connect  charges.  Also
     exhibits were filed related to up to $1,750,000  Medium Term Notes,  Series
     D, Due Nine Months or More from Date of Issue.

     On November 7, 1997,  PacBell filed a current Report on Form 8-K, reporting
     on Item 5. Other  Events In the  Report,  PacBell  indicated  that the CPUC
     ordered PacBell to refund cross-connect charges dating from 1993.

     On November 7, 1997,  PacBell filed a Current Report on Form 8-K, reporting
     on Item 7. Financial Statements and Exhibits. The Report contained exhibits
     related to PacBell's  issuance of $150 million of 6 5/8% Notes due November
     1, 2009 and $100 million of 7 1/4% Debentures due November 1, 2027.


<PAGE>

<TABLE>
<CAPTION>

                                          PACIFIC BELL AND SUBSIDIARIES
                                    SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
                                             Allowance for Uncollectibles
                                                  Dollars in Millions

---------------------------------------------------------------------------------------------------------------------
                 COL. A                       COL. B                 COL. C                 COL. D        COL. E
---------------------------------------------------------------------------------------------------------------------
                                                                   Additions
                                                         -------------------------------
                                                               (1)            (2)
                                                                            Charged
                                            Balance at       Charged        to Other                      Balance
                                           Beginning of   to Costs and      Accounts      Deductions     at End of
               Description                    Period      Expenses (a)     -Note (b)      -Note (c)       Period
---------------------------------------------------------------------------------------------------------------------
<S>                                         <C>              <C>             <C>             <C>           <C>
  Year 1997..............................   $ 161            245             256             425           $ 237
  Year 1996..............................   $ 131            129             216             315           $ 161
  Year 1995..............................   $ 132            166             147             314           $ 131

<FN>
(a)   Provision for uncollectibles as stated in the Consolidated Statements of Income includes certain direct
     write-offs which were not reflected in this account.

(b)   Amounts previously written off which were credited directly to this account when recovered.

(c)  Amounts written off as uncollectible.
</FN>
</TABLE>


<PAGE>
<TABLE>
<CAPTION>
                                          PACIFIC BELL AND SUBSIDIARIES
                                    SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
                                               Reserve for Restructuring
                                                  Dollars in Millions

---------------------------------------------------------------------------------------------------------------------
                 COL. A                       COL. B                 COL. C                 COL. D        COL. E
---------------------------------------------------------------------------------------------------------------------
                                                                   Additions
                                                         -------------------------------
                                                               (1)            (2)
                                                                            Charged
                                            Balance at       Charged        to Other                      Balance
                                           Beginning of   to Costs and      Accounts      Deductions     at End of
               Description                    Period        Expenses         -Note        -Note (a)       Period
---------------------------------------------------------------------------------------------------------------------
<S>                                         <C>             <C>              <C>             <C>           <C>
  Year 1997..............................   $  93              -               -              93           $   -
  Year 1996..............................   $ 219              -               -             126           $  93
  Year 1995..............................   $ 819              -               -             600           $ 219

<FN>
(a)  The 1996 and 1995 amounts reflect $(64), and $219 of costs, respectively,
     for enhanced retirement benefits paid from pension fund assets which do not
     require current outlays of the Company's funds. The 1996 reversal of $64
     resulted from revised estimates of these retirement costs.
</FN>
</TABLE>

<PAGE>


                                   SIGNATURES


Pursuant to the  requirements of Section 13 or 15(d) 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,  on the 11th day of March
1998.

                                       PACIFIC BELL


                                       By: /s/ Robert B. Pickering
                                       (Robert B. Pickering
                                       Vice President and Chief Financial
                                       Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following  persons on behalf of the  registrant and
in the capacities and on the date indicated.

Principal Executive Officer:
    Edward A. Mueller*
    President and Chief
    Executive Officer

Principal Financial and
 Accounting Officer:
    Robert B. Pickering
    Vice President and Chief Financial
    Officer
                                       /s/ Robert B. Pickering
Directors:                             (Robert B. Pickering, as attorney-in-fact
                                       and on his own behalf as Principal
    Royce S. Caldwell*                 Financial Officer and Principal
    Cassandra C. Carr*                 Accounting Officer)
    William E. Dreyer*
    James D. Ellis*                    March 11, 1998
    Charles E. Foster*
    Donald E. Kiernan*
    Edward A. Mueller*
    T. Michael Payne*








* by power of attorney


<PAGE>

                                  EXHIBIT INDEX


 Exhibit
 Number

4    Pursuant to Regulation  S-K,  Item  601(b)(4)(iii)(A),  no instrument  that
     defines the rights of holders of long-term  debt of the registrant is filed
     herewith.  Pursuant to this  regulation,  the  registrant  hereby agrees to
     furnish a copy of any such instrument to the SEC upon request.

12   Computation of Ratios of Earnings to Fixed Charges.

23a  Consent of Ernst & Young LLP.

23b  Consent of Coopers & Lybrand L.L.P.

24   Powers of Attorney.

27   Financial Data Schedule.