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, 1998

                                      OR

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

                      For the transition period from to 

                        Commission File Number:  1-1414

                                PACIFIC BELL
            Incorporated under the laws of the State of California
               I.R.S. Employer Identification Number 94-0745535

        140 New Montgomery Street, San Francisco, California 94105-3705
                         Telephone Number 415-542-9000

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

Ten Year 7 1/4% Note,                          New York Stock Exchange
Due July 1, 2002

Twelve Year 6 1/4% Note,                       New York Stock Exchange
Due March 1, 2005

Thirty-Three Year 7 1/8% Debenture,            New York Stock Exchange
Due March 15, 2026

Forty Year 7 1/2% Debenture,                   New York Stock Exchange
Due February 1, 2033

Thirty Year 6 7/8% Debenture,                  New York Stock Exchange
Due August 15, 2023

Forty-One Year 6 5/8% Debenture,               New York Stock Exchange
Due October 15, 2034


                                       

<PAGE>




                               TABLE OF CONTENTS




Item                                                                  Page
----                                                                  ----

                                  PART I

 1.  Business.......................................................     4
 2.  Properties.....................................................     7
 3.  Legal Proceedings..............................................     7
 4.  Submission of Matters to a Vote of Security Holders............     *


                                    PART II

 5.  Market for Registrant's Common Equity and Related
       Stockholder Matters..........................................     8
 6.  Selected Financial and Operating Data..........................     8
 7.  Management's Discussion and Analysis of Results of Operations
     (Abbreviated pursuant to General Instruction I(2)).............     9
 7A. Quantitative and Qualitative Disclosures about Market Risk.....    18
 8.  Financial Statements and Supplementary Data....................    20
 9.  Changes in and Disagreements with Accountants on Accounting
       and Financial Disclosure.....................................    42


                                   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   43




----------

*Omitted pursuant to General Instruction I(2).

                                       

<PAGE>



                                           PART I

ITEM 1. BUSINESS

                                          GENERAL

Pacific Bell (PacBell,  which also includes its subsidiary,  PacBell Information
Services (PBIS)) is a telecommunications  company that operates 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  provides  landline   telecommunications   services  over
approximately  18 million  access lines in  California.  PacBell  provides local
exchange  services  and  is  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).

On February 8, 1996, the Federal Government enacted the  Telecommunications  Act
of 1996 (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 regulation of RHCs under the MFJ.

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 "Regulatory Environment" beginning on page 13.

Business Combinations

With the  completion  of SBC's  mergers  with PAC in 1997 and with  Southern New
England Telecommunications  Corporation in 1998, SBC began reviews of operations
of  PacBell,  Southwestern  Bell  Telephone,  Nevada Bell and The  Southern  New
England Telephone Company (collectively referred to as the Telephone Companies).
As a  result  of  the  review  and  recommendations  of  merger  teams,  SBC  is
centralizing  several key  functions  that will  support the  operations  of the
Telephone  Companies,   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.  The  Telephone
Companies will continue as separate legal entities.  These initiatives  continue
to 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. Additional information on this
matter is contained in Note 2 of Notes to Consolidated Financial Statements.


<PAGE>

                                    BUSINESS OPERATIONS

PacBell provides telecommunications services by serving approximately 18 million
access lines in the nation's most populous state, California, which includes two
of the country's five largest  metropolitan  areas.  PacBell offers customers an
expansive range of services and products,  varying by market,  including:  local
exchange  services,  long  distance,  telecommunications  equipment and enhanced
services.  Services  and products  (described  more fully below) are provided by
PacBell and its wholly-owned subsidiary, PBIS.

PacBell's  revenues are  categorized for financial  reporting  purposes as local
service, network access, long distance service and other.

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
------------------------------------------------ -------------------------------
                                                      1998      1997       1996
------------------------------------------------ ---------- --------- ----------
Local service                                          52%       52%        49%
Network access                                         28%       29%        30%
Long distance service                                  13%       13%        15%
------------------------------------------------ ---------- --------- ----------

Local  services  involve the  transport of wireline  telecommunications  traffic
between telephones and other customer premises equipment 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,  voice messaging and
Caller ID 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.

Long  distance  services  involve the  transport of  telecommunications  traffic
between  local  calling  areas within the same LATA  (intraLATA).  Long distance
services  also  include  other  services  such as Wide  Area  Telecommunications
Service (WATS or 800 services) and other special services.

PacBell provides its services over  approximately  10.9 million  residential and
7.0 million business access lines in California.  During 1998 total access lines
grew by 4.0%.

Customer Premises Equipment and Other Equipment Sales

Equipment offerings at PacBell range from single-line and cordless telephones to
sophisticated  digital  business  exchange  (PBX)  systems,  all of which can be
offered  with  PacBell's  central  office  based  solutions.  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.

New Products

As  part  of  its    continuing    strategy  to be   among  the  leaders  in the
communications services industry,  PacBell is constantly developing new services
and   products. It   currently   is introducing   several   new  data   products


<PAGE>


including   Asymmetrical    Digital    Subscriber  Line  (ADSL).   ADSL  enables
customers to transfer over existing telephone lines, data,  graphics,  audio and
video files at speeds up to 1.5  megabits per second.  ADSL allows  customers to
simultaneously  make a phone call and access  information via the Internet or an
office  local  area  network.  ADSL is the  subject  of a  pending  FCC  review.
Additional  information  relating to the pending FCC review of ADSL is contained
in Item 7, Management's Discussion and Analysis of Results of Operations of this
report under "Regulatory Environment" beginning on page 13.

During  1998,  PacBell  continued  to expand its  offering of vertical  services
throughout  its operating  areas.  These services  include,  among other things,
Caller ID, a feature which  displays the telephone  number of the person calling
and the caller's name in certain  markets;  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 has 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).

Since 1996,  PacBell has been offering  certain local  services on a "wholesale"
basis to  competitors,  as well as  providing  elements  of its  networks  on an
"unbundled"  basis for local  competition.  These  services are being offered as
specified by the Telecom Act and state actions and  interconnection  agreements.
The Telecom Act and the regulations promulgated by federal and state agencies to
implement  it  have  resulted  in  PacBell  facing   increased   competition  in
significant  portions of its business.  At December 31, 1998,  PacBell  provided
wholesale  services to  approximately  240,000 access lines.  Management  cannot
quantify  the  impact  to  PacBell's   business  in  1999  from  local  exchange
competition,  as uncertainty  exists as to the breadth and scope of competitors'
offering of local exchange services to all portions of the market in-region, and
as certain regulations,  tariffs and negotiations governing such competition are
not yet finalized,  but expects  continued  increases in local exchange services
competition.

Operating Segments

In June 1997, the Financial Accounting Standards Board issued Statement No. 131,
"Disclosures About Segments of an Enterprise and Related Information" (FAS 131),
which establishes  standards for the way that public business enterprises report
information   about  operating   segments  in  quarterly  and  annual  financial
statements.  FAS 131 changes segment reporting from an industry segment basis to
an operating  segment  basis  defined  based on how the business is managed.  As
PacBell  operates  in only one of SBC's  segments,  wireline  telecommunications
services, separate segment reporting does not apply to PacBell.

                                   GOVERNMENT REGULATION

PacBell is 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 services.  PacBell is also subject to the jurisdiction of the
FCC with respect to interstate and international  rates and services,  including
interstate access charges. Access charges are designed to compensate PacBell for
the use of their  facilities for the origination or termination of long distance
and other communications by other carriers.

Additional  information  relating to federal and state  regulation of PacBell is
contained  in Item  7,  Management's  Discussion  and  Analysis  of  Results  of
Operations of this report under the heading "Regulatory Environment" on page 13.


<PAGE>

                                       MAJOR CUSTOMER

No customer  accounted for more than 10% of PacBell's  consolidated  revenues in
1998, 1997 or 1996.

                                        COMPETITION

Information  relating  to  competition  in the  telecommunications  industry  is
contained  in Item  7,  Management's  Discussion  and  Analysis  of  Results  of
Operations of this report under the heading "Competition" beginning on page 16.

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).  PacBell 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 RHCs
sold  Bellcore to a third party but continue to have a research  agreement  with
Bellcore.  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. (TRI), a
subsidiary of SBC. TRI provides  research,  technology  planning and  evaluation
services to SBC and its subsidiaries, including PacBell.

                                         EMPLOYEES

As  of  December  31,  1998,  PacBell  employed  approximately  46,440  persons.
Approximately   three-fourths   of  the   employees  are   represented   by  the
Communications  Workers of America  (CWA).  A new agreement  between the CWA and
PacBell was reached on April 7, 1998,  covering an  estimated  34,000  employees
through  April 1, 2001.  Among  other  items,  the  agreement  specifies  an 11%
increase in wages over the life of the contract.

ITEM 2.  PROPERTIES

The properties of PacBell do not lend themselves to description by character and
location  of  principal  units.  At  December  31,  1998  network  access  lines
represented  40% of  PacBell's  investment  in  property,  plant and  equipment;
central office equipment  represented  40%; 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 5%.

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          1998             1997
 -------------------------------------------------------------------------------
 Debt Ratio (debt, including current
      maturities, as a percentage of                  
      total capital)                          65.79%           67.94%
 Network access lines in  service (000)       18,066           17,369
 Access minutes of use (000,000) *            73,847           68,727
 Resold lines (000)                              240              238
 Number of employees                          46,440           45,740
 -------------------------------------------------------------------------------

* Amounts have been restated.



<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
                                                1998        1997   1998 vs. 1997
--------------------------------------------------------------------------------
Operating revenues                          $  9,406    $  8,726            7.8%
Operating expenses                          $  7,107    $  8,243         (13.8)%
Income before extraordinary loss and
  cumulative effect of accounting changes   $  1,137    $      -            -
Extraordinary loss                          $    (60)   $      -            -
Cumulative effect of accounting changes     $      -    $    345            -
Net income                                  $  1,077    $    345            -
--------------------------------------------------------------------------------

PacBell  recognized  an  extraordinary  loss  in  1998  relating  to  the  early
retirement of debt (see Note 5 of Notes to Consolidated Financial Statements).

Net income for 1997 includes a cumulative  effect of accounting  changes related
to conforming accounting  methodologies between PacBell and SBC for, among other
items,  pensions  and  postretirement   benefits.   (See  Note  2  of  Notes  to
Consolidated Financial Statements.)

PacBell's  income  before  cumulative  effect  of  accounting  changes  for 1997
includes after-tax charges of $1,023 reflecting strategic  initiatives resulting
from SBC's merger with PAC, the impact of several recent regulatory  rulings and
ongoing merger integration costs. In addition, 1997 was favorably affected by an
$87 after-tax  settlement gain associated  with lump-sum  pension  payments that
exceeded the projected  service and interest costs for 1996  retirements  and an
$18  after-tax  gain on the sale of PacBell's  interest in  Bellcore.  Excluding
these 1997 one-time  charges and gains,  PacBell's  income before  extraordinary
loss and cumulative effect of accounting changes for 1997 was $918,  compared to
$1,137 for 1998,  an increase  of $219,  or 23.9%.  The primary  factor for this
increase in income before extraordinary loss and cumulative effect of accounting
change during 1998 was growth in demand for services and products.

Items  affecting the comparison of the operating  results  between 1998 and 1997
are discussed in the following sections.


<PAGE>


Management's Discussion and Analysis, continued
Dollars in millions

Operating Revenues

PacBell's  operating  revenues  increased $680, or 7.8%, in 1998.  Components of
total operating revenues,  including percentage changes from the prior year, are
as follows:

-------------------------------------------------------------------------------
                                                                  Percent Change
                                            1998        1997       1998 vs. 1997
-------------------------------------------------------------------------------
Local service                           $  4,852    $  4,515                7.5%
Network access:
  Interstate                               1,913       1,715               11.5
  Intrastate                                 764         790               (3.3)
Long distance service                      1,210       1,176                2.9
Other                                        667         530               25.8
================================================================
  Total operating revenues              $  9,406    $  8,726                7.8%
===============================================================================

    Local  Service  revenues  increased  $337, or 7.5%, in 1998 due primarily to
    increased demand,  which totaled $299,  including  increases in access lines
    and vertical  services  revenues.  The number of access  lines  increased by
    approximately 4.0% in 1998, with approximately 53% of access line growth due
    to the sales of additional access lines to existing  residential  customers.
    Vertical  services  revenues,  which include custom calling  services,  call
    control  options,  Caller  ID,  voice  mail  and  other  enhanced  services,
    increased by approximately 26% and totaled approximately $732 for 1998.

    Additionally,  local  service  revenues  increased  as a result  of  several
    regulatory  actions that also had the effect of decreasing one or more other
    types of operating  revenues.  In 1998, federal payphone  regulation and the
    introduction of the California High Cost Fund (CHCFB) collectively increased
    local service  revenues by  approximately  $77 and  decreased  long distance
    revenue  by  approximately   $43,   intrastate  network  access  revenue  by
    approximately $24, interstate network access revenue by approximately $8 and
    other  operating  revenue  by  approximately  $7.  The net  effect  on total
    operating  revenue for these items was a decrease of $5. 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 increase in local service  revenues was  partially  offset by
    decreases of $22 resulting from rate reductions under CPUC price cap orders.

    Network Access The increase in interstate  network  access  revenues in 1998
    reflects  second  quarter  1997  one-time  charges of $134.  These  one-time
    charges  included  billing  claim  settlements  related to the effect of the
    change of the  Percentage  Interstate  Usage (PIU) factor in California  and
    several federal regulatory issues including end-user charges,  800 data base
    charges,  recovery of certain employee-related  expenses and the retroactive
    effect  of the  productivity  factor  adjustment  in the  federal  price cap
    filing.  While the 1997 change in the PIU factor,  which is used to allocate
    network access usage between interstate and intrastate  jurisdictions,  also
    had the effect of increasing intrastate network access revenues, it resulted
    in a slight decline in total network access revenues due to rate differences
    between the two jurisdictions.

    Without these impacts, interstate access revenues increased $64, or 3.5%, in
    1998. The increase was due primarily to increased demand for access services
    by interexchange carriers,  primarily special access, and growth in end-user
    charges  attributable to an increasing access line base, which  collectively
    resulted in an increase of approximately  $169.  Partially  offsetting these
    increases  were  the  effects  of  PacBell's   annual  rate   reductions  of
    approximately  $47 related to the FCC's  productivity  factor adjustment and
    changes related to payphone  deregulation of approximately $8 noted in local
    service  


<PAGE>


Management's Discussion and Analysis, continued
Dollars in millions

    above.    Additional   decreases  in   1998    totaling  approximately   $38
    resulted from an increase in universal service fund net payments implemented
    in the  first  quarter  of 1998  that  exceeded  the  1997 net  payments  of
    long-term support,  which were designed to subsidize universal service.  The
    net federal  universal fund payments and receipts will be exogenous  factors
    in future federal price cap filings.

    Intrastate  network access  revenues  decreased $26, or 3.3%, in 1998 due to
    the 1997 PIU  settlements  of $32 described  above.  Excluding  this impact,
    intrastate  network access  increased  slightly,  attributable  to increased
    demand of $41, offset in part by the effects of the CHCFB described above in
    local  service  totaling  approximately  $24 and by CPUC rate  reductions of
    approximately $4.

    Long  Distance  Service  revenues  increased  $34,  or 2.9%,  in 1998.  This
    increase was related to a higher  volume of toll messages due to the growing
    California economy and alternative calling plans totaling  approximately $48
    and local exchange  carrier  billing  settlements of  approximately  $17. As
    noted in local service,  the increase in long distance  service revenues was
    partially  offset by the combined  effects of payphone  deregulation and the
    CHCFB of $43.

    Other operating  revenues increased $137, or 25.8%, in 1998 due primarily to
    increased   sales  from   nonregulated   products  and   services   totaling
    approximately $65 and increased  equipment sales of approximately $57. These
    increases  were  partially  offset by  approximately  $7  related to federal
    payphone regulation discussion in local service above.

Operating Expenses

Components of total operating  expenses  including  percentage  changes from the
prior year, are as follows:

-------------------------------------------------------------------------------
                                                                  Percent Change
                                            1998        1997       1998 vs. 1997
-------------------------------------------------------------------------------
Operations and support                  $  5,242    $  6,320             (17.1)%
Depreciation and amortization              1,865       1,923              (3.0)
----------------------------------------------------------------
  Total operating expenses              $  7,107    $  8,243             (13.8)%
===============================================================================

PacBell manages its financial and business operations excluding special one-time
or  unusual  charges  and  refers  to  these  adjusted   results  as  normalized
operations.   As  discussed  in  Note  2  of  Notes  to  Consolidated  Financial
Statements,  PacBell's  operating  expenses  in 1997  reflect  $1.3  billion  of
adjustments for charges related to SBC's strategic initiatives,  a comprehensive
review of operations  of the merged  company,  the impact of several  regulatory
rulings and ongoing merger integration costs. In addition, 1997 includes a first
quarter  settlement gain of $146 associated with lump-sum  pension payments that
exceeded  the  projected  service  and  interest  costs  for  1996  retirements.
Excluding  these  1997  adjustments,  PacBell's  normalized  operating  expenses
increased $184, or 2.7%, for 1998.

    Operations and Support  Components of operations and support and normalizing
    adjustments for 1998 and 1997 are as follows:

-------------------------------------------------------------------------------
                                                                  Percent Change
                                            1998        1997       1998 vs. 1997
-------------------------------------------------------------------------------
Operations and support                  $  5,242    $  6,320             (17.1)%
Adjustments                                    -      (1,194)              -
----------------------------------------------------------------
  Normalized operations and support     $  5,242    $  5,126               2.3%
===============================================================================

    
<PAGE>


Management's Discussion and Analysis, continued
Dollars in millions

    Normalized  operations  and support  increased  $116, or 2.3%, in 1998.  The
    increase  for  1998  includes  costs  of   approximately   $411  related  to
    progression  in the merger  implementation  process  including  charges from
    centralized  support functions  throughout SBC and other merger initiatives.
    Operations and support also increased in 1998 due to 1997 pension settlement
    gains relating to 1997 retirees  totaling  approximately  $146 and increased
    costs  associated  with  reciprocal  compensation  for  the  termination  of
    Internet traffic of approximately $76 (see "Federal  Regulation" for further
    discussion  about   reciprocal   compensation).   In  addition,   materials,
    right-to-use   fees  and  union   contract   ratification   fees   increased
    approximately  $67. These  increases were partially  offset by reductions in
    use of  contract  labor of  approximately  $181,  reduced  expenditures  for
    interconnection,   customer  number   portability   and  local   competition
    initiatives of approximately  $195 and net reductions to wages and salaries,
    benefits,  research and development costs and other non-labor costs totaling
    approximately $199.

    Depreciation and Amortization Summarization of depreciation and amortization
    expense and normalizing adjustments for 1998 and 1997 is as follows:

-------------------------------------------------------------------------------
                                                                  Percent Change
                                            1998        1997       1998 vs. 1997
-------------------------------------------------------------------------------
Depreciation and amortization           $  1,865    $  1,923              (3.0)%
Adjustments                                    -        (127)              -
----------------------------------------------------------------
  Normalized depreciation and 
    amortization                        $  1,865    $  1,796                3.8%
===============================================================================

    Depreciation  and  amortization  expense for 1997 reflects  charges totaling
    $127  to  record  impairment  of  plant  and  intangibles  including  analog
    switching   equipment.   Excluding  these   adjustments,   depreciation  and
    amortization  increased  $69, or 3.8%,  in 1998.  The net  increase  was due
    primarily to increased  depreciation  expense of $97 resulting  from overall
    higher  plant  levels.   This  increase  was  partially  offset  by  reduced
    depreciation of $42 on analog switching equipment.

Interest  Expense  decreased  $34,  or  7.4%,  in 1998  due to  interest  of $27
associated  with the second  quarter  1997  one-time  charges.  Excluding  these
one-time  charges,  interest  expense  decreased  $7, or 1.6%,  due primarily to
reductions  in interest  expense  resulting  from lower  average debt levels and
lower weighted average interest rates.

Other Income  (Expense) - Net in 1997 included a second quarter  one-time charge
of $30 for SBC's  strategic  initiatives,  primarily  writeoffs of  nonoperating
plant,  partially  offset  by the gain  recognized  from  the sale of  PacBell's
interest in Bellcore of $30.

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 and the impact of several  regulatory rulings as well as taxes on
the  pension  settlement  gain  and gain on the sale of  PacBell's  interest  in
Bellcore  discussed in operations  and support.  Excluding  these items,  income
taxes for 1997  would  have been  $580.  Income  taxes for 1998 were  higher due
primarily to higher income before income taxes.

Extraordinary  Loss In  1998,  PacBell  recorded  an  extraordinary  loss of $60
related to the refinancing of $684 of long-term debt.

Cumulative  Effect of  Accounting  Changes,  as  discussed in Note 2 of Notes to
Consolidated  Financial  Statements,  includes  the  effect of  changes  applied
retroactively  to  conform  accounting  methodologies 


<PAGE>


Management's Discussion and Analysis, continued
Dollars in millions

between PacBell and   SBC effective January 1, 1997.  The  cumulative  after-tax
effect of these one-time changes is $345.

Operating Environment and Trends of the Business

Regulatory Environment

Overview

The  telecommunications  industry  is in a period of dynamic  transition  from a
tightly  regulated  industry  overseen  by  multiple   regulatory  bodies  to  a
market-driven industry monitored by state and federal agencies.  PacBell remains
subject to  regulation  by the CPUC for  intrastate  services and by the FCC for
interstate services.

Consolidation  of  companies  is  occurring  within  the  marketplace  for local
telephone  service and across other  telecommunications  services,  such as long
distance,  cellular,  cable  television,  Internet  and other data  transmission
services.  Companies  operating in some of these markets are also expanding into
others,  such as the  provision  of local  service by long  distance  companies.
Additionally,  new  technologies  are also affecting the way people view and use
communications services.

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

Federal Regulation

Under the Telecom Act, before being  permitted to offer landline  interLATA long
distance service in any state within the regulated operating areas, 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 the
CPUC,   requires  favorable   determinations   that  PacBell  has  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 PacBell has a statement of terms and
conditions  effective  in that state  under  which  they offer the  "competitive
checklist"  items.  The  FCC  must  also  make  favorable  public  interest  and
structural separation  determinations in connection with such applications.  See
"State Regulation" for status of the California application.

In December 1997, the United States District Court for the Northern  District of
Texas ruled that parts of the Telecom Act were  unconstitutional  on the grounds
that they improperly  discriminate against PacBell by imposing restrictions that
prohibit  PacBell  by name  from  offering  interLATA  long  distance  and other
services  that other Local  Exchange  Carriers  (LECs) are free to  provide.  In
September  1998,  the United  States Court of Appeals for the Fifth Circuit (5th
Circuit) reversed this decision and ruled that the challenged  provisions of the
Telecom Act were  constitutional.  In January 1999,  the United  States  Supreme
Court (Supreme Court) declined to hear an appeal of the 5th Circuit decision.

Interconnection  In August 1996, the FCC issued rules by which competitors could
connect with LECs' networks, including those of PacBell. 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.


<PAGE>


Management's Discussion and Analysis, continued
Dollars in millions

In July 1997,  the United  States  Court of Appeals for the Eighth  Circuit (8th
Circuit)  held  that the FCC did not  have the  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.

In January  1999,  the  Supreme  Court  ruled on an appeal of the 8th  Circuit's
order.  The ruling held that the Telecom Act gives the FCC the  authority to set
guidelines  for states to follow in setting  prices  under the Telecom  Act, and
reinstated  the FCC rules allowing  those seeking to  interconnect  to "pick and
choose" specific provisions from previous  interconnection  agreements.  Because
the 8th Circuit's  decision did not address the lawfulness of the content of the
FCC pricing guidelines, the Supreme Court remanded that issue to the 8th Circuit
for  further  consideration.  The Supreme  Court also held that,  before the FCC
could require  telecommunications  carriers to make a particular network element
available to requesting carriers,  the FCC must first consider as to proprietary
elements,  whether  access to the elements was necessary and whether the failure
to provide access to a particular element would impair the requesting  carrier's
ability to provide the  service it seeks to offer.  The effect of this ruling on
PacBell cannot be determined at this time.

Reciprocal   Compensation  Reciprocal  compensation  is  billed  to  PacBell  by
Competitive Local Exchange Carriers (CLECs) for the termination of certain local
exchange  traffic to CLEC customers.  Several state  commissions,  including the
CPUC  in  an  October  1998  order,   expressed   the  position   that  Internet
communications  is intrastate  or local traffic and the CPUC ordered  PacBell to
pay  reciprocal   compensation  to  certain  CLECs  pursuant  to  then  existing
contracts. PacBell has filed an application for rehearing of this decision which
is pending.

In  February  1999,  the  FCC  ruled  that a  substantial  portion  of  Internet
communications   is  interstate   traffic  and  therefore   subject  to  federal
jurisdiction. The FCC noted that carriers were bound by existing interconnection
contracts  as  interpreted  by  state  commissions.  The FCC  will  issue  rules
determining the extent,  if any, such  communications  are subject to reciprocal
compensation. The FCC also ruled that, in the context of interpreting particular
interconnection   agreements,   the  state   commissions  might  determine  that
reciprocal  compensation was appropriately based on the agreement of the parties
or  other  factors.  SBC  believes  that the FCC  ruling  should  prevent  state
commissions from imposing reciprocal compensation on this traffic.

Asymmetrical   Digital  Subscriber  Line  ADSL  is  a  high-speed  data  service
principally  used for Internet  access.  In June 1998,  SBC filed with the FCC a
petition  requesting  relief  for  ADSL  from  pricing,  unbundling  and  resale
regulatory  restrictions.   The  FCC  denied  the  petition  and  declared  that
incumbents  must offer  such  services  for resale at a discount  and must offer
unbundled  access  to the  equipment  used in ADSL  provisioning  to the  extent
possible.  SBC has filed with the FCC a  petition  for  reconsideration  of this


<PAGE>


Management's Discussion and Analysis, continued
Dollars in millions

order.  The FCC sought  comments on offering  the  incumbent  LECs the option of
providing  deregulated  advanced  services through an affiliate with appropriate
safeguards. In California, PacBell has state approved ADSL tariffs, therefore it
is uncertain what effect, if any, the FCC regulations might have on PacBell.

The  effects of the FCC  decisions  on the above  topics 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 CPUC's  review and  handling  of
related  matters within its  jurisdiction.  Accordingly,  PacBell is not able to
assess the impact of the FCC orders and proposed rulemaking at this time.

State Regulation

Long Distance  Application  In October 1998, the CPUC staff released a report on
PacBell's  checklist  compliance efforts concluding that PacBell had not met all
items  of the  FCC's  14-point  checklist  required  for  entry  into  in-region
interLATA long  distance.  In December 1998, the CPUC issued a decision that set
forth items for implementation for final compliance with the checklist.  By June
1, 1999, PacBell is required either to make a compliance filing or to inform the
CPUC when it will make a filing.  The CPUC will then issue a  proposed  decision
within 60 days of the filing.

IntraLATA  Toll Dialing  Parity In a January 1999  decision,  the Supreme  Court
ruled that the FCC had the authority to issue rules implementing  intrastate and
intraLATA  dialing parity.  The CPUC ruled in 1997 that PacBell should implement
intraLATA dialing parity under the Telecom Act at the same time its affiliate is
able to provide interLATA long distance services. Several interexchange carriers
are arguing  before the CPUC that the Supreme  Court ruling  requires  immediate
implementation  of dialing parity,  preempting  state  requirements and that the
CPUC must change its earlier  decision.  PacBell takes the position that dialing
parity  requirements should be consistent with state laws and that it should not
be required to provide  intraLATA  toll dialing  parity prior to interLATA  long
distance  authorization.  In states where dialing parity  exists,  customers are
able to subscribe to an intraLATA toll carrier just as they do for long distance
services. The parties have filed briefs addressing these issues and are awaiting
the CPUC's position in the proceeding.  It is also anticipated that the FCC will
issue an order dealing with implementation of intraLATA toll dialing parity.

California  Regulation In October 1998, the CPUC issued a decision modifying the
current regulatory framework for PacBell effective January 1, 1999. The decision
adopted  PacBell's  proposal that the current cap on basic  residential rates be
continued  for three more  years,  through  2001,  with the CPUC  retaining  the
ability  to adjust  basic  telephone  rates.  The  decision  suspended  earnings
sharing,  rate of return reviews and the use of earnings caps and floors through
2001.  In  addition,  the  decision  adopted  PacBell's  proposal  to  eliminate
depreciation reviews and granted PacBell the freedom to set its own depreciation
rates and  methodology.  It also  continued the  suspension of the  productivity
factor  adjustment.  In  addition,  the CPUC  decision  eliminated  most  future
exogenous cost  adjustments  including the recovery of future costs related to a
1993  accounting  change  for  postretirement   benefits  other  than  pensions.
Management  currently  estimates the items  embodied  within the new  regulatory
framework will have the net effect of reducing revenue annually by approximately
$100 from 1999 through 2004.

Uniform System of Accounts  Rewrite In a 1988 CPUC decision,  PacBell received a
rate increase as a result of an FCC mandated change in accounting which required
the expensing of 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.  PacBell filed an application in 1995 to terminate
the rate reductions and with  subsequent  CPUC approval,  halted rate reductions
for 1996, 1997 and 1998, pending the outcome 


<PAGE>


Management's Discussion and Analysis, continued
Dollars in millions

of hearings. In September 1998, the CPUC issued a decision that grants PacBell's
request to discontinue the rate reductions. The decision became final in October
1998.

Universal  Service In July 1998,  the CPUC  issued a rate  rebalancing  decision
related  to its  1996  order on  universal  service.  The  CPUC's  decision  was
implemented  prospectively  beginning  September  1, 1998 and reduces  PacBell's
non-basic local service,  network access and long distance  service  revenues by
$305 annually to offset the approximately  $305 annually that PacBell expects to
receive  from the CHCFB.  Beginning  in February  1997,  PacBell,  and all other
California  telecommunications  carriers,  began  collecting  funds via customer
surcharges consistent with the CPUC's 1996 decision.  The CPUC has yet to decide
on the  specific  mechanism to be employed to ensure the  distribution  of funds
collected by PacBell and other  carriers from February 1997 through  August 1998
is revenue neutral.

Competition

Competition  continues  to  increase  for   telecommunications  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 as
well as new opportunities in significant portions of its business.

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 PacBell's  networks and
exchange local calls must enter into  interconnection  agreements  with PacBell.
These  agreements are then subject to approval by the CPUC.  PacBell has reached
approximately 66  interconnection  and resale  agreements with competitive local
service providers,  and most have been approved by the CPUC. AT&T, MCI WorldCom,
Inc. and other competitors are reselling PacBell's local exchange services,  and
as of December 31, 1998,  there were  approximately  240,000 of PacBell's 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.  PacBell  has  incurred
substantial   costs   implementing   local   competition   and  customer  number
portability.  In November 1998, the CPUC issued a decision  allowing  PacBell to
begin recovery of local competition implementation costs.

PacBell expects increased  competitive pressure in 1999 and beyond from multiple
providers in various markets  including  facilities-based  CLECs,  interexchange
carriers 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.  Competition
also continues to intensify in PacBell's  intraLATA long distance  markets.  For
example,  it is estimated that providers  other than PacBell now serve more than
half of the business  intraLATA  long  distance  customers in PacBell's  service
areas. In addition, if intraLATA toll dialing parity is required, competition in
intraLATA long distance markets is expected to increase.


<PAGE>


Management's Discussion and Analysis, continued
Dollars in millions

Other Business Matters

New Accounting  Standards In June 1998, the Financial Accounting Standards Board
issued  Statement No. 133,  "Accounting  for Derivative  Instruments and Hedging
Activities"  (FAS 133) which will require all  derivatives to be recorded on the
balance sheet at fair value,  and will require changes in the fair values of the
derivatives to be recorded in net income or comprehensive  income.  FAS 133 must
be  adopted  for years  beginning  after  June 15,  1999 with  earlier  adoption
permitted. PacBell currently has no derivative financial instruments.

See Note 1 of Notes to Consolidated Financial Statements for a discussion of the
new accounting standard on software costs.

SBC's Year 2000  Project  SBC and its  subsidiaries  and  affiliates,  including
PacBell,  operate  numerous  date-sensitive  computer  applications  and systems
throughout  its  businesses.  Since  1996,  SBC has been  working to upgrade its
networks and computer  systems to properly  recognize the Year 2000 and continue
to process critical operational and financial information. Companywide teams are
in place to address and resolve Year 2000 issues and  processes are under way to
evaluate  and  manage  the risks  and  costs  associated  with  preparing  SBC's
date-impacted systems and networks for the new millennium.

SBC is using a  four-step  methodology  to address  the issue.  The  methodology
consists of inventory and assessment,  hardware and software fixes,  testing and
deployment.  SBC  measures  its  progress  by tracking  the number of  completed
hardware and software applications,  network components,  personal computers and
building facilities that can correctly process Year 2000 dates.

Inventory and  assessment is estimated to require 20% of the overall  effort and
includes  the  identification  of items (i.e.,  line-by-line  review of software
code, switch generics, vendor products, etc.) that could be impacted by the Year
2000 and the determination of the work effort required to ensure compliance. The
inventory  and  assessment  phase  has been  completed.  This  process  involved
reviewing  over 340  million  lines  of  software  code,  1,200  central  office
switches,  7,000 company  buildings,  conducting an inventory and  assessment of
117,000  personal  computers,  and  coordinating  with 1,300 suppliers of 14,000
products  to obtain  adequate  assurance  they will be Year  2000  compliant  or
determine and address any appropriate contingency plans or backup systems.

Making the hardware and software fixes is the second phase of the process and is
estimated to require 25% of the overall effort. This activity involves modifying
program code,  upgrading computer software and upgrading or replacing  hardware.
As of December 31, 1998,  the  hardware  and software  fixes were  substantially
complete.

Testing involves ensuring that hardware and software fixes will work properly in
1999 and  beyond  and  occurs  both  before  and after  deployment.  Testing  is
estimated to comprise 45% of the overall effort. Testing began early in 1998, is
more than  two-thirds  complete,  and will  continue  through  1999 to allow for
thorough testing before the Year 2000.  Contingency plans and backup systems are
currently being written.

Deployment  involves  placing the "fixed"  systems  into a live  environment  to
ensure they are working properly. Additional testing is done after deployment as
well.  Deployment is estimated to require 10% of the overall  effort.  More than
half of the deployment phase was completed as of December 31, 1998.

SBC  expects  to  spend   approximately   $265  on  the  entire  project,   with
approximately  $140 spent through December 31, 1998. As testing and hardware and
software fixes are estimated to require most of the expenditures, there is not a
strict correlation between expenditures and project completion.


<PAGE>


Management's Discussion and Analysis, continued
Dollars in millions

The activities involved in SBC's Year 2000 project necessarily require estimates
and  projections,  as described  above, of activities and resources that will be
required in the future.  These  estimates and  projections  could change as work
progresses on the project.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk

PacBell's capital costs are managed by SBC, and are directly linked to financial
and business  risks.  SBC seeks to manage the  potential  negative  effects from
market volatility and market risk. Certain financial  instruments used to obtain
capital are subject to market risks from  fluctuations in market interest rates.
The majority of SBC's financial instruments are medium- and long-term fixed rate
notes  and  debentures.  Fluctuations  in  market  interest  rates  can  lead to
significant fluctuations in the fair value of these notes and debentures.  It is
the policy of SBC to manage its debt structure in order to manage capital costs,
control financial risks and maintain  financial  flexibility over the long term.
Where  appropriate,  SBC will  take  actions  to limit  the  negative  effect of
interest rates, liquidity and counterparty risks on shareowner value.

Quantitative Information about Market Risk

Interest Rate Sensitivity

PacBell currently has no derivative financial instruments.  The principal amount
by  expected  maturity,  average  interest  rate and fair  values  of  PacBell's
liabilities  that are exposed to interest rate risk are described in Notes 4 and
5 of Notes to Consolidated Financial Statements.

There has been no material change in the updated market risks since December 31,
1997.

Qualitative Information about Market Risk

Interest Rate Risk

PacBell's  interest  rate risk is managed by SBC.  SBC issues  debt in fixed and
floating  rate  instruments.  Interest  rate  swaps are used for the  purpose of
controlling  interest expense by fixing the interest rate of floating rate debt.
When market conditions favor issuing debt in floating rate instruments,  and SBC
prefers not to take the risk of floating  rates,  SBC will enter  interest  rate
swap contracts to obtain  floating rate payments to service the debt in exchange
for  paying a fixed  rate.  SBC does not seek to make a profit  from  changes in
interest rates.  SBC manages  interest rate  sensitivity by measuring  potential
increases  in  interest  expense  that would  result  from a probable  change in
interest  rates.  When the  potential  increase in interest  expense  exceeds an
acceptable  amount,  SBC  reduces  risk  through  the  issuance  of  fixed  rate
instruments and purchasing derivatives.

            CAUTIONARY LANGUAGE CONCERNING FORWARD-LOOKING STATEMENTS

Information set forth in this form contains forward-looking  statements that are
subject to risks and  uncertainties.  PacBell  claims the protection of the safe
harbor  for  forward-looking  statements  provided  by  the  Private  Securities
Litigation Reform Act of 1995.

The following  factors could cause PacBell's future results to differ materially
from those expressed in the  forward-looking  statements:  (1) adverse  economic
changes in the markets served by PacBell or changes in available technology; (2)
the final outcome of various FCC  rulemakings  and judicial  review,  if any, of
such


<PAGE>


Management's Discussion and Analysis, continued
Dollars in millions

rulemakings;  (3) the final  outcome  of  various  CPUC  proceedings,  and
judicial review,  if any, of such  proceedings;  and (4) the timing of entry and
the extent of competition in the local and intraLATA toll markets in California.
Readers are cautioned  that other factors  discussed in this form,  although not
enumerated here, also could materially impact PacBell's future earnings.

<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 sheets of Pacific Bell (a
wholly-owned  subsidiary of Pacific Telesis Group, a wholly-owned  subsidiary of
SBC  Communications  Inc.) as of  December  31,  1998 and 1997,  and the related
consolidated  statements of income,  shareowner's  equity and cash flows for the
years 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 financial statements and schedules based on our audits.

We  conducted  our  audits  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 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 the
Company at  December  31,  1998 and 1997,  and the  consolidated  results of its
operations  and its cash  flows for the years 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 1 to the  consolidated  financial  statements,  in 1998 the
Company changed its reporting entity. We have audited the adjustments  described
in Note 10 that were applied to restate the financial statements of the Company.
In our opinion, such adjustments are appropriate and have been properly applied.

As discussed in Note 2 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 12, 1999



<PAGE>



                       REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Shareowner of Pacific Bell:

We have  audited the  accompanying  consolidated  statements  of income and cash
flows for the year  ended  December  31,  1996 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 for the
year ended December 31, 1996, as included in the column `Originally reported' in
Note 10. These  consolidated  financial  statements  are the  responsibility  of
management.  Our  responsibility  is to express  an  opinion on these  financial
statements based on our audit.

We conducted our audit 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 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  results of operations of
Pacific Bell and  Subsidiaries  and their cash flows for the year ended December
31, 1996 in conformity with generally accepted accounting principles.




                                            PRICEWATERHOUSECOOPERS LLP

San Francisco, California
February 27, 1997




<PAGE>


<TABLE>
PACIFIC BELL
-----------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
Dollars in millions
-----------------------------------------------------------------------------
<CAPTION>
                                                     1998     1997      1996
-----------------------------------------------------------------------------
<S>                                               <C>      <C>       <C>
Operating Revenues
Local service                                     $ 4,852  $ 4,515   $ 4,151
Network access:
  Interstate                                        1,913    1,715     1,807
  Intrastate                                          764      790       718
Long distance service                               1,210    1,176     1,274
Other                                                 667      530       497
-----------------------------------------------------------------------------
Total operating revenues                            9,406    8,726     8,447
-----------------------------------------------------------------------------

Operating Expenses
Operations and support                              5,242    6,320     4,700
Depreciation and amortization                       1,865    1,923     1,804
-----------------------------------------------------------------------------
Total operating expenses                            7,107    8,243     6,504
-----------------------------------------------------------------------------
Operating Income                                    2,299      483     1,943
-----------------------------------------------------------------------------

Other Income (Expense)
Interest expense                                     (426)    (460)     (379)
Other income - net                                     (2)      11         4
-----------------------------------------------------------------------------
Total other income (expense)                         (428)    (449)     (375)
-----------------------------------------------------------------------------
Income Before Income Taxes, Extraordinary Loss
  and Cumulative Effect of Accounting Changes       1,871       34     1,568
-----------------------------------------------------------------------------
Income Taxes                                          734       34       619
-----------------------------------------------------------------------------
Income Before Extraordinary Loss and
  Cumulative Effect of Accounting Changes           1,137        -       949
Extraordinary Loss from Early Extinguishment
  of Debt, net of tax                                 (60)       -         -
Cumulative Effect of Accounting Changes, net of tax     -      345         -
-----------------------------------------------------------------------------
Net Income                                        $ 1,077  $   345   $   949
-----------------------------------------------------------------------------
The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.
</TABLE>


<PAGE>


<TABLE>
PACIFIC BELL
-------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
Dollars in millions except per share amounts
-------------------------------------------------------------------------------
<CAPTION>
                                                               December 31,
                                                        -----------------------
                                                             1998         1997
-------------------------------------------------------------------------------
<S>                                                      <C>          <C>
Assets
Current Assets
Cash and cash equivalents                                $     15     $     43
Accounts receivable - net of allowances for
  uncollectibles of $161 and $152                           2,015        1,782
Prepaid expenses                                               90           53
Deferred income taxes                                         280          415
Other current assets                                           31           44
-------------------------------------------------------------------------------
Total current assets                                        2,431        2,337
-------------------------------------------------------------------------------
Property, Plant and Equipment - at cost                    29,871       28,695
  Less: Accumulated depreciation and amortization          18,272       17,442
-------------------------------------------------------------------------------
Property, Plant and Equipment - Net                        11,599       11,253
-------------------------------------------------------------------------------
Other Assets                                                1,063          749
-------------------------------------------------------------------------------
Total Assets                                             $ 15,093     $ 14,339
-------------------------------------------------------------------------------

Liabilities and Shareowner's Equity
Current Liabilities
Intercompany loans                                       $  1,551     $    542
Current portion of long-term obligations                      103            4
-------------------------------------------------------------------------------
Total debt maturing within one year                         1,654          546
Accrued taxes                                                 122          334
Accounts payable and accrued liabilities                    2,669        2,719
-------------------------------------------------------------------------------
Total current liabilities                                   4,445        3,599
-------------------------------------------------------------------------------
Long-Term Debt                                              4,614        5,358
-------------------------------------------------------------------------------

Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes                                       1,082          957
Postemployment benefit obligation                             894          881
Unamortized investment tax credits                            149          188
Other noncurrent liabilities                                  649          569
-------------------------------------------------------------------------------
Total deferred credits and other noncurrent liabilities     2,774        2,595
-------------------------------------------------------------------------------

Shareowner's Equity
Common shares ($1 par value, 300,000,000 authorized:
issued 224,504,982 at December 31, 1998 and 1997)             225          225
Capital in excess of par value                              4,210        4,814
Retained earnings (deficit)                                (1,175)      (2,252)
-------------------------------------------------------------------------------
Total shareowner's equity                                   3,260        2,787
-------------------------------------------------------------------------------
Total Liabilities and Shareowner's Equity                $ 15,093     $ 14,339
-------------------------------------------------------------------------------
The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.
</TABLE>


<PAGE>


<TABLE>
PACIFIC BELL
-----------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
Dollars in millions, increase (decrease) in cash and cash equivalents
-----------------------------------------------------------------------------
<CAPTION>
                                                      1998      1997    1996
-----------------------------------------------------------------------------
<S>                                                <C>      <C>       <C>
Operating Activities
Net income                                         $ 1,077    $  345  $  949
Adjustments to reconcile net income to net cash
  provided by operating activities:
   Depreciation and amortization                     1,865     1,923   1,804
   Provision for uncollectible accounts                150       184     130
   Amortization of investment tax credits              (39)      (47)    (47)
   Deferred income taxes                               335        49     257
   Extraordinary loss, net of tax                       60         -       -
   Cumulative effect of accounting change, net of tax    -      (345)      -
     Changes in operating assets and liabilities:
     Accounts receivable                              (383)        5    (460)
     Other current assets                              (24)      (28)     21
     Accounts payable and accrued liabilities         (261)      651     (76)
Other - net                                           (336)     (243)   (401)
-----------------------------------------------------------------------------
Total adjustments                                    1,367     2,149   1,228
-----------------------------------------------------------------------------
Net Cash Provided by Operating Activities            2,444     2,494   2,177
-----------------------------------------------------------------------------

Investing Activities
Construction and capital expenditures               (2,140)   (2,045) (1,911)
Dispositions                                             -        65       -
Other                                                    -       (14)    (22)
-----------------------------------------------------------------------------
Net Cash Used in Investing Activities               (2,140)   (1,994) (1,933)
-----------------------------------------------------------------------------

Financing Activities
Net change in short-term borrowings with original
  maturities of three months or less                 1,009      (122)   (280)
Issuance of other short-term borrowings                  -       610       -
Repayment of other short-term borrowings                 -      (610)      -
Issuance of long-term debt                             217       252     495
Repayment of long-term debt                           (185)        -      (4)
Early extinguishment of debt and related call
  premiums                                            (765)        -       - 
Equity received from parent                            155        49     388
Dividends paid                                        (763)     (693)   (879)
Other                                                    -         -      33
-----------------------------------------------------------------------------
Net Cash Used in Financing Activities                 (332)     (514)   (247)
-----------------------------------------------------------------------------
Net decrease in cash and cash equivalents              (28)      (14)     (3)
-----------------------------------------------------------------------------
Cash and cash equivalents beginning of year             43        57      60
-----------------------------------------------------------------------------
Cash and Cash Equivalents End of Period            $    15    $   43  $   57
-----------------------------------------------------------------------------
The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.
</TABLE>

<PAGE>


<TABLE>
PACIFIC BELL
---------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF SHAREOWNER'S EQUITY
Dollars in millions
---------------------------------------------------------------------------
<CAPTION>
                                                                  Retained
                                            Common      Paid-in   Earnings
                                             Stock      Surplus  (Deficit)
---------------------------------------------------------------------------
<S>                                      <C>         <C>        <C>
Balance, December 31, 1995               $     225   $   5,071  $  (2,667)
Net income                                       -           -        949
Dividend to shareowner                           -           -       (879)
Equity from parent                               -         388          -
Other                                            -          (1)         -
---------------------------------------------------------------------------
Balance, December 31, 1996                     225       5,458     (2,597)
---------------------------------------------------------------------------
Net income                                       -           -        345
Dividend to shareowner                           -        (693)         -
Equity from parent                               -          49          -
---------------------------------------------------------------------------
Balance, December 31, 1997                      225      4,814     (2,252)
---------------------------------------------------------------------------
Net income                                       -           -      1,077
Dividend to shareowner                           -        (763)         -
Equity from parent                               -         155          -
Other                                            -           4          -
---------------------------------------------------------------------------
Balance, December 31, 1998               $     225   $   4,210  $  (1,175)
---------------------------------------------------------------------------
The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.
</TABLE>


<PAGE>
                                     

Notes to Consolidated 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 also  includes  its  subsidiary
    Pacific Bell Information Services).  PacBell is a wholly-owned subsidiary of
    Pacific Telesis Group (PAC), a wholly-owned subsidiary of SBC Communications
    Inc. (SBC).  PacBell operates in the  telecommunications  industry providing
    landline services in California.  On March 31, 1998, PacBell distributed the
    shares of Pacific Bell Directory, Pacific Bell Mobile Services, Pacific Bell
    Internet  Services and PB COMM Switches,  Inc. to PAC. PacBell has accounted
    for this  distribution  as a  change  in  reporting  entity.  The  financial
    statements of all periods  presented  have been  restated to show  financial
    information for the new reporting entity.

    All   significant   intercompany   transactions   are   eliminated   in  the
    consolidation process.

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

    Comprehensive  Income - Comprehensive  income for PacBell is the same as net
    income for all periods presented.

    Operating Segments - In June 1997, the Financial  Accounting Standards Board
    issued Statement No. 131,  "Disclosures  About Segments of an Enterprise and
    Related Information" (FAS 131), which establishes standards for the way that
    public business  enterprises  report information about operating segments in
    quarterly and annual financial statements. FAS 131 changes segment reporting
    from an industry  segment basis to an operating  segment basis defined based
    on how the  business  is managed.  As PacBell  operates in only one of SBC's
    segments, wireline  telecommunications  services, separate segment reporting
    is not applicable to PacBell.

    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  (Agreement) between PacBell and
    SBC. In general, PacBell's income tax provision under the 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.

    Revenue Recognition - PacBell recognizes revenues as earned.  Amounts billed
    in advance of the period in which  service is  rendered  are  recorded  as a
    liability.

    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  


<PAGE>


Notes to Consolidated Financial Statements, continued
Dollars in millions    

    maintenance  and  repairs  of property,  plant   and equipment is charged to
    operating  expenses.  Property, plant and  quipment  is depreciated  using
    straight-line  methods  over  their estimated   economic  lives,  generally 
    ranging    from  3  to  50  years.   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 estimated  economic
    lives of the associated hardware. The American Institute of Certified Public
    Accountants   has  issued  a  Statement  of  Position  (SOP)  that  requires
    capitalization of certain computer software expenditures beginning in 1999.

    Management  continues  to  evaluate  the impact of the change in  accounting
    required by the SOP and anticipates that it will increase net income by less
    than $100 in 1999. With comparable levels of software expenditures,  the SOP
    would tend to  increase  net income in  comparison  with  PacBell's  current
    method of accounting for software  costs.  However,  the increases  would be
    largest  in the  year of  adoption  with  diminishing  levels  of  increases
    compared  with  current  accounting   throughout  the  amortization  period.
    Consequently,  given otherwise  comparable income levels excluding software,
    and otherwise comparable software expenditures,  the effect of the SOP would
    be to  increase  income  in the  first  year  and  decrease  income  in each
    subsequent  year  until the number of years  affected  by the SOP equals the
    amortization period.

    Advertising Costs - Costs for advertising products and services or corporate
    image are expensed as incurred (see Note 9).

2.  Completion of Merger

    On April 1, 1997, SBC and PAC completed the merger of an SBC subsidiary with
    PAC, in a transaction  in which each  outstanding  share of PAC common stock
    was  exchanged  for  1.4629  shares  of  SBC  common  stock  (equivalent  to
    approximately   626  million  shares).   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.

    On  October  26,  1998,  SBC and  Southern  New  England  Telecommunications
    Corporation (SNET) completed the merger of an SBC subsidiary with SNET, in a
    transaction  in which  each share of SNET  common  stock was  exchanged  for
    1.7568 shares of SBC common stock  (equivalent to approximately  120 million
    shares).  SNET became a  wholly-owned  subsidiary of SBC effective  with the
    merger and the  transaction has been accounted for as a pooling of interests
    and a tax-free reorganization.

    Conforming accounting changes
    PacBell's  results  include  merger  transaction  costs and the  effects  of
    changes to conform  accounting  methodologies  between  PacBell and SBC for,
    among other items, pensions and postretirement  benefits. These changes were
    recorded by PacBell in the second quarter of 1997, retroactive to January 1,
    1997, as a cumulative  effect of accounting  changes of $345 net of deferred
    taxes of $239, and increased income before income taxes,  extraordinary loss
    and cumulative  effect of accounting  changes and net income for 1997 by $84
    and $50. The changes in accounting for pension and  postretirement  benefits
    were to adopt SBC's  methodology  of  amortizing  gains and losses on assets
    held within those benefit plans.  Among other costs relating to the close of
    the merger,  PacBell recorded the present value of amounts to be returned to
    California  ratepayers  as a  condition  of the  merger of $276 ($173 net of
    tax).


<PAGE>


Notes to Consolidated Financial Statements, continued
Dollars in millions

    Post-merger initiatives
    During the second quarter of 1997,  PacBell  recorded  after-tax  charges of
    $883  related  to SBC's June 19,  1997  announcement  of  several  strategic
    decisions  resulting from the merger integration process that began with the
    April 1, 1997 closing of its merger with PAC.  These  charges  included $107
    ($65 after tax) of charges related to several  regulatory rulings during the
    second  quarter  of 1997 and $276 ($173  after tax) for the merger  approval
    costs.  The  decisions  resulted  from an  extensive  review  of  operations
    throughout  the  merged  company  and  include  significant  integration  of
    operations and consolidation of some  administrative  and support functions.
    The charges  related to the  strategic  decisions  totaled $1 billion  ($645
    after tax). In the fourth  quarter of 1998,  SBC again  performed a complete
    review of all  operations  affected by the merger with SNET to determine the
    impact on ongoing merger implementation  processes.  This review resulted in
    no significant  additional financial effect on PacBell. At December 31, 1998
    and December 31, 1997,  remaining accruals for anticipated cash expenditures
    related to these decisions were  approximately $61 and $202.  Following is a
    discussion of the most significant of these charges.

    Reorganization  SBC is centralizing  several key functions that will support
    the  operations  of PacBell and three other SBC  subsidiaries,  Nevada Bell,
    Southwestern  Bell Telephone  Company  (SWBell) and The Southern New England
    Telephone Company (SNETel),  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,  SWBell and SNETel will  continue as separate  legal  entities.  These
    initiatives  are resulting in the creation of some jobs and the  elimination
    and realignment of others,  with many of the affected employees changing job
    responsibilities and in some cases assuming positions in other locations.

    PacBell  recognized a charge of  approximately  $127 ($80 net of tax) during
    the second quarter of 1997 in connection with these initiatives. This charge
    was  comprised  mainly of  postemployment  benefits,  primarily  related  to
    severance,  and costs  associated  with closing down  duplicate  operations,
    primarily  contract  cancellations.  Other charges arising out of the merger
    related to relocation, retraining and other effects of consolidating certain
    operations  are being  recognized in the periods those charges are incurred.
    The initial  integration  process  subsequent to the PAC merger  resulted in
    PacBell  incurring  expense for these merger related items in advance of any
    substantive  synergistic  benefits.  These charges totaled $234 ($139 net of
    tax) during the second half of 1997.

    Impairments/asset  valuation As a result of SBC's merger  integration plans,
    strategic  review of  domestic  operations  and  organizational  alignments,
    PacBell  reviewed the carrying  values of related  long-lived  assets.  This
    review  included  estimating  remaining  useful  lives  and cash  flows  and
    identifying assets to be abandoned.  Where this review indicated impairment,
    discounted cash flows related to those assets were analyzed to determine the
    amount of the  impairment.  As a result of these reviews,  PacBell wrote off
    some assets and  recognized  impairments to the value of other assets with a
    combined  charge of $341 ($219 after tax) recorded in the second  quarter of
    1997.  These  impairments and writeoffs  related to certain analog switching
    equipment,   duplicate  or  obsolete  equipment,   cable  within  commercial
    buildings, certain nonoperating plant and other assets.

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


<PAGE>


Notes to Consolidated Financial Statements, continued
Dollars in millions

    tax)  associated  with these  activities. During the third quarter  of 1997 
    PacBel   recorded   the   corresponding  short-term debt of $610 previously 
    incurred by the ACN trust on its balance sheet.

3.  Property, Plant and Equipment

    Property, plant and equipment is summarized as follows at December 31:

                                                              1998          1997
   -----------------------------------------------------------------------------
   Land                                                   $    212     $     207
   Buildings                                                 2,836         2,744
   Central office equipment                                 11,809        10,929
   Cable, wiring and conduit                                11,890        11,673
   Other equipment                                           2,395         2,487
   Under construction                                          729           655
   -----------------------------------------------------------------------------
                                                            29,871        28,695
   Accumulated depreciation and amortization                18,272        17,442
   -----------------------------------------------------------------------------
   Property, plant and equipment - net                    $ 11,599     $  11,253
   =============================================================================

    PacBell's  depreciation expense as a percentage of average depreciable plant
    was 6.6%, 7.1% and 6.9% for 1998, 1997 and 1996.

    Certain  facilities and equipment used in operations are under  operating or
    capital leases.  Rental  expenses under operating  leases for 1998, 1997 and
    1996 were $118,  $124 and $141.  At December  31, 1998,  the future  minimum
    rental  payments  under  noncancelable  operating  leases for the years 1999
    through  2003 were $50,  $20,  $11, $7 and $5, and $13  thereafter.  Capital
    leases were not significant.



<PAGE>


Notes to Consolidated Financial Statements, continued
Dollars in millions

4.  Debt

    Long-term debt,  including  interest rates and maturities,  is summarized as
    follows at December 31:

 -------------------------------------------------------------------------------
                                                          1998           1997
 -------------------------------------------------------------------------------
 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                             1,587          2,250
   8.50%           2031                                     29            225
 -------------------------------------------------------------------------------
                                                         3,285          4,144
 Unamortized discount - net of premium                     (65)           (89)
 -------------------------------------------------------------------------------
 Total debentures                                        3,220          4,055
 -------------------------------------------------------------------------------
 Notes
   6.12%-8.70%     2001-2009                             1,500          1,300
 Unamortized discount                                      (18)           (18)
 -------------------------------------------------------------------------------
 Total notes                                             1,482          1,282
 -------------------------------------------------------------------------------
 Capitalized leases                                         15             25
 -------------------------------------------------------------------------------
 Total long-term debt, including current maturities      4,717          5,362
 Current maturities                                       (103)            (4)
 -------------------------------------------------------------------------------
 Total long-term debt                                 $  4,614       $  5,358
 ===============================================================================

    In October 1998, PacBell repurchased $684 of long-term debt. The repurchases
    resulted in a $60 after-tax extraordinary loss, net of taxes of $42.

    At December 31, 1998, the aggregate  principal amounts of long-term debt and
    average  interest  rate  scheduled  for repayment for the years 1999 through
    2003 were $103 (4.6%),  $127 (4.6%),  $203 (8.7%),  $432 (6.9%), $166 (6.5%)
    with $3,769 (6.9%) due thereafter.  As of December 31, 1998,  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:

 -------------------------------------------------------------------------------
                                                           1998         1997
 -------------------------------------------------------------------------------
 Intercompany loans                                    $  1,551     $    542
 Current maturities of long-term debt                       103            4
 ===============================================================================
 Total                                                 $  1,654     $    546
 ===============================================================================

    During the third quarter of 1997, PacBell's commercial paper was replaced by
    intercompany  loans from SBC. The  weighted  average  interest  rate on debt
    maturing with one year,  excluding current  maturities of long-term debt, at
    December 31, 1998 and 1997 was 5.0% and 6.0%.


<PAGE>


Notes to Consolidated Financial Statements, continued
Dollars in millions

5.  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:

 -------------------------------------------------------------------------------
                                                 1998               1997
 -------------------------------------------------------------------------------
                                          Carrying     Fair  Carrying      Fair
                                            Amount    Value    Amount     Value
 -------------------------------------------------------------------------------
 Debentures                                  3,220    3,463     4,055     4,337
 Notes                                       1,482    1,590     1,282     1,342
 -------------------------------------------------------------------------------

    The fair values of  long-term  debt were  estimated  based on quoted  market
    prices.  PacBell's  cash  equivalents  are  recorded at cost.  The  carrying
    amounts of cash and cash equivalents and customer deposits  approximate fair
    values.

    PacBell  does  not hold or  issue  any  financial  instruments  for  trading
    purposes.

6.  Income Taxes

    Significant  components of PacBell's deferred tax assets and liabilities are
    as follows at December 31:

 -------------------------------------------------------------------------------
                                                               1998        1997
 -------------------------------------------------------------------------------
 Deferred tax (assets)/liabilities due to:
   Depreciation and amortization                         $    1,192   $   1,083
   Employee benefits                                           (179)       (280)
   Unamortized investment tax credits                           (51)        (76)
   Jurisdictional revenues                                     (286)       (311)
   Other, net                                                   (12)        (44)
 -------------------------------------------------------------------------------
 Net deferred tax liabilities                            $      664   $     372
 -------------------------------------------------------------------------------
 Amounts recorded in consolidated balance sheets:
 -------------------------------------------------------------------------------
 Deferred tax assets*                                    $      418   $     585
 ===============================================================================
 Deferred tax liabilities*                               $    1,082   $     957
 ===============================================================================

    *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.


<PAGE>


Notes to Consolidated Financial Statements, continued
Dollars in millions

The components of income tax expense (benefit) are as follows:

 -------------------------------------------------------------------------------
                                                  1998        1997        1996
 -------------------------------------------------------------------------------
 Federal
   Current                                    $    349    $     32    $    313
   Deferred - net                                  260          57         193
   Amortization of investment tax credits          (39)        (47)        (47)
 -------------------------------------------------------------------------------
                                                   570          42         459
 -------------------------------------------------------------------------------
 State and local
   Current                                          89           -          96
   Deferred - net                                   75          (8)         64
 -------------------------------------------------------------------------------
                                                   164          (8)        160
 ===============================================================================
 Total                                        $    734    $     34    $    619
 ===============================================================================

    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:

-------------------------------------------------------------------------------
                                                   1998       1997       1996
-------------------------------------------------------------------------------
Taxes computed at federal statutory rate       $    655   $     12   $    549
Increases (decreases) in taxes resulting from:
  Amortization of investment tax credits over
    the life of the plant that gave
    rise to the credits                             (25)       (31)       (31)
  State and local income taxes - net of 
    federal tax benefit                             107         (5)       104
  1997 implementation of the Tax Allocation
    Agreement                                         -         56          -
  Other - net                                        (3)         2         (3)
===============================================================================
Total                                          $    734   $     34   $    619
===============================================================================

7.  Employee Benefits

    Pensions  -   Substantially   all   employees  of  PacBell  are  covered  by
    noncontributory  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>


Notes to Consolidated Financial Statements, continued
Dollars in millions

    Significant  assumptions  used  by SBC  in  developing  pension  information
    include:

--------------------------------------------------------------------------------
                                               1998         1997       1996
--------------------------------------------------------------------------------
Discount rate for determining projected        
    benefit obligation                         7.0%        7.25%       7.5%
Long-term rate of return on plan assets        8.5%         8.5%       9.0%
Composite rate of compensation increase        4.3%         4.3%       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  benefit for 1998, 1997 and 1996 of $256, $243 and $168.
    As of  December  31,  1998,  the amount of  PacBell's  cumulative  amount of
    contributions  recognized  in excess of its  pension  cost made to the trust
    were  $728  and  as  of  December  31,  1997,  the   cumulative   amount  of
    contributions  recognized  in excess of its  pension  cost made to the trust
    were $403.

    During 1998,  certain bargained  employees accepted early retirement benefit
    offers that resulted in special termination  benefits recognized of $53 that
    are excluded from the pension benefit amount disclosed above.

    During 1997, a significant amount of lump sum pension payments resulted in a
    partial  settlement of PacBell's  pension plans.  Therefore,  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.

    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 the  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 of $92 in 1998,  1997 and 1996.  PacBell
    recognized postretirement benefit cost for 1998, 1997 and 1996 of $222, $252
    and  $250.  At  December  31,  1998 and 1997,  the  amount  included  in the
    Consolidated  Balance Sheets for accrued  postretirement  benefit obligation
    was $562 and $581. 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 1998 and 1997, PacBell contributed $239
    and $295  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 1999 is 7.0%,  decreasing linearly to
    5.5% in 2002 prior to adjustment for cost-sharing provisions of the plan for
    active and certain recently retired employees. The 


<PAGE>


Notes to Consolidated Financial Statements, continued
Dollars in millions

    assumed dental cost trend rate in 1999 is 5.75%, 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,   1998 by   approximately   5.2%.  Decreasing the annual 
    medical  and dental cost trend rates by one  percentage  point    decreases 
    the net periodic postretirement   benefit    cost for 1998 by  approximately
    $4.1%.

    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.

8.  Stock Option Plans

    Management  employees of PacBell  participate  in various stock option plans
    sponsored by SBC.  Options issued  through  December 31, 1998 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 206
    million shares may be issued 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 Board 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 1998,  1997 and 1996 as  defined  by FAS
    123, PacBell's net income would have been $1,055, $331 and $948.

    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 1998,  1997 and 1996:  risk-free   interest
    rate of 5.72%,  6.56% and 6.25%;  dividend yield of 2.21%, 3.07% and 4.91%; 
    expected  volatility factor of 15%, 15% and 18%;  and  expected  option life
    of 5.3, 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>


Notes to Consolidated Financial Statements, continued
Dollars in millions


9.  Additional Financial Information

 -------------------------------------------------------------------------------
                                                               December 31,
                                                          ----------------------
  Balance Sheets                                             1998         1997
 -------------------------------------------------------------------------------
 Accounts payable and accrued liabilities:
    Accounts payable                                     $  1,501     $  1,620
    Advance billing and customer deposits                     359          300
    Compensated future absences                               252          260
    Accrued interest                                          129          145
    Accrued payroll                                            87           77
    Other                                                     341          317
 ===============================================================================
 Total                                                   $  2,669     $  2,719
 ===============================================================================

 -------------------------------------------------------------------------------
 Statements of Income                          1998          1997         1996
 ===============================================================================
 Advertising expense                       $    157      $    120     $     94
 ===============================================================================
 Interest expense incurred                 $    461      $    497     $    412
 Capitalized interest                           (35)          (37)         (33)
 -------------------------------------------------------------------------------
 Total interest expense                    $    426      $    460     $    379
 ===============================================================================

 -------------------------------------------------------------------------------
 Statements of Cash Flows                      1998          1997         1996
 -------------------------------------------------------------------------------
 Cash paid during the year for:
    Interest                               $    441      $    445     $    370
    Income taxes, net of refunds           $    651      $   (184)    $    320
 ===============================================================================

    No customer accounted for more than 10% of PacBell's  consolidated  revenues
    in 1998, 1997 and 1996.

    Approximately  three-fourths  of PacBell's  employees are represented by the
    Communications  Workers  of  America  (CWA).  In April  1998,  a  three-year
    contract was negotiated  between the CWA and PacBell.  This contract was the
    result  of  renegotiations  of a  contract  that  expired  in  mid-1998.  No
    contracts are expiring in 1999.

10. Change in Entity

    On March 31, 1998, PacBell distributed the shares of Pacific Bell Directory,
    Pacific Bell Mobile  Services,  Pacific Bell  Internet  Services and PB COMM
    Switches,  Inc. to PAC.  PacBell has  accounted for this  distribution  as a
    change  in  reporting  entity.  The  financial  statements  of  all  periods
    presented  have been  restated  to show  financial  information  for the new
    reporting entity.

    The following  financial  statements  present the  pre-distribution  entity,
    adjustments to effect the  distribution  and reclassify  certain  amounts to
    conform to the 1998  presentation,  and the  restated  entity  amounts.  The
    Consolidated  Statements of Income and the  Consolidated  Statements of Cash
    Flows are presented for the twelve months ended  December 31, 1997 and 1996.
    The Consolidated Balance Sheets are presented for December 31, 1997.


<PAGE>


Notes to Consolidated Financial Statements, continued
Dollars in millions

<TABLE>
PACIFIC BELL
-----------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
Dollars in millions
For the year ended December 31, 1997
-----------------------------------------------------------------------------------
<CAPTION>
                                                Originally
                                                  Reported  Distribution*   Restated
-----------------------------------------------------------------------------------
<S>                                              <C>        <C>           <C>
Operating Revenues
Local service                                     $ 4,386   $     129     $   4,515
Network access:
  Interstate                                        1,714           1         1,715
  Intrastate                                          790           -           790
Long distance service                               1,182          (6)        1,176
Directory advertising and other                     1,866      (1,336)          530
-----------------------------------------------------------------------------------
Total operating revenues                            9,938      (1,212)        8,726
-----------------------------------------------------------------------------------

Operating Expenses
Operations and support                              7,408      (1,088)        6,320
Depreciation and amortization                       2,021         (98)        1,923
-----------------------------------------------------------------------------------
Total operating expenses                            9,429      (1,186)        8,243
-----------------------------------------------------------------------------------
Operating Income                                      509         (26)          483
-----------------------------------------------------------------------------------

Other Income (Expense)
Interest expense                                     (461)          1          (460)
Other income - net                                      6           5            11
-----------------------------------------------------------------------------------
Total other income (expense)                         (455)          6          (449)
-----------------------------------------------------------------------------------
Income Before Income Taxes and Cumulative
  Effect of Accounting Changes                         54         (20)           34
-----------------------------------------------------------------------------------
Income Taxes                                           46         (12)           34
-----------------------------------------------------------------------------------
Income Before Cumulative Effect of Accounting Changes   8          (8)            -
-----------------------------------------------------------------------------------
Cumulative Effect of Accounting Changes, net of tax   342           3           345
-----------------------------------------------------------------------------------
Net Income                                        $   350   $      (5)    $     345
-----------------------------------------------------------------------------------

* Also includes certain reclassifications to conform to the current year's presentation.
</TABLE>


<PAGE>


Notes to Consolidated Financial Statements, continued
Dollars in millions

<TABLE>
PACIFIC BELL
-----------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
Dollars in millions
For the year ended December 31, 1996
-----------------------------------------------------------------------------------
<CAPTION>
                                                Originally
                                                  Reported  Distribution*  Restated
-----------------------------------------------------------------------------------
<S>                                               <C>       <C>           <C>
Operating Revenues
Local service                                     $ 3,956   $     195     $   4,151
Network access:
  Interstate                                        1,805           2         1,807
  Intrastate                                          718           -           718
Long distance service                               1,274           -         1,274
Directory advertising and other                     1,693      (1,196)          497
-----------------------------------------------------------------------------------
Total operating revenues                            9,446        (999)        8,447
-----------------------------------------------------------------------------------

Operating Expenses
Operations and support                              5,316        (616)        4,700
Depreciation and amortization                       1,826         (22)        1,804
-----------------------------------------------------------------------------------
Total operating expenses                            7,142        (638)        6,504
-----------------------------------------------------------------------------------
Operating Income                                    2,304        (361)        1,943
-----------------------------------------------------------------------------------

Other Income (Expense)
Interest expense                                     (363)        (16)         (379)
Other income - net                                      4           -             4
-----------------------------------------------------------------------------------
Total other income (expense)                         (359)        (16)         (375)
-----------------------------------------------------------------------------------
Income Before Income Taxes and Cumulative
  Effect of Accounting Change                       1,945        (377)        1,568
-----------------------------------------------------------------------------------
Income Taxes                                          775        (156)          619
-----------------------------------------------------------------------------------
Income Before Cumulative Effect of Accounting 
  Change                                            1,170        (221)          949
-----------------------------------------------------------------------------------
Cumulative Effect of Accounting Change, net of tax     85         (85)            -
-----------------------------------------------------------------------------------
Net Income                                        $ 1,255   $    (306)    $     949
-----------------------------------------------------------------------------------

* Also includes certain reclassifications to conform to the current year's presentation.
</TABLE>


<PAGE>


Notes to Consolidated Financial Statements, continued
Dollars in millions

<TABLE>
PACIFIC BELL
----------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
Dollars in millions except per share amounts
December 31, 1997
----------------------------------------------------------------------------------------
<CAPTION>
                                                      Originally
                                                        Reported  Distribution Restated
----------------------------------------------------------------------------------------
<S>                                                    <C>         <C>        <C>
Assets
Current Assets
Cash and cash equivalents                              $     43   $       -   $     43
Accounts receivable - net of allowances for  
  uncollectibles                                          2,199        (417)     1,782
Prepaid expenses                                             54          (1)        53
Deferred income taxes                                       329          86        415
Other current assets (including deferred charges)            78         (34)        44
----------------------------------------------------------------------------------------
Total current assets                                      2,703        (366)     2,337
----------------------------------------------------------------------------------------
Property, Plant and Equipment - at cost                  29,681        (986)    28,695
  Less: Accumulated depreciation and amortization        17,606        (164)    17,442
----------------------------------------------------------------------------------------
Property, Plant and Equipment - Net                      12,075        (822)    11,253
----------------------------------------------------------------------------------------
Other Assets                                                725          24        749
----------------------------------------------------------------------------------------
Total Assets                                           $ 15,503   $  (1,164)  $ 14,339
----------------------------------------------------------------------------------------

Liabilities and Shareowner's Equity
Current Liabilities
Debt maturing within one year                          $    716   $    (170)  $    546
Accrued taxes                                               340          (6)       334
Accounts payable and accrued liabilities                  2,955        (236)     2,719
----------------------------------------------------------------------------------------
Total current liabilities                                 4,011        (412)     3,599
----------------------------------------------------------------------------------------
Long-Term Debt                                            5,588        (230)     5,358
----------------------------------------------------------------------------------------

Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes                                       952          5         957
Postemployment benefit obligation                           917        (36)        881
Unamortized investment tax credits                          188          -         188
Other noncurrent liabilities                                574         (5)        569
----------------------------------------------------------------------------------------
Total deferred credits and other noncurrent liabilities   2,631        (36)      2,595
----------------------------------------------------------------------------------------

Shareowner's Equity
Common shares ($1 par value, 300,000,000 authorized:
  issued 224,504,982 at December 31, 1997)                  225           -        225
Capital in excess of par value                            5,096        (282)     4,814
Retained earnings (deficit)                              (2,048)       (204)    (2,252)
----------------------------------------------------------------------------------------
Total shareowner's equity                                 3,273        (486)     2,787
----------------------------------------------------------------------------------------
Total Liabilities and Shareowner's Equity              $ 15,503   $  (1,164)  $ 14,339
----------------------------------------------------------------------------------------
</TABLE>


<PAGE>


Notes to Consolidated Financial Statements, continued
Dollars in millions

<TABLE>
PACIFIC BELL
-----------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
Dollars in millions, increase (decrease) in cash and cash  equivalents 
For the year ended December 31, 1997
-----------------------------------------------------------------------------------
<CAPTION>
                                                Originally
                                                  Reported  Distribution  Restated
------------------------------------------------------------------------------------
<S>                                                <C>        <C>         <C>
Operating Activities
Net income (loss)                                  $   350    $     (5)   $    345
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
   Depreciation and amortization                     2,021         (98)      1,923
   Provision for uncollectible accounts                245         (61)        184
   Amortization of investment tax credits              (48)          1         (47)
   Deferred income taxes                               158        (109)         49
   Cumulative effect of accounting change, net of tax (342)         (3)       (345)
    Changes in operating assets and liabilities:
     Accounts receivable                              (312)        317           5
     Other current assets                              (13)        (15)        (28)
     Accounts payable and accrued liabilities          749         (98)        651
Other - net                                           (209)        (34)       (243)
------------------------------------------------------------------------------------
Total adjustments                                    2,249        (100)      2,149
------------------------------------------------------------------------------------
Net Cash Provided by (Used in) Operating Activities  2,599        (105)      2,494
------------------------------------------------------------------------------------

Investing Activities
Construction and capital expenditures               (2,312)        267      (2,045)
Dispositions                                            65           -          65
Other                                                  (14)          -         (14)
------------------------------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities (2,261)        267      (1,994)
------------------------------------------------------------------------------------

Financing Activities
Net change in short-term borrowings with original
  maturities of three months or less                   406        (528)       (122)
Issuance of other short-term borrowings                610           -         610
Repayment of other short-term borrowings              (610)          -        (610)
Issuance of long-term debt                             253          (1)        252
Repayment of long-term debt                             (8)          8           -
Equity received from parent                            156        (107)         49
Dividends paid                                      (1,160)        467        (693)
------------------------------------------------------------------------------------
Net Cash Used in Financing Activities                 (353)       (161)       (514)
------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents   (15)          1         (14)
------------------------------------------------------------------------------------
Cash and cash equivalents beginning of year             58          (1)         57
------------------------------------------------------------------------------------
Cash and Cash Equivalents End of Period            $    43    $      -    $     43
------------------------------------------------------------------------------------
</TABLE>


<PAGE>


Notes to Financial Statements - Continued
Dollars in millions

<TABLE>
PACIFIC BELL
-----------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
Dollars in millions, increase (decrease) in cash and cash equivalents 
For the year ended December 31, 1996
-----------------------------------------------------------------------------------
                                                Originally
                                                  Reported  Distribution  Restated
------------------------------------------------------------------------------------
<S>                                                <C>        <C>         <C>
Operating Activities
Net income (loss)                                  $ 1,255    $   (306)   $    949
Adjustments to reconcile net income (loss) to
  net cash provided by operating activities:
   Depreciation and amortization                     1,826         (22)      1,804
   Provision for uncollectible accounts                167         (37)        130
   Amortization of investment tax credits              (47)          -         (47)
   Deferred income taxes                               250           7         257
   Cumulative effect of accounting change, net of tax  (85)         85           -
   Changes in operating assets and liabilities:
     Accounts receivable                              (719)        259        (460)
     Other current assets                              294        (273)         21
     Accounts payable and accrued liabilities         (114)         38         (76)
Other - net                                           (305)        (96)       (401)
------------------------------------------------------------------------------------
Total adjustments                                    1,267         (39)      1,228
------------------------------------------------------------------------------------
Net Cash Provided by (Used in) Operating Activities  2,522        (345)      2,177
------------------------------------------------------------------------------------

Investing Activities
Construction and capital expenditures               (2,334)        423      (1,911)
Other                                                  (29)          7         (22)
------------------------------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities (2,363)        430      (1,933)
------------------------------------------------------------------------------------

Financing Activities
Net change in short-term borrowings with original
  maturities of three months or less                  (504)        224        (280)
Issuance of long-term debt                             770        (275)        495
Repayment of long-term debt                             (4)          -          (4)
Equity received from parent                            713        (325)        388
Dividends paid                                      (1,151)        272        (879)
Other                                                    7          26          33
------------------------------------------------------------------------------------
Net Cash Used in Financing Activities                 (169)        (78)       (247)
------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents   (10)          7          (3)
------------------------------------------------------------------------------------
Cash and cash equivalents beginning of year             68          (8)         60
------------------------------------------------------------------------------------
Cash and Cash Equivalents End of Period            $    58    $     (1)   $     57
------------------------------------------------------------------------------------
</TABLE>


<PAGE>


Notes to Consolidated Financial Statements, continued
Dollars in millions

11.   Quarterly Financial Information (Unaudited)

------------------------------------------------------------------------------
  Calendar        Total Operating          Operating              Net
   Quarter            Revenue            Income (Loss)        Income (Loss)
------------------------------------------------------------------------------
                   1998       1997      1998      1997       1998       1997
------------------------------------------------------------------------------
First 1        $  2,272   $  2,139   $   521   $   564    $   252    $   626
Second 2          2,323      2,093       636      (789)       321       (605)
Third 2           2,386      2,221       631       485        320        231
Fourth 2          2,425      2,273       511       223        184         93
===============================================================================
Annual 1,2     $  9,406   $  8,726   $ 2,299   $   483    $ 1,077    $   345
===============================================================================

1  1997 Net Income amounts reflect a cumulative effect of accounting changes of 
   $345 for merger  conforming  adjustments, primarily related to  pensions and 
   postretirement benefits (see Note 2).
2  1997 includes after-tax charges of $884 of second quarter charges  related to
   post-merger    initiatives  (see Note 2), $2  and $137 of third   and fourth 
   quarter  merger  integration   costs and $18 fourth quarter   gain on sale of
   PacBell's interest in Bell Communications Research, Inc.


<PAGE>


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

Effective   April  1,  1997,   Coopers  &  Lybrand  L.L.P  (a   predecessor   of
PricewaterhouseCoopers  LLP)  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).


<PAGE>


                                          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.........................20-21
         Financial Statements Covered by Report of Independent Auditors:
           Statements of Income..................................  22
           Balance Sheets........................................  23
           Statements of Cash Flows..............................  24
           Statements of Shareowner's Equity.....................  25
           Notes to Consolidated Financial Statements............  26

     (2) Financial Statement Schedules:
         II - Valuation and Qualifying Accounts.................44-45

     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.

     (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 PricewaterhouseCoopers LLP.

     24     Powers of Attorney.

     27     Financial Data Schedule.

(b) Reports on Form 8-K:

      On October 28, 1998, 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, 1998 and 1997.

      On October 30, 1998, Pacific Bell (PacBell) filed a Current Report on Form
      8-K,  reporting  on  Item  5.  Other  Events.  The  Report  discussed  the
      commencement of a debenture buyback.


<PAGE>


<TABLE>

                                PACIFIC BELL                               SCHEDULE II - SHEET 1
                 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
                          Allowance for Uncollectibles
                               Dollars in Millions

---------------------------------------------------------------------------------------------------------------------
                 COL. A                       COL. B                 COL. C                 COL. D        COL. E
---------------------------------------------------------------------------------------------------------------------
<CAPTION>
                                                                   Additions
                                                         -------------------------------
                                                               (1)            (2)
                                                                            Charged
                                            Balance at      Charged        to Other                      Balance
                                           Beginning of   to Costs and     Accounts      Deductions     at End of
               Description                    Period        Expenses       -Note (a)      -Note (b)      Period
---------------------------------------------------------------------------------------------------------------------
<S>                                         <C>              <C>             <C>             <C>           <C>
 Year 1998..............................    $ 152            150             155             296           $ 161
 Year 1997..............................    $ 127            184             217             376           $ 152
 Year 1996..............................    $ 131            130             160             294           $ 127
<FN>
(a)  Amounts previously written off which were credited directly to this account
     when recovered.

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



<PAGE>


<TABLE>

                                 PACIFIC BELL                              SCHEDULE II - SHEET 2
                 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
                            Reserve for Restructuring
                               Dollars in Millions

---------------------------------------------------------------------------------------------------------------------
                 COL. A                       COL. B                 COL. C                 COL. D        COL. E
---------------------------------------------------------------------------------------------------------------------
<CAPTION>
                                                                   Additions
                                                         -------------------------------
                                                               (1)            (2)
                                                                            
                                            Balance at       Charged        Charged                      Balance
                                           Beginning of   to Costs and      to Other     Deductions     at End of
               Description                    Period        Expenses        Accouts       -Note (a)      Period
---------------------------------------------------------------------------------------------------------------------
<S>                                         <C>                <C>             <C>           <C>           <C>
 Year 1998..............................    $   -              -               -               -           $   -
 Year 1997..............................    $  93              -               -              93           $   -
 Year 1996..............................    $ 219              -               -             126           $  93
<FN>
(a)  The 1996 amount reflect $(64) of costs,  for enhanced  retirement  benefits
     paid from  pension  fund  assets  which do not require  current  outlays of
     PacBell's  funds.  This 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 12th day of March
1999.

                                       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)
    James D. Ellis*
    Charles E. Foster*        March 12, 1999
    Karen Jennings*                                                          
    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 PricewaterhouseCoopers LLP.

24   Powers of Attorney.

27   Financial Data Schedule.