<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the period ended September 30, 1996
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 1-6417
GTE CALIFORNIA INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 95-0510200
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
600 Hidden Ridge, HQE04B12 - Irving, Texas 75038
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code 972-718-5600
(Former name, former address and former fiscal year, if
changed since last report)
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
----- -----
The Company had 69,438,190 shares of $20 par value common stock outstanding at
October 31, 1996. The Company's common stock is 100% owned by GTE Corporation.
<PAGE> 2
PART I. FINANCIAL INFORMATION
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
1996 1995 1996 1995
-------- -------- -------- --------
(Thousands of Dollars)
<S> <C> <C> <C> <C>
REVENUES AND SALES
Local services $265,906 $309,220 $899,942 $937,136
Network access services 193,379 175,714 557,166 532,650
Toll services 105,144 119,179 329,339 335,239
Other services and sales 120,359 102,071 255,210 267,287
-------- -------- -------- --------
Total revenues and sales 684,788 706,184 2,041,657 2,072,312
-------- -------- -------- --------
OPERATING COSTS AND EXPENSES
Cost of services and sales 219,482 252,446 724,704 770,146
Selling, general and administrative 95,144 121,027 337,539 369,227
Depreciation and amortization 152,721 152,275 456,490 448,035
-------- -------- -------- --------
Total operating costs and expenses 467,347 525,748 1,518,733 1,587,408
-------- -------- -------- --------
OPERATING INCOME 217,441 180,436 522,924 484,904
OTHER (INCOME) EXPENSE
Interest - net 21,852 24,836 68,200 75,159
Other - net (6) -- (1,129) --
-------- -------- -------- --------
INCOME BEFORE INCOME TAXES 195,595 155,600 455,853 409,745
Income taxes 74,592 65,424 177,918 171,030
-------- -------- -------- --------
NET INCOME $121,003 $ 90,176 $277,935 $238,715
======== ======== ======== ========
</TABLE>
Per share data is omitted since the Company's common
stock is 100% owned by GTE Corporation (GTE).
See Notes to Condensed Consolidated Financial Statements.
1
<PAGE> 3
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in Millions)
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ --------------------------
1996 1995 1996 1995
------ ------ ------ -------
<S> <C> <C> <C> <C>
Net income $121.0 $90.2 $277.9 $238.7
</TABLE>
Net income increased 34% or $30.8 and 16% or $39.2 for the three and nine
months ended September 30, 1996, respectively, compared to the same periods in
1995. The increases are primarily associated with lower operating costs and
expenses and lower interest expense.
Revenues and Sales
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ --------------------------
1996 1995 1996 1995
------ ------ ------ -------
<S> <C> <C> <C> <C>
Local services $265.9 $309.2 $899.9 $937.1
Network access services 193.4 175.7 557.2 532.7
Toll services 105.1 119.2 329.4 335.2
Other services and sales 120.4 102.1 255.2 267.3
------ ------ -------- --------
Total revenues and sales $684.8 $706.2 $2,041.7 $2,072.3
</TABLE>
Total revenues and sales decreased 3% or $21.4 and 2% or $30.6 for the three
and nine months ended September 30, 1996, respectively, compared to the same
periods in 1995.
Local service revenues decreased 14% or $43.3 and 4% or $37.2 for the three and
nine months ended September 30, 1996, respectively, compared to the same
periods in 1995. These decreases are primarily due to a $30.3 (total $36 net
$5.7 of current refunds) and a $32.4 reduction in revenues reflecting the
refund of anticipated merger expense savings and $5.3 and $20.5 in revenue
reductions associated with the Company's 1996 California Price Cap Index (PCI),
both of which are discussed in Other Matters. In addition, a $20.6 reserve was
recorded in the third quarter of 1996 for operating tax settlements.
The three and nine month decreases in local service revenues are also due to a
$2.5 and an $8.1 decline in directory assistance and operator service revenues.
The nine month decrease is also due to a $12.1 reduction in revenues associated
with customers electing measured usage rate plans. The three and nine month
decreases are partially offset by a 4% increase in switched access lines which
resulted in revenue growth of $10.6 and $26.4, respectively. These decreases
are also offset by a $1.5 and a $30.2 increase in revenue resulting from a
favorable ruling by the California Public Utilities Commission (CPUC)
associated with the Implementation Rate Design (IRD), as discussed in Other
Matters and a $2.2 and a $4.5 growth in sales of SmartCall(trademark) and
other custom calling features.
2
<PAGE> 4
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)
Network access service revenues increased 10% or $17.7 and 5% or $24.5 for the
three and nine months ended September 30, 1996, respectively, compared to the
same periods in 1995. Minutes of use increased 10% for both the three and nine
months ended September 30, 1996, which generated additional revenues of $9.1
and $24.2, respectively. The increases also reflect $3.9 and $13.6 increases
in special access revenues associated with growth in special access lines. In
addition, the increases also reflect a revenue adjustment of $3.5 for both the
three and nine month periods associated with the favorable IRD ruling mentioned
above and discussed in Other Matters. These increases were partially offset by
a $2.4 reserve associated with the operating tax settlements mentioned above.
The nine month increase is also offset by $22.1 of nonrecurring favorable
carrier settlement activities recorded in the first quarter of 1995, the most
significant of which was a switched access meet point billing settlement with
Pacific Bell for the period January 1, 1990 through December 31, 1994. In
addition, $5 and $8.2 of other favorable meet point billing revenues were
recognized for the three and nine months ended September 30, 1996,
respectively.
Toll service revenues decreased 12% or $14.1 and 2% or $5.8 for the three and
nine months ended September 30, 1996, respectively, compared to the same
periods in 1995. These decreases are primarily due to the introduction of
optional discount calling plans, which effectively lowered intrastate long
distance rates. The three and nine month decreases are also due to a $2.3
reserve for the refund of merger expense savings and an $8.6 reserve for
operating tax settlements, both of which are mentioned above. These decreases
also reflect a $2.7 and an $8.6 revenue reduction associated with the Company's
1996 California PCI, mentioned above. These decreases are partially offset by
$4.8 and $1 of other favorable revenue increases associated with the annual
California rate index and $1.9 and $12.7 in increases resulting from a
favorable ruling by the CPUC associated with the IRD, as discussed in Other
Matters. The nine month decrease is also offset by an increase in toll
volumes, a $4.1 increase resulting from unfavorable revenue adjustments
recorded in the first quarter of 1995 and a $4.6 increase in revenues from
residential and business 800 services.
Other services and sales revenues increased 18% or $18.3 and decreased 5% or
$12.1 for the three and nine months ended September 30, 1996, respectively,
compared to the same periods in 1995. The three month increase is primarily
the result of increased directory advertising revenues of $10 related to timing
of directory publications, a $5.6 increase in business equipment sales and a
$2.4 growth in sales of voice messaging services. The nine month decrease is
primarily due to a $9.5 reduction, recorded during the first quarter of 1996,
associated with the completion of the State of California's telecommunications
network (CALNET) project. The nine month decrease is also due to decreased
directory advertising revenues of $1.9 related to timing of directory
publications and a $2.1 decrease in business equipment sales. The nine month
decrease is partially offset by a $6.1 growth in sales of voice messaging
services.
Operating Costs and Expenses
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ --------------------------
1996 1995 1996 1995
------ ------ ------ -------
<S> <C> <C> <C> <C>
Total operating costs and expenses $467.3 $525.7 $1,518.7 $1,587.4
</TABLE>
Total operating costs and expenses decreased 11% or $58.4 and 4% or $68.7 for
the three and nine months ended September 30, 1996, respectively, compared to
the same periods in 1995.
3
<PAGE> 5
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)
The decrease in operating costs and expenses for the three months ended
September 30, 1996 is primarily due to actuarial adjustments of $10.4 to the
Company's benefit plans which were recorded in the third quarter of 1996, $9.4
in regulation expense recorded in 1995, a $5.6 reduction in labor and benefit
costs associated with productivity gains from process re-engineering and other
cost containment programs and a $5.9 decrease in contractor costs. The
decrease is also attributable to a $5.3 reduction in uncollectible charges
related to calling card calls, a $1 decrease in data processing costs and a
$5.9 reduction in access charge payments associated with the Company's
Originating Responsibility Plan (ORP) for intraLATA access settlement
arrangements. These decreases are partially offset by a $7.4 increase in
material costs and a $0.4 increase in depreciation expense associated with
additions to plant balances.
The decrease in operating costs and expenses for the nine months ended
September 30, 1996 is primarily due to a $35.6 reduction in labor and benefit
costs associated with productivity gains from process re-engineering and other
cost containment programs, $18.4 in regulation expense recorded in 1995 and a
$16.9 decrease in expenses reflecting labor charges recorded in the second
quarter of 1995, which were related to flood damage incurred during the first
quarter of 1995. The favorable impact of $7.8 in actuarial adjustments
recorded during the second quarter of 1995 was offset by $10.4 of actuarial
adjustments to the Company's benefit plans which were recorded during the third
quarter of 1996. The decrease is also attributable to reductions of $7 in data
processing costs and $10.5 in contractor charges. In addition, the decrease
partially reflects an $8.9 reduction in uncollectible charges related to
calling card calls. The impact of $9.6 in pension settlement gains recorded in
the first quarter of 1996 was partially offset by $4.9 of settlement gains
recorded in the second quarter of 1995 which resulted from lump sum payments
from the Company's pension plans. In addition, the decreases are partially
offset by an $8.4 increase in depreciation expense associated with additions to
plant balances, $13.4 of application software amortization, $11.3 associated
with the Customer Notification and Education Plan (CNEP), which is a CPUC
mandated program to educate consumers about Caller ID, blocking options and
related privacy issues, and a $1.9 increase in costs associated with the
Company's ORP settlement mentioned above.
Other (Income) Expense
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ --------------------------
1996 1995 1996 1995
------ ------ ------ -------
<S> <C> <C> <C> <C>
Interest - net $21.9 $24.8 $68.2 $75.2
Other - net -- -- (1.1) --
Income taxes 74.6 65.4 177.9 171.0
</TABLE>
Interest - net decreased 12% or $3 and 9% or $7 for the three and nine months
ended September 30, 1996, respectively, compared to the same periods in 1995,
primarily due to lower average short-term debt levels and the favorable effects
of the long-term debt refinancing program completed in May 1996.
Other - net for the nine months ended September 30, 1996 includes a $1.2
pre-tax gain resulting from the sale of a parcel of land.
Income taxes increased 14% or $9.2 and 4% or $6.9 for the three and nine months
ended September 30, 1996, respectively, compared to the same periods in 1995.
These increases are primarily due to a corresponding increase in pre-tax
income, partially offset by adjustments to prior years' tax provision.
4
<PAGE> 6
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)
CAPITAL RESOURCES AND LIQUIDITY
Management believes that the Company has adequate internal and external
resources available to meet ongoing operating requirements for construction of
new plant, modernization of facilities and payment of dividends. The Company
generally funds its construction program from operations, although external
financing is available. Short-term borrowings can be obtained through
commercial paper borrowings or borrowings from GTE. On July 1, 1996, the
Company began participating with other affiliates in a $1,500 syndicated line
of credit to back up commercial paper borrowings. Through this shared
arrangement, the Company can issue up to $500 of commercial paper.
The Company's primary source of funds during the first nine months of 1996 was
cash from operations of $760.1 compared to $615.8 for the same period in 1995.
The year-to-year increase is primarily due to a decrease in working capital
requirements and improved results of operations. Cash from operations is also
being utilized to fund the Company's re- engineering plan.
The Company's capital expenditures during the first nine months of 1996 were
$240.9 compared to $293.1 for the same period in 1995. The declining
requirement for modernization of current facilities continues to offset the
expenditures associated with continued growth in access lines and the
introduction of new products and services, including broadband digital
services. The Company anticipates lower capital expenditures during the
remainder of 1996 compared to 1995, as future capital expenditures related to
the deployment of broadband video networks will be incurred by Media Ventures
Incorporated, a separate subsidiary of GTE. The video network originally
constructed by the Company was transferred at its cost of $6.9 to Media
Ventures in the third quarter of 1996 (see discussion in Other Matters).
In December 1995, the Company entered into an agreement to sell a parcel of
land. By June 1996, the total proceeds of $12.5 related to this sale were
received. The Company recognized a pre-tax gain of $1.2 as a result of this
sale. An additional property sale resulting in proceeds of $2.9 occurred
during the third quarter of 1996.
Cash used in financing activities was $551.1 during the first nine months of
1996 compared to $336.3 for the same period in 1995. These included dividend
payments of $321.4 in the first nine months of 1996 compared to $262.1 for the
same period in 1995. The Company issued $100 of 7% debentures in May 1996 to
refinance the debt called and redeemed in the fourth quarter of 1995.
Short-term financing, including the net change in affiliate notes, decreased
$332.8 for the first nine months of 1996, compared to $39 for the same period
in 1995, reflecting a reduction in commercial paper partially from the proceeds
of the long-term debt issuance.
During 1995, the Company entered into forward contracts to sell $75 of U.S.
Treasury bonds in order to hedge against future changes in market interest
rates related to debt that was called and redeemed by the Company during the
fourth quarter of 1995, and subsequently refinanced in May 1996. A gain of
approximately $5 occurred upon the settlement of the forward contracts and will
be amortized over the life of the associated refinanced debt as an offset to
interest expense.
5
<PAGE> 7
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)
OTHER MATTERS
In connection with the re-engineering plan, during the first nine months of
1996, costs of approximately $56.5 have been incurred, including $45.9 to
re-engineer customer service processes and $10.7 to re-engineer administrative
processes. Since the plan's inception at the beginning of 1994, costs of
approximately $297.3 have been incurred, including $199.8 to re-engineer
customer service processes and $45 to re-engineer administrative processes.
The restructuring costs also include $52.5 to consolidate facilities and
operations and other related costs. These expenditures were primarily
associated with the closure and relocation of various service centers, software
enhancements and separation benefits associated with employee reductions.
Implementation of the re-engineering plan is expected to be substantially
completed by the end of 1996. As of September 30, 1996, $147.9 remains in the
restructuring reserve which management believes is adequate to cover future
expenditures.
On August 8, 1996, the Federal Communications Commission (FCC) published its
Report and Order (Order) containing rules implementing Section 251 of the
Telecommunications Act of 1996 (the Telecommunications Act) dealing with
interconnection, unbundling of network elements and wholesale prices and other
terms for competitive entry into local-exchange service (Competitive Entry
Terms). On August 9, 1996, the FCC released its Second Report and Order
implementing the provision of number portability and dialing parity in accord
with the Telecommunications Act.
GTE believes that if the Order were implemented as drafted, it would cause
irreparable harm to local-exchange carriers (LECs) by providing unfair
advantages to other carriers who will compete with the LECs in providing local
service in the LEC's local territory.
On September 16, 1996, GTE filed an appeal and motion for stay of the Order with
the United States Court of Appeals for the District of Columbia. This appeal
argued that the FCC had no jurisdiction to impose national pricing rules for
what is essentially local service. This appeal was subsequently transferred to
the Court of Appeals for the Eighth Circuit together with appeals by other LECs
and state regulatory commissions. On October 15, 1996, the Eighth Circuit
granted a partial stay. The stay delays implementation of the Order's pricing
provisions and associated rules, as well as the rules requiring GTE and other
LECs to permit requesting carriers to select terms and conditions from various
agreements between them and other carriers for purposes of interconnection.
Additionally, the Court scheduled oral argument on the merits for the week of
January 13, 1997. On November 12, 1996, the Supreme Court denied applications
to vacate the stay filed by the FCC and various companies seeking to enter the
local-exchange business.
While GTE cannot predict the outcome of the Court's final decision, GTE intends
to continue to vigorously present its position in Court.
GTE is continuing to negotiate with requesting carriers over the terms of
interconnection, unbundled network elements and resale rates. In some cases,
the parties have been unable to agree within the statutory period for
negotiation and have gone to arbitration before various state regulatory
commissions, including California. It is expected that in late November 1996,
the first state commission decision determining the prices and terms of
unresolved issues will be released. Subsequent decisions are expected to be
issued over a period extending through the first quarter of 1997.
On October 31, 1996, the Administrative Law Judge (ALJ) arbitrator assigned to
AT&T's arbitration request submitted his report. The arbitrator recommends the
continued use of the interim wholesale discounts, previously adopted by the
CPUC, for bundled services. The arbitrator also recommends interim unbundled
wholesale rates
6
<PAGE> 8
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)
based on the Company's interim cost studies filed as part of the Open Access
Network Architecture Development (OANAD) proceeding (mentioned below), which
are pending approval, adjusted by 16% to reflect a contribution for shared and
common costs. Based on the recommendations of the arbitrator and the Company's
comments to the arbitration report, the CPUC is expected to approve an
arbitration agreement by year end 1996.
The Company submitted its 1996 annual interstate access filing on April 2,
1996, utilizing the FCC's interim price cap rules. On June 24, 1996, the FCC
ordered all LECs subject to price cap regulation, including the Company, to
update their GDP-PI inflation factors through the fourth quarter of 1995.
Overall the final 1996 interstate access filing resulted in an annual price
increase of $0.3, effective July 1, 1996.
On May 8, 1996, the CPUC denied the Company's petition to modify its New
Regulatory Framework (NRF) Settlement Agreement and the NRF Phase I decision.
As a result of the CPUC's denial of the Company's petition, the Company reduced
its rates $41.7 associated with its 1996 Price Cap effective January 1, 1996 of
which $29.1 has been recorded during 1996. The amount recorded in 1996
includes $8 ($5.3 local services and $2.7 toll services) reported during the
third quarter. These refunds began in the third quarter of 1996 and are to be
completed by year end. The indexing mechanism of the price cap formula will
be suspended for 1997 and 1998.
In September 1994, the CPUC issued a final order that authorized intraLATA toll
competition (without pre-subscription) in California, effective January 1,
1995, associated with the IRD. The final order also provides for rate
rebalancing with significant rate reductions for toll service and access
charges while increasing basic local-exchange rates closer to the actual cost
of providing such service. Although this rate rebalancing was not intended to
cause significant changes in revenue, the actual increase in volumes did not
fully compensate for the toll and access rate reductions. This decision did
not permit rate increases to compensate for competitive losses of market share.
Revenues decreased by approximately $194.3 in 1995 as a result of the
implementation of this order. The Company's request for reconsideration of
this aspect of the order was denied on February 7, 1996. On March 11, 1996,
the Company filed a petition to correct calculations contained in the February
7 decision which denied the request for rehearing. In this petition, the
Company presented a calculation error in the application of the adopted
elasticity factor to message toll revenue.
On April 17, 1996, the Company filed a petition to modify the February 7
decision to allow recovery of the revenue shortfall associated with the
elasticity factor error surcharge applicable to all of its intrastate
surchargeable services rather than only toll and access services. On June 6,
1996, the CPUC approved the Company's request to correct mathematical errors,
which resulted in a favorable $53 revenue ruling for the Company. Based on
this order, a retroactive favorable revenue adjustment of $39.5 ($28.7 local
services and $10.8 toll services) was recorded in June 1996 for the period
January 26, 1995 through June 30, 1996. In addition, $13.5 of revenue is being
recognized during the second half of 1996, of which $6.9 ($1.5 local services,
$3.5 network access and $1.9 toll services) was recognized during the third
quarter. The Company was able to net the $53 of favorable surcharges related
to the CPUC's June 6, 1996 decision against $41.7 of unfavorable surcredits
associated with the 1996 Price Cap rate reduction, discussed above, and $11.3
of unfavorable surcredits resulting from the savings due to ratepayers
associated with the 1996 merger of the Company and Contel of California, Inc.,
which is discussed below.
In September 1995, the Company and Pacific Bell filed a joint petition asking
the CPUC to correct erroneous elasticity estimates, used in the original IRD
order, based on actual data available. The Company asked for recovery of $107
through increases in specific rates and through the surcharge mechanism. The
amount of requested recovery has been subsequently reduced to $80 as a result
of the favorable June 6, 1996 ruling mentioned above. A final decision is
expected by year end 1996.
7
<PAGE> 9
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)
On May 17, 1996, the CPUC consolidated a joint petition filed by AT&T, MCI,
Sprint and the California Association of Long Distance Carriers (CALTEL) and a
motion by Pacific Bell. The consolidated filing requested a procedural order
requiring the Company to initiate immediate implementation of intraLATA equal
access and pre-subscription rulings as a result of the Telecommunications Act.
In July, the Company received "provisional" authority to begin converting its
central offices to intraLATA equal access. The Company expects this conversion
to be completed by the end of the first quarter of 1997. Settlement
discussions and workshops were held with respect to the remaining issues
related to intraLATA equal access. On September 11, 1996, the Company filed a
joint motion to adopt a settlement agreement for the CPUC's approval. Three
issues remain unresolved including customer notification, cost recovery, and
intraLATA equal access from pay telephones. Hearings for these issues began on
September 24, 1996 and concluded on October 21, 1996. A final decision is
expected by year end 1996.
In December 1994, the CPUC issued a decision which adopted an initial
procedural plan to facilitate opening local-exchange telecommunications markets
to competition by January 1, 1997. On April 26, 1995, the CPUC issued a formal
rulemaking proceeding and investigation as a procedural vehicle to develop and
adopt rules for local competition. The rulemaking document contained proposed
interim rules that authorized competitive local-exchange carriers (CLCs) to
seek authority to offer local-exchange services beginning in June 1995.
On July 19, 1995, the CPUC issued interim Universal Service (US) rules and
obligations as a precursor to local competition. On October 25, 1996, the CPUC
issued a decision which established permanent rules and procedures to meet
California's US goal in a competitive telecommunications marketplace. The CPUC
concluded that a statewide subsidy fund of $351 will be required to sustain
basic residential service in high cost areas and will be paid for by
instituting a 2.87% end user surcharge on customer bills. This surcharge will
be collected by all telecommunication providers.
Incumbent LECs are initially designated as carriers of last resort (COLR) and
are eligible to receive subsidies from the fund for providing service in high
cost areas. The authorized subsidy per line is the difference between the
higher of a statewide average cost benchmark of twenty dollars and thirty cents
or the COLR's average revenue (basic service rate plus the end user line charge
plus the common carrier line charge) and the LEC's cost proxy model estimate,
which is different for each geographic study area (GSA). COLRs who receive
high cost support must implement an offsetting surcredit applied to all
competitive services excluding basic residential service.
The decision also establishes a "Teleconnect Fund" to support discounting high
speed services to schools, libraries, government owned hospitals and health
care organizations, and tax exempt community-based organizations.
The CPUC issued interim rules for local competition on July 24, 1995, which
permitted facilities-based local competition on January 1, 1996, with resale
authority granted two months later. On December 20, 1995, the Company was
granted approval by the CPUC to provide intraLATA toll, high-speed digital
private line services, and facilities-based local services outside of its
current franchise areas in competition with other LECs. On February 23, 1996,
the CPUC approved the Company's request to provide resale-based local services
outside of its current franchise areas.
On February 23, 1996, the CPUC also adopted additional local competition rules
addressing interconnection terms and conditions, joint provisioning of access
services, information-mass announcement services and additional intercompany
arrangements. On April 10, 1996, the CPUC adopted interim number portability
(INP) rates and rules, effective April 18, 1996, which will be charged to CLCs
in order to allow their customers to retain use of their existing LEC telephone
numbers when switching providers of local telephone service. The Company is
required to establish a memorandum account to track the revenues collected from
billings of INP rates to allow for a subsequent true-up once permanent rates
are adopted in the OANAD proceeding.
8
<PAGE> 10
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)
In March 1996, the CPUC approved rules permitting local resale competition
effective March 31, 1996. The CPUC required the Company to provide wholesale
discounts of 7 percent on basic residential service and 12 percent on toll and
business services to future resale competitors. On April 12, 1996, the Company
filed an Application for Rehearing of the resale decision requesting the
correction of three legal errors including ordering the Company to file resale
tariffs prior to allowing LECs the opportunity to negotiate wholesale rates as
permitted in the Telecommunications Act, imposing onerous restrictions on the
Company's pricing flexibility and allowing facilities-based CLCs to establish
their own rating areas before mitigation measures are implemented. On April
12, 1996, the Company also filed a Motion for a Stay of the implementation of
certain resale rates ordered in the resale decision. In its motion, the
Company is requesting that the CPUC authorize the Company to charge its
existing retail rates for the resale of business and residential services
pending action on the Company's Application for Rehearing and the establishment
of an interest-bearing memorandum account to track the difference between the
revenues based on adopted resale rates and revenues based on existing retail
rates. On May 1, 1996, the Company provided the CPUC with service category
specific cost studies for wholesale services in the CPUC's unbundling
proceedings. A final decision was expected by year end 1996. However, on
October 4, 1996, the CPUC issued a ruling which suspended its schedule for
adopting permanent wholesale rates until it determines how to proceed in
response to the FCC's First Report and Order. Once the impact of the FCC's
order on the CPUC's proceeding has been determined, a new procedural schedule
for adopting permanent wholesale rates will be issued.
Evidentiary hearings were held in the first quarter of 1996 to address whether
the CPUC's local competition rules have changed the CPUC's regulatory structure
so drastically, that they have violated their obligation to ensure the Company
an opportunity to earn a fair return on investment and a fair opportunity to
recover invested capital. On April 17, 1996, the Company filed a petition to
reopen LEC franchise impact hearings for the limited purpose of submitting
additional evidence quantifying the financial impact the Company will suffer
under the resale and pricing flexibility rules recently adopted by the CPUC.
On September 20, 1996, the CPUC issued a decision which concluded that the CPUC
could not determine if its recently adopted local competition rules impaired
the Company's ability to earn a fair return on investment and recover
invested capital. In response to this decision, the Company will be allowed to
file, as early as January 1, 1997, an application to provide additional
evidence supporting its impairment and also recommend alternative recovery
methods. The Company plans to provide evidence supporting the fact that the
CPUC's new regulatory program combined with NRF established depreciation
methods which have an adverse effect on the Company's opportunity to earn a
fair return on its assets in a competitive environment.
On October 5, 1995, the Governor of the State of California signed a law which
clarified the authority of the CPUC to allocate utility merger benefits between
ratepayers and shareholders with not less than 50% going to the ratepayers of
the merged company. The new law became effective January 1, 1996. On April
10, 1996, the CPUC issued a decision approving the merger of Contel of
California, Inc. into the Company under the terms of the amended legislation.
It is currently anticipated that the merger will occur by December 31, 1996.
As a part of this order the CPUC ordered $69.7 of merger savings to be returned
to the local, access and toll customers of the merged company over a five year
period. These savings represent half of the total savings expected to be
realized by this merger. In September 1996, the Company recorded a $36
reduction in local service revenues to adequately provide for the impact of
this decision in its financial statements. Rate integration and the
determination of Contel of California, Inc.'s premerger NRF startup revenue
requirement will be handled in Phase III of this proceeding. If a negotiated
settlement is reached between the Company and interested parties, it is
anticipated that permanent rates could be effective as early as March 1997. If
full evidentiary hearings are required, then a Phase III decision may be
delayed until the second half of 1997.
9
<PAGE> 11
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)
During 1995 and the first six months of 1996, the Company had expended $6.9 on
the construction of its broadband video dialtone network in Ventura County,
California. On July 2, 1996, the Ventura County, California County Board
approved a cable TV franchise application which enabled Media Ventures
Incorporated (Media Ventures), a separate subsidiary of GTE, to begin offering
cable service in September 1996. As a result, the network originally
constructed by the Company was transferred at its cost to Media Ventures in the
third quarter of 1996. All future cable services will be offered by GTE
through Media Ventures.
On July 18, 1996, GTE, through a separate subsidiary, began offering long
distance service to its customers in California, marketed under the name GTE
Easy Savings Plan(service mark). GTE plans to offer this service by December
31, 1996 in all 50 states, including the 28 states where it currently offers
local telephone service.
10
<PAGE> 12
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
------------ ------------
(Thousands of Dollars)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and temporary investments $ 21,502 $ 31,126
Receivables, less allowances of $57,876 and $56,810 493,001 554,171
Note receivable from affiliate 81,682 100
Inventories and supplies 26,811 31,022
Deferred income tax benefits 54,449 81,181
Other 19,199 13,906
------------ ------------
Total current assets 696,644 711,506
------------ ------------
PROPERTY, PLANT, AND EQUIPMENT, at cost 8,684,382 8,597,000
Accumulated depreciation (5,197,598) (4,882,561)
------------ ------------
Total property, plant and equipment, net 3,486,784 3,714,439
OTHER ASSETS, primarily employee benefit plans 550,443 480,153
------------ ------------
Total assets $ 4,733,871 $ 4,906,098
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term obligations, including current maturities $ 95,286 $ 221,518
Accounts payable 146,453 239,503
Taxes payable 143,192 67,808
Accrued interest 23,122 22,836
Accrued payroll costs 83,199 100,041
Dividends payable 163,975 88,754
Accrued restructuring costs 147,879 204,430
Other 196,538 153,160
------------ ------------
Total current liabilities 999,644 1,098,050
------------ ------------
Long-term debt 1,265,094 1,285,771
Deferred income taxes 301,780 316,716
Employee benefit plans 134,912 98,676
Other liabilities 417,621 373,352
------------ ------------
Total liabilities 3,119,051 3,172,565
------------ ------------
SHAREHOLDERS' EQUITY:
Preferred stock 81,866 81,866
Common stock (69,438,190 shares issued) 1,388,764 1,388,764
Additional paid-in capital 2,040 2,040
Retained earnings 142,150 260,863
------------ ------------
Total shareholders' equity 1,614,820 1,733,533
------------ ------------
Total liabilities and shareholders' equity $ 4,733,871 $ 4,906,098
============ ============
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
11
<PAGE> 13
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
--------------------------------
1996 1995
---------- ---------
(Thousands of Dollars)
<S> <C> <C>
OPERATIONS
Net income $ 277,935 $ 238,715
Adjustments to reconcile net income
to net cash from operations:
Depreciation and amortization 456,490 448,035
Deferred income taxes 11,796 14,032
Provision for uncollectible accounts 50,723 55,975
Change in current assets and current liabilities 30,153 (118,547)
Other - net (66,991) (22,387)
---------- ---------
Net cash from operations 760,106 615,823
---------- ---------
INVESTING
Capital expenditures (240,943) (293,060)
Proceeds from sale of land 12,496 --
Proceeds from sale of assets 2,918 --
Proceeds from transfer of assets 6,851 --
Other - net -- 5,469
---------- ---------
Net cash used in investing (218,678) (287,591)
---------- ---------
FINANCING
Long-term debt issued 98,405 --
Long-term debt retired (206) (35,280)
Dividends (321,427) (262,082)
Net change in affiliate notes (132,694) 14,126
Decrease in short-term obligations, excluding current maturities (200,130) (53,079)
Other - net 5,000 --
---------- ---------
Net cash used in financing (551,052) (336,315)
---------- ---------
Decrease in cash and temporary investments (9,624) (8,083)
Cash and temporary investments:
Beginning of period 31,126 43,118
---------- ---------
End of period $ 21,502 $ 35,035
========== =========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
12
<PAGE> 14
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) The unaudited condensed consolidated financial statements included
herein have been prepared by the Company pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. However, in the opinion of management of the Company,
the condensed consolidated financial statements include all
adjustments, which consist only of normal recurring accruals,
necessary to present fairly the financial information for such
periods. These condensed consolidated financial statements should be
read in conjunction with the financial statements and the notes
thereto included in the Company's 1995 Annual Report on Form 10-K.
(2) Reclassifications of prior year data have been made, where
appropriate, to conform to the 1996 presentation.
13
<PAGE> 15
PART II. OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits required by Item 601 of Regulation S-K.
(12) Statement re: Calculation of the Consolidated Ratio of
Earnings to Fixed Charges
(27) Financial Data Schedule
(b) The Company filed no reports on Form 8-K during the third
quarter of 1996.
14
<PAGE> 16
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
GTE California Incorporated
--------------------------------
(Registrant)
Date: November 14, 1996 William M. Edwards, III
------------------------------ --------------------------------
William M. Edwards, III
Vice President - Controller
(Principal Accounting Officer)
15
<PAGE> 17
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -------------------------------------------------------
<S> <C>
12 Statement re: Calculation of the Consolidated Ratio of
Earnings to Fixed Charges
27 Financial Data Schedule
</TABLE>
<PAGE> 1
Exhibit 12
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
STATEMENT OF THE CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES
(Thousands of Dollars)
<TABLE>
<CAPTION>
Nine Months Ended
September 30, 1996
------------------
<S> <C>
Net earnings available for fixed charges:
Income from continuing operations $ 277,935
Add - Income taxes 177,918
- Fixed charges 81,462
------------
Adjusted earnings $ 537,315
============
Fixed charges:
Interest expense $ 73,122
Portion of rent expense
representing interest 8,340
------------
Adjusted fixed charges $ 81,462
============
RATIO OF EARNINGS TO FIXED CHARGES 6.60
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 21,502
<SECURITIES> 0
<RECEIVABLES> 632,559
<ALLOWANCES> 57,876
<INVENTORY> 26,811
<CURRENT-ASSETS> 696,644
<PP&E> 8,684,382
<DEPRECIATION> 5,197,598
<TOTAL-ASSETS> 4,733,871
<CURRENT-LIABILITIES> 999,644
<BONDS> 1,265,094
0
81,866
<COMMON> 1,388,764
<OTHER-SE> 144,190
<TOTAL-LIABILITY-AND-EQUITY> 4,733,871
<SALES> 2,041,657
<TOTAL-REVENUES> 2,041,657
<CGS> 724,704
<TOTAL-COSTS> 1,518,733
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 68,200
<INCOME-PRETAX> 455,853
<INCOME-TAX> 177,918
<INCOME-CONTINUING> 277,935
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 277,935
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
