<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 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
Securities registered pursuant to Section 12(b) of the act:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
FIRST MORTGAGE BONDS, SERIES X, DUE 2001 PACIFIC STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act:
41/2% SERIES CUMULATIVE PREFERRED STOCK $20 PAR VALUE
41/2% SERIES CUMULATIVE PREFERRED STOCK $20 PAR VALUE
5% SERIES CUMULATIVE PREFERRED STOCK $20 PAR VALUE
7.48% SERIES CUMULATIVE PREFERRED STOCK $100 PAR VALUE
(TITLE OF CLASS)
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. X
-----
THE COMPANY HAD 70,000,000 SHARES OF $20 PAR VALUE COMMON STOCK OUTSTANDING AT
FEBRUARY 28, 1997. THE COMPANY'S COMMON STOCK IS 100% OWNED BY GTE CORPORATION.
THE AGGREGATE MARKET VALUE OF THE REGISTRANT'S VOTING PREFERRED STOCK HELD BY
NON-AFFILIATES AT FEBRUARY 28, 1997, AMOUNTED TO $3,610,419.
DOCUMENT INCORPORATED BY REFERENCE: PROXY STATEMENT FOR ANNUAL MEETING OF
SHAREHOLDERS TO BE HELD ON APRIL 9, 1997 (INCORPORATED IN PART III).
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Item Page
<S> <C>
Part I
1. Business 1
2. Properties 5
3. Legal Proceedings 5
4. Submission of Matters to a Vote of Security Holders 5
Part II
5. Market for the Registrant's Common Equity and Related 6
Shareholder Matters
6. Selected Financial Data 7
7. Management's Discussion and Analysis of Financial 8
Condition and Results of Operations
8. Financial Statements and Supplementary Data 15
9. Changes in and Disagreements with Accountants on 39
Accounting and Financial Disclosure
Part III
10. Directors and Executive Officers of the Registrant 40
11. Executive Compensation 42
12. Security Ownership of Certain Beneficial Owners and Management 42
13. Certain Relationships and Related Transactions 42
Part IV
14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 43
</TABLE>
<PAGE> 3
PART I
Item 1. Business
GTE California Incorporated (the Company) was incorporated in California in
1929. The Company is a wholly-owned subsidiary of GTE Corporation (GTE) and
provides communications services in the states of California, Nevada and
Arizona.
The Company has a wholly-owned subsidiary, Contel Advance Systems, Inc., which
markets telecommunications customer premise equipment and other products and
services.
On September 10, 1992, the Company entered into an Agreement of Merger with
Contel of California, Inc., a California corporation (Contel California). The
agreement provides that Contel California would merge with and into the
Company, with the Company to be the surviving corporation in the merger (the
Merger). On April 20, 1994, the California Public Utilities Commission (CPUC)
issued a decision giving final approval to the Merger. The decision required
the merging companies to flow through to their ratepayers all of the estimated
savings that will be produced from the Merger. This flow through requirement is
based on the CPUC's interpretation of certain statutory requirements. The CPUC,
however, provided the parties with the opportunity to supplement the
evidentiary record to show why the estimated merger savings should be
apportioned between ratepayers and shareholders. That filing was made on April
29, 1994. By making the filing, the effective date of the decision approving
the Merger was delayed. The Company and other interested parties filed reports
and comments pursuant to this proceeding. 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 ratepayers. The CPUC approved the Merger in April
1996. As part of the order, the CPUC ordered $69.7 million of merger savings to
be returned to the ratepayers of both companies, which represents half of the
total savings expected to be realized by this merger over a five-year period.
The Company received approval to return these savings to local, toll and access
customers beginning in mid-1996. The Merger was concluded December 31, 1996,
and is being accounted for in a manner similar to a "pooling of interests."
The Company's principal line of business is providing communications services
ranging from local telephone service for the home and office to highly complex
voice and data services for industry. The Company provides local telephone
service within its franchise area and intraLATA (Local Access Transport Area)
toll service between the Company's facilities and the facilities of other
telephone companies within the Company's LATAs. InterLATA service to other
points in and out of the states in which the Company operates is provided
through connection with interexchange (long distance) common carriers. These
common carriers are charged fees (access charges) for interconnection to the
Company's local facilities. Business and residential customers also pay access
charges to connect to the local network to obtain long distance service. The
Company earns other revenues by providing such services as billing and
collection and operator services to interexchange carriers. At December 31,
1996, the Company served 4,744,534 access lines in its service territories.
At December 31, 1996, the Company had 11,937 employees.
The Company has written agreements with the Communications Workers of America
(CWA) and the International Brotherhood of Electrical Workers (IBEW) covering
substantially all non-management employees. In 1996, a new contract was reached
with the CWA and IBEW. No contracts will expire during 1997.
REGULATORY AND COMPETITIVE TRENDS
The Company is subject to regulation by the regulatory bodies of the states of
California, Nevada and Arizona as to its intrastate business operations and by
the Federal Communications Commission (FCC) as to its interstate operations.
1
<PAGE> 4
Advances in technology, together with a number of regulatory, legislative and
judicial actions, continue to accelerate and expand the level of competition
and opportunities available to the Company. Presently, the Company is subject
to competition from numerous sources, including competitive access providers
(CAPs) for network access services. In addition, competition from alternative
local-exchange carriers (ALECs), interexchange carriers (IXCs), wireless
carriers and cable providers, as well as more recent entry by media and
computer companies, is expected to increase in the rapidly changing
telecommunications marketplace.
On February 8, 1996, the Telecommunications Act of 1996 (the Telecommunications
Act) became law. This comprehensive telecommunications reform legislation
addresses a wide range of competitive and regulatory issues that will affect
the future development of local and long distance services, cable television
and information services. The new law removes regulatory and court-ordered
barriers to competition between segments of the industry, enabling
local-exchange, long distance, wireless and cable companies to compete in
offering voice, video and information services.
The Telecommunications Act requires the FCC and state commissions to open
local-exchange markets and to set new guidelines for interconnection, loosens
restrictions barring local telephone companies from entering the cable
television market, and preserves universal service while equalizing the
responsibility for contribution among all carriers.
Following passage of the Telecommunications Act, the FCC has undertaken to
issue rules governing three areas: interconnection, universal service and
access charge reform. In August 1996, the FCC released its rules implementing
the provision of number portability and dialing parity in accord with the
Telecommunications Act. In August 1996, the FCC also adopted its rules
governing interconnection, unbundling of network elements and wholesale prices
and other terms for competitive entry into local-exchange service. These rules
generally require local-exchange carriers (LECs) to make their services
available to competitors at a wholesale discount and to make their network
elements available to competitors at below-cost prices. GTE petitioned for
judicial review of these rules on the grounds that they were inconsistent with
the Telecommunications Act. In October 1996, the U.S. Court of Appeals for the
Eighth Circuit granted GTE's request for stay of the pricing provisions of the
FCC's rules pending the Court's resolution of the merits of GTE's petition.
Oral arguments on the merits were held in January 1997, and the Court's ruling
is expected in the spring of 1997.
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. Since November 1996, a number of state commission decisions
determining the prices and terms of unresolved issues have been released (See
Note 12 of the Company's consolidated financial statements included in Item 8).
Subsequent decisions are expected to be issued over a period extending through
the first half of 1997.
The Company has exercised its right under the Telecommunications Act to
challenge state regulatory commission arbitration orders that govern agreements
between the Company and its competitors. The Company has filed lawsuits in
federal district courts in California.
In November 1996, the Federal-State Joint Board released its recommended
universal service plan, and in December 1996, the FCC issued its access reform
proposals. Both proposals incorporate a pricing methodology similar to the one
that GTE is appealing in the interconnection case. A final order in the
universal service proceeding must be adopted by early May 1997, and a decision
on the access reform proceeding is expected shortly thereafter.
A key provision of the Telecommunications Act eliminated the legal restraints
of the GTE Consent Decree which kept the Company from providing interLATA long
distance services. This action will simplify GTE's ability to market local,
intraLATA and interLATA service to its customers as a bundled service. In
February 1996, GTE executed an agreement whereby WorldCom, Inc. will provide,
on a non-exclusive basis, a full array of telecommunications services in
support of GTE's entry into the interLATA long distance market. In March 1996,
GTE, through a separate subsidiary, began offering long distance service to its
customers in selected markets. GTE now offers the service, marketed under the
name GTE Easy Savings Plan(sm), in all 50 states.
2
<PAGE> 5
The Telecommunications Act forbids states from imposing any barriers to entry
into local and toll competition. To date, local competition has been authorized
in all 28 states where GTE currently offers local telephone service, including
California, Nevada and Arizona. In addition, nineteen states, including
California and Arizona, have authorized plans that would allow customers to
pre-subscribe to a specific carrier to handle their intraLATA toll calls.
Pre-subscribed customers will simply dial "1" before the telephone number in
order to complete intraLATA calls. GTE has proposals pending in all nine of the
states, including Nevada, which have not ordered implementation.
Federal and state regulatory activity continued to change the traditional
cost-based, rate-of-return regulatory framework for intrastate and interstate
telephone service. Regulatory authorities have adopted various forms of
alternative regulation, which provide economic incentives to telephone service
providers to improve productivity and provide the foundation for implementing
pricing flexibility necessary to address competitive entry into the Company's
markets. The state regulatory commissions in California and Arizona have
adopted price regulation for intrastate telephone service. The regulatory
commission in the state of Nevada continues to remain under the traditional
cost-based, rate-of-return regulatory framework for intrastate telephone
service.
For the provision of interstate access services, the Company operates under the
terms of the FCC's price cap incentive plan. The "price cap" mechanism serves
to limit the rates a carrier may charge, rather than just regulating the rate
of return which may be achieved. Under this approach, the maximum prices that
the LEC may charge are increased or decreased each year by a price index based
upon inflation less a predetermined productivity target. LECs have limited
pricing flexibility provided they do not exceed the allowed price cap.
Further information regarding the Company's activities with the various
regulatory agencies and revenue arrangements with other telephone companies is
discussed in Note 12 of the Company's consolidated financial statements
included in Item 8.
The Company continues to support greater competition in telecommunications,
provided that, overall, the actions to eliminate existing legal and regulatory
barriers benefit consumers by allowing an opportunity for all service providers
to participate equally in a competitive marketplace under comparable
conditions.
The Company intends to continue to respond aggressively to regulatory and legal
developments that allow for increased competition and opportunities in the
marketplace. The Company expects its financial results to benefit from reduced
costs and the introduction of new products and services that will result in
increased usage of its telephone networks. However, it is likely that such
improvements will be offset, in part, by continued strategic pricing reductions
and the effects of increased competition.
INITIATIVES
In 1996, the Company and its parent, GTE, continued to position themselves to
respond aggressively to competitive developments and benefit from new
opportunities.
GTE California Incorporated (the Company):
Restructuring and Cost Control
During 1996, the Company substantially completed the implementation of its
three-year $494.2 million re-engineering program. Total costs of the program
included $322.5 million related to improvements in customer service processes,
$116.1 million related to improvements in administrative processes and $55.6
million related to the consolidation of facilities and operations and other
related costs. These costs were primarily associated with the closure and
relocation of various centers, software enhancements and separation benefits
related to employee reductions.
3
<PAGE> 6
GTE Corporation (GTE):
Video Services
The Telecommunications Act eliminates the telephone company programming ban and
allows GTE the flexibility to choose whether it will enter the wireline video
distribution business through an open video platform arrangement or via a
standard cable television operation (Title VI). The legislation also allows GTE
to deploy video networks which are fully integrated with its telephone
operations.
GTE, through a separate subsidiary, made its initial entry into the video
market under Title VI. The most technologically-advanced hybrid fiber/coaxial
network available is being deployed. At the end of 1996, GTE had been granted
six franchises, including three franchises in the Ventura County, California
market. Construction of the networks in those markets is underway and
approximately 7,000 video subscribers were acquired in 1996, bringing GTE's
total video subscribers to approximately 15,000.
Internet Access
GTE, through a separate subsidiary, was the first local-exchange carrier to
introduce nationwide Internet services to residential and business customers in
1996. By year-end 1996, GTE's Internet access service, marketed as GTE Internet
Solutions, was offered in over 350 cities covering 49 states, including
California, Arizona and Nevada. An agreement with UUNET Technologies provides
the Internet backbone and local dialing capabilities. Over 70,000 customers
were subscribing to GTE Internet Solutions at December 31, 1996.
GTE Long Distance
One of the most significant impacts of the Telecommunications Act's passage was
the removal of certain restrictions previously included in GTE's Consent
Decree. Prior to February 8, 1996, GTE was restricted from jointly marketing
the products and services of the Company with those of GTE's interexchange
subsidiaries. With this joint marketing restriction lifted, GTE can now offer
its customers many services on one monthly bill, with one point of contact.
This opportunity facilitated GTE's entry into the long distance business, as
discussed above. By December 31, 1996, GTE, through a separate subsidiary, was
offering the service, marketed under the name GTE Easy Savings Plan(sm), in all
50 states and was serving over 825,000 customers.
ENVIRONMENTAL MATTERS
GTE maintains monitoring and compliance programs related to environmental
matters. The Company's annual expenditures for environmental compliance have
not been and are not expected to be material. Costs incurred include outlays
required to keep existing operations in compliance with environmental
regulations and an underground storage tank replacement program.
4
<PAGE> 7
Item 2. Properties
The Company's property consists principally of land, structures and equipment
required to provide various telecommunications services. All of these
properties, located in the states of California, Nevada and Arizona, are
generally in good operating condition and adequate to satisfy the needs of the
business. Substantially all of the Company's property is subject to the liens
of its respective mortgages securing funded debt. From January 1, 1992 to
December 31, 1996, the Company made capital expenditures of $2.5 billion for
new plant and facilities required to meet telecommunication service needs and
to modernize plant and facilities. These additions were equal to 26% of gross
plant of $9.7 billion at December 31, 1996.
In the fourth quarter of 1995, the Company discontinued the use of Statement of
Financial Accounting Standards No. 71, "Accounting for the Effects of Certain
Types of Regulation" (FAS 71).
In general, FAS 71 required the Company to depreciate its telephone plant and
equipment over lives approved by regulators which, in many cases, extended
beyond the assets' economic lives. FAS 71 also required the deferral of certain
costs based upon approvals received from regulators to recover such costs in
the future. As a result of these requirements, the recorded net book value of
certain assets and liabilities, primarily telephone plant and equipment, were
in many cases higher than that which would otherwise have been recorded based
on their economic lives. See Note 2 to the Company's consolidated financial
statements included in Item 8.
Item 3. Legal Proceedings
There are no pending legal proceedings which would have a material impact on
the Company's consolidated financial statements.
Item 4. Submission of Matters to a Vote of Security Holders
None.
5
<PAGE> 8
PART II
Item 5. Market for the Registrant's Common Equity and Related
Shareholder Matters
Market information is omitted since the Company's common stock is wholly-owned
by GTE Corporation (GTE).
SHAREHOLDER SERVICES
The First National Bank of Boston, Transfer Agent and Registrar for GTE and the
Company's common stock and preferred stock, should be contacted with any
questions relating to shareholder accounts. This includes the following:
o Account information
o Dividends
o Market prices
o Transfer instructions
o Statements and reports
o Change of address
Shareholders may call toll-free at 1-800-225-5160 anytime, seven days a week.
Customer Service Representatives are available Monday through Friday between
the hours of 8 a.m. and 5 p.m. Eastern Time. Outside the United States call
1-617-575-2990.
Or write to:
Bank of Boston
c/o Boston EquiServe, L.P.
P.O. Box 9121
Boston, MA 02205-9121
For overnight delivery services, use the following address:
Bank of Boston
c/o Boston EquiServe, L.P.
Blue Hills Office Park
150 Royall Street
Canton, MA 02021
The Bank of Boston address where shareholders, banks and brokers may deliver
certificates is One Exchange Place, 55 Broadway in New York City.
PARENT COMPANY ANNUAL REPORT
To obtain a copy of the 1996 annual report of our parent company or the annual
Form 10-K filed with the Securities and Exchange Commission, call
1-800-225-5160.
INFORMATION VIA THE INTERNET
Internet World Wide Web users can access
information on GTE through the following universal resource:
http://www.gte.com
PRODUCTS AND SERVICES HOTLINE
Shareholders may call 1-800-828-7280 to receive information concerning GTE
products and services.
6
<PAGE> 9
Item 6. Selected Financial Data (See Note 4 to the Company's consolidated
financial statements included in Item 8)
GTE California Incorporated and Subsidiary
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------------------------------
Selected Income Statement Items (a) 1996 1995 1994 1993(b) 1992
- ----------------------------------- -------------------------------------------------------------------------
(Thousands of Dollars)
<S> <C> <C> <C> <C> <C>
Revenues and sales $ 3,141,166 $ 3,144,816 $ 3,319,871 $ 3,349,525 $ 3,423,405
Operating costs and expenses 2,198,552 2,454,598 2,374,199 2,973,050 2,487,378
-------------------------------------------------------------------------
Operating income 942,614 690,218 945,672 376,475 936,027
Interest - net 98,567 111,823 105,801 122,617 132,297
Gain on disposition of assets (1,117) -- -- -- --
Other - net -- -- -- (2,762) (3,160)
Income taxes 329,326 235,534 339,585 107,932 297,822
-------------------------------------------------------------------------
Income before extraordinary charges 515,838 342,861 500,286 148,688 509,068
Extraordinary charges -- (711,048)(c) -- (20,214) --
-------------------------------------------------------------------------
Net income (loss) $ 515,838 $ (368,187) $ 500,286 $ 128,474 $ 509,068
=========================================================================
Dividends declared on common stock $ 504,154 $ 325,863 $ 422,791 $ 461,471 $ 457,267
Dividends declared on preferred stock 4,784 4,784 4,850 4,891 4,867
</TABLE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
As of December 31,
-------------------------------------------------------------------------
Selected Balance Sheet Items 1996 1995 1994 1993 1992
- ---------------------------- -------------------------------------------------------------------------
(Thousands of Dollars)
<S> <C> <C> <C> <C> <C>
Property, plant and equipment, net (c) $3,754,635 $3,994,596 $5,361,502 $5,495,604 $5,568,541
Total assets 5,083,385 5,345,522 6,718,720 6,628,075 6,556,691
Long-term debt and preferred
stock, subject to
mandatory redemption 1,280,151 1,375,771 1,370,157 957,908 1,692,157
Shareholders' equity 1,848,628 1,841,728 2,540,562 2,467,917 2,805,805
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Per share data is omitted since the Company's common stock is 100% owned
by GTE Corporation.
(b) Operating income in 1993 included a $494.2 million pre-tax charge for
restructuring costs which reduced net income by $304.4 million.
(c) See Note 2 to the consolidated financial statements included in Item 8.
7
<PAGE> 10
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in Millions)
BUSINESS OPERATIONS
GTE California Incorporated (the Company) provides a wide variety of
communications services ranging from local telephone service for the home and
office to highly complex voice and data services for various industries. At
December 31, 1996, the Company served 4,744,534 access lines in the states of
California, Nevada and Arizona. The Company is a wholly-owned subsidiary of
GTE Corporation (GTE).
On September 10, 1992, the Company entered into an Agreement of Merger with
Contel of California, Inc., a California corporation (Contel California). The
agreement provided that Contel California would merge with and into the
Company, with the Company to be the surviving corporation (the Merger). On
October 5, 1995, the Governor of the State of California signed a law which
clarified the authority of the California Public Utilities Commission (CPUC) to
allocate the merger savings between ratepayers and shareholders with not less
than 50% going to the ratepayers of the merged company. In accordance with the
enacted legislation, on April 10, 1996, the CPUC issued its decision for the
approval of the Merger. The Merger was concluded on December 31, 1996, and has
been accounted for in a manner similar to a "pooling of interests."
Accordingly, the financial statements include the combined historical results
of operations and financial position of the Company and Contel California as
though the Merger had occurred at the beginning of each period presented and
reflect the elimination of all significant intercompany transactions.
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------------
1996 1995 1994
--------------- --------------- -------------
<S> <C> <C> <C>
Net income (loss) $ 515.8 $ (368.2) $ 500.3
</TABLE>
The net loss for 1995 includes one-time extraordinary charges (net of tax) of
$711 related to the discontinuance of Statement of Financial Accounting
Standards No. 71, "Accounting for the Effects of Certain Types of Regulation"
(FAS 71) and the early retirement of debt recorded in the fourth quarter of
1995.
Excluding these special items, net income increased 50% or $172.9 and decreased
31% or $157.4 for 1996 and 1995, respectively. The 1996 increase is driven by
significant improvements in the level of operating costs and expenses. The
slight decrease in revenues is a result of several major regulatory rulings
which offset strong customer growth.
The 1995 decrease is the result of lower operating income primarily due to
corresponding decreases in revenues associated with the Implementation Rate
Design (IRD) discussed below. The 1995 decrease is also due to higher labor
charges due to flood damage incurred during the first quarter of 1995 and
higher depreciation expense primarily associated with additions to plant
balances during the year.
On January 1, 1995, pursuant to an order issued by the CPUC, competition in
toll services (without customer pre-subscription) became effective in
California. The order also provided for rate rebalancing with significant rate
reductions for toll services and access charges while increasing basic local
service rates closer to the actual cost of providing such service. Although
this rate rebalancing was intended by the CPUC to be revenue neutral, the
actual increase in volumes did not fully compensate for the toll and access
rate reductions. Revenue reductions attributed to the implementation of this
order were $232.3 in 1995.
8
<PAGE> 11
REVENUES AND SALES
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Local services $ 1,361.3 $ 1,403.1 $ 1,062.0
Network access services 870.5 812.6 806.6
Toll services 490.1 510.6 1,068.6
Other services and sales 419.2 418.5 382.7
---------- ---------- ----------
Total revenues and sales $ 3,141.1 $ 3,144.8 $ 3,319.9
</TABLE>
Total revenues and sales decreased less than 1% or $3.7 and 5% or $175.1 during
1996 and 1995, respectively.
Local service revenues are based on fees charged to customers for providing
local-exchange service within designated franchise areas. Local service
revenues decreased 3% or $41.8 in 1996 and increased 32% or $341.1 in 1995. The
1996 decrease is due to a combination of the following: a $34 reduction in
revenues reflecting the refund of anticipated merger expense savings; a $27.3
reduction in revenues associated with the Company's 1996 California Price Cap
Index (PCI), discussed below; a $20.6 reserve recorded in the third quarter of
1996 for operating tax settlements; a $14.8 net reduction in refunds received
from the California High Cost Fund, a fund established to subsidize rural
providers for the costs of providing universal service; an $11.5 scheduled
reduction in revenues associated with a previous rate order; and an $11.1
decrease in directory and operator service revenues.
The foregoing decreases were offset by the following increases: $34.6 increase
in revenue resulting from a favorable ruling by the CPUC associated with the
IRD discussed in Note 12 of the Company's consolidated financial statements
included in Item 8; $28.2 increase driven by a 5% growth in switched access
lines, and increased sales of Integrated Services Digital Network (ISDN) and
Digital Channel Service (DCS); $8 increase in SmartCall(R) and other custom
calling features; and $7.3 growth in CentraNet(R) sales.
The increase in 1995 is primarily the result of $292.6 in rate increases
associated with the IRD. Also, a one-time support payment of $31.9 was recorded
in December 1995 from the California High Cost Fund. The number of access lines
increased 3% in 1995 compared to the same period in 1994, which generated $18.5
of additional revenues. The 1995 increase was partially offset by a $10.4
reduction in revenues due to more customers electing measured usage rate plans
and by a $4.2 reduction in revenues associated with the refund of installation
charges to customers.
Network access service revenues are based on fees charged to interexchange
carriers that use the Company's local- exchange network in providing long
distance services. In addition, residential and business customers pay end user
access fees to connect to the local network to obtain long distance service.
Cellular service providers and other local- exchange carriers also pay access
charges for cellular and intraLATA (Local Access Transport Area) toll calls
hauled or terminated by the Company. Network access service revenues increased
7% or $57.9 and less than 1% or $6 in 1996 and 1995, respectively. Minutes of
use increased in 1996 by 12%, which generated additional revenues of $45.9. The
1996 increase also reflects a $22 increase in special access revenues
associated with growth in dedicated access lines and $9.7 of favorable meet
point billing settlements. Higher end user access charge revenues of $5.9 were
recorded in connection with access line growth. In addition, the increase also
reflects a revenue adjustment of $4 associated with the favorable IRD ruling
mentioned above and discussed in Note 12 of the Company's consolidated
financial statements included in Item 8. These increases were partially offset
by a $2.4 reserve associated with the operating tax settlements mentioned above
and $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, revenues decreased by $4.4 reflecting
the net effect of changes in interstate access rates associated with the
Federal Communications Commission's (FCC) 1995 and 1996 price caps.
Minutes of use increased 11% in 1995, compared to the same period in 1994. This
increase generated $26.1 of additional revenues. In addition, the 1995 increase
is due to $22.1 in nonrecurring favorable carrier settlement activities
recorded in the first quarter of 1995, reflecting a switched access meet point
billing settlement with Pacific Bell for the
9
<PAGE> 12
period January 1, 1990 through December 31, 1994. The increase is also due to
the net effect of the May and August 1995 interstate rate changes that resulted
in $6 of additional revenues associated with the FCC Price Cap. These increases
are partially offset by a $19 reduction in interstate access revenues
associated with affiliate audit price reductions and by $14.5 of carrier
billing settlements recorded in the fourth quarter of 1994. Other decreases of
$8.1 in rate reductions associated with the previously mentioned IRD and $3 in
lower support payments received from the Universal Service Fund were also
partial offsets to the aforementioned increase.
The Company's toll services are based on fees charged for service beyond a
customer's local calling area but within the LATA. Toll service revenues
decreased 4% or $20.5 and 52% or $558 in 1996 and 1995, respectively. The 1996
decrease is primarily due to the impacts of optional discount calling plans,
which effectively lowered intrastate long distance rates. This decrease also
reflects an $11.5 revenue reduction associated with the Company's 1996
California PCI, mentioned above. Additionally, this decline results from a $5.2
reserve for the refund of merger savings and an $8.6 reserve for operating tax
settlements, both of which are noted above. These reductions are partially
offset by a $14.5 increase resulting from a favorable ruling by the CPUC
associated with IRD, as discussed above. The decrease is also offset by an
increase in toll volumes and a $9.9 increase resulting from unfavorable revenue
adjustments recorded in the first quarter of 1995. The decline in 1995 is
primarily the result of $526 in rate reductions associated with the previously
mentioned IRD.
Other services and sales revenues increased less than 1% or $0.7 and 9% or
$35.8 in 1996 and 1995, respectively. The 1996 increase is primarily
attributable to an $8.4 growth in sales of voice messaging services and growth
in sales of radio paging of $2.2. These increases are partially offset by 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 increase for 1995 is primarily due to a $9.1 increase in revenues
associated with the IRD, a $6.9 increase in operator service revenues, an $11.7
increase in billing and collection revenues and a $9.2 increase in revenues due
to growth in sales of voice messaging and radio paging. These increases are
partially offset by $5.2 of lower sales of single line telephone systems.
OPERATING COSTS AND EXPENSES
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Cost of services and sales $ 1,052.4 $ 1,198.6 $ 1,184.8
Selling, general and administrative 477.7 583.5 544.9
Depreciation and amortization 668.4 672.5 644.5
---------- ---------- ----------
Total operating costs and expenses $ 2,198.5 $ 2,454.6 $ 2,374.2
</TABLE>
Total operating costs and expenses decreased 10% or $256.1 in 1996 and
increased 3% or $80.4 in 1995. The decrease in operating costs and expenses for
1996 is largely due to the following: $79.5 reduction in labor and benefit
costs associated with productivity gains from process re-engineering and other
cost containment programs; $28.9 reversal of the Communications Workers of
America (CWA) arbitration reserve due to a favorable ruling; $27.3 reduction in
regulation expense recorded in 1995; $16 decrease in expenses reflecting labor
charges relating to flood damage incurred in first quarter of 1995; $17
decrease in the provision for uncollectible accounts; $12.4 reduction in data
processing costs; $8.1 reduction in contract labor charges. The 1996 decrease
was also due to $25.6 of pension settlement gains recorded in 1996 partially
offset by $13.7 of settlement gains recorded in 1995 which resulted from
lump-sum payments from the Company's pension plans.
Effective January 1, 1995, the Company transitioned to an Originating
Responsibility Plan (ORP) for intraLATA access settlement arrangements. As part
of this CPUC-ordered rate rebalancing, the Company incurred $35.9 of intraLATA
access charge payments in 1995 for intraLATA toll calls that were originated by
the Company and terminated by another local-exchange carrier (LEC). In
addition, the 1995 increase is also due to a $16 increase in labor charges
related to flood damage incurred during the first quarter of 1995, a $28
increase in depreciation primarily associated with additions to plant balances,
$17.5 of higher costs associated with the collection of interexchange carrier
receivables, an
10
<PAGE> 13
$8 increase in the provision for uncollectible accounts, $7.4
in nonrecurring favorable settlement activities recorded in 1994 and $6.3
related to changes in plan participation in the Company's incentive
compensation programs. These increases are partially offset by $13.7 of
settlement gains which resulted from lump-sum payments from the Company's
pension plans, $19.1 of lower labor and benefit costs associated with the
Company's re-engineering plan, $5 of costs incurred during 1994 related to
earthquake damage and $2.9 of insurance proceeds received in 1995 that were
related to 1994 earthquake damage. The increases are also partially offset by a
$6.7 increase in pension income and an $11.3 reduction in rent expense.
OTHER EXPENSES
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Interest - net $ 98.6 $ 111.8 $ 105.8
Income taxes 329.3 235.5 339.6
</TABLE>
Interest - net decreased 12% or $13.2 in 1996 and increased 6% or $6 in 1995.
The 1996 decrease is attributable to favorable effects of the long-term debt
refinancing program completed in June 1996. The 1995 increase is primarily due
to higher average long-term debt balances.
Income taxes increased 40% or $93.8 in 1996 and decreased 31% or $104.1 in
1995. These changes are primarily due to corresponding changes in pre-tax
income. Additionally, the 1995 decrease is partially offset by lower
amortization of investment tax credits.
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
has an existing shelf registration statement for an additional $400 of
debentures.
The Company's primary source of funds during 1996 was cash from operations of
$1,071.1 compared to $873.1 in 1995. The increase is primarily reflective of
improved results from operations and a decrease in the Company's working
capital requirements.
Net cash used in investing activities was $411.8 and $432.7 during 1996 and
1995, respectively. The Company's capital expenditures during 1996 were $434.1
compared to $438.2 in 1995. The decrease in capital expenditures was primarily
related to continued declining requirements for modernization of current
facilities offset by expenditures associated with growth in access lines. The
video network originally constructed by the Company was transferred at its cost
of $6.9 to Media Ventures Incorporated, a separate subsidiary of GTE (as
discussed in Note 12 of the Company's consolidated financial statements
included in Item 8). The Company's anticipated construction costs for 1997 are
expected to increase from the 1996 level, reflecting the continued expansion of
existing networks, upgrades associated with the support of expanded services
and compliance with the local number portability requirements of the
Telecommunications Act.
In 1996, proceeds of $15.4 were generated from the sales of selected real
estate properties. The Company recognized a pre-tax gain of $1.1 as a result of
this sale.
Net cash used in financing activities was $670.4 in 1996 compared to $452.5 in
1995. The Company retired $45.3 of long-term debt in 1996 compared to total
retirements of $150.3 in 1995. In May 1996, the Company issued $100 of 7%
Series D Debentures, due 2008, for the repayment of short-term borrowings
incurred in connection with the redemption
11
<PAGE> 14
of long-term debt in December 1995. The Company made dividend payments of
$485.2 in 1996 compared to $390.6 in 1995. Short-term financing, including the
net change in affiliate notes, decreased $243.3 in 1996 compared to an increase
of $88.4 in 1995, reflecting a reduction in commercial paper partially from the
proceeds of long-term debt.
At December 31, 1995, the Company had entered into forward contracts to sell
$75 of U.S. Treasury Bonds to hedge against changes in market interest
rates related to the debt the Company called and refinanced during the first
half of 1996. A gain of approximately $5 occurred upon the settlement
of the forward contracts and is being amortized over the life of the associated
refinanced debt as an offset to interest expense.
REGULATORY AND COMPETITIVE TRENDS
The Company is subject to regulation by the regulatory bodies of the states of
California, Nevada and Arizona as to its intrastate business operations and by
the FCC as to its interstate operations.
Significant regulatory and legislative developments occurred during 1996,
including the passage of the Telecommunications Act. The Telecommunications Act
is intended to promote competition in all sectors of the telecommunications
marketplace, while preserving and advancing universal telephone service.
As a result of the Telecommunications Act, the Company may be faced with
increased competition from numerous sources, including competitive access
providers (CAPs), alternative local-exchange carriers (ALECs), interexchange
carriers (IXCs), wireless carriers, cable providers, media and computer
companies. These companies collectively have the ability to offer a broad array
of voice, video and data services to business and residential customers.
Following passage of the Telecommunications Act, the FCC has undertaken to
issue rules governing three areas: interconnection, universal service and
access charge reform. In August 1996, the FCC adopted its rules governing
interconnection. These rules generally require LECs to make their services
available to competitors at a wholesale discount and to make their network
elements available to competitors at below-cost prices. GTE petitioned for
judicial review of these rules on the grounds that they were inconsistent with
the Telecommunications Act. In October 1996, the U.S. Court of Appeals for the
Eighth Circuit granted GTE's request for a stay of the pricing provisions of
the FCC's rules pending the Court's resolution of the merits of GTE's petition.
Oral arguments on the merits were held in January 1997, and the Court's ruling
is expected in the spring of 1997.
In November 1996, the Federal-State Joint Board released its recommended
universal service plan, and in December 1996, the FCC issued its access reform
proposals. Both proposals incorporate a pricing methodology similar to the one
that GTE is appealing in the interconnection case. A final order in the
universal service proceeding must be adopted by early May 1997, and a decision
on the access reform proceeding is expected shortly thereafter.
A key provision of the Telecommunications Act eliminated the legal restraints
of the GTE Consent Decree which kept the Company from providing interLATA long
distance services. This action will simplify GTE's ability to market local,
intraLATA and interLATA service to its customers as a bundled service. In
February 1996, GTE executed an agreement whereby WorldCom, Inc. will provide,
on a nonexclusive basis, a full array of telecommunications services in support
of GTE's entry into the interLATA long distance market. In March 1996, GTE,
through a separate subsidiary, began offering long distance service to its
customers in selected markets. GTE now offers the service, marketed under the
name GTE Easy Savings Plan(sm), in all 50 states.
The Telecommunications Act forbids states from imposing any barriers to entry
into local and toll competition. To date, local competition has been authorized
in all 28 states where GTE currently offers local telephone service, including
California, Nevada and Arizona. In addition, nineteen states, including
California and Arizona, have authorized plans that would allow customers to
pre-subscribe to a specific carrier to handle their intraLATA toll calls.
Pre-subscribed customers will simply dial "1" before the telephone number in
order to complete intraLATA calls. GTE has proposals pending in all nine of the
states, including Nevada, which have not ordered implementation.
12
<PAGE> 15
Federal and state regulatory activity continued to change the traditional
cost-based, rate-of-return regulatory framework for intrastate and interstate
telephone service. Regulatory authorities have adopted various forms of
alternative regulation, which provide economic incentives to telephone service
providers to improve productivity and provide the foundation for implementing
pricing flexibility necessary to address competitive entry into the Company's
markets. The state regulatory commissions in California and Arizona have
adopted price regulation for intrastate telephone service. The regulatory
commission in the state of Nevada continues to remain under the traditional
cost-based, rate-of-return regulatory framework for intrastate telephone
service.
For the provision of interstate access services, the Company operates under the
terms of the FCC's price cap incentive plan. The "price cap" mechanism serves
to limit the rates a carrier may charge, rather than just regulating the rate
of return which may be achieved. Under this approach, the maximum prices that
the LEC may charge are increased or decreased each year by a price index based
upon inflation less a predetermined productivity target. LECs have limited
pricing flexibility provided they do not exceed the allowed price cap.
On January 1, 1995, pursuant to an order issued by the CPUC, competition in
toll services (without customer pre-subscription) became effective in
California. The order also provided for rate rebalancing with significant rate
reductions for toll services and access charges while increasing basic local
service rates closer to the actual cost of providing such service. Although
this rate rebalancing was intended by the CPUC to be revenue neutral, the
actual increase in volumes did not fully compensate for the toll and access
rate reductions. Revenues decreased by approximately $232.3 in 1995 as a result
of the implementation of this order.
On February 23, 1996, GTE Mobilnet and GTE Card Services received approval of
their Certificates of Public Convenience and Necessity to provide resale based
local-exchange service within GTE and Pacific Bell service territories.
On September 10, 1992, GTE California Incorporated (the Company) and Contel of
California, Inc. entered into an Agreement of Merger whereby Contel California
would merge with and into the Company, with the Company to be the surviving
corporation in the merger (the Merger). 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. In accordance with
the enacted legislation, the CPUC approved the Merger on April 10, 1996. As
part of the order, the CPUC ordered $69.7 of merger savings to be returned to
the ratepayers of both companies, which represents half of the total savings
expected to be realized by the Merger over a five-year period. The Company has
provided for the impact of this decision in its financial statements. The
Company received approval to return these savings to local, toll and access
customers beginning in mid-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 Index effective January 1,
1996. The indexing mechanism of the price cap formula will be suspended for
1997 and 1998.
Further information regarding the Company's activities with the various
regulatory agencies and revenue arrangements with other telephone companies is
discussed in Note 12 of the Company's consolidated financial statements
included in Item 8.
The Company continues to support greater competition in telecommunications,
provided that, overall, the actions to eliminate existing legal and regulatory
barriers benefit consumers by allowing an opportunity for all service providers
to participate equally in a competitive marketplace under comparable
conditions.
The Company intends to continue to respond aggressively to regulatory and legal
developments that allow for increased competition and opportunities in the
marketplace. The Company expects its financial results to benefit from reduced
costs and the introduction of new products and services that will result in
increased usage of its telephone networks. However, it is likely that such
improvements will be offset, in part, by continued strategic pricing reductions
and the effects of increased competition.
13
<PAGE> 16
INITIATIVES
In 1996, the Company and its parent, GTE, continued to position themselves to
respond aggressively to competitive developments and benefit from new
opportunities. Further information regarding these initiatives is discussed in
Item 1.
INFLATION
The Company's management generally does not believe inflation has a significant
impact on the Company's earnings. However, increases in costs or expenses not
otherwise offset by increases in revenues could have an adverse effect on
earnings.
14
<PAGE> 17
Item 8. Financial Statements and Supplementary Data
GTE California Incorporated and Subsidiary
CONSOLIDATED STATEMENTS OF INCOME (Note 4)
<TABLE>
<CAPTION>
Years Ended December 31 1996 1995 1994
- ----------------------- ----------- ----------- -----------
(Thousands of Dollars)
<S> <C> <C> <C>
REVENUES AND SALES (a)
Local services $ 1,361,305 $ 1,403,101 $ 1,062,008
Network access services 870,496 812,570 806,558
Toll services 490,128 510,650 1,068,579
Other services and sales 419,237 418,495 382,726
----------- ----------- -----------
Total revenues and sales 3,141,166 3,144,816 3,319,871
----------- ----------- -----------
OPERATING COSTS AND EXPENSES (b)
Cost of services and sales 1,052,423 1,198,628 1,184,836
Selling, general and administrative 477,715 583,476 544,859
Depreciation and amortization 668,414 672,494 644,504
----------- ----------- -----------
Total operating costs and expenses 2,198,552 2,454,598 2,374,199
----------- ----------- -----------
OPERATING INCOME 942,614 690,218 945,672
OTHER (INCOME) EXPENSE
Interest - net 98,567 111,823 105,801
Gain on disposition of assets (1,117) -- --
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 845,164 578,395 839,871
Income taxes 329,326 235,534 339,585
----------- ----------- -----------
INCOME BEFORE EXTRAORDINARY CHARGES 515,838 342,861 500,286
Extraordinary charges -- (711,048) --
----------- ----------- -----------
NET INCOME (LOSS) $ 515,838 $ (368,187) $ 500,286
=========== =========== ===========
</TABLE>
(a) Includes billings to affiliates of $130,621, $122,591, and $124,704 for the
years 1996 - 1994, respectively.
(b) Includes billings from affiliates of $194,022, $228,512, and $204,621 for
the years 1996 - 1994, respectively.
See Notes to Consolidated Financial Statements.
15
<PAGE> 18
GTE California Incorporated and Subsidiary
CONSOLIDATED BALANCE SHEETS (Note 4)
<TABLE>
<CAPTION>
December 31 1996 1995
- ----------- ---------- -----------
(Thousands of Dollars)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 22,158 $ 33,265
Receivables, less allowances of $72,010 and $61,705 600,818 675,143
Inventories and supplies 25,658 31,674
Deferred income tax benefits 58,364 99,613
Other 14,387 14,747
---------- ----------
Total current assets 721,385 854,442
---------- ----------
Property, plant and equipment, net 3,754,635 3,994,596
Employee benefit plans 567,065 443,591
Other assets 40,300 52,893
---------- ----------
Total assets $5,083,385 $5,345,522
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term obligations, including current maturities $ 196,284 $ 273,356
Accounts payable 125,923 158,709
Affiliate payables and accruals 159,278 116,285
Advanced billings and customer deposits 61,797 71,371
Taxes payable 54,418 89,751
Accrued interest 25,272 25,225
Accrued payroll costs 97,680 109,410
Dividends payable 112,466 88,754
Accrued restructuring costs -- 224,885
Other 134,514 109,408
---------- ----------
Total current liabilities 967,632 1,267,154
---------- ----------
Long-term debt 1,280,151 1,375,771
Deferred income taxes 342,349 322,497
Employee benefit plans 229,914 159,192
Other liabilities 414,711 379,180
---------- ----------
Total liabilities 3,234,757 3,503,794
---------- ----------
Shareholders' equity:
Preferred stock 81,866 81,866
Common stock (70,000,000 shares issued) 1,400,000 1,400,000
Additional paid-in capital 82,239 82,239
Retained earnings 284,523 277,623
---------- ----------
Total shareholders' equity 1,848,628 1,841,728
---------- ----------
Total liabilities and shareholders' equity $5,083,385 $5,345,522
========== ==========
</TABLE>
See Notes to Consolidated Financial Statements.
16
<PAGE> 19
GTE California Incorporated and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS (Note 4)
<TABLE>
<CAPTION>
Years Ended December 31 1996 1995 1994
- ----------------------- ----------- ----------- -----------
(Thousands of Dollars)
<S> <C> <C> <C>
OPERATIONS
Income before extraordinary charges $ 515,838 $ 342,861 $ 500,286
Adjustments to reconcile income before extraordinary
charges to net cash from operations:
Depreciation and amortization 668,414 672,494 644,504
Deferred income taxes 53,455 34,309 31,326
Provision for uncollectible accounts 69,439 84,365 73,956
Change in current assets and current liabilities:
Receivables - net 27,971 (92,149) (139,896)
Other current assets 5,441 14,396 1,209
Accrued taxes and interest (35,286) (9,626) (5,257)
Other current liabilities (97,724) (107,125) (111,610)
Other - net (136,490) (66,411) (17,604)
----------- ----------- -----------
Net cash from operations 1,071,058 873,114 976,914
----------- ----------- -----------
INVESTING
Capital expenditures (434,053) (438,201) (504,787)
Proceeds from sale of assets 15,414 -- 14,023
Proceeds from transfer of assets 6,851 -- --
Other - net -- 5,469 --
----------- ----------- -----------
Net cash used in investing (411,788) (432,732) (490,764)
----------- ----------- -----------
FINANCING
Long-term debt issued 98,405 -- 790,724
Long-term debt and preferred stock retired (45,283) (150,347) (43,548)
Dividends (485,226) (390,556) (432,177)
Increase (decrease) in short-term obligations,
excluding current maturities (243,273) 88,424 (762,475)
Other - net 5,000 -- --
----------- ----------- -----------
Net cash used in financing (670,377) (452,479) (447,476)
----------- ----------- -----------
Increase (decrease) in cash and cash equivalents (11,107) (12,097) 38,674
Cash and cash equivalents:
Beginning of year 33,265 45,362 6,688
----------- ----------- -----------
End of year $ 22,158 $ 33,265 $ 45,362
=========== =========== ===========
Cash paid during the year for:
Interest $ 106,167 $ 121,005 $ 98,037
Income taxes 310,763 203,980 334,519
</TABLE>
See Notes to Consolidated Financial Statements.
17
<PAGE> 20
GTE California Incorporated and Subsidiary
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (Note 4)
<TABLE>
<CAPTION>
Additional
Preferred Common Paid-In Retained
Stock Stock Capital Earnings Total
----------- ----------- ----------- ----------- -----------
(Thousands of Dollars)
<S> <C> <C> <C> <C> <C>
Shareholders' equity, December 31, 1993 $ 81,866 $ 1,400,000 $ 82,239 $ 903,812 $ 2,467,917
Net income 500,286 500,286
Dividends declared (427,641) (427,641)
----------- ----------- ----------- ----------- -----------
Shareholders' equity, December 31, 1994 81,866 1,400,000 82,239 976,457 2,540,562
Net loss (368,187) (368,187)
Dividends declared (330,647) (330,647)
----------- ----------- ----------- ----------- -----------
Shareholders' equity, December 31, 1995 81,866 1,400,000 82,239 277,623 1,841,728
Net income 515,838 515,838
Dividends declared (508,938) (508,938)
----------- ----------- ----------- ----------- -----------
Shareholders' equity, December 31, 1996 $ 81,866 $ 1,400,000 $ 82,239 $ 284,523 $ 1,848,628
=========== =========== =========== =========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
18
<PAGE> 21
GTE California Incorporated and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
GTE California Incorporated (the Company) provides a wide variety of
communications services ranging from local telephone service for the home and
office to highly complex voice and data services for various industries. At
December 31, 1996, the Company served 4,744,534 access lines in the states of
California, Nevada and Arizona. The Company is a wholly-owned subsidiary of
GTE Corporation (GTE).
BASIS OF PRESENTATION
The Company prepares its consolidated financial statements in accordance
with generally accepted accounting principles which require that management
make estimates and assumptions that affect reported amounts. Actual results
could differ from those estimates.
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, Contel Advanced Systems, Inc. All significant
intercompany transactions have been eliminated.
The Company discontinued applying the provisions of Statement of Financial
Accounting Standards No. 71, "Accounting for the Effects of Certain Types of
Regulation" (FAS 71), in the fourth quarter of 1995 (see Note 2).
Reclassifications of prior-year data have been made, where appropriate, to
conform to the 1996 presentation.
TRANSACTIONS WITH AFFILIATES
GTE Supply (100% owned by GTE) provides construction and maintenance equipment,
supplies and electronic repair services to the Company. These purchases and
services amounted to $119.5 million, $104.6 million and $93.4 million for the
years 1996-1994, respectively. Such purchases and services are recorded in the
accounts of the Company, at cost, which includes a normal return realized by
GTE Supply.
The Company is billed for certain printing and other costs associated with
telephone directories, data processing services and equipment rentals, and
receives management, consulting, research and development and pension
management services from other affiliated companies. These charges amounted to
$194 million, $228.5 million and $204.6 million for the years 1996-1994,
respectively. The amounts charged for these affiliated transactions are based
on a proportional cost allocation method.
The Company's consolidated financial statements include allocated expenses
based on the sharing of certain executive, administrative, financial,
accounting, marketing, personnel, engineering, and other support services being
performed at consolidated work centers among the domestic GTE Telephone
Operating Companies. The amounts charged for these affiliated transactions are
based on a proportional cost allocation method as filed with the Federal
Communications Commission (FCC).
The Company has an agreement with GTE Directories Corporation (Directories)
(100% owned by GTE), whereby the Company provides its subscriber lists, billing
and collection and other services to Directories. Revenues from these
activities amounted to $130.6 million, $122.6 million and $124.7 million for
the years 1996-1994, respectively.
19
<PAGE> 22
TELEPHONE PLANT
In 1996, the Company began providing for depreciation on a straight-line basis
over the estimated economic lives of its assets (see Note 2). The Company had
previously provided for depreciation on a straight-line basis over asset lives
approved by regulators. Maintenance and repairs of property are charged to
income as incurred. Additions to, replacements and renewals of property are
charged to telephone plant accounts. Property retirements are charged in total
to the accumulated depreciation account. No adjustment to depreciation is made
at the time properties are retired or otherwise disposed of, except in the case
of significant sales or extraordinary retirements of property where profit or
loss is recognized.
REVENUE RECOGNITION
Revenues are recognized when earned. This is generally based on usage of the
Company's local-exchange networks or facilities. For other products and
services, revenues are generally recognized when services are rendered or
products are delivered to customers. Long-term contracts are generally
accounted for using the percentage-of-completion method with revenues
recognized in the proportion that costs incurred bear to the estimated total
costs to completion. Expected losses, if any, are charged to income currently.
INVENTORIES AND SUPPLIES
Inventories and supplies are stated at the lower of cost, determined
principally by the average cost method, or net realizable value.
EMPLOYEE BENEFIT PLANS
Pension and postretirement health care and life insurance benefits earned
during the year as well as interest on accumulated benefit obligations are
accrued currently. Prior service costs and credits resulting from changes in
plan benefits are amortized over the average remaining service period of the
employees expected to receive benefits. Material curtailment/settlement gains
and losses associated with employee separations are recognized in the period in
which they occur.
STOCK OPTION PLANS
In 1995, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (FAS
123). As permitted by FAS 123, the Company continues to apply the recognition
and measurement provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25). The difference between the
recognition and measurement provisions of FAS 123 and APB 25 is not significant
to the Company's results of operations.
INCOME TAXES
The Company's results are included in GTE's consolidated federal income tax
return. The Company participates in a tax-sharing agreement with GTE and remits
tax payments to GTE based on its tax liability on a separate company basis.
Deferred tax assets and liabilities are established for temporary differences
between the way certain income and expense items are reported for financial
reporting and tax purposes and subsequently adjusted to reflect changes in tax
rates expected to be in effect when the temporary differences reverse. A
valuation allowance is established for any deferred tax asset for which
realization is not likely.
20
<PAGE> 23
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include investments in short-term, highly liquid
securities, which have maturities when purchased of three months or less.
2. EXTRAORDINARY CHARGES
In response to legislation (see Note 12) and the increasingly competitive
environment, the Company discontinued the use of FAS 71 in the fourth quarter
of 1995.
As a result of the decision to discontinue FAS 71, the Company recorded a
non-cash, after-tax extraordinary charge of $710.8 million (net of tax benefits
of $493.9 million) in the fourth quarter of 1995. The charge primarily
represents a reduction in the net book value of telephone plant and equipment
through an increase in accumulated depreciation. In addition to the one-time
charge, beginning in 1996, the Company, shortened the depreciable lives of its
telephone plant and equipment as follows:
<TABLE>
<CAPTION>
Depreciable Lives
---------------------------
Average
Asset Category Before After
----------------- ----------- -------------
<S> <C> <C>
Copper 20-30 15
Switching 17-19 10
Circuit 11-13 8
Fiber 25-30 20
</TABLE>
In addition, during 1995, the Company redeemed prior to stated maturity, $75
million of long-term debt. This redemption resulted in an after-tax
extraordinary charge of $0.2 million (net of tax benefits of $0.1 million).
3. RESTRUCTURING COSTS
During 1993, the Company recorded one-time restructuring costs of $494.2
million, which reduced net income by $304.4 million, primarily for incremental
costs related to implementation of the Company's re-engineering plan to improve
customer-responsiveness and product quality, reduce the time necessary to
introduce new products and services and further reduce costs. The restructuring
costs included $322.5 million to re-engineer customer service processes and
$116.1 million to re-engineer administrative processes. The restructuring costs
also included $55.6 million 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. The re-engineering plan was
substantially completed in 1996, consistent with the original cost estimates.
21
<PAGE> 24
4. LEGAL ENTITY MERGER
On September 10, 1992, the Company entered into an Agreement of Merger with
Contel of California, Inc., a California corporation (Contel California). The
agreement provides that Contel California would merge with and into the
Company, with the Company to be the surviving corporation in the merger (the
Merger).
On October 5, 1995, the Governor of the State of California signed a law which
clarified the authority of the California Public Utilities Commission (CPUC) to
allocate utility merger benefits between ratepayers and shareholders with not
less than 50% going to the ratepayers of the merged company. In accordance with
the enacted legislation, on April 10, 1996, the CPUC issued its decision for
the approval of the Merger. The Merger, which occurred on December 31, 1996,
was accounted for in a manner consistent with a transfer of entities under
common control which is similar to a "pooling of interests." All material
intercompany transactions have been eliminated.
Listed below are details of the results of operations of the previously
separate enterprises that are included in the current combined net income
(loss):
<TABLE>
<CAPTION>
GTE Contel GTE
California California California
(Pre-Merger) (Pre-Merger) (Post-Merger)
------------ ------------ ------------
(Thousands of Dollars)
<S> <C> <C> <C>
Year Ended December 31, 1996
Revenues and sales $ 2,789,919 $ 351,247 $ 3,141,166
Operating income 796,105 146,509 942,614
Net income 435,664 80,174 515,838
Year Ended December 31, 1995
Revenues and sales $ 2,801,333 $ 343,483 $ 3,144,816
Operating income 593,735 96,483 690,218
Net loss (a) (290,306) (77,881) (368,187)
Year Ended December 31, 1994
Revenues and sales $ 2,947,947 $ 371,924 $ 3,319,871
Operating income 822,485 123,187 945,672
Net income 434,540 65,746 500,286
</TABLE>
(a) Net loss for 1995 includes $711 million of extraordinary charges (net of
tax) for the discontinuance of FAS 71 and the early retirement of debt
(see Note 2).
22
<PAGE> 25
5. PREFERRED STOCK
Cumulative preferred stock, not subject to mandatory redemption, exclusive of
amounts held in treasury, as of December 31, 1996 and 1995 is as follows:
<TABLE>
<CAPTION>
Shares
-----------
<S> <C>
Authorized:
$ 20 par value 2,499,174
$100 par value 500,000
-----------
2,999,174
===========
<CAPTION>
Shares Amount
----------- ------------
(Thousands of Dollars)
<S> <C> <C>
Outstanding:
$ 20 par value
4 1/2 % Series (issued in 1945) 280,312 $ 5,606
4 1/2 % Series (issued in 1956) 718,862 14,378
5 % Series (issued in 1957) 1,500,000 30,000
$100 par value
7.48 % Series (issued in 1973) 318,821 31,882
----------- ------------
Total 2,817,995 $ 81,866
=========== ============
</TABLE>
At the Company's option, these series of preferred stock are redeemable at
premiums, in whole or in part, on thirty days notice.
There were no retirements, redemptions or other activity for the years
1996-1995. On March 1, 1994, all outstanding shares of Contel California's
preferred stock were redeemed with cash from operations.
The 4 1/2% Series (1945 issue) is entitled to one vote per share, with the
right to vote cumulatively in the election of directors. Otherwise, the
preferred shareholders have no voting rights.
No shares of preferred stock were reserved for officers and employees, or for
options, warrants, conversions or other rights. The Company is not in arrears
in its dividend payments at December 31, 1996.
6. COMMON STOCK
The authorized common stock of the Company consists of 100,000,000 shares with
a par value of $20 per share. All outstanding shares of common stock are held
by GTE.
There were no shares of common stock held by or for the account of the Company
and no shares were reserved for officers and employees, or for options,
warrants, conversions or other rights.
At December 31, 1996, $49.3 million were restricted as to the payment of cash
dividends on common stock under the most restrictive terms of the Articles of
Incorporation.
23
<PAGE> 26
7. DEBT
Long-term debt as of December 31, was as follows:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
(Thousands of Dollars)
<S> <C> <C>
First mortgage bonds:
7 5/8% Series J, due 1997 $ 10,000 $ 10,000
6% Series S, due 1996 -- 45,000
6 3/4% Series T, due 1997 55,000 55,000
7 1/8% Series U, due 1998 60,000 60,000
9.45% Series V, due 1997 10,000 10,000
9.41% Series W, maturing through 2014 40,000 40,000
7 5/8% Series X, due 2001 50,000 50,000
9.44% Series X, due 2015 30,000 30,000
6 1/4% Series TT, due 1998 150,000 150,000
----------- -----------
405,000 450,000
----------- -----------
Debentures:
5 5/8% Series A, due 2001 300,000 300,000
6 3/4% Series B, due 2004 250,000 250,000
8.07% Series C, due 2024 250,000 250,000
7% Series D, due 2008 100,000 --
----------- -----------
900,000 800,000
----------- -----------
Other:
7.38% GTE Finance Corporation promissory note, due 1997 50,000 50,000
6.60% GTE Finance Corporation promissory note, due 2000 50,000 50,000
Commercial paper expected to be refinanced on a long-term basis -- 75,000
Capitalized leases 856 1,139
----------- -----------
Total principal amount 1,405,856 1,426,139
Less: discount and premium - net (422) (5,092)
----------- -----------
Total 1,405,434 1,421,047
Less: current maturities (125,283) (45,276)
----------- -----------
Total long-term debt $ 1,280,151 $ 1,375,771
=========== ===========
</TABLE>
In May 1996, the Company issued $100 million of 7% Series D Debentures, due
2008. The net proceeds were applied toward the repayment of short-term
borrowings incurred in connection with the redemption of long-term debt in
December 1995 prior to stated maturity (see Note 2). Net proceeds were used to
finance the Company's construction program and for general corporate purposes.
Long-term debt as of December 31, 1995 includes $75 million of commercial paper
which the Company refinanced during the first half of 1996 as further discussed
above and in Note 8.
The aggregate principal amount of bonds and debentures that may be issued is
subject to the restrictions and provisions of the Company's indentures. None of
the securities shown above were held in sinking or other special funds of the
Company or pledged by the Company. Debt discounts and premiums on the Company's
outstanding long-term debt are amortized over the lives of the respective
issues. Substantially all of the Company's telephone plant is subject to the
liens of the indentures under which the bonds listed above were issued.
24
<PAGE> 27
Estimated payments of long-term debt during the next five years are: $125.3
million in 1997; $210.3 million in 1998; $0.1 million in 1999; $52.5 million in
2000; and $352.5 million in 2001.
Total short-term obligations as of December 31, were as follows:
<TABLE>
<CAPTION>
1996 1995
-------- --------
(Thousands of Dollars)
<S> <C> <C>
Commercial paper - average rates 5.5% and 5.8% $ 71,001 $125,130
Notes payable to affiliate - average rate 5.6% -- 102,950
Current maturities of long-term debt 125,283 45,276
-------- --------
Total $196,284 $273,356
======== ========
</TABLE>
On July 1, 1996, the Company began participating with other affiliates in a
$1.5 billion syndicated line of credit to back up commercial paper borrowings.
Through this shared arrangement, the Company can issue up to $500 million of
commercial paper.
8. FINANCIAL INSTRUMENTS
At December 31, 1995, the Company had entered into forward contracts to sell
$75 million of U.S. Treasury Bonds to hedge against changes in market interest
rates related to the debt the Company called and refinanced during the first
half of 1996. A gain of approximately $5 million occurred upon the settlement
of the forward contracts and is being amortized over the life of the associated
refinanced debt as an offset to interest expense.
The fair values of financial instruments, other than long-term debt, closely
approximate their carrying values. As of December 31, 1996 and 1995, the
estimated fair value of long-term debt based on either reference to quoted
market prices or an option pricing model, exceeded the carrying value by
approximately $11 million and $54 million, respectively.
25
<PAGE> 28
9. INCOME TAXES
The income tax provision is as follows:
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
Current:
Federal $ 231,579 $ 149,317 $ 234,141
State 44,292 51,908 74,118
--------- --------- ---------
275,871 201,225 308,259
--------- --------- ---------
Deferred:
Federal 51,549 37,893 38,999
State 17,080 14,901 13,382
--------- --------- ---------
68,629 52,794 52,381
--------- --------- ---------
Amortization of deferred investment tax credits (15,174) (18,485) (21,055)
--------- --------- ---------
Total $ 329,326 $ 235,534 $ 339,585
========= ========= =========
</TABLE>
A reconciliation between taxes computed by applying the statutory federal
income tax rate to pre-tax income and income taxes provided in the consolidated
statements of income is as follows:
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
Amounts computed at statutory rates $ 294,133 $ 200,764 $ 293,955
State and local income taxes, net of federal income tax benefits 39,892 43,426 56,875
Amortization of deferred investment tax credits, net of federal (9,864) (18,485) (21,055)
income tax benefits
Depreciation of telephone plant construction costs
previously deducted for tax purposes - net -- 17,864 23,030
Rate differentials applied to reversing temporary differences -- (7,589) (12,393)
Other differences, including settlements of prior year
tax issues 5,165 (446) (827)
--------- --------- ---------
Total provision $ 329,326 $ 235,534 $ 339,585
========= ========= =========
</TABLE>
The tax effects of temporary differences that give rise to the deferred income
tax benefits and deferred income tax liabilities at December 31, are as
follows:
<TABLE>
<CAPTION>
1996 1995
--------- ---------
(Thousands of Dollars)
<S> <C> <C>
Depreciation and amortization $ 255,088 $ 300,672
Employee benefit obligations (111,575) (89,175)
Prepaid pension cost 121,727 50,794
Investment tax credits 22,317 32,181
Other - net (27,413) (87,783)
--------- ---------
Total $ 260,144 $ 206,689
========= =========
</TABLE>
26
<PAGE> 29
10. EMPLOYEE BENEFIT PLANS
RETIREMENT PLANS
The Company sponsors noncontributory defined benefit pension plans covering
substantially all employees. The benefits to be paid under these plans are
generally based on years of credited service and average final earnings. The
Company's funding policy, subject to the minimum funding requirements of U.S.
employee benefit and tax laws, is to contribute such amounts as are determined
on an actuarial basis to provide the plans with assets sufficient to meet the
benefit obligations of the plans. The assets of the plans consist primarily of
corporate equities, government securities and corporate debt securities.
The components of the net pension credit for 1996-1994 were as follows:
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
Benefits earned during the year $ 36,801 $ 32,481 $ 43,059
Interest cost on projected benefit obligations 105,886 108,517 101,376
Return on plan assets:
Actual (421,922) (502,472) 4,963
Deferred 201,375 300,107 (201,122)
Other - net (37,120) (45,487) (41,490)
--------- --------- ---------
Net pension credit $(114,980) $(106,854) $ (93,214)
========= ========= =========
</TABLE>
The expected long-term rate of return on plan assets was 9.0% for 1996 and 8.5%
for 1995 and 1994.
The funded status of the plans and the net prepaid pension cost at December 31,
were as follows:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
(Thousands of Dollars)
<S> <C> <C>
Vested benefit obligations $ 1,054,805 $ 1,034,295
=========== ===========
Accumulated benefit obligations $ 1,155,684 $ 1,147,403
=========== ===========
Plan assets at fair value $ 2,964,345 $ 2,745,653
Less: projected benefit obligations 1,431,393 1,424,566
----------- -----------
Excess of assets over projected benefit obligations 1,532,952 1,321,087
Unrecognized net transition asset (126,793) (150,251)
Unrecognized net gain (839,094) (741,298)
----------- -----------
Net prepaid pension cost $ 567,065 $ 429,538
=========== ===========
</TABLE>
Assumptions used to develop the projected benefit obligations at December 31,
were as follows:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Discount rate 7.50% 7.50%
Rate of compensation increase 5.25% 5.25%
</TABLE>
27
<PAGE> 30
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
Substantially all of the Company's employees are covered under postretirement
health care and life insurance benefit plans. The health care benefits paid
under the plans are generally based on comprehensive hospital, medical and
surgical benefit provisions. The Company funds amounts for postretirement
benefits as deemed appropriate from time to time.
The postretirement benefit cost for 1996-1994 included the following
components:
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
(Thousands of Dollars)
<S> <C> <C> <C>
Benefits earned during the year $ 7,545 $ 7,282 $ 8,679
Interest on accumulated postretirement benefit obligations 49,305 56,202 57,398
Actual (return) loss on plan assets (5,499) (19,476) 3,795
Amortization of transition obligation 28,202 29,044 31,099
Other - net (11,367) 9,348 (16,427)
-------- -------- --------
Postretirement benefit cost $ 68,186 $ 82,400 $ 84,544
======== ======== ========
</TABLE>
The following table sets forth the plans' funded status and the accrued
postretirement benefit obligations as of December 31:
<TABLE>
<CAPTION>
1996 1995
--------- ---------
(Thousands of Dollars)
<S> <C> <C>
Accumulated postretirement benefit obligations attributable to:
Retirees $ 508,792 $ 580,789
Fully eligible active plan participants 24,212 16,851
Other active plan participants 158,382 163,966
--------- ---------
Total accumulated postretirement benefit obligations 691,386 761,606
Less: fair value of plan assets 205,750 173,645
--------- ---------
Excess of accumulated obligations over plan assets 485,636 587,961
Unrecognized transition obligation (443,945) (479,433)
Unrecognized net gain 172,766 19,765
--------- ---------
Accrued postretirement benefit obligations $ 214,457 $ 128,293
========= =========
</TABLE>
The assumed discount rates used to measure the accumulated postretirement
benefit obligations were 7.5% at December 31, 1996 and December 31, 1995. The
assumed health care cost trend rate was 8.75% in 1996 and averaged 9.75% in
1995 and is assumed to decrease gradually to an ultimate rate of 6% in the year
2004. A one percentage point increase in the assumed health care cost trend
rates for each future year would have increased 1996 costs by $5.3 million and
the accumulated postretirement benefit obligations as of December 31, 1996 by
$57 million.
SAVINGS PLANS
The Company sponsors employee savings plans under section 401(k) of the
Internal Revenue Code. The plans cover substantially all full-time employees.
Under the plans, the Company provides matching contributions in GTE common
stock based on qualified employee contributions. Matching contributions charged
to income were $10.8 million, $10.5 million and $9.9 million in 1996-1994,
respectively.
28
<PAGE> 31
11. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is summarized as follows at December 31:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
(Thousands of Dollars)
<S> <C> <C>
Land $ 60,729 $ 63,375
Buildings 677,040 669,768
Plant and equipment 8,043,861 7,839,394
Other 925,317 939,754
----------- -----------
Total 9,706,947 9,512,291
Accumulated depreciation (see Note 2) (5,952,312) (5,517,695)
----------- -----------
Total property, plant and equipment - net $ 3,754,635 $ 3,994,596
=========== ===========
</TABLE>
Depreciation expense in 1996-1994 was equivalent to a composite average
percentage of 7.0%, 7.2% and 7.2%, respectively.
12. REGULATORY AND COMPETITIVE MATTERS
The Company is subject to regulation by the regulatory bodies of the states of
California, Nevada and Arizona as to its intrastate business operations and by
the Federal Communications Commission (FCC) as to its interstate operations.
INTRASTATE SERVICES
The Company provides local-exchange services to customers within its designated
franchise areas. The Company also provides toll services within designated
geographic areas called Local Access and Transport Areas (LATAs) under
agreements with connecting local-exchange carriers (LECs) in conformity with
state regulatory orders. The Company also provides long distance access
services directly to interexchange carriers (IXCs) and other customers who
provide service between LATAs.
New Regulatory Framework (NRF)
Effective January 1, 1990, the California Public Utilities Commission (CPUC)
adopted the NRF for the Company. The new framework replaced the traditional
"rate case" process with a framework that centers around a Price Cap Index
(PCI) mechanism with "sharing" of intrastate earnings (those earnings subject
to CPUC regulation) above a benchmark rate of return. This plan is designed to
stimulate productivity and efficiencies with a portion of these gains flowing
directly to the customer. In May 1992, the CPUC initiated a proceeding to
review the NRF plan. On September 1, 1993, the CPUC ordered that modifications
be made to the Company's NRF plan, effective January 1, 1994, which required
the Company to refund to the customers all earnings over a 15.5% rate of return
(ROR). As part of the settlement agreement approved by the CPUC, the Company
eliminated the previous sharing mechanism where half of any earnings over the
13% ROR benchmark would be refunded to ratepayers. A policy order issued by the
CPUC on July 24, 1991 urged the Company to adopt the NRF for Contel
California's operations to be effective no later than January 1, 1994. The
Company has requested that it be allowed to adopt the NRF for its Contel
California operations.
Under the NRF, rates are adjusted annually by the PCI which is based on
inflation minus a productivity improvement factor. Rates for partially
competitive services (i.e., Centrex and custom calling features) may be priced
below the price cap within a range set by the CPUC. Rates are also adjusted for
exogenous events that are beyond the control of management as defined in this
plan. Fully competitive services (e.g., directory advertising) are not subject
to pricing limits set by the CPUC.
29
<PAGE> 32
On December 21, 1994, the CPUC approved the Company's 1995 PCI filing which
resulted in a rate reduction of $12 million. On December 20, 1995, the CPUC
approved the 1996 PCI filing whereby the CPUC modified the terms of the
Company's price cap based incentive regulation plan in recognition of growing
competition. In 1996, the Company was ordered to continue to use a price cap
formula which included a productivity factor of 4.6% as an offset to inflation
to adjust prices for 1996. For 1997 and 1998 the order adopted a productivity
factor that equals the inflation factor which results in no rate change. The
order resulted in a $41.7 million rate reduction for 1996. On December 20, 1996
the CPUC approved the Company's 1997 price cap filing. Although there was no
revenue impact from the productivity factor, other components of the price cap
mechanism generated a revenue increase of $27.5 million which will be effective
in 1997.
Several regulatory proceedings are underway in California to determine the
terms and conditions for unbundling GTE's network, to consider additional
pricing flexibility under the CPUC's NRF, to modify the NRF to reflect the new
competitive marketplace, to institute intraLATA 1+ dialing parity provisions
and to establish final rules and obligations for Universal Service funding.
Implementation Rate Design (IRD)
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. Specifically, the CPUC reduced rates for the
Company's toll services by an average of 42% and its switched access rates by
more than 50% while offsetting the revenue impacts by increasing other rates
closer to cost. Monthly service rates for flat-rate residential customers
increased from $11.21 to $17.25 while measured business customers' rates
increased from $10.46 to $19.22. Although this rate rebalancing was intended by
the CPUC to be revenue neutral, 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 $232.3 million 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 ruling of $53 million ($35 million local
services, $14 million toll services and $4 million network access) which was
recorded in 1996.
On September 1, 1995, the Company and Pacific Bell filed a joint petition
requesting 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 million through increases in specific rates and through the
surcharge mechanism. The amount of requested recovery has been subsequently
reduced to $80 million as a result of the favorable June 6, 1996 decision. On
February 19, 1997, the CPUC voted 4-1 to reject the joint petition.
The Company filed a general rate case on December 6, 1995 for the former Contel
of California service territories. The Company proposes to recover $45.3
million of revenue requirement from a combination of increases to basic
exchange rates and universal high cost fund which is currently under review by
the CPUC.
30
<PAGE> 33
Competition
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. The
parties filed comments on the proposed rules on May 24, 1995. The Company's
comments asserted the need for evidentiary hearings to address critical issues
such as regulatory parity and interconnection prior to the authorization of
local competition.
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 million 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 $20.30 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.
On December 4, 1996, the Company filed an application for rehearing of the
October 25 decision. In the application, the Company stated that the decision
was unreasonable and discriminatory because: (1) the fund size is seriously
understated; (2) the decision does not provide GTE adequate support in high
cost areas; (3) GTE customers are penalized by subsidizing Pacific Bell's below
cost rates; (4) the decision fails to properly calculate revenues-per-line that
GTE will receive in high cost areas.
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
of 1996 (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. On December 20, 1996, the Company received commission approval of its
settlement agreement as filed with the CPUC. A final decision regarding the
hearing issues is expected in April 1997.
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 September 1, 1995, the Company filed
with the CPUC for a certificate of public convenience and necessity (CPCN)
which would enable the Company to compete within Pacific Bell franchised
service areas to provide customers with facilities-based and resale-based
local-exchange services, high-speed digital private line services, and
intraLATA toll services. Pacific Bell and over 60 other carriers have made
similar filings seeking CPCNs to compete in both the Company's and Pacific
Bell's service territories. On December 20, 1995, the CPUC approved the
Company's request to provide intraLATA toll, high-speed
31
<PAGE> 34
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 March 13, 1996, the CPUC
adopted interim resale rates and rules, effective March 31, 1996, allowing CLCs
to begin providing service.
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 Open Access and Network Architecture Development (OANAD)
proceeding.
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% on basic residential service and 12% 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 resale 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 discussed below. On January 24, 1997, an Administrative Law Judge (ALJ)
ruling was issued setting forth a schedule for submission of permanent resale
rate proposals and avoided costs models. The submission is currently scheduled
in April 1997.
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 was allowed to file, no
earlier than 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 that
adversely affects the Company's opportunity to earn a fair return on its assets
in a competitive environment.
Arbitration
On October 31, 1996, the ALJ arbitrator assigned to AT&T's arbitration request
submitted his report. The arbitrator recommended the continued use of the
interim wholesale discounts, previously adopted by the CPUC, for bundled
services. The arbitrator also recommended interim unbundled wholesale rates
based on the Company's interim cost studies filed as part of the OANAD
proceeding (mentioned above), which are pending approval, adjusted by 16% to
reflect a contribution for shared and common costs.
32
<PAGE> 35
On January 13, 1997, the CPUC issued its decision in the Company's arbitration
with AT&T to determine interconnection, resale, and unbundling terms and
conditions. The decision increased the mark-up for joint and common costs from
the 16% proposed by the ALJ arbitrator to 22%. On January 23, 1997, an
arbitrition agreement conforming to this decision was executed under protest.
Also, on January 23, 1997, the CPUC issued its decision in the Company's
arbitration with MCI.
The Company filed suit on January 14, 1997 in Federal District Court seeking
judicial review of the CPUC's final arbitration order in the AT&T proceeding,
pursuant to Section 252 of the Telecommunications Act. The Company's suit
focused on various aspects of the decision including: rates for unbundled
network elements; rate arbitrage opportunities created by the decision for
AT&T; unbundled rate elements which do not allow recovery of actual costs;
collocation requirements; rules for reservations of pole and duct space; and
imposition of contractual terms not before the CPUC for arbitration. On January
24, 1997, a similar suit was filed requesting review of the CPUC's final order
in the MCI arbitration. The Company requested a review of the same issues as in
the AT&T suit except for the issue of collocation which was not included in the
MCI review request.
Merger
In March 1991, the merger of the Company's parent, GTE, and Contel Corporation
(Contel) was consummated. In a decision issued on March 13, 1991, the CPUC
approved a stipulation agreement which tentatively approved the merger of GTE
and Contel. The decision also established a second phase of the proceeding in
which GTE was directed to show that the merger meets certain California
statutory requirements. GTE was also ordered to submit a plan for the merger of
Contel of California, Inc. into the Company. On September 14, 1992, the Company
and Contel of California, Inc. joined with GTE and Contel in filing a
comprehensive plan with the CPUC to merge Contel of California, Inc. into the
Company.
On December 23, 1993, an ALJ issued a proposed Phase II order approving the
Merger. The proposed order would add a third phase to the Merger proceeding in
which the issues of a start-up revenue requirement for Contel's pre-merger
operations and rate integration of the respective company tariffs will be
considered.
On April 20, 1994, the CPUC issued a decision giving final approval to the
Merger. The decision required the merging companies to flow through to their
ratepayers all of the estimated savings that will be produced from the Merger.
This flow through requirement was based on the CPUC's interpretation of certain
statutory requirements. The CPUC, however, provided the parties with the
opportunity to supplement the evidentiary record to show why the estimated
merger savings should be apportioned between ratepayers and shareholders. That
filing was made on April 29, 1994. By making the filing, the effective date of
the decision approving the Merger was delayed. The Company and other interested
parties filed reports and comments pursuant to this proceeding. 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 ratepayers. The CPUC approved
the merger of Contel California into the Company in April 1996. As part of the
order, the CPUC ordered $69.7 million of merger savings to be returned to the
ratepayers of both companies, which represents half of the total savings
expected to be realized by this merger over a five-year period. The Company
received approval to return these savings to local, toll and access customers
beginning in mid-1996. The Merger was concluded December 31, 1996.
In addition, merger applications were filed with the Arizona Corporation
Commission (ACC) on October 4, 1993 and the Nevada Public Service Commission
(NPSC) on April 2, 1993. These applications were approved during 1994 but were
made subject to final approval in California, which was granted in April 1996.
Contel California is now part of GTE California Incorporated and operates in
California and Arizona under that name. The Nevada Company does business as
"GTE of Nevada."
Phase III of the merger is pending in California. Phase III will integrate the
rates of GTE California Incorporated and Contel California and provide for a
start up revenue requirement for the former Contel service territories. Phase
III was consolidated with the general rate case mentioned under IRD above.
33
<PAGE> 36
Other Matters
On October 12, 1994, the CPUC issued a decision which authorized further
proceedings to be held with regard to a previous CPUC decision that adopted
accrual accounting for FAS 106, which permitted the Company to recover its FAS
106 costs as an exogenous factor in annual price cap filings. This decision
reaffirmed the CPUC decision to adopt FAS 106 for rate making purposes.
However, the issue of exogenous recovery will be further reviewed and any
revenues collected in rates subsequent to October 12, 1994, are subject to
refund pending further investigation. The Company is currently recovering $30
million annually in rates for FAS 106 costs.
INTERSTATE SERVICES
For the provision of interstate services, the Company operates under the terms
of the FCC's price cap incentive plan. The "price cap" mechanism serves to
limit the rates a carrier may charge, rather than just regulating the rate of
return which may be achieved. Under this approach, the maximum price that the
LEC may charge is increased or decreased each year by a price index based upon
inflation less a predetermined productivity target. LECs have limited pricing
flexibility provided they do not exceed the allowed price cap.
In March 1995, the FCC adopted interim rules to be utilized by LECs, including
the Company, for their 1995 Annual Price Cap Filing. The interim rules allowed
LECs to select from three productivity/sharing options for each tariff entity.
Each of the three options reflected an increase to the 3.3% productivity factor
used since 1991. The Company selected the following productivity factors and
sharing thresholds for use in the following tariff years:
<TABLE>
<CAPTION>
Sharing Parameters
Tariff Productivity ---------------------------------------
Entity Factor 50% 100%
- -------------------------------------- ------------ ------------------ ---------------
<S> <C> <C> <C>
1996-1997 Tariff Year
- ---------------------
California (GTE), Arizona (Contel) 4.0% 12.25%-13.25% ROR Over 13.25% ROR
Nevada, California (Contel) 5.3% None None
1995-1996 Tariff Year
- ---------------------
California (GTE) 4.0% 12.25%-13.25% ROR Over 13.25% ROR
Arizona, Nevada,
California (Contel) 5.3% None None
</TABLE>
Since the Company's access fees were priced significantly below the FCC's
maximum price, the Company was permitted to file tariffs effective May 24, 1995
to increase rates $26 million, annually. In addition, the Company filed tariffs
effective August 1, 1995 under the interim rules to reduce rates $22.9 million,
annually. On September 20, 1995, the FCC released its proposed rulemaking
proceeding on price caps which proposes specific changes to reflect and
encourage emerging competition in local and access services markets and to
establish the path towards decreased regulation of LECs' services. On September
27, 1995, the FCC solicited comments on a number of specific issues regarding
methods for establishing the price caps, such as productivity measurements,
sharing, the common line formula and exogenous costs.
The Company submitted its 1996 annual interstate access filing on April 2,
1996, utilizing the FCC's interim price cap rules. In doing so, the Company
changed its productivity factor from 5.3% to 4.0% for its Arizona (Contel)
tariff entity. 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 reduction of $2.1 million, effective July 1,
1996.
34
<PAGE> 37
In May 1995, GTE obtained approval from the FCC to begin construction of its
video dialtone network in Ventura County, California. In December 1995, GTE
negotiated with local governments in California to begin construction of a
traditional cable network in Ventura County, California. This network began
delivery of video services to customers in 1996. The network originally
constructed by the Company was transferred at its cost to Media Ventures
Incorporated, a separate GTE subsidiary, in the third quarter of 1996. All
future cable services will be offered by GTE through Media Ventures
Incorporated.
On February 8, 1996, the Telecommunications Act became law. This comprehensive
telecommunications reform legislation addresses a wide range of competitive and
regulatory issues that will affect the future development of local and long
distance services, cable television and information services. The new law
removes regulatory and court-ordered barriers to competition between segments
of the industry, enabling local-exchange, long distance, wireless and cable
companies to compete in offering voice, video and information services.
The Telecommunications Act requires the FCC and state commissions to open
local-exchange markets and to set new guidelines for interconnection, loosens
restrictions barring local telephone companies from entering the cable
television market, and preserves universal service while equalizing the
responsibility for contribution among all carriers.
On August 8, 1996, the FCC published its First Report and Order (the Order)
containing rules implementing Section 251 of the Telecommunications Act dealing
with interconnection, unbundling of network elements and wholesale prices and
other terms for competitive entry into local-exchange service. On August 9,
1996, the FCC released its Second Report and Order implementing the provision
of number portability and dialing parity in accordance with the
Telecommunications Act.
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. 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. Additionally, the Court held oral arguments on the merits on January
17, 1997. The Court's ruling is expected in the spring of 1997.
While GTE cannot predict the outcome of the Court's final decision, GTE intends
to continue to vigorously present its position in Court.
In November 1996, the Federal-State Joint Board released its recommended
universal service plan, and in December 1996, the FCC issued its access reform
proposals. Both proposals incorporate a pricing methodology similar to the one
that GTE is appealing in the interconnection case. A final order in the
universal service proceeding must be adopted by early May 1997, and a decision
on the access reform proceeding is expected shortly thereafter.
SIGNIFICANT CUSTOMER
Revenues received from AT&T Corp. include amounts for access and billing and
collection during the years 1996-1994 under various arrangements and amounted
to $258.7 million, $264.3 million and $331.8 million, respectively.
35
<PAGE> 38
13. COMMITMENTS AND CONTINGENCIES
The Company has noncancelable leases covering certain buildings, office space
and equipment. Rental expense was $40.9 million, $30.6 million and $40.9
million in 1996-1994, respectively. Minimum rental commitments for
noncancelable leases through 2001 do not exceed $12.4 million annually and
aggregate $56.8 million thereafter.
The Company is subject to a number of proceedings arising out of the conduct of
its business, including those relating to regulatory actions, commercial
transactions and/or environmental, safety and health matters. Management
believes that the ultimate resolution of these matters will not have a material
adverse effect on the results of operations or the financial position of the
Company.
Recent judicial and regulatory developments, as well as the pace of
technological change, have continued to influence industry trends, including
accelerating and expanding the level of competition. As a result, the Company's
operations face increasing competition in virtually all aspects of its
business. The Company continues to support greater competition in
telecommunications, provided that, overall, the actions to eliminate existing
legal and regulatory barriers benefit consumers by allowing an opportunity for
all service providers to participate in a competitive marketplace under
comparable conditions.
14. QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized 1996 and 1995 quarterly financial data is as follows:
<TABLE>
<CAPTION>
Revenues Operating Net Income
and Sales Income (Loss)
---------- ---------- -----------
(Thousands of Dollars)
<S> <C> <C> <C>
1996
First Quarter $ 747,799 $ 179,591 $ 93,037
Second Quarter 778,746 192,502 97,415
Third Quarter 772,425 256,000 143,114
Fourth Quarter 842,196 314,521 182,272
---------- ---------- ----------
Total $3,141,166 $ 942,614 $ 515,838
========== ========== ==========
1995
First Quarter $ 764,349 $ 194,276 $ 99,627
Second Quarter 758,322 151,570 69,035
Third Quarter 781,897 196,662 97,804
Fourth Quarter (a) 840,248 147,710 (634,653)
---------- ---------- ----------
Total $3,144,816 $ 690,218 $ (368,187)
========== ========== ==========
</TABLE>
(a) Net income includes $711 million of extraordinary charges (net of tax) for
the discontinuance of FAS 71 and the early retirement of debt. Income before
these extraordinary charges was $76.4 million.
36
<PAGE> 39
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
GTE California Incorporated:
We have audited the accompanying consolidated balance sheets of GTE California
Incorporated (a California corporation and wholly-owned subsidiary of GTE
Corporation) and subsidiary as of December 31, 1996 and 1995, and the related
consolidated statements of income, shareholders' equity and cash flows for each
of the three years in the period ended December 31, 1996. These financial
statements and the schedule and exhibit referred to below are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and the schedule and exhibit 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 financial statements referred to above present fairly, in
all material respects, the financial position of GTE California Incorporated
and subsidiary as of December 31, 1996, and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, in 1995, the
Company discontinued applying the provisions of Statement of Financial
Accounting Standards No. 71, "Accounting for the Effects of Certain Types of
Regulation".
Our audit was made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The supporting schedule and exhibit listed under
Item 14 are presented for purposes of complying with the Securities and
Exchange Commission's rules and are not a required part of the basic financial
statements. The supporting schedule and exhibit have been subjected to the
auditing procedures applied in the audit of the basic financial statements and,
in our opinion, fairly state in all material respects the financial data
required to be set forth therein in relation to the basic financial statements
taken as a whole.
ARTHUR ANDERSEN LLP
Dallas, Texas
January 28, 1997
37
<PAGE> 40
MANAGEMENT REPORT
To Our Shareholders:
The management of the Company is responsible for the integrity and objectivity
of the financial and operating information contained in this Annual Report on
Form 10-K, including the consolidated financial statements covered by the
Report of Independent Public Accountants. These statements were prepared in
conformity with generally accepted accounting principles and include amounts
that are based on the best estimates and judgments of management.
The Company has a system of internal accounting controls which provides
management with reasonable assurance that transactions are recorded and
executed in accordance with its authorizations, that assets are properly
safeguarded and accounted for, and that financial records are maintained so as
to permit preparation of financial statements in accordance with generally
accepted accounting principles. This system includes written policies and
procedures, an organizational structure that segregates duties, and a
comprehensive program of periodic audits by the internal auditors. The Company
has also instituted policies and guidelines which require employees to maintain
the highest level of ethical standards.
M. L. KEITH, JR.
President
GERALD K. DINSMORE
Senior Vice President - Finance and Planning
38
<PAGE> 41
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
39
<PAGE> 42
PART III
Item 10. Directors and Executive Officers of the Registrant
Reference is made to the Registrant's Proxy Statement covering the Annual
Meeting of Shareholders to be held April 9, 1997, pages 3 and 4, which is
incorporated herein by reference. A complete list of executive officers of the
Registrant as of March 1, 1997 is provided below.
There are no family relationships between any of the directors or executive
officers of the Company, except that Mr. Jacobson and Ms. Jacobson are married
to one another.
The Company's policies are established not only by the Company's executive
officers, but also by the executive officers of GTE Telephone Operations.
Accordingly, the list below contains the names, ages and positions of the
executive officers of both the Company and GTE Telephone Operations (Telops) as
of March 1, 1997.
40
<PAGE> 43
Identification of Executive Officers
<TABLE>
<CAPTION>
Year Assumed
Present Position
------------------------------
the
Name Age Telops Company Position
- ----------------------- --------- ------------ ------------ ---------------------------------------------
<S> <C> <C> <C> <C>
Thomas W. White 50 1995 -- President of GTE Telephone Operations
John C. Appel 48 1996 1995 Executive Vice President - Network
Operations of GTE Telephone Operations and
the Company
James G. Badders 44 1994 -- Vice President-Consumer Customer Contact
of GTE Telephone Operations
Mary Beth Bardin 42 1994 1995 Vice President - Public Affairs of GTE
Telephone Operations and the Company
C. F. Bercher 53 1994 -- President - Consumer Markets of GTE
Telephone Operations
-- 1995 Vice President - Consumer Markets of the
Company
Richard M. Cahill 58 1988 1995 Vice President - General Counsel of GTE
Telephone Operations and the Company
Terri L. Compton 40 1996 -- Vice President-Business Development of GTE
Telephone Operations
C. Michael Crawford 50 1996 -- Vice President-Information Technology of
GTE Telephone Operations
Gerald K. Dinsmore 47 1994 1993 Senior Vice President - Finance and
Planning of GTE Telephone Operations and
the Company
William M. Edwards, III 48 -- 1993 Vice President-Controller of the Company
Michael B. Esstman 50 1994 -- Executive Vice President - Customer
Segments of GTE Telephone Operations
Oscar C. Gomez 50 1997 -- Vice President-Diversity Marketing and
Management of GTE Telephone Operations
Gregory D. Jacobson 45 -- 1994 Treasurer of the Company
Pamela S. Jacobson 39 1996 -- Vice President-Strategic Planning of GTE
Telephone Operations
M.L. Keith, Jr. 54 -- 1995 President of the Company
Brad M. Krall 55 1993 1995 Vice President - Centralized Operations of
GTE Telephone Operations and the Company
Michael J. McDonough 47 1996 -- Senior Vice President-Market Integration
of GTE Telephone Operations
Paul E. Miner 52 1995 -- Vice President-Program Management Office
of GTE Telephone Operations
Christopher D. Owens 41 1996 1996 Vice President-Regulatory and Governmental
Affairs of GTE Telephone Operations and
the Company
Barry W. Paulson 44 1996 1996 Vice President-Network Operations Planning
and Support of GTE Telephone Operations
and the Company
Richard L. Schaulin 54 1989 1995 Vice President - Human Resources of GTE
Telephone Operations and the Company
Leland W. Schmidt 63 1987 -- Vice President-Industry Affairs of GTE
Telephone Operations
Charles J. Somes 50 -- 1994 Secretary of the Company
Larry J. Sparrow 53 1994 -- President - Carrier Markets of GTE
Telephone Operations
-- 1995 Vice President - Carrier Markets of the
Company
Lewis O. Wilks (1) 43 1996 -- President - Business Markets of GTE
Telephone Operations
-- 1996 Vice President - Business Markets of the
Company
</TABLE>
(1) Lewis O. Wilks was appointed President-Business Markets of GTE Telephone
Operations and Vice President-Business Markets of the Company replacing
Michael J. McDonough, who was appointed Senior Vice President-Market
Integration of GTE Telephone Operations.
41
<PAGE> 44
Each of these executive officers has been an employee of the Company or an
affiliated company for the last five years. Except for duly elected officers
and directors, no other employees had a significant role in decision making.
All officers are appointed for a term of one year.
Item 11. Executive Compensation
Reference is made to the Registrant's Proxy Statement covering the Annual
Meeting of Shareholders to be held April 9, 1997, pages 4 to 16, which is
incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Reference is made to the Registrant's Proxy Statement covering the Annual
Meeting of Shareholders to be held April 9, 1997, page 16, which is
incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
Reference is made to the Registrant's Proxy Statement covering the Annual
Meeting of Shareholders to be held April 9, 1997, pages 3, 4 and 17, which is
incorporated herein by reference.
42
<PAGE> 45
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) Financial Statements - See GTE California Incorporated's consolidated
financial statements and report of independent accountants thereon in
the Financial Statements section included elsewhere herein.
(2) Financial Statement Schedules - Schedules supporting the
consolidated financial statements for the years ended December 31,
1996-1994 (as required):
II - Valuation and Qualifying Accounts
Note: Schedules other than the one listed above are omitted as not
applicable, not required, or the information is included in the
consolidated financial statements or notes thereto.
(3) Exhibits - Included in this report or incorporated by reference.
2.1* Agreement of Merger, dated September 10, 1992 between GTE
California Incorporated and Contel of California, Inc. (Exhibit
2.1 of the 1993 Form 10-K, File No. 1-6417)
3* Articles of Incorporation and Bylaws (Exhibit 3 of the 1988 Form
10-K, File No. 1-6417)
4.1* Indenture dated as of December 1, 1993 between GTE California
Incorporated and Bank of America National Trust and Savings
Association, as Trustee, dated as of December 1, 1993 (Exhibit
4.1 of the Company's Registration Statement on Form S-3, File
No. 33-51541, filed with the Securities and Exchange Commission
on December 17, 1993)
4.2* First Supplemental Indenture dated as of April 15, 1996 between
GTE California Incorporated and First Trust of California,
National Association, as Trustee (as successor trustee to Bank of
America National Trust and Savings Association) (Exhibit 4.3 of
the Company's Report on Form 8-K, dated April 23, 1996)
10* Material Contracts - Agreements Between GTE and Certain
Executive Officers (Exhibit 10 of the 1995 Form 10-K, File No.
1-6417)
12 Statements re: Calculation of the Consolidated Ratio of Earnings
to Fixed Charges
23 Consent of Independent Public Accountants
26* Revised Form of Invitation for Bids pertaining to Registration
Statements on Form S-3 (File Nos. 33-51541 and 333-01001)
27 Financial Data Schedule
(b) Reports on Form 8-K
On December 20, 1996, the Company filed a report on Form 8-K, dated
December 20,1996, under Item 5 "Other Events". Financial information
was filed with this report.
* Denotes exhibits incorporated herein by reference to previous filings with
the Securities and Exchange Commission as designated.
43
<PAGE> 46
GTE California Incorporated and Subsidiary
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 1996, 1995 and 1994
(Thousands of Dollars)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E
- ------------------------------------------------------------------------------------------------------------------
Additions
-------------------------
Charged Deductions
Balance at Charged (Credited) to from
Beginning (Credited) to Other Reserves Balance at
Description of Year Income Accounts (Note 1) Close of Year
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Allowance for uncollectible accounts
for the years ended:
December 31, 1996 $ 61,705 $ 69,439 $73,951 (2) $133,085 $ 72,010
=======================================================================
December 31, 1995 $ 42,060 $ 84,365 $87,127 (2) $151,847 $ 61,705
=======================================================================
December 31, 1994 $ 55,572 $ 73,956 $28,087 (2) $115,555 $ 42,060
=======================================================================
Accrued restructuring costs for the
years ended (Note 4):
December 31, 1996 $224,885 $ -- $(54,899)(3) $169,986 $ --
=======================================================================
December 31, 1995 $354,088 $ -- $ -- $129,203 $224,885
=======================================================================
December 31, 1994 $494,162 $ -- $ -- $140,074 $354,088
=======================================================================
</TABLE>
NOTES:
(1) Charges for which reserve was created.
(2) Recoveries of previously written-off amounts.
(3) Represents amounts necessary to satisfy commitments related to the
re-engineering program that have been reclassified to Accounts Payable and
Accrued Expenses.
(4) See Note 3 to the consolidated financial statements
included elsewhere herein.
44
<PAGE> 47
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.
GTE CALIFORNIA INCORPORATED
-------------------------------------------
(Registrant)
Date March 27, 1997 By M.L. Keith, Jr.
-----------------------------------------
M.L. Keith, Jr.
President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report is signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
M. L. Keith, Jr. President March 27, 1997
- ------------------------ (Principal Executive Officer)
M. L. Keith, Jr.
Gerald K. Dinsmore Senior Vice President - Finance March 27, 1997
- ------------------------ and Planning and Director
Gerald K. Dinsmore (Principal Financial Officer
William M. Edwards, III Vice President - Controller March 27, 1997
- ------------------------ (Principal Accounting Officer)
William M. Edwards, III
John C. Appel Director March 27, 1997
- ------------------------
John C. Appel
Richard M. Cahill Director March 27, 1997
- ------------------------
Richard M. Cahill
Michael B. Esstman Director March 27, 1997
- ------------------------
Michael B. Esstman
Thomas W. White Director March 27, 1997
- ------------------------
Thomas W. White
45
<PAGE> 48
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------------- -----------------------------------------------------
<S> <C>
12 Statements re: Calculation of the Consolidated Ratio
of Earnings to Fixed Charges
23 Consent of Independent Public Accountants
27 Financial Data Schedule
</TABLE>
<PAGE> 1
EXHIBIT 12
GTE California Incorporated and Subsidiary
STATEMENTS OF THE CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES
(Thousands of Dollars)
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------------------------------------
1996 1995 1994 1993(a) 1993 1992
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Net earnings available for fixed charges:
Income before extraordinary charges $515,838 $342,861 $500,286 $476,088 $148,688 $509,068
Add - Income tax expense 329,326 235,534 339,585 312,432 107,932 297,822
- Fixed charges 119,737 133,635 131,761 144,729 144,729 156,782
-------- -------- -------- -------- -------- --------
Adjusted earnings $964,901 $712,030 $971,632 $933,249 $401,349 $963,672
======== ======== ======== ======== ======== ========
Fixed charges:
Interest expense $106,112 $120,010 $115,012 $133,214 $133,214 $144,946
Portion of rent expense
representing interest 13,625 13,625 16,749 11,515 11,515 11,836
-------- -------- -------- -------- -------- --------
Adjusted fixed charges $119,737 $133,635 $131,761 $144,729 $144,729 $156,782
======== ======== ======== ======== ======== ========
RATIO OF EARNINGS TO FIXED
CHARGES 8.06 5.33 7.37 6.45 2.77 6.15
</TABLE>
(a) Results for 1993 exclude an after-tax restructuring charge of approximately
$304.4 million for the implementation of a re-engineering plan and a
one-time after-tax charge of approximately $23 million related to the
enhanced early retirement and voluntary separation programs offered to
eligible employees in 1993.
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation
of our report, dated January 28, 1997, on the consolidated financial statements
and supporting schedule of GTE California Incorporated and subsidiary included
in this Form 10-K, into the Registration Statement previously filed on Form S-3
(File No. 333-01001).
ARTHUR ANDERSEN LLP
Dallas, Texas
March 27, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 22,158
<SECURITIES> 0
<RECEIVABLES> 672,828
<ALLOWANCES> 72,010
<INVENTORY> 25,658
<CURRENT-ASSETS> 721,385
<PP&E> 9,706,947
<DEPRECIATION> 5,952,312
<TOTAL-ASSETS> 5,083,385
<CURRENT-LIABILITIES> 967,632
<BONDS> 1,280,151
0
81,866
<COMMON> 1,400,000
<OTHER-SE> 366,762
<TOTAL-LIABILITY-AND-EQUITY> 5,083,385
<SALES> 3,141,166
<TOTAL-REVENUES> 3,141,166
<CGS> 1,052,423
<TOTAL-COSTS> 2,198,552
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 98,567
<INCOME-PRETAX> 845,164
<INCOME-TAX> 329,326
<INCOME-CONTINUING> 515,838
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 515,838
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
