<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended: MARCH 31, 1999
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)
1255 Corporate Drive, SVC04C08, Irving, Texas 75038
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code 972-507-5000
(Former name, former address and former fiscal year, if changed since
last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES [X] NO [ ]
The Company had 70,000,000 shares of $20 par value common stock outstanding at
April 30, 1999. The Company's common stock is 100% owned by GTE Corporation.
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PART I. FINANCIAL INFORMATION
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
Condensed Consolidated Statements of Income (Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-----------------------
1999 1998
---------- ----------
(Dollars in Millions)
<S> <C> <C>
REVENUES AND SALES
Local services $ 359.7 $ 354.3
Network access services 277.5 211.6
Toll services 64.3 77.6
Other services and sales 125.6 91.8
---------- ----------
Total revenues and sales 827.1 735.3
---------- ----------
OPERATING COSTS AND EXPENSES
Cost of services and sales 216.7 278.5
Selling, general and administrative 134.6 105.4
Depreciation and amortization 154.1 143.6
---------- ----------
Total operating costs and expenses 505.4 527.5
---------- ----------
OPERATING INCOME 321.7 207.8
OTHER EXPENSE
Interest - net 35.1 27.1
---------- ----------
INCOME BEFORE INCOME TAXES 286.6 180.7
Income taxes 116.5 72.6
---------- ----------
NET INCOME $ 170.1 $ 108.1
========== ==========
</TABLE>
Per share data is omitted since the Company's common stock is 100% owned by GTE
Corporation.
The accompanying notes are an integral part of these statements.
1
<PAGE> 3
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
Condensed Consolidated Balance Sheets (Unaudited)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
---------- -----------
(Dollars in Millions)
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $ 5.9 $ 16.4
Receivables, less allowances of
$65.0 million and $65.9 million 586.7 661.8
Receivables from affiliates 29.7 11.2
Inventories and supplies 59.3 54.8
Prepaid insurance 16.5 43.3
Deferred income tax benefits 34.8 27.8
Other 3.9 4.4
---------- ----------
Total current assets 736.8 819.7
---------- ----------
Property, plant and equipment, at cost 10,418.5 10,513.3
Accumulated depreciation (6,543.5) (6,601.2)
---------- ----------
Total property, plant and equipment, net (a) 3,875.0 3,912.1
---------- ----------
Prepaid pension costs 883.3 847.9
Other assets 20.5 25.8
---------- ----------
Total assets $ 5,515.6 $ 5,605.5
========== ==========
</TABLE>
(a) Includes $40.7 million held for sale at March 31, 1999 and December 31,
1998, see Note 6.
The accompanying notes are an integral part of these statements.
2
<PAGE> 4
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
Condensed Consolidated Balance Sheets (Unaudited) - Continued
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
---------- ------------
(Dollars in Millions)
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Notes payable to affiliates $ 84.1 $ 281.7
Accounts payable 128.2 113.9
Affiliate payables 128.6 131.8
Taxes payable 260.8 163.6
Accrued payroll costs 119.4 97.6
Dividends payable 147.5 205.5
Other 295.6 285.3
---------- ----------
Total current liabilities 1,164.2 1,279.4
---------- ----------
Long-term debt 1,690.4 1,691.2
Deferred income taxes 604.6 579.2
Deferred employee benefit plans 157.9 157.7
Other liabilities 112.6 134.6
---------- ----------
Total liabilities 3,729.7 3,842.1
---------- ----------
Shareholders' equity
Preferred stock 50.0 50.0
Common stock (70,000,000 shares issued) 1,400.0 1,400.0
Additional paid-in capital 82.2 82.2
Retained earnings 253.7 231.2
---------- ----------
Total shareholders' equity 1,785.9 1,763.4
---------- ----------
Total liabilities and shareholders' equity $ 5,515.6 $ 5,605.5
========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
3
<PAGE> 5
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
Condensed Consolidated Statements of Cash Flows (Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------------
1999 1998
---------- ----------
(Dollars in Millions)
<S> <C> <C>
OPERATIONS
Net income $ 170.1 $ 108.1
Adjustments to reconcile net income to net cash from operations:
Depreciation and amortization 154.1 143.6
Deferred income taxes 18.3 25.2
Provision for uncollectible accounts 11.8 15.6
Changes in current assets and current liabilities 188.4 (38.9)
Other - net (33.2) 3.6
---------- ----------
Net cash from operations 509.5 257.2
---------- ----------
INVESTING
Capital expenditures (113.9) (149.0)
---------- ----------
Cash used in investing (113.9) (149.0)
---------- ----------
FINANCING
Long-term debt issued 222.4 --
Long-term debt retired -- (150.0)
Dividends (205.6) (158.3)
Net change in affiliate notes (422.9) 195.9
---------- ----------
Net cash used in financing (406.1) (112.4)
---------- ----------
Decrease in cash and cash equivalents (10.5) (4.2)
Cash and cash equivalents:
Beginning of period 16.4 9.9
---------- ----------
End of period $ 5.9 $ 5.7
========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
4
<PAGE> 6
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (Unaudited)
NOTE 1. BASIS OF PRESENTATION
GTE California Incorporated (the Company) is incorporated under the laws of the
State of California and is a subsidiary of GTE Corporation (GTE).
The unaudited condensed consolidated financial statements included herein have
been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. However, in the opinion of management
of the Company, the condensed consolidated financial statements include all
adjustments, which consist only of normal recurring accruals, necessary to
present fairly the financial information for such periods. These condensed
consolidated financial statements should be read in conjunction with the
consolidated financial statements and the notes thereto included in the
Company's 1998 Annual Report on Form 10-K.
Reclassifications of prior year data have been made, where appropriate, to
conform to the 1999 presentation.
NOTE 2. DEBT
In January 1999, the Company issued $225.0 million of 5.50% Series G
Debentures, due 2009. The net proceeds were applied toward the repayment of
short-term borrowings used to finance the Company's construction program and
for general corporate purposes.
NOTE 3. CAPITALIZED SOFTWARE
Effective January 1, 1999, the Company adopted the American Institute of
Certified Public Accountants' (AICPA) Statement of Position (SOP) 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." As a result of adopting SOP 98-1, in the first quarter of 1999
the Company capitalized $5.1 million of software expenditures, which would
previously have been expensed.
NOTE 4. SPECIAL CHARGE
In 1999, GTE continued the review of its operations and cost structure to
ensure they were consistent with its growth objectives. In connection with this
ongoing review, GTE initiated voluntary and involuntary employee separation
programs that resulted in a one-time charge for GTE during the first quarter of
1999. The charge pertaining to the Company totaled $19.9 million and is
reflected as "Selling, general and administrative" costs and expenses in the
condensed consolidated income statements. The components of the charge include
voluntary and involuntary separation programs and related benefits such as
outplacement and benefit continuation costs. These programs were completed
during the first quarter of 1999.
NOTE 5. RECENT ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. The Company is
currently assessing the impact of adopting SFAS No. 133, which is effective
January 1, 2000.
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<PAGE> 7
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued
NOTE 6. PLANNED ASSET SALES
During the first quarter of 1998, the Company committed to a plan that resulted
in a decision to sell approximately 46,000 switched access lines located in
California and Arizona. Due to the regulatory approvals that are required, it
is projected that most of the sales of local access lines will close in 2000.
As a result, the net book value of these lines, which approximates $40.7
million, continues to be reported in "Property, plant and equipment, net" in
the condensed consolidated balance sheets. Until sold, the Company intends to
continue to operate all of these assets. Based on the decision to sell,
however, the Company stopped recording depreciation expense for these assets.
Due to the centralized manner in which GTE's local telephone companies are
managed and since the access lines to be sold represent portions of states
rather than entire operating companies, revenues and operating income
applicable to the access lines to be sold are not readily determinable. The
46,000 access lines represent approximately 1% of the average switched access
lines that the Company had in service during 1998.
NOTE 7. PROPOSED MERGER WITH BELL ATLANTIC CORPORATION
Bell Atlantic and GTE have announced a proposed merger of equals under a
definitive merger agreement dated as of July 27, 1998. Under the terms of the
agreement, GTE shareholders will receive 1.22 shares of Bell Atlantic common
stock for each share of GTE common stock that they own.
We expect the merger to qualify as a pooling of interests, which means that for
accounting and financial reporting purposes the companies will be treated as if
they had always been combined. The completion of the merger is subject to a
number of conditions, including certain regulatory approvals, receipt of
opinions that the merger will be tax-free, and the approval of the shareholders
of both Bell Atlantic and GTE. Special meetings to vote on the merger will be
held on May 18, 1999 for GTE shareholders and on May 19, 1999 for Bell Atlantic
shareholders.
6
<PAGE> 8
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
Management's Discussion and Analysis of Financial Condition
And Results of Operations
<TABLE>
<CAPTION>
RESULTS OF OPERATIONS
(Dollars in Millions) Three Months Ended
March 31,
------------------------------ Percent
1999 1998 Increase Change
------------- ------------- ------------- ----------
<S> <C> <C> <C> <C>
Net income $ 170.1 $ 108.1 $ 62.0 57%
</TABLE>
The increase in net income for the three months ended March 31, 1999, compared
to the same period in 1998, is primarily the result of higher network access
services revenues and lower cost of services and sales, partially offset by a
one-time special charge of $19.9 million and higher income taxes.
<TABLE>
<CAPTION>
REVENUES AND SALES
(Dollars in Millions) Three Months Ended
March 31,
----------------------- Increase Percent
1999 1998 (Decrease) Change
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Local services $ 359.7 $ 354.3 $ 5.4 2%
Network access services 277.5 211.6 65.9 31%
Toll services 64.3 77.6 (13.3) (17)%
Other services and sales 125.6 91.8 33.8 37%
---------- ---------- ----------
Total revenues and sales $ 827.1 $ 735.3 $ 91.8 12%
========== ========== ==========
</TABLE>
Local Services Revenues
The first quarter increase in local services revenues is primarily due to 4%
growth in the Company's switched access lines that generated $10.1 million in
basic local services revenues and $3.0 million in CentraNet(R) services revenue.
In 1998, the Company received overpayments from the Universal Service Fund
(USF) related to the Lifeline support program and was required to refund $5.3
million back to the USF.
Network Access Services Revenues
The first quarter increase in network access services revenues is driven by a 6%
increase in minutes of use, which generated revenues of $7.7 million. Special
access revenues grew by $15.3 million as a result of greater demand for
increased bandwidth services by high capacity users. The variance also includes
an increase of $34.0 million resulting from the sharing provisions of the
Federal Communications Commission's (FCC) 1997 price cap recorded in the first
quarter of 1998. Partially offsetting these increases is a decrease of $6.6
million reflecting the impact of interstate and intrastate access price changes.
Toll Services Revenues
The first quarter decrease in toll services revenues is primarily due to
reduced toll volumes, resulting from intraLATA (Local Access Transport Area)
toll competition, which decreased revenues by $11.6 million.
Other Services and Sales Revenues
The first quarter increase in other services and sales revenues is primarily
the result of rental activity of $10.8 million and nonregulated service
revenues and equipment sales of $6.6 million. Also contributing to the increase
is growth of $6.1 million from billing and collection services and higher usage
and recurring charges of $2.1 million related to wireless products and
services.
7
<PAGE> 9
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
<TABLE>
<CAPTION>
OPERATING COSTS AND EXPENSES
(Dollars in Millions) Three Months Ended
March 31,
------------------------- Percent
1999 1998 (Decrease) Change
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Total operating costs and expenses $ 505.4 $ 527.5 $ (22.1) (4)%
</TABLE>
Total operating costs and expenses declined for the three months ended March
31, 1999, compared to the same period in 1998, primarily due to reduced
right-to-use (RTU) software fees, associated with the Company's network
switching equipment, of $13.3 million. This includes a reduction in RTU costs
of $5.1 million due to the capitalization of software costs in 1999, as a
result of adoption of the AICPA's SOP 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use," in addition to a
reduction in overall 1999 RTU fees of $8.2 million. Lower charges from an
affiliate for customer information pages included in the Company's White Pages
directories contributed $6.8 million to the decrease in operating costs and
expenses. Additionally, reduced labor and benefits due to productivity
improvements contributed $27.0 million to the decrease. The labor and benefits
reduction is partially offset by a one-time special charge of $19.9 million
associated with voluntary and involuntary employee separation programs
completed in the first quarter of 1999. Higher depreciation charges associated
with the investment in additional network facilities resulting from increased
demand for switched access lines contributed to the increase in depreciation
expense.
OTHER INCOME STATEMENT ITEMS
Interest - net increased 30% or $8.0 million for the three months ended March
31, 1999, compared to the same period in 1998, primarily as the result of
higher average long-term debt.
Income taxes increased 60% or $43.9 million for the three months ended March
31, 1999, compared to the same period in 1998, primarily due to the
corresponding increase in pretax income.
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 financing can be obtained through borrowings
from the Company's parent, GTE, or GTE Funding Incorporated, an affiliate of
the Company. The Company participates with other affiliates in a $1.5 billion,
364-day syndicated revolving line of credit and has access to an additional
$1.0 billion in short-term liquidity through GTE and GTE Funding Incorporated's
bi-lateral revolving lines of credit. The Company has an existing shelf
registration statement outstanding for an additional $275.0 million of
debentures.
The Company's primary source of funds during the first three months of 1999 was
cash from operations of $509.5 million compared to $257.2 million for the same
period in 1998. The increase primarily reflects a decrease in working capital
requirements, primarily due to the change in accounts receivable and
prepayments, combined with improved results from operations.
The Company's capital expenditures during the first three months of 1999 were
$113.9 million compared to $149.0 million for the same period in 1998. The
majority of new investment is being made to meet the demands of growth,
modernize facilities and develop and install new software, all of which are
required to support new products and
8
<PAGE> 10
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
enhanced services. The overall anticipated capital expenditures for 1999 are
expected to be less than the total capital expenditures incurred during 1998.
Net cash used in financing activities was $406.1 million during the first three
months of 1999 compared to $112.4 million for the same period in 1998. This
included dividend payments of $205.6 million in the first three months of 1999
compared to $158.3 million for the same period in 1998. Short-term financing,
represented by the net change in affiliate notes, decreased $422.9 million in
the first three months of 1999 compared to an increase of $195.9 million for
the same period in 1998. There was no long-term debt retired during the first
three months of 1999 compared to $150.0 million during the first three months
of 1998. The Company issued $225.0 million of 5.50% debentures in January 1999.
The net proceeds were applied toward the repayment of the Company's short-term
borrowings used to finance the Company's construction program and for general
corporate purposes.
INTERSTATE REGULATORY DEVELOPMENTS
During the first quarter of 1999, regulatory and legislative activity at both
the state and federal levels continued to be a direct result of the
Telecommunications Act of 1996 (Telecommunications Act). Along with promoting
competition in all segments of the telecommunications industry, the
Telecommunications Act was intended to preserve and advance universal service.
GTE continued in the first quarter of 1999 to meet the wholesale requirements
of new competitors. GTE signed interconnection agreements with other carriers,
providing them the capability to purchase individual unbundled network elements
(UNEs), resell retail services and interconnect facilities-based networks.
Several of these interconnection agreements were the result of the arbitration
process established by the Telecommunications Act, and incorporated prices or
terms and conditions based upon the Federal Communications Commission (FCC)
rules that were subsequently overturned by the Eighth Circuit Court (Eighth
Circuit) in July 1997. GTE challenged a number of such agreements in federal
district courts during 1997.
GTE's position in these challenges was supported by the Eighth Circuit's July
1997 decision stating that the FCC had overstepped its authority in several
areas concerning implementation of the interconnection provisions of the
Telecommunications Act. In January 1999, the U.S. Supreme Court (Supreme Court)
reversed in part and affirmed in part the Eighth Circuit's decisions. The
Supreme Court reversed the Eighth Circuit on many of the FCC rules related to
pricing and costing, that had previously been reversed by the Eighth Circuit on
jurisdictional grounds. The pricing rules established by the FCC will now be
remanded back to the Eighth Circuit for a determination on the merits. On the
other hand, the Supreme Court vacated the FCC rule requiring incumbent local
exchange carriers (LECs) to provide UNEs to competitive LECs. This latter ruling
will be the subject of continued proceedings before the FCC and the state
commissions concerning what elements will have to be offered under what
conditions. Pending the final rulemaking by the FCC on the provisions of UNEs,
GTE will continue to provide individual UNEs set forth in existing
interconnection agreements even though it is not legally obligated to do so.
Universal Service
In October 1998, the FCC issued an order selecting a cost model for universal
service and plans to select cost inputs in the second quarter of 1999. For this
reason, the FCC moved the implementation date of the new universal service
mechanism for nonrural carriers to July 1999. GTE filed a Petition for
Reconsideration in December 1998, stating that the adopted model is incomplete
and requires additional time for proper evaluation. GTE is currently awaiting
action from the FCC.
9
<PAGE> 11
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
Advanced Telecommunications Services
Section 706 of the Telecommunications Act required the FCC to "encourage the
deployment on a reasonable and timely basis of advanced telecommunications
capability to all Americans." Further, the FCC was required to conduct a
proceeding aimed at determining the availability of advanced telecommunications
and to take action to remove barriers to infrastructure investment and to
promote competition.
In an Order and Notice of Proposed Rule Making (NPRM) released in August 1998,
the FCC clarified that advanced services offered by an incumbent LEC are
subject to the unbundling and resale requirements of the Telecommunications
Act. In the NPRM, the FCC sought comment on extensive, new separate affiliate
rules under which an incumbent LEC's affiliate could offer advanced services
free from the unbundling and resale obligations of the Telecommunications Act.
In addition, the NPRM sought comment on a number of issues regarding
collocation, local loops and unbundling and resale obligations for network
facilities needed for advanced services.
On March 31, 1999, the FCC released an Order stemming from the August 1998
NPRM. In the Order the FCC adopted a number of new collocation rules designed
to make competitive entry easier and less costly. These rules specify how
incumbent LECs will manage such items as alternate collocation arrangements,
security, space preparation cost allocation, provisioning intervals and space
exhaustion. The FCC also released a Further NPRM seeking comment on spectrum
compatibility issues and line sharing. Line sharing is a concept wherein two or
more service providers are allowed to use the same local loop (e.g., voice and
xDSL). GTE will vigorously oppose line sharing. The FCC has yet to release an
order addressing separate affiliates, local loops, unbundling and resale.
INTRASTATE REGULATORY DEVELOPMENTS
Merger
In December 1998, GTE and Bell Atlantic filed a Joint Application requesting
approval of the GTE/Bell Atlantic merger. The applicants propose that
California ratepayers receive rate reductions reflecting fifty percent of the
forecasted merger-related net cost savings attributable to the regulated
intrastate Category I and II services. The applicants estimate the total amount
of such net savings is $132.2 million over four years, the present value of
which is $88.6 million. The applicants propose to allocate fifty percent of the
present value of the net savings, or $44.3 million, to California ratepayers in
two ways: (1) An annual surcredit of $10.3 million for a four-year period that
would apply to local, toll and access services with the exception of basic
residential service, and (2) Increase the level of the Company's corporate
donations to community-based organizations and programs by $2.5 million per
year for a minimum of four years.
PROPOSED MERGER WITH BELL ATLANTIC CORPORATION
On July 27, 1998, GTE and Bell Atlantic entered into a merger agreement
providing for the combination of the two companies. Under the terms of the
agreement, which was unanimously approved by the boards of directors of both
companies, GTE shareholders will receive 1.22 shares of Bell Atlantic stock for
each GTE share they own.
We expect the merger to qualify as a pooling of interests, which means that for
accounting and financial reporting purposes the companies will be treated as if
they had always been combined. The completion of the merger is subject to a
number of conditions, including certain regulatory approvals, receipt of
opinions that the merger will be
10
<PAGE> 12
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
tax-free, and the approval of the shareholders of both Bell Atlantic and GTE.
Special meetings to vote on the merger will be held on May 18, 1999 for GTE
shareholders and on May 19, 1999 for Bell Atlantic shareholders.
OTHER DEVELOPMENTS
Planned Asset Sales
In April 1998, GTE announced the planned sale of local telephone exchanges that
have approximately 1.6 million access lines in 13 states. Specifically, 46,000
access lines in the states of California and Arizona have been identified for
sale or trade. The identified assets constituted approximately 1% of the
average switched access lines that the Company had in service during 1998. FCC
and state commission approvals of the access line sales will be required.
Preliminary meetings have been held with the regulators. Transition of these
properties to the buyers will occur in 2000.
11
<PAGE> 13
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
YEAR 2000 CONVERSION
General
The Year 2000 issue concerns the potential inability of information systems to
properly recognize and process date-sensitive information beyond January 1,
2000, and has industry-wide implications. GTE has had an active Year 2000
program in place since 1995. This program is necessary because the Year 2000
issue could impact telecommunications networks, systems and business processes
at GTE. Although GTE maintains a significant portion of its own systems and
infrastructure, it also depends on certain, material external supplier products
that GTE must verify as Year 2000 compliant in their condition of use. In 1997,
GTE's Year 2000 methodology and processes were certified by the Information
Technology Industry Association of America. GTE presently expects that the
essential functions of its domestic wireline telecommunications business will
complete Year 2000 testing by June 30, 1999, and remaining businesses will
complete before October 1999.
State of Readiness
GTE's Year 2000 program is focused on both information technology (IT) and
non-IT systems, including: 1) telecommunications network elements that
constitute the portion of the public switched telephone network (PSTN) for
which GTE is responsible; 2) systems that directly support GTE's
telecommunications network operations and interactions with customers; 3)
systems and products that support GTE's national and international business
units; 4) software that supports basic business operations, customer premise
equipment and interconnection with other telecommunications carriers; and 5)
systems that support GTE's physical infrastructure, financial operations and
facilities.
Corporate-wide, essential remediation was approximately 88% complete as of
March 31, 1999. In addition to the essential remediation budget, GTE has set
aside funds equivalent to approximately 11% of it's overall Year 2000 budget.
These funds are planned for verification, problem resolution and administrative
program closeout in the last six months of 1999 and to address contingencies
and millennium program operations and control through March 2000. GTE's portion
of the PSTN in the United States has been upgraded substantially for Year 2000;
97% of GTE's access lines are already operational using Year 2000 compliant
central office switches. Additionally, over 98% of GTE's essential software has
been remediated. GTE's focus continues to be on deployment and testing of these
systems throughout GTE's operations.
GTE's Year 2000 program has been organized into five phases as follows:
Awareness: program definition and general education; Assessment: analysis and
prioritization of systems supporting the core business; Renovation: rectifying
Year 2000 issues; Validation: testing the Year 2000 solutions; Implementation:
placing the tested systems into production. Awareness and Assessment are more
than 95% complete; System Renovation, including supplier products, is
approximately 91% complete; Validation, including enterprise testing in
operational environments, and Implementation, including regional deployment,
are approximately 73% complete. It is anticipated that the Renovation,
Validation and Implementation phases for essential functions will be
substantially complete in June 1999.
In summary, compliant product deployment and enterprise testing for GTE's
domestic telecommunications-related business, including national and
international interoperability and validation, are presently expected to be
complete by the end of June 1999. The remaining domestic and international
businesses are on schedule for completing testing before October 1999.
Successful conclusion of GTE's Year 2000 program depends upon timely delivery
of Year 2000 compliant products and services from external suppliers. With the
addition of new products, approximately 1,500 of third-party
12
<PAGE> 14
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
products used by GTE have been determined to be "vital" products, critical to
GTE's business and operations. As of March 31, 1999, Year 2000 compliant
versions, or suitable alternatives, for 95% of these vital supplier products
have been provided and are currently undergoing certification testing by GTE.
Use of Independent Verification and Validation
Independent verification and validation is the final step in GTE's process. As
part of independent verification and validation, GTE's Year 2000 program
management office has established a corporate-wide quality oversight and
control function that reviews and evaluates quality reports on the Year 2000
issue. Each GTE business unit has access to an independent quality team that
evaluates the conversion and testing of applications and third-party supplier
products. This quality assurance process is expected to be completed in October
1999. Separately, GTE's corporate internal auditors conduct periodic reviews
and report significant findings, if any, to business unit and corporate
management and the audit committee of the Board of Directors. Program status is
also reported each quarter to GTE's external auditors.
Cost to Address Year 2000 Issues
The current estimate for the cost of GTE's Year 2000 Program is expected not to
exceed $400 million. Through March 31, 1999, expenditures totaled $283 million.
The current estimate for the cost of remediation for the Company is
approximately $52 million. Through March 31, 1999, expenditures totaled $25.3
million. Year 2000 remediation costs are expensed in the year incurred. GTE has
not elected to replace or accelerate the planned replacement of systems due to
the Year 2000 issue.
Currently supporting GTE's Year 2000 program worldwide are an estimated 1,000
to 1,200 full-time equivalent workers (both company employees and contractors).
Approximately 10% of these full-time equivalent workers are engaged in all
aspects of program management; 4% are engaged in system conversion; 27% are
involved in external supplier management; 54% are involved in testing at all
levels; and 5% are addressing contingency planning and interoperability
operations both nationally and internationally. Approximately 66% of GTE's
program effort involves U.S. domestic operations of all types.
Risks of Year 2000 Issues
GTE has begun to examine the risks associated with its "most reasonably likely
worst case Year 2000 scenarios." To date, GTE has no indication that any
specific function or system is so deficient in technical progress as to
threaten GTE's present schedule. GTE's program and plans currently indicate a
compliant network infrastructure to be deployed by the end of June 1999. A
general, unspecific, schedule shift that would erode progress beyond January 1,
2000, cannot reasonably be calculated. If, however, there were a schedule delay
lasting no more than six months, such schedule erosion would likely affect only
nonessential systems due to the prioritization of work schedules.
Other scenarios might include a possible but presently unforeseen failure of
key supplier or customer business processes or systems. This situation could
conceivably persist for some months after the millennium transition and could
lead to possible revenue losses. GTE's present assessment of its key suppliers
and customers does not indicate that this scenario is likely.
To date, GTE has not encountered any conditions requiring tactical contingency
planning to its existing Year 2000 program; however, contingency planning for
business and network operations and customer contact during 1999 and 2000 is
ongoing.
13
<PAGE> 15
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
GTE is bolstering its normal business continuity planning to address potential
Year 2000 interruptions. In addition, GTE's disaster preparedness recovery
teams are including procedures and activities for a "multi-regional" Year 2000
contingency, if it occurs. GTE is also developing its plans with respect to
possible occurrences immediately before, during, and after the millennium
transition. These plans are expected to be completed by June 30, 1999, and
tested (as appropriate) by the end of September 1999. This contingency plan
includes: business continuity planning; disaster recovery/emergency
preparedness; millennium rollover planning; post millennium degradation
tracking; a network and information technology "stabilization" period; employee
availability and logistics backup planning; "follow-the-sun" time-zone impact
analysis; coordination with other (non-PSTN) telecommunications providers; a
Year 2000 "war room" operation to provide high-priority recovery support, plans
for key personnel availability, command structures and contingency traffic
routing; and plans for round-the-clock, on-call repair teams.
RECENT ACCOUNTING PRONOUNCEMENT
Derivative Instruments and Hedging Activities
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. The statement requires
entities that use derivative instruments to measure these instruments at fair
value and record them as assets or liabilities on the balance sheet. It also
requires entities to reflect the gains or losses associated with changes in the
fair value of these derivatives, either in earnings or as a separate component
of comprehensive income, depending on the nature of the underlying contract or
transaction. The Company is currently assessing the impact of adopting SFAS No.
133, which is effective January 1, 2000.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
In this Management's Discussion and Analysis, the Company has made
forward-looking statements. These statements are based on the Company's
estimates and assumptions and are subject to certain risks and uncertainties.
Forward-looking statements include the information concerning possible or
assumed future results of operations of the Company, as well as those
statements preceded or followed by the words "anticipates," "believes,"
"estimates," "expects," "hopes," "targets" or similar expressions. For each of
these statements, the Company claims the protection of the safe harbor for
forward-looking statements contained in the Private Securities Litigation
Reform Act of 1995.
The future results of the Company could be affected by subsequent events and
could differ materially from those expressed in the forward-looking statements.
If future events and actual performance differ from the Company's assumptions,
the actual results could vary significantly from the performance projected in
the forward-looking statements.
The following important factors could affect the future results of the Company
and could cause those results to differ materially from those expressed in the
forward-looking statements: (1) materially adverse changes in economic
conditions in the markets served by the Company; (2) material changes in
available technology; (3) the final resolution of federal, state and local
regulatory initiatives and proceedings, including arbitration proceedings, and
judicial review of those initiatives and proceedings, pertaining to, among
other matters, the terms of interconnection, access charges, universal service,
UNEs and resale rates; (4) the extent, timing, success and overall effects of
competition from others in the local telephone and intraLATA toll service
markets; and (5) the success
14
<PAGE> 16
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
and expense of our remediation efforts and those of our suppliers, customers
and all interconnecting carriers in achieving Year 2000 compliance.
15
<PAGE> 17
PART II. OTHER INFORMATION
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits required by Item 601 of Regulation S-K.
12 Statement re: Calculation of the Consolidated Ratio of Earnings
to Fixed Charges
27 Financial Data Schedule
(b) The Company filed no reports on Form 8-K during the first quarter of
1999.
16
<PAGE> 18
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
GTE California Incorporated
------------------------------------------
(Registrant)
Date: May 13, 1999 /s/ Stephen L. Shore
-------------------- ------------------------------------------
Stephen L. Shore
Controller
(Principal Accounting Officer)
17
<PAGE> 19
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------------------- ----------------------------------------------------
<S> <C>
12 Statement re: Calculation of the Consolidated Ratio
of Earnings to Fixed Charges
27 Financial Data Schedule
</TABLE>
<PAGE> 1
EXHIBIT 12
GTE CALIFORNIA INCORPORATED AND SUBSIDIARY
Statement of the Consolidated Ratio of Earnings to Fixed Charges
(Unaudited)
<TABLE>
<CAPTION>
(Dollars in Millions) Three Months Ended
March 31, 1999
------------------
<S> <C>
Net earnings available for fixed charges:
Income from continuing operations $ 170.1
Add - Income taxes 116.5
- Fixed charges 37.1
----------------
Adjusted earnings $ 323.7
================
Fixed charges:
Interest expense $ 36.2
Portion of rent expense representing interest 0.9
----------------
Adjusted fixed charges $ 37.1
================
RATIO OF EARNINGS TO FIXED CHARGES 8.73
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 5,900
<SECURITIES> 0
<RECEIVABLES> 681,400
<ALLOWANCES> 65,000
<INVENTORY> 59,300
<CURRENT-ASSETS> 736,800
<PP&E> 10,418,500
<DEPRECIATION> 6,543,500
<TOTAL-ASSETS> 5,515,600
<CURRENT-LIABILITIES> 1,164,200
<BONDS> 1,690,400
0
50,000
<COMMON> 1,400,000
<OTHER-SE> 335,900
<TOTAL-LIABILITY-AND-EQUITY> 5,515,600
<SALES> 827,100
<TOTAL-REVENUES> 827,100
<CGS> 216,700
<TOTAL-COSTS> 505,400
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 36,200
<INCOME-PRETAX> 286,600
<INCOME-TAX> 116,500
<INCOME-CONTINUING> 170,100
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 170,100
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
