<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, 1997
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from to
Commission File Number 0-1210
GTE NORTH INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
WISCONSIN 35-1869961
(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:
NONE
Securities registered pursuant to Section 12(g) of the Act:
$1.15 SERIES CUMULATIVE PREFERRED STOCK-OH NO PAR VALUE
$1.25 SERIES CUMULATIVE PREFERRED STOCK-OH NO PAR VALUE
$2.00 SERIES CUMULATIVE PREFERRED STOCK-IN NO PAR VALUE
$2.10 SERIES CUMULATIVE PREFERRED STOCK-PA NO PAR VALUE
$2.20 SERIES CUMULATIVE PREFERRED STOCK-OH NO PAR VALUE
$2.25 SERIES CUMULATIVE PREFERRED STOCK-PA NO PAR VALUE
$2.30 SERIES CUMULATIVE PREFERRED STOCK-IL NO PAR VALUE
$2.375 SERIES CUMULATIVE PREFERRED STOCK-IL NO PAR VALUE
$2.40 SERIES CUMULATIVE PREFERRED STOCK-MI $50 PAR VALUE
$2.50 SERIES CUMULATIVE PREFERRED STOCK-IL NO PAR VALUE
$2.50 SERIES CUMULATIVE PREFERRED STOCK-IN NO PAR VALUE
$2.50C SERIES CUMULATIVE PREFERRED STOCK-IN NO PAR VALUE
$4.50 SERIES CUMULATIVE PREFERRED STOCK-WI $100 PAR VALUE
$5.00 SERIES CUMULATIVE PREFERRED STOCK-WI $100 PAR VALUE
4.60% SERIES CUMULATIVE PREFERRED STOCK-MI $50 PAR VALUE
5.16% SERIES CUMULATIVE PREFERRED STOCK-MI $50 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 978,351 SHARES OF $1,000 STATED VALUE COMMON STOCK OUTSTANDING
AT FEBRUARY 28, 1998. THE COMPANY'S COMMON STOCK IS 100% OWNED BY GTE
CORPORATION.
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Item Page
<S> <C>
Part I
1. Business 1
2. Properties 4
3. Legal Proceedings 4
4. Submission of Matters to a Vote of Security Holders 4
Part II
5. Market for the Registrant's Common Equity and Related 5
Shareholder Matters
6. Selected Financial Data 6
7. Management's Discussion and Analysis of Financial 7
Condition and Results of Operations
8. Financial Statements and Supplementary Data 14
9. Changes in and Disagreements with Accountants on 37
Accounting and Financial Disclosure
Part III
10. Directors and Executive Officers of the Registrant 38
11. Executive Compensation 40
12. Security Ownership of Certain Beneficial Owners and Management 48
13. Certain Relationships and Related Transactions 48
Part IV
14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 49
</TABLE>
<PAGE> 3
PART I
Item 1. Business
GTE North Incorporated (the Company) was incorporated in Wisconsin on January
27, 1987 and was the successor to the merger of eight telephone companies into
the Company on March 31, 1987. The Company is a wholly-owned subsidiary of GTE
Corporation (GTE).
The Company has one wholly-owned subsidiary, GTW Telephone Systems Incorporated,
which markets and services telecommunications customer premises equipment in
Wisconsin. In addition, on August 30, 1995, the Company purchased certain assets
from GTE Telecom Marketing Incorporated (TMC), an affiliated telephone sales and
services company.
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 various industries. The Company provides local
telephone service within its franchise areas 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.
The number of access lines in the states in which the Company operates as of
December 31, 1997, was as follows:
<TABLE>
<CAPTION>
Access
State Lines Served
- ----- ------------
<S> <C>
Illinois 963,245
Indiana 1,067,070
Michigan 727,127
Ohio 966,956
Pennsylvania 722,475
Wisconsin 542,293
------------
Total 4,989,166
============
</TABLE>
At December 31, 1997, the Company had 14,241 employees.
The Company has written agreements with the International Brotherhood of
Electrical Workers (IBEW), the Communications Workers of America (CWA), the
United Steelworkers of America (USW) and the International Association of
Machinists (IAM). Contracts with the USW and the IAM will expire in 1998.
REGULATORY AND COMPETITIVE TRENDS
The Company is subject to regulation by the regulatory bodies of the states of
Illinois, Indiana, Michigan, Ohio, Pennsylvania and Wisconsin for its intrastate
business operations and by the Federal Communications Commission (FCC) for its
interstate operations.
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. The Company continues to face additional
competition from numerous sources, such as competitive local-exchange carriers,
wireless carriers, cable television service providers and long distance
companies.
1
<PAGE> 4
Much of the regulatory and legislative activity that occurred in the United
States in 1997 was a direct result of the Telecommunications Act of 1996 (the
Telecommunications Act) adopted by Congress. The Telecommunications Act is
intended to promote competition in all sectors of the telecommunications
marketplace while preserving and advancing universal telephone service.
The Company supports greater competition in telecommunications, provided that
consumers benefit from an opportunity for all service providers to participate
in a competitive marketplace under comparable conditions. The Company believes
that a number of recent FCC and state regulatory agency decisions did not
establish comparable conditions; consequently, the Company and its parent, GTE,
have exercised their right to challenge actions they believe act to increase
competition at the expense of the shareholders of incumbent firms.
In July 1997, the U.S. Court of Appeals for the Eighth Circuit (Eighth Circuit)
released its decision on the challenge filed in 1996 by GTE and numerous other
parties to rules developed by the FCC to implement the interconnection
provisions of the Telecommunications Act. The Telecommunications Act required
local-exchange carriers (LECs) to make their retail services and the underlying
network elements available to competitors. The FCC required that prices for both
resold services and network elements be set using a methodology created by the
FCC. The court challenge asserted that the FCC's rules were inconsistent with
the Telecommunications Act. The July 1997 court decision found that the FCC
overstepped its authority in many instances and upheld GTE's position that state
regulatory agencies bear the primary responsibility for determining the prices
which competing firms must pay when interconnecting their networks. In January
1998, the U.S. Supreme Court announced that it would review this decision. Oral
argument in the Supreme Court is expected to take place in October 1998, with a
final decision likely to be issued no later than June 1999.
The favorable ruling by the Eighth Circuit did not impede the progress of
competition. The Company has finalized interconnection agreements with various
competitive LECs in Illinois, Indiana, Michigan, Ohio, Pennsylvania and
Wisconsin. A number of these interconnection agreements, adopted as a result of
the arbitration process established by the Telecommunications Act, incorporate
prices or terms and conditions based upon the FCC's rules that were overturned
by the Eighth Circuit. Thus, the Company has exercised its right to challenge
such agreements in Illinois, Michigan, Ohio, Pennsylvania and Wisconsin.
In May 1997, the FCC released two new major decisions related to implementation
of the Telecommunications Act's provisions - the universal service and access
charge reform orders. The universal service order established the support
mechanisms to ensure continued availability of affordable local telephone
service and created new programs to provide discounted telecommunications
services to schools, libraries and rural health care providers. GTE and numerous
other parties have challenged the FCC's decision before the U.S. Court of
Appeals for the Fifth Circuit on the grounds that the FCC did not follow the
requirements of the Telecommunications Act to develop a sufficient, explicit and
competitively neutral universal service program. A decision is expected in 1998.
The access charge reform order, also released in May 1997, revamped the rate
structure for use of the local network by interexchange carriers to originate
and complete long distance calls. GTE and numerous other parties also challenged
this decision before the Eighth Circuit based on the belief that the FCC not
only failed to remove all of the universal service subsidies hidden within
interstate access charges, but in fact created additional subsidy charges paid
only by business and multi-line residential customers. Oral argument has been
held and a decision is expected in 1998.
Also in May 1997, the FCC released a decision completing a periodic review of
its price cap regulatory oversight of interstate access charges. GTE and
numerous other LECs have challenged this decision before the Eighth Circuit
based on the belief that the FCC established a fundamentally unfair annual price
reduction formula and required retroactive price reductions. Oral argument has
been held and a decision on this challenge is also expected in 1998.
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 in Michigan and Wisconsin have adopted
various forms of alternative regulation, which provide economic incentives for
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 regulatory commissions in the states of Indiana,
Illinois, Ohio, and Pennsylvania continue to remain under the traditional
cost-based, rate-of-return regulatory framework for intrastate telephone
service.
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<PAGE> 5
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 cap
index based upon inflation less a predetermined productivity target. LECs have
limited pricing flexibility provided they do not exceed the allowed price cap.
In the May 1997 order on its price cap triennial review, the FCC revised the
price cap plan for LECs by adopting a uniform productivity factor of 6.0% with
an additive consumer productivity dividend of 0.5%. The FCC also eliminated the
sharing requirements of the price cap rules.
The Company filed interstate access revisions during 1997 that became effective
June 3, 1997 and July 1, 1997. Overall, these filings resulted in a net annual
price increase of $4.8 million. On December 1, 1997, the FCC issued an Order to
file revised access rates effective January 1, 1998, which resulted in
interstate access charge reductions of approximately $6 million. In 1997, the
FCC also ordered significant changes that altered the structure of access
charges collected by the Company, effective January 1, 1998. Generally, the FCC
reduced and restructured the per minute charges paid by long distance carriers
and implemented new per line charges. The FCC also created an access charge
structure that resulted in different access charges for residential primary and
secondary lines and for single line and multi-line business lines. In aggregate,
new per line charges and the charges paid by end-users exceed the reductions in
usage sensitive access charges paid by long distance carriers.
Further information regarding the Company's activities with the various
regulatory agencies and revenue arrangements with other telephone companies is
discussed in Note 11 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 1997, the Company's parent, GTE, continued to position itself to respond
aggressively to competitive developments and benefit from new opportunities.
In May 1997, GTE announced plans to become a leading national provider of data
communications services that included the acquisition of BBN Corporation (BBN),
a leading supplier of end-to-end Internet solutions. BBN brings valuable skills,
a leading position in the Internet market and an impressive list of Fortune 500
clients. In addition, GTE announced a strategic alliance with Cisco Systems,
Inc. to jointly develop enhanced data and Internet services for customers; and
the purchase of a national, state-of-the-art fiber-optic network from Qwest
Communications. This expansion of data services continued in November 1997 with
the announcement of the acquisition of Genuity Inc. (Genuity), a subsidiary of
Bechtel Enterprises. Genuity is a premier value-added provider of distributed
application hosting solutions.
3
<PAGE> 6
ENVIRONMENTAL MATTERS
GTE maintains monitoring and compliance programs related to environmental
matters. Currently, the Company has been named as a potentially responsible
party at a number of "Superfund Sites." GTE has reviewed each site in which it
has an involvement to establish an expected remediation cost. Based on this
review, management believes the Company is not subject to administrative or
judicial proceedings which would result in a material adverse effect on the
Company's results of operations or financial position. The Company has
established adequate reserves for estimated remediation and cleanup costs.
The Company's annual expenditures for site cleanups and environmental compliance
have not been and are not expected to be material. Costs incurred include the
Company's share of cleanup expenses for Superfund Sites, outlays required to
keep existing operations in compliance with environmental regulations and an
underground storage tank replacement program.
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 Illinois, Indiana, Michigan, Ohio,
Pennsylvania and Wisconsin, are generally in good operating condition and are
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, 1993 to December 31, 1997, the Company made capital
expenditures of $3.1 billion for new plant and facilities required to meet
telecommunication service needs and to modernize plant and facilities. These
additions were equal to 32% of gross plant of $9.6 billion at December 31, 1997.
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 of 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.
4
<PAGE> 7
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
BankBoston, N.A., 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
1-718-575-2990.
Or write to:
BankBoston, N.A.
c/o Boston EquiServe, L.P.
P.O. Box 8031
Boston, MA 02206-8031
For overnight delivery services, use the following address:
BankBoston, N.A.
c/o Boston EquiServe, L.P.
Blue Hills Office Park
150 Royall Street
Mail Stop 4502-60
Canton, MA 02021
The BankBoston, N.A. address where shareholders, banks and brokers may deliver
certificates is Securities Transfers and Reporting Services, 55 Broadway in New
York City.
PARENT COMPANY ANNUAL REPORT
To obtain a copy of the 1997 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.
DIVERSITY AT GTE
The Company and GTE strive to be a workplace of choice in which people of
diverse backgrounds are valued, challenged, acknowledged and rewarded, leading
to higher levels of fulfillment and productivity. A copy of our Diversity at GTE
brochure is available upon request from the GTE Corporate Secretary's Office.
5
<PAGE> 8
Item 6. Selected Financial Data
GTE North Incorporated and Subsidiary
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------------------------------------
Selected Income Statement Items (a) 1997 1996 1995 1994 1993(b)
- ----------------------------------- --------------------------------------------------------------------------------
(Thousands of Dollars)
<S> <C> <C> <C> <C> <C>
Revenues and sales $ 3,113,636 $ 2,988,803 $ 2,861,163 $ 2,794,465 $ 2,637,564
Operating costs and expenses 1,849,902 2,002,253 1,981,530 1,924,409 2,383,648
----------- ----------- ----------- ----------- -----------
Operating income 1,263,734 986,550 879,633 870,056 253,916
Interest - net 121,826 113,875 114,646 109,487 113,775
Gain on disposition of assets (15,939) -- -- -- --
Other - net 422 -- -- -- --
Income taxes 425,970 321,175 271,743 284,293 34,925
----------- ----------- ----------- ----------- -----------
Income before extraordinary charges 731,455 551,500 493,244 476,276 105,216
Extraordinary charges -- -- (1,253,960)(c) -- (14,270)
----------- ----------- ----------- ----------- -----------
Net income (loss) $ 731,455 $ 551,500 $ (760,716) $ 476,276 $ 90,946
=========== =========== =========== =========== ===========
Dividends declared on common stock $ 565,584 $ 548,502 $ 336,000 $ 277,729 $ 165,052
Dividends declared on preferred stock 1,810 2,559 2,592 2,643 2,680
</TABLE>
<TABLE>
<CAPTION>
As of December 31,
---------------------------------------------------------------------------
Selected Balance Sheet Items 1997 1996 1995 1994 1993
- ---------------------------- ---------------------------------------------------------------------------
(Thousands of Dollars)
<S> <C> <C> <C> <C> <C>
Property, plant and equipment, net (c) $ 3,131,325 $ 2,939,321 $ 2,841,574 $ 4,780,079 $ 4,680,338
Total assets 4,775,881 4,609,928 4,289,081 6,120,013 5,813,016
Long-term debt and preferred stock,
subject to mandatory redemption 1,784,385 1,549,587 1,348,437 1,384,397 1,486,589
Shareholders' equity 1,415,850 1,265,880 1,265,441 2,364,657 2,168,750
</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 $374.6 million pre-tax charge for
restructuring costs which reduced net income by $230.8 million.
(c) See Note 2 of the consolidated financial statements included in Item 8.
6
<PAGE> 9
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Dollars in Millions)
BUSINESS OPERATIONS
GTE North Incorporated (the Company), a wholly-owned subsidiary of GTE
Corporation (GTE), provides local-exchange, network access and toll services to
customers in Illinois, Indiana, Michigan, Ohio, Pennsylvania and Wisconsin. At
December 31, 1997, the Company served 4,989,166 access lines in its service
territories.
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Net income (loss) $ 731.5 $ 551.5 $ (760.7)
</TABLE>
Net income increased 33% or $180 in 1997. The 1997 increase is primarily the
result of an increase in local and network access revenues combined with
significantly lower operating costs and expenses. The gain on the sale of
certain non-strategic properties also contributed to the increase. These
favorable items are partially offset by a decline in toll service revenues.
The net loss for 1995 includes one-time extraordinary charges (net of tax) of
$1,241.5 for the discontinuance of Statement of Financial Accounting Standards
No. 71, "Accounting for the Effects of Certain Types of Regulation" (FAS 71) and
$12.5 for the early retirement of debt in the fourth quarter of 1995. Excluding
these extraordinary charges, net income increased 12% or $58.3 in 1996. The 1996
increase represents higher revenues and sales, reflecting customer growth from
an increase in access lines and minutes of use, and lower depreciation expense,
partially offset by higher operating costs.
REVENUES AND SALES
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Local services $ 1,212.6 $ 1,131.7 $ 1,064.0
Network access services 1,180.8 1,081.4 1,060.7
Toll services 280.5 352.4 366.6
Other services and sales 439.7 423.3 369.9
---------- ---------- ----------
Total revenues and sales $ 3,113.6 $ 2,988.8 $ 2,861.2
</TABLE>
Total revenues and sales increased 4% or $124.8 in 1997 and 4% or $127.6 in
1996.
Local service revenues are based on fees charged to customers for providing
local telephone exchange service within designated franchise areas. Local
service revenues increased 7% or $80.9 in 1997 and 6% or $67.7 in 1996. Access
line growth of 4% in 1997 generated additional revenues of $23.3 from basic
local services, $8.9 from CentraNet(R) services and $8.1 from Integrated
Services Digital Network (ISDN) and Digital Channel Services (DCS). Demand for
enhanced custom calling features, such as SmartCall(R) services, contributed
$35.1 to the increase. The increase for 1997 also reflects the $7.2 favorable
impact of the tax adjustment recorded in 1996 to correct the billing of certain
state excise taxes. Access line growth of 4% in 1996 generated additional
revenues of $30.9 from basic local services, $10.7 from CentraNet(R) services
and $4.8 from sales of ISDN. Demand for
7
<PAGE> 10
enhanced custom calling features contributed $9.7 to the 1996 increase. A
revenue-neutral rate restructuring in Michigan, effective fourth quarter 1995,
resulted in an increase in local service revenues of $13, which is offset by
corresponding decreases in both network access and toll services revenues. The
tax adjustment made in the second quarter of 1996 of $7.2, as discussed above,
partially offsets the 1996 increases.
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, business and residential customers pay 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. Revenues derived from network access services
increased 9% or $99.4 in 1997 and 2% or $20.7 in 1996. This growth is largely
due to increased demand for access services by interexchange carriers and
growing demand for increased bandwidth services. Minutes of use increased 14%
for 1997, generating an additional $86.6 in revenues. Special access revenues
grew $39 due to greater demand for increased bandwidth services by Internet
Service Providers (ISPs) and other high-capacity users. These favorable items
were partially offset by a 1997 reduction in interstate and intrastate access
revenues of $42.3 from the rate changes associated with the FCC's 1996 and 1997
price cap filings and the Illinois conversion to an Originating Responsibility
Plan (ORP) in July 1996. The 1996 increase is primarily due to an 11% increase
in minutes of use, which generated $59.2 of additional revenues. The increase in
network access revenues also reflects a $9.7 growth in special access revenues.
A reduction of $44.2 in interstate access revenues reflecting the net effect of
the rate changes associated with the Federal Communications Commission's (FCC's)
1995 and 1996 price cap filings and the rate restructure in Michigan, partially
offset the increases to revenues in 1996.
Toll service revenues are based on fees charged for service beyond a customer's
local calling area but within the LATA. Toll service revenues decreased 20% or
$71.9 in 1997 and 4% or $14.2 in 1996. The 1997 and 1996 decline in revenues is
attributable to lower toll volumes, primarily related to intraLATA toll
competition, including 10XXX and 1+ presubscription, and the impact from
optional discount calling plans, which effectively lowered intrastate toll
rates. These decreases are partially offset by an increase in toll revenues
primarily due to the Illinois conversion to an ORP in July 1996. The 1996
decrease is also due to the effect of the rate restructure in Michigan, as
discussed above in local service revenues, and $5.9 of unfavorable intrastate
settlement activity. Equal access (1+ presubscription) was completed for all
states in which the Company operates effective May 1997.
Other services and sales revenues increased 4% or $16.4 in 1997 and 14% or $53.4
in 1996. The 1997 increase is primarily due to the favorable impact of the FCC's
order on payphone interim compensation of $10.3 (as discussed in Note 11 of the
Company's financial statements included in Item 8). Increases in revenues from
billing and collections of $8.5, DataBase 800 services of $5.4, directory
advertising of $3.3 and voice messaging services of $1.6, also contributed to
the 1997 increase in other services and sales revenues. These increases are
partially offset by the $18.1 decrease in equipment sales and single-line rent
revenues. The 1996 increase is primarily due to $57.1 of additional equipment
sales. The increase is also related to higher directory advertising revenues of
$6.1 due to timing of publications and growth of $3.4 in revenues from sales of
paging and voice messaging services. These 1996 increases are partially offset
by a decrease of $12.5 in billing and collection revenues.
OPERATING COSTS AND EXPENSES
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Cost of services and sales $ 966.4 $ 1,061.0 $ 1,003.3
Selling, general and administrative 390.3 447.1 412.8
Depreciation and amortization 493.2 494.2 565.4
--------- --------- ---------
Total operating costs and expenses $ 1,849.9 $ 2,002.3 $ 1,981.5
</TABLE>
Total operating costs and expenses decreased 8% or $152.4 in 1997 and increased
1% or $20.8 in 1996.
8
<PAGE> 11
The 1997 decrease in operating costs and expenses is primarily due to pension
settlement gains of $80.9, recorded in 1997 as a result of lump-sum payments
from the Company's benefit plans, partially offset by $28.1 of gains recorded in
1996, which resulted in a $52.8 net decrease in operating costs and expenses.
The decrease also reflects the favorable impact of $5.6 in actuarial adjustments
made to the Company's pension plan and $53.3 in administrative productivity
gains achieved during the year. Lower access charges of $6.7 incurred to
terminate the customers' intraLATA toll calls outside of the Company's service
territories, lower operating taxes of $7.8 and the favorable impact of the
reserve recorded in 1996 for inside wire maintenance settlements of $5.7
contributed to the decrease. Lower material costs of $19.6 related to the
completion of a university project in the beginning of 1997 also contributed to
the decrease in costs. Higher depreciation charges associated with additions to
plant were offset by a reduction in depreciation rates to reflect higher net
salvage values of certain telephone plant and equipment. The decrease in
operating costs and expenses were partially offset by $10.5 in charges
associated with local number portability and an increase in advertising and
promotional costs of $33.9 aimed at stimulating sales of enhanced services and
preserving market share in an increasingly competitive environment.
The 1996 increase represents higher cost of services and sales expense and
higher selling, general and administrative costs associated with revenue
generation efforts, reduced partially by lower depreciation costs. The 1996
increase reflects higher material costs of $23.8 partially associated with a
large university project, greater labor costs of $17.1, including contractor
costs, and increased telecommunication costs of $15. In addition, the 1996
increase is related to higher application software costs of $14.7, higher data
processing costs of $11.9, and higher operating taxes of $5.8. Also contributing
to the 1996 increase are the change in actuarial adjustments to the Company's
benefit plans of $7.8 and a reserve of $5.7 for inside wire maintenance
settlements, as discussed in Other Matters. These increases are partially offset
by a net $71.2 decrease in depreciation due to revised estimates of salvage
values and the lives of certain assets, partially offset by higher depreciation
charges associated with additions to plant. Pension settlement gains of $28.1
recorded in 1996 were partially offset by settlement gains of $13.2 recorded in
1995, which resulted in a $14.9 net decrease.
OTHER (INCOME) EXPENSE
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Interest - net $ 121.8 $ 113.9 $ 114.6
Gain on disposition of assets (15.9) -- --
Income taxes 426.0 321.2 271.7
</TABLE>
Interest - net increased 7% or $7.9 in 1997 and remained relatively unchanged in
1996. The 1997 increase is primarily attributable to higher average debt levels.
On October 31, 1997, the Company sold 8 telephone exchanges in the state of
Michigan (representing 11,094 access lines). A pre-tax gain of $15.9 was
recorded on the sale of these non-strategic properties.
Income taxes increased 33% or $104.8 in 1997 and 18% or $49.5 in 1996. The 1997
and 1996 increases are primarily attributable to corresponding increases in
pre-tax income. The 1996 increase also reflects adjustments made to prior years'
tax liabilities.
9
<PAGE> 12
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 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 line of credit. In December 1997, the Company began
participating with GTE and other of its affiliates in a series of five bilateral
credit agreements for an additional $2 billion in credit capacity. These
facilities, which are shared by the participating companies, are aligned with
the maturity date of the existing 364-day line of credit. The additional
capacity provides greater flexibility to incur additional indebtedness of a
shorter-term duration during periods when it may not be desirable to access the
capital markets to refinance short-term debt. The Company has an existing shelf
registration statement for an additional $150 million of debentures.
The Company's primary source of funds during 1997 was cash from operations of
$1,289.4 compared to $1,094.7 in 1996. The increase in cash from operations
reflects improved results from operations and a decrease in the Company's
working capital requirements.
Net cash used in investing activities was $674.7 in 1997 compared to $609 in
1996. Capital expenditures were $708.2 and $609 during 1997 and 1996,
respectively. The 1997 expenditures reflect the Company's continued growth in
primary and secondary access lines and the modernization of interoffice
facilities to mitigate Internet congestion. The Company's anticipated
construction costs for 1998 are expected to decrease slightly from the 1997
level. In 1997, proceeds from sales of assets includes $34.1 received from the
sale of certain non-strategic properties.
Net cash used in financing activities was $615.5 in 1997 compared to $504.4 in
1996. This included dividend payments of $591.1 in 1997 compared to $524.7 in
1996. The Company paid a total of $265.7 for the retirement of debt and
preferred stock compared to $46.8 for 1996. Retirements for 1997 included $2.1
paid in premiums on the May 1997 retirement of $185.3 of long-term debt and
preferred stock redeemed prior to stated maturity. The Company issued $150
of 6.40% debentures in December 1997. The Company issued $200 of 7.625%
debentures in May 1996 and $250 of 6.90% debentures in November 1996 to
refinance the debt called and redeemed in the fourth quarter of 1995. Short-term
financings, including the net change in affiliate notes, increased $92.5 for
1997 compared to a decrease of $398.4 for 1996. The Company entered into forward
contracts to hedge against changes in interest rates related to the 1996 debt
refinancing. A $19 gain on the settlement of forward contracts is being
amortized over the life of the refinanced debt as an offset to interest expense.
On October 15, 1997, the Company's parent, GTE, proposed a merger with MCI
Communications Corporation (MCI) valued at approximately $28 billion. As a
result of the proposed merger, the rating agencies placed GTE, the Company and
its affiliates on "Credit Watch" for possible rating reductions. On November 10,
1997, MCI announced that it had reached an agreement to merge with WorldCom,
Inc.
REGULATORY AND COMPETITIVE TRENDS
The Company is subject to regulation by the regulatory bodies of the states of
Illinois, Indiana, Michigan, Ohio, Pennsylvania and Wisconsin for its intrastate
business operations and by the FCC for its interstate operations.
Much of the regulatory and legislative activity that occurred in the United
States in 1997 was a direct result of the Telecommunications Act of 1996 (the
Telecommunications Act) adopted by Congress. The Telecommunications Act is
intended to promote competition in all sectors of the telecommunications
marketplace while preserving and advancing universal telephone service.
The Company is a strong supporter of competition in all telecommunications
markets. The Company's position remains constant: the benefits of competition
should not be divided between customers or industry segments. There must be
fair, reasonable rules at the state and federal levels that enable all service
providers to participate
10
<PAGE> 13
equitably in the marketplace and benefit everyone. The Company believes the FCC
and a number of state regulatory agencies did not establish these comparable
conditions. The Company and its parent, GTE, have consequently exercised their
right to challenge regulatory actions they believe unfairly disadvantage their
customers and shareholders.
In July 1997, the U.S. Court of Appeals for the Eighth Circuit (Eighth Circuit)
released its decision on the challenge filed in 1996 by the Company's parent,
GTE, and numerous other parties to rules developed by the FCC to implement the
interconnection provisions of the Telecommunications Act. The Telecommunications
Act required local-exchange carriers (LECs) to make their retail services and
the underlying network elements available to competitors. The FCC required that
prices for both resold services and network elements be set using a methodology
created by the FCC. The court challenge asserted that the FCC's rules were
inconsistent with the Telecommunications Act. The July 1997 court decision found
that the FCC overstepped its authority in a number of areas and upheld GTE's
position that state regulatory agencies bear the primary responsibility for
determining the prices which competing firms must pay when interconnecting their
networks. On January 26, 1998, the U.S. Supreme Court announced that it would
review this decision. Oral argument in the Supreme Court is expected to take
place in October 1998, with a final decision likely to be issued no later than
June 1999.
The favorable ruling by the Eighth Circuit did not impede the progress of
competition. The Company has finalized interconnection agreements with various
competitive LECs in Illinois, Indiana, Michigan, Ohio, Pennsylvania and
Wisconsin. A number of these interconnection agreements, adopted as a result of
the arbitration process established by the Telecommunications Act, incorporate
prices or terms and conditions based upon the FCC's rules that were overturned
by the Eighth Circuit. Thus, the Company has exercised its right to challenge
such agreements in Illinois, Michigan, Ohio, Pennsylvania and Wisconsin. A
number of these complaints have been dismissed without prejudice on the grounds
that they were filed before the arbitrated agreements had received final
approval from state commissions. In such cases, the Company is refiling
complaints after final approval has occurred.
Interim rates for interconnection and unbundled network elements (UNEs) have
been established through negotiation and arbitration decisions. These interim
rates will be used until permanent rates are established through state
commission proceedings investigating cost studies. Cost studies have been filed
in Indiana, Illinois and Pennsylvania and additional studies in other states are
expected to be filed throughout 1998.
In May 1997, the FCC released two new major decisions related to implementation
of the Telecommunications Act's provisions - the universal service and access
charge reform orders. The universal service order established the support
mechanisms to ensure continued availability of affordable local telephone
service and created new programs to provide discounted telecommunications
services to schools, libraries and rural health care providers. GTE and numerous
other parties have challenged the FCC's decision before the U.S. Court of
Appeals for the Fifth Circuit on the grounds that the FCC did not follow the
requirements of the Telecommunications Act to develop a sufficient, explicit and
competitively neutral universal service program. A decision is expected in 1998.
Additional state commission proceedings have begun to establish rules and
procedures to implement state universal service funds (USF). USF proceedings
have begun in Illinois, Indiana, Pennsylvania and Wisconsin and additional
proceedings are scheduled to occur during the remainder of 1998. Separate USF
proceedings to address discount rates for intrastate telecommunications services
to elementary schools, secondary schools and public libraries have also begun in
Indiana and Wisconsin.
The FCC access charge reform order, also released in May 1997, revamped the rate
structure through which local and long distance companies charge customers for
using the local phone network to make long distance calls. The FCC ordered
decreases for long distance companies to be accomplished by increasing the
access charges for business and residential customers with more than one phone
line. GTE and numerous other parties also challenged this decision before the
Eighth Circuit based on the belief that the FCC did not eliminate the universal
service subsidies hidden within interstate access charges as directed by the
Telecommunications Act, and that the FCC created additional subsidy charges paid
only by business and multi-line residential customers. Oral argument has been
held and a decision is expected in 1998.
11
<PAGE> 14
Also in May 1997, the FCC released a decision completing a periodic review of
its price cap regulatory oversight of interstate access charges. GTE and
numerous other LECs have challenged this decision before the Eighth Circuit
based on the belief that the FCC established a fundamentally unfair annual price
reduction formula and required retroactive price reductions. Oral argument has
been held and a decision on this challenge is also expected in 1998.
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 in Michigan and Wisconsin have adopted
various forms of alternative regulation, which provide economic incentives for
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 regulatory commissions in the states of Indiana,
Illinois, Ohio and Pennsylvania continue 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 cap index based
upon inflation less a predetermined productivity target. LECs have limited
pricing flexibility provided they do not exceed the allowed price cap.
In the May 1997 order on its price cap triennial review, the FCC revised the
price cap plan for LECs by adopting a uniform productivity factor of 6.0% with
an additive consumer productivity dividend of 0.5%. The FCC also eliminated the
sharing requirements of the price cap rules.
The Company filed interstate access revisions during 1997 that became effective
June 3, 1997 and July 1, 1997. Overall, these filings resulted in a net annual
price increase of $4.8. On December 1, 1997, the FCC issued an order to file
revised access rates effective January 1, 1998, which resulted in interstate
access charge reductions of approximately $6. In 1997, the FCC also ordered
significant changes that altered the structure of access charges collected by
the Company, effective January 1, 1998. Generally, the FCC reduced and
restructured the per minute charges paid by long distance carriers and
implemented new per line charges. The FCC also created an access charge
structure that resulted in different access charges for residential primary and
secondary lines and single line and multi-line business lines. In aggregate, new
per line charges and the charges paid by end-users of $24.1 exceed the
reductions in usage sensitive access charges of $14.6 paid by long distance
carriers.
On June 4, 1996, the FCC issued its first Report and Order implementing Section
276 of the Telecommunications Act. As part of the overall goal of promoting
competition among payphone service providers (PSPs), this order mandated
compensation to all PSPs for all calls originating from payphones, including
"dial-around" access calls and toll-free subscriber calls for which PSPs were
not previously compensated. This compensation was to occur in two separate
phases. During phase one, from April 15, 1997 through October 6, 1997, PSPs were
to be paid a monthly, flat-rate compensation from interexchange carriers (IXCs).
During phase two, beginning October 7, 1997, PSPs were to be compensated on a
per-call basis, with the prevailing local coin rate of 35 cents established as
the default rate.
On July 19, 1997, the U.S. Court of Appeals in Washington, D.C. vacated the
FCC's directive concerning per-call compensation, stating that the FCC had not
shown that the 35 cent rate was a reasonable surrogate for fair compensation.
The court also set aside the FCC's flat-rate compensation mandate. Subsequently,
on October 9, 1997, the FCC issued a second Report and Order to address some of
the issues vacated by the court. In this second order, the FCC established a new
per-call rate of 28.4 cents for phase two compensation that all PSPs were
eligible to receive beginning October 9, 1997. The FCC tentatively concluded
that this per-call rate should also be used to calculate phase one compensation.
The Company has recorded approximately $10.3 of payphone revenues associated
with the October 9, 1997 FCC order. It is likely that the phase one compensation
directive will be revisited in a subsequent order.
Further information regarding the Company's activities with the various
regulatory agencies and revenue arrangements with other telephone companies is
discussed in Note 11 of the Company's consolidated financial statements included
in Item 8.
12
<PAGE> 15
YEAR 2000 CONVERSION
The Year 2000 issue has an industry-wide impact. The Company has had an active
Year 2000 Program in place. The Company's Year 2000 methodology and processes
were certified in 1997 by the Information Technology Association of America.
This program is necessary because the Year 2000 issue could impact systems,
networks and business processes at the Company. This program includes:
inventory; assessment and analysis of systems, networks and business processes;
remediation of any impacted software; and validation testing. The current
estimate for the cost of remediation for the Company is approximately $42.8.
Year 2000 remediation costs are expensed in the year incurred. Through 1997,
expenditures totaled $6.1. The Company currently has employees and contractors
mobilized to address the Year 2000 issue. Continued success is dependent on the
timely delivery of Year 2000 compliant products and services from the Company's
suppliers. The Company currently believes that its essential processes, systems
and business functions will be ready for the millennium transition.
LOCAL NUMBER PORTABILITY REQUIREMENTS
The Telecommunications Act mandated competition in the local telephone
marketplace. Local Number Portability (LNP) is one vehicle chosen by the FCC to
facilitate local competition. Local Service Provider Portability is the first
phase of LNP, which will allow residential and business customers to change
local service providers without changing their telephone numbers. The FCC has
mandated that Local Service Provider Portability be implemented in the top 100
Metropolitan Service Areas (MSAs) by the end of 1998. The second and third
phases of LNP will allow customers to retain their telephone numbers when they
move from one location to another or change services (e.g. landline to
cellular).
Through December 31, 1997, the Company had recorded approximately $21 to
implement Local Service Provider Portability within eighteen of the top 100
MSAs.
As a result of the major investment required to implement LNP, the FCC has
stated that local service providers should be allowed to recover a portion of
their costs. The Company is seeking regulatory recovery of LNP implementation
costs.
OTHER MATTERS
Eleven separate class action lawsuits were brought against GTE and twelve of its
subsidiaries (GTE Defendants), including the Company, relating to the provision
of inside wire maintenance services. On August 6, 1996, the GTE Defendants and
class counsel executed and filed a settlement agreement in one of the lawsuits.
The Court preliminarily approved the agreement and conditionally certified a
national class of plaintiffs for settlement purposes. A fairness hearing on the
settlement was held on December 18, 1996. On January 21, 1997, the Court
approved the settlement as written and issued a permanent injunction to prohibit
future lawsuits covering any claims from 1987 to the date of settlement.
Pursuant to the settlement, a proof of claim form was inserted into the March
1997 customer bills for the national class to request their benefits under the
settlement. The reserves established in 1996 were adequate for the processing of
all claims during 1997.
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.
13
<PAGE> 16
Item 8. Financial Statements and Supplementary Data
GTE North Incorporated and Subsidiary
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Years Ended December 31 1997 1996 1995
- ----------------------- ----------- ----------- -----------
(Thousands of Dollars)
<S> <C> <C> <C>
REVENUES AND SALES (a)
Local services $ 1,212,608 $ 1,131,681 $ 1,063,950
Network access services 1,180,842 1,081,374 1,060,670
Toll services 280,456 352,431 366,649
Other services and sales 439,730 423,317 369,894
----------- ----------- -----------
Total revenues and sales 3,113,636 2,988,803 2,861,163
----------- ----------- -----------
OPERATING COSTS AND EXPENSES (b)
Cost of services and sales 966,429 1,060,968 1,003,323
Selling, general and administrative 390,274 447,127 412,802
Depreciation and amortization 493,199 494,158 565,405
----------- ----------- -----------
Total operating costs and expenses 1,849,902 2,002,253 1,981,530
----------- ----------- -----------
OPERATING INCOME 1,263,734 986,550 879,633
OTHER (INCOME) EXPENSE
Interest - net (c) 121,826 113,875 114,646
Gain on disposition of assets (15,939) -- --
Other - net 422 -- --
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 1,157,425 872,675 764,987
Income taxes 425,970 321,175 271,743
----------- ----------- -----------
INCOME BEFORE EXTRAORDINARY CHARGES 731,455 551,500 493,244
Extraordinary charges -- -- (1,253,960)
----------- ----------- -----------
NET INCOME (LOSS) $ 731,455 $ 551,500 $ (760,716)
=========== =========== ===========
</TABLE>
(a) Includes billings to affiliates of $99,241, $96,491 and $91,192 for the
years 1997-1995, respectively.
(b) Includes billings from affiliates of $210,623, $201,630 and $203,520 for the
years 1997-1995, respectively.
(c) Includes interest paid to affiliates of $20,975 in 1997.
See Notes to Consolidated Financial Statements.
14
<PAGE> 17
GTE North Incorporated and Subsidiary
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31 1997 1996
- ----------- ---------- ----------
(Thousands of Dollars)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 12,208 $ 12,975
Receivables, less allowances of $29,851 and $31,248 657,928 805,965
Inventories and supplies 38,001 40,996
Deferred income tax benefits 40,981 59,438
Other 27,755 24,623
---------- ----------
Total current assets 776,873 943,997
---------- ----------
Property, plant and equipment, net 3,131,325 2,939,321
Employee benefit plans 837,271 686,134
Other assets 30,412 40,476
---------- ----------
Total assets $4,775,881 $4,609,928
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term obligations, including current maturities $ 16,247 $ 257,766
Accounts payable 150,750 159,098
Affiliate payables and accruals 97,980 67,989
Advanced billings and customer deposits 65,879 62,743
Taxes payable 197,081 159,589
Accrued interest 19,348 24,031
Accrued payroll costs 205,249 219,406
Dividends payable 100,849 124,555
Other 72,112 135,272
---------- ----------
Total current liabilities 925,495 1,210,449
---------- ----------
Long-term debt 1,768,132 1,532,650
Deferred income taxes 215,261 206,386
Employee benefit plans 406,545 352,200
Other liabilities 28,345 25,426
---------- ----------
Total liabilities 3,343,778 3,327,111
---------- ----------
Preferred stock, subject to mandatory redemption 16,253 16,937
---------- ----------
Shareholders' equity:
Preferred stock 15,208 29,033
Common stock (978,351 shares issued) 978,351 978,351
Additional paid-in capital 43,110 43,110
Retained earnings 379,181 215,386
---------- ----------
Total shareholders' equity 1,415,850 1,265,880
---------- ----------
Total liabilities and shareholders' equity $4,775,881 $4,609,928
========== ==========
</TABLE>
See Notes to Consolidated Financial Statements.
15
<PAGE> 18
GTE North Incorporated and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31 1997 1996 1995
- ----------------------- ----------- ----------- -----------
(Thousands of Dollars)
<S> <C> <C> <C>
OPERATIONS
Income before extraordinary charges $ 731,455 $ 551,500 $ 493,244
Adjustments to reconcile income before extraordinary
charges to net cash from operations:
Depreciation and amortization 493,199 494,158 565,405
Deferred income taxes 27,332 46,742 42,038
Gain on disposition of assets (15,939) -- --
Provision for uncollectible accounts 44,698 39,836 35,409
Change in current assets and current liabilities:
Receivables - net 41,869 (135,210) (57,605)
Other current assets (137) 16,599 (630)
Accrued taxes and interest 27,230 36,292 (17,438)
Other current liabilities 7,232 132,659 (180,091)
Other - net (67,551) (87,841) (61,042)
----------- ----------- -----------
Net cash from operations 1,289,388 1,094,735 819,290
----------- ----------- -----------
INVESTING
Capital expenditures (708,242) (608,984) (608,395)
Acquisition of assets -- -- (5,200)
Proceeds from the sale of assets 34,054 -- --
Other - net (500) -- 334
----------- ----------- -----------
Net cash used in investing (674,688) (608,984) (613,261)
----------- ----------- -----------
FINANCING
Long-term debt issued 148,845 446,100 --
Long-term debt and preferred stock retired,
including premiums paid on early retirement (265,692) (46,844) (290,329)
Dividends (591,100) (524,735) (294,870)
Increase (decrease) in short-term obligations,
excluding current maturities 92,480 (398,390) 392,887
Other - net -- 19,438 (12,435)
----------- ----------- -----------
Net cash used in financing (615,467) (504,431) (204,747)
----------- ----------- -----------
Increase (decrease) in cash and cash equivalents (767) (18,680) 1,282
Cash and cash equivalents:
Beginning of year 12,975 31,655 30,373
----------- ----------- -----------
End of year $ 12,208 $ 12,975 $ 31,655
=========== =========== ===========
Cash paid during the year for:
Interest $ 122,283 $ 117,724 $ 122,917
----------- ----------- -----------
Income taxes $ 350,936 $ 249,322 $ 229,354
----------- ----------- -----------
</TABLE>
See Notes to Consolidated Financial Statements.
16
<PAGE> 19
GTE North Incorporated and Subsidiary
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<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, 1994 $ 29,033 $ 978,351 $ 43,018 $1,314,255 $2,364,657
Net loss (760,716) (760,716)
Dividends declared (338,592) (338,592)
Redemption of preferred stock below stated par 92 --- 92
---------- ---------- ---------- ---------- ----------
Shareholders' equity, December 31, 1995 29,033 978,351 43,110 214,947 1,265,441
Net income 551,500 551,500
Dividends declared (551,061) (551,061)
---------- ---------- ---------- ---------- ----------
Shareholders' equity, December 31, 1996 29,033 978,351 43,110 215,386 1,265,880
Net income 731,455 731,455
Dividends declared (567,394) (567,394)
Redemption of preferred stock (13,825) (266) (14,091)
---------- ---------- ---------- ---------- ----------
Shareholders' equity, December 31, 1997 $ 15,208 $ 978,351 $ 43,110 $ 379,181 $1,415,850
========== ========== ========== ========== ==========
</TABLE>
See Notes to Consolidated Financial Statements.
17
<PAGE> 20
GTE North Incorporated and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
GTE North 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, 1997,
the Company served 4,989,166 access lines in the states of Illinois, Indiana,
Michigan, Ohio, Pennsylvania and Wisconsin. 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 management to make
estimates and assumptions that affect the reported amounts. Actual results could
differ from those estimates.
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, GTW Telephone Systems Incorporated. All significant
intercompany transactions have been eliminated.
Reclassifications of prior-year data have been made, where appropriate, to
conform to the 1997 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 $246.9 million, $219.3 million and $179.8 million for the
years 1997-1995, respectively. Such purchases and services are recorded in the
accounts of the Company, at cost, which includes a 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 $210.6
million, $201.6 million and $203.5 million for the years 1997-1995,
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 GTE's domestic telephone operating subsidiaries.
The amounts charged for these affiliated transactions are based on proportional
cost allocation methodologies.
GTE Funding Incorporated (an affiliate of the Company) provides short-term
financing and investment vehicles and cash management services for the Company.
The Company is contractually obligated to repay all amounts borrowed on its
behalf by GTE Funding Incorporated. Interest expense on these borrowings
amounted to approximately $21 million in 1997.
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 $99.2 million, $96.5 million and $91.2 million for the years
1997-1995, respectively.
18
<PAGE> 21
DEPRECIATION AND AMORTIZATION
The Company provides for depreciation on a straight-line basis over the
estimated economic lives of its assets. Prior to 1996, the Company provided for
depreciation on a straight-line basis over asset lives approved by regulators
(see Note 2). 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.
Franchises, goodwill and other intangibles are amortized on a straight-line
basis over the periods to be benefited, or 40 years, whichever is less.
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 projected 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.
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 are subsequently adjusted to reflect changes in
tax rates expected to be in effect when the temporary differences reverse. A
valuation allowance is established for deferred tax assets for which realization
is not likely.
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.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (FAS
130). FAS 130 establishes standards for reporting and displaying comprehensive
income and its components in the financial statements. FAS 130 is effective for
fiscal years beginning after December 15, 1997.
19
<PAGE> 22
Reclassification of financial statements for earlier periods provided for
comparative purposes is required. The adoption of this standard will have no
impact on the Company's results of operations, financial position or cash flows.
2. EXTRAORDINARY CHARGES
In response to legislation (see Note 11) and the increasingly competitive
environment, 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 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 $1,241.5 million (net of tax
benefits of $758 million) in the fourth quarter of 1995. The charge primarily
represented 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>
Average Depreciable Lives
-------------------------
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, $190.6
million of long-term debt. These redemptions resulted in an after-tax
extraordinary charge of $12.5 million (net of tax benefits of $7.7 million).
3. PROPERTY REPOSITIONING
On October 31, 1997, the Company sold 8 telephone exchanges in the state of
Michigan (representing 11,094 access lines) to PTI, Incorporated for $34.1
million in cash. A pre-tax gain of $15.9 million was recorded on the sale.
20
<PAGE> 23
4. PREFERRED STOCK
Cumulative preferred stock, not subject to mandatory redemption, exclusive of
amounts held in treasury, as of December 31, 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
December 31
-------------------
1997 1996
------- -------
Authorized Shares Shares
------- -------
<S> <C> <C>
No par value 248,396 388,396
$ 100 par value 33,524 33,524
------- -------
Total 281,920 421,920
======= =======
</TABLE>
<TABLE>
<CAPTION>
December 31
----------------------------------------------------------------
1997 1996
------------------------------ ------------------------------
Shares Amount Shares Amount
-------- -------------------- -------- --------------------
Outstanding (Thousands of Dollars) (Thousands of Dollars)
<S> <C> <C> <C> <C> <C>
$2.00 No par value 45,484 $ 2,215 45,484 $ 2,215
$2.10 No par value 66,390 3,542 66,390 3,542
$2.20 No par value 34,379 1,719 34,379 1,719
$2.25 No par value 90,765 4,538 90,765 4,538
$4.50 $100 par value 7,297 730 7,297 730
$5.00 $100 par value 24,639 2,464 24,639 2,464
$7.60 No par value -- -- 140,000 13,825
-------- -------- -------- --------
Total 268,954 $ 15,208 408,954 $ 29,033
======== ======== ======== ========
</TABLE>
21
<PAGE> 24
Cumulative preferred stock, subject to mandatory redemption, is as follows:
<TABLE>
<CAPTION>
Shares
------
<S> <C>
Authorized
No par value 462,934
$50 par value 166,721
-------
Total 629,655
=======
</TABLE>
<TABLE>
<CAPTION>
December 31
-----------------------------------------------------------------
1997 1996
------------------------------ ------------------------------
Shares Amount Shares Amount
-------- -------------------- -------- --------------------
Outstanding (Thousands of Dollars) (Thousands of Dollars)
<S> <C> <C> <C> <C> <C>
$ 1.15 No par value 115,200 $ 2,880 121,600 $ 3,040
$ 1.25 No par value 17,484 437 18,584 465
$ 2.30 No par value 24,000 1,200 25,200 1,260
$ 2.375 No par value 25,961 1,298 28,429 1,422
$ 2.40 $50 par value 25,490 1,275 27,490 1,375
$ 2.50 No par value 39,800 1,990 39,800 1,990
$ 2.50 No par value 41,562 2,056 44,631 2,208
$ 2.50C No par value 22,037 1,102 23,237 1,162
4.60% $50 par value 57,300 2,865 57,300 2,865
5.16% $50 par value 23,000 1,150 23,000 1,150
-------- -------- -------- --------
Total 391,834 $ 16,253 409,271 $ 16,937
======== ======== ======== ========
</TABLE>
In May 1997, the Company redeemed all outstanding shares of the $7.60 Series
preferred stock with cash from operations. The Company incurred $0.3 million in
premiums associated with this retirement.
The outstanding preferred stock is redeemable at a premium, at any time, in
whole or in part, on thirty days notice. Cumulative preferred stock, not subject
to mandatory redemption, held as treasury shares by the Company were 46 shares
at December 31, 1997, 1996 and 1995.
The Company is also required, for Series subject to mandatory redemption, to
purchase and retire shares each year through the operation of a purchase fund.
Shares can be acquired or tendered on a best efforts basis at not more than $50
per share, except for the $1.15 and $1.25 Series, at not more than $25 per
share. The maximum number of shares that can be purchased and retired each year
are: $1.15 Series - 6,400 shares; $1.25 Series - 1,200 shares; $2.30 Series -
1,200 shares; $2.375 Series - 2,468 shares; $2.40 Series - 2,000 shares; $2.50
Series (IL) - 2,000 shares; $2.50 (IN) - 2,958 shares; $2.50C Series - 1,200
shares; 4.60% Series - 3,200 shares and the 5.16% Series - 1,000 shares. The
aggregate maximum total of these shares per year is 23,626 shares.
The Company met this requirement through treasury stock and the purchase of
17,437, 17,054 and 23,626 shares in 1997-1995, respectively. The aggregate
retirement of preferred stock subject to a purchase fund is $989,000 in each of
the years 1998-2002.
At December 31, 1997 and 1996, the Company held no cumulative preferred stock,
subject to mandatory redemption as treasury shares. At December 31, 1995, the
Company held 1,200 shares of treasury stock to cover future redemption
requirements. No shares were reserved for officers or employees or for options,
warrants, conversions or other rights. The preferred shareholders have no voting
rights.
22
<PAGE> 25
5. COMMON STOCK
The authorized common stock of the Company consists of 2,200,000 shares with a
stated value of $1,000 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, 1997, $2.9 million of retained earnings were restricted as to
the payment of cash dividends on common stock under the most restrictive terms
of the Company's indentures.
6. DEBT
Long-term debt as of December 31, was as follows:
<TABLE>
<CAPTION>
1997 1996
------------ -----------
(Thousands of Dollars)
<S> <C> <C>
First mortgage bonds:
Maturing through 2031, weighted average rates of
8.32% and 7.92%, respectively $ 393,414 $ 642,566
Debentures:
6.00 % Series A, due 2004 250,000 250,000
5.50 % Series B, due 1999 200,000 200,000
7.625 % Series C, due 2026 200,000 200,000
6.90 % Series D, due 2008 250,000 250,000
6.40 % Series E, due 2005 150,000 --
Other:
GTE Finance Corporation promissory notes-maturing 1998
through 2016, weighted average rate of 9.02% 45,000 45,000
Note payable expected to be refinanced on a long-term basis 284,362 --
Capitalized leases 250 143
----------- -----------
Total principal amount 1,773,026 1,587,709
Premium and discount - net 11,335 10,807
----------- -----------
Total 1,784,361 1,598,516
Less: current maturities (16,229) (65,866)
----------- -----------
Total long-term debt $ 1,768,132 $ 1,532,650
=========== ===========
</TABLE>
In May and October 1997, the Company redeemed, prior to stated maturity, $171.5
million and $17 million, respectively, of first mortgage bonds. The Company
incurred $1.9 million in premiums associated with the May 1997 retirement.
The Company issued $150 million of 6.40% Series E debentures, due 2005, in
December 1997. Net proceeds were applied toward the repayment of short-term
borrowings incurred to finance the Company's construction program and for
general corporate purposes.
23
<PAGE> 26
Long-term debt as of December 31, 1997 includes $284.4 million of short-term
borrowings in the form of affiliate notes payable which the Company refinanced
in February 1998, with the issuance of $200 million of 6.375% Series F
debentures, due 2010 and $200 million of 6.73% Series G debentures, due 2028.
The Company issued $200 million of 7.625% Series C debentures, due 2026, in May
1996 and $250 million of 6.90% Series D debentures, due 2008, in November 1996.
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 also used to finance the
Company's construction program and for general corporate purposes.
None of the securities shown above were held in sinking or other special funds
of the Company, pledged by the Company or held by affiliates, except for the
promissory notes held by GTE Finance Corporation. 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.
Estimated payments of long-term debt during the next five years are: $16.2
million in 1998; $201 million in 1999; $1 million in 2000; $34 million in 2001
and $1.4 million in 2002.
Total short-term obligations as of December 31, were as follows:
<TABLE>
<CAPTION>
1997 1996
-------- --------
(Thousands of Dollars)
<S> <C> <C>
Commercial paper - average rate 5.4% $ -- $191,900
Note payable with affiliate - average rate 6% 18 --
Current maturities of long-term debt 16,229 65,866
-------- --------
Total $ 16,247 $257,766
======== ========
</TABLE>
The Company participates with other affiliates in a $1.5 billion, 364-day
syndicated line of credit. In December 1997, the Company began participating
with its parent, GTE, and other of its affiliates in a series of five bilateral
credit agreements for an additional $2 billion in credit capacity. These
facilities, which are shared by the participating companies, are aligned with
the maturity date of the existing 364-day line of credit.
7. FINANCIAL INSTRUMENTS
At December 31, 1997, the Company has entered into forward contracts to sell
U.S. Treasury Bonds to hedge against changes in market interest rates on $200
million of planned long-term debt issuances expected to be completed within the
next twelve months. Gains and losses recognized upon the expiration or
settlement of forward contracts to sell U.S. Treasury Bonds are amortized over
the life of the associated long-term debt issuance as an offset or addition to
interest expense.
The risk associated with these off-balance-sheet financial instruments arises
from the possible inability of counterparties to meet the contract terms and
from movements in interest rates. The Company carefully evaluates and
continually monitors the creditworthiness of its counterparties and believes the
risk of nonperformance is remote.
The fair values of financial instruments, other than long-term debt, closely
approximate their carrying value. As of December 31, 1997, the estimated fair
value of long-term debt based on either reference to quoted market prices or an
option pricing model, was higher than the carrying value by approximately $6
million. The estimated fair value of long-term debt as of December 31, 1996 was
lower than the carrying value by approximately $8 million.
24
<PAGE> 27
8. INCOME TAXES
The income tax provision is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
Current:
Federal $ 357,768 $ 244,128 $ 205,299
State 40,870 30,304 24,406
--------- --------- ---------
398,638 274,432 229,705
Deferred: --------- --------- ---------
Federal 26,904 49,139 45,433
State 7,875 6,932 9,903
--------- --------- ---------
34,779 56,071 55,336
--------- --------- ---------
Amortization of deferred investment tax credits - net (7,447) (9,328) (13,298)
--------- --------- ---------
Total $ 425,970 $ 321,175 $ 271,743
========= ========= =========
</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>
1997 1996 1995
--------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
Amounts computed at statutory rates $ 404,372 $ 304,541 $ 266,838
State and local income taxes, net of federal income tax benefits 31,684 24,203 22,301
Amortization of deferred investment tax credits, net of federal
income tax benefits (4,841) (6,063) (13,298)
Depreciation of telephone plant construction costs
previously deducted for tax purposes - net -- -- 5,325
Rate differentials applied to reversing temporary differences -- -- (6,743)
Other differences - net (5,245) (1,506) (2,680)
--------- --------- ---------
Total provision $ 425,970 $ 321,175 $ 271,743
========= ========= =========
</TABLE>
The tax effects of temporary differences that give rise to the current deferred
income tax benefits and deferred income tax liabilities at December 31, are as
follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(Thousands of Dollars)
<S> <C> <C>
Depreciation and amortization $ 59,681 $ 79,174
Employee benefit obligations (211,305) (190,078)
Prepaid pension cost 304,315 255,829
Investment tax credits 5,541 10,382
Other - net 16,048 (8,359)
--------- ---------
Total $ 174,280 $ 146,948
========= =========
</TABLE>
25
<PAGE> 28
9. 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
employee benefit and tax laws, is to contribute such amounts as are determined
on an actuarial basis to accumulate funds sufficient to meet the plans benefit
obligation to employees upon their retirement. The assets of the plans consist
primarily of corporate equities, government securities and corporate debt
securities.
The components of the net pension credit for 1997-1995 were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
Benefits earned during the year $ 43,873 $ 44,618 $ 38,142
Interest cost on projected benefit obligations 121,789 113,639 108,922
Return on plan assets:
Actual (574,944) (432,535) (509,740)
Deferred 331,589 200,931 305,521
Other - net (24,148) (33,369) (40,728)
--------- --------- ---------
Net pension credit $(101,841) $(106,716) $ (97,883)
========= ========= =========
</TABLE>
The expected long-term rate-of-return on plan assets was 9.0% for 1997 and 1996,
and 8.5% for 1995.
The funded status of the plans and the net prepaid pension cost at December 31,
were as follows:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
(Thousands of Dollars)
<S> <C> <C>
Vested benefit obligations $ 1,204,575 $ 1,225,528
=========== ===========
Accumulated benefit obligations $ 1,387,256 $ 1,345,246
=========== ===========
Plan assets at fair value $ 3,514,012 $ 3,185,513
Less: projected benefit obligations 1,721,128 1,672,419
----------- -----------
Excess of assets over projected obligations 1,792,884 1,513,094
Unrecognized net transition asset (83,169) (113,869)
Unrecognized net gain (872,444) (713,091)
----------- -----------
Net prepaid pension cost $ 837,271 $ 686,134
=========== ===========
</TABLE>
Assumptions used to develop the projected benefit obligations at December 31,
were as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Discount rate 7.25% 7.50%
Rate of compensation increase 5.00% 5.25%
</TABLE>
26
<PAGE> 29
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
Substantially all of the Company's employees are covered under postretirement
health care and life insurance benefit plans. The determination of benefit cost
for post-retirement health plans is generally based on comprehensive hospital,
medical and surgical benefit plan provisions. The Company funds amounts for
postretirement benefits as deemed appropriate from time to time. Plan assets
consist primarily of corporate equities, government securities and corporate
debt securities.
The postretirement benefit cost for 1997-1995 included the following components:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
(Thousands of Dollars)
<S> <C> <C> <C>
Benefits earned during the year $ 6,288 $ 7,469 $ 8,254
Interest on accumulated postretirement benefit obligations 42,224 42,740 45,049
Actual return on plan assets (2,214) (574) (2,509)
Amortization of transition obligation 14,796 17,144 19,879
Other - net 561 (678) 1,404
-------- -------- --------
Postretirement benefit cost $ 61,655 $ 66,101 $ 72,077
======== ======== ========
</TABLE>
The following table sets forth the plans' funded status and the accrued
postretirement benefit obligations as of December 31:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(Thousands of Dollars)
<S> <C> <C>
Accumulated postretirement benefit obligations attributable to:
Retirees $ 480,739 $ 414,580
Fully eligible active plan participants 17,480 15,290
Other active plan participants 168,411 173,329
--------- ---------
Total accumulated postretirement benefit obligations 666,630 603,199
Less: fair value of plan assets 25,744 21,900
--------- ---------
Excess of accumulated obligations over plan assets 640,886 581,299
Unrecognized transition obligation (221,943) (258,146)
Unrecognized net gain (loss) (56,374) 8,455
--------- ---------
Accrued postretirement benefit obligations $ 362,569 $ 331,608
========= =========
</TABLE>
The assumed discount rates used to measure the accumulated postretirement
benefit obligations were 7.25% and 7.5% at December 31, 1997 and 1996,
respectively. The assumed health care cost trend rate was 8.25% in 1997 and
8.75% in 1996 and is assumed to decrease gradually to an ultimate rate of 6.0%
in the year 2004. A one percentage point increase in the assumed health care
cost trend rates for each future year would have increased 1997 costs by
approximately $5 million and the accumulated postretirement benefit obligations
as of December 31, 1997, by approximately $64.7 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
$18 million, $17.9 million and $18.3 million in 1997-1995, respectively.
27
<PAGE> 30
10. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is summarized as follows at December 31:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
(Thousands of Dollars)
<S> <C> <C>
Land $ 30,003 $ 28,506
Buildings 595,888 547,408
Plant and equipment 8,224,712 7,822,174
Other 713,143 784,235
----------- -----------
Total 9,563,746 9,182,323
Accumulated depreciation (6,432,421) (6,243,002)
----------- -----------
Total property, plant and equipment - net $ 3,131,325 $ 2,939,321
=========== ===========
</TABLE>
Depreciation expense in 1997-1995 was equivalent to a composite average
percentage of 5.6%, 5.7% and 6.7%, respectively. During 1997, depreciation was
partially offset by the effects of a reduction in depreciation rates to reflect
higher net salvage values related to certain telephone plant and equipment.
11. REGULATORY AND COMPETITIVE MATTERS
The Company's intrastate business is regulated by the state regulatory
commissions in Illinois, Indiana, Michigan, Ohio, Pennsylvania and Wisconsin.
Interstate operations are subject to regulation by the Federal Communications
Commission (FCC).
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
individual state regulatory orders. Provisioning of intrastate toll services by
the Company is accomplished by either bill-and-keep arrangements or by
participation with other LECs in settlement arrangements. A portion of
intrastate toll compensation is earned through access rates which are billed to
other LECs for completing toll calls.
Illinois
All Primary Toll Carrier (PTC) agreements in Illinois were terminated by July
1996 pursuant to the order issued by the Illinois Commerce Commission (ICC) on
December 20, 1995. Under the PTC plan, each PTC was responsible for filing toll
rates and developing and administering compensation with other LECs. Each of the
other LECs were compensated through access charges relating to their involvement
in carrying, handling, and billing the calls. With PTC termination, each LEC is
responsible for providing intraMarket Service Area (MSA) toll to its end users.
In July 1996, after the termination of all PTC agreements, Illinois converted to
an Originating Responsibility Plan (ORP). Under an ORP, the Company keeps the
revenues from originating intraLATA toll calls, records them as toll revenues
and remits access charges to other LECs for calls terminating outside the
Company's service territories. The Company also receives access revenues for
intraLATA toll calls that are terminated by the Company. On an overall basis,
the ORP plan is intended to be income neutral, as decreases in access revenues
are offset by increases in toll revenues and corresponding increases in access
charge expenses.
On October 3, 1995, the ICC also issued an order requiring Line Side
Interconnection (unbundling) to be effective November 1, 1995. LECs are required
to unbundle local access lines into loops, ports and loop subelements and offer
them as separate services within 180 days of a bona fide request. Line side
interconnection is a term which
28
<PAGE> 31
describes the ability of a competitor or customer to interconnect its facilities
with the portion of the LEC network which extends from the central office to the
customer's premises.
On October 6, 1996, the ICC initiated its investigation into the Company's total
element long run incremental cost (TELRIC) studies and to establish rates for
interconnection, unbundled network elements (UNEs) and transport and termination
of traffic. The docket will address wholesale rates separately from UNEs, with
each issue having a separate procedural schedule. The determination of wholesale
rates is expected to conclude within the first nine months of 1998. The filing
for UNEs took place during the first quarter of 1998. Hearings are tentatively
scheduled to take place during the second quarter of 1998.
As of November 1, 1996, the Company converted all capable offices in Illinois to
1+ presubscription.
On December 3, 1996, the ICC issued its decision in the Company's arbitration
with AT&T Corp. (AT&T) to determine interconnection, resale, and unbundling
terms and conditions. Interim discount rates for the Company's resold services
were set equal to Ameritech's average rate of 20.07%. Where the Company does not
have services similar to Ameritech's, a default discount of 17.5% is to be used.
The Company's cost studies are to be used in the interim until permanent
discounts are established in a separate generic cost proceeding. The Company has
filed a lawsuit in the U.S. District Court challenging portions of the ICC's
arbitration determinations. AT&T withdrew its arbitration agreement with the
Company from the ICC's consideration, causing the time period for an ICC
decision to expire. Negotiations would have to run their course before another
request for arbitration can be submitted to the ICC. The Company remains in
negotiations with AT&T.
Indiana
On September 7, 1995, AT&T, LCI International, Inc., Sprint Corporation (Sprint)
and WorldCom, Inc. filed a petition requesting the Indiana Utility Regulatory
Commission (IURC) to require LECs to allow 1+ and 0+ intraLATA presubscription
in the state of Indiana. On November 26, 1996, the IURC ordered all LECs to
allow 1+ presubscription. As of May 1997, the Company had converted all capable
offices in Indiana to 1+ presubscription.
On December 12, 1996, the IURC issued its order in the arbitration proceeding
between the Company and AT&T Communications of Indiana, Inc. The IURC ordered
interim proxy rates for interconnection and UNEs using rates established in the
AT&T-Ameritech Indiana Interconnection Agreement plus 20%. The wholesale
discount rate was set at 17%. A separate cost investigation has been established
to review the Company's costs for establishing permanent interconnection rates.
On July 1, 1996, the IURC issued an interim order in its investigation relating
to local telephone exchange competition which addressed the resale of bundled
local services. The order required that existing LECs file wholesale tariffs for
all of their retail local-exchange services, with certain exceptions, reflecting
the applicable discounts for avoided costs. Requests for reconsideration or
clarification were received by several parties. The Company filed a Petition for
Rehearing, Reconsideration and Clarification stating that, among other items,
the filing of wholesale tariffs was in conflict with the negotiation process
permitted by the Telecommunications Act of 1996 (the Telecommunications Act).
The IURC issued its Order on Reconsideration and Resale Issues on December 18,
1996 addressing services available for discount and the applicable wholesale
discount. The IURC ruled that, on an interim basis and subject to true-up,
the 17% discount ordered in the Company's arbitration agreement with AT&T would
apply on a statewide basis. In February 1998, the IURC opened an investigation
of the Company's wholesale discount rate and the services available for
discount.
On March 26, 1997, the IURC opened an investigation into access charge reform
and universal service. This docket was established in anticipation of the FCC
decisions on the same issues. A final resolution is expected during the third
quarter of 1998.
On May 23, 1997, the Company filed its cost studies and supporting testimony for
UNEs with the IURC. Hearings were held in December 1997. A final order is
expected during the third quarter of 1998.
29
<PAGE> 32
Michigan
On June 9, 1995, the Company filed an application with the Michigan Public
Service Commission (MPSC) to increase basic local service rates by approximately
$18.1 million annually to offset planned reductions in intraLATA toll rates and
the implementation of new optional toll calling plans. On October 25, 1995, the
MPSC issued an order approving a settlement agreement, signed by all parties, to
increase basic local service rates by $12.9 million annually, effective November
24, 1995. In addition, the Company implemented reduced intraLATA toll rates,
including the impacts of new optional calling plans, totaling $12.9 million
annually.
LECs have been under price cap regulation in the state of Michigan since January
1, 1992, concurrent with the passage of Public Act 179. On November 30, 1995,
Public Act 216, a second generation regulatory reform law, became law in
Michigan replacing Public Act 179. While price caps are maintained, Public Act
216 allows for the rebalancing of local service rates based on the existing
variations in cost and the expansion of local competition by requiring tariffs
for unbundled service and local interconnection.
In Michigan, pursuant to Public Act 216, the Company eliminated an interLATA
carrier common line (CCL) surcharge retroactive to December 1, 1995, resulting
in an access revenue reduction of $5.2 million. On January 15, 1996, an end-user
charge was implemented to generate local revenue of $5.2 million in order to
compensate the Company for CCL surcharge revenues lost.
The Company provided intraLATA 1+ presubscription dialing parity in all capable
switches in Michigan by June 30, 1996 as mandated by the MPSC in order to comply
with Public Act 216.
On December 12, 1996 and January 15, 1997, the MPSC issued its decision in the
Company's arbitrations with AT&T and Sprint, respectively, to determine
interconnection, resale and unbundling terms and conditions. The interim
discount rate for the Company's resold services was set at 25%. The Company
filed lawsuits in the U.S. District Court challenging portions of the MPSC's
arbitration determinations. On May 30, 1997, the U.S. District Court dismissed
both cases.
In December 1997, the MPSC issued its decision in the Company's arbitration with
BRE Communications. This decision reaffirmed the interim discount rate of 25%
issued in the previous arbitration proceedings with AT&T and Sprint. The Company
filed objections to the MPSC's decision on December 30, 1997. The MPSC issued
its final order during the first quarter of 1998, which was superseded by its
decision in the proceedings related to the pricing of UNEs, interconnection
services and resold services, as discussed below.
On December 12, 1996, the MPSC issued an order initiating proceedings related to
applications filed by the Company and by Ameritech which address pricing and
costs of UNEs, interconnection services and resold services. The MPSC issued
its final order on February 25, 1998. The discount rate on resold services was
set at 16.76% including operator services and 15.8% without operator services.
The Company disagrees with the MPSC's final order, since it contains prices,
terms and conditions which are in conflict with the Eighth Circuit Court's
ruling. The Company filed motions for rehearing and stay with the MPSC. The
Company is evaluating its options to challenge the MPSC's decision.
Effective March 19, 1997, the Company increased the intrastate end-user charge
by $18.4 million annually, and effective April 1, 1997, the Company reduced
intraLATA toll rates by $6 million annually.
Ohio
On March 1, 1995, the Company filed a package of proposed access, toll and local
rate reductions with the Public Utilities Commission of Ohio (PUCO) in the
amount of $22 million on an annual basis. The Company's proposal also included a
commitment to eliminate multi-party services by 1998 and to install digital
switches in all exchanges by 1999. On April 13, 1995, the PUCO approved the
Company's proposal in its entirety.
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<PAGE> 33
On June 29, 1995, the Governor of Ohio signed the State of Ohio Biennium
Budget. This budget contains a provision which reduced the telecommunications
utility property tax assessment rate from 88% to 25% on all new investments
beginning with 1994 vintage, resulting in a $3.7 million decrease in property
taxes during 1995.
On October 9, 1996, the Company filed to reduce its intrastate terminating
Carrier Common Line Charge (CCLC) by $10 million, effective November 15, 1996.
On November 19, 1996, the Company filed to reduce the intrastate CCLC an
additional $6 million, effective January 1, 1997, and an additional $6 million
on July 1, 1997.
On December 24, 1996, the PUCO issued its decision in the Company's arbitration
with AT&T to determine interconnection, resale and unbundling terms and
conditions. The interim discount rate for the Company's resold services was set
at 12.16%. The Company filed a lawsuit in the U.S. District Court challenging
portions of the PUCO's arbitration determinations. The U.S. District Court
dismissed the case on May 12, 1997. On October 2, 1997, the PUCO directed the
Company and AT&T to file a composite agreement by October 17, 1997. The Company
and AT&T jointly requested extensions which expired on February 27, 1998.
On January 30, 1997, the PUCO issued its decision in the Company's arbitration
with Sprint on many of the same issues that were submitted by AT&T. These
decisions reaffirmed the interim discount rate of 12.16% issued in the previous
arbitration proceedings. The Company has filed a lawsuit in the U.S. District
Court challenging portions of the PUCO's arbitration determinations. The U.S.
District Court dismissed the case on January 14, 1998, in response to a motion
filed by Sprint.
Pennsylvania
On December 6, 1996, the Pennsylvania Public Utility Commission (PPUC) issued
its decision in the Company's arbitration with AT&T to determine
interconnection, resale and unbundling terms and conditions. The interim
discount rate for the Company's resold services was set at 22.8%. The Company
filed a lawsuit in the U.S. District Court challenging portions of the PPUC's
arbitration determinations. The U.S. District Court dismissed the case on August
19, 1997, in response to motions filed by the PPUC and AT&T.
On December 19, 1996, the PPUC issued its decision in the Company's arbitration
with Sprint on many of the same issues that were submitted by AT&T. These
decisions reaffirmed the interim discount rate of 22.8% issued in the previous
arbitration proceedings. The Company filed a lawsuit in the U.S. District Court
challenging portions of the PPUC's arbitration determinations. The U.S. District
Court dismissed the case on August 19, 1997, in response to a motion filed by
Sprint.
On December 12, 1996, the PPUC's Administrative Law Judge (ALJ) established a
schedule for addressing the 22.8% interim wholesale discount rate set during
arbitration through the examination of the parties' avoided cost studies. On
September 3, 1997, the ALJ recommended the wholesale discount rate of 18.98%.
All parties filed exceptions to this ruling. On March 10, 1998, the PPUC issued
an order which remanded the docket back to the ALJ for examination of more
current avoided costs studies from the parties.
On January 17, 1997, the PPUC entered an order directing the Company to file
revised cost studies to establish permanent rates for UNEs. The Company filed
the required cost studies and revisions on August 29, 1997 and October 2, 1997,
respectively. A revised non-recurring charge cost study was filed on March 9,
1998. Hearings are scheduled to begin in May 1998.
On January 28, 1997, the PPUC issued its Universal Service Order which
prescribed initial levels of basic universal service rates and cost study
methodology. On July 31, 1997, the PPUC issued an order in response to the
petitions for reconsideration of its Universal Service Order. The PPUC has
ordered that the record be reopened and that technical workshops be conducted on
the record to select a final basic universal service model. Technical workshops
and hearings were held during October 1997. A decision from the ALJ is expected
in the near future pending the outcome of a petition filed by Bell Atlantic and
other LECs.
31
<PAGE> 34
On February 13, 1997, the PPUC initiated a generic investigation into Intrastate
Access Charge Reform. The investigation's focus was on cost standards,
coordinating with local interconnection rulings and agreements, and rate making
standards. Hearings were conducted in September 1997. An order is expected in
the near future pending the outcome of a petition filed by Bell Atlantic and
other LECs.
Wisconsin
In January 1995, the Company elected to operate under price cap regulation in
Wisconsin. On March 15, 1996, the Company filed the results of its first year
under price regulation (1995). The Public Service Commission of Wisconsin (PSCW)
authorized a price increase of 0.63% in intraLATA toll rates based on the
established price cap formula and the Company's results of service quality and
infrastructure investment levels. No price increase was implemented due to
competitive market conditions. On April 30, 1997, the Company filed its second
year results (1996) under price cap regulation. On May 27, 1997, the PSCW issued
a letter order authorizing a 0.63% price increase in intraLATA toll rates.
Again, due to the competitive market conditions, the Company deferred the
opportunity to implement the price increase.
On January 24, 1997, the PSCW issued a Notice of Investigation to review the
degree to which the Company has met its infrastructure commitments during the
first two years under price cap regulation. In the original plan filed with the
PSCW, the Company stated that it would make capital investments within the range
of $235-$290 million over a six year period (1995-2000). The actual amount spent
will depend on the demand for new services such as Frame Relay, Integrated
Services Digital Network (ISDN) and Video Broadband services. The plan also
stated that the Company would provide schools and public libraries with credits
towards the purchase of GTE-provided enhanced services. On May 27, 1997, the
PSCW approved, as a result of the review, the Company's plan for incremental
investment in outside plant and high-speed data transmission services and
discounted rates for schools and public libraries.
On July 17, 1997, the PSCW ordered that intraLATA toll be removed from price cap
regulation. IntraLATA toll rates will no longer be subject to changes based upon
a formula related to the Gross Domestic Price Index.
In September 1996, the Company converted all capable offices in Wisconsin to 1+
presubscription pursuant to the PSCW's order issued July 29, 1996.
On December 12, 1996, the PSCW issued its decision in the Company's arbitration
with AT&T to determine interconnection, resale and unbundling terms and
conditions. The discount rate for resale was set at 18.45%. The Company has
filed a lawsuit in the U.S. District Court challenging portions of the PSCW's
arbitration determinations. In September 1997, the PSCW re-opened the
arbitration proceeding. The Company remains in negotiations with AT&T. Once
another request for interconnection is received, the Company will file new cost
studies which will be used to revise the discount rate for resold services.
INTERSTATE SERVICES
Much of the regulatory and legislative activity that occurred in the United
States in 1997 was a direct result of the Telecommunications Act adopted by
Congress. The Telecommunications Act is intended to promote competition in all
sectors of the telecommunications marketplace while preserving and advancing
universal telephone service.
In July 1997, the U.S. Court of Appeals from the Eighth Circuit (Eighth Circuit)
released its decision on the challenge filed in 1996 by the Company's parent,
GTE, and numerous other parties to rules developed by the FCC to implement the
interconnection provisions of the Telecommunications Act. The Telecommunications
Act required LECs to make their retail services and the underlying network
elements available to competitors. The FCC required that prices for both resold
services and network elements be set using a methodology created by the FCC. The
court challenge asserted that the FCC's rules were inconsistent with the
Telecommunications Act. The July 1997 court decision found that the FCC
overstepped its authority in a number of areas and upheld GTE's position that
state regulatory agencies bear the primary responsibility for determining the
prices which competing firms must pay
32
<PAGE> 35
when interconnecting their networks. On January 26, 1998, the U.S. Supreme Court
announced that it would review this decision. Oral argument in the Supreme Court
is expected to take place in October 1998, with a final decision likely to be
issued no later than June 1999.
In May 1997, the FCC released two new major decisions related to implementation
of the Telecommunications Act's provisions - the universal service and access
charge reform orders. The universal service order established the support
mechanisms to ensure continued availability of affordable local telephone
service and created new programs to provide discounted telecommunications
services to schools, libraries and rural health care providers. GTE and numerous
other parties have challenged the FCC's decision before the U.S. Court of
Appeals for the Fifth Circuit on the grounds that the FCC did not follow the
requirements of the Telecommunications Act to develop a sufficient, explicit and
competitively neutral universal service program. A decision is expected in 1998.
The FCC access charge reform order, also released in May 1997, revamped the rate
structure through which local and long distance companies charge customers for
using the local phone network to make long distance calls. The FCC ordered
decreases for long distance companies to be accomplished by increasing the
access charges for business and residential customers with more than one phone
line. GTE and numerous other parties also challenged this decision before the
Eighth Circuit based on the belief that the FCC did not eliminate the universal
service subsidies hidden within interstate access charges as directed by the
Telecommunications Act, and that the FCC created additional subsidy charges paid
only by business and multi-line residential customers. Oral argument has been
held and a decision is expected in 1998.
Also in May 1997, the FCC released a decision completing a periodic review of
its price cap regulatory oversight of interstate access charges. GTE and
numerous other LECs have challenged this decision before the Eighth Circuit
based on the belief that the FCC established a fundamentally unfair annual price
reduction formula and required retroactive price reductions. Oral argument has
been held and a decision on this challenge is also expected in 1998.
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 the May 1997 order on its price cap triennial review, the FCC revised the
price cap plan for LECs by adopting a uniform productivity factor of 6.0% with
an additive consumer productivity dividend of 0.5%. The FCC also eliminated the
sharing requirements of the price cap rules.
The Company filed interstate access revisions during 1997 that became effective
June 3, 1997 and July 1, 1997. Overall, these filings resulted in a net annual
price increase of $4.8 million. On December 1, 1997, the FCC issued an order to
file revised access rates effective January 1, 1998, which resulted in
interstate access charge reductions of approximately $6 million. In 1997, the
FCC also ordered significant changes that altered the structure of access
charges collected by the Company, effective January 1, 1998. Generally, the FCC
reduced and restructured the per minute charges paid by long distance carriers
and implemented new per line charges. The FCC also created an access charge
structure that resulted in different access charges for residential primary and
secondary lines and single line and multi-line business lines. In aggregate, new
per line charges and charges paid by end-users of $24.1 million exceed the
reductions in usage sensitive access charges of $14.6 million paid by long
distance carriers.
On June 4, 1996, the FCC issued its first Report and Order implementing Section
276 of the Telecommunications Act. As part of the overall goal of promoting
competition among payphone service providers (PSPs), this order mandated
compensation to all PSPs for all calls originating from payphones, including
"dial-around" access calls and toll-free subscriber calls for which PSPs were
not previously compensated. This compensation was to occur in two separate
phases. During phase one, from April 15, 1997 through October 6, 1997, PSPs were
to be paid a monthly, flat-rate compensation from interexchange carriers (IXCs).
During phase two, beginning October 7, 1997, PSPs were to be compensated on a
per-call basis, with the prevailing local coin rate of 35 cents established as
the default rate.
33
<PAGE> 36
On July 19, 1997, the U.S. Court of Appeals in Washington, D.C. vacated the
FCC's directive concerning per-call compensation, stating that the FCC had not
shown that the 35 cent rate was a reasonable surrogate for fair compensation.
The court also set aside the FCC's flat-rate compensation mandate. Subsequently,
on October 9, 1997, the FCC issued a second Report and Order to address some of
the issues vacated by the court. In this second order, the FCC established a new
per-call rate of 28.4 cents for phase two compensation that all PSPs were
eligible to receive beginning October 9, 1997. The FCC tentatively concluded
that this per-call rate should also be used to calculate phase one compensation.
The Company has recorded approximately $10.3 million of payphone revenues
associated with the October 9, 1997 FCC order. It is likely that the phase one
compensation directive will be revisited in a subsequent order.
SIGNIFICANT CUSTOMER
Revenues received from AT&T include amounts for access and billing and
collection during the years 1997-1995 under various arrangements and amounted to
$383.5 million, $375.3 million and $407.5 million, respectively.
12. COMMITMENTS AND CONTINGENCIES
The Company has noncancelable leases covering certain land, buildings, office
space and equipment that contain varying renewal options. The majority of lease
commitments relate to the lease for the centralized GTE Telephone Operations
general facilities entered into in 1991. The lease agreement requires rental
payments over 30 years (beginning in 1992) sufficient to pay scheduled principal
and interest payments for $210 million of Telephone Facility Lease Bonds issued
by the lessor. The lease expense is shared by the GTE domestic telephone
operating subsidiaries.
Rental expense was $29.9 million, $25.4 million and $27.6 million in 1997-1995,
respectively. Minimum rental commitments for noncancelable leases through 2002
do not exceed $37.5 million annually and aggregate $487.7 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 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 supports greater competition in telecommunications, provided that,
overall, the actions to eliminate existing legal and regulatory barriers allow
an opportunity for all service providers to participate equally in a competitive
marketplace under comparable conditions.
13. SUBSEQUENT EVENT (UNAUDITED)
On February 3, 1998, the Company issued $200 million of 6.375%, Series F
debentures, due 2010, and $200 million of 6.73%, Series G debentures, due 2028.
The net proceeds from the offerings and sales of these new debentures will be
applied toward the repayment of short-term borrowings incurred in connection
with the redemption of long-term debt and preferred stock in May 1997 prior to
stated maturity (see Note 6) and for the purpose of financing the Company's
construction program. The net proceeds will also be used for general corporate
purposes.
During 1997, the Company entered into forward contracts to sell $200 million of
U.S. Treasury Bonds in order to hedge against future changes in market interest
rates related to the debt the Company had called and subsequently refinanced on
February 3, 1998 (discussed above). A loss of approximately $22 million occurred
upon settlement of the forward contracts and will be amortized over the life of
the associated refinanced debt.
34
<PAGE> 37
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
GTE North Incorporated:
We have audited the accompanying consolidated balance sheets of GTE North
Incorporated (a Wisconsin corporation and wholly-owned subsidiary of GTE
Corporation) and subsidiary as of December 31, 1997 and 1996, and the related
consolidated statements of income, shareholders' equity and cash flows for each
of the three years in the period ended December 31, 1997 as set forth on pages
14 through 17 and Schedule II of this report. 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 North Incorporated and
subsidiary as of December 31, 1997 and 1996, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1997, in conformity with generally accepted accounting principles.
As discussed in Note 2 of 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 audits were 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 audits 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.
Dallas, Texas ARTHUR ANDERSEN LLP
January 26, 1998
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<PAGE> 38
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.
JOHN C. APPEL
President
GERALD K. DINSMORE
Senior Vice President - Finance and Planning
36
<PAGE> 39
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
37
<PAGE> 40
PART III
Item 10. Directors and Executive Officers of the Registrant
a. Identification of Directors
The names, ages and positions of the directors of the Company as of March 2,
1998 are listed below along with their business experience during the past five
years.
<TABLE>
<CAPTION>
Name Age Director Since Business Experience
- ---------------------- --- -------------- ----------------------------------------------------------
<S> <C> <C> <C>
John C. Appel 49 1996 President, GTE Network Services, 1997; Executive Vice
President - Network Operations, GTE Telephone
Operations, 1996; Executive Vice President - Network
Operations, all GTE domestic telephone subsidiaries of
which he is not President, 1996; Director, all GTE
domestic telephone subsidiaries, 1996; President, GTE
South Incorporated and GTE North Incorporated, 1995;
Senior Vice President - Regulatory Operations, GTE
Telephone Operations, 1994; President, GTE Southwest
Incorporated, 1994; State President - Texas/New Mexico,
1993.
Mateland L. Keith, Jr. 55 1997 Senior Vice President - Regional Operations, GTE
Network Services, 1997; President, GTE California
Incorporated, 1995; Assistant Vice President -
Engineering, GTE Telephone Operations, 1995; Area Vice
President - Sales, GTE North Incorporated, 1993.
Lawrence R. Whitman 46 1997 Vice President - Finance and Planning, Business
Development and Integration, 1997; Controller, GTE
Corporation, 1995; Vice President - Finance, TP&S, 1993.
</TABLE>
Directors are elected annually. There are no family relationships between any of
the directors or executive officers of the Company.
38
<PAGE> 41
b. Identification of Executive Officers
The Company's policies are established not only by the Company's executive
officers, but also by the executive officers of GTE Network Services.
Accordingly, the list below contains the names, ages and positions of the
executive officers of both the Company and GTE Network Services as of March 2,
1998.
<TABLE>
<CAPTION>
Year Assumed
Present Position
-----------------------
Network the
Name Age Services Company Position
- --------------------------- --- -------- ------ --------------------------------------------
<S> <C> <C> <C> <C>
John C. Appel (1) 49 1997 1995 President of GTE Network Services and the
Company
Mary Beth Bardin 43 -- 1995 Vice President - Public Affairs of the
Company
Gerald K. Dinsmore 48 -- 1993 Senior Vice President - Finance and
Planning of the Company
William M. Edwards, III 49 -- 1993 Vice President - Controller of the Company
William A. Griswold 45 -- 1994 Vice President - Northeast Region of the
Company
Gregory D. Jacobson 46 -- 1994 Treasurer of the Company
Mateland L. Keith, Jr. (2) 55 1997 -- Senior Vice President - Regional Operations
of GTE Network Services
Brad M. Krall 56 1993 1995 Vice President - Centralized Operations of
GTE Network Services and the Company
Robert G. McCoy (3) 53 1997 1997 President - Retail Markets of GTE Network
Services and Vice President - Retail
Markets of the Company
William G. Mundy (4) 48 1997 1998 Vice President and General Counsel of GTE
Network Services and the Company
Barry W. Paulson 46 1996 1996 Vice President - Network Operations
Planning and Support of GTE Network
Services and the Company
Richard L. Schaulin 55 1989 1995 Vice President - Human Resources of GTE
Network Services and the Company
Charles J. Somes 51 -- 1994 Secretary of the Company
Larry J. Sparrow (5) 54 1997 -- President - Wholesale Markets of GTE
Network Services
-- 1995 Vice President - Carrier Markets of the
Company
Edward J. Weise (6) 53 -- 1997 Vice President - North Region of the Company
</TABLE>
(1) John C. Appel was appointed President of GTE Network Services in June 1997
replacing Thomas W. White, who was appointed Senior Executive Vice
President - Market Operations of GTE Service Corporation.
(2) Mateland L. Keith, Jr. was appointed Senior Vice President - Regional
Operations of GTE Network Services in June 1997, replacing John C. Appel.
(3) Robert G. McCoy was appointed President - Retail Markets of GTE Network
Services and elected Vice President - Retail Markets of the Company in
October 1997 replacing C.F. Bercher, who was appointed and elected
President of GTE Communications Corporation.
(4) William G. Mundy was appointed Vice President and General Counsel of GTE
Network Services in October 1997 and elected Vice President - General
Counsel of the Company in January 1998. Mr. Mundy replaced Richard M.
Cahill, who was appointed Vice President and Associate General Counsel of
GTE Service Corporation.
(5) Larry J. Sparrow was appointed President - Wholesale Markets of GTE Network
Services in June 1997.
(6) Edward J. Weise was appointed Vice President - North Region of the Company
in July 1997 replacing William A. Zielke.
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.
39
<PAGE> 42
Item 11. Executive Compensation
Executive Compensation Tables
The following tables provide information about executive compensation.
SUMMARY COMPENSATION TABLE
The following table sets forth information about the compensation of the
individual who served as Principal Executive Officer of the Company in 1997,
each of the other four most highly compensated executive officers of the Company
(other than the Chief Executive Officer) who served as such and were compensated
by the Company or GTE Network Services at the end of 1997 and the two additional
individuals who served as executive officers of the Company or GTE Network
Services in 1997 but did not serve as such or were not being compensated by the
Company or GTE Network Services at the end of 1997 (collectively, the Named
Executive Officers). The information in this table under the caption "Annual
Compensation" sets forth all compensation paid to the Named Executive Officers
by the Company and GTE Network Services. The caption "Long-Term Compensation"
sets forth all long-term compensation paid to the Named Executive Officers under
employee benefit plans administered by GTE Corporation or GTE Service
Corporation. Footnote 1 to this table sets forth the actual 1997 annual
compensation for each of the Named Executive Officers that was allocated to the
Company.
<TABLE>
<CAPTION>
Long-Term Compensation
------------------------------------------------
Annual Compensation (2) Awards Payouts
--------------------------------- ------------------------ ---------------------
Restricted Securities
Other Annual Stock Underlying LTIP All Other
Name and Principal Salary Bonus Compensation Awards Options/ Payouts Compensation
Position in Group (1) Year ($) (3) ($) (4) ($) ($) (5) SARs (#) ($) ($) (6)
- ---------------------------- ---- ------- ------- ------------- ---------- ---------- ------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
John C. Appel 1997 348,365 399,386 -- 59,881 76,000 548,700 11,320
President 1996 295,977 380,700 -- 51,229 124,400 439,200 10,572
1995 239,600 258,100 -- -- 63,500 162,800 10,194
Larry J. Sparrow 1997 315,565 256,400 -- 39,481 40,700 375,300 11,320
President - 1996 294,812 260,800 -- 41,561 81,400 404,100 10,613
Wholesale Markets 1995 261,866 255,600 -- -- 36,400 211,300 10,613
GTE Network Services
Mateland L. Keith, Jr 1997 250,413 157,100 -- 16,025 32,700 163,400 10,376
Senior Vice President - 1996 217,762 117,300 -- 5,118 15,200 87,600 9,799
Regional Operations 1995 204,308 104,000 -- -- 12,500 -- 9,111
GTE Network Services
Barry W. Paulson 1997 197,538 141,900 -- 14,706 19,900 93,400 7,200
Vice President - 1996 191,945 112,800 -- 9,231 19,900 34,900 6,750
Network Operations 1995 156,027 73,100 -- -- 6,500 -- 6,750
Planning and Support
GTE Network Services
Brad M. Krall 1997 205,608 107,200 -- 15,956 15,200 148,100 9,252
Vice President - 1996 200,205 113,900 -- -- 15,200 159,600 8,840
Centralized Operations 1995 184,336 106,000 -- -- 12,500 75,600 7,945
GTE Network Services
Thomas W. White (7) 1997 470,776 520,646 -- 84,756 91,700 822,400 11,320
Senior Executive 1996 463,115 533,700 -- 81,511 183,400 770,000 10,613
Vice President - 1995 418,884 443,800 -- -- 98,800 331,800 10,613
Market Operations
GTE Service Corporation
Gerald K. Dinsmore (8) 1997 302,532 314,807 -- 45,906 62,200 411,800 11,320
Senior Vice President - 1996 288,619 263,700 -- 41,751 81,400 404,100 10,613
Finance and Planning 1995 265,125 255,600 -- -- 36,400 211,300 10,613
</TABLE>
40
<PAGE> 43
(1) All persons named in the table are officers of the Company except as
otherwise noted.
(2) Annual Compensation represents the total annual cash compensation of
salaries, bonuses and other compensation. The Company's allocated share for
Messrs. Appel, Sparrow, Keith, Paulson, Krall, White and Dinsmore, for whom
total annual amounts are shown above, is $159,999, $122,892, $32,636,
$72,932, $67,210, $212,325 and $132,352, respectively.
(3) The data in the table includes fees of $7,280, $15,692 and $16,607 received
by Mr. White for serving as director of BC TEL during 1997, 1996, and 1995.
BC TEL, a Canadian company, is an indirectly-owned subsidiary of GTE
Corporation. Mr. White also received BC TEL deferred stock units valued at
$10,695, which amount is included in this column.
(4) The data in this column represents the annual bonus received in 1997 by
each of the Named Executive Officers under the GTE Corporation 1997
Executive Incentive Plan (the EIP) and a similar predecessor plan (the
Executive Incentive Plan). In connection with GTE's Equity Participation
Program (the EPP), a portion of this amount has been deferred into
restricted stock units payable at maturity (generally, a minimum of three
years) in GTE Common Stock (Restricted Stock Units). The number of
Restricted Stock Units received was calculated by dividing the amount of
the annual bonus deferred by the average closing price of GTE Common Stock
on the New York Stock Exchange (NYSE) composite tape for the 20 consecutive
trading days following the release to the public of GTE's financial results
for the fiscal year in which the bonus was earned (the Average Closing
Price). Additional Restricted Stock Units are received on each dividend
payment date based upon the amount of the dividend paid and the closing
price of GTE Common Stock on the composite tape of NYSE issues on the
dividend declaration date.
(5) The data in this column represents the dollar value of the matching
Restricted Stock Units based upon the Average Closing Price. Matching
Restricted Stock Units are received on the basis of one additional
Restricted Stock Unit for every four Restricted Stock Units deferred
through annual bonus deferrals described in footnote 4 above. The matching
Restricted Stock Units were designed as an inducement to encourage full
participation in the EPP and to compensate the executives for their
agreement not to realize the economic value associated with the Restricted
Stock Units representing deferred annual bonus for a minimum of three
years. Additional Restricted Stock Units are received on each dividend
payment date based upon the amount of the dividend paid and the closing
price of GTE Common Stock on the composite tape of NYSE issues on the
dividend declaration date. Messrs. Appel, Sparrow, Keith, Paulson, Krall,
White and Dinsmore hold a total of 11,024, 8,106, 2,025, 2,346, 1,467,
16,568 and 8,716 Restricted Stock Units, respectively, which had a dollar
value of $576,025, $423,517, $105,801, $122,591, $76,641, $865,678 and
$455,397, respectively, based solely upon the closing price of GTE Common
Stock on December 31, 1997.
(6) The column "All Other Compensation" includes, for 1997, Company
contributions to the GTE Savings Plan of $7,200 for each of Messrs. Appel,
Sparrow, Paulson, Krall, White and Dinsmore, and $6,731 for Mr. Keith. This
column also includes Company contributions to the GTE Executive Salary
Deferral Plan of $4,120 for each of Messrs. Appel, Sparrow, White and
Dinsmore, $3,645 for Mr. Keith and $2,052 for Mr. Krall.
(7) Mr. White was elected Senior Executive Vice President - Market Operations
of GTE Service Corporation in June 1997. He served as President of GTE
Telephone Operations from July 1995 until June 1997, and before that as an
Executive Vice President of GTE Telephone Operations from 1991.
(8) Mr. Dinsmore was appointed President, Business Development and Integration
(a separate business unit of GTE) in June 1997. Mr. Dinsmore has served as
Senior Vice President - Finance and Planning of the Company since 1993.
Although Mr. Dinsmore has retained his title with the Company, since June
1997 he has been compensated solely through his new position.
41
<PAGE> 44
OPTION GRANTS IN LAST FISCAL YEAR
The following table shows all grants of options to the Named Executive Officers
of the Company in 1997, whether or not specifically allocated to the Company.
The options were granted under the GTE Corporation 1997 Long-Term Incentive Plan
(the 1997 LTIP) and the GTE Corporation 1991 Long-Term Incentive Plan (the 1991
LTIP). Pursuant to Securities and Exchange Commission rules, the table also
shows the value of the options granted at the end of the option terms (ten
years) if the stock price were to appreciate annually by 5% and 10%,
respectively. There is no assurance that the stock price will appreciate at the
rates shown in the table. The table also indicates that if the stock price does
not appreciate, the potential realizable value of the options granted will be
zero.
<TABLE>
<CAPTION>
Potential Realizable Value at
Assumed Annual Rate of Stock
Price Appreciation for
Individual Grants Option Term
----------------------------------------------------- -------------------------------
Number of Percent of
Securities Total Options Exercise
Underlying Granted to or Base
Options Employees in Price Expiration
Name Granted (1) Fiscal Year ($/SH) Date 0% 5% 10%
- ---------------------- ---------- ------------- ------- ---------- -- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
John C. Appel 62,200 .29% 48.625 02/16/07 -- 1,902,076 4,820,234
13,800 .06% 44.125 06/04/07 -- 382,950 970,470
Larry J. Sparrow 40,700 .19% 48.625 02/16/07 -- 1,244,606 3,154,076
Mateland L. Keith, Jr. 15,200 .07% 48.625 02/16/07 -- 464,816 1,177,935
17,500 .08% 44.125 06/04/07 -- 485,625 1,230,668
Barry W. Paulson 19,900 .09% 48.625 02/16/07 -- 608,542 1,542,165
Brad M. Krall 15,200 .07% 48.625 02/16/07 -- 464,816 1,177,935
Thomas W. White 91,700 .43% 48.625 02/16/07 -- 2,804,186 7,106,358
Gerald K. Dinsmore 40,700 .19% 48.625 02/16/07 -- 1,244,606 3,154,076
21,500 .10% 44.125 06/04/07 -- 596,624 1,511,964
</TABLE>
(1) Each option granted may be exercised with respect to one-third of the
aggregate number of shares subject to the grant each year, commencing one
year after the date of grant. No stock appreciation rights (SARs) were
granted to the Named Executive Officers of the Company in 1997.
42
<PAGE> 45
AGGREGATED OPTION/SAR EXERCISES
IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
The following table provides information as to options and SARs exercised by
each of the Named Executive Officers of the Company during 1997. The table sets
forth the value of options and SARs held by such officers at year-end measured
in terms of the closing price of GTE Corporation (GTE) Common Stock on December
31, 1997.
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options/SARs
Shares Options/SARs at FY-End at FY-End ($)
Acquired Value ---------------------------- -----------------------------
Name On Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable
- --------------------- --------------- ------------ ----------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
John C. Appel 56,567 600,134 -- 200,834 -- 1,539,141
Larry J. Sparrow -- -- 73,566 120,668 1,234,142 924,580
Mateland L. Keith, Jr. 26,533 450,092 5,066 47,001 40,687 338,674
Barry W. Paulson 6,700 117,281 10,966 35,334 130,074 203,344
Brad M. Krall 17,034 249,251 5,066 29,501 40,687 206,064
Thomas W. White 69,300 1,055,056 132,232 277,468 2,094,451 2,158,179
Gerald K. Dinsmore -- -- 35,999 142,168 531,517 1,089,190
</TABLE>
LONG-TERM INCENTIVE PLAN - AWARDS IN LAST FISCAL YEAR
The 1997 LTIP and 1991 LTIP provide for awards to participating employees,
including stock options, SARs, performance bonuses and other stock-based awards.
The stock options awarded under the 1997 LTIP and 1991 LTIP to the Named
Executive Officers in 1997 are shown in the table on page 42.
<TABLE>
<CAPTION>
Estimated Future Payouts
Performance Under Non-Stock Price Based Plans (1)
Number of Or Other Period -----------------------------------------------
Shares, Units Until Maturation Threshold (2) Target (3)
Name Or Other Rights Or Payout (# of Units) (# of Units) Maximum (4)
- ---------------------------- --------------- ---------------- ------------- ------------ -----------
<S> <C> <C> <C> <C>
John C. Appel (5) 7,400 3 Years 2,146 8,254
1,380 30 Months 396 1,524
845 18 Months 235 902
290 6 Months 60 299
Larry J. Sparrow 4,900 3 Years 1,421 5,466
Mateland L. Keith, Jr. (6) 1,900 3 Years 551 2,119
1,720 30 Months 494 1,899
1,055 18 Months 293 1,126
310 6 Months 64 319
Barry W. Paulson 2,400 3 Years 696 2,677
Brad M. Krall 1,900 3 Years 551 2,119
Thomas W. White 10,900 3 Years 3,161 12,158
Gerald K. Dinsmore (7) 4,900 3 Years 1,421 5,466
2,155 30 Months 619 2,379
1,320 18 Months 366 1,409
410 6 Months 84 422
</TABLE>
43
<PAGE> 46
(1) An individual's award may not exceed the applicable individual award limit
(the Award Limit), which is expressed as a percentage of the LTIP Award
Pool. The Award Limit depends on the individual's base salary at the end of
the award cycle, and may not exceed 3.5% of the LTIP Award Pool. The
amounts described in footnotes 2 through 4 below are subject to and cannot
exceed the Award Limit. An individual is initially granted a specified
number of GTE Common Stock equivalent units (Equivalent Units) at the
beginning of an award cycle. During the award cycle, additional Equivalent
Units are added based upon the price of GTE Common Stock and the amount of
the per share dividend paid on each dividend payment date. It is not
possible to predict future dividends and, accordingly, estimated Equivalent
Unit accruals in this table are calculated for illustrative purposes only
and are based upon the dividend rate and price of GTE Common Stock at the
close of business on December 31, 1997. The "Target" award or future payout
is the dollar amount derived by multiplying the Equivalent Unit balance
credited to the participant at the end of the award cycle by the average
closing price of GTE Common Stock, as reported on the composite tape of
NYSE issues, during the last 20 business days of the award cycle. The
Target award measures performance attainment as described in footnote 3.
(2) The Threshold represents attainment of minimum acceptable levels of
performance (the Threshold Levels) with respect to the five Long-Term
Performance Bonus Measures (the Measures) adopted for the 1997-1999
Performance Bonus award cycle -- revenue growth; earnings per share (EPS)
growth; earnings before interest, taxes, depreciation and amortization
(EBITDA) growth; average return on investment (ROI) and relative total
shareholder return (TSR). If the Threshold Level is attained with respect
to each of the Measures, the award will be equal to approximately 25% of
the combined Target award (the TSR Threshold is set at 50%, while the
Threshold for the other four Measures is set at 20%). Because performance
is measured separately for each Measure, it is possible to receive an award
if the Threshold Level is achieved with respect to at least one but not all
of the Measures. If the actual results for all Measures are below the
Threshold Levels, no award will be paid.
(3) The Target represents attainment of levels of three-year revenue growth,
EPS growth, EBITDA growth, ROI and TSR established at the beginning of an
award cycle (the Target Levels). If GTE's actual results for each of the
Measures are equivalent to the Target Levels, this would represent
outstanding performance, and the award will be equal to 100% of the
combined Target award. GTE's performance is measured separately for each
Measure. Accordingly, if the actual result for any Measure is at the
applicable Target Levels, the portion of the award determined by that
Measure will be at 100% of the Target award for that Measure. Similarly,
the portion of the award determined by any Measure performing at less than
the applicable Target Level, but above the Threshold, will be less than the
Target award for that Measure.
(4) This column has intentionally been left blank because it is not possible to
determine the maximum number of Equivalent Units until the award cycle has
been completed. Subject to the Award Limit discussed in footnote 1 above,
the maximum amount of the award is limited by the extent to which GTE's
actual results for the five Measures exceed the Target Levels. If GTE's
actual results during the cycle for the five Measures exceed the respective
Target Levels, additional awards may be paid, based on a linear
interpolation. For example, for revenue growth, the schedule is as follows:
<TABLE>
<CAPTION>
Performance Increment Above
Revenue Performance Target Added Percentage to Combined Awards
- ----------------------------------- -----------------------------------
<S> <C>
Each 0.1% improvement in cumulative
revenue growth +2%
</TABLE>
Thus, if the revenue growth Measure exceeds its Target Level by .5% while
the remaining four Measures are precisely at their respective Target
Levels, then the performance bonus will equal 110% of the combined Target
award.
44
<PAGE> 47
(5) The award of 7,400 units to Mr. Appel represents the grant for the
1997-1999 performance period made while he was Executive Vice President of
GTE Telephone Operations. Pursuant to GTE's compensation policies, the
other grants shown are incremental, prorated awards made when he was
promoted to President of GTE Network Services in June 1997. The incremental
units apply to the 1997-1999, 1996-1998 and 1995-1997 performance periods.
(6) The award of 1,900 units to Mr. Keith represents the grant for the
1997-1999 performance period made while he was President of GTE California
Incorporated, an affiliate of the Company. Pursuant to GTE's compensation
policies, the other grants shown are incremental, prorated awards made when
he was promoted to Senior Vice President - Regional Operations of GTE
Network Services in June 1997. The incremental units apply to the
1997-1999, 1996-1998 and 1995-1997 performance periods.
(7) The award of 4,900 units to Mr. Dinsmore represents the grant for the
1997-1999 performance period made while he was Senior Vice President -
Finance and Planning of the Company. Pursuant to GTE's compensation
policies, the other grants shown are incremental, prorated awards made when
he was promoted to President of Business Development and Integration, a
separate business unit of GTE, in June 1997. The incremental units apply to
the 1997-1999, 1996-1998 and 1995-1997 performance periods.
Executive Agreements
GTE has entered into agreements (the Agreements) with Messrs. Appel, Sparrow,
White and Dinsmore regarding benefits to be paid in the event of a change in
control of GTE (a Change in Control).
A Change in Control is deemed to have occurred if (a) any person or group of
persons acquires, other than from GTE or as described below, 20% (or under
certain circumstances, a lower percentage, not less than 10%) of GTE's voting
power, (b) three or more directors are elected in any twelve-month period
without the approval of a majority of the members of GTE's Incumbent Board (as
defined in the Agreements) then serving as members of the Board, (c) the members
of the Incumbent Board no longer constitute a majority of the Board or (d) GTE's
shareholders approve (i) a merger, consolidation or reorganization involving
GTE, (ii) a complete liquidation or dissolution of GTE or (iii) an agreement for
the sale or other disposition of all or substantially all of the assets of the
Corporation to any person other than a subsidiary of GTE. An individual whose
initial assumption of office occurred pursuant to an agreement to avoid or
settle a proxy or other election contest is not considered a member of the
Incumbent Board. In addition, a director who is elected pursuant to such a
settlement agreement will not be deemed a director who is elected or nominated
by the Incumbent Board for purposes of determining whether a Change in Control
has occurred. Notwithstanding the foregoing, a Change in Control will not occur
in the following situations: (1) certain merger transactions in which there is
at least 50% GTE shareholder continuity in the surviving corporation, at least a
majority of the members of the board of directors of the surviving corporation
consists of members of the Board and no person owns more than 20% (or under
certain circumstances, a lower percentage, not less than 10%) of the voting
power of the surviving corporation following the transaction, and (2)
transactions in which GTE's securities are acquired directly from GTE.
The Agreements provide for benefits to be paid in the event these individuals
separate from service and have a "good reason" for leaving or are terminated
without "cause" within two years after a Change in Control of GTE. Good reason
for leaving includes, but is not limited to, the following events: demotion,
relocation or a reduction in total compensation or benefits, or the new entity's
failure to expressly assume obligations under the Agreements. Termination for
cause includes certain unlawful acts on the part of the executive or a material
violation of his or her responsibilities to the Corporation resulting in
material injury to the Corporation.
An executive who experiences a qualifying separation from service will be
entitled to receive up to two times the sum of (i) base salary and (ii) the
average of his or her percentage awards under the EIP for the previous three
years. The executive will also continue to receive medical and life insurance
coverage for up to two years and will be provided with financial and
outplacement counseling.
45
<PAGE> 48
In addition, each executive covered under an Agreement will be considered to
have not less than 76 points and 15 years of accredited service for the purpose
of determining his or her eligibility for early retirement benefits.
The Agreements provide that there will be no duplication of benefits.
Each of the Agreements remains in effect until July 1, 1999 unless terminated
earlier pursuant to its terms. The Agreements will be automatically renewed on
each successive July 1 unless, not later than December 31 of the preceding year,
one of the parties notifies the other that he or she does not wish to extend his
or her respective Agreement. If a Change in Control occurs, the Agreements will
remain in effect until the obligations of GTE (or its successor) under the
Agreements have been satisfied.
Retirement Programs
Pension Plans
The estimated annual benefits payable, calculated on a single life annuity
basis, under GTE's defined benefit pension plans at normal retirement at age 65,
based upon final average earnings (integrated with social security as described
below) and years of service, is illustrated in the following table:
<TABLE>
<CAPTION>
PENSION PLAN TABLE
Years of Service
Final Average -----------------------------------------------------------------------
Earnings 15 20 25 30 35
- ------------- -----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 200,000 $ 42,182 $ 56,242 $ 70,303 $ 84,363 $ 98,424
300,000 63,932 85,242 106,553 127,863 149,174
400,000 85,682 114,242 142,803 171,363 199,924
500,000 107,432 143,242 179,053 214,863 250,674
600,000 129,182 172,242 215,303 258,363 301,424
700,000 150,932 201,242 251,553 301,863 352,174
800,000 172,682 230,242 287,803 345,363 402,924
900,000 194,432 259,242 324,053 388,863 453,674
1,000,000 216,182 288,242 360,303 432,363 504,424
1,200,000 259,682 346,242 432,803 519,363 605,924
1,500,000 324,932 433,242 541,553 649,863 758,174
2,000,000 433,682 578,242 722,803 867,363 1,011,924
</TABLE>
GTE Service Corporation, a wholly-owned subsidiary of GTE, maintains the GTE
Service Corporation Plan for Employees' Pensions (the Service Corporation Plan),
a noncontributory pension plan for the benefit of all GTE employees who are not
covered by collective bargaining agreements. It provides a benefit based on a
participant's years of service and earnings. Pension benefits to be paid from
the Service Corporation Plan and contributions to the Service Corporation Plan
are related to basic salary and incentive payments exclusive of overtime,
differentials, certain incentive compensation and other similar types of
payments. Under the Service Corporation Plan, pensions are computed on a
two-rate formula basis of 1.15% and 1.45% for each year of service, with the
1.15% service credit being applied to that portion of the average annual salary
for the five highest consecutive years that does not exceed the Social Security
Integration Level (the portion of salary subject to the Federal Social Security
Act), and the 1.45% service credit being applied to that portion of the average
annual salary for the five highest consecutive years that exceeds said level up
to the statutory limit on compensation. As of December 31, 1997, the credited
years of service under the Service Corporation Plan for Messrs. Appel, Sparrow,
Keith, Paulson, Krall, White and Dinsmore are 26, 30, 31, 24, 31, 29 and 22,
respectively.
Under Federal law, an employee's benefits under a qualified pension plan, such
as the Service Corporation Plan, are limited to certain maximum amounts. GTE
maintains the GTE Excess Pension Plan (the Excess Plan), which supplements the
benefits of any participant in the Service Corporation Plan in an amount by
which any participant's benefits under the Service Corporation Plan are limited
by law. In addition, the Supplemental Executive Retirement Plan (SERP) includes
a provision permitting the payment of additional retirement benefits determined
in a similar
46
<PAGE> 49
manner as under the Service Corporation Plan on remuneration accrued under
management incentive plans as determined by the Committee. SERP and Excess Plan
benefits are payable in a lump sum or an annuity.
Executive Retired Life Insurance Plan
The GTE Corporation Executive Retired Life Insurance Plan (ERLIP) provides
Messrs. Appel, Sparrow, Keith, Paulson, White and Dinsmore a postretirement life
insurance benefit of three times final base salary and provides Mr. Krall a
postretirement life insurance benefit of two and one-half times final base
salary. Upon retirement, ERLIP benefits may be paid as life insurance or,
alternatively, an equivalent amount equal to the present value of the life
insurance amount (based on actuarial factors and the interest rate then in
effect), may be paid as a lump sum payment, as an annuity or as installment
payments.
Directors' Compensation
The current directors, all of whom are employees of GTE, are not paid any fees
or remuneration, as such, for service on the Board.
47
<PAGE> 50
Item 12. Security Ownership of Certain Beneficial Owners and Management
(a) Security Ownership of Certain Beneficial Owners as of February 28, 1998:
<TABLE>
<CAPTION>
Name and Address of Shares of
Title of Class Beneficial Owner Beneficial Ownership Percent of Class
- ------------------- ---------------------------- -------------------- ----------------
<S> <C> <C> <C>
Common Stock of GTE GTE Corporation 978,351 100%
North Incorporated One Stamford Forum shares of record
Stamford, Connecticut 06904
</TABLE>
(b) Security Ownership of Management as of December 31, 1997:
<TABLE>
<CAPTION>
Shares Beneficially
Owned as of
Title of Class Name of Director (1) (2) (3) December 31, 1997
- ------------------- --------------------------------------- -------------------
<S> <C> <C>
Common Stock of GTE John C. Appel 48,159
Corporation Mateland L. Keith, Jr. 21,678
Lawrence R. Whitman 15,211
------------------
85,048
==================
Executive Officers (1) (2) (3)
-------------------------------------------------------------
John C. Appel 48,159
Larry J. Sparrow 127,612
Mateland L. Keith, Jr. 21,678
Barry W. Paulson 19,814
Brad M. Krall 25,150
Thomas W. White 228,845
Gerald K. Dinsmore 55,636
------------------
526,894
==================
All directors and executive
officers as a group (1) (2) (3) 756,249
==================
</TABLE>
(1) Includes shares acquired through participation in the GTE Savings Plan.
(2) Included in the number of shares beneficially owned by Messrs. Appel,
Keith, Whitman, Sparrow, Paulson, Krall, White, Dinsmore and all directors
and executive officers as a group, 41,466, 17,366, 10,900, 112,833, 11,800,
19,366, 214,532, 52,833 and 664,394 shares, respectively, which such
persons have the right to acquire within 60 days pursuant to stock options.
(3) No director or executive officer owns as much as one-tenth of one percent
of the total outstanding shares of GTE Common Stock, and all directors and
executive officers as a group own less than one-fifth of one percent of the
total outstanding shares of GTE Common Stock.
(c) There were no changes in control of the Company during 1997.
Item 13. Certain Relationships and Related Transactions
The Company's executive officers or directors were not materially indebted to
the Company or involved in any material transaction in which they had a direct
or indirect material interest. None of the Company's directors were involved in
any business relationships with the Company.
48
<PAGE> 51
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) Financial Statements - See GTE North 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, 1997-1995 (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.
3.1* Articles of Incorporation and amendments are referenced in the
1986 and 1987 Form 10-K's, respectively
3.2* Amended Bylaws (Exhibit 3.2 of the 1995 Form 10-K, File
No. 0-1210)
4.1* Indenture dated as of January 1, 1994 between GTE North
Incorporated and The First National Bank of Chicago, as
Trustee (Exhibit 4.1 of the Company's Registration Statements
on Form S-3, File No. 33-51911)
4.2* First Supplemental Indenture dated as of May 1, 1996 between
GTE North Incorporated and The First National Bank of Chicago,
as Trustee (Exhibit 4.3 of the Company's Report on Form 8-K,
dated May 7, 1996)
10.1* Material Contracts - Agreements between GTE and Certain
Executive Officers (Exhibit 10 of 1995 Form 10-K, File
No. 0-1210)
10.2 Material Contracts - Separation Agreement between GTE and
Richard M. Cahill
12 Statements re: Calculation of the Consolidated Ratio of
Earnings to Fixed Charges
23 Consent of Independent Public Accountants
27 Financial Data Schedule
(b) Reports on Form 8-K
The Company filed a report on Form 8-K, dated December 9, 1997, under
Item 7 "Financial Statements and Exhibits." No financial statements
were filed with this report.
* Denotes exhibits incorporated herein by reference to previous filings with the
Securities and Exchange Commission as designated.
49
<PAGE> 52
GTE North Incorporated and Subsidiary
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
For The Years Ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
(Thousands of Dollars)
- --------------------------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E
- --------------------------------------------------------------------------------------------------------------------
Additions
--------------------------- Deductions
Balance at Charged from
Beginning Charged (Credited) to Reserves Balance at
Description of Year to Income Other Accounts (Note 1) Close of Year
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Allowance for uncollectible accounts
for the years ended:
December 31, 1997 $ 31,248 $ 44,698 $ 48,577(2) $ 94,672 $ 29,851
========== ======== ========= ========= ==========
December 31, 1996 $ 24,059 $ 39,836 $ 47,446(2) $ 80,093 $ 31,248
========== ======== ========= ========= ==========
December 31, 1995 $ 23,241 $ 35,409 $ 52,959(2) $ 87,550 $ 24,059
========== ======== ========= ========= ==========
Accrued restructuring costs for the
years ended:
December 31, 1996 $ 93,501 $ -- $ (46,796)(3) $ 46,705 $ --
========== ======== ========= ========= ==========
December 31, 1995 $ 231,049 $ -- $ -- $ 137,548 $ 93,501
========== ======== ========= ========= ==========
</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 were reclassified to accounts payable and
accrued expenses.
50
<PAGE> 53
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 NORTH INCORPORATED
-----------------------------
(Registrant)
Date March 27, 1998 By /s/ John C. Appel
-------------- -----------------------------
John C. Appel
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.
<TABLE>
<S> <C> <C>
/s/ John C. Appel President and Director March 27, 1998
- --------------------------- (Principal Executive Officer)
John C. Appel
/s/ Gerald K. Dinsmore Senior Vice President - Finance and March 27, 1998
- --------------------------- Planning
Gerald K. Dinsmore (Principal Financial Officer)
/s/ William M. Edwards, III Vice President - Controller March 27, 1998
- --------------------------- (Principal Accounting Officer)
William M. Edwards, III
/s/ Mateland L. Keith, Jr. Director March 27, 1998
- ---------------------------
Mateland L. Keith, Jr.
/s/ Lawrence R. Whitman Director March 27, 1998
- ---------------------------
Lawrence R. Whitman
</TABLE>
51
<PAGE> 54
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
<S> <C>
10.2 Material Contracts - Separation Agreement Between GTE and Richard M. Cahill
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 10-2
[AS AMENDED JANUARY 23, 1998]
December 24, 1997
Mr. Richard M. Cahill
1158 Hidden Ridge
Apartment 2311
Irving, Texas 75038
Dear Dick:
As we discussed, I want to provide you with an appropriate transition
arrangement prior to your scheduled separation and to enter into a consulting
arrangement with you in accordance with the terms set forth below. This
agreement ("Letter Agreement") supersedes any other agreements you may have with
GTE (as defined below) or may have received from GTE with regard to the subject
matter contained herein, including but not limited to the letter dated August
13, 1997. The terms of this Letter Agreement are as follows:
A. RESIGNATION FROM EMPLOYMENT
1. RESIGNATION - Effective July 31, 1997, you irrevocably resign from your
position as Vice President and General Counsel - GTE Telephone Operations.
Effective no later than December 31, 1997, you also irrevocably resign from any
officer, director, or other positions you hold for GTE Corporation or any
affiliate of GTE Corporation (collectively referred to in this Letter Agreement
as "GTE") and from any internal or external Boards where you represent GTE
effective as of that date.
2. SPECIAL ASSIGNMENT - From August 1, 1997 through June 30, 1998 ("Special
Assignment Period"), you will continue on the GTE Service Corporation (the
"Company") payroll as an active employee in your new special assignment as Vice
President and Associate General Counsel, reporting to me or my successor or
designee. During the Special Assignment Period, you will work on special
projects as assigned by me or my successor or designee. In addition, during the
Special Assignment Period, you will continue to receive your base salary as in
effect on July 31, 1997 and will receive all benefits that active employees
receive, except that your EIP and LTIP participation will be governed by the
terms of this Letter Agreement. Except as otherwise expressly provided herein,
all perquisites provided by the Company will cease at the end of the Special
Assignment Period. In the event the Company offers any new employee plans, any
new, enhanced, or supplemental executive plans, or, except as expressly provided
herein, any new grants, awards, or benefits under existing executive plans on or
after July 31, 1997, you will not participate in such plans or receive such
grants, awards, or benefits. You irrevocably resign from employment with GTE and
the position of Vice President and Associate General Counsel effective June 30,
1998. During and after the Special Assignment Period, you will not seek
reinstatement, recall, or future or other employment with GTE.
3. SEPARATION BENEFITS - At the conclusion of the Special Assignment
Period, you will separate from employment with the Company and you will be
eligible for separation benefits pursuant to the Company's Involuntary
Separation Program ("ISEP") or its equivalent as then in effect, subject to any
applicable release requirements.
4. EIP AWARDS - You will participate in the Executive Incentive Plan
("EIP") at a Salary Grade Level 20 for the full 1997 Plan Year and one half
(1/2) of the 1998 Plan Year in accordance
<PAGE> 2
Mr. Richard M. Cahill
December 24, 1997
Page 2
with the terms of the EIP. Your 1997 EIP award and pro-rated 1998 EIP award will
be the same as the average EIP rating for the Company's Legal Department for
each such year. You will not participate in EIP for the 1999 Plan Year or
thereafter. All EIP awards will be subject to approval by the GTE Corporation
Executive Compensation and Organizational Structure Committee ("ECC"). The EIP
awards will be payable at the same time EIP awards are payable to other EIP
participants. You will be eligible to defer, and thus receive a match pursuant
to the Equity Participation Program ("EPP"), only those of your EIP awards
payable while you are still employed by GTE (in this case, only the 1997 Plan
Year award). Note that the ECC reserves the right not to approve EIP awards in
1997 and/or 1998, and, if so, you will be treated in the same manner as other
executives at your salary level.
5. LTIP - Subject to ECC approval, in the spring of 1998, you will be
eligible for a standard grant of Stock Options, and you also will be eligible
for a Performance Bonus Award for the 1998-2000 award cycle under the GTE
Long-Term Incentive Plan ("LTIP"). You will not receive grants of Stock Options
or Performance Bonus Awards under LTIP after the initial spring of 1998 grants.
Your outstanding Stock Options will vest immediately upon your separation at the
end of the Special Assignment Period (subject to applicable release
requirements), and you will have until the earlier of: (i) five years from your
date of separation or (ii) the expiration date of the Option to exercise those
Stock Options ("Special Exercise Period"). The Special Assignment Period will be
counted for prorating your existing Performance Bonus Awards. As such, your
participation in LTIP Performance Bonus Cycles will be as follows: 1995-1997
(Full Participation), 1996-1998 Cycle (30/36 Participation), 1997-99 (18/36
Participation), and 1998-2000 (6/36 Participation). You will not receive any
Performance Bonus Award in 1999 or thereafter. Achievement of targets,
determination of the amount of Performance Bonus Awards, and determination of
the number of shares covered by your grant of Stock Options will be established
in the sole discretion of the ECC. Each Performance Bonus Award will be payable
at the same time LTIP awards are payable to other LTIP participants. You will be
eligible to defer, and thus receive a match pursuant to the EPP, only those of
your LTIP Performance Bonus Awards payable while you are still employed by GTE
(in this case, only the 1995-97 Performance Bonus Award). For purposes of this
Letter Agreement, your 1998 Stock Option and Performance Bonus Award grants are
collectively referred to as "LTIP Grants." Note that the ECC reserves the right
not to make Stock Option or Performance Bonus Awards in 1998, and, if so, you
will be treated in the same manner as other executives at your salary level.
6. RELEASE - In order to receive full Separation Benefits (including but
not limited to full ISEP and the Special Exercise Period described in paragraph
5 above) and the 1998 EIP Award, and in order for your participation in the LTIP
Performance Bonus Award Cycles to be as described in paragraph 5 above, you will
be required to sign a release upon the expiration of the Special Assignment
Period.
7. VACATION - At the end of the Special Assignment Period, you may elect to
take the remainder of your banked/accrued but unused vacation in a lump sum. In
the alternative, you may elect to use your banked/accrued but unused vacation to
extend your last day as an active employee on payroll; provided that any such
extension shall not affect the payment or pro-ration of your EIP and LTIP awards
as set forth in paragraphs 4 and 5 above.
8. MISCELLANEOUS BENEFITS - During the Special Assignment Period, you will
be entitled to the same level of executive perquisites as other similarly
situated executives in Dallas are accorded, and you will also be entitled to
office space at a location to be determined by GTE in its sole discretion. After
the end of the Special Assignment Period, the Company will pay for tax
preparation services for you for the 1998 calendar year, which would be paid in
1999, up to a maximum of $3,000. The benefits
<PAGE> 3
Mr. Richard M. Cahill
December 24, 1997
Page 3
described in this paragraph A.8 are collectively referred to in this Letter
Agreement as miscellaneous benefits ("Miscellaneous Benefits").
9. CIRCUMSTANCES WHEN ABOVE PAYMENTS/BENEFITS WILL NOT BE PAID - In the
event any of the following occur prior to the expiration of the Special
Assignment Period (or if applicable after the expiration of the Special
Assignment Period), you will cease to receive any further salary, the Special
Exercise Period will not apply, you will not receive any EIP Payments, LTIP
Grants, payment of Performance Bonus Awards, Separation Benefits (including but
not limited to ISEP), Miscellaneous Benefits, or any other benefits or payments,
and you will not be required to perform, and will not be paid for, any
consulting services:
o you voluntarily terminate your employment for any reason;
o your employment is terminated for cause as determined by me or my
successor or designee; or
o you violate any of the terms of the attached Separation Agreement and
General Release (including but not limited to the provisions regarding
confidentiality and non-embarrassment) or the non-compete provisions
of paragraphs A.10 and B.7 of this Letter Agreement.
In the event that you die or become disabled (within the meaning of GTE's
Long-Term Disability Plan) during the Special Assignment Period, all further
salary will cease, your eligibility for the Miscellaneous Benefits will cease,
your EIP Payments and Performance Bonus Awards will be pro-rated to the date of
your death or disability (but will not be paid until the date they otherwise
would have been paid had you not died or become disabled), the Special Exercise
Period will not apply, your Separation Benefits (including but not limited to
ISEP) will be treated in accordance with the terms of the relevant plans or
policies, your eligibility for the LTIP Grants will be determined in accordance
with the relevant plan provisions, and you will not be required to perform, and
will not be paid for, any consulting services.
10. MISCELLANEOUS - Since you will remain a GTE employee until the end of
the Special Assignment Period, you will remain subject to all GTE policies,
including but not limited to GTE's policies relating to non-competition and
disclosure of confidential information. You shall be responsible for the payment
of all applicable taxes relating to the benefits described in Paragraph A of
this Letter Agreement, including but not limited to taxes as a result of ISEP or
any ISEP equivalent payment.
B. CONSULTING ARRANGEMENT
1. CONSULTING PERIOD. You will serve as a non-employee consultant for the
period July 1, 1998 through June 30, 2000 (the "Consulting Period"). During the
Consulting Period and thereafter, you will not be entitled to any benefits
provided by GTE to its active employees and, by signing below, you acknowledge
and agree that you shall not be entitled to any such benefits and effectively
waive participation in any such benefits.
2. CONSULTING SERVICES. During the Consulting Period, you will perform
special projects as assigned by me or my successor or designee. All required
services will be performed by you. You will be free at all times to arrange the
time and manner of performance of the consulting services to be rendered
hereunder and will not be expected to maintain or observe a schedule of duties
or assignments. You will not report to the Company on any regular basis, but
will
<PAGE> 4
Mr. Richard M. Cahill
December 24, 1997
Page 4
work as you may independently decide. You will not be required to provide
consulting services to the Company for more than 30% of the regularly scheduled
working days in any calendar year during the term of this Letter Agreement. The
Company is entering into this arrangement with the understanding that the
performance of your services will be subject to the non-compete provisions of
paragraph B.7 below. During the Consulting Period and thereafter, you may, in
your discretion, provide services to others without being constrained by your
obligations under this Letter Agreement, provided only that such services do not
prevent you from providing the consulting services required under this Letter
Agreement, and provided further that such services to others do not cause you to
violate your obligations regarding non-competition, confidentiality, and
intellectual property rights as described in this Letter Agreement and the
attached Separation Agreement and General Release.
3. COMPANY CONTACT. I or my successor or designee will be your contact at
the Company during the Consulting Period and will be responsible for
coordinating your assignments. All services must be performed to my satisfaction
or to the satisfaction of my successor or designee.
4. CONSULTING FEES. You will be paid $164,000 per year for your consulting
services during the Consulting Period, payable in equal quarterly installments
of $41,000 in arrears. You also will be entitled to be reimbursed for reasonable
travel expenses you incur in the performance of consulting services for the
Company as approved by me or my successor or designee. Please submit quarterly
invoices to me or to my successor or designee for payment. You will be paid the
full amount of your annual consulting fees during the Consulting Period whether
or not you actually perform consulting services for the Company.
5. PERFORMANCE OF CONSULTING SERVICES. As a non-employee consultant, the
Company does not retain or exercise the right to direct, control, or supervise
you as to the details and means by which the consulting services contracted for
are accomplished. You and the Company agree that, as a non-employee consultant,
you will serve as an independent contractor in the performance of your duties
under this Letter Agreement. As a result, you will be responsible for payment of
all taxes and expenses incurred arising out of the payments under the Letter
Agreement for your activities as a non-employee consultant in accordance with
this Letter Agreement, including but not limited to, federal and state income
taxes, social security taxes, unemployment insurance taxes, and any other taxes
or business license fees as required. Moreover, you agree that, except as
authorized by the Company, you will not represent directly or indirectly that
you are an agent or legal representative of the Company, nor will you incur any
liabilities or obligations of any kind in the name of or on behalf of the
Company, other than those specifically made or approved as part of this Letter
Agreement.
6. OFFICE SPACE. You are responsible for securing your own office space,
office equipment, and clerical support services during the Consulting Period,
but visiting office space and appropriate office equipment will be provided to
you if you are meeting with individuals at GTE's offices.
7. NON-COMPETE PROVISIONS. As a non-employee consultant, you agree that,
among other policies and guidelines, the GTE Conflict of Interest Guidelines and
the Business and Scientific Information Policy or replacement policies will
apply to you. In addition, you agree not to
<PAGE> 5
Mr. Richard M. Cahill
December 24, 1997
Page 5
engage directly or indirectly in a Competitive Business during the Consulting
Period, unless the Company approves such an arrangement in writing in advance.
For purposes of this paragraph B.7, a "Competitive Business" is any
inter-exchange carrier (such as MCI Communications Corporation, Sprint
Corporation, AT&T Corp., WorldCom, Inc., LCI International, Inc., and Cable &
Wireless PLC) and its Affiliates, any local exchange carrier (such as any
Regional Bell Operating Company ("RBOC") and British Telecommunications PLC) and
its Affiliates, or any of the following companies and their Affiliates: Digex,
Incorporated, Qwest Communications International Inc., Netscape Communications
Corporation, Cisco Systems, Inc., Ascend Communications, Inc., Airtouch
Communications, Inc., NEXTEL Communications, Inc., and Teleport Communications
Group, Inc. An Affiliate for purposes of this paragraph B.7 shall mean any
entity, whether or not incorporated, (i) in which a Competitive Business has
equity ownership of 10% or more, or (ii) which provides goods or services
(including but not limited to software, processing, switching, marketing, or
consulting) to a Competitive Business to materially compete with GTE.
You acknowledge that the obligations imposed on you pursuant to this
paragraph B.7 are reasonable in their nature, scope and duration and will not
deprive you of the opportunity to earn a livelihood. During and after the
Consulting Period, you also will remain subject to those GTE policies which
apply following termination of service.
Subject to paragraph B.8, in consideration of your compliance with the
provisions of this paragraph B.7, the Company will pay to you $25,000 per
quarter payable in arrears, commencing with the quarter beginning July 1998 and
ending with the quarter ending June 2000 (or such later date as the parties may
agree in writing). If you fail to comply with the provisions of this paragraph
B.7, you will forfeit your right to receive the payments described in this
paragraph B.7.
8. EARLY TERMINATION OF CONSULTING SERVICES. In the event any of the
following occurs during the Consulting Period, this Letter Agreement will
terminate immediately, and, except as provided in the immediately succeeding
sentence, you will not be entitled to any further payments under paragraphs B.4
or B.7: you violate any of the provisions of this Letter Agreement or the
Separation and General Release referred to below; you die; you become disabled;
or you fail to provide services under this Letter Agreement to the satisfaction
of the Company. Of course you will be entitled to payment of amounts due
pursuant to paragraphs B.4 and B.7 with respect to that portion of the quarter
prior to the termination of your consulting services in an amount equal to the
payment due for the quarter multiplied by a fraction, the numerator of which is
the number of days in the quarter prior to the termination of your consulting
services and the denominator of which is 90.
C. GENERAL PROVISIONS
1. CONFIDENTIALITY. You agree that any information you receive or acquire
during the performance of your obligations in accordance with this Letter
Agreement or have received or acquired from your prior employment with GTE will
be treated by you in the strictest confidence and will not be disclosed to or
used for the benefit of any persons, firms or organizations. This provision will
survive the termination of this Letter Agreement.
2. GTE AS EXCLUSIVE OWNER OF WORK PRODUCT. You agree that GTE will be the
exclusive owner of all works conceived or first produced by you within the scope
of your prior
<PAGE> 6
Mr. Richard M. Cahill
December 24, 1997
Page 6
employment with GTE or pursuant to or related to this Letter Agreement and your
services as a consultant, including that GTE will be the exclusive owner of all
copyrights and other intellectual property rights in or based upon such works.
With regard to such copyrightable works, you agree that GTE will be the "person
for whom the work is prepared" and that GTE will be the exclusive work-for-hire
author under the copyright laws of the United States. In addition, you agree to
and to hereby assign exclusively to GTE such works, copyrights and other
intellectual property rights. This provision will survive the termination of
this Letter Agreement.
The arrangements described above are contingent upon your executing the
attached Separation Agreement and General Release (the "Release"). As you know,
you were given a version of this Letter Agreement dated October 16, 1997 and,
therefore, you have been given twenty-one days to sign the Release (with a
seven-day period to revoke) as required by law. Although not legally required,
we have determined to give you an additional twenty-one day period commencing as
of December 24, 1997 (with a seven-day period to revoke) to sign the Release.
Since the December 24, 1997 version of this Letter Agreement has been modified
based on requests you have made, you continue to have twenty-one days from
December 24, 1997 to sign the Release (with a seven-day period to revoke). If
you fail to sign the Release or if you sign and revoke the Release within seven
days of signing it, this Letter Agreement shall be void, and you will not
receive any of the benefits described in this Letter Agreement.
Dick, your past contributions to GTE are appreciated by me and the entire
GTE management team.
Sincerely,
William P. Barr
Executive Vice President -
Government and Regulatory Advocacy,
General Counsel
I have read, understand, and agree to the terms of this Letter Agreement
including the attached Separation Agreement and General Release.
- ----------------- -------------------
Richard M. Cahill Date
<PAGE> 7
SEPARATION AGREEMENT AND GENERAL RELEASE
This Agreement is by and between GTE Service Corporation (the "Company")
and Richard M. Cahill ("Cahill").
PART I
In consideration of the provisions in Part II, the Company agrees as
follows:
1. The Company will provide Cahill with the benefits described in William
P. Barr's letter dated December 24, 1997, as amended January 9, 1998 (the
"December 24, 1997 Letter"). (The December 24, 1997 Letter and this Separation
Agreement and General Release are collectively referred to as the "Agreement").
2. By making this Agreement, the Company does not admit that it has done
anything wrong, and the Company specifically states that it has not committed
any tort, breach of contract, or violation of any federal, state, or local
statute or ordinance.
PART II
In consideration of the provisions in Part I, Cahill agrees as follows:
1. Effective July 31, 1997, Cahill irrevocably resigns from his position as
Vice President and General Counsel - GTE Telephone Operations, from any officer,
director, or other positions he holds for GTE Corporation or any of its
affiliates, and from any internal or external Boards where he represents GTE (as
described in paragraph 3 below), at which time Cahill will commence the Special
Assignment described in the December 24, 1997 Letter. Cahill irrevocably resigns
from employment with GTE effective at the end of the Special Assignment Period
described in the December 24, 1997 Letter. Cahill agrees not to seek
reinstatement, recall, or future employment with GTE after the end of the
Special Assignment Period.
Cahill agrees that GTE retains the right to make future organizational changes,
including but not limited to the right to combine, create, and/or fill
positions.
2. Cahill agrees and understands that the payments and the benefits
described in Part I, paragraph 1 above are more than any payments or benefits
due to him under the Company's policies or practices. Cahill waives and forever
discharges GTE (as described in paragraph 3 below) from any liability to provide
any notice of termination, including but not limited to any notice under the
Worker Adjustment and Retraining Notification Act, or to pay any additional
salary continuance, separation pay, severance pay, retention bonus or pay,
retirement incentive, or payments or benefits arising under any other plan,
policy, practice, or program (offered on a qualified or non-qualified or
voluntary or involuntary basis) which may have been payable as a result of the
termination of his employment, except as provided in paragraph 3 below. Cahill
agrees that, should the Company offer any retirement incentive, early
retirement, or voluntary separation program on or after July 31, 1997, Cahill
shall not be eligible to participate. In addition, Cahill has not relied on any
statement, agreement, or promise of eligibility for any benefits, other than
those set forth in this Agreement.
<PAGE> 8
3. Cahill agrees to release GTE Corporation and any related or affiliated
companies, and any and all current and former directors, employees, officers,
agents, and contractors of these companies, and any and all employee pension or
welfare benefit plans of these companies, including current and former trustees
and administrators of these plans, (hereinafter GTE Corporation, the Company,
and the other entities and persons referenced above are collectively referred to
in this Separation Agreement and General Release as "GTE") from all known and
unknown claims, charges, or demands Cahill may have based on his employment with
GTE, including a release of any rights or claims Cahill may have under the Age
Discrimination in Employment Act ("ADEA"), which prohibits age discrimination in
employment; Title VII of the Civil Rights Act of 1964, and the Civil Rights Act
of 1991, which prohibit discrimination in employment based on race, color, sex,
religion, and national origin; the Americans with Disabilities Act, which
prohibits discrimination based upon disability; Section 1981 of the Civil Rights
Act of 1866, which prohibits discrimination based on race; the Employee
Retirement Income Security Act, which governs employee benefits; any state laws
against discrimination; or any other federal, state, or local statute or common
law relating to employment. This includes a release by Cahill of any claims for
wrongful discharge, breach of contract, employment-related torts, or any other
claims in any way related to Cahill's employment with GTE.
This release does not include, however, a waiver of any right to vested benefits
under any pension or savings plan, any right to Worker's Compensation, any right
to receive pay for banked and accrued, but unused, vacation, or any right to
unemployment compensation that Cahill may have.
4. Cahill has not filed and promises not to file, or permit to be filed on
his behalf, any lawsuit or complaint against GTE regarding the claims released
in Part II, paragraph 3 above. Cahill also promises to opt out of and to take
such other steps as he has the power to take to disassociate himself from any
class seeking relief against GTE regarding any claims released in Part II,
paragraph 3. If a court, administrative agency, arbitrator, or any other
decision maker with authority awards Cahill money damages or other relief, with
respect to claims released in Part II, paragraph 3, Cahill hereby assigns to the
Company all rights and interest in such money damages and other relief.
5. Cahill agrees not to disclose the terms of this Agreement, that this
Agreement exists, or that he received any payments from the Company to anyone
except his attorney, his financial planner, or his immediate family (spouse,
children, siblings, parents). If he does disclose the terms of this Agreement to
his immediate family, his financial planner, or his attorney, he will advise
them that they must not disclose the terms of this Agreement.
6. Cahill acknowledges that, during the period he has served as an in-house
attorney with GTE, he has had access to confidential information relating to
GTE. Consistent with the Rules of Professional Conduct, Cahill will not use or
disclose any such confidential information without first obtaining the consent
of the Company.
Cahill agrees to comply with the provisions of GTE H.R. Policy 412 (Attachment
I) provided that, in the event of a conflict between Policy 412 and this
Agreement, the terms of this Agreement shall take precedence. Contemporaneously
with the execution of this Agreement, if Cahill has not executed a copy of the
Business and Scientific Information Agreement, Cahill shall do so (Policy
Attachment A). Upon his termination, Cahill shall execute Policy Attachment D.
Cahill further agrees to take no action that would cause GTE (including its
employees, directors, and shareholders) embarrassment or humiliation or
otherwise cause or contribute to GTE (including its
<PAGE> 9
employees, directors, and shareholders) being held in disrepute by the general
public or GTE's clients, shareholders, customers, federal or state regulatory
agencies, employees, agents, officers, or directors.
Cahill will cooperate and make all reasonable efforts to assist the Company in
any investigation of matters involving GTE. Cahill also agrees to testify as a
witness and be available for interviews and to assist GTE in preparation for any
legal proceedings involving GTE in which Cahill has direct knowledge or specific
expertise. Cahill will be compensated appropriately and reimbursed for
reasonable expenses.
Nothing in this Agreement shall be construed to prevent Cahill from giving
compelled truthful testimony before any federal or state agency or in any
judicial proceeding; provided that, in order to permit GTE to seek an injunction
or other judicial relief, he will timely notify GTE in advance of any such
proceeding in which he expects to be called to testify or for which he has
received a subpoena.
7. Cahill acknowledges and agrees that he has not been discriminated
against in any way during his employment with GTE or with regard to his
separation from employment with the Company.
8. Cahill agrees that GTE will be entitled to recover liquidated damages in
the amount of $75,000 if he breaks his promises in Part II, paragraphs 1-6 of
this Agreement. These liquidated damages are based upon the parties' recognition
that damages to GTE due to Cahill's breaking of these promises are not capable
of measurement with any degree of certainty. The amount specified is not to be
considered a penalty, but solely as liquidated damages. If Cahill breaks his
promise in Part II, paragraph 4 and files a lawsuit or complaint regarding
claims Cahill has released, in addition to the liquidated damages described
above, Cahill will pay for all costs incurred by GTE, including reasonable
attorneys' fees, in defending against his claim.
9. Cahill understands that he has been given 21 days to review and consider
this Agreement before signing it. Cahill further understands that he may use as
much of this 21-day period as he wishes prior to signing this Agreement.
10. Cahill may revoke this Agreement within seven days after he signs it.
If Cahill wishes to revoke this Agreement within this seven-day period, written
notice of revocation should be delivered to the office of Thomas W. Green,
Senior Head of Stamford Transition Team, by the close of business seven days
after Cahill signs the Agreement. This Agreement will not become effective or
enforceable until seven days after Cahill signs it. If Cahill revokes this
Agreement, it will not be effective or enforceable, and he will not receive the
benefits described in Part I, paragraph 1.
11. Cahill agrees that the Company advised Cahill to consult with an
attorney before signing this Agreement.
12. The parties participated jointly in the negotiation of this Agreement,
and each party had the opportunity to obtain the advice of legal counsel and to
review, comment upon, and redraft this Agreement. Accordingly, it is agreed that
no rule of construction shall apply against any party or in favor of any party,
and any uncertainty or ambiguity shall not be interpreted against any one party
and in favor of the other.
13. Cahill and the Company hereby consent that any disputes relating to
this Agreement will be governed by Connecticut law.
<PAGE> 10
14. In the event that any one or more of the provisions contained in this
Agreement shall, for any reason, be held to be invalid, illegal, or
unenforceable in any respect, such invalidity, illegality, or unenforceability
shall not affect any other provision of this Agreement.
15. This Separation Agreement and General Release and the December 24, 1997
Letter constitute the entire Agreement between Cahill and the Company and shall
be binding upon the heirs, successors, and assigns of Cahill and the Company. No
other promises or agreements have been made to Cahill other than those in this
Agreement. Cahill is not relying on any statement, representation, or warranty
that is not contained in this Agreement. Cahill acknowledges that he has read
this Agreement carefully, fully understands the meaning of the terms of this
Agreement, and is signing this Agreement knowingly and voluntarily.
-------------------
Subscribed and sworn to before Richard M. Cahill
me this____day of____, 1998.
- ------------------------- -------------------
Notary Public Date
Subscribed and sworn to before GTE Service Corporation
me this____day of____, 1998.
- -------------------------- --------------------
Notary Public By:
Title:
--------------------
Date
<PAGE> 1
EXHIBIT 12
GTE North Incorporated and Subsidiary
STATEMENTS OF THE CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------------------------------------------
1997 1996 1995 1994 1993 1993 (a)
--------------------------------------------------------------------------------------
(Thousands of Dollars)
<S> <C> <C> <C> <C> <C> <C>
Net earnings available for fixed charges:
Income before extraordinary charges $ 731,455 $ 551,500 $ 493,244 $ 476,276 $ 105,216 $ 340,316
Add - Income taxes 425,970 321,175 271,743 284,293 34,925 181,325
- Fixed charges 138,668 129,084 128,105 121,978 136,262 136,262
---------- ---------- ---------- ---------- ---------- ----------
Adjusted earnings $1,296,093 $1,001,759 $ 893,092 $ 882,547 $ 276,403 $ 657,903
========== ========== ========== ========== ========== ==========
Fixed charges:
Interest expense $ 128,707 $ 120,607 $ 118,921 $ 112,885 $ 123,557 $ 123,557
Portion of rent expense
representing interest 9,961 8,477 9,184 9,093 12,705 12,705
---------- ---------- ---------- ---------- ---------- ----------
Adjusted fixed charges $ 138,668 $ 129,084 $ 128,105 $ 121,978 $ 136,262 $ 136,262
========== ========== ========== ========== ========== ==========
RATIO OF EARNINGS TO FIXED
CHARGES 9.35 7.76 6.97 7.24 2.03 4.83
</TABLE>
(a) Excludes an after-tax restructuring charge of approximately $230.8 million
for the implementation of a re-engineering plan and a one-time after-tax
charge of approximately $4.3 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 26, 1998, on the consolidated financial statements
and supporting schedule and exhibit of GTE North Incorporated and subsidiary
included in this Form 10-K, into the Registration Statement previously filed on
Form S-3 (File No. 333-44297).
Dallas, Texas ARTHUR ANDERSEN LLP
March 27, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
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16,253
15,208
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</TABLE>
