<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the period ended June 30, 1996
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission File Number 1-7077
GTE SOUTHWEST INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 75-0573444
(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 214-718-5600
(Former name, former address and formal fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO
------ ------
The Company had 6,500,000 shares of $100 stated value common stock outstanding
at July 31, 1996. The Company's common stock is 100% owned by GTE Corporation.
<PAGE> 2
PART I. FINANCIAL INFORMATION
GTE SOUTHWEST INCORPORATED
CONDENSED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
1996 1995 1996 1995
---- ---- ---- ----
(Thousands of Dollars)
<S> <C> <C> <C> <C>
REVENUES AND SALES:
Local services $142,044 $128,891 $286,416 $252,225
Network access services 155,525 139,674 306,811 276,251
Toll services 46,216 50,512 92,854 106,416
Other services and sales 72,614 57,567 128,542 101,156
-------- -------- -------- --------
Total revenues and sales 416,399 376,644 814,623 736,048
-------- -------- -------- --------
OPERATING COSTS AND EXPENSES:
Cost of services and sales 142,728 148,216 286,665 291,479
Selling, general and administrative 85,199 67,947 142,703 124,415
Depreciation and amortization 86,140 84,824 167,515 168,098
-------- -------- -------- --------
Total operating costs and expenses 314,067 300,987 596,883 583,992
-------- -------- -------- --------
OPERATING INCOME 102,332 75,657 217,740 152,056
OTHER (INCOME) EXPENSE:
Interest - net 13,170 15,846 26,779 32,670
Gain on disposition of assets (4,322) (5,319) (4,322) (5,319)
Other - net -- -- -- (2,000)
-------- -------- -------- --------
INCOME BEFORE INCOME TAXES 93,484 65,130 195,283 126,705
Income taxes 31,402 21,627 64,881 42,628
-------- -------- -------- --------
NET INCOME $ 62,082 $ 43,503 $130,402 $ 84,077
======== ======== ======== ========
</TABLE>
Per share data is omitted since the Company's common stock is 100% owned by
GTE Corporation (GTE).
See Notes to Condensed Financial Statements.
1
<PAGE> 3
GTE SOUTHWEST INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in Millions)
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
1996 1995 1996 1995
--------- ------- -------- --------
<S> <C> <C> <C> <C>
Net income $ 62.1 $ 43.5 $ 130.4 $ 84.1
</TABLE>
Net income increased 43% or $18.6 and 55% or $46.3 for the three and six months
ended June 30, 1996, respectively, compared to the same periods in 1995. These
increases are primarily due to higher revenues and sales, partially offset by
modest increases in operating costs and expenses.
Revenues and Sales
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
1996 1995 1996 1995
------------------------- -------------------------
<S> <C> <C> <C> <C>
Local services $ 142.1 $ 128.9 $ 286.4 $ 252.2
Network access services 155.5 139.7 306.8 276.3
Toll services 46.2 50.5 92.9 106.4
Other services and sales 72.6 57.5 128.5 101.1
------- ------- ------- -------
Total revenues and sales $ 416.4 $ 376.6 $ 814.6 $ 736.0
</TABLE>
Total revenues and sales increased 11% or $39.8 and 11% or $78.6 for the three
and six months ended June 30, 1996, respectively, compared to the same periods
in 1995.
Local service revenues increased 10% or $13.2 and 14% or $34.2 for the three
and six months ended June 30, 1996, respectively, compared to the same periods
in 1995. The number of switched access lines increased 5% for both the three
and six months ended June 30, 1996, which generated additional revenues of $3.4
and $7, respectively. The increases also reflect growth of $3.7 and $7.1 in
sales of CentraNet(R) and custom calling features, such as SmartCall(R), and a
favorable impact on local service revenues of $6.7 and $15.4 resulting from the
discontinuance of the monthly provision related to the Company's 1989 Texas
rate case and the monthly amortization of the associated reserve previously
established. In addition to these items, the increase reflects a slight growth
in revenues associated with the continued expansion of local area calling
zones.
Network access service revenues increased 11% or $15.8 and 11% or $30.5 for the
three and six months ended June 30, 1996, respectively, compared to the same
periods in 1995. Minutes of use increased 8% and 9% for the three and six
months ended June 30, 1996, which generated $6.2 and $14 of additional
revenues, respectively. The increases also reflect higher end user access
charge revenues associated with access line growth of $2.3 and $4.3, growth in
special access revenues of $3.3 and $8 and favorable impacts on network access
service revenues of $2.3 and $5.2 resulting from the discontinuance of the
monthly provision related to the Company's 1989 Texas rate case and the monthly
amortization of the associated reserve previously established.
2
<PAGE> 4
GTE SOUTHWEST INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)
Toll service revenues decreased 9% or $4.3 and 13% or $13.5 for the three and
six months ended June 30, 1996, respectively, compared to the same periods in
1995. The decreases are driven by declines in revenues resulting from lower
toll volumes, primarily relating to 10XXX intraLATA toll competition, and the
expansion of local area calling zones.
Other services and sales revenues increased 26% or $15.1 and 27% or $27.4 for
the three and six months ended June 30, 1996, respectively, compared to the
same periods in 1995. The increases are primarily related to $4.2 and $7.2 of
additional equipment sales, $4.1 and $9.6 of growth in Tele-Go(R) personal
phone service revenues and additional revenues of $5 and $8.1 resulting from
service bureau contracts. Through service bureau contracts, the Company
provides general, administrative and operational services (e.g., invoice and
payroll processing, billing and collection services, human resource services,
etc.) on a contractual basis to certain affiliates and other local-exchange
carriers (LECs).
Operating Costs and Expenses
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ----------------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Total operating costs and expenses $314.1 $301.0 $596.9 $584.0
</TABLE>
Total operating costs and expenses increased 4% or $13.1 and 2% or $12.9 for
the three and six months ended June 30, 1996, respectively, compared to the
same periods in 1995. The increases are primarily due to higher contractor
charges of $2.5 and $4.9 and investments in the Infrastructure Fund Assessment
for the provision of broadband facilities to schools, libraries and hospitals
of $2.3 and $4.6. The year-to-date increase is also due to additional
purchases of digital network software of $3.6. The impact of $5.8 in pension
settlement gains recorded in the second quarter of 1995 was partially offset by
settlement gains of $3.3 recorded in the first quarter of 1996 which resulted
from lump-sum payments from the Company's pension plans. The three and six
month increases are partially offset by lower labor and benefit costs of $2.7
and $7.1, respectively, associated with ongoing cost-reduction programs from
process re-engineering activities.
Other (Income) Expenses
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ----------------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Interest - net $13.2 $15.8 $26.8 $32.7
Gain on disposition of assets (4.3) (5.3) (4.3) (5.3)
Income taxes 31.4 21.6 64.9 42.6
</TABLE>
Interest - net decreased 16% or $2.6 and 18% or $5.9 for the three and six
months ended June 30, 1996, respectively, compared to the same periods in 1995,
which reflects lower interest rates associated with the high-coupon debt
refinancing program initiated during the fourth quarter of 1995. These
decreases also reflect increases in interest income from affiliate notes
receivable.
In the second quarter of 1996, the Company recorded $4.3 of pre-tax gains on
the sales of certain properties in the state of Texas. On May 14, 1995, the
Company recorded a $5.3 pre-tax gain on the sale of its unconsolidated
investment in Metropolitan Houston Metro Paging Service, Inc.
3
<PAGE> 5
GTE SOUTHWEST INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)
Income taxes increased 45% or $9.8 and 52% or $22.3 for the three and six
months ended June 30, 1996, respectively, compared to the same periods in 1995,
primarily the result of corresponding increases in pre-tax income.
CAPITAL RESOURCES AND LIQUIDITY
Management believes that the Company has adequate internal and external
resources available to meet ongoing operating requirements for construction of
new plant, modernization of facilities and payment of dividends. The Company
generally funds its construction program from operations, although external
financing is available. Short-term borrowings can be obtained through
commercial paper borrowings or borrowings from GTE. As of July 1, 1996, the
Company participated with other affiliates in a $1,500 syndicated line of
credit to back up commercial paper borrowings. Through this shared arrangement
the Company can issue up to $300 of commercial paper.
The Company's primary source of funds during the first six months of 1996 was
cash from operations of $202.1 compared to $192.3 for the same period in 1995.
The year-to-year increase in cash from operations reflects improved results
from operations, partially offset by an increase in working capital
requirements. Cash from operations is also being utilized to fund the
Company's re-engineering plan.
The Company's capital expenditures during the first six months of 1996 were
$176.9 compared to $149.7 for the same period in 1995. The 1996 expenditures
reflect the Company's continued access line growth and modernization of current
facilities and introduction of new products and services, including broadband
digital services and switched digital services. The Company anticipates capital
expenditures for 1996 to increase from the 1995 level, reflecting the continued
modernization of facilities and anticipated growth.
Cash used in financing activities was $7.4 during the first six months of 1996
compared to $47 for the same period in 1995. Financing activities included
dividend payments of $0.6 in the first six months of 1996 compared to $88.1 for
the same period in 1995. Short-term financing, including the net change in
affiliate notes, decreased $144.7 for the first six months of 1996, compared to
an increase of $51.9 for the same period in 1995. In January 1996, the Company
issued $150 of 6% debentures to refinance $105.8 of commercial paper.
OTHER MATTERS
In connection with the re-engineering plan, during the first six months of
1996, costs of approximately $14.8 have been incurred, including $12.6 to
re-engineer customer service processes and $2.2 to re-engineer administrative
processes. Since the plan's inception at the beginning of 1994, costs of
approximately $130.9 have been incurred, including $95 to re-engineer customer
service processes and $20.1 to re-engineer administrative processes. The
restructuring costs also include $15.8 to consolidate facilities and operations
and other related costs. These expenditures were primarily associated with the
closure and relocation of various service centers, software enhancements and
separation benefits associated with employee reductions. Implementation of the
re-engineering plan is expected to be substantially completed by the end of
1996. As of June 30, 1996, $68.1 remains in the restructuring reserve which
management believes is adequate to cover future expenditures.
On August 1, 1996, the Federal Communications Commission (FCC) voted to release
its rules implementing Section 251 of the Telecommunications Act of 1996 (the
Telecommunications Act) dealing with interconnection, unbundling of network
elements and wholesale prices and other terms for competitive entry into
local-exchange service (Competitive Entry Terms). The terms of the FCC's
Report and Order (Order) were published on August 8, 1996, and GTE is in the
process of reviewing the Order.
The Order acknowledges that the Telecommunications Act calls for negotiation of
terms and prices for Competitive Entry Terms between the local-exchange carrier
(LEC) and the competing carriers. The Order, among other things, prescribes
the rules for interconnection of a LEC's facilities with those of carriers
competing in the local-exchange market and the pricing methodology to be used
by states in establishing interconnection rates. The FCC methodology calls for
the states to use forward-looking costs defined as Total Element Long Run
Incremental Cost (TELRIC), including a reasonable amount of forward-looking
joint and common costs. State regulatory commissions are to establish the
appropriate prices based on this methodology. The FCC also identified network
elements to be unbundled and priced by the states using the same TELRIC plus
reasonable joint and common costs. Proxy prices for the various network
elements are set out and may be used by states which have not approved cost
studies by statutory deadlines for completing any arbitration of issues
unresolved by negotiation between the LEC and other carriers. Access to the
unbundled elements are to be at technically feasible points.
Additionally, the Order mandated use of a method of determining a LEC's avoided
costs for purposes of resale rates. States are to determine the specific rates
using this methodology but, on an interim basis, may instead elect to use a
default range of rates established by the FCC. The default discount rates
range from 17% - 25% off retail rates.
To continue to support universal service, the FCC established a temporary
access framework. A competitor purchasing local service for resale or
providing only long distance service must pay full current access rates. If
unbundled local switching is purchased, the competitor must pay 75% of the
existing Transport Interconnection Charge and all of the existing Carrier
Common Line Charge. A competitor providing its own switching facility pays no
access charges even if it purchases an unbundled loop from a LEC.
The Order also provides for mutual compensation for interconnection but
presumes calling will be balanced and permits "bill and keep" arrangements. If
the LEC demonstrates calling is not balanced, interconnection prices are to be
set by the state for both carriers at the LEC's forward-looking costs.
GTE is still reviewing the impact of the approximately 700-page Order. In
addition, the FCC is scheduled to release additional rules relating to
universal service and access charge reform in the second quarter of 1997.
Until all the rules have been issued, it is difficult to determine the effect
on GTE. However, GTE has concerns about the Order as it relates to the ability
of a local-exchange carrier to recover all of its present costs from its
ongoing retail customers and the wholesale prices to be set by state regulatory
agencies pursuant to the FCC's guidelines.
GTE plans to appeal various aspects of the Order. Although it is too early to
determine the impact of these rules, GTE believes that, if implemented as
contained in the Order, they may advantage new entrants and competitors in a
LEC's territory. Thus, while the Order may contribute to some market erosion in
GTE's franchised territories, it may also advantage GTE outside of its
franchised territory.
4
<PAGE> 6
GTE SOUTHWEST INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)
The Company submitted its 1996 annual interstate access filing on April 2, 1996,
utilizing the Federal Communications Commission's (FCC) interim price cap rules.
In doing so, the Company changed its productivity factor from 5.3% to 4.0% for
its Oklahoma tariff entity. On June 24, 1996, the FCC ordered all LECs subject
to price cap regulation, including the Company, to update their GDP-PI inflation
factors through the fourth quarter of 1995. Overall, the final 1996 interstate
access filing resulted in an annual price reduction of $5, effective July 1,
1996.
On March 7, 1996, the Oklahoma Communications Commission (OCC) approved a
comprehensive set of rules designed to implement competition according to the
provisions of the Telecommunications Act of 1996 (the Telecommunications Act).
These rules outline the certification process for new entrants and
substantially mirror the interconnection requirements of the Telecommunications
Act. Subsequently, in May 1996 AT&T received approval for certification to
provide local telephone service in Oklahoma.
5
<PAGE> 7
GTE SOUTHWEST INCORPORATED
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December 31,
1996 1995
---------- --------------
(Thousands of Dollars)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and temporary investments $ 46,646 $ 17,825
Receivables, less allowances of $22,754 and $21,182 279,928 277,838
Inventories and supplies 21,431 20,452
Deferred income tax benefits 26,527 32,033
Prepaid taxes and other 51,367 45,630
----------- -----------
Total current assets 425,899 393,778
----------- -----------
PROPERTY, PLANT AND EQUIPMENT, at cost 4,964,080 4,854,212
Accumulated depreciation (2,982,261) (2,887,706)
----------- -----------
Total property, plant and equipment, net 1,981,819 1,966,506
----------- -----------
OTHER ASSETS, primarily employee benefit plans 112,822 86,276
----------- -----------
Total assets $ 2,520,540 $ 2,446,560
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term obligations, including current maturities $ 2,206 $ 49,862
Accounts payable 129,679 145,518
Taxes payable 27,635 36,940
Accrued interest 10,796 6,657
Accrued payroll costs 40,558 46,038
Dividends payable 28,881 198
Accrued restructuring costs 68,057 82,872
Other 111,307 121,078
----------- -----------
Total current liabilities 419,119 489,163
----------- -----------
NON-CURRENT LIABILITIES:
Long-term debt 868,172 827,082
Deferred income taxes 177,072 178,003
Employee benefit plans 163,091 145,799
Other liabilities 69,968 84,404
----------- -----------
Total non-current liabilities 1,278,303 1,235,288
----------- -----------
PREFERRED STOCK, subject to mandatory redemption 8,250 8,390
----------- -----------
SHAREHOLDERS' EQUITY:
Preferred stock 7,600 7,600
Common stock (6,500,000 shares issued) 650,000 650,000
Additional paid-in capital 48,751 48,751
Retained earnings 108,517 7,368
----------- -----------
Total shareholders' equity 814,868 713,719
----------- -----------
Total liabilities and shareholders' equity $ 2,520,540 $ 2,446,560
=========== ===========
</TABLE>
See Notes to Condensed Financial Statements.
6
<PAGE> 8
GTE SOUTHWEST INCORPORATED
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Six Months Ended
June 30,
------------------------------
1996 1995
---- ----
(Thousands of Dollars)
<S> <C> <C>
OPERATIONS:
Net income $ 130,402 $ 84,077
Adjustments to reconcile net income
to net cash from operations:
Depreciation and amortization 167,515 168,098
Deferred income taxes 4,575 12,891
Gain on disposition of assets (4,322) (5,319)
Provision for uncollectible accounts 19,293 16,598
Changes in current assets and current liabilities (103,912) (87,757)
Other - net (11,436) 3,716
--------- ---------
Net cash from operations 202,115 192,304
--------- ---------
INVESTING:
Capital expenditures (176,886) (149,707)
Proceeds from disposition of assets 10,972 7,000
Other - net -- (5,469)
--------- ---------
Net cash used in investing (165,914) (148,176)
--------- ---------
FINANCING:
Long-term debt issued 147,884 --
Long-term debt and preferred stock retired (9,968) (10,880)
Dividends (570) (88,050)
Net change in affiliate notes (38,926) 48,220
Increase (decrease) in short-term obligations,
excluding current maturities (105,800) 3,662
--------- ---------
Net cash used in financing (7,380) (47,048)
--------- ---------
Increase (decrease) in cash and temporary investments 28,821 (2,920)
Cash and temporary investments:
Beginning of period 17,825 10,462
--------- ---------
End of period $ 46,646 $ 7,542
========= =========
</TABLE>
See Notes to Condensed Financial Statements.
7
<PAGE> 9
GTE SOUTHWEST INCORPORATED
NOTES TO CONDENSED FINANCIAL STATEMENTS
(1) The unaudited condensed financial statements included herein have been
prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. However, in
the opinion of management of the Company, the condensed financial
statements include all adjustments, which consist only of normal recurring
accruals, necessary to present fairly the financial information for such
period. These condensed financial statements should be read in
conjunction with the financial statements and the notes thereto included
in the Company's 1995 Annual Report on Form 10-K.
(2) In the second quarter of 1996, the Company sold a portion of its
telephone plant-in-service, inventories and supplies and customers in the
state of Texas to various parties for $11 million in cash. A pre-tax gain
of $4.3 million was recorded on the sale.
(3) Reclassifications of prior year data have been made, where appropriate,
to conform to the 1996 presentation.
8
<PAGE> 10
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits required by Item 601 of Regulation S-K.
(12) Statement re: Calculation of the Ratio of Earnings to Fixed
Charges
(27) Financial Data Schedule
(b) The Company filed no reports on Form 8-K during the second quarter
of 1996.
9
<PAGE> 11
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
GTE Southwest Incorporated
--------------------------------
(Registrant)
Date: August 14, 1996 William M. Edwards, III
----------------- --------------------------------
William M. Edwards, III
Vice President - Controller
(Principal Accounting Officer)
10
<PAGE> 12
EXHIBIT INDEX
Exhibit
Number Description
- ------- -----------
12 Statement re: Calculation of the Ratio of Earnings to Fixed Charges
27 Financial Data Schedule
<PAGE> 1
EXHIBIT 12
GTE SOUTHWEST INCORPORATED
STATEMENT OF THE RATIO OF EARNINGS TO FIXED CHARGES
(Thousands of Dollars)
<TABLE>
<CAPTION>
Six Months Ended
June 30, 1996
----------------
<S> <C>
Net earnings available for fixed charges:
Income from continuing operations $130,402
Add - Income taxes 64,881
- Fixed charges 32,500
--------
Adjusted earnings $227,783
========
Fixed charges:
Interest expense $ 29,938
Portion of rent expense representing interest 2,562
--------
Adjusted fixed charges $ 32,500
========
RATIO OF EARNINGS TO FIXED CHARGES 7.01
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1996
<PERIOD-END> JUN-30-1996
<CASH> 46,646
<SECURITIES> 0
<RECEIVABLES> 302,682
<ALLOWANCES> 22,754
<INVENTORY> 21,431
<CURRENT-ASSETS> 425,899
<PP&E> 4,964,080
<DEPRECIATION> 2,982,261
<TOTAL-ASSETS> 2,520,540
<CURRENT-LIABILITIES> 419,119
<BONDS> 868,172
<COMMON> 650,000
8,250
7,600
<OTHER-SE> 157,268
<TOTAL-LIABILITY-AND-EQUITY> 2,520,540
<SALES> 814,623
<TOTAL-REVENUES> 814,623
<CGS> 286,665
<TOTAL-COSTS> 596,883
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 26,779
<INCOME-PRETAX> 195,283
<INCOME-TAX> 64,881
<INCOME-CONTINUING> 130,402
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 130,402
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
