<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 1996
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission File Number 1-7077
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 972-718-5600
Securities registered pursuant to Section 12(b) of the act:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
FIRST MORTGAGE BONDS-7 1/2%-SERIES, DUE 2002 AMERICAN STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act:
4.60% SERIES CUMULATIVE PREFERRED STOCK $20 PAR VALUE
5.10% SERIES CUMULATIVE PREFERRED STOCK $20 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 6,500,000 SHARES OF $100 STATED VALUE COMMON STOCK OUTSTANDING
AT FEBRUARY 28, 1997. THE COMPANY'S COMMON STOCK IS 100% OWNED BY GTE
CORPORATION.
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Item Page
<S> <C> <C>
Part I
1. Business 1
2. Properties 5
3. Legal Proceedings 5
4. Submission of Matters to a Vote of Security Holders 5
Part II
5. Market for the Registrant's Common Equity and Related 6
Shareholder Matters
6. Selected Financial Data 7
7. Management's Discussion and Analysis of Financial 8
Condition and Results of Operations
8. Financial Statements and Supplementary Data 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 41
12. Security Ownership of Certain Beneficial Owners and Management 49
13. Certain Relationships and Related Transactions 49
Part IV
14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 50
</TABLE>
<PAGE> 3
PART I
Item 1. Business
GTE Southwest Incorporated (the Company) was incorporated in Delaware in 1926.
The Company is a wholly-owned subsidiary of GTE Corporation (GTE) and provides
communications services in the states of Arkansas, New Mexico, Oklahoma and
Texas.
In December 1992, GTE announced a plan to pursue the sale or trade of a small
percentage of local-exchange telephone properties (representing less than 5% of
its U.S. access lines) in markets that may be of greater long-term strategic
value to other telephone service providers. As part of this program, during
1996-1994, the Company sold various local- exchange telephone properties in the
states of Texas, Arizona, and Oklahoma, as discussed below.
On May 31, 1996 and September 30, 1995, the Company sold a portion of its
telephone plant in service, inventories and supplies and customers
(representing 16,713 access lines) in the state of Texas to various parties.
On November 30, 1994, the Company sold a portion of its telephone
plant-in-service, inventories and supplies and customers (representing 8,898
access lines) in the state of Oklahoma to Pioneer Telephone Cooperative, Inc.
The Company also sold a portion of its telephone plant-in-service, inventories
and supplies and customers (representing 26,519 access lines) in the state of
Arizona to Citizens Utilities Company. On May 1, 1994, the Company sold a
portion of its telephone plant-in-service, inventories and supplies and
customers (representing 12,798 access lines) in the state of Oklahoma to
Eaglenet, Inc.
In addition, on May 4, 1995, the Company sold its unconsolidated investment in
Metropolitan Houston Paging Service, Inc., a Texas corporation, to ProNet, Inc.
On February 28, 1995, the Company entered into an Agreement of Merger with
Contel of Texas, Inc., a Texas corporation and Contel of the West, Inc., an
Arizona corporation (collectively, the Contel Subsidiaries). The agreement
provided that the Contel Subsidiaries would merge with and into the Company,
with the Company to be the surviving corporation (the Merger). The Contel
Subsidiaries provided communication services in the states of Texas and New
Mexico. The Merger became effective on December 31, 1995, and has been
accounted for in a manner similar to a "pooling of interests."
Additional information related to the above transactions can be found in Note 3
and Note 5 to the Company's financial statements included in Item 8.
The Company's principal line of business is providing communications services
ranging from local telephone service for the home and office to highly complex
voice and data services for industry. The Company provides local telephone
service within its franchise area and intraLATA (Local Access Transport Area)
toll service between the Company's facilities and the facilities of other
telephone companies within the Company's LATAs. InterLATA service to other
points in and out of the states in which the Company operates is provided
through connection with interexchange (long distance) common carriers. These
common carriers are charged fees (access charges) for interconnection to the
Company's local facilities. Business and residential customers also pay access
charges to connect to the local network to obtain long distance service. The
Company earns other revenues by providing such services as billing and
collection and operator services to interexchange carriers.
1
<PAGE> 4
The number of access lines in the states in which the Company operates as of
December 31, 1996, was as follows:
<TABLE>
<CAPTION>
Access
State Lines Served
------------- --------------
<S> <C>
Texas 2,056,732
Oklahoma 111,041
New Mexico 87,752
Arkansas 83,412
------------
Total 2,338,937
============
</TABLE>
At December 31, 1996, the Company had 5,941 employees.
The Company has three written agreements with the Communications Workers of
America (CWA). In 1996, two agreements were reached with the CWA. No
agreements expire in 1997.
REGULATORY AND COMPETITIVE TRENDS
The Company is subject to regulation by the regulatory bodies of the states of
Texas, Oklahoma, New Mexico and Arkansas as to its intrastate business
operations and by the Federal Communications Commission (FCC) as to 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. Presently, the Company is subject
to competition from numerous sources, including competitive access providers
(CAPs) for network access services. In addition, competition from alternative
local-exchange carriers (ALECs), interexchange carriers (IXCs), wireless
carriers and cable providers, as well as more recent entry by media and
computer companies, is expected to increase in the rapidly changing
telecommunications marketplace.
On February 8, 1996, the Telecommunications Act of 1996 (the Telecommunications
Act) became law. This comprehensive telecommunications reform legislation
addresses a wide range of competitive and regulatory issues that will affect
the future development of local and long distance services, cable television
and information services. The new law removes regulatory and court-ordered
barriers to competition between segments of the industry, enabling
local-exchange, long distance, wireless and cable companies to compete in
offering voice, video and information services.
The Telecommunications Act requires the FCC and state commissions to open
local-exchange markets and to set new guidelines for interconnection, loosens
restrictions barring local telephone companies from entering the cable
television market, and preserves universal service while equalizing the
responsibility for contribution among all carriers.
Following passage of the Telecommunications Act, the FCC has undertaken to
issue rules governing three areas: interconnection, universal service and
access charge reform. In August 1996, the FCC released its rules implementing
the provision of number portability and dialing parity in accordance with the
Telecommunications Act. In August 1996, the FCC also adopted its rules
governing interconnection, unbundling of network elements and wholesale prices
and other terms for competitive entry into local-exchange service. These rules
generally require local-exchange carriers (LECs) to make their services
available to competitors at a wholesale discount and to make their network
elements available to competitors at below-cost prices. GTE petitioned for
judicial review of these rules on the grounds that they were inconsistent with
the Telecommunications Act. In October 1996, the U.S. Court of Appeals for the
Eighth Circuit granted GTE's request for stay of the pricing provisions of the
FCC's rules pending the Court's resolution of the merits of GTE's petition.
Oral arguments on the merits were held in January 1997, and the Court's ruling
is expected in the spring of 1997.
2
<PAGE> 5
GTE is continuing to negotiate with requesting carriers over the terms of
interconnection, unbundled network elements and resale rates. In some cases,
the parties have been unable to agree within the statutory period for
negotiation and have gone to arbitration before various state regulatory
commissions. Since November 1996, a number of state commission decisions
determining the prices and terms of unresolved issues have been released (See
Note 13 to the Company's financial statements included in Item 8). Subsequent
decisions are expected to be issued over a period extending through the first
half of 1997.
The Company has exercised its right under the Telecommunications Act to
challenge state regulatory commission arbitration orders that govern agreements
between the Company and its competitors. The Company has filed lawsuits in
federal district courts in Texas and Oklahoma.
In November 1996, the Federal-State Joint Board released its recommended
universal service plan, and in December 1996, the FCC issued its access reform
proposals. Both proposals incorporate a pricing methodology similar to the one
that GTE is appealing in the interconnection case. A final order in the
universal service proceeding must be adopted by early May 1997, and a decision
on the access reform proceeding is expected shortly thereafter.
A key provision of the Telecommunications Act eliminated the legal restraints
of the GTE Consent Decree which kept the Company from providing interLATA long
distance services. This action will simplify GTE's ability to market local,
intraLATA and interLATA service to its customers as a bundled service. In
February 1996, GTE executed an agreement whereby WorldCom, Inc. will provide,
on a non-exclusive basis, a full array of telecommunications services in
support of GTE's entry into the interLATA long distance market. In March 1996,
GTE, through a separate subsidiary, began offering long distance service to its
customers in selected markets. GTE now offers the service, marketed under the
name GTE Easy Savings Plan (sm), in all 50 states.
The Telecommunications Act forbids states from imposing any barriers to entry
into local and toll competition. To date, local competition has been
authorized in all 28 states where GTE currently offers local telephone service,
including Texas, Arkansas, Oklahoma and New Mexico. In addition, nineteen
states, including Texas, have authorized plans that would allow customers to
pre-subscribe to a specific carrier to handle their intraLATA toll calls.
Pre-subscribed customers will simply dial "1" before the telephone number in
order to complete intraLATA calls. GTE has proposals pending in all nine
states, including Arkansas, New Mexico and Oklahoma, which have not ordered
implementation.
Federal and state regulatory activity continued to change the traditional
cost-based, rate-of-return regulatory framework for intrastate and interstate
telephone service. Regulatory authorities have adopted various forms of
alternative regulation, which provide economic incentives to telephone service
providers to improve productivity and provide the foundation for implementing
pricing flexibility necessary to address competitive entry into the Company's
markets. The Public Utility Commission of Texas has adopted price regulation
for its intrastate telephone service. Regulatory commissions in the states of
Oklahoma, New Mexico and Arkansas 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 index based
upon inflation less a predetermined productivity target. LECs have limited
pricing flexibility provided they do not exceed the allowed price cap.
Further information regarding the Company's activities with the various
regulatory agencies and revenue arrangements with other telephone companies is
discussed in Note 13 to the Company's 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.
3
<PAGE> 6
The Company intends to continue to respond aggressively to regulatory and legal
developments that allow for increased competition and opportunities in the
marketplace. The Company expects its financial results to benefit from reduced
costs and the introduction of new products and services that will result in
increased usage of its telephone networks. However, it is likely that such
improvements will be offset, in part, by continued strategic pricing reductions
and the effects of increased competition.
INITIATIVES
In 1996, the Company and its parent, GTE, continued to position themselves to
respond aggressively to competitive developments and benefit from new
opportunities.
GTE Southwest Incorporated (the Company):
Restructuring and Cost Control
During 1996, the Company substantially completed the implementation of its
three-year $199 million re-engineering program. Total costs of the program
included $134.7 million related to improvements in customer service processes,
$48.5 million related to improvements in administrative processes and $15.8
million related to the consolidation of facilities and operations and other
related costs. These costs were primarily associated with the closure and
relocation of various service centers, software enhancements and separation
benefits related to employee reductions.
GTE Corporation (GTE):
Video Services
The Telecommunications Act eliminates the telephone company programming ban and
allows GTE the flexibility to choose whether it will enter the wireline video
distribution business through an open video platform arrangement or via a
standard cable television operation (Title VI). The legislation also allows
GTE to deploy video networks which are fully integrated with its telephone
operations.
GTE, through a separate subsidiary, made its initial entry into the video
market under Title VI. The most technologically-advanced hybrid fiber/coaxial
network available is being deployed. At the end of 1996, GTE had been granted
six franchises, three in California and three in Florida. Construction of the
networks in those markets is underway and approximately 7,000 video subscribers
were acquired in 1996, bringing GTE's total video subscribers to approximately
15,000.
Internet Access
GTE, through a separate subsidiary, was the first local-exchange carrier to
introduce nationwide Internet services to residential and business customers in
1996. By year-end 1996, GTE's Internet access service, marketed as GTE
Internet Solutions, was offered in over 350 cities covering 49 states,
including Arkansas, New Mexico, Oklahoma and Texas. An agreement with UUNET
Technologies provides the Internet backbone and local dialing capabilities.
Over 70,000 customers were subscribing to GTE Internet Solutions at December
31, 1996.
GTE Long Distance
One of the most significant impacts of the Telecommunications Act's passage was
the removal of certain restrictions previously included in GTE's Consent
Decree. Prior to February 8, 1996, GTE was restricted from jointly marketing
the products and services of the Company with those of GTE's interexchange
subsidiaries. With this joint marketing restriction lifted, GTE can now offer
its customers many services on one monthly bill, with one point of contact.
This opportunity facilitated GTE's entry into the long distance business, as
discussed above. By December 31, 1996, GTE, through a separate subsidiary, was
offering the service, marketed under the name GTE Easy Savings Plan (sm), in
all 50 states and was serving over 825,000 customers.
4
<PAGE> 7
ENVIRONMENTAL MATTERS
GTE maintains monitoring and compliance programs related to environmental
matters. The Company's annual expenditures for environmental compliance have
not been and are not expected to be material. Costs incurred include outlays
required to keep existing operations in compliance with environmental
regulations and an underground storage tank replacement program.
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 Texas, Oklahoma, New Mexico and Arkansas,
are generally in good operating condition and adequate to satisfy the needs of
the business. Substantially all of the Company's property is subject to the
liens of its respective mortgages securing funded debt. From January 1, 1992
to December 31, 1996, the Company made capital expenditures of $1.7 billion for
new plant and facilities required to meet telecommunication service needs and
to modernize plant and facilities. These additions were equal to 34% of gross
plant of $5 billion at December 31, 1996.
In the fourth quarter of 1995, the Company discontinued the use of Statement of
Financial Accounting Standards No. 71, "Accounting for the Effects of Certain
Types of Regulation" (FAS 71).
In general, FAS 71 required the Company to depreciate its telephone plant and
equipment over lives approved by regulators which, in many cases, extended
beyond the assets' economic lives. FAS 71 also required the deferral of
certain costs based upon approvals received from regulators to recover such
costs in the future. As a result of these requirements, the recorded net book
value of certain assets and liabilities, primarily telephone plant and
equipment, were in many cases higher than that which would otherwise have been
recorded based on their economic lives. See Note 2 to the Company's 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 financial statements.
Item 4. Submission of Matters to a Vote of Security Holders
None.
5
<PAGE> 8
PART II
Item 5. Market for the Registrant's Common Equity and Related Shareholder
Matters
Market information is omitted since the Company's common stock is wholly-owned
by GTE Corporation (GTE).
SHAREHOLDER SERVICES
The First National Bank of Boston, Transfer Agent and Registrar for GTE and the
Company's common stock and preferred stock, should be contacted with any
questions relating to shareholder accounts. This includes the following:
o Account information
o Dividends
o Market prices
o Transfer instructions
o Statements and reports
o Change of address
Shareholders may call toll-free at 1-800-225-5160 anytime, seven days a week.
Customer Service Representatives are available Monday through Friday between
the hours of 8 a.m. and 5 p.m. Eastern Time. Outside the United States call 1-
617-575-2990.
Or write to:
Bank of Boston
c/o Boston EquiServe, L.P.
P.O. Box 9121
Boston, MA 02205-9121
For overnight delivery services, use the following address:
Bank of Boston
c/o Boston EquiServe, L.P.
Blue Hills Office Park
150 Royall Street
Canton, MA 02021
The Bank of Boston address where shareholders, banks and brokers may deliver
certificates is One Exchange Place, 55 Broadway in New York City.
PARENT COMPANY ANNUAL REPORT
To obtain a copy of the 1996 annual report of our parent company or the annual
Form 10-K filed with the Securities and Exchange Commission, call
1-800-225-5160.
INFORMATION VIA THE INTERNET
Internet World Wide Web users can access information on GTE through the
following universal resource:
http://www.gte.com
PRODUCTS AND SERVICES HOTLINE
Shareholders may call 1-800-828-7280 to receive information concerning GTE
products and services.
6
<PAGE> 9
Item 6. Selected Financial Data (See Note 3 to the Company's financial
statements included in Item 8)
GTE Southwest Incorporated
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------------------
Selected Income Statement Items (a) 1996 1995 1994 1993(b) 1992
- ----------------------------------- -------------------------------------------------------------
(Thousands of Dollars)
<S> <C> <C> <C> <C> <C>
Revenues and sales $1,622,939 $1,515,379 $1,482,495 $1,457,263 $1,457,369
Operating costs and expenses 1,215,174 1,186,518 1,203,019 1,348,211 1,086,785
-------------------------------------------------------------
Operating income 407,765 328,861 279,476 109,052 370,584
Interest - net 54,297 61,218 63,568 82,722 86,133
Gain on disposition of assets (4,322) (21,583) (63,688) (17,536) --
Other - net (28,179) (5,500) -- 1,224 --
Income taxes (benefit) 130,173 99,437 95,068 (12,731) 93,692
-------------------------------------------------------------
Income before extraordinary charges 255,796 195,289 184,528 55,373 190,759
Extraordinary charges -- (549,438)(c) -- (31,250) --
-------------------------------------------------------------
Net income (loss) $ 255,796 $ (354,149) $ 184,528 $ 24,123 $ 190,759
=============================================================
Dividends declared on common stock $ 136,021 $ 80,900 $ 243,033 $ 149,348 $ 179,383
Dividends declared on preferred stock 1,043 1,118 1,258 1,409 1,588
</TABLE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
As of December 31,
-------------------------------------------------------------
Selected Balance Sheet Items 1996 1995 1994 1993 1992
- ---------------------------- -------------------------------------------------------------
(Thousands of Dollars)
<S> <C> <C> <C> <C> <C>
Property, plant and equipment, net (c) $1,985,744 $1,966,506 $2,832,912 $2,843,398 $2,912,515
Total assets 2,568,856 2,446,560 3,243,367 3,286,638 3,288,049
Long-term debt and preferred stock,
subject to mandatory redemption 873,344 835,472 755,530 798,255 833,056
Shareholders' equity 832,451 713,719 1,149,886 1,232,177 1,358,811
</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 $199 million pre-tax charge for
restructuring costs which reduced net income by $122.6 million.
(c) See Note 2 to the financial statements included in Item 8.
7
<PAGE> 10
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in Millions)
BUSINESS OPERATIONS
GTE Southwest Incorporated (the Company), a wholly-owned subsidiary of GTE
Corporation (GTE), provides local-exchange, network access and toll services in
Arkansas, New Mexico, Oklahoma and Texas. The Company also markets
telecommunications systems and equipment. At December 31, 1996, the Company
served 2,338,937 access lines in its service territories, with 88% of these
lines in Texas.
On February 28, 1995, the Company entered into an Agreement of Merger with
Contel of Texas, Inc., a Texas corporation and Contel of the West, Inc., an
Arizona corporation (collectively, the Contel Subsidiaries). The agreement
provided that the Contel Subsidiaries would merge with and into the Company,
with the Company to be the surviving corporation (the Merger). The Merger
became effective on December 31, 1995, and has been accounted for in a manner
similar to a "pooling of interests." Accordingly, the financial statements
include the combined historical results of operations and financial position of
the Company and the Contel Subsidiaries as though the Merger had occurred at
the beginning of each period presented and reflect the elimination of all
significant intercompany transactions.
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------
1996 1995 1994
------ ------- ------
<S> <C> <C> <C>
Net income (loss) $255.8 $(354.1) $184.5
</TABLE>
Net income for 1996 includes the one-time $18.7 reversal (net of tax) of
expired representation and warranty reserves related to certain property sales
in 1994. The net loss for 1995 includes one-time extraordinary charges (net of
tax) of $549.4 related to the discontinuance of Statement of Financial
Accounting Standards No. 71, "Accounting for the Effects of Certain Types of
Regulation" (FAS 71) and the early retirement of debt in the fourth quarter of
1995. In addition, $2.9 and $14.3 of one-time gains (net of tax) were recorded
on the sales of non-strategic properties in the state of Texas during 1996 and
1995, respectively. Also in 1996 and 1995, $8.3 and $3.8 of settlement gains
(net of tax) from the Company's pension plans were recorded. Net income for
1994 includes one-time gains (net of tax) of $39.8 recorded on the sales of
non-strategic properties in the states of Arizona and Oklahoma.
Excluding these special items, net income increased 27% or $48.7 for 1996 and
22% or $32.5 for 1995. The 1996 increase reflects higher revenues and sales
resulting from continued customer growth, partially offset by increases in
operating costs and expenses. The 1995 increase is also primarily attributable
to higher revenues and sales from customer growth, partially offset by an
increase in depreciation expense.
REVENUES AND SALES
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Local services $ 589.1 $ 531.9 $ 490.4
Network access services 627.3 579.0 577.7
Toll services 182.8 214.3 244.9
Other services and sales 223.7 190.2 169.5
-------- -------- --------
Total revenues and sales $1,622.9 $1,515.4 $1,482.5
</TABLE>
Total revenues and sales increased 7% or $107.5 and 2% or $32.9 during 1996 and
1995, respectively.
8
<PAGE> 11
Local service revenues are comprised mainly of fees charged to customers for
providing local-exchange service within designated franchise areas. Local
service revenues increased 11% or $57.2 and 8% or $41.5 in 1996 and 1995,
respectively. The number of access lines increased 6.4% and 5% in 1996 and
1995, respectively, which generated additional revenues of $23.1 and $11.2.
The 1996 increase is also attributable to a $5.5 growth in integrated digital
services revenues, a $4.2 growth in revenues associated with the continued
expansion of local area calling zones and the Expanded Local Calling Surcharge
(as discussed in Note 13 to the financial statements included in Item 8), a
$5.9 increase in revenues related to sales of Centranet (R), and a $10.9 growth
in the sales of custom calling features, such as SmartCall (R). In addition to
these items, the increase reflects $19.2 of favorable impacts on local service
revenues resulting from the discontinuance of the monthly provision related to
the Company's 1989 Texas rate case (as discussed in Note 13 to the financial
statements included in Item 8). The 1996 increase is slightly offset by a
reduction in local rates in Oklahoma of $4, effective in March 1996 and a $6.8
reduction in local rates in Arkansas, effective July 1995. The 1995 increase
is also driven by additional revenues of $5.7 related to the expansion of local
area calling zones, a $3.1 growth in sales of Centranet (R) and custom calling
features, a $5.2 growth in new local services and $15.8 of favorable impacts
from the Company's 1989 Texas rate case.
Network access service revenues are based on fees charged to interexchange
carriers that use the Company's local- exchange network in providing long
distance services. In addition, residential and business customers pay end
user access fees to connect to the local network to obtain long distance
service. Cellular service providers and other local-exchange carriers also pay
access charges for cellular and intraLATA (Local Access and Transport Area)
toll calls hauled or terminated by the Company. Network access service
revenues increased 8% or $48.3 and less than 1% or $1.3 in 1996 and 1995,
respectively. Minutes of use increased 9% and 11% in 1996 and 1995,
respectively, generating $27.4 and $20.7 of additional revenues. Also
contributing to the 1996 increase are $6.8 of higher end user access charge
revenues associated with an increase in access lines, a $13.3 growth in special
access revenues from an increase in lines, $5.1 of favorable impacts from the
discontinuance of the monthly provisions related to the Company's 1989 Texas
rate case and a $2 growth in the volume of cellular service providers accessing
the Company's network. The 1996 increase is partially offset by an $8.5
decrease in National Exchange Carrier Association (NECA) support payments.
Additionally, the 1995 increase reflects $6.9 of favorable impacts from the
interstate rate changes associated with the Federal Communications Commission
(FCC) Price Cap (as discussed in Note 13 to the financial statements included
in Item 8), a $7.3 growth in special access revenues and $5.3 of favorable
impacts from the Company's 1989 Texas rate case. The 1995 increase is
partially offset by $11.6 of lower NECA support payments and a $30.2 decline in
revenues due to the Company's access charge restructuring plan, as discussed
below.
The Company began participating in the Texas Pooling Alternative Settlement
Plan (PASP) effective January 1, 1994. The PASP is also known as an
Originating Responsibility Plan. Under this plan, the toll rates billed to end
users for intraLATA toll calls originating in the Company's service area are
retained by the Company. The Company, in turn, pays access charges to the
telephone company hauling and terminating the call based on that company's
approved access charge tariff. Likewise, the Company will receive access
charges for terminating any intraLATA toll call that originates outside of its
service area based on its approved access charge tariff.
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 15% or
$31.5 and 13% or $30.6 in 1996 and 1995, respectively. The decreases in 1996
and 1995 reflect the end of transitional support payments of $14.1 and $8.9,
respectively, as a result of the Company's exit from the Texas state intraLATA
toll pool in 1994. In addition, the 1996 and 1995 decreases are driven by a
decrease in toll activity, primarily a result of intraLATA toll competition and
the expansion of local area calling zones.
Other services and sales revenues increased 18% or $33.5 and 12% or $20.7 in
1996 and 1995, respectively. The 1996 increase is a result of $8.9 of
additional equipment sales, such as telephones and caller identification boxes,
a $16.7 growth in Tele-Go (R) personal phone service revenue and a $6.2 growth
in DataBase 800 services. The 1995 increase is attributable to $17.1 of higher
equipment sales and a $3.7 growth in DataBase 800 services.
9
<PAGE> 12
OPERATING COSTS AND EXPENSES
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Cost of services and sales $ 603.6 $ 590.2 $ 621.3
Selling, general and administrative 269.8 257.5 260.7
Depreciation and amortization 341.8 338.8 321.0
-------- -------- --------
Total operating costs and expenses $1,215.2 $1,186.5 $1,203.0
</TABLE>
Total operating costs and expenses increased 2% or $28.7 and decreased 1% or
$16.5 in 1996 and 1995, respectively. The 1996 increase reflects a $15.8
reserve for right-of-way settlement costs in the state of Texas and a $9.2
investment in the Infrastructure Fund Assessment for the provision of broadband
facilities to schools, libraries and hospitals. The 1996 increase also
includes a $6.3 increase in charges associated with Tele-Go (R) sales, a $3
increase in depreciation expense, associated with higher gross plant balances,
a $2.1 reserve for inside wire maintenance settlements, discussed below, and a
$1.8 increase in end user uncollectibles. The 1996 increase is partially
offset by $5.9 of lower costs associated with the collection of interexchange
carrier receivables and a $12.6 pension settlement gain from the Company's
pension plans.
The 1995 decrease is primarily attributable to lower labor and benefit costs
associated with ongoing cost-reduction programs from process re-engineering
activities, a decrease in charges related to unbillable calling card calls, and
a settlement gain recorded in 1995 which resulted from lump-sum payments from
the Company's pension plans, partially offset by an increase in depreciation
expenses associated with additions to gross plant balances.
OTHER (INCOME) EXPENSES
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Interest - net $ 54.3 $ 61.2 $ 63.6
Gain on disposition of assets (4.3) (21.6) (63.7)
Other - net (28.2) (5.5) --
Income taxes 130.2 99.4 95.1
</TABLE>
Interest - net decreased 11% or $6.9 and 4% or $2.4 in 1996 and 1995,
respectively. The 1996 decrease reflects lower interest rates associated with
the high-coupon debt refinancing program initiated during the fourth quarter of
1995 and an increase in interest income from affiliate notes receivable.
In the second quarter of 1996, the Company recorded a $4.3 pre-tax gain on the
sale of certain non-strategic properties in the state of Texas (representing
6,196 access lines). In addition, on September 30, 1995, the Company recorded
a $16.3 pre-tax gain on the sale of certain non-strategic properties in the
state of Texas (representing 10,517 access lines). On May 4, 1995, the Company
recorded a $5.3 pre-tax gain on the sale of its unconsolidated investment in
Metropolitan Houston Paging Service, Inc. On November 30, 1994, the Company
recorded pre-tax gains of $12.6 and $41.8 on the sales of certain non-strategic
properties in the states of Oklahoma (representing 8,898 access lines) and
Arizona (representing 26,519 access lines), respectively. On May 1, 1994, the
Company recorded a $9.3 pre-tax gain on the sale of certain non-strategic
properties in the state of Oklahoma (representing 12,798 access lines).
Other - net income of $28.2 in 1996 and $5.5 in 1995 represents the reversal of
expired representation and warranty reserves related to certain 1994 property
dispositions.
Income taxes increased 31% or $30.8 in 1996 and 5% or $4.3 in 1995. The 1996
and 1995 increases are primarily driven by corresponding increases in pre-tax
income. The 1995 increase is also attributable to lower amortization of
investment tax credits and lower reversals of temporary differences provided in
prior years at higher tax rates.
10
<PAGE> 13
CAPITAL RESOURCES AND LIQUIDITY
Management believes the Company has adequate internal and external resources
available to meet ongoing operating requirements for construction of new plant,
modernization of facilities and payment of dividends. The Company generally
funds its construction program from operations, although external financing is
available. Short-term borrowings can be obtained through commercial paper
borrowings or borrowings from GTE. On July 1, 1996, the Company began
participating with other affiliates in a $1,500 syndicated line of credit to
back up commercial paper borrowings. Through this shared arrangement, the
Company can issue up to $300 of commercial paper. The Company has an existing
shelf registration statement for an additional $150 of debentures.
The Company's primary source of funds during 1996 was cash from operations of
$509.8 compared to $392.8 in 1995. The year-to-year increase is primarily
attributable to improved results from operations and a decrease in working
capital requirements.
Net cash used in investing activities was $342.3 and $288.1 during 1996 and
1995, respectively. The Company's capital expenditures during 1996 were $354.6
compared to $319.2 during the same period in 1995. The 1996 expenditures
reflect the Company's continued access line growth and modernization of current
facilities to support new products and expanded service capabilities. The
Company's anticipated construction costs for 1997 are expected to increase from
the 1996 level, reflecting the continued expansion of existing networks,
upgrades associated with the support of expanded services and compliance with
the local number portability requirements of the Telecommunications Act of 1996
(the Telecommunications Act). These expenditures were partially offset by cash
proceeds of $12.3 and $36.6 received from the sale of certain non-strategic
properties, discussed above, during 1996 and 1995, respectively.
Net cash used in financing was $162.2 and $97.4 during 1996 and 1995,
respectively. This included dividend payments of $87.5 in 1996 compared to
$143.2 in 1995. Financing included a decrease in short-term borrowings of
$208.9 in 1996, compared to an increase in short-term borrowings of $66.1 in
1995. In January 1996, the Company issued $150 of 6% debentures to refinance
commercial paper outstanding at December 31, 1995 (as discussed in Note 8 to
the financial statements included in Item 8). In December 1995, the Company
redeemed prior to stated maturity, $5.6 of long-term debt with proceeds from
commercial paper borrowings. The Company retired an additional $15.4 of
long-term debt and preferred stock in 1995 compared to total retirements of
$13.7 in 1996. During 1994, the Company returned $22.5 of capital to GTE with
the cash proceeds from certain non-strategic property sales.
REGULATORY AND COMPETITIVE TRENDS
The Company is subject to regulation by the regulatory bodies of the states of
Texas, Oklahoma, New Mexico and Arkansas as to its intrastate operations and by
the FCC as to its interstate operations.
Significant regulatory and legislative developments occurred during 1996,
including the passage of the Telecommunications Act. The Telecommunications
Act is intended to promote competition in all sectors of the telecommunications
marketplace, while preserving and advancing universal telephone service.
As a result of the Telecommunications Act, the Company may be faced with
increased competition from numerous sources, including competitive access
providers (CAPs), alternative local-exchange carriers (ALECs), interexchange
carriers (IXCs), wireless carriers, cable providers, media and computer
companies. These companies collectively have the ability to offer a broad
array of voice, video and data services to business and residential customers.
Following passage of the Telecommunications Act, the FCC has undertaken to
issue rules governing three areas: interconnection, universal service and
access charge reform. In August 1996, the FCC adopted its rules governing
interconnection. These rules generally require local-exchange carriers (LECs)
to make their services available to competitors at a wholesale discount and to
make their network elements available to competitors at below-cost prices. GTE
petitioned for judicial review of these rules on the grounds that they were
inconsistent with the Telecommunications Act. In October 1996, the U.S. Court
of Appeals for the Eighth Circuit granted GTE's request for
11
<PAGE> 14
a stay of the pricing provisions of the FCC's rules pending the Court's
resolution of the merits of GTE's petition. Oral arguments on the merits were
held in January 1997, and the Court's ruling is expected in the spring of 1997.
In November 1996, the Federal-State Joint Board released its recommended
universal service plan, and in December 1996, the FCC issued its access reform
proposals. Both proposals incorporate a pricing methodology similar to the one
that GTE is appealing in the interconnection case. A final order in the
universal service proceeding must be adopted by early May 1997, and a decision
on the access reform proceeding is expected shortly thereafter.
A key provision of the Telecommunications Act eliminated the legal restraints
of the GTE Consent Decree which kept the Company from providing interLATA long
distance services. This action will simplify GTE's ability to market local,
intraLATA and interLATA service to its customers as a bundled service. In
February 1996, GTE executed an agreement whereby WorldCom, Inc. will provide,
on a non-exclusive basis, a full array of telecommunications services in
support of GTE's entry into the interLATA long distance market. In March 1996,
GTE, through a separate subsidiary, began offering long distance service to its
customers in selected markets. GTE now offers the service, marketed under the
name GTE Easy Savings Plan (sm), in all 50 states.
The Telecommunications Act forbids states from imposing any barriers to entry
into local and toll competition. To date, local competition has been
authorized in all 28 states where GTE currently offers local telephone service,
including Arkansas, New Mexico, Oklahoma and Texas. In addition, nineteen
states, including Texas, have authorized plans that would allow customers to
pre-subscribe to a specific carrier to handle their intraLATA toll calls.
Pre-subscribed customers will simply dial "1" before the telephone number in
order to complete intraLATA calls. GTE has proposals pending in all nine
states, including Arkansas, New Mexico and Oklahoma, which have not ordered
implementation.
Federal and state regulatory activity continued to change the traditional
cost-based, rate-of-return regulatory framework for intrastate and interstate
telephone service. Regulatory authorities have adopted various forms of
alternative regulation, which provide economic incentives to telephone service
providers to improve productivity and provide the foundation for implementing
pricing flexibility necessary to address competitive entry into the Company's
markets. The Public Utility Commission of Texas has adopted price regulation
for its intrastate telephone service. Regulatory commissions in the states of
Oklahoma, New Mexico and Arkansas 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 index based
upon inflation less a predetermined productivity target. LECs have limited
pricing flexibility provided they do not exceed the allowed price cap.
Further information regarding the Company's activities with the various
regulatory agencies and revenue arrangements with other telephone companies is
discussed in Note 13 to the Company's 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.
12
<PAGE> 15
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. Management believes that the Company has
adequately provided for this settlement in its financial statements for the
year ended December 31, 1996.
The Company is involved in two lawsuits and a Public Utility Commission of
Texas (TPUC) Complaint with Texas cities involving disputes over amounts owed
under right-of-way contracts. On September 30, 1996, the Company and 21 of the
cities announced an agreement in principle that will end the right-of-way
disputes between them. Final approval by the cities and the Company is
pending, but the settlement will include implementation of new right-of-way
agreements. Management believes that the Company has adequately provided for
these disputes in its financial statements for the year ended December 31,
1996.
INITIATIVES
In 1996, the Company and its parent, GTE, continued to position themselves to
respond aggressively to competitive developments and benefit from new
opportunities. Further information regarding these initiatives is discussed in
Item 1.
INFLATION
The Company's management generally does not believe inflation has a significant
impact on the Company's earnings. However, increases in costs or expenses not
otherwise offset by increases in revenues could have an adverse effect on
earnings.
13
<PAGE> 16
Item 8. Financial Statements and Supplementary Data
GTE Southwest Incorporated
STATEMENTS OF INCOME (Note 3)
<TABLE>
<CAPTION>
Years Ended December 31 1996 1995 1994
- ----------------------- ----------- ----------- -----------
(Thousands of Dollars)
<S> <C> <C> <C>
REVENUES AND SALES (a)
Local services $ 589,143 $ 531,849 $ 490,359
Network access services 627,313 579,038 577,706
Toll services 182,832 214,278 244,856
Other services and sales 223,651 190,214 169,574
----------- ----------- -----------
Total revenues and sales 1,622,939 1,515,379 1,482,495
----------- ----------- -----------
OPERATING COSTS AND EXPENSES (b)
Cost of services and sales 603,598 590,258 621,299
Selling, general and administrative 269,834 257,465 260,704
Depreciation and amortization 341,742 338,795 321,016
----------- ----------- -----------
Total operating costs and expenses 1,215,174 1,186,518 1,203,019
----------- ----------- -----------
OPERATING INCOME 407,765 328,861 279,476
OTHER (INCOME) EXPENSE
Interest - net 54,297 61,218 63,568
Gain on disposition of assets (4,322) (21,583) (63,688)
Other - net (28,179) (5,500) --
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 385,969 294,726 279,596
Income taxes 130,173 99,437 95,068
----------- ----------- -----------
INCOME BEFORE EXTRAORDINARY CHARGES 255,796 195,289 184,528
Extraordinary charges -- (549,438) --
----------- ----------- -----------
NET INCOME (LOSS) $ 255,796 $ (354,149) $ 184,528
=========== =========== ===========
</TABLE>
(a) Includes billings to affiliates of $39,736, $45,564 and $35,658 for the
years 1996-1994, respectively.
(b) Includes billings from affiliates of $98,071, $103,877 and $89,766 for the
years 1996-1994, respectively.
See Notes to Financial Statements.
14
<PAGE> 17
GTE Southwest Incorporated
BALANCE SHEETS (Note 3)
<TABLE>
<CAPTION>
December 31 1996 1995
- ----------- ---------- ----------
(Thousands of Dollars)
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 23,134 $ 17,825
Receivables, less allowances of $23,633 and $21,182 312,047 274,838
Note receivable from affiliate 79,727 3,000
Inventories and supplies 20,310 20,452
Deferred income tax benefits 12,684 32,033
Prepaid taxes and other 11,940 45,630
---------- ----------
Total current assets 459,842 393,778
---------- ----------
Property, plant and equipment, net 1,985,744 1,966,506
Employee benefit plans and other assets 123,270 86,276
---------- ----------
Total assets $2,568,856 $2,446,560
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term obligations, including current maturities $ 1,669 $ 49,862
Accounts payable 93,850 101,548
Affiliate payables and accruals 74,275 43,970
Advanced billings and customer deposits 38,011 36,568
Taxes payable 35,059 36,940
Accrued interest 10,785 6,657
Accrued payroll costs 43,732 46,038
Dividends payable 49,752 198
Accrued restructuring costs -- 82,872
Other 99,496 84,510
---------- ----------
Total current liabilities 446,629 489,163
---------- ----------
Long-term debt 866,894 827,082
Deferred income taxes 169,383 178,003
Employee benefit plans 192,362 145,799
Other liabilities 54,687 84,404
---------- ----------
Total liabilities 1,729,955 1,724,451
---------- ----------
Preferred stock, subject to mandatory redemption 6,450 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 126,100 7,368
---------- ----------
Total shareholders' equity 832,451 713,719
---------- ----------
Total liabilities and shareholders' equity $2,568,856 $2,446,560
========== ==========
</TABLE>
See Notes to Financial Statements.
15
<PAGE> 18
GTE Southwest Incorporated
STATEMENTS OF CASH FLOWS (Note 3)
<TABLE>
<CAPTION>
Years Ended December 31 1996 1995 1994
- ----------------------- --------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
OPERATIONS
Income before extraordinary charges $ 255,796 $ 195,289 $ 184,528
Adjustments to reconcile income before extraordinary
charges to net cash from operations:
Depreciation and amortization 341,742 338,795 321,016
Deferred income taxes 10,729 16,312 (10,697)
Gain on disposition of assets (4,322) (21,583) (63,688)
Provision for uncollectible accounts 36,010 33,136 34,868
Change in current assets and current liabilities:
Receivables - net (96,446) (59,328) (34,660)
Other current assets (1,977) (15,635) (8,905)
Accrued taxes and interest 26,908 (17,924) (11,132)
Other current liabilities (43,591) (65,392) 21,699
Other - net (15,024) (10,857) 48,982
--------- --------- ---------
Net cash from operations 509,825 392,813 482,011
--------- --------- ---------
INVESTING
Capital expenditures (354,615) (319,162) (378,037)
Proceeds from sale of assets 12,344 36,576 158,189
Other - net -- (5,478) (964)
--------- --------- ---------
Net cash used in investing (342,271) (288,064) (220,812)
--------- --------- ---------
FINANCING
Long-term debt issued 147,884 -- --
Long-term debt and preferred stock retired (13,673) (20,968) (48,980)
Dividends (87,510) (143,194) (201,279)
Increase (decrease) in short-term obligations,
excluding current maturities (208,946) 66,064 15,142
Return of capital to GTE -- -- (22,528)
Other - net -- 712 --
--------- --------- ---------
Net cash used in financing (162,245) (97,386) (257,645)
--------- --------- ---------
Increase in cash and cash equivalents 5,309 7,363 3,554
Cash and cash equivalents:
Beginning of year 17,825 10,462 6,908
--------- --------- ---------
End of year $ 23,134 $ 17,825 $ 10,462
========= ========= =========
Cash paid during the year for:
Interest $ 56,751 $ 64,626 $ 66,410
Income taxes 99,670 111,154 112,303
</TABLE>
See Notes to Financial Statements.
16
<PAGE> 19
GTE Southwest Incorporated
STATEMENTS OF SHAREHOLDERS' EQUITY (Note 3)
<TABLE>
<CAPTION>
Additional
Preferred Common Paid-In Retained
Stock Stock Capital Earnings Total
---------- ---------- ---------- ---------- ----------
(Thousands of Dollars)
<S> <C> <C> <C> <C> <C>
Shareholders' equity, December 31, 1993 $ 7,600 $ 650,000 $ 71,279 $ 503,298 $1,232,177
Net income 184,528 184,528
Dividends declared (244,291) (244,291)
Return of capital (a) (22,528) (22,528)
---------- ---------- ---------- ---------- ----------
Shareholders' equity, December 31, 1994 7,600 650,000 48,751 443,535 1,149,886
Net loss (354,149) (354,149)
Dividends declared (82,018) (82,018)
---------- ---------- ---------- ---------- ----------
Shareholders' equity, December 31, 1995 7,600 650,000 48,751 7,368 713,719
Net income 255,796 255,796
Dividends declared (137,064) (137,064)
---------- ---------- ---------- ---------- ----------
Shareholders' equity, December 31, 1996 $ 7,600 $ 650,000 $ 48,751 $ 126,100 $ 832,451
========== ========== ========== ========== ==========
</TABLE>
(a) During 1994, the Company returned $22.5 million of capital to GTE with the
cash proceeds from certain non- strategic property sales (see Note 5 to
the financial statements).
See Notes to Financial Statements.
17
<PAGE> 20
GTE Southwest Incorporated
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
GTE Southwest Incorporated (the Company) provides a wide variety of
communications services ranging from local telephone service for the home and
office to highly complex voice and data services for various industries. At
December 31, 1996, the Company served 2,338,937 access lines in the states of
Arkansas, New Mexico, Oklahoma and Texas. The Company is a wholly-owned
subsidiary of GTE Corporation (GTE).
BASIS OF PRESENTATION
The Company prepares its financial statements in accordance with generally
accepted accounting principles which require that management make estimates and
assumptions that affect reported amounts. Actual results could differ from
those estimates.
On February 28, 1995, the Company entered into an Agreement of Merger with
Contel of Texas, Inc., a Texas corporation and Contel of the West, Inc., an
Arizona corporation (the Merger). The Merger became effective on December 31,
1995 and has been accounted for in a manner similar to a "pooling of interests"
(see Note 3).
The Company discontinued applying the provisions of Statement of Financial
Accounting Standards No. 71, "Accounting for the Effects of Certain Types of
Regulation" (FAS 71), in the fourth quarter of 1995 (see Note 2).
Reclassifications of prior year data have been made, where appropriate, to
conform to the 1996 presentation.
TRANSACTIONS WITH AFFILIATES
GTE Supply (100% owned by GTE) provides construction and maintenance equipment,
supplies and electronics repair services to the Company. These purchases and
services amounted to $105.7 million, $91.2 million and $90.3 million for the
years 1996-1994, respectively. Such purchases and services are recorded in the
accounts of the Company, at cost, which includes a normal return realized by
GTE Supply.
The Company is billed for certain printing and other costs associated with
telephone directories, data processing services and equipment rentals, and
receives management, consulting, research and development and pension
management services from other affiliated companies. These charges amounted to
$98.1 million, $103.9 million and $89.8 million for the years 1996-1994,
respectively. The amounts charged for these affiliated transactions are based
on a proportional cost allocation method.
The Company's financial statements include allocated expenses based on the
sharing of certain executive, administrative, financial, accounting, marketing,
personnel, engineering, and other support services being performed at
consolidated work centers among the domestic GTE Telephone Operating Companies.
The amounts charged for these affiliated transactions are based on a
proportional cost allocation method as filed with the Federal Communications
Commission (FCC).
The Company has an agreement with GTE Directories Corporation (Directories)
(100% owned by GTE), whereby the Company provides its subscriber lists, billing
and collection and other services to Directories. Revenues from these
activities amounted to $39.7 million, $45.6 million and $35.7 million for the
years 1996-1994, respectively.
18
<PAGE> 21
TELEPHONE PLANT
In 1996, the Company began providing for depreciation on a straight-line basis
over the estimated economic lives of its assets (see Note 2). The Company had
previously provided for depreciation on a straight-line basis over asset lives
approved by regulators. Maintenance and repairs of property are charged to
income as incurred. Additions to, replacements and renewals of property are
charged to telephone plant accounts. Property retirements are charged in total
to the accumulated depreciation account. No adjustment to depreciation is made
at the time properties are retired or otherwise disposed of, except in the case
of significant sales or extraordinary retirements of property where profit or
loss is recognized.
REVENUE RECOGNITION
Revenues are recognized when earned. This is generally based on usage of the
Company's local-exchange networks or facilities. For other products and
services, revenues are generally recognized when services are rendered or
products are delivered to customers.
INVENTORIES AND SUPPLIES
Inventories and supplies are stated at the lower of cost, determined
principally by the average cost method, or net realizable value.
EMPLOYEE BENEFIT PLANS
Pension and postretirement health care and life insurance benefits earned
during the year as well as interest on accumulated benefit obligations are
accrued currently. Prior service costs and credits resulting from changes in
plan benefits are amortized over the average remaining service period of the
employees expected to receive benefits. Material curtailment/settlement gains
and losses associated with employee separations are recognized in the period in
which they occur.
STOCK OPTION PLANS
In 1995, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (FAS
123). As permitted by FAS 123, the Company continues to apply the recognition
and measurement provisions of Accounting Principles Board Opinion No. 25, "
Accounting for Stock Issued to Employees" (APB 25). The difference between the
recognition and measurement provisions of FAS 123 and APB 25 is not significant
to the Company's results of operations.
INCOME TAXES
The Company's results are included in GTE's consolidated federal income tax
return. The Company participates in a tax- sharing agreement with GTE and
remits tax payments to GTE based on its tax liability on a separate company
basis.
Deferred tax assets and liabilities are established for temporary differences
between the way certain income and expense items are reported for financial
reporting and tax purposes and subsequently adjusted to reflect changes in tax
rates expected to be in effect when the temporary differences reverse. A
valuation allowance is established for any deferred tax asset for which
realization is not likely.
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.
19
<PAGE> 22
2. EXTRAORDINARY CHARGES
In response to legislation (see Note 13) and the increasingly competitive
environment, the Company discontinued the use of FAS 71 in the fourth quarter
of 1995.
As a result of the decision to discontinue FAS 71, the Company recorded a
non-cash, after-tax extraordinary charge of $549.3 million (net of tax benefits
of $301.6 million) in the fourth quarter of 1995. The charge primarily
represents a reduction in the net book value of telephone plant and equipment
through an increase in accumulated depreciation. In addition to the one-time
charge, beginning in 1996, the Company shortened the depreciable lives of its
telephone plant and equipment as follows:
<TABLE>
<CAPTION>
Depreciable Lives
------------------------
Average
Asset Category Before After
-------------- --------- -------
<S> <C> <C>
Copper 20-30 15
Switching 17-19 10
Circuit 11-13 8
Fiber 25-30 20
</TABLE>
In addition, during 1995, the Company redeemed prior to stated maturity, $5.6
million of long-term debt. These redemptions resulted in an after-tax
extraordinary charge of $0.1 million (net of tax benefits).
3. LEGAL ENTITY MERGER
On February 28, 1995, the Company entered into an Agreement of Merger with
Contel of Texas, Inc., a Texas corporation and Contel of the West, Inc., an
Arizona corporation (collectively, the Contel Subsidiaries). The agreement
provided that the Contel Subsidiaries would merge with and into the Company,
with the Company to be the surviving corporation (the Merger). The Merger
became effective on December 31, 1995, and has been accounted for in a manner
similar to a "pooling of interests." Accordingly, the financial statements
include the combined historical results of operations and financial position of
the Company and the Contel Subsidiaries as though the Merger had occurred at
the beginning of each period presented and reflect the elimination of
significant intercompany transactions.
4. RESTRUCTURING COSTS
During 1993, the Company recorded one-time restructuring costs of $199 million,
which reduced net income by $122.6 million, primarily for incremental costs
related to implementation of the Company's re-engineering plan to improve
customer-responsiveness and product quality, reduce the time necessary to
introduce new products and services and further reduce costs. The
restructuring costs included $134.7 million to re-engineer customer service
processes and $48.5 million to re-engineer administrative processes. The
restructuring costs also included $15.8 million to consolidate facilities and
operations and other related costs. These expenditures were primarily
associated with the closure and relocation of various service centers, software
enhancements and separation benefits associated with employee reductions. The
re-engineering plan was substantially completed in 1996, consistent with the
original cost estimates.
20
<PAGE> 23
5. PROPERTY REPOSITIONING
On May 31, 1996, the Company sold a portion of its telephone plant-in-service,
inventories and supplies and customers (representing 6,196 access lines) in the
state of Texas for $11 million in cash. A pre-tax gain of $4.3 million was
recorded on the sale. The proceeds from this transaction were used primarily
to reduce short-term obligations.
On September 30, 1995, the Company sold a portion of its telephone
plant-in-service, inventories and supplies and customers (representing 10,517
access lines) in the state of Texas to various parties for $29.6 million in
cash. A pre-tax gain of $16.3 million was recorded on the sale. The proceeds
from this transaction were used primarily to reduce short-term obligations and
to pay $18.7 million of dividends to GTE in the fourth quarter of 1995.
On May 4, 1995, the Company sold its unconsolidated investment in Metropolitan
Houston Paging Service, Inc. (a Texas corporation) for $7 million in cash. A
pre-tax gain of $5.3 million was recorded on the sale. The proceeds from this
transaction were used primarily to reduce short-term obligations.
On November 30, 1994, the Company sold a portion of its telephone
plant-in-service, inventories and supplies and customers (representing 8,898
access lines) in the state of Oklahoma to Pioneer Telephone Cooperative, Inc.
for $26.8 million in cash. A pre-tax gain of $12.6 million was recorded on the
sale. The proceeds from this transaction were used primarily to reduce
short-term obligations.
On November 30, 1994, the Company sold a portion of its telephone
plant-in-service, inventories and supplies and customers (representing 26,519
access lines) in the state of Arizona to Citizens Utilities Company for $90.4
million in cash. A pre-tax gain of $41.8 million was recorded on the sale.
The proceeds from this transaction were used primarily to pay down $8 million
of long-term debt and pay $54.5 million of dividends to GTE.
On May 1, 1994, the Company sold a portion of its telephone plant-in-service,
inventories and supplies and customers (representing 12,798 access lines) in
the state of Oklahoma to Eaglenet, Inc. for $41 million in cash. A pre-tax
gain of $9.3 million was recorded on the sale. The proceeds from this
transaction were used primarily to pay down $30 million of long-term debt.
21
<PAGE> 24
6. PREFERRED STOCK
The authorized cumulative preferred stock, not subject to mandatory redemption,
consists of 2,060,758 shares. Shares outstanding at December 31, 1996 and 1995
are as follows:
<TABLE>
<CAPTION>
Outstanding: Shares Amount
------- ------
(Thousands
of Dollars)
<S> <C> <C>
$2.20 no par value 32,000 $1,600
5.10% $20 par value 300,000 6,000
------- ------
Total 332,000 $7,600
======= ======
</TABLE>
Cumulative preferred stock, subject to mandatory redemption, is as follows:
<TABLE>
<CAPTION>
Authorized: Shares
<S> <C>
4.60% $20 par value 350,000
$8.10 no par value 300,000
-------
650,000
=======
</TABLE>
<TABLE>
<CAPTION>
December 31
-----------------------------------------
1996 1995
------------------- -------------------
Shares Amount Shares Amount
-------- -------- -------- --------
Outstanding: (Thousands (Thousands
of Dollars) of Dollars)
<S> <C> <C> <C> <C>
4.60% $20 par value 82,500 $ 1,650 89,500 $ 1,790
$8.10 no par value 48,000 4,800 66,000 6,600
-------- -------- -------- --------
Total 130,500 $ 6,450 155,500 $ 8,390
======== ======== ======== ========
</TABLE>
The 4.60% Series sinking fund provisions require the Company to redeem a
minimum of 7,000 shares at $20 per share on April 1 of each year. This
requirement was met in 1996 and 1995 with the purchase of 7,000 shares per
year.
The $8.10 Series sinking fund provisions require the redemption of a minimum of
9,000 shares at $100 per share on November 1 of each year. The Company
redeemed 18,000 shares in 1996 and 1995 to meet this requirement.
The preferred shareholders are entitled to voting rights (on an equal basis
with the common shareholder) in the event dividends in arrears equal or exceed
the annual dividends on all preferred stock. Otherwise, the preferred
shareholders have no voting rights. The Company is not in arrears in its
dividend payments at December 31, 1996.
The aggregate redemption requirements of preferred stock subject to mandatory
redemption are $1 million in each of the years 1997-2001.
No shares of preferred stock were 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.
22
<PAGE> 25
7. COMMON STOCK
The authorized common stock of the Company consists of 6,500,000 shares with a
stated value of $100 per share. All outstanding shares of common stock are
held by GTE.
Effective December 31, 1995, the Company issued 50,000 shares of its common
stock to GTE in exchange for all of the outstanding common stock of the Contel
Subsidiaries (see Note 3).
There were no shares of common stock held by or for the account of the Company
and no shares were reserved for officers and employees, or for options,
warrants, conversions or other rights.
At December 31, 1996, $55.9 million of the Company's retained earnings were
restricted as to the payment of cash dividends on common stock under the most
restrictive terms of the Company's Certificate of Incorporation.
23
<PAGE> 26
8. DEBT
Long-term debt as of December 31, was as follows:
<TABLE>
<CAPTION>
1996 1995
--------- --------
(Thousands of Dollars)
<S> <C> <C>
First mortgage bonds:
5 3/8 % Series, due 1996 $ -- $ 9,000
6 7/8 % Series, due 1998 25,000 25,000
7 1/2 % Series, due 2002 40,000 40,000
8 1/2 % Series, due 2031 100,000 100,000
9.70 % Series S, due 2002 8,180 9,544
9.74 % Series T, due 2013 12,600 12,900
9.36 % Series U, due 2014 35,000 35,000
Debentures:
5.82 % Series A, due 1999 250,000 250,000
6.54 % Series B, due 2005 250,000 250,000
6.00 % Series C, due 2006 150,000 --
Other:
Commercial paper refinanced on a long-term basis -- 105,800
Capitalized leases 61 1,130
--------- --------
Total principal amount 870,841 838,374
Less: discount (2,278) (933)
--------- --------
Total 868,563 837,441
Less: current maturities (1,669) (10,359)
--------- --------
Total long-term debt $ 866,894 $827,082
========= ========
</TABLE>
The Company issued $150 million of 6% Series C Debentures, due 2006, in January
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.
Long-term debt as of December 31, 1995, includes $105.8 million of commercial
paper which was refinanced in January 1996, as discussed above.
The aggregate principal amount of first mortgage bonds and debentures that may
be issued is subject to the restrictions and provisions of the Company's
indentures. None of the securities shown above were held in sinking or other
special funds of the Company or pledged by the Company. Debt discounts 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: $1.7
million in 1997; $26.7 million in 1998; $251.7 million in 1999 and $4 million
in 2000 and 2001.
24
<PAGE> 27
Total short-term obligations as of December 31, were as follows:
<TABLE>
<CAPTION>
1996 1995
--------- ---------
(Thousands of Dollars)
<S> <C> <C>
Notes payable to affiliate - average rate 6.1% $ -- $ 39,503
Current maturities of long-term debt 1,669 10,359
--------- ---------
Total $ 1,669 $ 49,862
========= =========
</TABLE>
On July 1, 1996, the Company began participating with other affiliates in a
$1.5 billion syndicated line of credit to back up commercial paper borrowings.
Through this shared arrangement, the Company can issue up to $300 million of
commercial paper.
9. FINANCIAL INSTRUMENTS
The fair values of financial instruments, other than long-term debt, closely
approximate their carrying values. As of December 31, 1996 and 1995, the
estimated fair value of long-term debt based on either reference to quoted
market prices or an option pricing model, exceeded the carrying value by
approximately $5 million and $42 million, respectively.
25
<PAGE> 28
10. INCOME TAXES
The provision (benefit) for income taxes is as follows:
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
Current:
Federal $ 124,689 $ 78,708 $ 92,583
State (5,245) 4,417 13,182
--------- --------- ---------
119,444 83,125 105,765
--------- --------- ---------
Deferred:
Federal 9,220 26,111 3,933
State 8,133 (1,729) (4,348)
--------- --------- ---------
17,353 24,382 (415)
--------- --------- ---------
Amortization of deferred investment tax credits (6,624) (8,070) (10,282)
--------- --------- ---------
Total $ 130,173 $ 99,437 $ 95,068
========= ========= =========
</TABLE>
A reconciliation between taxes computed by applying the statutory federal
income tax rate to pre-tax income and income taxes provided in the statements
of income is as follows:
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
Amounts computed at statutory rates $ 134,724 $ 102,763 $ 97,858
State and local income taxes, net of federal income tax benefits 1,877 2,124 5,730
Amortization of deferred investment tax credits, net of
federal income tax benefits (4,305) (8,070) (10,282)
Depreciation of telephone plant construction costs
previously deducted for tax purposes - net -- 3,133 2,382
Rate differentials applied to reversing temporary differences -- (1,299) (3,087)
Other differences, including settlements of prior year
tax issues (2,123) 786 2,467
--------- --------- ---------
Total provision $ 130,173 $ 99,437 $ 95,068
========= ========= =========
</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>
1996 1995
--------- ---------
(Thousands of Dollars)
<S> <C> <C>
Depreciation and amortization $ 179,800 $ 198,756
Employee benefit obligations (67,056) (59,879)
Prepaid pension cost 36,146 24,655
Investment tax credits 9,961 14,266
Other- net (2,152) (31,828)
--------- ---------
Total $ 156,699 $ 145,970
========= =========
</TABLE>
26
<PAGE> 29
11. EMPLOYEE BENEFIT PLANS
RETIREMENT PLANS
The Company sponsors noncontributory defined benefit pension plans covering
substantially all employees. The benefits to be paid under these plans are
generally based on years of credited service and average final earnings. The
Company's funding policy, subject to the minimum funding requirements of U.S.
employee benefit and tax laws, is to contribute such amounts as are determined
on an actuarial basis to provide the plans with assets sufficient to meet the
benefit obligations of the plans. The assets of the plans consist primarily of
corporate equities, government securities and corporate debt securities.
The components of the net pension credit for 1996-1994 were as follows:
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
Benefits earned during the year $ 15,158 $ 13,435 $ 18,955
Interest cost on projected benefit obligations 37,971 37,427 38,626
Return on plan assets:
Actual (133,257) (156,937) 1,834
Deferred 63,342 94,244 (68,923)
Other - net (11,953) (14,491) (11,106)
--------- --------- ---------
Net pension credit $ (28,739) $ (26,322) $ (20,614)
========= ========= =========
</TABLE>
The expected long-term rate of return on plan assets was 9.0% for 1996 and 8.5%
for 1995 and 1994.
The funded status of the plans and the net prepaid pension cost at December 31,
were as follows:
<TABLE>
<CAPTION>
1996 1995
--------- ---------
(Thousands of Dollars)
<S> <C> <C>
Vested benefit obligations $ 395,321 $ 349,378
========= =========
Accumulated benefit obligations $ 447,751 $ 404,047
========= =========
Plan assets at fair value $ 980,646 $ 861,063
Less: projected benefit obligations 558,970 516,001
--------- ---------
Excess of assets over projected obligations 421,676 345,062
Unrecognized net transition asset (40,339) (46,505)
Unrecognized net gain (276,061) (225,922)
--------- ---------
Net prepaid pension cost $ 105,276 $ 72,635
========= =========
</TABLE>
Assumptions used to develop the projected benefit obligations at December 31,
were as follows:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Discount rate 7.50% 7.50%
Rate of compensation increase 5.25% 5.25%
</TABLE>
27
<PAGE> 30
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
Substantially all of the Company's employees are covered under postretirement
health care and life insurance benefit plans. The health care benefits paid
under the plans are generally based on comprehensive hospital, medical and
surgical benefit provisions. The Company funds amounts for postretirement
benefits as deemed appropriate from time to time.
The postretirement benefit cost for 1996-1994 included the following
components:
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
(Thousands of Dollars)
<S> <C> <C> <C>
Benefits earned during the year $ 4,707 $ 6,123 $ 7,862
Interest on accumulated postretirement benefit obligations 23,474 26,265 26,816
Actual return on plan assets (72) (485) --
Amortization of transition obligation 11,505 13,980 14,723
Other - net (283) (242) 18
-------- -------- --------
Postretirement benefit cost $ 39,331 $ 45,641 $ 49,419
======== ======== ========
</TABLE>
The following table sets forth the plans' funded status and the accrued
postretirement benefit obligations as of December 31:
<TABLE>
<CAPTION>
1996 1995
--------- ---------
(Thousands of Dollars)
<S> <C> <C>
Accumulated postretirement benefit obligations attributable to:
Retirees $ 221,067 $ 217,377
Fully eligible active plan participants 9,066 7,458
Other active plan participants 104,962 133,013
--------- ---------
Total accumulated postretirement benefit obligations 335,095 357,848
Less: fair value of plan assets 2,799 4,736
--------- ---------
Excess of accumulated obligations over plan assets 332,296 353,112
Unrecognized transition obligation (182,752) (229,973)
Unrecognized net gain 39,290 18,653
--------- ---------
Accrued postretirement benefit obligations $ 188,834 $ 141,792
========= =========
</TABLE>
The assumed discount rates used to measure the accumulated postretirement
benefit obligations were 7.5% at December 31, 1996 and December 31, 1995. The
assumed health care cost trend rate was 8.75% in 1996 and averaged 9.75% in
1995 and is assumed to decrease gradually to an ultimate rate of 6.0% in the
year 2004. A one percentage point increase in the assumed health care cost
trend rate for each future year would have increased 1996 costs by $2.8 million
and the accumulated postretirement benefit obligations as of December 31, 1996,
by $28.7 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 $5.5 million, $4.9 million and $5.1 million in
1996-1994, respectively.
28
<PAGE> 31
12. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is summarized as follows at December 31:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
(Thousands of Dollars)
<S> <C> <C>
Land $ 15,725 $ 17,220
Buildings 360,121 366,791
Plant and equipment 4,260,841 4,086,569
Other 407,143 383,632
----------- -----------
Total 5,043,830 4,854,212
Accumulated depreciation (see Note 2) (3,058,086) (2,887,706)
----------- -----------
Total property, plant and equipment - net $ 1,985,744 $ 1,966,506
=========== ===========
</TABLE>
Depreciation expense in 1996-1994 was equivalent to a composite average
percentage of 7.0%, 6.3%, and 6.8%, respectively.
13. REGULATORY AND COMPETITIVE MATTERS
The Company's intrastate business is regulated by the state regulatory
commissions in Arkansas, New Mexico, Oklahoma and Texas. The Company is
subject to regulation by the FCC for its interstate business operations.
INTRASTATE SERVICES
The Company provides local-exchange services to customers within its designated
franchise area. 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. The Company also provides long distance
access services directly to interexchange carriers and other customers who
provide services between LATAs.
Texas
The Public Utility Commission of Texas (TPUC) approved a rulemaking procedure
on December 17, 1991, with an effective date of January 1, 1991, allowing the
Company and other LECs to exit the intraLATA toll pool with diminishing
transition payments from Southwestern Bell Telephone Company to be received
through 1997.
After exiting the toll pool, the Company began participating in the Texas
Pooling Alternative Settlement Plan (PASP) effective January 1, 1994. The PASP
is also known as an Originating Responsibility Plan. Under this plan, the toll
rates billed to end users for intraLATA toll calls originating in the Company's
service area are retained by the Company. The Company, in turn, pays access
charges to the telephone company hauling and terminating the call based on that
company's approved access charge tariff. Likewise, the Company will receive
access charges for terminating any intraLATA toll call that originates outside
of its service area based on its approved access charge tariff.
On August 2, 1996, the TPUC approved an interim Expanded Local Calling (ELC)
surcharge of $0.92 per line to be assessed on customers in non-ELC exchanges
consistent with the Public Utility Regulatory Act (PURA). The Company began
billing the interim rate on September 16, 1996. On November 21, 1996, the
Company filed a Stipulation and Settlement Agreement. A final order, approved
in February 1997, stipulated a surcharge of $0.73 per line which will generate
approximately $11.6 million annually. The difference in the interim surcharge
and the stipulated surcharge will be refunded to the ratepayers in April 1997.
29
<PAGE> 32
On December 12, 1996, the TPUC 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 22.99%. The Company must file revised cost studies by June 1, 1997.
Interim rates were ordered and negotiated permanent rates must be established
by September 15, 1997. The Company filed a lawsuit in the U.S. District Court
challenging portions of the TPUC's arbitration determinations. On March 13,
1997, the case was dismissed without prejudice, and the Company will have to
refile after the contract is effective.
On December 19, 1996, the TPUC issued its decision in the Company's arbitration
with Sprint on many of the same issues that were submitted by AT&T. This
decision reaffirmed the rates issued in the previous arbitration proceedings.
The Company has filed a lawsuit in the U.S. District Court challenging portions
of the TPUC's arbitration determinations.
On February 10, 1997, the TPUC ordered implementation of intraLATA 1+
pre-subscription which allows customers to choose their primary carrier for
intraLATA toll calls. Currently, the local phone company carries all intraLATA
toll calls when the customer dials one plus the called number. In the future,
the customer will be able to choose the local telephone company, or another
company, to carry these calls. The Company is required to convert all capable
offices to 1+ pre-subscription by August 8, 1997.
Texas Rate Case
On June 19, 1991, the Texas Third District Court of Appeals (Court of Appeals)
affirmed, in part, and reversed in part a decision by the District Court of
Travis County (District Court) regarding the Company's 1989 rate case. The
Court of Appeals affirmed the portion of the District Court's order which
determined that the TPUC had no authority to retroactively adjust the Company's
rates. That portion of the TPUC's order would have resulted in customer
refunds of approximately $140 million. The Court of Appeals also affirmed the
District Court's determination relating to the manner in which the TPUC had
calculated the Company's rate of return in setting its rates. The Court of
Appeals, however, reversed the District Court's determination that the TPUC had
made appropriate findings related to payments made by the Company to two of its
affiliates. In addition, the Court of Appeals reversed the District Court's
determination related to the TPUC's treatment of the Company's federal income
tax expense. The Company appealed this decision to the Supreme Court of Texas
and, in April 1995, the Supreme Court of Texas ruled on an appeal of the
Company's 1989 rate case. The Court agreed with the Company's position
concerning retroactive ratemaking, the ratemaking treatment of federal income
tax expense and the payment for services provided by GTE Service Corporation, a
wholly-owned subsidiary of GTE. The issue of payments associated with
telephone directories published by GTE Directories Corporation, also a
wholly-owned subsidiary of GTE, was remanded to the TPUC.
Subsequent to the Supreme Court's decision, the state of Texas passed a
telecommunications reform bill which was signed into law on May 26, 1995, and
became effective September 1, 1995. This new legislation opens the
local-exchange to competition and permits existing LECs to elect a form of
price regulation rather than rate of return regulation. The incentive form of
price regulation requires LECs to cap basic service rates for four years, after
which indexed, TPUC- approved rate adjustments will be permitted. The price
regulation plan contained in the reform bill also requires all calls be
digitally switched by year-end 1998 and for the provision of broadband
facilities to schools, libraries and hospitals on customer demand. On
September 20, 1995, the Company notified the TPUC of its election of price
regulation and, in doing so, resolved the remaining open issues of the 1989
rate case. In conjunction with its decision to elect price regulation, the
Company must make certain investments in its network, as discussed above. The
Company also elected to amortize the reserve previously established for
potential refunds related to the rate case on a straight-line basis over the
four-year period for which revenues will be capped. The remaining reserve is
reflected on the balance sheets as other current liabilities and other
non-current liabilities.
Oklahoma
On April 19, 1994, the Oklahoma Corporation Commission (OCC) approved a Joint
Stipulation and Settlement Agreement in the consolidated docket to end the Toll
Surcharge Pool in Oklahoma. This order allowed the Company to exit the toll
pool while receiving transition payments during a three-year (1994-1996)
conversion period to an access
30
<PAGE> 33
charge arrangement. During this transition period, the industry, interexchange
carriers and OCC staff developed an agreement for an IntraLATA Access Plan.
The OCC approved the Access Plan Stipulation Plan (the Plan) in January 1996,
and the Plan became effective March 1, 1996.
On December 7, 1995, the OCC approved a Joint Stipulation in the Company's rate
case which reduced annual revenues by $5.5 million and allowed for full
recovery of $14.7 million in OCC-mandated network modernization requirements
through a modernization surcharge. Tariffs, which reflect the ordered revenue
changes, were filed with the OCC on January 8, 1996. The local service rate
changes amount to $4.7 million and the approved access tariff changes amount to
$0.8 million. These rate changes became effective March 6, 1996.
On March 7, 1996, the 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. On December 12, 1996, the OCC 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 16.1%. Interim rates based on the FCC proxy rates will be
used for interconnection and unbundled network elements until permanent
discounts are established upon further investigation into cost methodology,
which is expected to take place in the second quarter of 1997. The Company has
filed a lawsuit in the U.S. District Court challenging portions of the OCC's
arbitration determinations.
New Mexico
On September 1, 1994, the Company filed a rate case proceeding in New Mexico.
The proceeding was bifurcated into two phases. On April 13, 1995, the New
Mexico Service Corporation Commission (NMSCC) issued an order in the first
phase of the New Mexico rate proceeding requiring the Company to decrease its
revenues by $8.3 million annually, effective immediately. Hearings were held
on the second phase of the proceeding, which considered rate design, and an
order was issued on December 27, 1995 approving various rates and structures
which were placed into service during the first quarter of 1996. Refunds to
customers back to April 13, 1995 were made in the second quarter of 1996.
Arkansas
On June 9, 1995, the Arkansas Public Service Commission (APSC) ordered the
Company to reduce rates by $12.8 million annually. The Company filed a motion
for reconsideration on July 7, 1995, which was approved by the APSC on July 10,
1995. The APSC issued a final decision, effective December 5, 1995, which
upheld its original order.
INTERSTATE SERVICES
For the provision of interstate services, the Company operates under the terms
of the FCC's price cap incentive plan. The "price cap" mechanism serves to
limit the rates a carrier may charge, rather than just regulating the rate of
return which may be achieved. Under this approach, the maximum price that the
LEC may charge is increased or decreased each year by a price index based upon
inflation less a predetermined productivity target. LECs have limited pricing
flexibility provided they do not exceed the allowed price cap.
The interim rules allowed LECs to select from three productivity/sharing
options for each tariffed entity. Each of the three options reflected an
increase to the 3.3% productivity factor used since 1991. The Company selected
the following productivity factors and sharing thresholds for use in the
1996-1997 and 1995-1996 tariff years:
31
<PAGE> 34
<TABLE>
<CAPTION>
Sharing Parameters
Tariff Productivity ------------------------------------
Entity Factor 50% 100%
------ ------------ ---------------- --------------
<S> <C> <C> <C>
1996-1997 Tariff Year
---------------------
Arkansas, Texas (GTE) and 4.0% 12.25-13.25% ROR Over 13.25% ROR
Oklahoma
New Mexico and Texas (Contel) 5.3% None None
1995-1996 Tariff Year
---------------------
Arkansas and Texas (GTE) 4.0% 12.25-13.25% ROR Over 13.25% ROR
New Mexico, Texas (Contel) and
Oklahoma 5.3% None None
</TABLE>
Since the Company's access fees were priced significantly below the FCC's
maximum price, the Company was permitted to file tariffs effective May 24,
1995, to increase rates $9.6 million annually. In addition, the Company filed
tariffs effective August 1, 1995, under the interim rules to reduce rates $0.9
million, annually. On September 20, 1995, the FCC released its proposed
rulemaking proceeding on price caps which proposes specific changes to reflect
and encourage emerging competition in local and access services markets and to
establish the path towards decreased regulation of LECs' services. On
September 27, 1995, the FCC solicited comments on a number of specific issues
regarding methods for establishing the price caps, such as productivity
measurements, sharing, the common line formula and exogenous costs.
The Company submitted its 1996 annual interstate access filing on April 2,
1996, utilizing the FCC's interim price cap rules. In doing so, the Company
changed its productivity factor from 5.3% to 4.0% for its 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 million, effective July 1,
1996.
On February 8, 1996, the Telecommunications Act became law. This comprehensive
telecommunications reform legislation addresses a wide range of competitive and
regulatory issues that will affect the future development of local and long
distance services, cable television and information services. The new law
removes regulatory and court-ordered barriers to competition between segments
of the industry, enabling local-exchange, long distance, wireless and cable
companies to compete in offering voice, video and information services.
The Telecommunications Act requires the FCC and state commissions to open
local-exchange markets and to set new guidelines for interconnection, loosens
restrictions barring local telephone companies from entering the cable
television market, and preserves universal service while equalizing the
responsibility for contribution among all carriers.
On August 8, 1996, the FCC published its First Report and Order (the Order)
containing rules implementing Section 251 of the Telecommunications Act dealing
with interconnection, unbundling of network elements and wholesale prices and
other terms for competitive entry into local-exchange service. On August 9,
1996, the FCC released its Second Report and Order implementing the provision
of number portability and dialing parity in accordance with the
Telecommunications Act.
On September 16, 1996, GTE filed an appeal and motion for stay of the Order
with the United States Court of Appeals for the District of Columbia. This
appeal argued that the FCC had no jurisdiction to impose national pricing rules
for what is essentially local service. This appeal was subsequently
transferred to the Court of Appeals for the Eighth Circuit together with
appeals by other LECs and state regulatory commissions. On October 15, 1996,
the Eighth Circuit
32
<PAGE> 35
granted a partial stay. The stay delays implementation of the Order's pricing
provisions and associated rules, as well as the rules requiring GTE and other
LECs to permit requesting carriers to select terms and conditions from various
agreements between them and other carriers for purposes of interconnection. On
November 12, 1996, the Supreme Court denied applications to vacate the stay
filed by the FCC and various companies seeking to enter the local-exchange
business. Additionally, the Court held oral arguments on the merits on January
17, 1997. The Court's ruling is expected in the spring of 1997.
While GTE cannot predict the outcome of the Court's final decision, GTE intends
to continue to vigorously present its position in Court.
In November 1996, the Federal-State Joint Board released its recommended
universal service plan, and in December 1996, the FCC issued its access reform
proposals. Both proposals incorporate a pricing methodology similar to the one
that GTE is appealing in the interconnection case. A final order in the
universal service proceeding must be adopted by early May 1997, and a decision
on the access reform proceeding is expected shortly thereafter.
SIGNIFICANT CUSTOMER
Revenues received from AT&T Corp. include amounts for access and billing and
collection during the years 1996-1994 under various arrangements and amounted
to $220.3 million, $223 million and $208.1 million, respectively.
14. COMMITMENTS AND CONTINGENCIES
The Company has noncancelable leases covering certain buildings, office space
and equipment. Rental expense was $18.4 million, $15.2 million and $14.4
million in 1996-1994, respectively. Minimum rental commitments under
noncancelable leases through 2001 do not exceed $1.8 million annually and
aggregate $1.6 million thereafter.
The Company is subject to a number of proceedings arising out of the conduct of
its business, including those relating to regulatory actions, commercial
transactions and/or environmental, safety and health matters. Management
believes that the ultimate resolution of these matters will not have a material
adverse effect on the results of operations or the financial position of the
Company.
Recent judicial and regulatory developments, as well as the pace of
technological change, have continued to influence industry trends, including
accelerating and expanding the level of competition. As a result, the
Company's operations face increasing competition in virtually all aspects of
its business. The Company continues to support greater competition in
telecommunications, provided that, overall, the actions to eliminate existing
legal and regulatory barriers benefit consumers by allowing an opportunity for
all service providers to participate in a competitive marketplace under
comparable conditions.
33
<PAGE> 36
15. QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized 1996 and 1995 quarterly financial data is as follows :
<TABLE>
<CAPTION>
Revenues Operating Net Income
and Sales(a) Income (Loss)
----------- ---------- ----------
(Thousands of Dollars)
<S> <C> <C> <C>
1996
First Quarter $ 392,432 $ 115,408 $ 68,320
Second Quarter (b) 403,334 102,332 62,082
Third Quarter 410,679 100,769 59,087
Fourth Quarter 416,494 89,256 66,307
---------- ---------- ----------
Total $1,622,939 $ 407,765 $ 255,796
========== ========== ==========
1995
First Quarter $ 349,094 $ 78,505 $ 40,574
Second Quarter (c) 371,548 74,403 43,503
Third Quarter (d) 383,717 103,192 68,738
Fourth Quarter (e) 411,020 72,761 (506,964)
---------- ---------- ----------
Total $1,515,379 $ 328,861 $ (354,149)
========== ========== ==========
</TABLE>
(a) Quarterly revenues and sales reflect the reclassification of certain
costs billed to affiliated companies for shared services as an offset to
operating costs and expenses.
(b) Second quarter 1996 net income includes after-tax gains on the sale of
non-strategic properties of $2.8 million (see Note 5).
(c) Second quarter 1995 net income includes after-tax gains on the sale of
the Company's unconsolidated investment in Metropolitan Houston Paging,
Inc. and the sale of non-strategic properties of $3.5 million (see Note
5).
(d) Third quarter 1995 net income includes an after-tax gain on the sale of
non-strategic properties of $10.8 million (see Note 5).
(e) Fourth quarter 1995 net income includes $549.4 million of extraordinary
charges (net of tax) for the discontinuance of FAS 71 and the early
retirement of debt (see Note 2).
34
<PAGE> 37
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
GTE Southwest Incorporated:
We have audited the accompanying balance sheets of GTE Southwest Incorporated
(a Delaware corporation and wholly-owned subsidiary of GTE Corporation) as of
December 31, 1996 and 1995, and the related statements of income, shareholders'
equity and cash flows for each of the three years in the period ended December
31, 1996. These financial statements and the schedule and exhibit referred to
below are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and the schedule and
exhibit based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of GTE Southwest Incorporated as
of December 31, 1996 and 1995, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1996, in
conformity with generally accepted accounting principles.
As discussed in Note 2 to the financial statements, in 1995, the Company
discontinued applying the provisions of Statement of Financial Accounting
Standards No. 71, "Accounting for the Effects of Certain Types of Regulation".
Our audit was made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The supporting schedule and exhibit listed under
Item 14 are presented for purposes of complying with the Securities and
Exchange Commission's rules and are not a required part of the basic financial
statements. The supporting schedule and exhibit have been subjected to the
auditing procedures applied in the audit of the basic financial statements and,
in our opinion, fairly state in all material respects the financial data
required to be set forth therein in relation to the basic financial statements
taken as a whole.
ARTHUR ANDERSEN LLP
Dallas, Texas
January 28, 1997
35
<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 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.
THOMAS W. HALL
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 1,
1997 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 48 1996 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; Vice President and General
Manager - California, GTE Telephone Operations West
Area, 1992.
Richard M. Cahill 58 1993 Vice President - General Counsel, GTE Telephone
Operations, 1988; Director, all GTE domestic telephone
subsidiaries, 1993 and/or 1994; Director, GTE Vantage
Incorporated, 1991; Vice President - General Counsel,
all GTE domestic telephone subsidiaries, 1995.
Gerald K. Dinsmore 47 1993 Senior Vice President - Finance and Planning, GTE
Telephone Operations, 1994; Senior Vice President -
Finance and Planning, all GTE domestic telephone
subsidiaries, 1994; Vice President - Finance, GTE
Telephone Operations, 1993; President of all South Area
Companies, GTE Telephone Operations, 1992; Director,
GTE Florida Incorporated and GTE South Incorporated,
1992; Director, all other GTE domestic telephone
subsidiaries, 1993 and/or 1994.
Michael B. Esstman 50 1993 Executive Vice President - Customer Segments, GTE
Telephone Operations, 1994; Executive Vice President -
Operations, GTE Telephone Operations, 1993; Director,
all Central Area Companies, 1991; Director, all other
GTE domestic telephone subsidiaries, 1993 and/or 1994.
Thomas W. White 50 1993 President, GTE Telephone Operations, 1995; Executive
Vice President - Network Operations, GTE Telephone
Operations, 1994; Executive Vice President - GTE
Telephone Operations, 1993; Director, all GTE domestic
telephone subsidiaries, 1993 and/ or 1994; Director,
Quebec-Telephone.
</TABLE>
Directors are elected annually. There are no family relationships between any
of the directors or executive officers of the Company, except that Mr. Jacobson
and Ms. Jacobson are married to one another.
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 Telephone Operations.
Accordingly, the list below contains the names, ages and positions of the
executive officers of both the Company and GTE Telephone Operations (Telops) as
of March 1, 1997.
<TABLE>
<CAPTION>
Year Assumed
Present Position
-----------------------
the
Name Age Telops Company Position
- ----------------------- ---- -------- --------- ----------------------------------------------
<S> <C> <C> <C> <C>
Thomas W. White 50 1995 -- President of GTE Telephone Operations
John C. Appel 48 1996 1995 Executive Vice President - Network Operations
of GTE Telephone Operations and the Company
James G. Badders 44 1994 -- Vice President-Consumer Customer Contact of GTE
Telephone Operations
Mary Beth Bardin 42 1994 1995 Vice President - Public Affairs of GTE
Telephone Operations and the Company
C. F. Bercher 53 1994 -- President - Consumer Markets of GTE Telephone
Operations
-- 1995 Vice President - Consumer Markets of the
Company
Richard M. Cahill 58 1988 1995 Vice President - General Counsel of GTE
Telephone Operations and the Company
Terri L. Compton 40 1996 -- Vice President-Business Development of GTE
Telephone Operations
C. Michael Crawford 50 1996 -- Vice President-Information Technology of GTE
Telephone Operations
Gerald K. Dinsmore 47 1994 1993 Senior Vice President - Finance and Planning of
GTE Telephone Operations and the Company
William M. Edwards, III 48 -- 1993 Vice President-Controller of the Company
Michael B. Esstman 50 1994 -- Executive Vice President - Customer Segments of
GTE Telephone Operations
M. Michael Foster (1) 53 -- 1996 Vice President-Midwest Region of the Company
Oscar C. Gomez 50 1997 -- Vice President-Diversity Marketing and
Management of GTE Telephone Operations
Thomas W. Hall (2) 45 -- 1996 President of the Company
Gregory D. Jacobson 45 -- 1994 Treasurer of the Company
Pamela S. Jacobson 39 1996 -- Vice President-Strategic Planning of GTE
Telephone Operations
Brad M. Krall 55 1993 1995 Vice President - Centralized Operations of GTE
Telephone Operations and the Company
Michael J. McDonough 47 1996 -- Senior Vice President-Market Integration of GTE
Telephone Operations
Paul E. Miner 52 1995 -- Vice President-Program Management Office of GTE
Telephone Operations
Christopher D. Owens 41 1996 1996 Vice President-Regulatory and Governmental
Affairs of GTE Telephone Operations and the
Company
Barry W. Paulson 45 1996 1996 Vice President - Network Operations Planning
and Support of GTE Telephone Operations and the
Company
Richard L. Schaulin 54 1989 1995 Vice President - Human Resources of GTE
Telephone Operations and the Company
Leland W. Schmidt 63 1987 -- Vice President-Industry Affairs of GTE
Telephone Operations
Charles J. Somes 50 -- 1994 Secretary of the Company
Larry J. Sparrow 53 1994 -- President - Carrier Markets of GTE Telephone
Operations
-- 1995 Vice President - Carrier Markets of the Company
Lewis O. Wilks (3) 43 1996 -- President - Business Markets of GTE Telephone
Operations
-- 1996 Vice President - Business Markets of the
Company
</TABLE>
(1) M. Michael Foster was appointed Vice President-Midwest Region of the
Company, replacing Barry W. Paulson, who was appointed Vice
President-Network Operations Planning and Support of GTE Telephone
Operations and the Company.
39
<PAGE> 42
(2) Thomas W. Hall was appointed President of the Company, replacing Katherine
J. Harless, who was appointed President of GTE Airfone Incorporated.
(3) Lewis O. Wilks was appointed President-Business Markets of GTE Telephone
Operations and Vice President-Business Markets of the Company replacing
Michael J. McDonough, who was appointed Senior Vice President-Market
Integration of GTE Telephone Operations.
Each of these executive officers has been an employee of the Company or an
affiliated company for the last five years, with the exception of Thomas W.
Hall. Mr. Hall joined GTE in October 1994 as General Manager-Branch
Operations. He was named Vice President-General Manager of GTE Internet
Solutions in April 1996 and President of the Company on November 11, 1996.
Prior to joining GTE, Mr. Hall served as a branch manager for Corporate
National Accounts with MCI from November 1988 to October 1994.
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.
40
<PAGE> 43
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 1996
Principal Executive Officers of the Company and each of the other four most
highly compensated executive officers (the named executive officers) of GTE
Telephone Operations in 1996. The information in this table under the caption
"Annual Compensation" sets forth all compensation paid to the named executive
officers by GTE Telephone Operations. The caption "Long-Term Compensation" in
this table 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 1996
annual compensation for each of the named executive officers that was allocated
to the Company.
<TABLE>
<CAPTION>
Long-Term Compensation
------------------------ ----------------------
Annual Compensation (1) Awards Payouts
------------------------------- ------------------------ ----------------------
Restricted Securities
Other Annual Stock Underlying LTIP All Other
Name and Principal Salary Bonus Compensation Awards Options/ Payouts Compensation
Position in Group Year ($) (2) ($) (3) ($) ($) (4) SARs (#) ($) ($) (5)
------------------------ ----- --------- ------- ------------ ----------- ----------- ------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Thomas W. Hall (6) 1996 49,050 65,600 -- -- 7,000 -- 6,230
President
Katherine J. Harless (7) 1996 93,119 69,700 -- -- 19,900 166,100 8,178
President 1995 167,746 113,800 -- -- 12,500 75,600 7,548
1994 160,092 110,300 -- -- 10,600 18,800 4,887
Thomas W. White 1996 463,115 533,700 -- 81,511 183,400 770,000 10,613
President- 1995 418,884 443,800 -- -- 98,800 331,800 10,613
GTE Telephone Operations 1994 353,508 368,200 -- -- 53,700 164,100 7,075
Michael B. Esstman 1996 369,958 359,600 -- 61,702 124,400 627,400 10,613
Executive Vice President - 1995 350,731 349,400 -- -- 63,500 305,900 7,238
Customer Segments 1994 327,546 358,200 -- -- 53,700 158,300 4,998
GTE Telephone Operations
John C. Appel 1996 295,977 380,700 -- 51,229 124,400 439,200 10,572
Executive Vice President- 1995 239,600 258,100 -- -- 63,500 162,800 10,194
Network Operations 1994 193,023 182,400 -- -- 24,800 34,700 6,230
GTE Telephone Operations
Larry J. Sparrow 1996 294,812 260,800 -- 41,561 81,400 404,100 10,613
President- 1995 261,866 255,600 -- -- 36,400 211,300 10,613
Carrier Markets 1994 260,662 233,800 -- -- 30,900 117,200 7,075
GTE Telephone Operations
</TABLE>
(1) Annual Compensation represents the total annual cash compensation of
salaries, bonuses and other compensation. The Company's allocated share
for Ms. Harless and Messrs. Hall, White, Esstman, Appel and Sparrow, for
whom total annual amounts are shown above, is $162,819; $114,650;
$123,474; $91,814; $87,657 and $69,924, respectively.
(2) The data in the table includes fees of $15,692 and $16,607 received by Mr.
White for serving as director of BC TEL during 1996 and 1995. BC TEL, a
Canadian company, is an indirectly-owned subsidiary of GTE Corporation.
41
<PAGE> 44
(3) The data in this column represents the annual bonus received by each of
the named executive officers under the GTE Corporation Executive Incentive
Plan (the EIP) in 1996. In connection with GTE's Equity Participation
Program (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 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.
(4) 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 3 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. White, Esstman, Appel and Sparrow
each hold a total of 8,598; 6,509; 5,406 and 4,385 Restricted Stock Units,
respectively, which had a dollar value of $390,134; $295,346; $245,298 and
$198,970, respectively, based solely upon the closing price of GTE Common
Stock on December 31, 1996.
(5) The column "All Other Compensation" includes, for 1996, contributions by
GTE and its related companies to the GTE Savings Plan of $6,230 for Mr.
Hall and $6,750 for each of Ms. Harless and Messrs. White, Esstman, Appel
and Sparrow and contributions by GTE and its related companies to the GTE
Executive Salary Deferral Plan of $1,428 for Ms. Harless, $3,822 for Mr.
Appel, and $3,863 for each of Messrs. White, Esstman and Sparrow.
(6) Mr. Hall was elected President of the Company in November 1996, replacing
Ms. Harless.
(7) Ms. Harless served as President of the Company until July 1996, at which
time she was elected President of GTE Airfone Incorporated.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
The following table shows all grants of options and tandem stock appreciation
rights (SARs) to the named executive officers of the Company in 1996, whether
or not specifically allocated to the Company. The options and SARs were
granted under the Long-Term Incentive Plan (LTIP). Pursuant to Securities and
Exchange Commission (the SEC) rules, the table also shows the value of the
options granted at the end of the option terms (ten years) if the stock price
were to appreciate annually by 5% and 10%, respectively. There is no assurance
that the stock price will appreciate at the rates shown in the table. The
table also indicates that if the stock price does not appreciate, there will be
no increase in the potential realizable value of the options granted.
42
<PAGE> 45
<TABLE>
<CAPTION>
Potential Realizable Value at
Assumed Annual Rate of Stock
Price Appreciation For
Individual Grants Option Term
-------------------------------------------------------- ------------------------------
Percent of
Number of Total Options/
Securities SARs Granted Exercise
Underlying to Or Base
Options / SARs Employees in Price Expiration
Name Granted Fiscal Year ($/SH) Date 0% 5% 10%
- --------------------- -------------- -------------- --------- ---------- ----- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Thomas W. Hall 7,000 (1) .05% 43.75 2/20/06 -- $192,532 $ 487,876
Katherine J. Harless 15,200 (1) .12% 43.75 2/20/06 -- 418,070 1,059,388
4,700 (1) .04% 43.00 7/14/06 -- 127,056 321,958
Thomas W. White 91,700 (1) .69% 43.75 2/20/06 -- 2,522,173 6,391,179
91,700 (2) .69% 43.06 6/05/06 -- 2,482,539 6,290,746
Michael B. Esstman 62,200 (1) .47% 43.75 2/20/06 -- 1,710,787 4,335,129
62,200 (2) .47% 43.06 6/05/06 -- 1,683,903 4,267,005
John C. Appel 62,200 (1) .47% 43.75 2/20/06 -- 1,710,787 4,335,129
62,200 (2) .47% 43.06 6/05/06 -- 1,683,903 4,267,005
Larry J. Sparrow 40,700 (1) .31% 43.75 2/20/06 -- 1,119,438 2,836,652
40,700 (2) .31% 43.06 6/05/06 -- 1,101,847 2,792,076
</TABLE>
(1) Each option was granted in tandem with a SAR, which will expire upon
exercise of the option. Under the LTIP, 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.
(2) Messrs. White, Esstman, Appel and Sparrow also received a special
"performance-based" stock option grant during 1996. The options were
granted in tandem with SARs at a price equal to the fair market value on
the date of grant. They are intended both to motivate the executives to
remain with GTE during a period of unprecedented opportunities and
challenges, and to give them an opportunity to accelerate the enhancement
of their equity position in GTE, but only if specific and aggressive
shareholder returns are met. Unlike the three-year graduated vesting
schedule that applies to the other options reflected in the table, each
performance-based option grant will vest in three stages according to the
following schedule: (i) each option may be exercised with respect to
one-third of the aggregate number of shares represented by the grant if
the closing price of GTE Common Stock on the NYSE is $60 or more per share
for 20 consecutive days (or, if earlier, on the fifth anniversary of the
grant date); (ii) each option may be exercised with respect to an
additional one-third of the aggregate number of shares represented by the
grant if the closing price of GTE Common Stock on the NYSE is $70 or more
per share for 20 consecutive days (or, if earlier, on the sixth
anniversary of the grant date); and (iii) each option may be exercised
with respect to the final one- third of the aggregate number of shares
represented by the grant if the closing price of GTE Common Stock on the
NYSE is $80 or more per share for 20 consecutive days (or, if earlier, on
the seventh anniversary of the grant date).
43
<PAGE> 46
AGGREGATED OPTION/SAR EXERCISES
IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
The following table provides information as to options and SARs exercised by
each of the named executive officers of the Company during 1996. The table
sets forth the value of options and SARs held by such officers at year-end
measured in terms of the closing price of GTE Corporation (GTE) Common Stock on
December 31, 1996.
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options/SARs
Shares Options/SARs at FY-End at FY-End ($)
Acquired Value ---------------------------- ----------------------------
Name On Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable
- ------------------- ---------------- ------------- ------------ ------------- ------------ --------------
<S> <C> <C> <C> <C> <C> <C>
Thomas W. Hall -- -- 600 8,200 7,313 27,313
Katherine J. Harless -- -- 26,432 31,768 321,002 187,548
Thomas W. White 43,800 697,575 120,132 267,168 1,474,402 1,377,266
Michael B. Esstman -- -- 95,766 184,634 1,180,292 1,019,121
John C. Appel 25,467 316,222 6,400 175,001 62,400 841,706
Larry J. Sparrow 48,466 601,963 37,567 115,967 469,003 606,460
</TABLE>
LONG-TERM INCENTIVE PLAN - AWARDS IN LAST FISCAL YEAR
The LTIP provides for awards, currently in the form of stock options with
tandem SARs, other stock-based awards and dollar denominated awards, to
participating employees. The stock options and tandem SARs awarded under the
LTIP to the named executive officers are shown in the table on page 43.
<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>
Thomas W. Hall 1,500 3 Years 435 1,675
Katherine J. Harless 2,400 3 Years 697 2,679
Thomas W. White 10,900 3 Years 3,164 12,169
Michael B. Esstman 7,400 3 Years 2,148 8,262
John C. Appel 7,400 3 Years 2,148 8,262
Larry J. Sparrow 4,900 3 Years 1,422 5,471
</TABLE>
(1) An individual's award may not exceed the applicable individual award limit,
which is expressed as a percentage of the LTIP Award Pool (the Award
Limit). The Award Limit depends on the individual's base salary at the end
of the 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, 1996. The Target future payout or award is the dollar amount
derived by multiplying the Equivalent Unit balance credited to the
participant at the end of the award cycle by the price of GTE Common Stock.
The Target award measures performance attainment as described in footnote
3.
44
<PAGE> 47
(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 1996-1998
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 a
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 Level, 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>
<S> <C>
Performance Increment Above Added Percentage to
Revenue Performance Target Combined Awards
-------------------------- -------------------
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.
45
<PAGE> 48
Executive Agreements
GTE has entered into agreements (the Agreements) with Messrs. White, Esstman
and Appel 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 of
Directors 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 consist 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 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.
In addition, the Agreements with Messrs. White, Esstman and Appel provide that
in the event of a separation from service, they will receive service credit in
the following amounts: two times years of service otherwise credited if the
executive has five or fewer years of credited service; 10 years if credited
service is more than five and not more than 10 years; and, if the executive's
credited service exceeds 10 years, the actual number of credited years of
service. These additional years of service will apply towards vesting,
retirement eligibility, benefit accrual and all other purposes under the
Supplemental Executive Retirement Plan (SERP) and the GTE Corporation Executive
Retired Life Insurance Plan (ERLIP). 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 remain 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 does not wish to extend his
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.
46
<PAGE> 49
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:
PENSION PLAN TABLE
<TABLE>
<CAPTION>
Years of Service
Final Average --------------------------------------------------------------------------------
Earnings 15 20 25 30 35
- ---------------- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 150,000 $ 31,388 $ 41,850 $ 52,313 $ 62,775 $ 73,238
200,000 42,263 56,350 70,438 84,525 98,613
300,000 64,013 85,350 106,688 128,025 149,363
400,000 85,763 114,350 142,938 171,525 200,113
500,000 107,513 143,350 179,188 215,025 250,863
600,000 129,263 172,350 215,438 258,525 301,613
700,000 151,013 201,350 251,688 302,025 352,363
800,000 172,763 230,350 287,938 345,525 403,113
900,000 194,513 259,350 324,188 389,025 453,863
1,000,000 216,263 288,350 360,438 432,525 504,613
1,200,000 259,763 346,350 432,938 519,525 606,113
1,500,000 325,013 433,350 541,688 650,025 758,363
2,000,000 433,763 578,350 722,938 867,525 1,012,113
</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
based on 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 exclusive of overtime, differentials, incentive
compensation (except as otherwise described) 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, 1996, the credited
years of service under the Service Corporation Plan for Ms. Harless is 24 and
for Messrs. Hall, White, Esstman, Appel and Sparrow are 2, 28, 28, 25 and 29,
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 a SERP, 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 SERP
includes a provision permitting the payment of additional retirement benefits
determined in a similar manner as under the Service Corporation Plan on
remuneration accrued under management incentive plans as determined by the
Committee. SERP benefits are payable in a lump sum or an annuity.
47
<PAGE> 50
Executive Retired Life Insurance Plan
The ERLIP provides Messrs. White, Esstman, Appel and Sparrow a postretirement
life insurance benefit of three times final base salary, provides Ms. Harless a
postretirement life insurance benefit of two and one-half times final base
salary and provides Mr. Hall a postretirement life insurance benefit of two
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.
48
<PAGE> 51
Item 12. Security Ownership of Certain Beneficial Owners and Management
(a) Security Ownership of Certain Beneficial Owners as of February 28, 1997:
<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 6,500,000 100%
Southwest Incorporated One Stamford Forum shares of record
Stamford, Connecticut 06904
</TABLE>
(b) Security Ownership of Management as of December 31, 1996:
<TABLE>
<CAPTION>
Title of Class Name of Director or Nominee (1) (2) (3)
----------------------- -----------------------------------------------------
<S> <C> <C>
Common Stock of GTE John C. Appel 45,162
Corporation Richard M. Cahill 78,150
Gerald K. Dinsmore 37,724
Michael B. Esstman 162,084
Thomas W. White 203,785
----------
526,905
==========
Executive Officers (1) (2) (3)
-----------------------------------------------------
Thomas W. Hall 3,863
Katherine J. Harless 42,700
Thomas W. White 203,785
Michael B. Esstman 162,084
John C. Appel 45,162
Larry J. Sparrow 86,892
----------
544,486
==========
All directors and executive
officers as a group (1) (2) (3) 1,442,682
==========
</TABLE>
(1) Includes shares acquired through participation in the GTE Savings Plan.
(2) Included in the number of shares beneficially owned by Messrs. Appel,
Cahill, Dinsmore, Esstman, White, Hall, Sparrow and Ms. Harless and all
directors and executive officers as a group are 41,667; 72,100; 35,999;
155,566; 189,765; 3,533; 73,566; 39,199 and 1,261,616 shares,
respectively, which such persons have the right to acquire within 60 days
pursuant to stock options.
(3) No director, nominee for 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 1996.
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.
49
<PAGE> 52
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) Financial Statements - See GTE Southwest Incorporated's
financial statements and report of independent accountants
thereon in the financial statements section included elsewhere
herein.
(2) Financial Statement Schedules - Schedules supporting the
financial statements for the years ended December 31, 1996-1994
(as required):
II - Valuation and Qualifying Accounts
Note: Schedules other than the one listed above are omitted as not
applicable, not required, or the information is included in the
financial statements or notes thereto.
(3) Exhibits - Included in this report or incorporated by reference.
2.1* Agreement of Merger, dated February 28, 1995, between GTE
Southwest Incorporated, Contel of Texas, Inc. and Contel of
the West, Inc. (Exhibit 2.1 of the Company's Report on Form
8-K, dated December 1, 1995, and filed on December 4, 1995)
3* Articles of Incorporation and Bylaws (Exhibit 3 of the 1993
Form 10-K, File No. 1-7077)
4* Indenture between GTE Southwest Incorporated and
NationsBank of Georgia, National Association, as Trustee,
dated as of November 15, 1993 (Exhibit 4.1 of the Company's
Registration Statement on Form S-3, File No. 33-50939,
filed with the Securities and Exchange Commission on
November 5, 1993)
10* Material Contracts - Agreements Between GTE and Certain
Executive Officers (Exhibit 10 of the 1995 Form 10-K, File
No. 1-7077)
12 Statements re: Calculation of the 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 no reports on Form 8-K during the fourth
quarter of 1996.
* Denotes exhibits incorporated herein by reference to previous filings
with the Securities and Exchange Commission as designated.
50
<PAGE> 53
GTE Southwest Incorporated
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
For the Years Ended December 31, 1996, 1995 and 1994
(Thousands of Dollars)
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E
- --------------------------------------------------------------------------------------------------------------
Additions
-------------------------------
Deductions
Balance at Charged Charged from
Beginning (Credited) to (Credited) to Reserves Balance at
Description of Year Income Other Accounts (Note 1) Close of Year
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Allowance for uncollectible accounts
for the years ended:
December 31, 1996 $ 21,182 $ 36,010 $ 30,124 (2) $ 63,683 $ 23,633
================================================================================
December 31, 1995 $ 20,043 $ 33,136 $ 33,692 (2) $ 65,689 $ 21,182
================================================================================
December 31, 1994 $ 19,542 $ 34,868 $ 14,612 (2) $ 48,979 $ 20,043
================================================================================
Accrued restructuring costs for the
years ended (Note 4):
December 31, 1996 $ 82,872 $ $(26,877) (3) $ 55,995 $ --
================================================================================
December 31, 1995 $ 156,734 $ $ $ 73,862 $ 82,872
================================================================================
December 31, 1994 $ 198,974 $ -- $ -- $ 42,240 $ 156,734
================================================================================
</TABLE>
NOTES:
(1) Charges for which reserve was created.
(2) Recoveries of previously written-off amounts.
(3) Represents amounts necessary to satisfy commitments related to the
re-engineering program that have been reclassified to Accounts Payable and
Accrued Expenses.
(4) See Note 4 to the financial statements included elsewhere herein.
51
<PAGE> 54
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 SOUTHWEST INCORPORATED
--------------------------------------
(Registrant)
Date March 26, 1997 By Thomas W. Hall
--------------------------------------
Thomas W. Hall
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>
Thomas W. Hall President March 26, 1997
- -------------------------- (Principal Executive Officer)
Thomas W. Hall
Gerald K. Dinsmore Senior Vice President - Finance and March 26, 1997
- -------------------------- Planning and Director
Gerald K. Dinsmore (Principal Financial Officer)
William M. Edwards, III Vice President - Controller March 26, 1997
- -------------------------- (Principal Accounting Officer)
William M. Edwards, III
John C. Appel Director March 26, 1997
- --------------------------
John C. Appel
Richard M. Cahill Director March 26, 1997
- --------------------------
Richard M. Cahill
Michael B. Esstman Director March 26, 1997
- --------------------------
Michael B. Esstman
Thomas W. White Director March 26, 1997
- --------------------------
Thomas W. White
</TABLE>
52
<PAGE> 55
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
- ---------- -------------------------------------------------------------
<S> <C>
12 Statements re: Calculation of the Ratio of Earnings to Fixed
Charges
23 Consent of Independent Public Accountants
27 Financial Data Schedule
</TABLE>
<PAGE> 1
Exhibit 12
GTE Southwest Incorporated
STATEMENTS OF RATIO OF EARNINGS TO FIXED CHARGES
(Thousands of Dollars)
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------------------
1996 1995(a) 1995 1994(b)
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net earnings available for
fixed charges:
Income before extraordinary $ 255,796 $ 180,991 $ 195,289 $ 144,762
charges
Add - Income taxes (benefit) 130,173 92,152 99,437 71,146
- Fixed charges 66,798 68,925 68,925 70,761
--------- --------- --------- ---------
Adjusted earnings $ 452,767 $ 342,068 $ 363,651 $ 286,669
========= ========= ========= =========
Fixed charges:
Interest expense $ 60,653 $ 63,848 $ 63,848 $ 65,913
Portion of rent expense
representing interest 6,145 5,077 5,077 4,848
--------- --------- --------- ---------
Adjusted fixed charges $ 66,798 $ 68,925 $ 68,925 $ 70,761
========= ========= ========= =========
RATIO OF EARNINGS TO FIXED
CHARGES 6.78 4.96 5.28 4.05
<CAPTION>
Years Ended December 31,
-------------------------------------------------
1994 1993(c) 1993 1992
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net earnings available for
fixed charges:
Income before extraordinary $ 184,528 $ 171,814 $ 55,373 $ 190,759
charges
Add - Income taxes (benefit) 95,068 61,684 (12,731) 93,692
- Fixed charges 70,761 91,107 91,107 93,355
--------- --------- --------- ---------
Adjusted earnings $ 350,357 $ 324,605 $ 133,749 $ 377,806
========= ========= ========= =========
Fixed charges:
Interest expense $ 65,913 $ 85,044 $ 85,044 $ 87,561
Portion of rent expense
representing interest 4,848 6,063 6,063 5,794
--------- --------- --------- ---------
Adjusted fixed charges $ 70,761 $ 91,107 $ 91,107 $ 93,355
========= ========= ========= =========
RATIO OF EARNINGS TO FIXED
CHARGES 4.95 3.56 1.47 4.05
</TABLE>
(a) Excludes after-tax gains of approximately $14 million related to the sale
of the Company's unconsolidated investment in Metropolitan Houston Paging
Service, Inc. and non-strategic local exchanges in Texas.
(b) Results for 1994 exclude after-tax gains of approximately $40 million
related to the sale of non-strategic local exchanges in Oklahoma and
Arizona.
(c) Results for 1993 exclude an after-tax restructuring charge of
approximately $123 million for the implementation of a re-engineering
plan, a one-time after-tax charge of approximately $6 million related to
the enhanced early retirement and voluntary separation programs offered to
eligible employees in 1993, and an after-tax gain of approximately $13
million related to Contel of the West, Inc.'s sale of non-strategic local
exchanges in Utah.
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation
of our report, dated January 28, 1997, on the financial statements and
supporting schedule and exhibit of GTE Southwest Incorporated included in this
Form 10-K, into the Registration Statement previously filed on Form S-3 (File
No. 33-64795).
Dallas, Texas
March 26, 1997
ARTHUR ANDERSEN LLP
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 23,134
<SECURITIES> 0
<RECEIVABLES> 415,407
<ALLOWANCES> 23,633
<INVENTORY> 20,310
<CURRENT-ASSETS> 459,842
<PP&E> 5,043,830
<DEPRECIATION> 3,058,086
<TOTAL-ASSETS> 2,568,856
<CURRENT-LIABILITIES> 446,629
<BONDS> 866,894
6,450
7,600
<COMMON> 650,000
<OTHER-SE> 174,851
<TOTAL-LIABILITY-AND-EQUITY> 2,568,856
<SALES> 1,622,939
<TOTAL-REVENUES> 1,622,939
<CGS> 603,598
<TOTAL-COSTS> 1,215,174
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 54,297
<INCOME-PRETAX> 385,969
<INCOME-TAX> 130,173
<INCOME-CONTINUING> 255,796
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 255,796
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
