<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 1997
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission File Number 1-7077
GTE SOUTHWEST INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
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)
</TABLE>
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, 1998. THE COMPANY'S COMMON STOCK IS 100% OWNED BY GTE
CORPORATION.
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Item Page
<S> <C>
Part I
1. Business 1
2. Properties 4
3. Legal Proceedings 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 16
9. Changes in and Disagreements with Accountants on 38
Accounting and Financial Disclosure
Part III
10. Directors and Executive Officers of the Registrant 39
11. Executive Compensation 41
12. Security Ownership of Certain Beneficial Owners and Management 49
13. Certain Relationships and Related Transactions 50
Part IV
14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 51
</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
1994-1996, 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.
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 communications 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 4 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.
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The number of access lines in the states in which the Company operates as of
December 31, 1997, was as follows:
<TABLE>
<CAPTION>
Access
State Lines Served
----- ------------
<S> <C>
Arkansas 87,154
New Mexico 93,898
Oklahoma 123,601
Texas 2,269,996
---------
Total 2,574,649
=========
</TABLE>
At December 31, 1997, the Company had 6,948 employees.
The Company has three written agreements with the Communications Workers of
America (CWA). One agreement expires in 1998.
REGULATORY AND COMPETITIVE TRENDS
The Company is subject to regulation by the regulatory bodies of the states of
Arkansas, New Mexico, Oklahoma and Texas for its intrastate business operations
and by the Federal Communications Commission (FCC) for its interstate
operations.
Advances in technology, together with a number of regulatory, legislative and
judicial actions, continue to accelerate and expand the level of competition and
opportunities available to the Company. The Company continues to face additional
competition from numerous sources, such as competitive local-exchange carriers,
wireless carriers, cable television service providers and long distance
companies.
Much of the regulatory and legislative activity that occurred in the United
States in 1997 was a direct result of the Telecommunications Act of 1996 (the
Telecommunications Act) adopted by Congress. The Telecommunications Act is
intended to promote competition in all sectors of the telecommunications
marketplace while preserving and advancing universal telephone service.
The Company supports greater competition in telecommunications, provided that
consumers benefit from an opportunity for all service providers to participate
in a competitive marketplace under comparable conditions. The Company believes
that a number of recent FCC and state regulatory agency decisions did not
establish comparable conditions; consequently, the Company and its parent, GTE,
have exercised their right to challenge actions they believe act to increase
competition at the expense of the shareholders of incumbent firms.
In July 1997, the U.S. Court of Appeals for the Eighth Circuit (Eighth Circuit)
released its decision on the challenge filed in 1996 by GTE and numerous other
parties to rules developed by the FCC to implement the interconnection
provisions of the Telecommunications Act. The Telecommunications Act required
local-exchange carriers (LECs) to make their retail services and the underlying
network elements available to competitors. The FCC required that prices for both
resold services and network elements be set using a methodology created by the
FCC. The court challenge asserted that the FCC's rules were inconsistent with
the Telecommunications Act. The July 1997 court decision found that the FCC
overstepped its authority in many instances and upheld GTE's position that state
regulatory agencies bear the primary responsibility for determining the prices
which competing firms must pay when interconnecting their networks. In January
1998, the U.S. Supreme Court announced that it would review this decision. Oral
argument in the Supreme Court is expected to take place in October 1998, with a
final decision likely to be issued no later than June 1999.
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The favorable ruling by the Eighth Circuit did not impede the progress of
competition. The Company has finalized interconnection agreements with various
competitive LECs in New Mexico, Oklahoma and Texas. A number of these
interconnection agreements, adopted as a result of the arbitration process
established by the Telecommunications Act, incorporate prices or terms and
conditions based upon the FCC's rules that were overturned by the Eighth
Circuit. Thus, the Company has exercised its right to challenge such agreements
in Texas, Oklahoma and New Mexico.
In May 1997, the FCC released two new major decisions related to implementation
of the Telecommunications Act's provisions - the universal service and access
charge reform orders. The universal service order established the support
mechanisms to ensure continued availability of affordable local telephone
service and created new programs to provide discounted telecommunications
services to schools, libraries and rural health care providers. GTE and numerous
other parties have challenged the FCC's decision before the U.S. Court of
Appeals for the Fifth Circuit on the grounds that the FCC did not follow the
requirements of the Telecommunications Act to develop a sufficient, explicit and
competitively neutral universal service program. A decision is expected in 1998.
The access charge reform order, also released in May 1997, revamped the rate
structure for use of the local network by interexchange carriers to originate
and complete long distance calls. GTE and numerous other parties also challenged
this decision before the Eighth Circuit based on the belief that the FCC not
only failed to remove all of the universal service subsidies hidden within
interstate access charges, but in fact created additional subsidy charges paid
only by business and multi-line residential customers. Oral argument has been
held and a decision is expected in 1998.
Also in May 1997, the FCC released a decision completing a periodic review of
its price cap regulatory oversight of interstate access charges. GTE and
numerous other LECs have challenged this decision before the Eighth Circuit
based on the belief that the FCC established a fundamentally unfair annual price
reduction formula and required retroactive price reductions. Oral argument has
been held and a decision on this challenge is also expected in 1998.
Federal and state regulatory activity continued to change the traditional
cost-based, rate-of-return regulatory framework for intrastate and interstate
telephone service. Regulatory authorities in Texas have adopted various forms of
alternative regulation, which provide economic incentives for telephone service
providers to improve productivity and provide the foundation for implementing
pricing flexibility necessary to address competitive entry into the Company's
markets. The regulatory commissions in the states of Arkansas, New Mexico and
Oklahoma continue to remain under the traditional cost-based, rate-of-return
regulatory framework for intrastate telephone service.
For the provision of interstate access services, the Company operates under the
terms of the FCC's price cap incentive plan. The price cap mechanism serves to
limit the rates a carrier may charge, rather than just regulating the rate-of-
return which may be achieved. Under this approach, the maximum prices that the
LEC may charge are increased or decreased each year by a price cap index based
upon inflation less a predetermined productivity target. LECs have limited
pricing flexibility provided they do not exceed the allowed price cap.
In the May 1997 order on its price cap triennial review, the FCC revised the
price cap plan for LECs by adopting a uniform productivity factor of 6.0% with
an additive consumer productivity dividend of 0.5%. The FCC also eliminated the
sharing requirements of the price cap rules.
The Company filed interstate access revisions during 1997 that became effective
June 3, 1997 and July 1, 1997. Overall, these filings resulted in a net annual
price reduction of $25.5 million. On December 1, 1997, the FCC issued an order
to file revised access rates effective January 1, 1998, which resulted in
additional interstate access charge reductions of approximately $3.1 million. In
1997, the FCC also ordered significant changes that altered the structure of
access charges collected by the Company, effective January 1, 1998. Generally,
the FCC reduced and
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<PAGE> 6
restructured the per minute charges paid by long distance carriers and
implemented new per line charges. The FCC also created an access charge
structure that resulted in different access charges for residential primary and
secondary lines and for single line and multi-line business lines. In aggregate,
the reductions in usage sensitive access charges paid by long distance carriers
were offset by new per line charges and the charges paid by end-users.
Further information regarding the Company's activities with the various
regulatory agencies and revenue arrangements with other telephone companies is
discussed in Note 12 of the Company's financial statements included in Item 8.
The Company continues to support greater competition in telecommunications,
provided that, overall, the actions to eliminate existing legal and regulatory
barriers benefit consumers by allowing an opportunity for all service providers
to participate equally in a competitive marketplace under comparable conditions.
The Company intends to continue to respond aggressively to regulatory and legal
developments that allow for increased competition and opportunities in the
marketplace. The Company expects its financial results to benefit from reduced
costs and the introduction of new products and services that will result in
increased usage of its telephone networks. However, it is likely that such
improvements will be offset, in part, by continued strategic pricing reductions
and the effects of increased competition.
INITIATIVES
In 1997, the Company's parent, GTE, continued to position itself to respond
aggressively to competitive developments and benefit from new opportunities.
In May 1997, GTE announced plans to become a leading national provider of data
communications services that included the acquisition of BBN Corporation (BBN),
a leading supplier of end-to-end Internet solutions. BBN brings valuable skills,
a leading position in the Internet market and an impressive list of Fortune 500
clients. In addition, GTE announced a strategic alliance with Cisco Systems,
Inc. to jointly develop enhanced data and Internet services for customers; and
the purchase of a national, state-of-the-art fiber-optic network from Qwest
Communications. This expansion of data services continued in November 1997 with
the announcement of the acquisition of Genuity Inc. (Genuity), a subsidiary of
Bechtel Enterprises. Genuity is a premier value-added provider of distributed
application hosting solutions.
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 Arkansas, New Mexico, Oklahoma and Texas
are generally in good operating condition and are adequate to satisfy the needs
of the business. Substantially all of the Company's property is subject to the
liens of its respective mortgages securing funded debt. From January 1, 1993 to
December 31, 1997, the Company made capital expenditures of $1.9 billion for new
plant and facilities required to meet telecommunication service needs and to
modernize plant and facilities. These additions were equal to 35% of gross plant
of $5.4 billion at December 31, 1997.
In the fourth quarter of 1995, the Company discontinued the use of Statement of
Financial Accounting Standards No. 71, "Accounting for the Effects of Certain
Types of Regulation" (FAS 71). In general, FAS 71 required the
4
<PAGE> 7
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
BankBoston, N.A., Transfer Agent and Registrar for GTE and the Company's common
stock and preferred stock, should be contacted with any questions relating to
shareholder accounts. This includes the following:
o Account information
o Dividends
o Market prices
o Transfer instructions
o Statements and reports
o Change of address
Shareholders may call toll-free at 1-800-225-5160 anytime, seven days a week.
Customer Service Representatives are available Monday through Friday between the
hours of 8 a.m. and 5 p.m. Eastern Time. Outside the United States call
1-718-575-2990.
Or write to:
BankBoston, N.A.
c/o Boston EquiServe, L.P.
P.O. Box 8031
Boston, MA 02206-8031
For overnight delivery services, use the following address:
BankBoston, N.A.
c/o Boston EquiServe, L.P.
Blue Hills Office Park
150 Royall Street
Mail Stop 4502-60
Canton, MA 02021
The BankBoston, N.A. address where shareholders, banks and brokers may deliver
certificates is Securities Transfers and Reporting Services, 55 Broadway in New
York City.
PARENT COMPANY ANNUAL REPORT
To obtain a copy of the 1997 annual report of our parent company or the annual
Form 10-K filed with the Securities and Exchange Commission, call
1-800-225-5160.
INFORMATION VIA THE INTERNET
Internet World Wide Web users can access information on GTE through the
following universal resource:
http://www.gte.com
PRODUCTS AND SERVICES HOTLINE
Shareholders may call 1-800-828-7280 to receive information concerning GTE
products and services.
DIVERSITY AT GTE
The Company and GTE strive to be a workplace of choice in which people of
diverse backgrounds are valued, challenged, acknowledged and rewarded, leading
to higher levels of fulfillment and productivity. A copy of our Diversity at GTE
brochure is available upon request from the GTE Corporate Secretary's Office.
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) 1997 1996 1995 1994 1993(b)
- ------------------------------------- ----------- ----------- ----------- ----------- -----------
(Thousands of Dollars)
<S> <C> <C> <C> <C> <C>
Revenues and sales $ 1,676,599 $ 1,622,939 $ 1,515,379 $ 1,482,495 $ 1,457,263
Operating costs and expenses 1,186,116 1,215,174 1,186,518 1,203,019 1,348,211
----------- ----------- ----------- ----------- -----------
Operating income 490,483 407,765 328,861 279,476 109,052
Interest - net 60,067 54,297 61,218 63,568 82,722
Gain on disposition of assets -- (4,322) (21,583) (63,688) (17,536)
Other - net -- (28,179) (5,500) -- 1,224
Income taxes (benefit) 142,262 130,173 99,437 95,068 (12,731)
----------- ----------- ----------- ----------- -----------
Income before extraordinary charges 288,154 255,796 195,289 184,528 55,373
Extraordinary charges -- -- (549,438)(c) -- (31,250)
----------- ----------- ----------- ----------- -----------
Net income (loss) $ 288,154 $ 255,796 $ (354,149) $ 184,528 $ 24,123
=========== =========== =========== =========== ===========
Dividends declared on common stock $ 267,382 $ 136,021 $ 80,900 $ 243,033 $ 149,348
Dividends declared on preferred stock 577 1,043 1,118 1,258 1,409
</TABLE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
As of December 31,
--------------------------------------------------------------------------
Selected Balance Sheet Items 1997 1996 1995 1994 1993
- ---------------------------- ---------- ---------- ---------- ---------- ----------
(Thousands of Dollars)
<S> <C> <C> <C> <C> <C>
Property, plant and equipment, net (c) $2,101,061 $1,985,744 $1,966,506 $2,832,912 $2,843,398
Total assets 2,732,215 2,568,856 2,446,560 3,243,367 3,286,638
Long-term debt and preferred stock,
subject to mandatory redemption 986,465 873,344 835,472 755,530 798,255
Shareholders' equity 852,555 832,451 713,719 1,149,886 1,232,177
</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.
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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, 1997, the Company
served 2,574,649 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,
---------------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Net income (loss) $ 288.2 $ 255.8 $(354.1)
</TABLE>
Net income increased 13% or $32.3 in 1997. 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. Excluding this item, net
income increased 23% or $54 in 1997, largely as a result of strong revenue
growth from local and network access services combined with a slight decrease in
operating costs and expenses, partially offset by lower revenues from toll
services.
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. Excluding these items, and the reversal of expired representation
and warranty reserves mentioned previously, net income increased 29% or $53.2 in
1996, primarily from higher revenues and sales resulting from continued customer
growth, partially offset by increases in operating costs and expenses.
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REVENUES AND SALES
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Local services $ 649.2 $ 581.2 $ 522.9
Network access services 660.4 627.3 579.0
Toll services 138.1 182.8 214.3
Other services and sales 228.9 231.6 199.2
-------- -------- --------
Total revenues and sales $1,676.6 $1,622.9 $1,515.4
</TABLE>
Total revenues and sales increased 3% or $53.7 and 7% or $107.5 during 1997 and
1996, respectively.
Local Services
Local service revenues are comprised mainly of fees charged to customers for
providing local-exchange service within designated franchise areas. Local
service revenues increased 12% or $68 in 1997 and 11% or $58.3 in 1996. Access
line growth of 7% in 1997 generated additional revenues of $12.2 from basic
local services, $10.3 from CentraNet(R) services and $7 from Integrated Services
Digital Network (ISDN) and Digital Channel Services (DCS). Growth in demand for
SmartCall(R) and CLASS services, driven primarily by the popularity of Caller ID
and pay-per-use services such as automatic call return/redial, increased
revenues by $17.4. In addition, the Expanded Local Calling (ELC) surcharge in
Texas, discussed in Note 12 to the financial statements included in Item 8,
increased revenues by $15 in 1997.
In 1996, access lines grew 6%, which generated higher revenues of $23.1 from
basic local services, $5.9 from CentraNet(R) services and $5.5 from ISDN and
DCS. Higher revenues from SmartCall(R) and CLASS services contributed $10.9 to
the increase, and the ELC surcharge in Texas, mentioned above, increased
revenues by $4.2. The 1996 increase also reflects $19.2 from the favorable
impact of discontinuing the monthly provision related to the Company's 1989
Texas rate case (as discussed in Note 12 of the Company's financial statements
included in Item 8). These increases were slightly offset by a $4 reduction in
local rates in Oklahoma, effective in March 1996, and a $6.8 reduction in local
rates in Arkansas, effective in July 1995.
Network Access Services
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 (LECs) 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 5% or $33.1 in 1997 and 8% or $48.3 in 1996. Increased demand for
access services by interexchange carriers resulted in a 9% increase in minutes
of use in both 1997 and 1996, which generated additional revenues of $30.9 and
$27.4, respectively. Special access revenues grew $16 in 1997 and $13.3 in 1996
due to greater demand for increased bandwidth services by Internet Service
Providers (ISPs) and other high capacity users. Revenues from end-user access
charges increased $5.8 and $6.8 in 1997 and 1996, respectively, primarily due to
line growth. In addition, revenues from meet-point-billing arrangements
increased $7.5 in 1997. The 1996 increase also includes $5.1 from the favorable
impact of discontinuing the monthly provisions related to the Company's 1989
Texas rate case (as discussed in Note 12 of the Company's financial statements
included in Item 8) and $2 from an increase in the volume of cellular service
providers accessing the Company's network. These increases are partially offset
by decreases in National Exchange Carrier Association (NECA) support payments
totaling $10.1 in 1997 and $8.5 in 1996. The 1997 increase was also partially
offset by a $17.1 revenue reduction associated with interstate rate changes and
sharing provisions related to the Federal Communications Commission's (FCC's)
1996 and 1997 price cap filings.
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Toll Services
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 24% or
$44.7 and 15% or $31.5 in 1997 and 1996, respectively. These decreases reflect
the end of transitional support payments totaling $20.3 and $14.1 in 1997 and
1996, respectively, resulting from the Company's exit from the Texas state
intraLATA toll pool in 1994. In addition, the 1997 and 1996 decreases are also
driven by lower toll revenues resulting from intraLATA toll competition,
including 10XXX and 1+ presubscription, and the impact of optional calling
plans, which effectively lowered intrastate long distance rates. The Company
completed the conversion of all capable offices to 1+ presubscription by August
1997.
Other Services and Sales
Other services and sales revenues decreased 1% or $2.7 in 1997 and increased 16%
or $32.4 in 1996. The 1997 decrease reflects lower equipment sales of $6.4,
partially offset by a $3.2 favorable impact from the FCC's order on payphone
interim compensation (as discussed in Note 12 of the Company's financial
statements included in Item 8). The 1996 increase was primarily the result of a
$16.7 increase in Tele-Go(R) personal phone service revenue and higher equipment
sales totaling $8.9. Revenue growth from DataBase 800 services also contributed
$6.2 to the 1996 increase.
OPERATING COSTS AND EXPENSES
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Cost of services and sales $ 591.0 $ 603.6 $ 590.2
Selling, general and administrative 241.5 269.8 257.5
Depreciation and amortization 353.6 341.8 338.8
-------- -------- --------
Total operating costs and expenses $1,186.1 $1,215.2 $1,186.5
</TABLE>
Total operating costs and expenses decreased 2% or $29.1 in 1997 and increased
2% or $28.7 in 1996.
The 1997 decrease was the result of several factors including a $7.6 reduction
in access charges incurred to terminate customers' intraLATA toll calls outside
the Company's service territory, lower operating taxes of $11.8 and a decline in
uncollectibles expense of $4.6. Pension settlement gains of $16.9, recorded in
1997 as a result of lump-sum payments from the Company's benefit plans, were
partially offset by $5.4 of gains recorded in 1996, which resulted in a net
decrease of $11.5. The 1997 results also reflect the favorable impact of a $15.8
reserve recorded in 1996 for right-of-way settlement costs in the state of Texas
and a $2.1 reserve recorded in 1996 for inside wire maintenance settlements (as
discussed in Note 12 of the Company's financial statements included in Item 8).
The 1997 decrease also reflects the Company's 1996 investment of $9.2 in the
Investment Fund Assessment, described below. These decreases were offset by
$15.4 in higher labor and benefits costs and $16.8 from increased selling and
marketing efforts aimed at stimulating sales of enhanced services and preserving
market share in an increasingly competitive environment. Depreciation increases
in 1997 from higher plant balances were partially offset by a reduction in
depreciation rates to reflect higher net salvage values related to certain of
the Company's telephone plant and equipment, which resulted in a net increase of
$11.9.
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
10
<PAGE> 13
settlements, discussed in the Other Matters section, 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
$5.4 pension settlement gain from the Company's pension plans.
OTHER (INCOME) EXPENSE
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Interest - net $ 60.1 $ 54.3 $ 61.2
Gain on disposition of assets -- (4.3) (21.6)
Other - net -- (28.2) (5.5)
Income taxes 142.3 130.2 99.4
</TABLE>
Interest - net increased 11% or $5.8 in 1997 compared to a decrease of 11% or
$6.9 in 1996. The 1997 increase is primarily attributable to higher average
short-term debt levels. 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 sixteen telephone exchanges 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).
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 9% or $12.1 and 31% or $30.8 in 1997 and 1996,
respectively. These increases are primarily driven by corresponding increases in
pre-tax income. The 1997 increase is partially offset by adjustments to prior
years' tax liabilities.
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 financings can be obtained through borrowings from the
Company's parent, GTE, or GTE Funding Incorporated, an affiliate of the Company.
The Company participates with other affiliates in a $1.5 billion, 364-day
syndicated line of credit. In December 1997, the Company began participating
with GTE and other of its affiliates in a series of five bilateral credit
agreements for an additional $2 billion in credit capacity. These facilities,
which are shared by the participating companies, are aligned with the maturity
date of the existing 364-day line of credit. The additional capacity provides
greater flexibility to incur additional indebtedness of a shorter-term duration
during periods when it may not be desirable to access the capital markets to
refinance short-term debt.
The Company's primary source of funds during 1997 was cash from operations of
$562.5 compared to $509.8 in 1996. The year-to-year increase is primarily
attributable to improved results from operations, partially offset by an
increase in working capital requirements.
Net cash used in investing activities was $510 and $342.3 during 1997 and 1996,
respectively. The Company's capital expenditures during 1997 totaled $510
compared to $354.6 in 1996. The 1997 increase in capital expenditures reflects
the Company's continued growth in primary and secondary access lines and the
modernization
11
<PAGE> 14
of interoffice facilities to mitigate Internet congestion. The Company's
construction costs for 1998 are expected to decrease slightly from the 1997
level. The 1996 expenditures were partially offset by cash proceeds of $12.3
received from the sale of sixteen telephone exchanges in Texas (representing
6,196 access lines).
Cash used in financing activities was $51.3 in 1997 compared to $162.2 in 1996.
This included dividend payments of $272.3 in 1997 compared to $87.5 in 1996.
Short-term financings, including the net change in affiliate notes, increased
$259.5 in 1997 compared to a decrease of $208.9 in 1996. The Company retired
$38.5 of long-term debt and preferred stock in 1997 compared to total
retirements of $13.7 in 1996. In January 1996, the Company issued $150 of 6%
debentures to refinance commercial paper outstanding at December 31, 1995 (as
discussed in Note 7 of the Company's financial statements included in Item 8).
On October 15, 1997, the Company's parent, GTE, proposed a merger with MCI
Communications Corporation (MCI) valued at approximately $28 billion. As a
result of the proposed merger, the rating agencies placed GTE, the Company and
its affiliates on "Credit Watch" for possible rating reductions. On November 10,
1997, MCI announced that it had reached an agreement to merge with WorldCom,
Inc.
REGULATORY AND COMPETITIVE TRENDS
The Company is subject to regulation by the regulatory bodies of the states of
Arkansas, New Mexico, Oklahoma and Texas for its intrastate business operations
and by the Federal Communications Commission (FCC) for its interstate
operations.
Much of the regulatory and legislative activity that occurred in the United
States in 1997 was a direct result of the Telecommunications Act of 1996 (the
Telecommunications Act) adopted by Congress. The Telecommunications Act is
intended to promote competition in all sectors of the telecommunications
marketplace while preserving and advancing universal telephone service.
The Company is a strong supporter of competition in all telecommunications
markets. The Company's position remains constant: the benefits of competition
should not be divided between customers or industry segments. There must be
fair, reasonable rules at the state and federal levels that enable all service
providers to participate equitably in the marketplace and benefit everyone. The
Company believes the FCC and a number of state regulatory agencies did not
establish these comparable conditions. The Company and its parent, GTE, have
consequently exercised their right to challenge regulatory actions they believe
unfairly disadvantage their customers and shareholders.
In July 1997, the U.S. Court of Appeals for the Eighth Circuit (Eighth Circuit)
released its decision on the challenge filed in 1996 by the Company's parent,
GTE, and numerous other parties to rules developed by the FCC to implement the
interconnection provisions of the Telecommunications Act. The Telecommunications
Act required LECs to make their retail services and the underlying network
elements available to competitors. The FCC required that prices for both resold
services and network elements be set using a methodology created by the FCC. The
court challenge asserted that the FCC's rules were inconsistent with the
Telecommunications Act. The July 1997 court decision found that the FCC
overstepped its authority in a number of areas and upheld GTE's position that
state regulatory agencies bear the primary responsibility for determining the
prices which competing firms must pay when interconnecting their networks. On
January 26, 1998, the U.S. Supreme Court announced that it would review this
decision. Oral argument in the Supreme Court is expected to take place in
October 1998, with a final decision likely to be issued no later than June 1999.
The favorable ruling by the Eighth Circuit did not impede the progress of
competition. The Company has finalized interconnection agreements with various
competitive LECs in Arkansas, New Mexico, Oklahoma and Texas. A number of these
interconnection agreements, adopted as a result of the arbitration process
established by the Telecommunications Act, incorporate prices or terms and
conditions based upon the FCC's rules that were overturned by the Eighth
Circuit. Thus, the Company has exercised its right to challenge such agreements
in Texas, Oklahoma and New Mexico.
12
<PAGE> 15
Interim rates for interconnection and unbundled network elements (UNEs) have
been established through negotiation and arbitration decisions. These interim
rates will be used until permanent rates are established through state
commission proceedings investigating cost studies. Cost studies have been filed
in New Mexico, Oklahoma and Texas and additional studies in Arkansas are
expected to be filed throughout 1998.
In May 1997, the FCC released two new major decisions related to implementation
of the Telecommunications Act's provisions - the universal service and access
charge reform orders. The universal service order established the support
mechanisms to ensure continued availability of affordable local telephone
service and created new programs to provide discounted telecommunications
services to schools, libraries and rural health care providers. GTE and numerous
other parties have challenged the FCC's decision before the U.S. Court of
Appeals for the Fifth Circuit on the grounds that the FCC did not follow the
requirements of the Telecommunications Act to develop a sufficient, explicit and
competitively neutral universal service program. A decision is expected in 1998.
Additional state commission proceedings have begun to establish rules and
procedures to implement state universal service funds (USF). USF proceedings
have begun in Arkansas, New Mexico, Oklahoma and Texas and are scheduled to
continue during the remainder of 1998. Separate USF proceedings to address
discount rates for intrastate telecommunications services to elementary schools,
secondary schools and public libraries have also begun in Arkansas, Oklahoma and
Texas.
The FCC access charge reform order, also released in May 1997, revamped the rate
structure through which local and long distance companies charge customers for
using the local phone network to make long distance calls. The FCC ordered
decreases for long distance companies to be accomplished by increasing the
access charges for business and residential customers with more than one phone
line. GTE and numerous other parties also challenged this decision before the
Eighth Circuit based on the belief that the FCC did not eliminate the universal
service subsidies hidden within interstate access charges as directed by the
Telecommunications Act, and that the FCC created additional subsidy charges paid
only by business and multi-line residential customers. Oral argument has been
held and a decision is expected in 1998.
Also in May 1997, the FCC released a decision completing a periodic review of
its price cap regulatory oversight of interstate access charges. GTE and
numerous other LECs have challenged this decision before the Eighth Circuit
based on the belief that the FCC established a fundamentally unfair annual price
reduction formula and required retroactive price reductions. Oral argument has
been held and a decision on this challenge is also expected in 1998.
Federal and state regulatory activity continued to change the traditional
cost-based, rate-of-return regulatory framework for intrastate and interstate
telephone service. Regulatory authorities in Texas have adopted various forms of
alternative regulation, which provide economic incentives for telephone service
providers to improve productivity and provide the foundation for implementing
pricing flexibility necessary to address competitive entry into the Company's
markets. The regulatory commissions in the states of Arkansas, New Mexico and
Oklahoma continue to remain under the traditional cost-based, rate-of-return
regulatory framework for intrastate telephone service.
For the provision of interstate access services, the Company operates under the
terms of the FCC's price cap incentive plan. The price cap mechanism serves to
limit the rates a carrier may charge, rather than just regulating the rate-of-
return which may be achieved. Under this approach, the maximum prices that the
LEC may charge are increased or decreased each year by a price cap index based
upon inflation less a predetermined productivity target. LECs have limited
pricing flexibility provided they do not exceed the allowed price cap.
In the May 1997 order on its price cap triennial review, the FCC revised the
price cap plan for LECs by adopting a uniform productivity factor of 6.0% with
an additive consumer productivity dividend of 0.5%. The FCC also eliminated the
sharing requirements of the price cap rules.
The Company filed interstate access revisions during 1997 that became effective
June 3, 1997 and July 1, 1997. Overall, these filings resulted in a net annual
price reduction of $25.5. On December 1, 1997, the FCC issued an
13
<PAGE> 16
order to file revised access rates effective January 1, 1998, which resulted in
additional interstate access charge reductions of approximately $3.1. In 1997,
the FCC also ordered significant changes that altered the structure of access
charges collected by the Company, effective January 1, 1998. Generally, the FCC
reduced and restructured the per minute charges paid by long distance carriers
and implemented new per line charges. The FCC also created an access charge
structure that resulted in different access charges for residential primary and
secondary lines and single line and multi-line business lines. In aggregate, the
reductions in usage sensitive access charges of $10.8 paid by long distance
carriers were offset by $10.8 of new per line charges and the charges paid by
end-users.
On June 4, 1996, the FCC issued its first Report and Order implementing Section
276 of the Telecommunications Act. As part of the overall goal of promoting
competition among payphone service providers (PSPs), this order mandated
compensation to all PSPs for all calls originating from payphones, including
"dial-around" access calls and toll-free subscriber calls for which PSPs were
not previously compensated. This compensation was to occur in two separate
phases. During phase one, from April 15, 1997 through October 6, 1997, PSPs were
to be paid a monthly, flat-rate compensation from interexchange carriers (IXCs).
During phase two, beginning October 7, 1997, PSPs were to be compensated on a
per-call basis, with the prevailing local coin rate of 35 cents established as
the default rate.
On July 19, 1997, the U.S. Court of Appeals in Washington, D.C. vacated the
FCC's directive concerning per-call compensation, stating that the FCC had not
shown that the 35 cent rate was a reasonable surrogate for fair compensation.
The court also set aside the FCC's flat-rate compensation mandate. Subsequently,
on October 9, 1997, the FCC issued a second Report and Order to address some of
the issues vacated by the court. In this second order, the FCC established a new
per-call rate of 28.4 cents for phase two compensation that all PSPs were
eligible to receive beginning October 9, 1997. The FCC tentatively concluded
that this per-call rate should also be used to calculate phase one compensation.
The Company has recorded approximately $3.2 of payphone revenues associated with
the October 9, 1997 FCC order. It is likely that the phase one compensation
directive will be revisited in a subsequent order.
Further information regarding the Company's activities with the various
regulatory agencies and revenue arrangements with other telephone companies is
discussed in Note 12 of the Company's financial statements included in Item 8.
YEAR 2000 CONVERSION
The Year 2000 issue has an industry-wide impact. The Company has had an active
Year 2000 Program in place. The Company's Year 2000 methodology and processes
were certified in 1997 by the Information Technology Association of America.
This program is necessary because the Year 2000 issue could impact systems,
networks and business processes at the Company. This program includes:
inventory; assessment and analysis of systems, networks and business processes;
remediation of any impacted software; and validation testing. The current
estimate for the cost of remediation for the Company is approximately $23.2.
Year 2000 remediation costs are expensed in the year incurred. Through 1997,
expenditures totaled $3.3. The Company currently has employees and contractors
mobilized to address the Year 2000 issue. Continued success is dependent on the
timely delivery of Year 2000 compliant products and services from the Company's
suppliers. The Company currently believes that its essential processes, systems
and business functions will be ready for the millennium transition.
LOCAL NUMBER PORTABILITY REQUIREMENTS
The Telecommunications Act mandated competition in the local telephone
marketplace. Local Number Portability (LNP) is one vehicle chosen by the FCC to
facilitate local competition. Local Service Provider Portability is the first
phase of LNP, which will allow residential and business customers to change
local service providers without changing their telephone numbers. The FCC has
mandated that Local Service Provider Portability be implemented in the top 100
Metropolitan Service Areas (MSAs) by the end of 1998. The second and third
phases of LNP will allow customers to retain their telephone numbers when they
move from one location to another or change services (e.g. landline to
cellular).
14
<PAGE> 17
Through December 31, 1997, the Company had recorded approximately $23.1 to
implement Local Service Provider Portability within ten of the top 100 MSAs.
As a result of the major investment required to implement LNP, the FCC has
stated that local service providers should be allowed to recover a portion of
their costs. The Company is seeking regulatory recovery of LNP implementation
costs.
OTHER MATTERS
Eleven separate class action lawsuits were brought against GTE and twelve of its
subsidiaries (GTE Defendants), including the Company, relating to the provision
of inside wire maintenance services. On August 6, 1996, the GTE Defendants and
class counsel executed and filed a settlement agreement in one of the lawsuits.
The Court preliminarily approved the agreement and conditionally certified a
national class of plaintiffs for settlement purposes. A fairness hearing on the
settlement was held on December 18, 1996. On January 21, 1997, the Court
approved the settlement as written and issued a permanent injunction to prohibit
future lawsuits covering any claims from 1987 to the date of settlement.
Pursuant to the settlement, a proof of claim form was inserted into the March
1997 customer bills for the national class to request their benefits under the
settlement. The reserves established by the Company in 1996 were adequate for
the processing of all claims during 1997.
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 to end the right-of-way disputes between
them. New right-of-way agreements have now been implemented in those cities. In
September 1997, the lawsuit with the remaining city went to trial and the Court
rendered a direct verdict for the Company on the breach of contract claims. In
December, the city filed a notice of limited appeal challenging portions of the
judgment. Management believes that the Company has adequately provided for this
dispute in its financial statements.
A lawsuit was filed previously against the Company for allegedly violating the
Texas Debt Collection Practices Act (the Act) by failing to include a "street
address" on the Company's disconnection notices. The Company's disconnection
notices provide a post office box for remittance of payment and a toll-free
number for inquiries, but do not provide a physical street address. On September
1, 1995, an amendment to the Act became effective which provides that a post
office box, street address or telephone number on delinquency notices meets the
requirements of the Act. The Court granted the Company's motion to defer the
case to the TPUC; however, the plaintiff's counsel is challenging the
constitutionality of the legislative amendment. As of December 31, 1997, the
potential financial impact is not estimable.
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.
15
<PAGE> 18
Item 8. Financial Statements and Supplementary Data
GTE Southwest Incorporated
STATEMENTS OF INCOME (Note 3)
<TABLE>
<CAPTION>
Years Ended December 31 1997 1996 1995
- ----------------------- ----------- ----------- -----------
(Thousands of Dollars)
<S> <C> <C> <C>
REVENUES AND SALES (a)
Local services $ 649,195 $ 581,155 $ 522,893
Network access services 660,402 627,313 579,038
Toll services 138,139 182,832 214,278
Other services and sales 228,863 231,639 199,170
----------- ----------- -----------
Total revenues and sales 1,676,599 1,622,939 1,515,379
----------- ----------- -----------
OPERATING COSTS AND EXPENSES (b)
Cost of services and sales 590,990 603,598 590,258
Selling, general and administrative 241,503 269,834 257,465
Depreciation and amortization 353,623 341,742 338,795
----------- ----------- -----------
Total operating costs and expenses 1,186,116 1,215,174 1,186,518
----------- ----------- -----------
OPERATING INCOME 490,483 407,765 328,861
OTHER (INCOME) EXPENSE
Interest - net (c) 60,067 54,297 61,218
Gain on disposition of assets -- (4,322) (21,583)
Other - net -- (28,179) (5,500)
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 430,416 385,969 294,726
Income taxes 142,262 130,173 99,437
----------- ----------- -----------
INCOME BEFORE EXTRAORDINARY CHARGES 288,154 255,796 195,289
Extraordinary charges -- -- (549,438)
----------- ----------- -----------
NET INCOME (LOSS) $ 288,154 $ 255,796 $ (354,149)
=========== =========== ===========
</TABLE>
(a) Includes billings to affiliates of $39,855, $39,736 and $45,564 for the
years 1997-1995, respectively.
(b) Includes billings from affiliates of $84,734, $98,071 and $103,877 for the
years 1997-1995, respectively.
(c) Includes interest paid to affiliates of $6,309.
See Notes to Financial Statements.
16
<PAGE> 19
GTE Southwest Incorporated
BALANCE SHEETS (Note 3)
<TABLE>
<CAPTION>
December 31 1997 1996
- ----------- ---------- ----------
(Thousands of Dollars)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 24,282 $ 23,134
Receivables, less allowances of $21,203 and $23,633 359,879 312,047
Notes receivable from affiliates -- 79,727
Inventories and supplies 24,032 20,310
Deferred income tax benefits -- 12,684
Prepaid taxes 52,796 4,040
Other 7,170 7,900
---------- ----------
Total current assets 468,159 459,842
---------- ----------
Property, plant and equipment, net 2,101,061 1,985,744
Employee benefit plans 145,221 105,276
Other assets 17,774 17,994
---------- ----------
Total assets $2,732,215 $2,568,856
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term obligations, including current maturities $ 313 $ 1,669
Notes payable to affiliates 42,826 --
Accounts payable 98,905 93,850
Affiliate payables and accruals 105,743 74,275
Advanced billings and customer deposits 40,030 38,011
Taxes payable 37,027 35,059
Accrued interest 10,103 10,785
Accrued payroll costs 33,252 43,732
Dividends payable 45,458 49,752
Other 66,237 99,496
---------- ----------
Total current liabilities 479,894 446,629
---------- ----------
Long-term debt 984,955 866,894
Deferred income taxes 174,745 169,383
Employee benefit plans 212,543 192,362
Other liabilities 26,013 54,687
---------- ----------
Total liabilities 1,878,150 1,729,955
---------- ----------
Preferred stock, subject to mandatory redemption 1,510 6,450
---------- ----------
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 146,204 126,100
---------- ----------
Total shareholders' equity 852,555 832,451
---------- ----------
Total liabilities and shareholders' equity $2,732,215 $2,568,856
========== ==========
</TABLE>
See Notes to Financial Statements.
17
<PAGE> 20
GTE Southwest Incorporated
STATEMENTS OF CASH FLOWS (Note 3)
<TABLE>
<CAPTION>
Years Ended December 31 1997 1996 1995
- ----------------------- --------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
OPERATIONS
Income before extraordinary charges $ 288,154 $ 255,796 $ 195,289
Adjustments to reconcile income before extraordinary charges to net cash from
operations:
Depreciation and amortization 353,623 341,742 338,795
Deferred income taxes 29,385 10,729 16,312
Gain on disposition of assets -- (4,322) (21,583)
Provision for uncollectible accounts 31,157 36,010 33,136
Change in current assets and current liabilities:
Receivables - net (58,275) (96,446) (59,328)
Other current assets (3,095) (1,977) (15,635)
Accrued taxes and interest (47,367) 26,908 (17,924)
Other current liabilities (24,166) (43,591) (65,392)
Other - net (6,953) (15,024) (10,857)
--------- --------- ---------
Net cash from operations 562,463 509,825 392,813
--------- --------- ---------
INVESTING
Capital expenditures (510,014) (354,615) (319,162)
Proceeds from sale of assets -- 12,344 36,576
Other - net -- -- (5,478)
--------- --------- ---------
Net cash used in investing (510,014) (342,271) (288,064)
--------- --------- ---------
FINANCING
Long-term debt issued -- 147,884 --
Long-term debt and preferred stock retired, including premiums
paid on early retirement (38,517) (13,673) (20,968)
Dividends (272,253) (87,510) (143,194)
Increase (decrease) in short-term obligations,
excluding current maturities 259,469 (208,946) 66,064
Other - net -- -- 712
--------- --------- ---------
Net cash used in financing (51,301) (162,245) (97,386)
--------- --------- ---------
Increase in cash and cash equivalents 1,148 5,309 7,363
Cash and cash equivalents:
Beginning of year 23,134 17,825 10,462
--------- --------- ---------
End of year $ 24,282 $ 23,134 $ 17,825
========= ========= =========
Cash paid during the year for:
Interest $ 59,786 $ 56,751 $ 64,626
--------- --------- ---------
Income taxes $ 119,841 $ 99,670 $ 111,154
--------- --------- ---------
</TABLE>
See Notes to Financial Statements.
18
<PAGE> 21
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, 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
Net income 288,154 288,154
Dividends declared (267,959) (267,959)
Premium paid on early retirement of
redeemable preferred stock (91) (91)
---------- ---------- ---------- ---------- ----------
Shareholders' equity, December 31, 1997 $ 7,600 $ 650,000 $ 48,751 $ 146,204 $ 852,555
========== ========== ========== ========== ==========
</TABLE>
See Notes to Financial Statements.
19
<PAGE> 22
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, 1997, the Company served 2,574,649 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 management to make estimates and
assumptions that affect the 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).
Reclassifications of prior year data have been made, where appropriate, to
conform to the 1997 presentation.
TRANSACTIONS WITH AFFILIATES
GTE Supply (100% owned by GTE) provides construction and maintenance equipment,
supplies and electronics repair services to the Company. These purchases and
services amounted to $121.9 million, $105.7 million and $91.2 million for the
years 1997-1995, respectively. Such purchases and services are recorded in the
accounts of the Company, at cost, which includes a return realized by GTE
Supply.
The Company is billed for certain printing and other costs associated with
telephone directories, data processing services and equipment rentals, and
receives management, consulting, research and development, and pension
management services from other affiliated companies. These charges amounted to
$84.7 million, $98.1 million and $103.9 million for the years 1997-1995,
respectively. The amounts charged for these affiliated transactions are based on
a proportional cost allocation method.
The Company's financial statements include allocated expenses based on the
sharing of certain executive, administrative, financial, accounting, marketing,
personnel, engineering and other support services being performed at
consolidated work centers among GTE's domestic telephone operating subsidiaries.
The amounts charged for these affiliated transactions are based on proportional
cost allocation methodologies.
GTE Funding Incorporated (an affiliate of the Company) provides short-term
financing and investment vehicles and cash management services for the Company.
The Company is contractually obligated to repay all amounts borrowed on its
behalf by GTE Funding Incorporated. Interest expense on these borrowings
amounted to approximately $6.3 million in 1997.
The Company has an agreement with GTE Directories Corporation (Directories)
(100% owned by GTE), whereby the Company provides its subscriber lists, billing
and collection and other services to Directories. Revenues from these activities
amounted to $39.9 million, $39.7 million and $45.6 million for the years
1997-1995, respectively.
20
<PAGE> 23
DEPRECIATION AND AMORTIZATION
The Company provides for depreciation on a straight-line basis over the
estimated economic lives of its assets. Prior to 1996, the Company provided for
depreciation on a straight-line basis over asset lives approved by regulators
(see Note 2). Maintenance and repairs of property are charged to income as
incurred. Additions to, replacements and renewals of property are charged to
telephone plant accounts. Property retirements are charged in total to the
accumulated depreciation account. No adjustment to depreciation is made at the
time properties are retired or otherwise disposed of, except in the case of
significant sales or extraordinary retirements of property where profit or loss
is recognized.
Franchises, goodwill and other intangibles are amortized on a straight-line
basis over the periods to be benefited, or 40 years, whichever is less.
REVENUE RECOGNITION
Revenues are recognized when earned. This is generally based on usage of the
Company's local-exchange networks or facilities. For other products and
services, revenues are generally recognized when services are rendered or
products are delivered to customers.
INVENTORIES AND SUPPLIES
Inventories and supplies are stated at the lower of cost, determined principally
by the average cost method, or net realizable value.
EMPLOYEE BENEFIT PLANS
Pension and postretirement health care and life insurance benefits earned during
the year, as well as interest on projected benefit obligations, are accrued
currently. Prior service costs and credits resulting from changes in plan
benefits are amortized over the average remaining service period of the
employees expected to receive benefits. Material curtailment/settlement gains
and losses associated with employee separations are recognized in the period in
which they occur.
INCOME TAXES
The Company's results are included in GTE's consolidated federal income tax
return. The Company participates in a tax-sharing agreement with GTE and remits
tax payments to GTE based on its tax liability on a separate company basis.
Deferred tax assets and liabilities are established for temporary differences
between the way certain income and expense items are reported for financial
reporting and tax purposes and are subsequently adjusted to reflect changes in
tax rates expected to be in effect when the temporary differences reverse. A
valuation allowance is established for deferred tax assets for which realization
is not likely.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include investments in short-term, highly liquid
securities, which have maturities when purchased of three months or less.
21
<PAGE> 24
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
(FAS 130). FAS 130 establishes standards for reporting and displaying
comprehensive income and its components in the financial statements. FAS 130
is effective for fiscal years beginning after December 15, 1997.
Reclassification of financial statements for earlier periods provided for
comparative purposes is required. The adoption of this standard will have no
impact on the Company's results of operations, financial position or cash
flows.
2. EXTRAORDINARY CHARGES
In response to legislation (see Note 12) and the increasingly competitive
environment, the Company discontinued the use of Statement of Financial
Accounting Standards No. 71, "Accounting for the Effects of Certain Types of
Regulation" (FAS 71) in the fourth quarter of 1995.
As a result of the decision to discontinue FAS 71, the Company recorded a
non-cash, after-tax extraordinary charge of $549.3 million (net of tax benefits
of $301.6 million) in the fourth quarter of 1995. The charge primarily
represented a reduction in the net book value of telephone plant and equipment
through an increase in accumulated depreciation. In addition to the one-time
charge, beginning in 1996, the Company shortened the depreciable lives of its
telephone plant and equipment as follows:
<TABLE>
<CAPTION>
Average Depreciable Lives
-------------------------
Asset Category Before After
- -------------- ------ -----
<S> <C> <C>
Copper 20-30 15
Switching 17-19 10
Circuit 11-13 8
Fiber 25-30 20
</TABLE>
In addition, during 1995, the Company redeemed prior to stated maturity, $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.
22
<PAGE> 25
4. PROPERTY REPOSITIONING
On May 31, 1996, the Company sold sixteen telephone exchanges (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 fifteen telephone exchanges
(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.
5. PREFERRED STOCK
The authorized cumulative preferred stock, not subject to mandatory redemption,
consists of 2,060,758 shares. Shares outstanding at December 31, 1997 and 1996
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>
1997 1996
Authorized: Shares Shares
--------- ---------
<S> <C> <C>
4.60% $20 par value 350,000 350,000
$8.10 no par value -- 300,000
--------- ---------
Total 350,000 650,000
========= =========
</TABLE>
<TABLE>
<CAPTION>
December 31
----------------------------------------------------
1997 1996
---------------------- ---------------------
Shares Amount Shares Amount
------- ------- ------ -------
Outstanding: (Thousands of Dollars) (Thousands of Dollars)
<S> <C> <C> <C> <C>
4.60% $20 par value 75,500 $ 1,510 82,500 $ 1,650
$8.10 no par value -- -- 48,000 4,800
------- ------- ------- -------
Total 75,500 $ 1,510 130,500 $ 6,450
======= ======= ======= =======
</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 1997 and 1996 with the purchase of 7,000 shares per year.
23
<PAGE> 26
In May 1997, the Company redeemed all outstanding shares of $8.10 Series
preferred stock with cash from operations. The Company incurred $0.1 million in
premiums associated with these redemptions.
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, 1997.
The aggregate redemption requirements of preferred stock subject to mandatory
redemption are $0.1 million in each of the years 1998-2002.
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.
6. 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, 1997, $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.
24
<PAGE> 27
7. DEBT
Long-term debt as of December 31, was as follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(Thousands of Dollars)
First mortgage bonds:
<S> <C> <C>
6 7/8% Series, due 1998 $ -- $ 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
9.74% Series T, due 2013 12,300 12,600
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
6.0% Series C, due 2006 150,000 150,000
Other:
Notes payable expected to be refinanced on a long-term basis 150,000 --
Capitalized leases 55 61
--------- ---------
Total principal amount 987,355 870,841
Less: discount (2,087) (2,278)
--------- ---------
Total 985,268 868,563
Less: current maturities (313) (1,669)
--------- ---------
Total long-term debt $ 984,955 $ 866,894
========= =========
</TABLE>
Long-term debt as of December 31, 1997 includes $150 million of short-term
borrowings in the form of affiliate notes payable which were refinanced by the
issuance, in January 1998, of $150 million of 6.23% Series D debentures, due
2007. Net proceeds were applied toward the repayment of short-term borrowings
incurred for the purpose of financing the Company's construction program and for
general corporate purposes.
In January 1996, the Company issued $150 million of 6% Series C debentures, due
2006. Net proceeds were applied toward the repayment of short-term borrowings
incurred in connection with the redemption of long-term debt in December 1995
prior to stated maturity (See Note 2). Net proceeds were also used to finance
the Company's construction program and for general corporate purposes.
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: $0.3
million in 1998; $250.3 million in 1999; $2.7 million in 2000; $2.6 million in
2001; and $42.6 million in 2002.
25
<PAGE> 28
Total short-term obligations as of December 31, were as follows:
<TABLE>
<CAPTION>
1997 1996
------- -------
(Thousands of Dollars)
<S> <C> <C>
Note payable to affiliate - average rate 6.15% $42,826 $ --
Current maturities of long-term debt 313 1,669
------- -------
Total $43,139 $ 1,669
======= =======
</TABLE>
The Company participates with other affiliates in a $1.5 billion, 364-day
syndicated line of credit. In December 1997, the Company began participating
with its parent, GTE, and other of its affiliates in a series of five bilateral
credit agreements for an additional $2 billion in credit capacity. These
facilities, which are shared by the participating companies, are aligned with
the maturity date of the existing 364-day line of credit.
8. FINANCIAL INSTRUMENTS
At December 31, 1997, the Company had entered into forward contracts to sell
U.S. Treasury Bonds to hedge against changes in market interest rates on $150
million of planned long-term debt issuances that were completed in January 1998.
Gains and losses recognized upon the expiration or settlement of forward
contracts to sell U.S. Treasury Bonds are amortized over the life of the
associated long-term debt issuance as an offset or addition to interest expense.
The risk associated with these off-balance-sheet financial instruments arises
from the possible inability of counterparties to meet the contract terms and
from movements in interest rates. The Company carefully evaluates and
continually monitors the creditworthiness of its counterparties and believes the
risk of nonperformance is remote.
The fair values of financial instruments, other than long-term debt, closely
approximate their carrying value. As of December 31, 1997 and 1996, 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 $18 million and $5 million, respectively.
26
<PAGE> 29
9. INCOME TAXES
The provision (benefit) for income taxes is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
Current:
Federal $ 106,828 $ 124,689 $ 78,708
State 6,049 (5,245) 4,417
--------- --------- ---------
112,877 119,444 83,125
--------- --------- ---------
Deferred:
Federal 37,974 9,220 26,111
State (2,928) 8,133 (1,729)
--------- --------- ---------
35,046 17,353 24,382
--------- --------- ---------
Amortization of deferred investment tax credits - net (5,661) (6,624) (8,070)
--------- --------- ---------
Total $ 142,262 $ 130,173 $ 99,437
========= ========= =========
</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>
1997 1996 1995
--------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
Amounts computed at statutory rates $ 150,412 $ 134,724 $ 102,763
State and local income taxes, net of federal income tax 2,029 1,877 2,124
benefits
Amortization of deferred investment tax credits, net of
federal income tax benefits (3,680) (4,305) (8,070)
Depreciation of telephone plant construction costs
previously deducted for tax purposes - net -- -- 3,133
Rate differentials applied to reversing temporary differences -- -- (1,299)
Other differences - net (6,499) (2,123) 786
--------- --------- ---------
Total provision $ 142,262 $ 130,173 $ 99,437
========= ========= =========
</TABLE>
The tax effects of temporary differences that give rise to the deferred income
tax benefits and deferred income tax liabilities at December 31, are as follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(Thousands of Dollars)
<S> <C> <C>
Depreciation and amortization $ 198,672 $ 179,800
Employee benefit obligations (80,023) (67,056)
Prepaid pension cost 41,503 36,146
Investment tax credits 6,281 9,961
Other - net 19,651 (2,152)
--------- ---------
Total $ 186,084 $ 156,699
========= =========
</TABLE>
27
<PAGE> 30
10. EMPLOYEE BENEFIT PLANS
RETIREMENT PLANS
The Company sponsors noncontributory defined benefit pension plans covering
substantially all employees. The benefits to be paid under these plans are
generally based on years of credited service and average final earnings. The
Company's funding policy, subject to the minimum funding requirements of U.S.
employee benefit and tax laws, is to contribute such amounts as are determined
on an actuarial basis to accumulate funds sufficient to meet the plans' benefit
obligation to employees upon their retirement. The assets of the plans consist
primarily of corporate equities, government securities and corporate debt
securities.
The components of the net pension credit for 1997-1995 were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
Benefits earned during the year $ 14,878 $ 15,158 $ 13,435
Interest cost on projected benefit obligations 40,805 37,971 37,427
Return on plan assets:
Actual (178,156) (133,257) (156,937)
Deferred 103,545 63,342 94,244
Other - net (9,772) (11,953) (14,491)
--------- --------- ---------
Net pension credit $ (28,700) $ (28,739) $ (26,322)
========= ========= =========
</TABLE>
The expected long-term rate-of-return on plan assets was 9.0% for 1997 and 1996,
and 8.5% for 1995.
The funded status of the plans and the net prepaid pension cost at December 31,
were as follows:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
(Thousands of Dollars)
<S> <C> <C>
Vested benefit obligations $ 404,746 $ 395,321
=========== ===========
Accumulated benefit obligations $ 470,888 $ 447,751
=========== ===========
Plan assets at fair value $ 1,076,509 $ 980,646
Less: projected benefit obligations 493,508 558,970
----------- -----------
Excess of assets over projected obligations 583,001 421,676
Unrecognized net transition asset (32,571) (40,339)
Unrecognized net gain (405,209) (276,061)
----------- -----------
Net prepaid pension cost $ 145,221 $ 105,276
=========== ===========
</TABLE>
Assumptions used to develop the projected benefit obligations at December 31,
were as follows:
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Discount rate 7.25% 7.50%
Rate of compensation increase 5.00% 5.25%
</TABLE>
28
<PAGE> 31
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
Substantially all of the Company's employees are covered under postretirement
health care and life insurance benefit plans. The determination of benefit cost
for postretirement health plans is generally based on comprehensive hospital,
medical and surgical benefit plan provisions. The Company funds amounts for
postretirement benefits as deemed appropriate from time to time. Plan assets
consist primarily of corporate equities, government securities and corporate
debt securities.
The postretirement benefit cost for 1997-1995 included the following components:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
(Thousands of Dollars)
<S> <C> <C> <C>
Benefits earned during the year $ 3,991 $ 4,707 $ 6,123
Interest on accumulated postretirement benefit obligations 22,359 23,474 26,265
Actual return on plan assets (327) (72) (485)
Amortization of transition obligation 11,184 11,505 13,980
Other - net (1,329) (283) (242)
-------- -------- --------
Postretirement benefit cost $ 35,878 $ 39,331 $ 45,641
======== ======== ========
</TABLE>
The following table sets forth the plans' funded status and the accrued
postretirement benefit obligations as of December 31:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(Thousands of Dollars)
<S> <C> <C>
Accumulated postretirement benefit obligations attributable to:
Retirees $ 227,289 $ 221,067
Fully eligible active plan participants 8,890 9,066
Other active plan participants 96,749 104,962
--------- ---------
Total accumulated postretirement benefit obligations 332,928 335,095
Less: fair value of plan assets 4,236 2,799
--------- ---------
Excess of accumulated obligations over plan assets 328,692 332,296
Unrecognized transition obligation (167,760) (182,752)
Unrecognized net gain 48,149 39,290
--------- ---------
Accrued postretirement benefit obligations $ 209,081 $ 188,834
========= =========
</TABLE>
The assumed discount rates used to measure the accumulated postretirement
benefit obligations were 7.25% at December 31, 1997 and 7.5% at December 31,
1996. The assumed health care cost trend rate was 8.25% in 1997 and 8.75% in
1996 and is assumed to decrease gradually to an ultimate rate of 6.0% in the
year 2004. A one percentage point increase in the assumed health care cost trend
rate for each future year would have increased 1997 costs by approximately $1.1
million and the accumulated postretirement benefit obligations as of December
31, 1997, by approximately $11.9 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
$5.1 million, $5.5 million and $4.9 million in 1997-1995, respectively.
29
<PAGE> 32
11. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is summarized as follows at December 31:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
(Thousands of Dollars)
<S> <C> <C>
Land $ 16,177 $ 15,725
Buildings 381,214 360,121
Plant and equipment 4,641,143 4,260,841
Other 379,713 407,143
----------- -----------
Total 5,418,247 5,043,830
Accumulated depreciation (3,317,186) (3,058,086)
----------- -----------
Total property, plant and equipment - net $ 2,101,061 $ 1,985,744
=========== ===========
</TABLE>
Depreciation expense in 1997-1995 was equivalent to a composite average
percentage of 6.9%, 7.0% and 6.3%, respectively. During 1997, depreciation was
partially offset by the effects of a reduction in depreciation rates to reflect
higher net salvage values related to certain telephone plant and equipment.
12. 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 Federal Communications Commission (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
In 1991, the Public Utility Commission of Texas (TPUC) approved a rulemaking
procedure which allowed the Company and other LECs to exit the Texas intraLATA
toll pool while receiving transitional support payments during a conversion
period ending in 1997. Currently, the Company participates in the Texas Pooling
Alternative Settlement Plan, also known as an Originating Responsibility Plan
(ORP). Under this ORP, 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 receives access charges for terminating any intraLATA toll
call that originates outside of its service area based on its approved access
charge tariff.
30
<PAGE> 33
In May 1995, the Texas legislature passed a telecommunications reform bill which
opened local exchanges to competition and allowed 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 the end of 1998 and requires 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 its 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 of $50.6 million
is reflected on the balance sheets as other current liabilities and other
non-current liabilities.
On August 2, 1996, the TPUC approved an interim Expanded Local Calling (ELC)
surcharge of 92 cents 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 and filed a Stipulation and
Settlement Agreement on November 21, 1996. A final order, approved in February
1997, stipulated a surcharge of 73 cents per line which will generate
approximately $11.6 million annually. The difference in the interim surcharge
and the stipulated surcharge was refunded to ratepayers in April 1997.
In December 1996, the TPUC issued decisions in the Company's arbitration with
AT&T, MCI, and Sprint to determine interconnection, resale and unbundling terms
and conditions. The interim discount rate for the Company's resold services was
set at 22.99%. Interim rates based on the FCC proxy rates will be used for
interconnection and unbundled network elements (UNEs) until permanent discounts
are established upon further investigation into cost methodology. The Company
filed cost studies on June 10, 1997 and revised cost studies on February 27,
1998. Negotiated permanent rates are expected to be established during the
second half of 1998. During 1997, the Company filed lawsuits in the U.S.
District Court challenging portions of the TPUC's determinations. These lawsuits
have been consolidated into a single lawsuit and a decision is anticipated in
the second quarter of 1998.
On February 10, 1997, the TPUC ordered implementation of intraLATA 1+
presubscription which allows customers to choose their primary carrier for
intraLATA toll calls. The Company converted all capable offices to 1+
presubscription by August 6, 1997. As a result of this conversion, customers in
Texas may choose the incumbent local-exchange carrier (ILEC) or an alternative
local-exchange carrier (ALEC) to carry all intraLATA toll calls when the
customer dials one plus the called number.
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 transitional support payments during a three-year conversion
period which ended in 1996. 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
amounted to $4.7 million and the approved access tariff changes totaled $0.8
million. These rate changes became effective March 6, 1996.
31
<PAGE> 34
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 UNEs until permanent discounts are established upon further
investigation into cost methodology, which is expected to take place in the
first half of 1998. The Company has filed a lawsuit in the U.S. District Court
challenging portions of the OCC's arbitration determinations.
New Mexico
On January 2, 1997, the New Mexico Service Corporation Commission (NMSCC) issued
an order on Western Wireless' petition for arbitration. In this order, the
Company was required to set wholesale local switching rates at incremental cost
plus a 15% general services allocator. On February 18, 1997, the Company filed a
lawsuit in the U.S. District Court challenging portions of the NMSCC's
arbitration order including the wholesale rate calculation.
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
Much of the regulatory and legislative activity that occurred in the United
States in 1997 was a direct result of the Telecommunications Act adopted by
Congress. The Telecommunications Act is intended to promote competition in all
sectors of the telecommunications marketplace while preserving and advancing
universal telephone service.
In July 1997, the U.S. Court of Appeals for the Eighth Circuit (Eighth Circuit)
released its decision on the challenge filed in 1996 by the Company's parent,
GTE, and numerous other parties to rules developed by the FCC to implement the
interconnection provisions of the Telecommunications Act. The Telecommunications
Act required LECs to make their retail services and underlying network elements
available to competitors. The FCC required that prices for both resold services
and network elements be set using a methodology created by the FCC. The court
challenge asserted that the FCC's rules were inconsistent with the
Telecommunications Act. The July 1997 court decision found that the FCC
overstepped its authority in a number of areas and upheld GTE's position that
state regulatory agencies bear the primary responsibility for determining the
prices which competing firms must pay when interconnecting their networks. On
January 26, 1998, the U.S. Supreme Court announced that it would review this
decision. Oral argument in the Supreme Court is expected to take place in
October 1998, with a final decision likely to be issued no later than June 1999.
In May 1997, the FCC released two new major decisions related to implementation
of the Telecommunications Act's provisions - the universal service and access
charge reform orders. The universal service order established the support
mechanisms to ensure continued availability of affordable local telephone
service and created new programs to provide discounted telecommunications
services to schools, libraries and rural health care providers. GTE and numerous
other parties have challenged the FCC's decision before the U.S. Court of
Appeals for the Fifth Circuit on the grounds that the FCC did not follow the
requirements of the Telecommunications Act to develop a sufficient, explicit and
competitively neutral universal service program. A decision is expected in 1998.
32
<PAGE> 35
The FCC access charge reform order, also released in May 1997, revamped the rate
structure through which local and long distance companies charge customers for
using the local phone network to make long distance calls. The FCC ordered
decreases for long distance companies to be accomplished by increasing the
access charges for business and residential customers with more than one phone
line. GTE and numerous other parties also challenged this decision before the
Eighth Circuit based on the belief that the FCC did not eliminate the universal
service subsidies hidden within interstate access charges as directed by the
Telecommunications Act, and that the FCC created additional subsidy charges paid
only by business and multi-line residential customers. Oral argument has been
held and a decision is expected in 1998.
Also in May 1997, the FCC released a decision completing a periodic review of
its price cap regulatory oversight of interstate access charges. GTE and
numerous other LECs have challenged this decision before the Eighth Circuit
based on the belief that the FCC established a fundamentally unfair annual price
reduction formula and required retroactive price reductions. Oral argument has
been held and a decision on this challenge is also expected in 1998.
For the provision of interstate services, the Company operates under the terms
of the FCC's price cap incentive plan. The price cap mechanism serves to limit
the rates a carrier may charge, rather than just regulating the rate-of-return
which may be achieved. Under this approach, the maximum price that the LEC may
charge is increased or decreased each year by a price index based upon inflation
less a predetermined productivity target. LECs have limited pricing flexibility
provided they do not exceed the allowed price cap.
In the May 1997 order on its price cap triennial review, the FCC revised the
price cap plan for LECs by adopting a uniform productivity factor of 6.0% with
an additive consumer productivity dividend of 0.5%. The FCC also eliminated the
sharing requirements of the price cap rules.
The Company filed interstate access revisions during 1997 that became effective
June 3, 1997 and July 1, 1997. Overall, these filings resulted in a net annual
price reduction of $25.5 million. On December 1, 1997, the FCC issued an order
to file revised access rates effective January 1, 1998, which resulted in
additional interstate access charge reductions of approximately $3.1 million.
In 1997, the FCC also ordered significant changes that altered the structure
of access charges collected by the Company, effective January 1, 1998.
Generally, the FCC reduced and restructured the per minute charges paid by
long distance carriers and implemented new per line charges. The FCC also
created an access charge structure that resulted in different access charges
for residential primary and secondary lines and single line and multi-line
business lines. In aggregate, the reductions in usage sensitive access charges
of $10.8 million paid by long distance carriers were offset by $10.8 million
of new per line charges and charges paid by end-users.
On June 4, 1996, the FCC issued its first Report and Order implementing Section
276 of the Telecommunications Act. As part of the overall goal of promoting
competition among payphone service providers (PSPs), this order mandated
compensation to all PSPs for all calls originating from payphones, including
"dial-around" access calls and toll-free subscriber calls for which PSPs were
not previously compensated. This compensation was to occur in two separate
phases. During phase one, from April 15, 1997 through October 6, 1997, PSPs were
to be paid a monthly, flat-rate compensation from interexchange carriers (IXCs).
During phase two, beginning October 7, 1997, PSPs were to be compensated on a
per-call basis, with the prevailing local coin rate of 35 cents established as
the default rate.
On July 19, 1997, the U.S. Court of Appeals in Washington, D.C. vacated the
FCC's directive concerning per-call compensation, stating that the FCC had not
shown that the 35 cent rate was a reasonable surrogate for fair compensation.
The court also set aside the FCC's flat-rate compensation mandate. Subsequently,
on October 9, 1997, the FCC issued a second Report and Order to address some of
the issues vacated by the court. In this second order, the FCC established a new
per-call rate of 28.4 cents for phase two compensation that all PSPs were
eligible
33
<PAGE> 36
to receive beginning October 9, 1997. The FCC tentatively concluded that this
per-call rate should also be used to calculate phase one compensation. The
Company has recorded approximately $3.2 million of payphone revenues associated
with the October 9, 1997 FCC order. It is likely that the phase one compensation
directive will be revisited in a subsequent order.
SIGNIFICANT CUSTOMER
Revenues received from AT&T Corp. include amounts for access and billing and
collection during the years 1997-1995 under various arrangements and amounted to
$218.8 million, $220.3 million and $223 million, respectively.
13. COMMITMENTS AND CONTINGENCIES
The Company has noncancelable leases covering certain buildings, office space
and equipment. Rental expense was $14.8 million, $18.4 million and $15.2
million in 1997-1995, respectively. Minimum rental commitments under
noncancelable leases through 2002 do not exceed $4.8 million annually and
aggregate $9.8 million thereafter.
The Company is subject to a number of proceedings arising out of the conduct of
its business, including those relating to regulatory actions, commercial
transactions and environmental, safety and health matters. Management believes
that the ultimate resolution of these matters will not have a material adverse
effect on the results of operations or the financial position of the Company.
Recent judicial and regulatory developments, as well as the pace of
technological change, have continued to influence industry trends, including
accelerating and expanding the level of competition. As a result, the Company's
operations face increasing competition in virtually all aspects of its business.
The Company supports greater competition in telecommunications, provided that,
overall, the actions to eliminate existing legal and regulatory barriers allow
an opportunity for all service providers to participate equally in a competitive
marketplace under comparable conditions.
34
<PAGE> 37
14. QUARTERLY FINANCIAL DATA (Unaudited)
Summarized 1997 and 1996 quarterly financial data is as follows :
<TABLE>
<CAPTION>
Revenues Operating
and Sales Income Net Income
---------- ---------- ----------
(Thousands of Dollars)
<S> <C> <C> <C>
1997
First Quarter $ 417,704 $ 145,187 $ 86,429
Second Quarter 411,342 111,332 64,801
Third Quarter 445,575 136,128 79,366
Fourth Quarter (a) 401,978 97,836 57,558
---------- ---------- ----------
Total $1,676,599 $ 490,483 $ 288,154
========== ========== ==========
1996
First Quarter $ 392,434 $ 115,408 $ 68,320
Second Quarter (b) 403,332 102,332 62,082
Third Quarter 410,687 100,769 59,087
Fourth Quarter 416,486 89,256 66,307
---------- ---------- ----------
Total $1,622,939 $ 407,765 $ 255,796
========== ========== ==========
</TABLE>
(a) Fourth quarter 1997 operating income includes the effects of a reduction
to depreciation rates to reflect higher net salvage values related to
certain of its telephone plant and equipment.
(b) Second quarter 1996 net income includes after-tax gains on the sale of
non-strategic properties of $2.8 million (see Note 4).
15. SUBSEQUENT EVENTS (Unaudited)
On January 8, 1998, the Company issued $150 million of 6.23% Series D
debentures, due 2007. Net proceeds were applied toward the repayment of
short-term borrowings incurred for the purpose of financing the Company's
construction program and for general corporate purposes.
During 1997, the Company entered into forward contracts to sell $150 million of
U.S. Treasury Bonds in order to hedge against future changes in market interest
rates related to the debt the Company called and subsequently refinanced on
January 8, 1998 (discussed above). A loss of approximately $2.6 million occurred
upon settlement of the forward contracts and will be amortized over the life of
the associated refinanced debt.
35
<PAGE> 38
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, 1997 and 1996, and the related statements of income, shareholders'
equity and cash flows for each of the three years in the period ended December
31, 1997, as set forth on pages 16 through 19 and Schedule II of this report.
These financial statements and the schedule and exhibit referred to below are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements and the schedule and exhibit based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of GTE Southwest Incorporated as
of December 31, 1997 and 1996, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.
As discussed in Note 2 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 audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The supporting schedule and exhibit
listed under Item 14 are presented for purposes of complying with the Securities
and Exchange Commission's rules and are not a required part of the basic
financial statements. The supporting schedule and exhibit have been subjected to
the auditing procedures applied in the audits of the basic financial statements
and, in our opinion, fairly state in all material respects the financial data
required to be set forth therein in relation to the basic financial statements
taken as a whole.
Dallas, Texas ARTHUR ANDERSEN LLP
January 26, 1998
36
<PAGE> 39
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.
LARRY E. ATWELL
President
GERALD K. DINSMORE
Senior Vice President - Finance and Planning
37
<PAGE> 40
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
38
<PAGE> 41
PART III
Item 10. Directors and Executive Officers of the Registrant
a. Identification of Directors
The names, ages and positions of the directors of the Company as of March 2,
1998 are listed below along with their business experience during the past five
years.
<TABLE>
<CAPTION>
Name Age Director Since Business Experience
- -------------------------- -------- -------------------- -----------------------------------------------------------
<S> <C> <C> <C>
John C. Appel 49 1996 President, GTE Network Services, 1997; Executive Vice
President - Network Operations, GTE Telephone Operations,
1996; Executive Vice President - Network Operations, all
GTE domestic telephone subsidiaries of which he is not
President, 1996; Director, all GTE domestic telephone
subsidiaries, 1996; President, GTE South Incorporated and
GTE North Incorporated, 1995; Senior Vice President -
Regulatory Operations, GTE Telephone Operations, 1994;
President, GTE Southwest Incorporated, 1994; State
President - Texas/New Mexico, 1993.
Mateland L. Keith, Jr. 55 1997 Senior Vice President - Regional Operations, GTE Network
Services, 1997; President, GTE California Incorporated,
1995; Assistant Vice President - Engineering, GTE
Telephone Operations, 1995; Area Vice President - Sales,
GTE North Incorporated, 1993.
Lawrence R. Whitman 46 1997 Vice President - Finance and Planning, Business
Development and Integration, 1997; Controller, GTE
Corporation, 1995; Vice President - Finance, TP&S, 1993.
</TABLE>
Directors are elected annually. There are no family relationships between any of
the directors or executive officers of the Company.
39
<PAGE> 42
b. Identification of Executive Officers
The Company's policies are established not only by the Company's executive
officers, but also by the executive officers of GTE Network Services.
Accordingly, the list below contains the names, ages and positions of the
executive officers of both the Company and GTE Network Services as of March 2,
1998.
<TABLE>
<CAPTION>
Year Assumed
Present Position
----------------------------
Network the
Name Age Services Company Position
- --------------------------- --------- ------------- ------------- ---------------------------------------------
<S> <C> <C> <C> <C>
John C. Appel (1) 49 1997 -- President of GTE Network Services
-- 1995 Executive Vice President - Network
Operations of the Company
Larry E. Atwell (2) 50 -- 1998 President of the Company
Mary Beth Bardin 43 -- 1995 Vice President - Public Affairs of the
Company
Gerald K. Dinsmore 48 -- 1993 Senior Vice President - Finance and
Planning of the Company
William M. Edwards, III 49 -- 1993 Vice President - Controller of the Company
M. Michael Foster 54 -- 1996 Vice President - Midwest Region of the
Company
Gregory D. Jacobson 46 -- 1994 Treasurer of the Company
Mateland L. Keith, Jr. (3) 55 1997 -- Senior Vice President - Regional Operations
of GTE Network Services
Brad M. Krall 56 1993 1995 Vice President - Centralized Operations of
GTE Network Services and the Company
Robert G. McCoy (4) 53 1997 1997 President - Retail Markets of GTE Network
Services and Vice President - Retail
Markets of the Company
William G. Mundy (5) 48 1997 1998 Vice President and General Counsel of GTE
Network Services and the Company
Barry W. Paulson 46 1996 1996 Vice President - Network Operations
Planning and Support of GTE Network
Services and the Company
Richard L. Schaulin 55 1989 1995 Vice President - Human Resources of GTE
Network Services and the Company
Charles J. Somes 51 -- 1994 Secretary of the Company
Larry J. Sparrow (6) 54 1997 -- President - Wholesale Markets of GTE
Network Services
-- 1995 Vice President - Carrier Markets of the
Company
</TABLE>
(1) John C. Appel was appointed President of GTE Network Services in June 1997
replacing Thomas W. White, who was appointed Senior Executive Vice
President - Market Operations of GTE Service Corporation.
(2) Larry E. Atwell was appointed President of the Company in January 1998
replacing Thomas W. Hall, who was appointed Assistant Vice President -
Internetworking Strategy of Business Development and Integration, a
separate business unit of GTE.
(3) Mateland L. Keith, Jr. was appointed Senior Vice President - Regional
Operations of GTE Network Services in June 1997, replacing John C. Appel.
(4) Robert G. McCoy was appointed President - Retail Markets of GTE Network
Services and elected Vice President - Retail Markets of the Company in
October 1997 replacing C.F. Bercher, who was appointed and elected
President of GTE Communications Corporation.
(5) William G. Mundy was appointed Vice President and General Counsel of GTE
Network Services in October 1997 and elected Vice President - General
Counsel of the Company in January 1998. Mr. Mundy replaced Richard M.
Cahill, who was appointed Vice President and Associate General Counsel of
GTE Service Corporation.
(6) Larry J. Sparrow was appointed President - Wholesale Markets of GTE Network
Services in June 1997.
Each of these executive officers has been an employee of the Company or an
affiliated company for the last five years. Except for duly elected officers and
directors, no other employees had a significant role in decision making. All
officers are appointed for a term of one year.
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
individual who served as Principal Executive Officer of the Company in 1997,
each of the other four most highly compensated executive officers of the Company
(other than the Chief Executive Officer) who served as such and were compensated
by the Company or GTE Network Services at the end of 1997 and the two additional
individuals who served as executive officers of the Company or GTE Network
Services in 1997 but did not serve as such or were not being compensated by the
Company or GTE Network Services at the end of 1997 (collectively, the Named
Executive Officers). The information in this table under the caption "Annual
Compensation" sets forth all compensation paid to the Named Executive Officers
by the Company and GTE Network Services. The caption "Long-Term Compensation"
sets forth all long-term compensation paid to the Named Executive Officers under
employee benefit plans administered by GTE Corporation or GTE Service
Corporation. Footnote 1 to this table sets forth the actual 1997 annual
compensation for each of the Named Executive Officers that was allocated to the
Company.
<TABLE>
<CAPTION>
Long-Term Compensation
------------------------------------------------
Annual Compensation (2) Awards Payouts
--------------------------------- ----------------------- ------------------------
Restricted Securities
Other Annual Stock Underlying LTIP All Other
Name and Principal Salary Bonus Compensation Awards Options/ Payouts Compensation
Position in Group (1) Year ($)(3) ($)(4) ($) ($)(5) SARs (#) ($) ($)(6)
- ---------------------------- ---- -------- ------- ------------ ------ ---------- ------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Thomas W. Hall (7) 1997 163,808 70,200 -- 2,109 11,100 42,300 7,200
President 1996 49,050 65,600 -- -- 7,000 -- 6,230
John C. Appel 1997 348,365 399,386 -- 59,881 76,000 548,700 11,320
President 1996 295,977 380,700 -- 51,229 124,400 439,200 10,572
GTE Network Services 1995 239,600 258,100 -- -- 63,500 162,800 10,194
Larry J. Sparrow 1997 315,565 256,400 -- 39,481 40,700 375,300 11,320
President - 1996 294,812 260,800 -- 41,561 81,400 404,100 10,613
Wholesale Markets 1995 261,866 255,600 -- -- 36,400 211,300 10,613
GTE Network Services
Mateland L. Keith, Jr. 1997 250,413 157,100 -- 16,025 32,700 163,400 10,376
Senior Vice President - 1996 217,762 117,300 -- 5,118 15,200 87,600 9,799
Regional Operations 1995 204,308 104,000 -- -- 12,500 -- 9,111
GTE Network Services
Barry W. Paulson 1997 197,538 141,900 -- 14,706 19,900 93,400 7,200
Vice President - 1996 191,945 112,800 -- 9,231 19,900 34,900 6,750
Network Operations 1995 156,027 73,100 -- -- 6,500 -- 6,750
Planning and Support
GTE Network Services
Thomas W. White (8) 1997 470,776 520,646 -- 84,756 91,700 822,400 11,320
Senior Executive 1996 463,115 533,700 -- 81,511 183,400 770,000 10,613
Vice President - 1995 418,884 443,800 -- -- 98,800 331,800 10,613
Market Operations
GTE Service Corporation
Gerald K. Dinsmore (9) 1997 302,532 314,807 -- 45,906 62,200 411,800 11,320
Senior Vice President - 1996 288,619 263,700 -- 41,751 81,400 404,100 10,613
Finance and Planning 1995 265,125 255,600 -- -- 36,400 211,300 10,613
</TABLE>
41
<PAGE> 44
(1) All persons named in the table are officers of the Company except as
otherwise noted.
(2) Annual Compensation represents the total annual cash compensation of
salaries, bonuses and other compensation. The Company's allocated share for
Messrs. Hall, Appel, Sparrow, Keith, Paulson, White and Dinsmore, for whom
total annual amounts are shown above, is $234,008, $91,620, $68,653,
$18,688, $40,743, $121,998 and $76,156, respectively.
(3) The data in the table includes fees of $7,280, $15,692 and $16,607 received
by Mr. White for serving as director of BC TEL during 1997, 1996, and 1995.
BC TEL, a Canadian company, is an indirectly-owned subsidiary of GTE
Corporation. Mr. White also received BC TEL deferred stock units valued at
$10,695, which amount is included in this column.
(4) The data in this column represents the annual bonus received in 1997
by each of the Named Executive Officers under the GTE Corporation 1997
Executive Incentive Plan (the EIP) and a similar predecessor plan (the
Executive Incentive Plan). In connection with GTE's Equity Participation
Program (the EPP), a portion of this amount has been deferred into
restricted stock units payable at maturity (generally, a minimum of three
years) in GTE Common Stock (Restricted Stock Units). The number of
Restricted Stock Units received was calculated by dividing the amount of
the annual bonus deferred by the average closing price of GTE Common Stock
on the New York Stock Exchange (NYSE) composite tape for the 20 consecutive
trading days following the release to the public of GTE's financial results
for the fiscal year in which the bonus was earned (the Average Closing
Price). Additional Restricted Stock Units are received on each dividend
payment date based upon the amount of the dividend paid and the closing
price of GTE Common Stock on the composite tape of NYSE issues on the
dividend declaration date.
(5) The data in this column represents the dollar value of the matching
Restricted Stock Units based upon the Average Closing Price. Matching
Restricted Stock Units are received on the basis of one additional
Restricted Stock Unit for every four Restricted Stock Units deferred
through annual bonus deferrals described in footnote 4 above. The matching
Restricted Stock Units were designed as an inducement to encourage full
participation in the EPP and to compensate the executives for their
agreement not to realize the economic value associated with the Restricted
Stock Units representing deferred annual bonus for a minimum of three
years. Additional Restricted Stock Units are received on each dividend
payment date based upon the amount of the dividend paid and the closing
price of GTE Common Stock on the composite tape of NYSE issues on the
dividend declaration date. Messrs. Hall, Appel, Sparrow, Keith, Paulson,
White and Dinsmore hold a total of 194, 11,024, 8,106, 2,025, 2,346, 16,568
and 8,716 Restricted Stock Units, respectively, which had a dollar value of
$10,132, $576,025, $423,517, $105,801, $122,591, $865,678 and $455,397,
respectively, based solely upon the closing price of GTE Common Stock on
December 31, 1997.
(6) The column "All Other Compensation" includes, for 1997, Company
contributions to the GTE Savings Plan of $7,200 for each of Messrs. Hall,
Appel, Sparrow, Paulson, White and Dinsmore, and $6,731 for Mr. Keith. This
column also includes Company contributions to the GTE Executive Salary
Deferral Plan of $4,120 for each of Messrs. Appel, Sparrow, White and
Dinsmore, and $3,645 for Mr. Keith.
(7) Mr. Hall served as President of the Company until January 1998, at which
time he was appointed Assistant Vice President - Internetworking Strategy
of Business Development and Integration, a separate business unit of GTE.
(8) Mr. White was elected Senior Executive Vice President - Market Operations
of GTE Service Corporation in June 1997. He served as President of GTE
Telephone Operations from July 1995 until June 1997, and before that as an
Executive Vice President of GTE Telephone Operations from 1991.
42
<PAGE> 45
(9) Mr. Dinsmore was appointed President, Business Development and Integration
(a separate business unit of GTE) in June 1997. Mr. Dinsmore has served as
Senior Vice President - Finance and Planning of the Company since 1993.
Although Mr. Dinsmore has retained his title with the Company, since June
1997 he has been compensated solely through his new position.
OPTION GRANTS IN LAST FISCAL YEAR
The following table shows all grants of options to the Named Executive Officers
of the Company in 1997, whether or not specifically allocated to the Company.
The options were granted under the GTE Corporation 1997 Long-Term Incentive Plan
(the 1997 LTIP) and the GTE Corporation 1991 Long-Term Incentive Plan (the 1991
LTIP). Pursuant to Securities and Exchange Commission rules, the table also
shows the value of the options granted at the end of the option terms (ten
years) if the stock price were to appreciate annually by 5% and 10%,
respectively. There is no assurance that the stock price will appreciate at the
rates shown in the table. The table also indicates that if the stock price does
not appreciate, the potential realizable value of the options granted will be
zero.
<TABLE>
<CAPTION>
Potential Realizable Value at
Assumed Annual Rate of Stock
Price Appreciation for
Individual Grants Option Term
-------------------------------------------------- -------------------------------
Number of Percent of
Securities Total Options Exercise
Underlying Granted to or Base
Options Employees in Price Expiration
Name Granted (1) Fiscal Year ($/SH) Date 0% 5% 10%
- ------------- ----------- ------------- -------- ---------- ----- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Thomas W. Hall 11,100 .05% 48.6250 2/16/07 -- $ 339,438 $ 860,203
John C. Appel 62,200 .29% 48.6250 2/16/07 -- 1,902,076 4,820,234
13,800 .06% 44.1250 6/04/07 -- 382,950 970,470
Larry J. Sparrow 40,700 .19% 48.6250 2/16/07 -- 1,244,606 3,154,076
Mateland L. Keith, Jr. 15,200 .07% 48.6250 2/16/07 -- 464,816 1,177,935
17,500 .08% 44.1250 6/04/07 -- 485,625 1,230,668
Barry W. Paulson 19,900 .09% 48.6250 2/16/07 -- 608,542 1,542,165
Thomas W. White 91,700 .43% 48.6250 2/16/07 -- 2,804,186 7,106,358
Gerald K. Dinsmore 40,700 .19% 48.6250 2/16/07 -- 1,244,606 3,154,076
21,500 .10% 44.1250 6/04/07 -- 596,624 1,511,964
</TABLE>
(1) Each option granted may be exercised with respect to one-third of the
aggregate number of shares subject to the grant each year, commencing one
year after the date of grant. No stock appreciation rights (SARs) were
granted to the Named Executive Officers of the Company in 1997.
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 1997. The table sets
forth the value of options and SARs held by such officers at year-end measured
in terms of the closing price of GTE Corporation (GTE) Common Stock on December
31, 1997.
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options/SARs
Shares Options/SARs at FY-End at FY-End ($)
Acquired Value -------------------------------------------------------------
Name On Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable
- --------------- --------------- ------------ ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Thomas W. Hall -- -- 4,899 19,101 54,698 111,328
John C. Appel 56,567 600,134 -- 200,834 -- 1,539,141
Larry J. Sparrow -- -- 73,566 120,668 1,234,142 924,580
Mateland L. Keith, Jr. 26,533 450,092 5,066 47,001 40,687 338,674
Barry W. Paulson 6,700 117,281 10,966 35,334 130,074 203,344
Thomas W. White 69,300 1,055,056 132,232 277,468 2,094,451 2,158,179
Gerald K. Dinsmore -- -- 35,999 142,168 531,517 1,089,190
</TABLE>
LONG-TERM INCENTIVE PLAN - AWARDS IN LAST FISCAL YEAR
The 1997 LTIP and 1991 LTIP provide for awards to participating employees,
including stock options, SARs, performance bonuses and other stock-based awards.
The stock options awarded under the 1997 LTIP and 1991 LTIP to the Named
Executive Officers in 1997 are shown in the table on page 43.
<TABLE>
<CAPTION>
Estimated Future Payouts
Under Non-Stock Price Based Plans (1)
Performance ----------------------------------------------
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> <C>
Thomas W. Hall 1,500 3 Years 435 1,673
John C. Appel (5) 7,400 3 Years 2,146 8,254
1,380 30 Months 396 1,524
845 18 Months 235 902
290 6 Months 60 299
Larry J. Sparrow 4,900 3 Years 1,421 5,466
Mateland L. Keith, Jr. (6) 1,900 3 Years 551 2,119
1,720 30 Months 494 1,899
1,055 18 Months 293 1,126
310 6 Months 64 319
Barry W. Paulson 2,400 3 Years 696 2,677
Thomas W. White 10,900 3 Years 3,161 12,158
Gerald K. Dinsmore (7) 4,900 3 Years 1,421 5,466
2,155 30 Months 619 2,379
1,320 18 Months 366 1,409
410 6 Months 84 422
</TABLE>
44
<PAGE> 47
(1) An individual's award may not exceed the applicable individual award limit
(the Award Limit), which is expressed as a percentage of the LTIP Award
Pool. The Award Limit depends on the individual's base salary at the end of
the award cycle, and may not exceed 3.5% of the LTIP Award Pool. The
amounts described in footnotes 2 through 4 below are subject to and cannot
exceed the Award Limit. An individual is initially granted a specified
number of GTE Common Stock equivalent units (Equivalent Units) at the
beginning of an award cycle. During the award cycle, additional Equivalent
Units are added based upon the price of GTE Common Stock and the amount of
the per share dividend paid on each dividend payment date. It is not
possible to predict future dividends and, accordingly, estimated Equivalent
Unit accruals in this table are calculated for illustrative purposes only
and are based upon the dividend rate and price of GTE Common Stock at the
close of business on December 31, 1997. The "Target" award or future payout
is the dollar amount derived by multiplying the Equivalent Unit balance
credited to the participant at the end of the award cycle by the average
closing price of GTE Common Stock, as reported on the composite tape of
NYSE issues, during the last 20 business days of the award cycle. The
Target award measures performance attainment as described in footnote 3.
(2) The Threshold represents attainment of minimum acceptable levels of
performance (the Threshold Levels) with respect to the five Long-Term
Performance Bonus Measures (the Measures) adopted for the 1997-1999
Performance Bonus award cycle -- revenue growth; earnings per share (EPS)
growth; earnings before interest, taxes, depreciation and amortization
(EBITDA) growth; average return on investment (ROI) and relative total
shareholder return (TSR). If the Threshold Level is attained with respect
to each of the Measures, the award will be equal to approximately 25% of
the combined Target award (the TSR Threshold is set at 50%, while the
Threshold for the other four Measures is set at 20%). Because performance
is measured separately for each Measure, it is possible to receive an award
if the Threshold Level is achieved with respect to at least one but not all
of the Measures. If the actual results for all Measures are below the
Threshold Levels, no award will be paid.
(3) The Target represents attainment of levels of three-year revenue growth,
EPS growth, EBITDA growth, ROI and TSR established at the beginning of an
award cycle (the Target Levels). If GTE's actual results for each of the
Measures are equivalent to the Target Levels, this would represent
outstanding performance, and the award will be equal to 100% of the
combined Target award. GTE's performance is measured separately for each
Measure. Accordingly, if the actual result for any Measure is at the
applicable Target Levels, the portion of the award determined by that
Measure will be at 100% of the Target award for that Measure. Similarly,
the portion of the award determined by any Measure performing at less than
the applicable Target Level, but above the Threshold, will be less than the
Target award for that Measure.
(4) This column has intentionally been left blank because it is not possible to
determine the maximum number of Equivalent Units until the award cycle has
been completed. Subject to the Award Limit discussed in footnote 1 above,
the maximum amount of the award is limited by the extent to which GTE's
actual results for the five Measures exceed the Target Levels. If GTE's
actual results during the cycle for the five Measures exceed the respective
Target Levels, additional awards may be paid, based on a linear
interpolation. For example, for revenue growth, the schedule is as follows:
<TABLE>
<CAPTION>
Performance Increment Above
Revenue Performance Target Added Percentage to Combined Awards
------------------------------------------- -----------------------------------------
<S> <C>
Each 0.1% improvement in cumulative
revenue growth +2%
</TABLE>
Thus, if the revenue growth Measure exceeds its Target Level by .5% while
the remaining four Measures are precisely at their respective Target
Levels, then the performance bonus will equal 110% of the combined Target
award.
45
<PAGE> 48
(5) The award of 7,400 units to Mr. Appel represents the grant for the
1997-1999 performance period made while he was Executive Vice President of
GTE Telephone Operations. Pursuant to GTE's compensation policies, the
other grants shown are incremental, prorated awards made when he was
promoted to President of GTE Network Services in June 1997. The incremental
units apply to the 1997-1999, 1996-1998 and 1995-1997 performance periods.
(6) The award of 1,900 units to Mr. Keith represents the grant for the
1997-1999 performance period made while he was President of GTE California
Incorporated, an affiliate of the Company. Pursuant to GTE's compensation
policies, the other grants shown are incremental, prorated awards made when
he was promoted to Senior Vice President - Regional Operations of GTE
Network Services in June 1997. The incremental units apply to the
1997-1999, 1996-1998 and 1995-1997 performance periods.
(7) The award of 4,900 units to Mr. Dinsmore represents the grant for the
1997-1999 performance period made while he was Senior Vice President -
Finance and Planning of the Company. Pursuant to GTE's compensation
policies, the other grants shown are incremental, prorated awards made when
he was promoted to President of Business Development and Integration, a
separate business unit of GTE, in June 1997. The incremental units apply to
the 1997-1999, 1996-1998 and 1995-1997 performance periods.
Executive Agreements
GTE has entered into agreements (the Agreements) with Messrs. Appel, Sparrow,
White and Dinsmore regarding benefits to be paid in the event of a change in
control of GTE (a Change in Control).
A Change in Control is deemed to have occurred if (a) any person or group of
persons acquires, other than from GTE or as described below, 20% (or under
certain circumstances, a lower percentage, not less than 10%) of GTE's voting
power, (b) three or more directors are elected in any twelve-month period
without the approval of a majority of the members of GTE's Incumbent Board (as
defined in the Agreements) then serving as members of the Board, (c) the members
of the Incumbent Board no longer constitute a majority of the Board or (d) GTE's
shareholders approve (i) a merger, consolidation or reorganization involving
GTE, (ii) a complete liquidation or dissolution of GTE or (iii) an agreement for
the sale or other disposition of all or substantially all of the assets of the
Corporation to any person other than a subsidiary of GTE. An individual whose
initial assumption of office occurred pursuant to an agreement to avoid or
settle a proxy or other election contest is not considered a member of the
Incumbent Board. In addition, a director who is elected pursuant to such a
settlement agreement will not be deemed a director who is elected or nominated
by the Incumbent Board for purposes of determining whether a Change in Control
has occurred. Notwithstanding the foregoing, a Change in Control will not occur
in the following situations: (1) certain merger transactions in which there is
at least 50% GTE shareholder continuity in the surviving corporation, at least a
majority of the members of the board of directors of the surviving corporation
consists of members of the Board and no person owns more than 20% (or under
certain circumstances, a lower percentage, not less than 10%) of the voting
power of the surviving corporation following the transaction, and (2)
transactions in which GTE's securities are acquired directly from GTE.
The Agreements provide for benefits to be paid in the event these individuals
separate from service and have a "good reason" for leaving or are terminated
without "cause" within two years after a Change in Control of GTE. Good reason
for leaving includes, but is not limited to, the following events: demotion,
relocation or a reduction in total compensation or benefits, or the new entity's
failure to expressly assume obligations under the Agreements. Termination for
cause includes certain unlawful acts on the part of the executive or a material
violation of his or her responsibilities to the Corporation resulting in
material injury to the Corporation.
An executive who experiences a qualifying separation from service will be
entitled to receive up to two times the sum of (i) base salary and (ii) the
average of his or her percentage awards under the EIP for the previous three
years. The executive will also continue to receive medical and life insurance
coverage for up to two years and will be provided with financial and
outplacement counseling.
46
<PAGE> 49
In addition, each executive covered under an Agreement will be considered to
have not less than 76 points and 15 years of accredited service for the purpose
of determining his or her eligibility for early retirement benefits. The
Agreements provide that there will be no duplication of benefits.
Each of the Agreements remains in effect until July 1, 1999 unless terminated
earlier pursuant to its terms. The Agreements will be automatically renewed on
each successive July 1 unless, not later than December 31 of the preceding year,
one of the parties notifies the other that he or she does not wish to extend his
or her respective Agreement. If a Change in Control occurs, the Agreements will
remain in effect until the obligations of GTE (or its successor) under the
Agreements have been satisfied.
Retirement Programs
Pension Plans
The estimated annual benefits payable, calculated on a single life annuity
basis, under GTE's defined benefit pension plans at normal retirement at age 65,
based upon final average earnings (integrated with social security as described
below) and years of service, is illustrated in the following table:
PENSION PLAN TABLE
<TABLE>
<CAPTION>
Years of Service
Final Average ----------------------------------------------------------------------------------
Earnings 15 20 25 30 35
- ------------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
$ 200,000 $ 42,182 $ 56,242 $ 70,303 $ 84,363 $ 98,424
300,000 63,932 85,242 106,553 127,863 149,174
400,000 85,682 114,242 142,803 171,363 199,924
500,000 107,432 143,242 179,053 214,863 250,674
600,000 129,182 172,242 215,303 258,363 301,424
700,000 150,932 201,242 251,553 301,863 352,174
800,000 172,682 230,242 287,803 345,363 402,924
900,000 194,432 259,242 324,053 388,863 453,674
1,000,000 216,182 288,242 360,303 432,363 504,424
1,200,000 259,682 346,242 432,803 519,363 605,924
1,500,000 324,932 433,242 541,553 649,863 758,174
2,000,000 433,682 578,242 722,803 867,363 1,011,924
</TABLE>
GTE Service Corporation, a wholly-owned subsidiary of GTE, maintains the GTE
Service Corporation Plan for Employees' Pensions (the Service Corporation Plan),
a noncontributory pension plan for the benefit of all GTE employees who are not
covered by collective bargaining agreements. It provides a benefit based on a
participant's years of service and earnings. Pension benefits to be paid from
the Service Corporation Plan and contributions to the Service Corporation Plan
are related to basic salary and incentive payments exclusive of overtime,
differentials, certain incentive compensation and other similar types of
payments. Under the Service Corporation Plan, pensions are computed on a
two-rate formula basis of 1.15% and 1.45% for each year of service, with the
1.15% service credit being applied to that portion of the average annual salary
for the five highest consecutive years that does not exceed the Social Security
Integration Level (the portion of salary subject to the Federal Social Security
Act), and the 1.45% service credit being applied to that portion of the average
annual salary for the five highest consecutive years that exceeds said level up
to the statutory limit on compensation. As of December 31, 1997, the credited
years of service under the Service Corporation Plan for Messrs. Hall, Appel,
Sparrow, Keith, Paulson, White and Dinsmore are 3, 26, 30, 31, 24, 29 and 22,
respectively.
Under Federal law, an employee's benefits under a qualified pension plan, such
as the Service Corporation Plan, are limited to certain maximum amounts. GTE
maintains the GTE Excess Pension Plan (the Excess Plan), which supplements the
benefits of any participant in the Service Corporation Plan in an amount by
which any participant's
47
<PAGE> 50
benefits under the Service Corporation Plan are limited by law. In addition, the
Supplemental Executive Retirement Plan (SERP) includes a provision permitting
the payment of additional retirement benefits determined in a similar manner as
under the Service Corporation Plan on remuneration accrued under management
incentive plans as determined by the Committee. SERP and Excess Plan benefits
are payable in a lump sum or an annuity.
Executive Retired Life Insurance Plan
The GTE Corporation Executive Retired Life Insurance Plan (ERLIP) provides Mr.
Hall a postretirement life insurance benefit of two times final base salary and
Messrs. Appel, Sparrow, Keith, Paulson, White and Dinsmore a postretirement life
insurance benefit of three 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, 1998:
<TABLE>
<CAPTION>
Name and Address of Shares of
Title of Class Beneficial Owner Beneficial Ownership Percent of Class
---------------------- --------------------------- -------------------- -------------------
<S> <C> <C> <C>
Common Stock of GTE GTE Corporation 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, 1997:
<TABLE>
<CAPTION>
Shares
Beneficially
Owned as of
Title of Class Name of Director (1)(2)(3) December 31, 1997
-------------------- ------------------------------------- -------------------
<S> <C> <C>
Common Stock of GTE John C. Appel 48,159
Corporation Mateland L. Keith, Jr. 21,678
Lawrence R. Whitman 15,211
-------------------
85,048
===================
Executive Officers (1)(2)(3)
------------------------------------------------------------
Thomas W. Hall 3,195
John C. Appel 48,159
Larry J. Sparrow 127,612
Mateland L. Keith, Jr. 21,678
Barry W. Paulson 19,814
Thomas W. White 228,845
Gerald K. Dinsmore 55,636
-------------------
504,939
===================
All directors and executive
officers as a group (1)(2)(3) 716,123
===================
</TABLE>
(1) Includes shares acquired through participation in the GTE Savings Plan.
(2) Included in the number of shares beneficially owned by Messrs. Appel,
Keith, Whitman, Hall, Sparrow, Paulson, White, Dinsmore and all directors
and executive officers as a group, are 41,466, 17,366, 10,900, 2,933,
112,833, 11,800, 214,532, 52,833 and 629,527 shares, respectively, which
such persons have the right to acquire within 60 days pursuant to stock
options.
(3) No director or executive officer owns as much as one-tenth of one percent
of the total outstanding shares of GTE Common Stock, and all directors and
executive officers as a group own less than one-fifth of one percent of
the total outstanding shares of GTE Common Stock.
(c) There were no changes in control of the Company during 1997.
49
<PAGE> 52
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.
50
<PAGE> 53
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, 1997-1995 (as required):
II - Valuation and Qualifying Accounts
Note: Schedules other than the one listed above are omitted as not
applicable, not required, or the information is included in the
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)
4.1* 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)
4.2* First Supplemental Indenture dated as of December 6, 1995 between
GTE Southwest Incorporated and The Bank of New York, as Trustee
(as successor trustee to NationsBank of Georgia, National
Association) (Exhibit 4.2 of the Company's Registration Statement
on Form S-3, File No. 33-64795, filed with the Securities and
Exchange Commission on December 13, 1995)
4.3* Second Supplemental Indenture dated as of January 1, 1998 between
GTE Southwest Incorporated and The Bank of New York, as Trustee
(as successor trustee to NationsBank of Georgia, National
Association) (Exhibit 4.4 of the Company's Report on Form 8-K,
dated January 5, 1998)
10.1* Material Contracts - Agreements between GTE and Certain Executive
Officers (Exhibit 10 of the 1995 Form 10-K, File No. 1-7077)
10.2 Material Contracts - Separation Agreement between GTE and Richard
M. Cahill
12 Statements re: Calculation of the Ratio of Earnings to Fixed
Charges
27 Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of 1997.
* Denotes exhibits incorporated herein by reference to previous filings with
the Securities and Exchange Commission as designated.
51
<PAGE> 54
GTE Southwest Incorporated
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
For the Years Ended December 31, 1997, 1996 and 1995
(Thousands of Dollars)
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E
-------- -------- -------- -------- --------
Additions
----------------------------
Balance at Charged Deductions
Beginning Charged to (Credited) to from Reserves Balance at
Description of Year Income Other Accounts (Note 1) Close of Year
----------- --------- ---------- -------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Allowance for uncollectible accounts
for the years ended:
December 31, 1997 $ 23,633 $ 31,157 $ 30,451(2) $ 64,038 $ 21,203
======== ======== ======== ======== ========
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
======== ======== ======== ======== ========
Accrued restructuring costs for the years ended:
December 31, 1996 $ 82,872 $ -- $(26,877)(3) $ 55,995 $ --
======== ======== ======== ======== ========
December 31, 1995 $156,734 $ -- $ -- $ 73,862 $ 82,872
======== ======== ======== ======== ========
</TABLE>
NOTES:
(1) Charges for which reserve was created.
(2) Recoveries of previously written-off amounts.
(3) Represents amounts necessary to satisfy commitments related to the
re-engineering program that were reclassified to accounts payable and
accrued expenses.
52
<PAGE> 55
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, 1998 By /s/ Larry E. Atwell
---------------------- --------------------------------------------
Larry E. Atwell
President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
is signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
<TABLE>
<S> <C> <C>
/s/ Larry E. Atwell President March 26, 1998
- ---------------------------- (Principal Executive Officer)
Larry E. Atwell
/s/ Gerald K. Dinsmore Senior Vice President - Finance and Planning March 26, 1998
- ---------------------------- (Principal Financial Officer)
Gerald K. Dinsmore
/s/ William M. Edwards, III Vice President - Controller March 26, 1998
- ---------------------------- (Principal Accounting Officer)
William M. Edwards, III
/s/ John C. Appel Director March 26, 1998
- ----------------------------
John C. Appel
/s/ Mateland L. Keith, Jr. Director March 26, 1998
- ----------------------------
Mateland L. Keith, Jr.
/s/ Lawrence R. Whitman Director March 26, 1998
- ----------------------------
Lawrence R. Whitman
</TABLE>
53
<PAGE> 56
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
<S> <C>
10.2 Material Contracts - Separation Agreement between GTE and Richard
M. Cahill
12 Statements re: Calculation of the Ratio of Earnings to Fixed
Charges
27 Financial Data Schedule
</TABLE>
<PAGE> 1
Exhibit 10-2
[AS AMENDED JANUARY 23, 1998]
December 24, 1997
Mr. Richard M. Cahill
1158 Hidden Ridge
Apartment 2311
Irving, Texas 75038
Dear Dick:
As we discussed, I want to provide you with an appropriate
transition arrangement prior to your scheduled separation and to enter into a
consulting arrangement with you in accordance with the terms set forth below.
This agreement ("Letter Agreement") supersedes any other agreements you may have
with GTE (as defined below) or may have received from GTE with regard to the
subject matter contained herein, including but not limited to the letter dated
August 13, 1997. The terms of this Letter Agreement are as follows:
A. RESIGNATION FROM EMPLOYMENT
1. RESIGNATION - Effective July 31, 1997, you irrevocably
resign from your position as Vice President and General Counsel - GTE Telephone
Operations. Effective no later than December 31, 1997, you also irrevocably
resign from any officer, director, or other positions you hold for GTE
Corporation or any affiliate of GTE Corporation (collectively referred to in
this Letter Agreement as "GTE") and from any internal or external Boards where
you represent GTE effective as of that date.
2. SPECIAL ASSIGNMENT - From August 1, 1997 through June 30,
1998 ("Special Assignment Period"), you will continue on the GTE Service
Corporation (the "Company") payroll as an active employee in your new special
assignment as Vice President and Associate General Counsel, reporting to me or
my successor or designee. During the Special Assignment Period, you will work on
special projects as assigned by me or my successor or designee. In addition,
during the Special Assignment Period, you will continue to receive your base
salary as in effect on July 31, 1997 and will receive all benefits that active
employees receive, except that your EIP and LTIP participation will be governed
by the terms of this Letter Agreement. Except as otherwise expressly provided
herein, all perquisites provided by the Company will cease at the end of the
Special Assignment Period. In the event the Company offers any new employee
plans, any new, enhanced, or supplemental executive plans, or, except as
expressly provided herein, any new grants, awards, or benefits under existing
executive plans on or after July 31, 1997, you will not participate in such
plans or receive such grants, awards, or benefits. You irrevocably resign from
employment with GTE and the position of Vice President and Associate General
Counsel effective June 30, 1998. During and after the Special Assignment Period,
you will not seek reinstatement, recall, or future or other employment with GTE.
3. SEPARATION BENEFITS - At the conclusion of the Special
Assignment Period, you will separate from employment with the Company and you
will be eligible for separation benefits pursuant to the Company's Involuntary
Separation Program ("ISEP") or its equivalent as then in effect, subject to any
applicable release requirements.
4. EIP AWARDS - You will participate in the Executive
Incentive Plan ("EIP") at a Salary Grade Level 20 for the full 1997 Plan Year
and one half (1/2) of the 1998 Plan Year in accordance
<PAGE> 2
Mr. Richard M. Cahill
December 24, 1997
Page 2
with the terms of the EIP. Your 1997 EIP award and pro-rated 1998 EIP award will
be the same as the average EIP rating for the Company's Legal Department for
each such year. You will not participate in EIP for the 1999 Plan Year or
thereafter. All EIP awards will be subject to approval by the GTE Corporation
Executive Compensation and Organizational Structure Committee ("ECC"). The EIP
awards will be payable at the same time EIP awards are payable to other EIP
participants. You will be eligible to defer, and thus receive a match pursuant
to the Equity Participation Program ("EPP"), only those of your EIP awards
payable while you are still employed by GTE (in this case, only the 1997 Plan
Year award). Note that the ECC reserves the right not to approve EIP awards in
1997 and/or 1998, and, if so, you will be treated in the same manner as other
executives at your salary level.
5. LTIP - Subject to ECC approval, in the spring of 1998, you
will be eligible for a standard grant of Stock Options, and you also will be
eligible for a Performance Bonus Award for the 1998-2000 award cycle under the
GTE Long-Term Incentive Plan ("LTIP"). You will not receive grants of Stock
Options or Performance Bonus Awards under LTIP after the initial spring of 1998
grants. Your outstanding Stock Options will vest immediately upon your
separation at the end of the Special Assignment Period (subject to applicable
release requirements), and you will have until the earlier of: (i) five years
from your date of separation or (ii) the expiration date of the Option to
exercise those Stock Options ("Special Exercise Period"). The Special Assignment
Period will be counted for prorating your existing Performance Bonus Awards. As
such, your participation in LTIP Performance Bonus Cycles will be as follows:
1995-1997 (Full Participation), 1996-1998 Cycle (30/36 Participation), 1997-99
(18/36 Participation), and 1998-2000 (6/36 Participation). You will not receive
any Performance Bonus Award in 1999 or thereafter. Achievement of targets,
determination of the amount of Performance Bonus Awards, and determination of
the number of shares covered by your grant of Stock Options will be established
in the sole discretion of the ECC. Each Performance Bonus Award will be payable
at the same time LTIP awards are payable to other LTIP participants. You will be
eligible to defer, and thus receive a match pursuant to the EPP, only those of
your LTIP Performance Bonus Awards payable while you are still employed by GTE
(in this case, only the 1995-97 Performance Bonus Award). For purposes of this
Letter Agreement, your 1998 Stock Option and Performance Bonus Award grants are
collectively referred to as "LTIP Grants." Note that the ECC reserves the right
not to make Stock Option or Performance Bonus Awards in 1998, and, if so, you
will be treated in the same manner as other executives at your salary level.
6. RELEASE - In order to receive full Separation Benefits
(including but not limited to full ISEP and the Special Exercise Period
described in paragraph 5 above) and the 1998 EIP Award, and in order for your
participation in the LTIP Performance Bonus Award Cycles to be as described in
paragraph 5 above, you will be required to sign a release upon the expiration of
the Special Assignment Period.
7. VACATION - At the end of the Special Assignment Period, you
may elect to take the remainder of your banked/accrued but unused vacation in a
lump sum. In the alternative, you may elect to use your banked/accrued but
unused vacation to extend your last day as an active employee on payroll;
provided that any such extension shall not affect the payment or pro-ration of
your EIP and LTIP awards as set forth in paragraphs 4 and 5 above.
8. MISCELLANEOUS BENEFITS - During the Special Assignment
Period, you will be entitled to the same level of executive perquisites as other
similarly situated executives in Dallas are accorded, and you will also be
entitled to office space at a location to be determined by GTE in its sole
discretion. After the end of the Special Assignment Period, the Company will pay
for tax preparation services for you for the 1998 calendar year, which would be
paid in 1999, up to a maximum of $3,000. The benefits
<PAGE> 3
Mr. Richard M. Cahill
December 24, 1997
Page 3
described in this paragraph A.8 are collectively referred to in this Letter
Agreement as miscellaneous benefits ("Miscellaneous Benefits").
9. CIRCUMSTANCES WHEN ABOVE PAYMENTS/BENEFITS WILL NOT BE PAID
- - In the event any of the following occur prior to the expiration of the Special
Assignment Period (or if applicable after the expiration of the Special
Assignment Period), you will cease to receive any further salary, the Special
Exercise Period will not apply, you will not receive any EIP Payments, LTIP
Grants, payment of Performance Bonus Awards, Separation Benefits (including but
not limited to ISEP), Miscellaneous Benefits, or any other benefits or payments,
and you will not be required to perform, and will not be paid for, any
consulting services:
o you voluntarily terminate your employment for any reason;
o your employment is terminated for cause as determined by
me or my successor or designee; or
o you violate any of the terms of the attached Separation
Agreement and General Release (including but not limited
to the provisions regarding confidentiality and non-
embarrassment) or the non-compete provisions of paragraphs
A.10 and B.7 of this Letter Agreement.
In the event that you die or become disabled (within the
meaning of GTE's Long-Term Disability Plan) during the Special Assignment
Period, all further salary will cease, your eligibility for the Miscellaneous
Benefits will cease, your EIP Payments and Performance Bonus Awards will be
pro-rated to the date of your death or disability (but will not be paid until
the date they otherwise would have been paid had you not died or become
disabled), the Special Exercise Period will not apply, your Separation Benefits
(including but not limited to ISEP) will be treated in accordance with the terms
of the relevant plans or policies, your eligibility for the LTIP Grants will be
determined in accordance with the relevant plan provisions, and you will not be
required to perform, and will not be paid for, any consulting services.
10. MISCELLANEOUS - Since you will remain a GTE employee until
the end of the Special Assignment Period, you will remain subject to all GTE
policies, including but not limited to GTE's policies relating to
non-competition and disclosure of confidential information. You shall be
responsible for the payment of all applicable taxes relating to the benefits
described in Paragraph A of this Letter Agreement, including but not limited to
taxes as a result of ISEP or any ISEP equivalent payment.
B. CONSULTING ARRANGEMENT
1. CONSULTING PERIOD. You will serve as a non-employee
consultant for the period July 1, 1998 through June 30, 2000 (the "Consulting
Period"). During the Consulting Period and thereafter, you will not be entitled
to any benefits provided by GTE to its active employees and, by signing below,
you acknowledge and agree that you shall not be entitled to any such benefits
and effectively waive participation in any such benefits.
2. CONSULTING SERVICES. During the Consulting Period, you will
perform special projects as assigned by me or my successor or designee. All
required services will be performed by you. You will be free at all times to
arrange the time and manner of performance of the consulting services to be
rendered hereunder and will not be expected to maintain or observe a schedule of
duties or assignments. You will not report to the Company on any regular basis,
but will
<PAGE> 4
Mr. Richard M. Cahill
December 24, 1997
Page 4
work as you may independently decide. You will not be required to provide
consulting services to the Company for more than 30% of the regularly scheduled
working days in any calendar year during the term of this Letter Agreement. The
Company is entering into this arrangement with the understanding that the
performance of your services will be subject to the non-compete provisions of
paragraph B.7 below. During the Consulting Period and thereafter, you may, in
your discretion, provide services to others without being constrained by your
obligations under this Letter Agreement, provided only that such services do not
prevent you from providing the consulting services required under this Letter
Agreement, and provided further that such services to others do not cause you to
violate your obligations regarding non-competition, confidentiality, and
intellectual property rights as described in this Letter Agreement and the
attached Separation Agreement and General Release.
3. COMPANY CONTACT. I or my successor or designee will be your
contact at the Company during the Consulting Period and will be responsible for
coordinating your assignments. All services must be performed to my satisfaction
or to the satisfaction of my successor or designee.
4. CONSULTING FEES. You will be paid $164,000 per year for
your consulting services during the Consulting Period, payable in equal
quarterly installments of $41,000 in arrears. You also will be entitled to be
reimbursed for reasonable travel expenses you incur in the performance of
consulting services for the Company as approved by me or my successor or
designee. Please submit quarterly invoices to me or to my successor or designee
for payment. You will be paid the full amount of your annual consulting fees
during the Consulting Period whether or not you actually perform consulting
services for the Company.
5. PERFORMANCE OF CONSULTING SERVICES. As a non-employee
consultant, the Company does not retain or exercise the right to direct,
control, or supervise you as to the details and means by which the consulting
services contracted for are accomplished. You and the Company agree that, as a
non-employee consultant, you will serve as an independent contractor in the
performance of your duties under this Letter Agreement. As a result, you will be
responsible for payment of all taxes and expenses incurred arising out of the
payments under the Letter Agreement for your activities as a non-employee
consultant in accordance with this Letter Agreement, including but not limited
to, federal and state income taxes, social security taxes, unemployment
insurance taxes, and any other taxes or business license fees as required.
Moreover, you agree that, except as authorized by the Company, you will not
represent directly or indirectly that you are an agent or legal representative
of the Company, nor will you incur any liabilities or obligations of any kind in
the name of or on behalf of the Company, other than those specifically made or
approved as part of this Letter Agreement.
6. OFFICE SPACE. You are responsible for securing your own
office space, office equipment, and clerical support services during the
Consulting Period, but visiting office space and appropriate office equipment
will be provided to you if you are meeting with individuals at GTE's offices.
7. NON-COMPETE PROVISIONS. As a non-employee consultant, you
agree that, among other policies and guidelines, the GTE Conflict of Interest
Guidelines and the Business and Scientific Information Policy or replacement
policies will apply to you. In addition, you agree not to
<PAGE> 5
Mr. Richard M. Cahill
December 24, 1997
Page 5
engage directly or indirectly in a Competitive Business during the Consulting
Period, unless the Company approves such an arrangement in writing in advance.
For purposes of this paragraph B.7, a "Competitive Business" is any
inter-exchange carrier (such as MCI Communications Corporation, Sprint
Corporation, AT&T Corp., WorldCom, Inc., LCI International, Inc., and Cable &
Wireless PLC) and its Affiliates, any local exchange carrier (such as any
Regional Bell Operating Company ("RBOC") and British Telecommunications PLC) and
its Affiliates, or any of the following companies and their Affiliates: Digex,
Incorporated, Qwest Communications International Inc., Netscape Communications
Corporation, Cisco Systems, Inc., Ascend Communications, Inc., Airtouch
Communications, Inc., NEXTEL Communications, Inc., and Teleport Communications
Group, Inc. An Affiliate for purposes of this paragraph B.7 shall mean any
entity, whether or not incorporated, (i) in which a Competitive Business has
equity ownership of 10% or more, or (ii) which provides goods or services
(including but not limited to software, processing, switching, marketing, or
consulting) to a Competitive Business to materially compete with GTE.
You acknowledge that the obligations imposed on you pursuant
to this paragraph B.7 are reasonable in their nature, scope and duration and
will not deprive you of the opportunity to earn a livelihood. During and after
the Consulting Period, you also will remain subject to those GTE policies which
apply following termination of service.
Subject to paragraph B.8, in consideration of your compliance
with the provisions of this paragraph B.7, the Company will pay to you $25,000
per quarter payable in arrears, commencing with the quarter beginning July 1998
and ending with the quarter ending June 2000 (or such later date as the parties
may agree in writing). If you fail to comply with the provisions of this
paragraph B.7, you will forfeit your right to receive the payments described in
this paragraph B.7.
8. EARLY TERMINATION OF CONSULTING SERVICES. In the event any
of the following occurs during the Consulting Period, this Letter Agreement will
terminate immediately, and, except as provided in the immediately succeeding
sentence, you will not be entitled to any further payments under paragraphs B.4
or B.7: you violate any of the provisions of this Letter Agreement or the
Separation and General Release referred to below; you die; you become disabled;
or you fail to provide services under this Letter Agreement to the satisfaction
of the Company. Of course you will be entitled to payment of amounts due
pursuant to paragraphs B.4 and B.7 with respect to that portion of the quarter
prior to the termination of your consulting services in an amount equal to the
payment due for the quarter multiplied by a fraction, the numerator of which is
the number of days in the quarter prior to the termination of your consulting
services and the denominator of which is 90.
C. GENERAL PROVISIONS
1. CONFIDENTIALITY. You agree that any information you receive
or acquire during the performance of your obligations in accordance with this
Letter Agreement or have received or acquired from your prior employment with
GTE will be treated by you in the strictest confidence and will not be disclosed
to or used for the benefit of any persons, firms or organizations. This
provision will survive the termination of this Letter Agreement.
2. GTE AS EXCLUSIVE OWNER OF WORK PRODUCT. You agree that GTE
will be the exclusive owner of all works conceived or first produced by you
within the scope of your prior
<PAGE> 6
Mr. Richard M. Cahill
December 24, 1997
Page 6
employment with GTE or pursuant to or related to this Letter Agreement and your
services as a consultant, including that GTE will be the exclusive owner of all
copyrights and other intellectual property rights in or based upon such works.
With regard to such copyrightable works, you agree that GTE will be the "person
for whom the work is prepared" and that GTE will be the exclusive work-for-hire
author under the copyright laws of the United States. In addition, you agree to
and to hereby assign exclusively to GTE such works, copyrights and other
intellectual property rights. This provision will survive the termination of
this Letter Agreement.
The arrangements described above are contingent upon your
executing the attached Separation Agreement and General Release (the "Release").
As you know, you were given a version of this Letter Agreement dated October 16,
1997 and, therefore, you have been given twenty-one days to sign the Release
(with a seven-day period to revoke) as required by law. Although not legally
required, we have determined to give you an additional twenty-one day period
commencing as of December 24, 1997 (with a seven-day period to revoke) to sign
the Release. Since the December 24, 1997 version of this Letter Agreement has
been modified based on requests you have made, you continue to have twenty-one
days from December 24, 1997 to sign the Release (with a seven-day period to
revoke). If you fail to sign the Release or if you sign and revoke the Release
within seven days of signing it, this Letter Agreement shall be void, and you
will not receive any of the benefits described in this Letter Agreement.
Dick, your past contributions to GTE are appreciated by me and
the entire GTE management team.
Sincerely,
William P. Barr
Executive Vice President -
Government and Regulatory Advocacy,
General Counsel
I have read, understand, and agree to the terms of this Letter Agreement
including the attached Separation Agreement and General Release.
- ---------------------- ---------------
Richard M. Cahill Date
<PAGE> 7
SEPARATION AGREEMENT AND GENERAL RELEASE
This Agreement is by and between GTE Service Corporation (the
"Company") and Richard M. Cahill ("Cahill").
PART I
In consideration of the provisions in Part II, the Company agrees as
follows:
1. The Company will provide Cahill with the benefits described in
William P. Barr's letter dated December 24, 1997, as amended January 9, 1998
(the "December 24, 1997 Letter"). (The December 24, 1997 Letter and this
Separation Agreement and General Release are collectively referred to as the
"Agreement").
2. By making this Agreement, the Company does not admit that it has
done anything wrong, and the Company specifically states that it has not
committed any tort, breach of contract, or violation of any federal, state, or
local statute or ordinance.
PART II
In consideration of the provisions in Part I, Cahill agrees as follows:
1. Effective July 31, 1997, Cahill irrevocably resigns from his
position as Vice President and General Counsel - GTE Telephone Operations, from
any officer, director, or other positions he holds for GTE Corporation or any of
its affiliates, and from any internal or external Boards where he represents GTE
(as described in paragraph 3 below), at which time Cahill will commence the
Special Assignment described in the December 24, 1997 Letter. Cahill irrevocably
resigns from employment with GTE effective at the end of the Special Assignment
Period described in the December 24, 1997 Letter. Cahill agrees not to seek
reinstatement, recall, or future employment with GTE after the end of the
Special Assignment Period.
Cahill agrees that GTE retains the right to make future organizational changes,
including but not limited to the right to combine, create, and/or fill
positions.
2. Cahill agrees and understands that the payments and the benefits
described in Part I, paragraph 1 above are more than any payments or benefits
due to him under the Company's policies or practices. Cahill waives and forever
discharges GTE (as described in paragraph 3 below) from any liability to provide
any notice of termination, including but not limited to any notice under the
Worker Adjustment and Retraining Notification Act, or to pay any additional
salary continuance, separation pay, severance pay, retention bonus or pay,
retirement incentive, or payments or benefits arising under any other plan,
policy, practice, or program (offered on a qualified or non-qualified or
voluntary or involuntary basis) which may have been payable as a result of the
termination of his employment, except as provided in paragraph 3 below. Cahill
agrees that, should the Company offer any retirement incentive, early
retirement, or voluntary separation program on or after July 31, 1997, Cahill
shall not be eligible to participate. In addition, Cahill has not relied on any
statement, agreement, or promise of eligibility for any benefits, other than
those set forth in this Agreement.
3. Cahill agrees to release GTE Corporation and any related or
affiliated companies, and any and all current and former directors, employees,
officers, agents, and contractors of these companies, and any and all employee
pension or welfare benefit plans of these companies, including current and
former
<PAGE> 8
trustees and administrators of these plans, (hereinafter GTE Corporation, the
Company, and the other entities and persons referenced above are collectively
referred to in this Separation Agreement and General Release as "GTE") from all
known and unknown claims, charges, or demands Cahill may have based on his
employment with GTE, including a release of any rights or claims Cahill may have
under the Age Discrimination in Employment Act ("ADEA"), which prohibits age
discrimination in employment; Title VII of the Civil Rights Act of 1964, and the
Civil Rights Act of 1991, which prohibit discrimination in employment based on
race, color, sex, religion, and national origin; the Americans with Disabilities
Act, which prohibits discrimination based upon disability; Section 1981 of the
Civil Rights Act of 1866, which prohibits discrimination based on race; the
Employee Retirement Income Security Act, which governs employee benefits; any
state laws against discrimination; or any other federal, state, or local statute
or common law relating to employment. This includes a release by Cahill of any
claims for wrongful discharge, breach of contract, employment-related torts, or
any other claims in any way related to Cahill's employment with GTE.
This release does not include, however, a waiver of any right to vested benefits
under any pension or savings plan, any right to Worker's Compensation, any right
to receive pay for banked and accrued, but unused, vacation, or any right to
unemployment compensation that Cahill may have.
4. Cahill has not filed and promises not to file, or permit to be filed
on his behalf, any lawsuit or complaint against GTE regarding the claims
released in Part II, paragraph 3 above. Cahill also promises to opt out of and
to take such other steps as he has the power to take to disassociate himself
from any class seeking relief against GTE regarding any claims released in Part
II, paragraph 3. If a court, administrative agency, arbitrator, or any other
decision maker with authority awards Cahill money damages or other relief, with
respect to claims released in Part II, paragraph 3, Cahill hereby assigns to the
Company all rights and interest in such money damages and other relief.
5. Cahill agrees not to disclose the terms of this Agreement, that this
Agreement exists, or that he received any payments from the Company to anyone
except his attorney, his financial planner, or his immediate family (spouse,
children, siblings, parents). If he does disclose the terms of this Agreement to
his immediate family, his financial planner, or his attorney, he will advise
them that they must not disclose the terms of this Agreement.
6. Cahill acknowledges that, during the period he has served as an
in-house attorney with GTE, he has had access to confidential information
relating to GTE. Consistent with the Rules of Professional Conduct, Cahill will
not use or disclose any such confidential information without first obtaining
the consent of the Company.
Cahill agrees to comply with the provisions of GTE H.R. Policy 412 (Attachment
I) provided that, in the event of a conflict between Policy 412 and this
Agreement, the terms of this Agreement shall take precedence. Contemporaneously
with the execution of this Agreement, if Cahill has not executed a copy of the
Business and Scientific Information Agreement, Cahill shall do so (Policy
Attachment A). Upon his termination, Cahill shall execute Policy Attachment D.
Cahill further agrees to take no action that would cause GTE (including its
employees, directors, and shareholders) embarrassment or humiliation or
otherwise cause or contribute to GTE (including its employees, directors, and
shareholders) being held in disrepute by the general public or GTE's clients,
shareholders, customers, federal or state regulatory agencies, employees,
agents, officers, or directors.
<PAGE> 9
Cahill will cooperate and make all reasonable efforts to assist the Company in
any investigation of matters involving GTE. Cahill also agrees to testify as a
witness and be available for interviews and to assist GTE in preparation for any
legal proceedings involving GTE in which Cahill has direct knowledge or specific
expertise. Cahill will be compensated appropriately and reimbursed for
reasonable expenses.
Nothing in this Agreement shall be construed to prevent Cahill from giving
compelled truthful testimony before any federal or state agency or in any
judicial proceeding; provided that, in order to permit GTE to seek an injunction
or other judicial relief, he will timely notify GTE in advance of any such
proceeding in which he expects to be called to testify or for which he has
received a subpoena.
7. Cahill acknowledges and agrees that he has not been discriminated
against in any way during his employment with GTE or with regard to his
separation from employment with the Company.
8. Cahill agrees that GTE will be entitled to recover liquidated
damages in the amount of $75,000 if he breaks his promises in Part II,
paragraphs 1-6 of this Agreement. These liquidated damages are based upon the
parties' recognition that damages to GTE due to Cahill's breaking of these
promises are not capable of measurement with any degree of certainty. The amount
specified is not to be considered a penalty, but solely as liquidated damages.
If Cahill breaks his promise in Part II, paragraph 4 and files a lawsuit or
complaint regarding claims Cahill has released, in addition to the liquidated
damages described above, Cahill will pay for all costs incurred by GTE,
including reasonable attorneys' fees, in defending against his claim.
9. Cahill understands that he has been given 21 days to review and
consider this Agreement before signing it. Cahill further understands that he
may use as much of this 21-day period as he wishes prior to signing this
Agreement.
10. Cahill may revoke this Agreement within seven days after he signs
it. If Cahill wishes to revoke this Agreement within this seven-day period,
written notice of revocation should be delivered to the office of Thomas W.
Green, Senior Head of Stamford Transition Team, by the close of business seven
days after Cahill signs the Agreement. This Agreement will not become effective
or enforceable until seven days after Cahill signs it. If Cahill revokes this
Agreement, it will not be effective or enforceable, and he will not receive the
benefits described in Part I, paragraph 1.
11. Cahill agrees that the Company advised Cahill to consult with an
attorney before signing this Agreement.
12. The parties participated jointly in the negotiation of this
Agreement, and each party had the opportunity to obtain the advice of legal
counsel and to review, comment upon, and redraft this Agreement. Accordingly, it
is agreed that no rule of construction shall apply against any party or in favor
of any party, and any uncertainty or ambiguity shall not be interpreted against
any one party and in favor of the other.
13. Cahill and the Company hereby consent that any disputes relating to
this Agreement will be governed by Connecticut law.
<PAGE> 10
14. In the event that any one or more of the provisions contained in
this Agreement shall, for any reason, be held to be invalid, illegal, or
unenforceable in any respect, such invalidity, illegality, or unenforceability
shall not affect any other provision of this Agreement.
15. This Separation Agreement and General Release and the December 24,
1997 Letter constitute the entire Agreement between Cahill and the Company and
shall be binding upon the heirs, successors, and assigns of Cahill and the
Company. No other promises or agreements have been made to Cahill other than
those in this Agreement. Cahill is not relying on any statement, representation,
or warranty that is not contained in this Agreement. Cahill acknowledges that he
has read this Agreement carefully, fully understands the meaning of the terms of
this Agreement, and is signing this Agreement knowingly and voluntarily.
Subscribed and sworn to before
me this____day of____, 1998. -----------------------
Richard M. Cahill
- ------------------------- -------------------
Notary Public Date
Subscribed and sworn to before GTE Service Corporation
me this____day of____, 1998.
- -------------------------- ------------------
Notary Public By:
Title:
--------------------
Date
<PAGE> 1
Exhibit 12
GTE Southwest Incorporated
STATEMENTS OF RATIO OF EARNINGS TO FIXED CHARGES
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------------------------------
1997 1996 1995 1995(a)
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
(Thousands of Dollars)
Net earnings available for fixed charges:
Income before extraordinary
charges $ 288,154 $ 255,796 $ 195,289 $ 180,991
Add - Income taxes (benefit) 142,262 130,173 99,437 92,152
- Fixed charges 68,920 66,798 68,925 68,925
--------- --------- --------- ---------
Adjusted earnings $ 499,336 $ 452,767 $ 363,651 $ 342,068
========= ========= ========= =========
Fixed charges:
Interest expense $ 63,992 $ 60,653 $ 63,848 $ 63,848
Portion of rent expense
representing interest 4,928 6,145 5,077 5,077
--------- --------- --------- ---------
Adjusted fixed charges $ 68,920 $ 66,798 $ 68,925 $ 68,925
========= ========= ========= =========
RATIO OF EARNINGS TO FIXED
CHARGES 7.25 6.78 5.28 4.96
<CAPTION>
Years Ended December 31,
----------------------------------------------------------------
1994 1994(b) 1993 1993(c)
--------- --------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C> <C>
Net earnings available for fixed charges:
Income before extraordinary
charges $ 184,528 $ 144,762 $ 55,373 $ 171,814
Add - Income taxes (benefit) 95,068 71,146 (12,731) 61,684
- Fixed charges 70,761 70,761 91,107 91,107
--------- --------- --------- ---------
Adjusted earnings $ 350,357 $ 286,669 $ 133,749 $ 324,605
========= ========= ========= =========
Fixed charges:
Interest expense $ 65,913 $ 65,913 $ 85,044 $ 85,044
Portion of rent expense
representing interest 4,848 4,848 6,063 6,063
--------- --------- --------- ---------
Adjusted fixed charges $ 70,761 $ 70,761 $ 91,107 $ 91,107
========= ========= ========= =========
RATIO OF EARNINGS TO FIXED
CHARGES 4.95 4.05 1.47 3.56
</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 telephone exchanges in Texas.
(b) Excludes after-tax gains of approximately $40 million related to the sale
of non-strategic telephone exchanges in Oklahoma and Arizona.
(c) Excludes 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 telephone exchanges in Utah.
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 24,282
<SECURITIES> 0
<RECEIVABLES> 381,082
<ALLOWANCES> 21,203
<INVENTORY> 24,032
<CURRENT-ASSETS> 468,159
<PP&E> 5,418,247
<DEPRECIATION> 3,317,186
<TOTAL-ASSETS> 2,732,215
<CURRENT-LIABILITIES> 479,894
<BONDS> 984,955
1,510
7,600
<COMMON> 650,000
<OTHER-SE> 194,955
<TOTAL-LIABILITY-AND-EQUITY> 2,732,215
<SALES> 1,676,599
<TOTAL-REVENUES> 1,676,599
<CGS> 590,990
<TOTAL-COSTS> 1,186,116
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 60,067
<INCOME-PRETAX> 430,416
<INCOME-TAX> 142,262
<INCOME-CONTINUING> 288,154
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 288,154
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
