<PAGE> 1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended: MARCH 31, 1999
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from _______ to _______
Commission File Number 1-7077
GTE SOUTHWEST INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 75-0573444
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
1255 Corporate Drive, SVC04C08, Irving, Texas 75038
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code 972-507-5000
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
The Company had 6,500,000 shares of $100 par value common stock outstanding at
April 30, 1999. The Company's common stock is 100% owned by GTE Corporation.
================================================================================
<PAGE> 2
PART I. FINANCIAL INFORMATION
GTE SOUTHWEST INCORPORATED
Condensed Statements of Income (Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-------------------
1999 1998
------- -------
(Dollars in Millions)
<S> <C> <C>
REVENUES AND SALES
Local services $ 172.4 $ 174.2
Network access services 174.3 166.0
Other services and sales 78.7 83.8
------- -------
Total revenues and sales 425.4 424.0
------- -------
OPERATING COSTS AND EXPENSES
Cost of services and sales 156.3 161.7
Selling, general and administrative 91.1 67.5
Depreciation and amortization 76.2 92.5
------- -------
Total operating costs and expenses 323.6 321.7
------- -------
OPERATING INCOME 101.8 102.3
OTHER EXPENSE
Interest - net 18.7 16.6
------- -------
INCOME BEFORE INCOME TAXES 83.1 85.7
Income taxes 29.3 29.6
------- -------
INCOME BEFORE EXTRAORDINARY CHARGE 53.8 56.1
Extraordinary charge -- (0.5)
------- -------
NET INCOME $ 53.8 $ 55.6
======= =======
</TABLE>
Per share data is omitted since the Company's common stock is 100% owned by GTE
Corporation.
The accompanying notes are an integral part of these statements.
1
<PAGE> 3
GTE SOUTHWEST INCORPORATED
Condensed Balance Sheets (Unaudited)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
-------- ------------
(Dollars in Millions)
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $ 2.6 $ 10.4
Receivables, less allowances
of $29.4 million and $28.6 million 308.8 286.2
Accounts receivable from affiliates 42.8 57.7
Inventories and supplies 20.9 16.4
Prepaid expenses and other 14.4 23.2
-------- --------
Total current assets 389.5 393.9
-------- --------
Property, plant and equipment, at cost 5,846.4 5,793.8
Accumulated depreciation (3,591.7) (3,555.7)
-------- --------
Total property, plant and equipment, net (a) 2,254.7 2,238.1
-------- --------
Prepaid pension costs 183.4 175.8
Other assets 21.8 21.5
-------- --------
Total assets $2,849.4 $2,829.3
======== ========
</TABLE>
(a) Includes $568.9 million held for sale at March 31, 1999 and December 31,
1998, see Note 4.
The accompanying notes are an integral part of these statements.
2
<PAGE> 4
GTE SOUTHWEST INCORPORATED
Condensed Balance Sheets (Unaudited) - Continued
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
-------- -----------
(Dollars in Millions)
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Current maturities of long-term debt $ 250.3 $ 250.3
Note payable to affiliate 141.9 163.0
Accounts payable 99.4 69.0
Affiliate payables and accruals 58.3 81.7
Accrued payroll costs 32.4 43.0
Other 226.1 200.1
-------- --------
Total current liabilities 808.4 807.1
-------- --------
Long-term debt 692.7 692.6
Employee benefit plans 220.0 216.8
Deferred income taxes and other 196.2 186.4
-------- --------
Total liabilities 1,917.3 1,902.9
-------- --------
Shareholders' equity
Preferred stock 7.6 7.6
Common stock (6,500,000 shares issued) 650.0 650.0
Additional paid-in capital 48.8 48.8
Retained earnings 225.7 220.0
-------- --------
Total shareholders' equity 932.1 926.4
-------- --------
Total liabilities and shareholders' equity $2,849.4 $2,829.3
======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
3
<PAGE> 5
GTE SOUTHWEST INCORPORATED
Condensed Statements of Cash Flows (Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------
1999 1998
------ ------
(Dollars in Millions)
<S> <C> <C>
OPERATIONS
Income before extraordinary charge $ 53.8 $ 56.1
Adjustments to reconcile income before extraordinary charge to net cash from
operations:
Depreciation and amortization 76.2 92.5
Provision for uncollectible accounts 7.0 8.5
Changes in current assets and current liabilities (1.8) 18.4
Deferred income taxes and other - net 20.8 6.5
------ ------
Net cash from operations 156.0 182.0
------ ------
INVESTING
Capital expenditures (90.4) (118.0)
------ ------
Cash used in investing (90.4) (118.0)
------ ------
FINANCING
Long-term debt issued -- 148.9
Long-term debt and preferred stock retired,
including premiums paid on early retirement -- (42.0)
Dividends paid (52.2) (45.5)
Net change in affiliate notes (21.2) (123.2)
Other - net -- (2.7)
------ ------
Net cash used in financing (73.4) (64.5)
------ ------
Decrease in cash and cash equivalents (7.8) (0.5)
Cash and cash equivalents:
Beginning of period 10.4 24.3
------ ------
End of period $ 2.6 $ 23.8
====== ======
</TABLE>
The accompanying notes are an integral part of these statements.
4
<PAGE> 6
GTE SOUTHWEST INCORPORATED
Notes to Condensed Financial Statements (Unaudited)
NOTE 1. BASIS OF PRESENTATION
GTE Southwest Incorporated (the Company) is incorporated under the laws of the
State of Delaware and is a subsidiary of GTE Corporation (GTE).
The unaudited condensed financial statements included herein have been prepared
by the Company pursuant to the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. However, in the opinion of management of the Company, the condensed
financial statements include all adjustments, which consist only of normal
recurring accruals, necessary to present fairly the financial information for
such periods. These condensed financial statements should be read in conjunction
with the financial statements and the notes thereto included in the Company's
1998 Annual Report on Form 10-K.
Reclassifications of prior year data have been made, where appropriate, to
conform to the 1999 presentation.
NOTE 2. CAPITALIZED SOFTWARE
Effective January 1, 1999, the Company adopted the American Institute of
Certified Public Accountants' Statement of Position (SOP) 98-1, "Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use." As a
result of adopting SOP 98-1, in the first quarter of 1999 the Company
capitalized $4.6 million of software expenditures which would previously have
been expensed.
NOTE 3. SPECIAL CHARGE
In 1999, GTE continued the review of its operations and cost structure to ensure
they were consistent with its growth objectives. In connection with this ongoing
review, GTE initiated voluntary and involuntary employee separation programs
that resulted in a one-time charge for GTE during the first quarter of 1999. The
charge pertaining to the Company totaled $18.4 million and is reflected as
"Selling, general and administrative" costs and expenses in the condensed income
statements. The components of the charge include voluntary and involuntary
separation programs and related benefits such as outplacement and benefit
continuation costs. These programs were completed during the first quarter of
1999.
NOTE 4. PLANNED ASSET SALES
During the first quarter of 1998, the Company committed to a plan that resulted
in a decision to sell approximately 606,000 switched access lines located in
Arkansas, New Mexico, Oklahoma and Texas. Due to the regulatory approvals that
are required, it is projected that most of the sales of local access lines will
close in 2000. As a result, the net book value of these lines, which
approximates $568.9 million, continues to be reported in "Property, plant and
equipment, net" in the balance sheets. Until sold, the Company intends to
continue to operate all of these assets. Based on the decision to sell, however,
the Company stopped recording depreciation expense for these assets.
Due to the centralized manner in which GTE's local telephone companies are
managed and since the access lines to be sold represent a portion of the
Company, revenues and operating income applicable to the access lines to be sold
are not readily determinable. The 606,000 access lines represent approximately
28% of the average switched access lines that the Company had in service during
1998.
5
<PAGE> 7
GTE SOUTHWEST INCORPORATED
Notes to Condensed Financial Statements (Unaudited) - Continued
NOTE 5. PROPOSED MERGER WITH BELL ATLANTIC CORPORATION
Bell Atlantic and GTE Corporation have announced a proposed merger of equals
under a definitive merger agreement dated as of July 27, 1998. Under the terms
of the agreement, GTE shareholders will receive 1.22 shares of Bell Atlantic
common stock for each share of GTE common stock that they own.
We expect the merger to qualify as a pooling of interests, which means that for
accounting and financial reporting purposes the companies will be treated as if
they had always been combined. The completion of the merger is subject to a
number of conditions, including certain regulatory approvals, receipt of
opinions that the merger will be tax-free, and the approval of the shareholders
of both Bell Atlantic and GTE. Special meetings to vote on the merger will be
held on May 18, 1999 for GTE shareholders and on May 19, 1999 for Bell Atlantic
shareholders.
NOTE 6. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. The Company is
currently assessing the impact of adopting SFAS No. 133 which is effective
January 1, 2000.
6
<PAGE> 8
GTE SOUTHWEST INCORPORATED
Management's Discussion and Analysis of Financial Condition
And Results of Operations
<TABLE>
<CAPTION>
RESULTS OF OPERATIONS
(Dollars in Millions) Three Months Ended
March 31,
------------------- Percent
1999 1998 Decrease Change
-------- ------- -------- ---------
<S> <C> <C> <C> <C>
Net income $ 53.8 $ 55.6 $ (1.8) (3)%
</TABLE>
The decline in net income is primarily due to a one-time special charge of $18.4
million partially offset by lower depreciation expense. Net income for 1998
includes an extraordinary after-tax charge of $0.5 million (net of tax benefits
of $0.3 million) related to the retirement of debt prior to stated maturity.
<TABLE>
<CAPTION>
REVENUES AND SALES
(Dollars in Millions) Three Months Ended
March 31,
------------------- Increase Percent
1999 1998 (Decrease) Change
-------- ------- ---------- ---------
<S> <C> <C> <C> <C>
Local services $ 172.4 $ 174.2 $ (1.8) (1)%
Network access services 174.3 166.0 8.3 5 %
Other services and sales 78.7 83.8 (5.1) (6)%
-------- ------- ---------
Total revenues and sales $ 425.4 $ 424.0 $ 1.4 --
======== ======= =========
</TABLE>
Local Services Revenues
Access line growth was 6% for the three months ended March 31, 1999 compared to
the same period last year, generating additional revenues of $4.7 million from
basic local services, CentraNet(R) services, Integrated Services Digital Network
and Digital Channel Services. Demand for enhanced custom calling features, such
as SmartCall(R) services, also contributed $3.2 million to the increase in local
services revenues for the three months ended March 31, 1999. These increases are
offset by a $9.5 million reduction in revenues due to completion during 1998 of
the amortization of a reserve previously established for potential refunds
related to the 1989 Texas rate case.
Network Access Services Revenues
Demand for access services by interexchange carriers (IXCs) resulted in a 6%
growth in minutes of use for the three months ended March 31, 1999, generating
$4.0 million in revenues. Special access revenues grew by $8.9 million in the
first quarter due to greater demand for increased bandwidth by high-capacity
users. These increases were partially offset by interstate and intrastate rate
decreases which lowered revenues by $4.4 million.
Other Services and Sales Revenues
Other services and sales revenues decreased for the first quarter, primarily due
to a $8.4 million decline in toll revenues, related to intraLATA (Local Access
and Transport Area) toll competition, and the impact of optional discount
calling plans, which effectively lowered intrastate toll rates. The decrease is
partially offset by an increase of $2.0 million due to higher usage and
recurring charges related to wireless products and services and a $1.5 million
increase from growth in paging and voice messaging services.
7
<PAGE> 9
GTE SOUTHWEST INCORPORATED
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
<TABLE>
<CAPTION>
OPERATING COSTS AND EXPENSES
(Dollars in Millions) Three Months Ended
March 31,
------------------ Increase Percent
1999 1998 (Decrease) Change
------- ------ --------- --------
<S> <C> <C> <C> <C>
Cost of services and sales $ 156.3 $161.7 $ (5.4) (3)%
Selling, general and administrative 91.1 67.5 23.6 35 %
Depreciation and amortization 76.2 92.5 (16.3) (18)%
------- ------ ------
Total operating costs and expenses $ 323.6 $321.7 $ 1.9 1 %
======= ====== ======
</TABLE>
Total operating costs and expenses for the first quarter of 1999 increased
compared to the same quarter in 1998 primarily due to a one-time special charge
of $18.4 million associated with voluntary and involuntary employee separation
programs completed in the first quarter. Costs associated with the expansion of
daily operating hours of the customer care centers and operator services
contributed $6.3 million to the increase. Additionally, higher operating taxes
contributed $3.5 million to the increase for the first quarter of 1999.
Partially offsetting these increases was a $8.4 million decrease due to lower
right-to-use (RTU) software fees associated with network switching equipment.
This included a reduction in RTU costs of $4.6 million due to the capitalization
of software costs in 1999 as a result of the adoption of the American Institute
of Certified Public Accountants' Statement of Position (SOP) 98-1, "Accounting
for the Costs of Computer Software Developed or Obtained for Internal Use," in
addition to a reduction in overall 1999 RTU fees of $3.8 million. Depreciation
and amortization decreased $16.3 million for the first quarter primarily due to
the discontinuation of depreciation on non-strategic access lines held for sale,
as discussed more fully in the "Other Developments" section.
OTHER INCOME STATEMENT ITEMS
Interest-net increased 13% or $2.1 million in the first quarter of 1999 compared
to the same period in 1998. The increase is primarily due to an increase in
interest expense resulting from higher average short-term debt levels.
During the first quarter of 1998, the Company recorded an after-tax
extraordinary charge of $0.5 million, reflecting premiums paid on the redemption
of high-coupon debt prior to stated maturity.
CAPITAL RESOURCES AND LIQUIDITY
Management believes that the Company has adequate internal and external
resources available to meet ongoing operating requirements for construction of
new plant, modernization of facilities and payment of dividends. The Company
generally funds its construction program from operations, although external
financing is available. Short-term financing can be obtained through borrowings
from GTE or GTE Funding Incorporated, an affiliate of the Company. The Company
participates with other affiliates in a $1.5 billion, 364-day syndicated
revolving line of credit and has access to an additional $1.0 billion in
short-term liquidity through GTE and GTE Funding Incorporated's bi-lateral
revolving lines of credit. The Company also has an existing shelf registration
statement for an additional $600 million of debentures.
The Company's primary source of funds during the first three months of 1999 was
cash from operations of $156.0 million compared to $182.0 million for the same
period in 1998. The year-to-year decrease in cash from operations primarily
reflects an increase in the Company's working capital requirements.
8
<PAGE> 10
GTE SOUTHWEST INCORPORATED
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
The Company's capital expenditures during the first three months of 1999 were
$90.4 million compared to $118.0 million for the same period in 1998. The
overall anticipated capital expenditures for 1999 are expected to decrease
slightly from the 1998 level.
Cash used in financing activities was $73.4 million during the first three
months of 1999 compared to $64.5 million for the same period in 1998. This
included dividend payments of $52.2 million during the first three months of
1999 compared to $45.5 million for the same period in 1998. Short-term
financing, representing the net change in affiliate notes, decreased $21.2
million for the first three months of 1999, compared to $123.2 million for the
same period in 1998. During the first three months of 1999, the Company did not
retire any long-term debt and preferred stock compared to a total of $42.0
million paid for retirements in 1998. In January 1998, the Company issued $150
million of 6.23% debentures to repay short-term borrowings incurred to finance
the Company's construction program and for general corporate purposes. The
Company recognized an interest rate hedge loss of approximately $2.7 million on
the settlement of forward contracts related to the January 1998 debt issuance.
The loss is being amortized over the life of the associated refinanced debt.
INTERSTATE REGULATORY DEVELOPMENTS
During the first quarter of 1999, regulatory and legislative activity at both
the state and federal levels continued to be a direct result of the
Telecommunications Act of 1996 (Telecommunications Act). Along with promoting
competition in all segments of the telecommunications industry, the
Telecommunications Act was intended to preserve and advance universal service.
GTE continued in the first quarter of 1999 to meet the wholesale requirements of
new competitors. GTE signed interconnection agreements with other carriers,
providing them the capability to purchase individual unbundled network elements
(UNEs), resell retail services and interconnect facilities-based networks.
Several of these interconnection agreements were the result of the arbitration
process established by the Telecommunications Act, and incorporated prices or
terms and conditions based upon the Federal Communications Commission (FCC)
rules that were subsequently overturned by the Eighth Circuit Court (Eighth
Circuit) in July 1997. GTE challenged a number of such agreements in federal
district courts during 1997.
GTE's position in these challenges was supported by the Eighth Circuit's July
1997 decision stating that the FCC had overstepped its authority in several
areas concerning implementation of the interconnection provisions of the
Telecommunications Act. In January 1999, the U.S. Supreme Court (Supreme Court)
reversed in part and affirmed in part the Eighth Circuit's decisions. The
Supreme Court reversed the Eighth Circuit on many of the FCC rules related to
pricing and costing, that had previously been reversed by the Eighth Circuit on
jurisdictional grounds. The pricing rules established by the FCC will now be
remanded back to the Eighth Circuit for a determination on the merits. On the
other hand, the Supreme Court vacated the FCC rule requiring incumbent local
exchange carriers (LECs) to provide unbundled network elements to competitive
LECs. This latter ruling will be the subject of continued proceedings before the
FCC and the state commissions concerning what elements will have to be offered
under what conditions. Pending the final rulemaking by the FCC on the provisions
of unbundled network elements, GTE will continue to provide individual unbundled
network elements set forth in existing interconnection agreements even though it
is not legally obligated to do so.
UNIVERSAL SERVICE
In October 1998, the FCC issued an order selecting a cost model for universal
service and plans to select cost inputs in the second quarter of 1999. For this
reason, the FCC moved the implementation date of the new universal service
9
<PAGE> 11
GTE SOUTHWEST INCORPORATED
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
mechanism for nonrural carriers to July 1999. GTE filed a Petition for
Reconsideration in December 1998, stating that the adopted model is incomplete
and requires additional time for proper evaluation. GTE is currently awaiting
action from the FCC.
ADVANCED TELECOMMUNICATIONS SERVICES
Section 706 of the Telecommunications Act required the FCC to "encourage the
deployment on a reasonable and timely basis of advanced telecommunications
capability to all Americans." Further, the FCC was required to conduct a
proceeding aimed at determining the availability of advanced telecommunications,
and to take action to remove barriers to infrastructure investment and to
promote competition.
In an Order and Notice of Proposed Rule Making (NPRM) released in August 1998,
the FCC clarified that advanced services offered by an incumbent LEC are subject
to the unbundling and resale requirements of the Telecommunications Act. In the
NPRM, the FCC sought comment on extensive, new separate affiliate rules under
which an incumbent LEC's affiliate could offer advanced services free from the
unbundling and resale obligations of the Telecommunications Act. In addition,
the NPRM sought comment on a number of issues regarding collocation, local loops
and unbundling and resale obligations for network facilities needed for advanced
services.
On March 31, 1999, the FCC released an Order stemming from the August 1998 NPRM.
In the Order the FCC adopted a number of new collocation rules designed to make
competitive entry easier and less costly. These rules specify how incumbent LECs
will manage such items as alternate collocation arrangements, security, space
preparation cost allocation, provisioning intervals, and space exhaustion. The
FCC also released a Further NPRM seeking comment on spectrum compatibility
issues and line sharing. Line sharing is a concept wherein two or more service
providers are allowed to use the same local loop (e.g., voice and xDSL). GTE
will vigorously oppose line sharing.
The FCC has yet to release an order addressing separate affiliates, local loops,
unbundling and resale.
INTRASTATE REGULATORY DEVELOPMENTS
Texas
The Company appealed an order of the Texas Public Utility Commission (TPUC)
pertaining to the manner in which the Company markets long distance service with
GTE Long Distance, a division of an affiliate company, GTE Communications
Corporation (GTECC). The Company had proposed that GTE Long Distance would
provide a discount on both the interLATA long distance service that GTE Long
Distance offered as well as a discount on the intraLATA toll provided by the
Company. GTE Long Distance would absorb the entire discount while the Company
would continue to receive its tariffed rate for the intraLATA service. Although
the administrative law judge in the case ruled the offering appropriate, the
TPUC reversed the ruling. The Company appealed the TPUC's ruling in district
court. A hearing was held in December 1998 and the order was reversed due to
inadequate justification and remanded to the TPUC. In April 1999, the TPUC
vacated its initial order on this case.
10
<PAGE> 12
GTE SOUTHWEST INCORPORATED
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
OTHER DEVELOPMENTS
Proposed Merger with Bell Atlantic Corporation
On July 27, 1998, GTE and Bell Atlantic entered into a merger agreement
providing for the combination of the two companies. Under the terms of the
agreement, which was unanimously approved by the boards of directors of both
companies, GTE shareholders will receive 1.22 shares of Bell Atlantic stock for
each GTE share they own.
We expect the merger to qualify as a pooling of interests, which means that for
accounting and financial reporting purposes the companies will be treated as if
they had always been combined. The completion of the merger is subject to a
number of conditions, including certain regulatory approvals, receipt of
opinions that the merger will be tax-free, and the approval of the shareholders
of both Bell Atlantic and GTE. Special meetings to vote on the merger will be
held on May 18, 1999 for GTE shareholders and on May 19, 1999 for Bell Atlantic
shareholders.
Planned Asset Sales
In April 1998, GTE announced the planned sale of local telephone exchanges that
have approximately 1.6 million access lines in 13 states. Specifically, 606,000
access lines in the states of Arkansas, New Mexico, Oklahoma and Texas have been
identified for sale or trade. The identified assets constituted approximately
28% of the average switched access lines that the Company had in service during
1998. FCC and state commission approvals of the access line sales will be
required. Preliminary meetings have been held with the regulators. Transition of
these properties to the buyers will occur into 2000.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. The statement requires
entities that use derivative instruments to measure these instruments at fair
value and record them as assets or liabilities on the balance sheet. It also
requires entities to reflect the gains or losses associated with changes in the
fair value of these derivatives, either in earnings or as a separate component
of comprehensive income, depending on the nature of the underlying contract or
transaction. The Company is currently assessing the impact of adopting SFAS No.
133, which is effective January 1, 2000.
YEAR 2000 CONVERSION
General
The Year 2000 issue concerns the potential inability of information systems to
properly recognize and process date-sensitive information beyond January 1,
2000, and has industry-wide implications. GTE has had an active Year 2000
program in place since 1995. This program is necessary because the Year 2000
issue could impact telecommunications networks, systems and business processes
at GTE. Although GTE maintains a significant portion of its own systems and
infrastructure, it also depends on certain, material external supplier products
that GTE must verify as Year 2000 compliant in their condition of use. In 1997,
GTE's Year 2000 methodology and processes were certified by the Information
Technology Industry Association of America. GTE presently expects that the
essential functions of its domestic wireline telecommunications business will
complete Year 2000 testing by June 30, 1999, and remaining businesses will
complete before October 1999.
State of Readiness
GTE's Year 2000 program is focused on both information technology (IT) and
non-IT systems, including: 1) telecommunications network elements that
constitute the portion of the public switched telephone network (PSTN) for which
GTE is responsible; 2) systems that directly support GTE's telecommunications
network operations and interactions with customers; 3) systems and products that
support GTE's national and international business units; 4) software that
supports basic business operations, customer premise equipment and
interconnection
11
<PAGE> 13
GTE SOUTHWEST INCORPORATED
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
with other telecommunications carriers; and 5) systems that support GTE's
physical infrastructure, financial operations and facilities.
Corporate-wide, essential remediation was approximately 88% complete as of March
31, 1999. In addition to the essential remediation budget, GTE has set aside
funds equivalent to approximately 11% of the it's overall Year 2000 budget.
These funds are planned for verification, problem resolution and administrative
program closeout in the last six months of 1999 and to address contingencies and
millennium program operations and control through March 2000. GTE's portion of
the PSTN in the United States has been upgraded substantially for Year 2000; 97%
of GTE's access lines are already operational using Year 2000 compliant central
office switches. Additionally, over 98% of GTE's essential software has been
remediated. GTE's focus continues to be on deployment and testing of these
systems throughout GTE's operations.
GTE's Year 2000 program has been organized into five phases as follows:
Awareness: program definition and general education; Assessment: analysis and
prioritization of systems supporting the core business; Renovation: rectifying
Year 2000 issues; Validation: testing the Year 2000 solutions; Implementation:
placing the tested systems into production. Awareness and Assessment are more
than 95% complete; System Renovation, including supplier products, is
approximately 91% complete; Validation, including enterprise testing in
operational environments, and Implementation, including regional deployment, are
approximately 73% complete. It is anticipated that the Renovation, Validation
and Implementation phases for essential functions will be substantially complete
in June 1999.
In summary, compliant product deployment and enterprise testing for GTE's
domestic telecommunications-related business, including national and
international interoperability and validation, are presently expected to be
complete by the end of June 1999. The remaining domestic and international
businesses are on schedule for completing testing before October 1999.
Successful conclusion of GTE's Year 2000 program depends upon timely delivery of
Year 2000 compliant products and services from external suppliers. With the
addition of new products, approximately 1,500 of third-party products used by
GTE have been determined to be "vital" products, critical to GTE's business and
operations. As of March 31, 1999, Year 2000 compliant versions, or suitable
alternatives, for 95% of these vital supplier products have been provided and
are currently undergoing certification testing by GTE.
Use of Independent Verification and Validation
Independent verification and validation is the final step in GTE's process. As
part of independent verification and validation, GTE's Year 2000 program
management office has established a corporate-wide quality oversight and control
function that reviews and evaluates quality reports on the Year 2000 issue. Each
GTE business unit has access to an independent quality team that evaluates the
conversion and testing of applications and third-party supplier products. This
quality assurance process is expected to be completed in October 1999.
Separately, GTE's corporate internal auditors conduct periodic reviews and
report significant findings, if any, to business unit and corporate management
and the audit committee of the Board of Directors. Program status is also
reported each quarter to GTE's external auditors.
Cost to Address Year 2000 Issues
The current estimate for the cost of GTE's Year 2000 Program is expected not to
exceed $400 million. Through March 31, 1999, expenditures totaled $283 million.
The current estimate for the cost of remediation for the Company is
approximately $23.2 million. Through March 31, 1999, expenditures totaled $14.2
million. Year 2000
12
<PAGE> 14
GTE SOUTHWEST INCORPORATED
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
remediation costs are expensed in the year incurred. GTE has not elected to
replace or accelerate the planned replacement of systems due to the Year 2000
issue.
Currently supporting GTE's Year 2000 program worldwide are an estimated 1,000 to
1,200 full-time equivalent workers (both company employees and contractors).
Approximately 10% of these full-time equivalent workers are engaged in all
aspects of program management; 4% are engaged in system conversion; 27% are
involved in external supplier management; 54% are involved in testing at all
levels; and 5% are addressing contingency planning and interoperability
operations both nationally and internationally. Approximately 66% of GTE's
program effort involves U.S. domestic operations of all types.
Risks of Year 2000 Issues
GTE has begun to examine the risks associated with its "most reasonably likely
worst case Year 2000 scenarios." To date, GTE has no indication that any
specific function or system is so deficient in technical progress as to threaten
GTE's present schedule. GTE's program and plans currently indicate a compliant
network infrastructure to be deployed by the end of June 1999. A general,
unspecific, schedule shift that would erode progress beyond January 1, 2000,
cannot reasonably be calculated. If, however, there were a schedule delay
lasting no more than six months, such schedule erosion would likely affect only
nonessential systems due to the prioritization of work schedules.
Other scenarios might include a possible but presently unforeseen failure of key
supplier or customer business processes or systems. This situation could
conceivably persist for some months after the millennium transition and could
lead to possible revenue losses. GTE's present assessment of its key suppliers
and customers does not indicate that this scenario is likely.
To date, GTE has not encountered any conditions requiring tactical contingency
planning to its existing Year 2000 program; however, contingency planning for
business and network operations and customer contact during 1999 and 2000 is
ongoing.
GTE is bolstering its normal business continuity planning to address potential
Year 2000 interruptions. In addition, GTE's disaster preparedness recovery teams
are including procedures and activities for a "multi-regional" Year 2000
contingency, if it occurs. GTE is also developing its plans with respect to
possible occurrences immediately before, during, and after the millennium
transition. These plans are expected to be completed by June 30, 1999, and
tested (as appropriate) by the end of September 1999. This contingency plan
includes: business continuity planning; disaster recovery/emergency
preparedness; millennium rollover planning; post millennium degradation
tracking; a network and information technology "stabilization" period; employee
availability and logistics backup planning; "follow-the-sun" time-zone impact
analysis; coordination with other (non-PSTN) telecommunications providers; a
Year 2000 "war room" operation to provide high-priority recovery support, plans
for key personnel availability, command structures and contingency traffic
routing; and plans for round-the-clock, on-call repair teams.
13
<PAGE> 15
GTE SOUTHWEST INCORPORATED
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
In this Management's Discussion and Analysis, the Company has made
forward-looking statements. These statements are based on the Company's
estimates and assumptions and are subject to certain risks and uncertainties.
Forward-looking statements include the information concerning possible or
assumed future results of operations of the Company, as well as those statements
preceded or followed by the words "anticipates," "believes," "estimates,"
"expects," "hopes," "targets" or similar expressions. For each of these
statements, the Company claims the protection of the safe harbor for
forward-looking statements contained in the Private Securities Litigation Reform
Act of 1995.
The future results of the Company could be affected by subsequent events and
could differ materially from those expressed in the forward-looking statements.
If future events and actual performance differ from the Company's assumptions,
the actual results could vary significantly from the performance projected in
the forward-looking statements.
The following important factors could affect the future results of the Company
and could cause those results to differ materially from those expressed in the
forward-looking statements: (1) materially adverse changes in economic
conditions in the markets served by the Company; (2) material changes in
available technology; (3) the final resolution of federal, state and local
regulatory initiatives and proceedings, including arbitration proceedings, and
judicial review of those initiatives and proceedings, pertaining to, among other
matters, the terms of interconnection, access charges, universal service,
unbundled network elements and resale rates; (4) the extent, timing, success and
overall effects of competition from others in the local telephone and intraLATA
toll service markets; and (5) the success and expense of our remediation efforts
and those of our suppliers, customers and all interconnecting carriers in
achieving Year 2000 compliance.
14
<PAGE> 16
PART II. OTHER INFORMATION
GTE SOUTHWEST INCORPORATED
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits required by Item 601 of Regulation S-K.
12 Statement re: Calculation of the Ratio of Earnings
to Fixed Charges
27 Financial Data Schedule
(b) The Company filed no reports on Form 8-K during the first
quarter of 1999.
15
<PAGE> 17
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
GTE Southwest Incorporated
------------------------------------------------
(Registrant)
Date: May 13, 1999 /s/ Stephen L. Shore
------------------------------------------------
Stephen L. Shore
Controller
(Principal Accounting Officer)
16
<PAGE> 18
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -------------------------------------------------------------------
<S> <C>
12 Statement re: Calculation of the Ratio of Earnings to Fixed Charges
27 Financial Data Schedule
</TABLE>
<PAGE> 1
EXHIBIT 12
GTE SOUTHWEST INCORPORATED
Statement of the Ratio of Earnings to Fixed Charges
(Unaudited)
<TABLE>
<CAPTION>
(Dollars in Millions) Three Months Ended
March 31, 1999
------------------
<S> <C>
Net earnings available for fixed charges:
Income from continuing operations $ 53.8
Add - Income taxes 29.3
- Fixed charges 20.0
-------
Adjusted earnings $ 103.1
=======
Fixed charges:
Interest expense $ 19.1
Portion of rent expense
representing interest 0.9
-------
Adjusted fixed charges $ 20.0
=======
RATIO OF EARNINGS TO FIXED CHARGES 5.16
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 2,600
<SECURITIES> 0
<RECEIVABLES> 381,000
<ALLOWANCES> 29,400
<INVENTORY> 20,900
<CURRENT-ASSETS> 389,500
<PP&E> 5,846,400
<DEPRECIATION> 3,591,700
<TOTAL-ASSETS> 2,849,400
<CURRENT-LIABILITIES> 808,400
<BONDS> 692,700
0
7,600
<COMMON> 650,000
<OTHER-SE> 274,500
<TOTAL-LIABILITY-AND-EQUITY> 2,849,400
<SALES> 425,400
<TOTAL-REVENUES> 425,400
<CGS> 156,300
<TOTAL-COSTS> 323,600
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 19,100
<INCOME-PRETAX> 83,100
<INCOME-TAX> 29,300
<INCOME-CONTINUING> 53,800
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 53,800
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
