GTE SOUTHWEST INC, 10-K405, 2000-03-30

GTE SOUTHWEST INC
10-K405, 2000-03-30
TELEPHONE COMMUNICATIONS (NO RADIOTELEPHONE)

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<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, 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)

Securities registered pursuant to Section 12(b) of the Act: NONE

Securities registered pursuant to Section 12(g) of the Act: NONE

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 29, 2000. The Company's common stock is 100% owned by GTE
Corporation.

The Company meets the conditions set forth in General Instruction I (1)(a) and
(b) of Form 10-K and is therefore filing this Form with the reduced disclosure
format.

================================================================================

<PAGE> 2
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.

The Company's principal line of business is providing communications services
ranging from local telephone service for the home and office to highly complex
voice and data services for various industries. The Company provides local
telephone service within its franchise 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 long-distance carriers. These 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
long-distance carriers.

The number of access lines in the states in which the Company operates as of
December 31, 1999, was as follows:

<TABLE>
<CAPTION>
Access
State Lines Served
----- ------------

<S> <C>
Arkansas 98,704
New Mexico 104,611
Oklahoma 145,392
Texas 2,802,659
---------
Total 3,151,366
=========
</TABLE>

At December 31, 1999, the Company had 6,248 employees.

The Company has written agreements with the Communications Workers of America
(CWA) covering substantially all non-management employees. An agreement with the
CWA in New Mexico was reached in 1999 and expires in 2002. A primary agreement
covering employees in Arkansas, New Mexico, Oklahoma and Texas expires in 2001.

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.

During 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.

INTERSTATE SERVICES

<PAGE> 3

conditions based upon the FCC rules that were subsequently appealed to the U. S.
Supreme Court (Supreme Court). GTE challenged a number of such agreements in
federal district courts during 1997.

GTE's position in these challenges was supported by a decision of the Eighth
Circuit Court (Eighth Circuit) in July 1997 which stated the FCC had overstepped
its authority in several areas concerning implementation of the interconnection
provisions of the Telecommunications Act. In January 1999, the Supreme Court
reversed in part and affirmed in part the Eighth Circuit's decisions. The
Supreme Court reversed the Eighth Circuit's determination that the FCC had no
jurisdiction over pricing. As a result, the pricing rules established by the FCC
are now subject to review on their merits by the Eighth Circuit. In addition,
the Supreme Court vacated the FCC rule setting forth the UNEs that incumbent
local exchange carriers (ILECs) are required to provide to competitive local
exchange carriers (CLECs). This latter ruling led to a proceeding before the FCC
concerning what elements had to be offered and under what conditions.

In November 1999, the FCC reaffirmed that incumbents must provide unbundled
access to five of the original seven network elements, which must be available
on either a stand-alone basis, or as a combined local service "platform" if the
elements have been previously combined by the ILEC. ILECs are no longer required
to provide unbundled operator services, including directory assistance where
alternate routing is available. In addition, in certain circumstances, local and
tandem switching need not be unbundled. However, the FCC expanded the definition
of some UNEs by specifying that components of the loop UNE must be made
available in sub-loop components, and augmenting the types of call-related
databases that must be unbundled as UNEs. The FCC also found that state
commissions can require ILECs to unbundle additional elements as long as they
are consistent with the requirements of the Telecommunications Act and the
national policy framework instituted in the FCC's order. Furthermore, the order
precludes states from removing network elements from the FCC's list of
unbundling obligations. The United States Telecom Association (USTA) has
appealed this order and GTE will participate.

In December 1999, the FCC released another order that requires ILECs to provide
line sharing to CLECs by unbundled access to the high-frequency portion of the
local loop over which the ILEC provides voice services. The FCC's stated intent
in adopting the line sharing order is to enable competitive carriers to provide
digital subscriber line (DSL) services over the same lines simultaneously used
by ILECs to provide basic phone services.

In June 1999, the Eighth Circuit established a schedule for addressing the
issues it did not decide in 1998. Parties to this action have filed briefs and
participated in oral arguments in September 1999. The major issues are: (1) the
FCC's cost methodology used to set prices, (2) its methodology for setting
wholesale discounts, (3) the "proxy rates" it set for interconnection, UNEs, and
wholesale discounts, (4) whether ILECs should be required to combine UNEs that
are not already combined, and (5) whether the FCC can require ILECs to provide
"superior quality" to competitors than what the ILEC provides to itself. A court
decision is expected during the first half of 2000.

Universal Service

GTE is active before both state and federal regulators advocating development
and implementation of measures that will meet the requirements of the universal
service provisions of the Telecommunications Act. Specifically, GTE urges
regulators to identify and remove all hidden subsidies and to provide explicit
universal service subsidies.

In October 1998, the FCC issued an order selecting a cost model for universal
service. In July 1999, the United States Court of Appeals for the Fifth Circuit
(Fifth Circuit) affirmed in part, reversed in part, and remanded in part the
FCC's universal service regime. In October 1999, the FCC released two orders in
response to the Fifth Circuit decision. One order permits ILECs to continue to
recover their universal service contributions from access charges or to
establish end-user charges. The second order changed the contribution basis for
school/library funding to eliminate calculations based upon intrastate revenues.
In January 2000, GTE requested the Supreme Court to review the Fifth Circuit
decision allowing the FCC to base universal service support from the results of
a hypothetical cost model rather than historical costs that were incurred to
provide local service. GTE argued that the Fifth Circuit ignored long standing
legal precedent in permitting a major revision to ILEC cost recovery mechanisms
without ensuring the new process would not result in a constitutionally
prohibited "taking".

<PAGE> 4

In November 1999, the FCC released an order selecting the cost inputs for the
federal universal service cost model. GTE is seeking reconsideration. Since the
FCC moved the implementation date of the new universal service mechanism for
non-rural carriers to January 2000, many state regulators awaited FCC action
before they began designing their universal service programs.

In November 1999, the FCC released an order dealing with implementation of the
new FCC federal high cost support mechanism for non-rural ILECs, including GTE.
The effective date for the new federal universal service plan is January 1,
2000. This plan will distribute federal high cost funds to states with higher
than average costs. The role of state commissions is to ensure reasonable
comparability within the borders of a state. Federal high cost support will be
calculated by comparing the nationwide average cost with each state's average
cost per line, and providing federal support for only states that exceed 135% of
the nationwide average. To guard against rate shock, the FCC also adopted a
"hold harmless" approach so that the amount of support provided to each
non-rural carrier under the new plan will not be less than the amount provided
today. U S WEST has appealed this order on the basis that it fails to provide a
sufficient amount of support. This FCC order also established a May 1, 2000
deadline by which state commissions must create at least three deaveraged price
zones for UNEs. In January 2000, GTE requested the FCC grant a one year delay to
give state commissions ample opportunity to implement deaveraged retail rates
and establish state universal service funds in concert with UNE deaveraging.

In December 1999, the FCC asked for comment on requests made by the North Dakota
and South Dakota state commissions and the Rural Utilities Service (RUS) asking
the FCC to redefine "voice grade access" in the FCC's universal service rules.
The FCC requires that, in order to be eligible for universal service support, a
carrier must offer, among other things, voice grade access to the public
switched telephone network. Current FCC rules specify that voice grade access
should occur in a frequency range between approximately 300 Hertz (Hz) to 3,000
Hz. The petitioners requested the frequency range be changed to 200 Hz to 3,500
Hz. GTE participated in this proceeding and opposed any change in FCC
requirements. The network is not designed for the proposed ubiquitous
requirement and would require a significant infrastructure investment and at
least a decade to implement.

Price Cap

The federal price cap regime allows access prices to change each year by a
measure of inflation minus a productivity factor offset. In May 1999, the U.S.
Court of Appeals for the District of Columbia (Court) released a decision
regarding the FCC's choice of a 6.5% price cap productivity factor in a 1997
order. The Court found the FCC's choice of a 6.0% base factor and a 0.5%
Consumer Productivity Dividend to be inadequately supported. The Court remanded
the matter back to the FCC for further action and established an April 2000 date
by which the FCC must issue a revised decision. As a result, in November 1999,
the FCC initiated a rulemaking proposal requesting comments on the interstate
price cap productivity factor. Currently, it is unknown whether the single price
cap productivity factor will be applied retroactively to July 1, 1997 and remain
in effect until the next price cap performance review in 2003, or whether one
factor will apply from 1997 to 2000 and another factor apply from 2000 to 2003.

Interstate Access Revision

Effective July 1999, access charges were further reduced using a 6.5%
productivity factor in compliance with FCC requirements to reflect the impacts
of access charge reform and in making GTE's 1999 Annual Filing. The total annual
financial impact of the reduction was $113 million. Similar filings during 1997
and 1998 had already resulted in price reductions.

In August 1999, GTE, along with a coalition of local exchange and long-distance
companies (CALLS), submitted a proposal for interstate access charge and
universal service reform to the FCC. The proposal would accelerate the shift in
non-usage sensitive access revenue recovery from per-minute to flat-rated
charges, set a schedule for elimination of the price cap productivity factor,
and provide more explicit support for universal service. The coalition filed a
revised plan in March 2000 and the FCC has offered the plan for comments. A
decision by the FCC is expected in 2000.

<PAGE> 5

In August 1999, the FCC released an order pertaining to access reform and
pricing flexibility. The order grants price cap LECs immediate flexibility under
certain circumstances to deaverage certain access services and permits the
introduction of new services on a streamlined basis, without prior FCC approval.

Advanced Telecommunications Services

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 March 1999, the FCC released an order adopting a number of new collocation
rules designed to make competitive entry easier and less costly. These rules
specify how ILECs will manage such items as alternate collocation arrangements,
security, space preparation cost allocation, provisioning intervals, and space
exhaustion. GTE asked the Court to review this order. In March 2000, the Court
issued a ruling granting, in part, challenges raised by GTE to the FCC's March
1999 order. The Court ruled that the FCC failed to justify its requirement that
ILECs must permit collocation of any CLEC equipment that was "used or useful"
for interconnection or access to network elements. The Court remanded this
portion of the decision back to the FCC for further deliberation.

In November 1999, the FCC released an order concluding that an ILEC's offering
of DSL services to Internet Service Providers (ISPs) pursuant to volume and term
discount plans that are a component of the ISPs high-speed Internet service are
not a retail offering, and thus not subject to the discounted resale obligation.
The order also concluded that an ILECs DSL offering to end users is a retail
offering if the ILEC performs certain consumer-oriented functions, such as
provisioning of customer premises equipment and wiring, marketing, billing and
collection, and accepting repair requests directly from the end user. The FCC
concluded that these services are subject to discounted resale obligation,
regardless of whether the service is classified as telephone exchange service
(local tariff) or exchange access service (access tariff).

Number Portability

In December 1998, the FCC released an order establishing cost recovery rules for
local number portability (LNP) that permitted the recovery of carrier-specific
costs directly related to the provision of long-term LNP via a federally
tariffed end-user monthly charge. GTE subsequently filed an LNP tariff with the
FCC, and in March 1999 instituted an end-user number portability fee. This
charge is levied on all business and residential customers. In June 1999, GTE's
tariffed LNP charge was reviewed and accepted by the FCC at $0.36 per access
line per month.

Internet Service Traffic

ILECs are required to provide open access to all ISPs, while cable television
operators are not. Several major cable television operators providing Internet
access through cable modem facilities are only offering their affiliated ISPs to
consumers. Cable television operators that do allow customers to select
non-affiliated ISPs often require the customer to also pay for their affiliated
ISP's service (i.e., to pay twice for the same service). GTE has been active in
encouraging municipalities engaged in reviewing cable television mergers or
franchise renewals to require cable modem open access as a condition for
approval. The City of Portland, Oregon was first to adopt such a requirement and
AT&T Corp. has appealed that decision. Arguments took place in November 1999
before the Ninth Circuit Court.

In October 1999, GTE filed an antitrust lawsuit contending that cable TV
providers' refusal to provide ISPs with "open access" to cable modem platforms
is a violation of federal antitrust law. The lawsuit filed in the U.S. District
Court in Pittsburgh, names Tele-Communications, Inc., (now a unit of AT&T
Corp.), Comcast Corp., and Excite@Home and seeks an injunction to require open
access and damages.

<PAGE> 6

party within GTE's current local serving area. It is GTE's position that ISP
traffic does not satisfy the definition of local traffic, and that no
compensation should be paid to CLECs that carry this traffic to their ISP
customers. In a recent ruling, the FCC has clarified that ISP traffic is largely
interstate and is not local traffic. Nevertheless, the FCC permitted state
commissions to arbitrate whether ILECs should pay as reciprocal compensation for
ISP-bound traffic, based upon existing interconnection agreements, until the FCC
reaches a decision on a long-term compensation scheme. GTE challenged this FCC
conclusion in federal district court. In March 2000, the Court vacated and
remanded the FCC's ruling that ISP-bound calls are interstate since the FCC
failed to provide a satisfactory explanation to support its ruling. As a result,
the Court did not address GTE's argument that the Telecommunications Act
preempts state commission authority to arbitrate disputes over non-local
traffic.

Further information regarding the Company's activities with the various state
regulatory agencies is included in Item 7, Management's Discussion and Analysis
of Financial Condition and Results of Operations - "REGULATORY AND COMPETITIVE
TRENDS - INTRASTATE SERVICES."

OTHER DEVELOPMENTS

Proposed Merger with Bell Atlantic Corporation

Bell Atlantic and GTE Corporation have announced a proposed merger of equals
under a definitive merger agreement dated 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 they own. Bell Atlantic shareholders
will continue to own their existing shares after the merger.

The merger is expected 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 and receipt of
opinions that the merger will be tax-free. At annual meetings held in May 1999,
the shareholders of each company approved the merger. All state regulatory
commissions have now approved the merger and the only remaining approval is
required from the FCC. Both companies are working diligently to complete the
merger and are targeting completion of the merger in the second quarter of 2000.

Planned Asset Sales

During 1999, the Company entered into agreements to sell approximately 606,000
switched access lines located in Arkansas, New Mexico, Oklahoma and Texas. These
agreements consummate the Company's previously announced 1998 plan to sell
selected access lines located in these states. All sales will be subject to
regulatory approval and are expected to close in 2000. The associated net
assets, which approximate $659.1 million, consist of property, plant and
equipment, and have been reclassified as "Net assets held for sale" in the
balance sheets at December 31, 1999. The net book value of these access lines is
reflected in "Property, plant and equipment, net" in the balance sheets at
December 31, 1998. The Company intends to continue to operate all of these
assets until sold. Based on the decision to sell, however, the Company stopped
recording depreciation expense for these assets. Accordingly, depreciation
expense was lowered by $106.5 million and $26.5 million in 1999 and 1998,
respectively. No charges were recorded for the access lines to be sold because
their estimated fair values were in excess of their carrying values. The access
line agreements represent approximately 26% of the switched access lines that
the Company had in service at the end of 1999, and contributed approximately 24%
to 1999 revenues.

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.

<PAGE> 7

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, 1995 to
December 31, 1999, the Company made capital expenditures of $2.1 billion for new
plant and facilities required to meet telecommunication service needs and to
modernize plant and facilities. These additions were equal to 48% of gross plant
of $4.3 billion at December 31, 1999.

Item 3. Legal Proceedings

There are no pending legal proceedings which would have a material impact on the
Company's consolidated financial statements.

Item 4. Submission of Matters to a Vote of Security Holders

This item has been omitted in accordance with the relief provisions under
General Instruction I (2) of Form 10-K.

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).

PARENT COMPANY ANNUAL REPORT

To obtain a copy of the 1999 annual report of our parent company or the annual
Form 10-K filed with the Securities and Exchange Commission, call 800/225-5160.

INFORMATION VIA THE INTERNET

World Wide Web users can access information about GTE at: http://www.gte.com.

OTHER SECURITIES

Questions regarding the bonds and debentures of the Company should be directed
to Treasury Department - Capital Markets, GTE Corporation, 1255 Corporate Drive,
Irving, TX 75038, or call 972/507-5038.

PRODUCTS AND SERVICES HOTLINE

To receive information concerning GTE products and services, please call
800/828-7280.

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.

Item 6. Selected Financial Data

This item has been omitted in accordance with the relief provisions under
General Instruction I (2) of Form 10-K.

<PAGE> 8

Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Abbreviated pursuant to General Instruction I (2) of Form
10-K)

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, 1999, the Company
served 3,151,366 access lines in its service territories, with 89% of these
lines in Texas.

RESULTS OF OPERATIONS
(Dollars in Millions)

<TABLE>
<CAPTION>
Years Ended December 31,
------------------------ Percent
1999 1998 Increase Change
------ ------ -------- ------

<S> <C> <C> <C> <C>
Net income $332.2 $260.5 $ 71.7 28%
</TABLE>

The increase in net income is primarily due to lower cost of services and sales
and depreciation and amortization expenses. 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.

REVENUES AND SALES
(Dollars in Millions)

<TABLE>
<CAPTION>
Years Ended December 31,
------------------------ Increase Percent
1999 1998 (Decrease) Change
-------- -------- ---------- ------

<S> <C> <C> <C> <C>
Local services $ 750.3 $ 719.2 $ 31.1 4%
Network access services 689.1 701.5 (12.4) (2)%
Other services and sales 348.7 366.5 (17.8) (5)%
-------- -------- --------
Total revenues and sales $1,788.1 $1,787.2 $ 0.9 --
======== ======== ========
</TABLE>

Local Services Revenues

Local services revenues are comprised mainly of fees charged to customers for
providing local-exchange service within designated franchise areas. Access line
growth of 5% in 1999 generated additional revenues of $24.4 million from basic
local services and $5.2 million from Integrated Services Digital Network and
Digital Channel Services. In addition, an increase in revenues of $57.3 million
resulted from a surcharge to offset access price reductions driven by the
implementation of the Texas universal service fund (USF), effective September
1999. These increases were partially offset by a $37.9 million reduction in
revenues due to the completion during 1998 of the amortization of a reserve
previously established for potential refunds related to the 1989 Texas rate
case. An extended area service rate reduction in Texas decreased 1999 revenues
by $10.6 million and a lower level of non-recurring charges paid by customers
and declining use of public telephones further reduced 1999 revenues by $6.8
million over 1998.

Network Access Services Revenues

Network access services revenues are based on fees charged to long-distance
carriers that use the Company's local-exchange network in providing
long-distance services. In addition, business and residential customers pay
end-user access fees to connect to the local network to obtain long-distance
service. Cellular service providers and other

<PAGE> 9

local-exchange carriers (LECs) also pay access charges for cellular and
intraLATA (Local Access and Transport Area) toll calls hauled by the Company.
Mandated interstate and intrastate access price changes, primarily driven by the
implementation of the Texas USF order reducing intrastate access rates effective
September 1999, resulted in a decrease in revenues of $67.1 million for the year
1999 as compared to 1998. Additional decreases of $13.9 million resulted from
the 1989 Texas rate case, as discussed in "Local Services Revenues" above. Also,
access settlement adjustments recorded in 1998 contributed $4.8 million to the
decrease in 1999 as compared to 1998. Partially offsetting the decreases is an
increase in special access revenues of $35.6 million as a result of greater
demand for increased bandwidth services by high capacity users. Minutes of use
increased by 7% generating additional revenues of $21.4 million in 1999. End
user surcharges increased $10.0 million primarily as a result of access line
growth and the implementation of the local number portability (LNP) surcharge
(for further information see "Regulatory and Competitive Trends - Interstate
Services - Number Portability"). Additionally, an increase of $10.4 million
resulted from the sharing provisions of the Federal Communications Commission's
(FCC) 1997 price cap recorded in the first quarter of 1998.

Other Services and Sales Revenues

Other services and sales revenues decreased $17.8 million in 1999 compared to
1998. The decrease is primarily driven by a $27.1 million decline in toll
services revenues, reflecting the continuing impacts of intraLATA toll
competition, offset by increases in nonregulated service revenues and equipment
sales of $11.4 million.

OPERATING COSTS AND EXPENSES
(Dollars in Millions)

<TABLE>
<CAPTION>
Years Ended December 31,
------------------------ Increase Percent
1999 1998 (Decrease) Change
-------- -------- ---------- ------

<S> <C> <C> <C> <C>
Cost of services and sales $ 614.4 $ 675.8 $ (61.4) (9)%
Selling, general and administrative 295.9 294.8 1.1 --
Depreciation and amortization 291.5 350.1 (58.6) (17)%
-------- -------- --------

Total operating costs and expenses $1,201.8 $1,320.7 $ (118.9) (9)%
======== ======== ========
</TABLE>

Operating costs and expenses decreased $118.9 million, or 9% in 1999 compared to
1998. An employee-reduction program initiated in the first quarter of 1999
resulted in the lump-sum settlement of pension obligations for the affected
employees. Accordingly, the Company recognized net pension plan gains of $57.2
million. Further contributing to the decrease were lower right-to-use (RTU) fees
of $43.9 million associated with the Company's network switching equipment, due
primarily to the capitalization of software costs in 1999 as a result of the
adoption of Statement of Position (SOP) 98-1, "Accounting for Costs of Computer
Software Developed or Obtained for Internal Use". Partially offsetting these
expense reductions is a one-time special charge of $18.4 million in 1999
associated with the employee separation program mentioned above and an increase
of $13.8 million due to 1998 adjustments to employee benefits and other
liabilities. The decrease in depreciation and amortization expenses is primarily
driven by the discontinuation of depreciation on approximately 606,000
non-strategic access lines held for sale, which reduced 1999 expenses by $80.0
million. The decreases are partially offset by $19.8 million of increased
depreciation expense driven by additional investment in network facilities
resulting from increased demand for switched access lines and amortization of
RTU fees.

<PAGE> 10

OTHER INCOME STATEMENT ITEMS
(Dollars in Millions)

<TABLE>
<CAPTION>
Years Ended December 31,
------------------------ Percent
1999 1998 Increase Change
------ ------ -------- ------

<S> <C> <C> <C> <C>
Interest - net $ 73.0 $ 69.1 $ 3.9 6%
Income taxes 181.1 136.5 44.6 33%
</TABLE>

Interest - net increased in 1999, primarily due to higher average short-term
debt balances.

Income tax expense increased in 1999, primarily due to an increase in pretax
income.

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 FCC for its interstate operations.

INTERSTATE SERVICES

GTE continued in 1999 to meet the wholesale requirements of new competitors. GTE
has signed interconnection agreements with other carriers, providing them the
capability to purchase 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 FCC rules that were subsequently appealed to the U. S. Supreme Court
(Supreme Court). GTE challenged a number of such agreements in federal district
courts during 1997.

<PAGE> 11

Universal Service

<PAGE> 12

and opposed any change in FCC requirements. The network is not designed for the
proposed ubiquitous requirement and would require a significant infrastructure
investment and at least a decade to implement.

Price Cap

Interstate Access Revision

Advanced Telecommunications Services

<PAGE> 13

collection, and accepting repair requests directly from the end user. The FCC
concluded that these services are subject to discounted resale obligation,
regardless of whether the service is classified as telephone exchange service
(local tariff) or exchange access service (access tariff).

Number Portability

Internet Service Traffic

GTE's interconnection contracts with CLECs specify that parties compensate each
other for the exchange of local traffic, defined as traffic that is originated
by an end user of one party and terminating to the end user of the other party
within GTE's current local serving area. It is GTE's position that ISP traffic
does not satisfy the definition of local traffic, and that no compensation
should be paid to CLECs that carry this traffic to their ISP customers. In a
recent ruling, the FCC has clarified that ISP traffic is largely interstate and
is not local traffic. Nevertheless, the FCC permitted state commissions to
arbitrate whether ILECs should pay as reciprocal compensation for ISP-bound
traffic, based upon existing interconnection agreements, until the FCC reaches a
decision on a long-term compensation scheme. GTE challenged this FCC conclusion
in federal district court. In March 2000, the Court vacated and remanded the
FCC's ruling that ISP-bound calls are interstate since the FCC failed to provide
a satisfactory explanation to support its ruling. As a result, the Court did
not address GTE's argument that the Telecommunications Act preempts state
commission authority to arbitrate disputes over non-local traffic.

INTRASTATE SERVICES

The Company provides local-exchange services to customers within its designated
franchise area and toll services within designated geographic areas called LATAs
under agreements with connecting LECs in conformity with individual state
regulatory orders. The Company also provides long distance access services
directly to long-distance carriers who provide services between LATAs.

New Mexico

In December 1999, the New Mexico Public Regulation Commission (NMPRC) issued two
orders in Phase III of the universal service fund (USF)/UNE proceeding that
established an initial USF size and adopted USF rules to implement the fund. The
initial fund size is $11 million and the NMPRC is considering how to distribute
the fund among the LECs.

<PAGE> 14

Oklahoma

In April 1998 the Corporation Commission of the State of Oklahoma (CCSO)
initiated an informal earnings review with the Company. Additionally, the
Oklahoma Modernization audit was consolidated with this proceeding. In November
1999, the Company reached a stipulated settlement with the CCSO and the State
Attorney General's office that closed both the earnings review as well as the
Modernization Audit. This settlement provided for the Company to make a one-time
payment in April 2000 of $3.6 million to all retail customers.

Texas

In December 1996, the Public Utility Commission of Texas (PUCT) issued decisions
in the Company's arbitration with AT&T Corp., MCI Worldcom Inc., and Sprint
Corp. to determine interconnection, resale and unbundling terms and conditions.
The discount rate for the Company's resold services was set at 22.99%. Interim
rates based on the Company's costs will be used for interconnection and UNEs
until permanent discounts are established upon further investigation into cost
methodology. The Company filed cost studies in June 1997 and revised cost
studies in February and August 1998. The Company has reached an agreement with
various carriers in the permanent UNE case under which the interim UNE rates
will continue until the parties' contracts expire. During 1997, the Company
filed lawsuits in the U.S. District Court challenging portions of the PUCT's
determinations. These lawsuits have been consolidated into a single lawsuit and
a decision is anticipated in the first half of 2000.

In May 1999, the Texas State Legislature passed significant revisions to the
Public Utility Regulatory Act (PURA), the state's regulatory framework. The
governor of Texas signed these amendments into law in June 1999 and the law
became effective in September 1999. Included in the law are provisions which:
(1) extend indefinitely a carrier's election into incentive regulation; (2)
allow packaging of services between regulated, nonregulated and affiliated
entities; (3) provide increased pricing flexibility for non-basic services; and
(4) allow in-franchise and out-of-franchise operations for carriers and their
affiliates. Also included are customer commitments including rate caps for basic
and switched access services and the provision of advanced telecommunication
services statewide. The PUCT is in the process of promulgating the necessary
rules to implement this bill.

Since early 1997, the PUCT has been working with the industry to construct and
implement a state universal service plan. Rules were adopted in December 1997
and an interim sizing of the high cost fund was accepted by the PUCT in December
1998. As of September 1999, the Company is now receiving $171 million annually
in fund disbursements and has implemented offsetting reductions to wholesale
switched access rates and intraLATA toll rates. In November 1999, the PUCT
granted the Company additional universal service funding as a result of
increased lines receiving universal service support. As of March 1, 2000, these
additional fund disbursements increased the Company's total high cost assistance
to $197.7 million annually with offsetting reductions to toll and wholesale
switched access rates.

PROPOSED MERGER WITH BELL ATLANTIC CORPORATION

<PAGE> 15

PLANNED ASSET SALES

During 1999, the Company entered into agreements to sell approximately 606,000
switched access lines in Arkansas, New Mexico, Oklahoma and Texas. These
agreements consummate the Company's previously announced 1998 plan to sell
selected access lines located in these states. All sales will be subject to
regulatory approval and are expected to close in 2000. The associated net
assets, which approximate $659.1 million, consist of property, plant and
equipment, and have been reclassified as "Net assets held for sale" in the
balance sheet at December 31, 1999. The net book value of these access lines is
reflected in "Property, plant and equipment, net" in the balance sheet at
December 31, 1998. The Company intends to continue to operate all of these
assets until sold. Based on the decision to sell, however, the Company stopped
recording depreciation expense for these assets. Accordingly, depreciation
expense was lowered by $106.5 million and $26.5 million in 1999 and 1998,
respectively. No charges were recorded for the access lines to be sold because
their estimated fair values were in excess of their carrying values. The access
line agreements represent approximately 26% of the switched access lines that
the Company had in service at the end of 1999, and contributed approximately 24%
to 1999 revenues.

YEAR 2000 CONVERSION

GTE does not believe that the Year 2000 rollover has had, or will have, any
material adverse impacts on results of operations or liquidity. Additionally,
GTE has not experienced any material contingencies regarding customers or major
suppliers. GTE experienced no significant Year 2000 events, and service to GTE's
customers was unaffected by the rollover to January 1, 2000. GTE completed its
Year 2000 renovation, conducted system testing and returned to production the
essential systems that support its businesses substantially in advance of
December 31, 1999. Additionally, GTE's portion of the public switched telephone
network (PSTN) in the United States was upgraded for Year 2000, and all of GTE's
access lines have been operating using Year 2000 compliant central office
switches and network elements since mid-year 1999. With the successful
transition into 2000, GTE believes that the risk of disruptions arising from
time/date transitions, that would affect GTE's ability to provide basic
services, has been eliminated.

GTE continues to enhance its normal business continuity planning to address
potential Year 2000 and other time/date interruptions. These include: potential
gradual system degradation after January 1, 2000; possible accumulation of
processing errors or degraded performance; leap year processing through February
29, 2000; and potential impacts of degrading performance from partners. GTE's
disaster preparedness recovery plans include procedures and activities for a
"multi-regional" time/date contingency, if it occurs.

The estimated total multi-year cost of GTE's Year 2000 Program is expected to
total approximately $380 million, of which $372 million has been expended
through December 31, 1999. The current estimate for the cost of remediation for
the Company is approximately $17.7 million. Through December 31, 1999,
expenditures totaled $17.7 million. Year 2000 renovation costs are expensed in
the year incurred. Approximately 69% of GTE's program effort involved U.S.
domestic operations. With the successful transition from 1999 to 2000, GTE has
completed its Year 2000 Program. All future efforts will be performed under
normal business operations.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board (FASB) 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, as amended, which is effective January 1, 2001.

<PAGE> 16

In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements," which currently must be adopted by June 30, 2000. SAB No. 101
provides additional guidance on revenue recognition as well as criteria for when
revenue is generally realized and earned and also requires the deferral of
incremental direct selling costs. The Company is currently assessing the impact
of SAB No. 101.

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.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

In this Management's Discussion and Analysis of Financial Condition and Results
of Operations, 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; and (4) the extent, timing, success
and overall effects of competition from others in the local telephone and
intraLATA toll service markets.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

The Company views derivative financial instruments as risk management tools and,
in accordance with Company policy, does not utilize them for speculative or
trading purposes. The Company is also not a party to any leveraged derivatives.
The Company is exposed to market risk from changes in interest rates. The
Company manages its exposure to market risks through its regular operating and
financing activities and, when deemed appropriate, through the use of derivative
financial instruments that have been authorized pursuant to the Company's
policies and procedures. The use of these derivatives allows the Company to
reduce its overall exposure to market risk, as the gains and losses on these
contracts substantially offset the gains and losses on the liabilities being
hedged.

The Company uses derivative financial instruments to manage its exposure to
interest rate movements and to reduce borrowing costs. The Company's net
exposure to interest rate risk primarily consists of floating rate instruments
that are benchmarked to U.S. money market interest rates. The Company manages
this risk by using interest rate swaps to convert floating rate short-term debt
to synthetic fixed rate instruments. The Company also uses forward contracts to
sell U.S. Treasury bonds to hedge interest rates on anticipated long-term debt
issuance.

<PAGE> 17

Item 8. Financial Statements and Supplementary Data

GTE SOUTHWEST INCORPORATED

Statements of Income

<TABLE>
<CAPTION>
Years Ended December 31, 1999 1998 1997
-------- -------- --------
(Dollars in Millions)

<S> <C> <C> <C>
REVENUES AND SALES (a)
Local services $ 750.3 $ 719.2 $ 649.2
Network access services 689.1 701.5 660.4
Other services and sales 348.7 366.5 367.0
-------- -------- --------
Total revenues and sales 1,788.1 1,787.2 1,676.6
-------- -------- --------

OPERATING COSTS AND EXPENSES (b)
Cost of services and sales 614.4 675.8 591.0
Selling, general and administrative 295.9 294.8 241.5
Depreciation and amortization 291.5 350.1 353.6
-------- -------- --------
Total operating costs and expenses 1,201.8 1,320.7 1,186.1
-------- -------- --------

OPERATING INCOME 586.3 466.5 490.5

OTHER (INCOME) EXPENSE
Interest - net (c) 73.0 69.1 60.1
Other - net -- (0.1) --
-------- -------- --------

INCOME BEFORE INCOME TAXES 513.3 397.5 430.4
Income taxes 181.1 136.5 142.2
-------- -------- --------

INCOME BEFORE EXTRAORDINARY CHARGE 332.2 261.0 288.2
Extraordinary charge -- (0.5) --
-------- -------- --------

NET INCOME $ 332.2 $ 260.5 $ 288.2
======== ======== ========
</TABLE>

(a) Includes billings to affiliates of $39.0 million, $39.7 million and $39.9
million for the years 1999-1997, respectively.

(b) Includes billings from affiliates of $197.9 million, $211.6 million and
$84.7 million for the years 1999-1997, respectively.

(c) Includes interest paid to affiliates of $11.2 million, $7.5 million and
$6.3 million for the years 1999-1997, respectively

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.

<PAGE> 18

GTE SOUTHWEST INCORPORATED
Balance Sheets

<TABLE>
<CAPTION>
December 31, 1999 1998
-------- --------
ASSETS (Dollars in Millions)

<S> <C> <C>
Current assets:
Cash and cash equivalents $ 10.5 $ 10.4
Receivables, less allowances of $26.1 million and $28.6 million 328.1 286.2
Accounts receivable from affiliates 65.4 57.7
Net assets held for sale (see Notes 3 and 11) 659.1 --
Inventories and supplies 20.0 16.4
Prepaid expenses and other 25.9 23.2
-------- --------
Total current assets 1,109.0 393.9
-------- --------

Property, plant and equipment, net (see Notes 3 and 11) 1,696.5 2,238.1
Prepaid pension costs 262.0 175.8
Other assets 1.5 21.5
-------- --------
Total assets $3,069.0 $2,829.3
======== ========

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
Current maturities of long-term debt $ 48.3 $ 250.3
Notes payable to affiliates 462.9 163.0
Accounts payable 89.5 69.0
Affiliate payables and accruals 25.1 81.7
Advanced billings and customer deposits 48.1 47.0
Taxes payable 82.0 75.6
Accrued payroll costs 39.7 43.0
Dividends payable 77.1 52.2
Other 30.1 25.3
-------- --------
Total current liabilities 902.8 807.1
-------- --------

Long-term debt 648.0 692.6
Deferred income taxes 267.3 182.5
Employee benefit plans 235.0 216.8
Other liabilities 1.6 3.9
-------- --------
Total liabilities 2,054.7 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 53.9 48.8
Retained earnings 302.8 220.0
-------- --------
Total shareholders' equity 1,014.3 926.4
-------- --------
Total liabilities and shareholders' equity $3,069.0 $2,829.3
======== ========
</TABLE>

The accompanying notes are an integral part of these statements.

<PAGE> 19

GTE SOUTHWEST INCORPORATED
Statements of Cash Flows

<TABLE>
<CAPTION>
Years Ended December 31, 1999 1998 1997
------ ------ ------
(Dollars in Millions)

<S> <C> <C> <C>
OPERATIONS
Income before extraordinary charge $332.2 $261.0 $288.2
Adjustments to reconcile income before extraordinary
charge to net cash from operations:
Depreciation and amortization 291.5 350.1 353.6
Employee retirement benefits (72.9) (31.2) (26.4)
Deferred income taxes 84.6 4.8 29.4
Provision for uncollectible accounts 32.2 38.3 31.2
Change in current assets and current liabilities:
Receivables - net (81.8) (22.2) (58.3)
Other current assets (2.9) 44.3 (3.1)
Accrued taxes and interest 5.6 42.0 (47.4)
Other current liabilities (45.6) (103.3) (24.2)
Other - net 38.3 (11.6) 19.5
------ ------ ------
Net cash from operations 581.2 572.2 562.5
------ ------ ------

INVESTING
Capital expenditures (407.1) (480.3) (510.0)
Other-net 1.0 -- --
------ ------ ------
Net cash used in investing (406.1) (480.3) (510.0)
------ ------ ------

FINANCING
Long-term debt issued -- 148.9 --
Long-term debt and preferred stock retired,
including premiums paid on early retirement (250.3) (42.3) (38.5)
Dividends (224.5) (179.9) (272.3)
Net change in affiliate notes 299.8 (29.8) 259.5
Other - net -- (2.7) --
------ ------ ------
Net cash used in financing (175.0) (105.8) (51.3)
------ ------ ------

Increase (decrease) in cash and cash equivalents 0.1 (13.9) 1.2

Cash and cash equivalents:
Beginning of year 10.4 24.3 23.1
------ ------ ------
End of year $ 10.5 $ 10.4 $ 24.3
====== ====== ======
Cash paid during the year for:
Interest $ 81.7 $ 73.3 $ 59.8
------ ------ ------
Income taxes $ 89.0 $ 63.7 $119.8
------ ------ ------
</TABLE>

The accompanying notes are an integral part of these statements.

<PAGE> 20

GTE SOUTHWEST INCORPORATED
Statements of Shareholders' Equity

<TABLE>
<CAPTION>
Additional
Preferred Common Paid-In Retained
Stock Stock Capital Earnings Total
-------- -------- -------- -------- --------
(Dollars in Millions)

<S> <C> <C> <C> <C> <C>
Shareholders' equity, December 31, 1996 $ 7.6 $ 650.0 $ 48.8 $ 126.1 $ 832.5

Net income 288.2 288.2
Dividends declared (268.0) (268.0)
Early redemption of preferred stock (0.1) (0.1)
-------- -------- -------- -------- --------
Shareholders' equity, December 31, 1997 7.6 650.0 48.8 146.2 852.6

Net income 260.5 260.5
Dividends declared (186.7) (186.7)
-------- -------- -------- -------- --------
Shareholders' equity, December 31, 1998 7.6 650.0 48.8 220.0 926.4

Net income 332.2 332.2
Dividends declared (249.4) (249.4)
Tax benefit from exercise of stock options 5.1 5.1
-------- -------- -------- -------- --------
Shareholders' equity, December 31, 1999 $ 7.6 $ 650.0 $ 53.9 $ 302.8 $1,014.3
======== ======== ======== ======== ========
</TABLE>

The accompanying notes are an integral part of these statements.

<PAGE> 21

GTE SOUTHWEST INCORPORATED
Notes to Financial Statements

1. DESCRIPTION OF BUSINESS AND 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, 1999, the Company served 3,151,366 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.

Reclassifications of prior-year data have been made, where appropriate, to
conform to the 1999 presentation.

TRANSACTIONS WITH AFFILIATES

GTE Supply (100% owned by GTE) provides construction and maintenance equipment,
supplies and electronic repair services to the Company. These purchases and
services amounted to $106.0 million, $104.0 million and $121.9 million for the
years 1999-1997, respectively. Such purchases and services are recorded in the
accounts of the Company at the lower of cost, including a return realized by GTE
Supply, or fair market value.

The Company is billed for data processing services, software development and
equipment rentals, and receives management, consulting, research and development
and pension management services from other affiliated companies. The Company's
financial statements also include allocated expenses resulting from the sharing
of certain executive, administrative, financial, accounting, marketing,
personnel, engineering and other support services being performed at
consolidated work centers within GTE. The amounts charged for these affiliated
transactions are based on proportional cost allocation methodologies. These
charges amounted to $170.2 million, $207.5 million and $77.7 million for the
years 1999-1997, respectively. The significant increases, beginning in 1998
charges, are due to a reorganization of support functions within GTE. Prior to
1998, the cost of these support functions was recorded directly by the Company,
and is now allocated to the Company on a proportional cost basis.

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 $11.2 million, $7.5 million and $6.3 million for the
years 1999-1997, respectively.

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. In addition, when Directories
sells Yellow Page directory advertising to customers within the Company's
franchise area, the Company records a portion of the sale as revenue. Revenues
from these activities amounted to $39.0 million, $39.7 million and $39.9 million
for the years 1999-1997, respectively. Also, the Company is billed for certain
printing and other costs associated with telephone directories, including the
cost of customer contact information pages which are included in the Company's
White Pages directories. These charges amounted to $27.7 million, $4.1 million
and $7.0 million for the years 1999-1997, respectively.

<PAGE> 22

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.

DEPRECIATION AND AMORTIZATION

Property, plant and equipment of the Company is depreciated on a straight-line
basis over the following estimated useful asset lives:

<TABLE>
<CAPTION>
Average lives (in years)
------------------------
<S> <C>
Buildings 20 - 40
Inside communications plant 5 - 10
Outside communications plant 8 - 40
Furniture, vehicles and other equipment 3 - 10
</TABLE>

The Company depreciates assets using the remaining life methodology. This method
depreciates the net investment in telephone plant less anticipated net salvage
value, over remaining useful asset lives and requires the periodic review and
revision of depreciation rates.

When depreciable plant of the Company is retired in the normal course of
business, the amount of such plant is deducted from the respective plant and
accumulated depreciation accounts. Gains or losses on disposition are amortized
with the remaining net investment in telephone plant. When depreciable telephone
plant is retired outside the normal course of business, for example if a local
exchange is sold, any resulting gain or loss is included in operating income.

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. Curtailment gains and losses associated
with employee separations are recognized when they occur. Settlement gains and
losses are recognized when significant pension obligations are settled and the
gain or loss is determinable.

VALUATION OF ASSETS

The impairment of tangible and intangible assets is assessed when changes in
circumstances indicate that their carrying value may not be recoverable. Under
the Financial Accounting Standards Board's (FASB) Statement of Financial
Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," a determination
of impairment, if any, is made based on estimated future cash flows, salvage
value or expected net sales proceeds depending on the circumstances. In
instances where goodwill has been recorded in connection with impaired assets,
the carrying amount of the goodwill is first eliminated before any reduction to
the carrying value of tangible or identifiable intangible assets. The Company's
policy is to record asset impairment losses, and any subsequent adjustments to
such losses as initially recorded, as well as net gains or losses on sales of
assets as a component of operating income.

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.

<PAGE> 23

Deferred income taxes are recorded to reflect the tax consequences in future
years of differences between the tax bases of assets and liabilities and their
financial reporting amounts at each reporting period. Deferred tax assets and
liabilities are subsequently adjusted, to the extent necessary, to reflect 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.

FINANCIAL INSTRUMENTS

The Company uses a variety of financial instruments to hedge its exposure to
fluctuations in interest rates. The Company does not use financial instruments
for speculative or trading purposes, nor is the Company a party to leveraged
derivatives. Amounts to be paid or received under interest rate swaps are
accrued as interest expense.

INVENTORIES AND SUPPLIES

Inventories and supplies are stated at the lower of cost, determined principally
by the average cost method, or net realizable value.

SOFTWARE

Software costs are recognized in accordance with the American Institute of
Certified Public Accountants (AICPA) Statement of Position (SOP) 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," which became effective in January 1999. The Company capitalizes
costs associated with externally acquired software (including right-to-use fees)
for internal use. Capitalized software is generally amortized on a straight-line
basis over its useful life, not to exceed five years for non-network software or
three years for network software. As a result of adopting SOP 98-1, the Company
capitalized software expenditures of $38.9 million, $33.2 million and $10.6
million, respectively, for 1999 - 1997, which would have previously been
expensed.

COMPREHENSIVE INCOME

The Company had no comprehensive income components for the years ended December
31, 1999 - 1997, therefore comprehensive income is the same as net income for
all three periods.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 1998, the FASB issued 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, as amended, which is effective January 1, 2001.

<PAGE> 24

2. PROPOSED MERGER WITH BELL ATLANTIC CORPORATION

3. NET ASSETS HELD FOR SALE

During October 1999, the Company entered into an agreement to sell approximately
120,000 switched access lines in Oklahoma to Valor Telecommunications (formerly
dba Communications, LLC). During September 1999, the Company entered into an
agreement to sell approximately 399,000 switched access lines located in New
Mexico and Texas to Valor Telecommunications. During June 1999, the Company
entered into an agreement to sell approximately 87,000 switched access lines
located in Arkansas to CenturyTel, Inc. These agreements consummate the
Company's previously announced 1998 plan to sell selected access lines located
in Arkansas, New Mexico, Oklahoma and Texas. All sales will be subject to
regulatory approval and are expected to close in 2000. The associated net
assets, which approximate $659.1 million, consist of property, plant and
equipment, and have been reclassified as "Net assets held for sale" in the
balance sheets at December 31, 1999. The net book value of these access lines is
reflected in "Property, plant and equipment, net" in the balance sheets at
December 31, 1998 (see Note 11). The Company intends to continue to operate all
of these assets until sold. Based on the decision to sell, however, the Company
stopped recording depreciation expense for these assets. Accordingly,
depreciation expense was lowered by $106.5 million and $26.5 million in 1999 and
1998, respectively. No charges were recorded for the access lines to be sold
because their estimated fair values were in excess of their carrying values. The
access line agreements represent approximately 26% of the switched access lines
that the Company had in service at the end of 1999, and contributed
approximately 24% to 1999 revenues.

4. EXTRAORDINARY CHARGE

During the first quarter of 1998, the Company recorded an after-tax
extraordinary charge of $0.5 million (net of tax benefits of $0.3), reflecting
premiums paid on the redemption of high-coupon debt prior to stated maturity.

5. PREFERRED STOCK

The authorized and outstanding shares of cumulative preferred stock, not subject
to mandatory redemption, at December 31, 1999 and 1998 were as follows:

<TABLE>
<CAPTION>
Shares Amount
------ ------
(Dollars in Millions)

<S> <C> <C>
$2.20 no par value 32,000 $ 1.6
5.10% $20 par value 300,000 6.0
------- -----
Total 332,000 $ 7.6
======= =====
</TABLE>

<PAGE> 25

The 4.60% Series sinking fund provisions required 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 with the purchase of 7,000 shares. In March 1998,
the Company redeemed all outstanding shares of 4.60% Series preferred stock with
cash from operations.

The preferred shareholders were entitled to voting rights (on an equal basis
with the common shareholder) in the event dividends in arrears equaled or
exceeded the annual dividends on all preferred stock. Otherwise, the preferred
shareholders had no voting rights. The Company was not in arrears in its
dividend payments at December 31, 1999.

At December 31, 1999, 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.

In March 2000, the Company redeemed all 332,000 outstanding shares of preferred
stock and paid call premiums of $0.6 million pretax on the early redemption.

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 6,500,000 outstanding shares of common stock
are held by GTE. There were no shares of common stock held by or for the account
of the Company and no shares were reserved for officers and employees, or for
options, warrants, conversions or other rights. At December 31, 1999, $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.

7. DEBT

Long-term debt as of December 31, was as follows:

<TABLE>
<CAPTION>
1999 1998
------ ------
(Dollars in Millions)

<S> <C> <C>
First mortgage bonds:
8.50% Series, due 2031 $100.0 $100.0
9.74% Series T, due 2013 11.7 12.0
9.36% Series U, due 2014 35.0 35.0
Debentures:
5.82% Series A, due 1999 -- 250.0
6.54% Series B, due 2005 250.0 250.0
6.00% Series C, due 2006 150.0 150.0
6.23% Series D, due 2007 150.0 150.0
Capitalized leases 3.4 --
------ ------
Total principal amount 700.1 947.0
Unamortized discount (3.8) (4.1)
------ ------
Total 696.3 942.9
Less: current maturities (48.3) (250.3)
------ ------
Total long-term debt $648.0 $692.6
====== ======
</TABLE>

In January 2000, the Company retired $46.7 million of long-term debt (first
mortgage bonds, Series T and U) prior to stated maturity and incurred $7.2
million in premiums associated with this retirement.

In January 1998, the Company issued $150.0 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. The Company recognized an interest
rate hedge loss of

<PAGE> 26

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.

In March 1998, the Company retired $40.0 million of long-term debt prior to
stated maturity. The Company incurred $0.5 million in premiums associated with
this retirement.

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 $48.3
million in 2000 and $1.7 million in 2001.

Total short-term obligations as of December 31, were as follows:

<TABLE>
<CAPTION>
1999 1998
------ ------
(Dollars in Millions)

<S> <C> <C>
Notes payable to affiliates - average rates 6.2% and 5.4% $462.9 $163.0
Current maturities of long-term debt 48.3 250.3
------ ------
Total $511.2 $413.3
====== ======
</TABLE>

The Company participates with other affiliates in a $1.5 billion, 364-day
syndicated revolving line of credit and has access to an additional $2.0 billion
in short-term liquidity through GTE and GTE Funding Incorporated's committed
bi-lateral revolving lines of credit. The Company also has an existing shelf
registration statement for an additional $600.0 million of debentures.

At December 31, 1999, the Company had a note payable with GTE Funding in the
amount of $453.2 million, which the Company is contractually obligated to repay.

8. FINANCIAL INSTRUMENTS

The Company entered into forward contracts to sell U.S. Treasury Bonds during
1997, to hedge against changes in market interest rates of planned long-term
debt issuances, which were completed in January 1998. A loss of approximately
$2.7 million occurred upon settlement of these agreements and is being amortized
over the life of the associated long-term debt issuance as an addition to
interest expense.

The fair values of financial instruments, other than long-term debt, closely
approximate their carrying value. As of December 31, 1999, the estimated fair
value of long-term debt based on either reference to quoted market prices or an
option pricing model, was lower than the carrying value by approximately $15.8
million. As of December 31, 1998, the estimated fair value of long-term debt
exceeded the carrying value by approximately $76.9 million.

<PAGE> 27

9. INCOME TAXES

The provision (benefit) for income taxes is as follows:

<TABLE>
<CAPTION>
1999 1998 1997
------ ------ ------
(Dollars in Millions)

<S> <C> <C> <C>
Current:
Federal $ 94.5 $132.3 $106.8
State 2.0 (0.6) 6.0
------ ------ ------
96.5 131.7 112.8
------ ------ ------
Deferred:
Federal 86.2 6.7 38.0
State 1.7 2.6 (2.9)
------ ------ ------
87.9 9.3 35.1
------ ------ ------

Amortization of deferred investment tax credits (3.3) (4.5) (5.7)
------ ------ ------
Total provision $181.1 $136.5 $142.2
====== ====== ======
</TABLE>

A reconciliation between taxes computed by applying the statutory federal income
tax rate to pretax income and income taxes provided in the statements of income
is as follows:

<TABLE>
<CAPTION>
1999 1998 1997
------ ------ ------
(Dollars in Millions)

<S> <C> <C> <C>
Amounts computed at statutory rates $179.5 $139.0 $150.4
State and local income taxes, net of federal income tax effect 2.4 1.3 2.0
Amortization of deferred investment tax credits (3.3) (4.5) (5.7)
Other differences - net 2.5 0.7 (4.5)
------ ------ ------
Total provision $181.1 $136.5 $142.2
====== ====== ======
</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>
1999 1998
------ ------
(Dollars in Millions)

<S> <C> <C>
Depreciation and amortization $244.5 $190.4
Employee benefit obligations (85.2) (83.7)
Prepaid pension costs 84.3 52.4
Investment tax credits 1.9 5.2
Other - net 30.0 26.6
------ ------
Net deferred tax liability $275.5 $190.9
====== ======
</TABLE>

10. EMPLOYEE BENEFIT PLANS

The FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits," in February 1998. Certain disclosures are required to
be made of the components of pension credits, postretirement benefit costs and
the funded status of the plans, including the actuarial present value of
accumulated plan benefits, accumulated or projected benefit obligation and the
fair value of plan assets. We do not present such disclosures because the
structure of the GTE plans does not permit the plans' data to be readily
disaggregated.

<PAGE> 28

PENSION PLANS

The Company participates in noncontributory defined benefit pension plans
sponsored by GTE covering substantially all employees. The benefits to be paid
under these plans are generally based on years of credited service and average
final earnings. GTE's funding policy, subject to the minimum funding
requirements of employee benefit and tax laws, is to contribute such amounts as
are determined on an actuarial basis to accumulate funds sufficient to meet the
plans' benefit obligation to employees upon their retirement. The assets of the
plans consist primarily of corporate equities, government securities, and
corporate debt securities.

The significant weighted-average assumptions used by GTE for the pension
measurements were as follows at December 31:

<TABLE>
<CAPTION>
1999 1998
---- ----

<S> <C> <C>
Discount rate 8.00% 7.00%
Rate of compensation increase 5.50% 4.75%
Expected return on plan assets 9.00% 9.00%
</TABLE>

Net periodic benefit credit was $86.2 million, $30.6 million, and $39.9 million
for the years 1999-1997, respectively. Included in the net periodic benefit
credit for 1999 and 1997 were net pension gains of $48.4 million and $11.2
million, respectively, comprised of one-time costs for special termination
benefits provided under voluntary and involuntary separation programs,
curtailment losses and settlement gains. These curtailment losses and settlement
gains are a result of the separation programs, as well as the required
settlement gain or loss recognition, due to the fact that in 1999, the Company's
lump-sum pension distributions surpassed the settlement threshold equal to the
sum of the service cost and interest cost components of net periodic pension
cost.

POSTRETIREMENT BENEFITS OTHER THAN PENSIONS

Substantially all of the Company's employees are covered under postretirement
healthcare and life insurance benefit plans sponsored by GTE. The determination
of benefit cost for postretirement health plans is generally based on
comprehensive hospital, medical and surgical benefit plan provisions. The
Company intends to fund amounts for postretirement benefits as deemed
appropriate.

Postretirement benefit cost was $34.7 million, $20.8 million, and $36.1 million
for the years 1999-1997, respectively. The weighted-average assumptions used by
GTE in the actuarial computations for postretirement benefits were as follows at
December 31:

<TABLE>
<CAPTION>
1999 1998
---- ----

<S> <C> <C>
Discount rate 8.00% 7.00%
Expected return on plan assets 8.00% 8.00%
</TABLE>

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
$4.9 million, $4.2 million and $5.1 million in 1999-1997, respectively.

<PAGE> 29

11. PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment is summarized as follows at December 31:

<TABLE>
<CAPTION>
1999 1998
-------- --------
(Dollars in Millions)

<S> <C> <C>
Land $ 12.5 $ 16.2
Buildings 309.3 394.0
Plant and equipment 3,864.0 5,264.0
Construction in progress and other 112.3 119.6
-------- --------

Total 4,298.1 5,793.8
Accumulated depreciation (2,601.6) (3,555.7)
-------- --------

Total property, plant and equipment - net $1,696.5 $2,238.1
======== ========
</TABLE>

At December 31, 1998, total property, plant and equipment - net included $568.9
million of access lines and related equipment held for sale. This represents
gross assets of $1.64 billion less accumulated depreciation of $1.07 billion.
Based on the signing of definitive agreements in 1999, the net book value of the
access lines and related equipment has been reclassified to "Net assets held for
sale" in the balance sheets at December 31, 1999 (See Note 3).

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.

SIGNIFICANT CUSTOMER

Revenues received from AT&T Corp. include amounts for access and billing and
collection during the years 1999-1997 under various arrangements and amounted to
$146.2 million, $208.5 million and $218.8 million, respectively.

13. COMMITMENTS AND CONTINGENCIES

The Company has noncancelable operating leases covering certain buildings,
office space and equipment. Rental expense was $17.8 million, $23.3 million and
$14.8 million in 1999-1997, respectively. Minimum rental commitments under
noncancelable leases are $6.0 million, $5.6 million, $4.5 million, $3.3 million
and $3.2 million for the years 2000-2004, respectively, and aggregate $5.9
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.

<PAGE> 30

14. SEGMENT REPORTING

The Company does not have separate reportable segments of its own. The Company
is part of the Network Services product segment of GTE's National Operations.
Network Services provides wireline communication services within franchised
areas. These services include local telephone service and toll calls as well as
access services that enable long-distance carriers to complete calls to or from
locations outside of the Company's operating areas. Network Services also
provides complex voice and data services to businesses, billing and collection,
and operator assistance services to other telecommunications companies and
receives revenues in the form of a publication right from an affiliate that
publishes telephone directories in its operating areas.

15. QUARTERLY FINANCIAL DATA (UNAUDITED)

Summarized 1999 and 1998 quarterly financial data is as follows:

<TABLE>
<CAPTION>
Revenues Operating Net
and Sales Income Income
-------- -------- --------
(Dollars in Millions)

<S> <C> <C> <C>
1999
First Quarter $ 425.4 $ 101.8 $ 53.8
Second Quarter 443.8 141.3 79.7
Third Quarter 464.3 163.4 93.6
Fourth Quarter 454.6 179.8 105.1
-------- -------- --------
Total $1,788.1 $ 586.3 $ 332.2
======== ======== ========

1998
First Quarter $ 424.0 $ 102.3 $ 55.6
Second Quarter 454.2 118.0 66.2
Third Quarter 467.2 112.3 58.7
Fourth Quarter 441.8 133.9 80.0
-------- -------- --------
Total $1,787.2 $ 466.5 $ 260.5
======== ======== ========
</TABLE>

<PAGE> 31

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Shareholder 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, 1999 and 1998, and the related statements of income, shareholders'
equity and cash flows for each of the three years in the period ended December
31, 1999, as set forth under Item 8 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, 1999 and 1998, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1999, in
conformity with generally accepted accounting principles.

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 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 27, 2000

<PAGE> 32

MANAGEMENT REPORT

To Our Shareholder:

The management of GTE Southwest Incorporated (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

LAWRENCE R. WHITMAN
Vice President - Finance and Planning

<PAGE> 33

Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure

None.

PART III

The following items have been omitted in accordance with the relief provisions
under General Instruction I(2) of Form 10-K:

Item 10. Directors and Executive Officers of the Registrant

Item 11. Executive Compensation

Item 12. Security Ownership of Certain Beneficial Owners and Management

Item 13. Certain Relationships and Related Transactions

<PAGE> 34

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 public 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, 1999-1997 (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)

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 - Severance Agreement between GTE Service
Corporation and John C. Appel (Exhibit 10.1 of the 1998 Form
10-K)

10.2* Material Contracts - Severance Agreements between GTE Service
Corporation and Richard L. Schaulin, Larry J. Sparrow and
Lawrence R. Whitman (Exhibit 10.2 of the 1998 Form 10-K)

10.3* Material Contracts -- Retention Agreement between GTE Service
Corporation and John C. Appel (Exhibit 10.3 of the 1998 Form
10-K)

10.4* Material Contracts -- Retention Agreements between GTE Service
Corporation and Richard L. Schaulin, Larry J. Sparrow and
Lawrence R. Whitman (Exhibit 10.4 of the 1998 Form 10-K)

10.5 Material Contracts -- Retention Agreement between GTE Service
Corporation and William M. Edwards, III.

12 Statements re: Calculation of the Ratio of Earnings to Fixed
Charges

23 Consent of Independent Public Accountants

27 Financial Data Schedule

<PAGE> 35

(b) Reports on Form 8-K

No reports on Form 8-K were filed during the fourth quarter of 1999.

* Denotes exhibits incorporated herein by reference to previous filings with
the Securities and Exchange Commission as designated.

<PAGE> 36

GTE SOUTHWEST INCORPORATED

Schedule II - Valuation and Qualifying Accounts
For the Years Ended December 31, 1999, 1998 and 1997

(Dollars in Millions)

<TABLE>
<CAPTION>
Column A Column B Column C Column D Column E
----------- -------- -------------------------- -------- -------------
Additions
--------------------------
Charged
Balance at (Credited) to Deductions
Beginning Charged to Other Accounts from Reserves Balance at
Description of Year Income (Note a) (Note b) Close of Year
----------- ------- ---------- -------------- -------- -------------

Allowance for uncollectible accounts
for the years ended:

<S> <C> <C> <C> <C> <C>
December 31, 1999 $ 28.6 $ 32.3 $ 5.2 $ 40.0 $ 26.1
====== ====== ====== ====== ======

December 31, 1998 $ 21.2 $ 38.3 $ 6.4 $ 37.3 $ 28.6
====== ====== ====== ====== ======

December 31, 1997 $ 23.6 $ 31.2 $ 30.4 $ 64.0 $ 21.2
====== ====== ====== ====== ======
</TABLE>

NOTES:

(a) Recoveries of previously written-off amounts.

(b) Charges for which reserve was created.

<PAGE> 37

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 29, 2000 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 29, 2000
- ---------------------------- (Principal Executive Officer)
Larry E. Atwell

/s/ Lawrence R. Whitman Vice President - Finance and Planning March 29, 2000
- ---------------------------- and Director
Lawrence R. Whitman (Principal Financial Officer)

/s/ Stephen L. Shore Controller March 29, 2000
- ---------------------------- (Principal Accounting Officer)
Stephen L. Shore

/s/ John C. Appel Director March 29, 2000
- ----------------------------
John C. Appel

/s/ Mateland L. Keith, Jr. Director March 29, 2000
- ----------------------------
Mateland L. Keith, Jr.
</TABLE>

<PAGE> 38

EXHIBIT INDEX

<TABLE>
<CAPTION>
Exhibit
Number Description
------ -----------

<S> <C>
10.5 Material Contracts -- Retention Agreement between GTE Service Corporation and William
M. Edwards, III.

12 Statements re: Calculation of the Ratio of Earnings to Fixed Charges

23 Consent of Independent Public Accountants

27 Financial Data Schedule
</TABLE>

<PAGE> 1

EXHIBIT 10.5

PERSONAL & CONFIDENTIAL

November 19, 1999

Mr. William Edwards
(Address)
(Address)

Dear Bill:

I want to take this opportunity to thank you for your many contributions to the
company, including your role in the repositioning efforts that have been so
critical to our success. Your leadership is greatly appreciated by the entire
GTE management team.

We recognize that your original plan, as set forth in our April 27, 1998 letter
agreement, was to retire on April 30, 2000. However, in light of the upcoming
divestitures of wireless properties as a result of GTE's planned merger with
Bell Atlantic, we would like to provide you with an incentive to continue your
employment through an appropriate point in the completion of this process (the
"Retention Period") and to establish a transition arrangement for your
separation from employment. For purposes of this Letter Agreement, the Retention
Period shall be from the date of this agreement through January 2, 2001 or, if
earlier, the date that repositioning efforts have been satisfactorily completed,
as determined by GTE.

A. RETENTION BONUS

1. RETENTION BONUS. Subject to the terms and conditions set forth
herein, on or about 45 days after the conclusion of the Retention Period, you
will receive a Retention Bonus equal (before withholding of applicable taxes) to
one times the sum of (i) your base annual salary as of the conclusion of the
Retention Period and (ii) the prior three-year average corporate rating (as of
the conclusion the Retention Period) under GTE's Executive Incentive Plan or any
successor plan ("EIP") for your grade level as of the conclusion of the
Retention Period multiplied by an amount equal to 100% of norm for that grade
level under EIP.

2. INVOLUNTARY TERMINATION WITHOUT CAUSE. If prior to the end of the
Retention Period your employment is terminated involuntarily without cause, as

<PAGE> 2

William Edwards
November 19, 1999
Page 2

determined by GTE, and for reasons other than your death or disability, you will
receive a payment equal to the Retention Bonus to which you would have been
entitled had your employment continued through the full Retention Period.
Payment will be made at the same time the Retention Bonus would have been paid
had you remained employed through the full Retention Period. Under no
circumstances will your resignation or retirement for any reason constitute an
involuntary termination without cause for purposes of this Letter Agreement.

3. DEATH OR DISABILITY. Should you die or become disabled (within the
meaning of GTE's Long Term Disability Plan) prior to the end of the Retention
Period, you, or, in the event of your death, your estate, will receive a
prorated Retention Bonus based on the ratio of (i) the number of days you
remained actively employed during the Retention Period to (ii) the total number
of days in the Retention Period. For purposes of this paragraph, the Retention
Period will be presumed to run through January 2, 2001, unless an earlier
conclusion date had already been communicated to you prior to your death or
disability. The prorated Retention Bonus payable under this paragraph shall be
paid at the same time the Retention Bonus would have been paid had you remained
employed through the Retention Period.

4. CIRCUMSTANCES WHEN NO BONUS WILL BE PAID. Should you resign or
retire for any reason prior to the end of the Retention Period, or should you at
any time engage in conduct that would constitute cause (as determined by GTE),
you will not be eligible to receive any portion of the Retention Bonus.

5. DEFERRAL. You will not be eligible to defer any Retention Bonus
payable to you under this Letter Agreement.

6. PAYMENT TAXABLE/NOT BENEFIT BEARING. Applicable taxes will be
withheld from any payment made pursuant to this Letter Agreement. Any Retention
Bonus payable under this Letter Agreement shall not be considered compensation
for purposes of computing or determining any benefit under any pension, savings,
insurance, or other employee compensation or benefit plan maintained by GTE.

B. SEPARATION

1. SEPARATION BENEFITS. You will retire from employment with GTE upon
conclusion of the Retention Period. Since your position is being eliminated, you
will be eligible to receive separation benefits in accordance with the terms of
GTE's Involuntary Separation Program or any successor plan which may exist
("ISEP") at that time, subject to signing a release of all claims against GTE.
You will also receive a lump sum payment for all accrued, unused (but unpaid)
vacation upon the

<PAGE> 3

William Edwards
November 19, 1999
Page 3

termination of your employment with GTE, but you will not receive service credit
for same. If your employment continues through January 2, 2001, you will earn
vacation for the 2001 calendar year.

2. EIP. You will continue to participate in EIP during the Retention
Period on the same basis as other executives at your level, subject to the terms
of that plan. Any payments under EIP will be made at the same time such payments
are made to other EIP participants. The Executive Compensation and
Organizational Structure Committee of the Board of Directors of GTE, its
designee, its successor or its successor's designee (the "ECC") will determine
the amount of your actual awards.

3. LTIP. You will continue to participate in GTE's Long Term Incentive
Plan or any successor plan that may exist ("LTIP") on the same terms as other
executives at your level during the Retention Period, subject to the terms of
the plan. All payments under LTIP will be paid at the same time payments are
made to other participants. The ECC will determine the amount of your actual
awards.

4. INTEREST RATE FOR PENSION PURPOSES. Consistent with the terms of
your April 27, 1988 letter and subsequent amendments to the GTE Service
Corporation Plan for Employees' Pensions ("the Plan"), upon retirement under the
terms of the Plan, your lump sum pension distribution amount will be based on
whichever of the following rates produces the largest lump sum distribution: the
GATT rate (based on 30 year Treasury bonds), 120% of the PBGC rate, or the Plan
rate (based on a six-month average of 10-year Treasury bonds). The lump sum
distribution will be payable from the Plan to the extent allowable by Plan
provisions and governmental regulations. The difference, if any, between the
total lump sum amount and the amount eligible to be paid from the Plan may be
paid from GTE's general assets, at GTE's discretion.

5. TERMINATION OF EMPLOYMENT. In accordance with company policy, GTE
reserves the right to terminate your employment prior to the end of the
Retention Period for cause, as determined by GTE. If you are discharged for
cause, elect to resign or retire, or die or become disabled (within the meaning
of GTE's Long Term Disability Plan) prior to the expiration of the Retention
Period, all further obligations under this Letter Agreement shall cease (except
for, in the case of termination due to death or disability, your right to any
prorated Retention Bonus as provided for above), and you will not be entitled to
separation benefits under this Letter Agreement or under any GTE policy or
practice.

<PAGE> 4

William Edwards
November 19, 1999
Page 4

C. GENERAL PROVISIONS

1. PROHIBITION AGAINST RECRUITING OR HIRING. Commencing on the date of
this Retention Agreement, and for one year following your separation from
employment with GTE, you agree that you will not, without the prior written
consent of the ECC:

(i) Recruit or solicit any employee of GTE (which, for purposes of
this Agreement, includes GTE Corporation, any corporate
subsidiary or other company affiliated with GTE Corporation,
any company in which GTE Corporation owns directly or
indirectly an equity interest of at least ten percent, and the
successors and assigns of any such company, including,
following the merger, Bell Atlantic Corporation, its
subsidiaries, affiliates, and other related entities and their
successors and assigns) for employment or retention as a
consultant or provider of services;
(ii) Hire, or participate with another entity or third party in the
process of hiring, any employee of GTE;
(iii) Provide names or other information about GTE employees to any
person or business under circumstances that you know or should
know could lead to the use of that information for purposes of
recruiting or hiring; or
(iv) Interfere with the relationship between GTE and any of its
employees, agents, or representatives.

2. PROHIBITION AGAINST SOLICITING GTE CUSTOMERS. Commencing on the date
of this Agreement, and, in the event you separate from employment with GTE for
any reason, for one year following such separation, you agree that you will not
solicit or contact, directly or indirectly, any customer, client, or prospect of
GTE with whom you or any of the GTE employees reporting to you had any contact
at any time during the year preceding your termination for the purpose of
inducing such customer, client, or prospect to cease being, or to not become, a
customer or client of GTE or to divert business from GTE.

3. CONFIDENTIALITY. You agree that you will not disclose or discuss
either the existence or the terms of this Agreement under any circumstances
where such information could reasonably be expected to, directly or indirectly,
come to the attention of any present or former employee, contractor, or
consultant of GTE. You further agree that you will require anyone with whom you
share information regarding this Retention Agreement to adhere to the same
standard of confidentiality.

<PAGE> 5

William Edwards
November 19, 1999
Page 5

4. PROPRIETARY INFORMATION. You agree that you will at all times comply
with your obligations under the Employee Agreement Relating to Intellectual
Property and preserve the confidentiality of all Proprietary Information and
trade secrets of GTE and the Proprietary Information and trade secrets of third
parties, including customers, that are in the possession of GTE by not
disclosing the same to any other party or using the same, or any portion
thereof, for the benefit of anyone other than GTE. "Proprietary Information"
means information obtained or developed by you or to which you had access during
your employment with GTE, including, but not limited to, customer information
and other trade secrets and Proprietary Information of GTE and third parties
that has not been fully disclosed in a writing generally circulated by GTE to
the public at large without any restrictions on use or disclosure. You agree
that you will return all copies, in whole or in part, in any form, of trade
secrets and Proprietary Information in your possession or control in the event
of your termination of employment or upon request by GTE, whichever occurs
earlier, without making or retaining a copy.

5. SURVIVAL OF AND CONSIDERATION FOR COVENANTS. You acknowledge and
agree that any payment made pursuant to this Letter Agreement includes
consideration for the covenants contained in paragraphs 1 through 4 of Section C
of this Letter Agreement and that the obligations set out in those paragraphs
shall survive any cancellation, termination, or expiration of this Letter
Agreement or the termination of your employment with GTE.

6. NO DUPLICATION OF BENEFITS. Except for grants and agreements
specifically approved by the ECC, there shall be no duplication between any
payment provided for by this Letter Agreement and any other payment or benefit
for which you are eligible, including any retention incentive program that
provides for payment of a retention bonus for continued employment during any
part of the same time period covered by this Letter Agreement. As a result, any
payment otherwise due under this Letter Agreement shall be reduced by any
amounts due under any such other duplicative plan, arrangement, agreement, or
program.

7. BUSINESS DISCRETION OF GTE. Nothing in this Letter Agreement is
intended to limit the business discretion of GTE. This Letter Agreement does not
entitle you to remain in the employ of GTE for any minimum or prescribed period
of term and does not modify the at-will status of your employment.

8. ASSIGNMENT BY GTE. GTE may assign this Letter Agreement without your
consent. This Letter Agreement may not be assigned by you, and no person other
than you (or your estate) may assert your rights under this Letter Agreement.

<PAGE> 6

William Edwards
November 19, 1999
Page 6

9. DISPUTE RESOLUTION. You agree that the ECC shall have sole
discretion to interpret this Letter Agreement and to resolve any and all
disputes under this Letter Agreement. You further agree that such determination
shall be final and binding.

10. WAIVER. The waiver by GTE of any breach of this Letter Agreement
shall not be construed as a waiver of any subsequent breach.

11. GOVERNING LAW. This Letter Agreement shall be interpreted and
enforced in accordance with the laws of the State of New York, disregarding its
choice of law rules, and any dispute shall be brought in a court sitting in New
York City, New York.

12. REMEDIES. You acknowledge that irreparable injury to GTE will
result in the event of any breach by you of any of the covenants or obligations
under this Letter Agreement, including other obligations referenced herein. In
the event of a breach of any of your covenants and commitments under this Letter
Agreement, including any other obligations referenced herein, GTE shall not be
obligated to make any payment otherwise required under this Letter Agreement and
may, at GTE's discretion, require you to repay any amounts already paid to you,
including amounts that may have been deferred. In addition, GTE reserves all
rights to seek any and all remedies and damages permitted under law, including,
but not limited to, injunctive relief, equitable relief, and compensatory and
punitive damages.

13. DEFINITIONS/RELATIONSHIP TO OTHER AGREEMENTS. The definitions
contained in this Letter Agreement shall be controlling for purposes of this
Letter Agreement and shall not be modified by, nor shall they modify,
definitions for terms in any plan, policy, program, or other agreement to which
you may be a party. This supersedes and replaces the terms of my prior letter to
you dated April 27, 1998.

14. ENTIRE AGREEMENT. You acknowledge and agree that this Retention
Agreement sets forth the entire understanding of the parties with regard to the
subject matter addressed herein and that this Retention Agreement supersedes all
prior agreements and communications, whether written or oral, pertaining to the
incentive described herein. This Retention Agreement shall not be modified
except by written agreement duly executed by you and GTE.

Bill, on behalf on the management team, I want to thank you for agreeing to
remain with GTE beyond your original planned retirement date. Your assistance in
the upcoming Wireless divestitures will be critical to the success of our
upcoming merger with Bell Atlantic. If this Agreement meets with your
satisfaction, please

<PAGE> 7

William Edwards
November 19, 1999
Page 7

sign below and return an original in the enclosed addressed envelope within
fifteen (15) business days.

Sincerely,

J. Randall MacDonald
Executive Vice President-
Human Resources & Administration

JRM:jls

I have read, understand and agree to the foregoing.

- ---------------------------------------
William Edwards

- ---------------------------------------
Date

<PAGE> 1

Exhibit 12

GTE SOUTHWEST INCORPORATED

Statements of the Ratio of Earnings to Fixed Charges

<TABLE>
<CAPTION>
Years Ended December 31,
1999 1998 1997 1996 1995 1995(a)
-------- -------- -------- -------- -------- --------
(Dollars in Millions)

<S> <C> <C> <C> <C> <C> <C>
Net earnings available for fixed charges:
Income before extraordinary
charges $ 332.2 $ 261.0 $ 288.2 $ 255.8 $ 195.3 $ 181.0
Add - Income taxes 181.1 136.5 142.2 130.2 99.4 92.1
- Fixed charges 81.5 80.7 68.9 66.8 68.9 68.9
-------- -------- -------- -------- -------- --------

Adjusted earnings $ 594.8 $ 478.2 $ 499.3 $ 452.8 $ 363.6 $ 342.0
======== ======== ======== ======== ======== ========

Fixed charges:
Interest expense $ 75.6 $ 72.9 $ 64.0 $ 60.7 $ 63.8 $ 63.8
Portion of rent expense
representing interest 5.9 7.8 4.9 6.1 5.1 5.1
-------- -------- -------- -------- -------- --------

Adjusted fixed charges $ 81.5 $ 80.7 $ 68.9 $ 66.8 $ 68.9 $ 68.9
======== ======== ======== ======== ======== ========

RATIO OF EARNINGS TO FIXED
CHARGES 7.30 5.93 7.25 6.78 5.28 4.96
</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.

<PAGE> 1

Exhibit 23

CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

As independent public accountants, we hereby consent to the incorporation
of our report, dated January 27, 2000, on the financial statements and
supporting schedule and exhibit of GTE Southwest Incorporated included in this
Form 10-K, into the Registration Statement previously filed on Form S-3 (File
No. 333-63657).

Dallas, Texas ARTHUR ANDERSEN LLP
March 29, 2000

<ARTICLE> 5
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 10,500
<SECURITIES> 0
<RECEIVABLES> 419,600
<ALLOWANCES> 26,100
<INVENTORY> 20,000
<CURRENT-ASSETS> 1,109,000
<PP&E> 4,298,100
<DEPRECIATION> 2,601,600
<TOTAL-ASSETS> 3,069,000
<CURRENT-LIABILITIES> 902,800
<BONDS> 648,000
0
7,600
<COMMON> 650,000
<OTHER-SE> 356,700
<TOTAL-LIABILITY-AND-EQUITY> 3,069,000
<SALES> 1,788,100
<TOTAL-REVENUES> 1,788,100
<CGS> 614,400
<TOTAL-COSTS> 1,201,800
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 75,600
<INCOME-PRETAX> 513,300
<INCOME-TAX> 181,100
<INCOME-CONTINUING> 332,200
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 332,200
<EPS-BASIC> 0
<EPS-DILUTED> 0

</TABLE>