<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the fiscal year ended December 31, 1997
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission File Number 0-2908
GTE NORTHWEST INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
WASHINGTON 91-0466810
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
600 Hidden Ridge, HQE04B12 - Irving, Texas 75038
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
</TABLE>
Registrant's telephone number, including area code 972-718-5600
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 17,920,000 SHARES OF NO PAR VALUE COMMON STOCK OUTSTANDING AT
FEBRUARY 28, 1998. THE COMPANY'S COMMON STOCK IS 100% OWNED BY GTE CORPORATION.
THE COMPANY MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION J (1) (a) AND
(b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE
FORMAT.
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Item Page
<S> <C>
Part I
1. Business 1
2. Properties 4
3. Legal Proceedings 4
4. Submission of Matters to a Vote of Security Holders - This item
has been omitted in accordance with the relief provisions under
General Instruction J of Form 10-K
Part II
5. Market for the Registrant's Common Equity and Related
Shareholder Matters 5
6. Selected Financial Data - This item has been omitted in accordance
with the relief provisions under General Instruction J of Form
10-K
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 6
8. Financial Statements and Supplementary Data 12
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 31
Part III
The following items have been omitted in accordance with the relief provisions
under General Instruction J of Form 10-K:
10. Directors and Executive Officers of the Registrant
11. Executive Compensation
12. Security Ownership of Certain Beneficial Owners and Management
13. Certain Relationships and Related Transactions
Part IV
14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 32
</TABLE>
<PAGE> 3
PART I
Item 1. Business
GTE Northwest Incorporated (the Company) (formerly General Telephone Company of
the Northwest, Inc., formerly West Coast Telephone Company) was incorporated in
Washington on March 31, 1964. The Company is a wholly-owned subsidiary of GTE
Corporation (GTE). Together with its wholly-owned subsidiary, GTE West Coast
Incorporated, the Company provides communications services in the states of
California, Idaho, Oregon and Washington.
On February 28, 1997, the Company sold three local exchanges (representing 1,800
access lines) in the state of Washington to Pend Oreille Telephone Company.
Additional information related to this transaction can be found in Note 3 of the
Company's consolidated financial statements included in Item 8.
The Company's principal line of business is providing communications services
ranging from local telephone service for the home and office to highly complex
voice and data services for industry. The Company provides local telephone
service within its franchise area and intraLATA (Local Access Transport Area)
toll service between the Company's facilities and the facilities of other
telephone companies within the Company's LATAs. InterLATA service to other
points in and out of the states in which the Company operates is provided
through connection with interexchange (long distance) common carriers. These
common carriers are charged fees (access charges) for interconnection to the
Company's local facilities. Business and residential customers also pay access
charges to connect to the local network to obtain long distance service. The
Company earns other revenues by providing such services as billing and
collection and operator services to interexchange carriers.
The number of access lines in the states in which the Company operates as of
December 31, 1997, was as follows:
<TABLE>
<CAPTION>
Access
State Lines Served
------------------ ----------------
<S> <C>
California 15,179
Idaho 140,170
Oregon 573,300
Washington 1,045,292
----------------
Total 1,773,941
================
</TABLE>
At December 31, 1997, the Company had 3,603 employees.
The Company has written agreements with the Communications Workers of America
(CWA) and the International Brotherhood of Electrical Workers (IBEW) covering
substantially all non-management employees. In 1996, a new contract was reached
with the IBEW. The contract with the CWA will expire in 1998.
REGULATORY AND COMPETITIVE TRENDS
The Company is subject to regulation by the regulatory bodies of the states of
California, Idaho, Oregon and Washington for its intrastate business operations
and by the Federal Communications Commission (FCC) for its interstate
operations.
Advances in technology, together with a number of regulatory, legislative and
judicial actions, continue to accelerate and expand the level of competition and
opportunities available to the Company. The Company continues to face additional
competition from numerous sources, such as competitive local-exchange carriers,
wireless carriers, cable television service providers and long distance
companies.
1
<PAGE> 4
Much of the regulatory and legislative activity that occurred in the United
States in 1997 was a direct result of the Telecommunications Act of 1996 (the
Telecommunications Act) adopted by Congress. The Telecommunications Act is
intended to promote competition in all sectors of the telecommunications
marketplace while preserving and advancing universal telephone service.
The Company supports greater competition in telecommunications, provided that
consumers benefit from an opportunity for all service providers to participate
in a competitive marketplace under comparable conditions. The Company believes
that a number of recent FCC and state regulatory agency decisions did not
establish comparable conditions; consequently, the Company and its parent, GTE,
have exercised their right to challenge actions they believe act to increase
competition at the expense of the shareholders of incumbent firms.
In July 1997, the U.S. Court of Appeals for the Eighth Circuit (Eighth Circuit)
released its decision on the challenge filed in 1996 by GTE and numerous other
parties to rules developed by the FCC to implement the interconnection
provisions of the Telecommunications Act. The Telecommunications Act required
local-exchange carriers (LECs) to make their retail services and the underlying
network elements available to competitors. The FCC required that prices for both
resold services and network elements be set using a methodology created by the
FCC. The court challenge asserted that the FCC's rules were inconsistent with
the Telecommunications Act. The July 1997 court decision found that the FCC
overstepped its authority in many instances and upheld GTE's position that state
regulatory agencies bear the primary responsibility for determining the prices
which competing firms must pay when interconnecting their networks. In January
1998, the U.S. Supreme Court announced that it would review this decision. Oral
argument in the Supreme Court is expected to take place in October 1998, with a
final decision likely to be issued no later than June 1999.
The favorable ruling by the Eighth Circuit did not impede the progress of
competition. The Company has finalized interconnection agreements with various
competitive LECs in Oregon and Washington. A number of these interconnection
agreements, adopted as a result of the arbitration process established by the
Telecommunications Act, incorporate prices or terms and conditions based upon
the FCC's rules that were overturned by the Eighth Circuit. Thus, the Company
has exercised its right to challenge such agreements in Oregon and Washington.
In May 1997, the FCC released two new major decisions related to implementation
of the Telecommunications Act's provisions - the universal service and access
charge reform orders. The universal service order established the support
mechanisms to ensure continued availability of affordable local telephone
service and created new programs to provide discounted telecommunications
services to schools, libraries and rural health care providers. GTE and numerous
other parties have challenged the FCC's decision before the U.S. Court of
Appeals for the Fifth Circuit on the grounds that the FCC did not follow the
requirements of the Telecommunications Act to develop a sufficient, explicit and
competitively neutral universal service program. A decision is expected in 1998.
The access charge reform order, also released in May 1997, revamped the rate
structure for use of the local network by interexchange carriers to originate
and complete long distance calls. GTE and numerous other parties also challenged
this decision before the Eighth Circuit based on the belief that the FCC not
only failed to remove all of the universal service subsidies hidden within
interstate access charges, but in fact created additional subsidy charges paid
only by business and multi-line residential customers. Oral argument has been
held and a decision is expected in 1998.
Also in May 1997, the FCC released a decision completing a periodic review of
its price cap regulatory oversight of interstate access charges. GTE and
numerous other LECs have challenged this decision before the Eighth Circuit
based on the belief that the FCC established a fundamentally unfair annual price
reduction formula and required retroactive price reductions. Oral argument has
been held and a decision on this challenge is also expected in 1998.
2
<PAGE> 5
Federal regulatory activity continued to change the traditional cost-based,
rate-of-return regulatory framework for interstate telephone service. The
regulatory commissions in the states of California, Idaho, Oregon and Washington
continue to remain under the traditional cost-based, rate-of-return regulatory
framework for intrastate telephone service.
For the provision of interstate access services, the Company operates under the
terms of the FCC's price cap incentive plan. The price cap mechanism serves to
limit the rates a carrier may charge, rather than just regulating the rate-of-
return which may be achieved. Under this approach, the maximum prices that the
LEC may charge are increased or decreased each year by a price cap index based
upon inflation less a predetermined productivity target. LECs have limited
pricing flexibility provided they do not exceed the allowed price cap.
In the May 1997 order on its price cap triennial review, the FCC revised the
price cap plan for LECs by adopting a uniform productivity factor of 6.0% with
an additive consumer productivity dividend of 0.5%. The FCC also eliminated the
sharing requirements of the price cap rules.
The Company filed interstate access revisions during 1997 that became effective
June 3, 1997 and July 1, 1997. Overall, these filings resulted in a net annual
price reduction of $6 million. On December 1, 1997, the FCC issued an order to
file revised access rates effective January 1, 1998, which resulted in
additional interstate access charge reductions of approximately $2.1 million. In
1997, the FCC also ordered significant changes that altered the structure of
access charges collected by the Company, effective January 1, 1998. Generally,
the FCC reduced and restructured the per minute charges paid by long distance
carriers and implemented new per line charges. The FCC also created an access
charge structure that resulted in different access charges for residential
primary and secondary lines and for single line and multi-line business lines.
In aggregate, the reductions in usage sensitive access charges paid by long
distance carriers were offset by new per line charges and the charges paid by
end-users.
Further information regarding the Company's activities with the various
regulatory agencies and revenue arrangements with other telephone companies is
discussed in Note 11 of the Company's consolidated financial statements included
in Item 8.
The Company continues to support greater competition in telecommunications,
provided that, overall, the actions to eliminate existing legal and regulatory
barriers benefit consumers by allowing an opportunity for all service providers
to participate equally in a competitive marketplace under comparable conditions.
The Company intends to continue to respond aggressively to regulatory and legal
developments that allow for increased competition and opportunities in the
marketplace. The Company expects its financial results to benefit from reduced
costs and the introduction of new products and services that will result in
increased usage of its telephone networks. However, it is likely that such
improvements will be offset, in part, by continued strategic pricing reductions
and the effects of increased competition.
INITIATIVES
In 1997, the Company's parent, GTE, continued to position itself to respond
aggressively to competitive developments and benefit from new opportunities.
In May 1997, GTE announced plans to become a leading national provider of data
communications services that included the acquisition of BBN Corporation (BBN),
a leading supplier of end-to-end Internet solutions. BBN brings valuable skills,
a leading position in the Internet market and an impressive list of Fortune 500
clients. In addition, GTE announced a strategic alliance with Cisco Systems,
Inc. to jointly develop enhanced data and Internet services for customers; and
the purchase of a national, state-of-the-art fiber-optic network from Qwest
Communications. This expansion of data services continued in November 1997 with
the announcement of the acquisition of Genuity Inc. (Genuity), a subsidiary of
Bechtel Enterprises. Genuity is a premier value-added provider of distributed
application hosting solutions.
3
<PAGE> 6
ENVIRONMENTAL MATTERS
GTE maintains monitoring and compliance programs related to environmental
matters. Currently, the Company has been named as a potentially responsible
party at a number of "Superfund Sites." GTE has reviewed each site in which it
has an involvement to establish an expected remediation cost. Based on this
review, management believes the Company is not subject to administrative or
judicial proceedings which would result in a material adverse effect on the
Company's results of operations or financial position. The Company has
established adequate reserves for estimated remediation and cleanup costs.
The Company's annual expenditures for site cleanups and environmental compliance
have not been and are not expected to be material. Costs incurred include the
Company's share of cleanup expenses for Superfund Sites, outlays required to
keep existing operations in compliance with environmental regulations and an
underground storage tank replacement program.
Item 2. Properties
The Company's property consists principally of land, structures and equipment
required to provide various telecommunications services. All of these
properties, located in the states of California, Idaho, Oregon and Washington,
are generally in good operating condition and are adequate to satisfy the needs
of the business. Substantially all of the Company's property is subject to the
liens of its respective mortgages securing funded debt. From January 1, 1993 to
December 31, 1997, the Company made capital expenditures of $1.2 billion for new
plant and facilities required to meet telecommunication service needs and to
modernize plant and facilities. These additions were equal to 35% of gross plant
of $3.4 billion at December 31, 1997.
In the fourth quarter of 1995, the Company discontinued the use of Statement of
Financial Accounting Standards No. 71, "Accounting for the Effects of Certain
Types of Regulation" (FAS 71). In general, FAS 71 required the Company to
depreciate its telephone plant and equipment over lives approved by regulators
which, in many cases, extended beyond the assets' economic lives. FAS 71 also
required the deferral of certain costs based upon approvals received from
regulators to recover such costs in the future. As a result of these
requirements, the recorded net book value of certain assets and liabilities,
primarily telephone plant and equipment, were in many cases higher than that
which would otherwise have been recorded based on their economic lives. See Note
2 to the Company's consolidated financial statements included in Item 8.
Item 3. Legal Proceedings
There are no pending legal proceedings which would have a material impact on the
Company's consolidated financial statements.
4
<PAGE> 7
PART II
Item 5. Market for the Registrant's Common Equity and Related Shareholder
Matters
Market information is omitted since the Company's common stock is wholly-owned
by GTE Corporation (GTE).
SHAREHOLDER SERVICES
BankBoston, N.A., Transfer Agent and Registrar for GTE and the Company's common
stock, should be contacted with any questions relating to shareholder accounts.
This includes the following:
- Account information
- Dividends
- Market prices
- Transfer instructions
- Statements and reports
- Change of address
Shareholders may call toll-free at 1-800-225-5160 anytime, seven days a week.
Customer Service Representatives are available Monday through Friday between the
hours of 8 a.m. and 5 p.m. Eastern Time. Outside the United States call
1-718-575-2990.
Or write to:
BankBoston, N.A.
c/o Boston EquiServe, L.P.
P.O. Box 8031
Boston, MA 02206-8031
For overnight delivery services, use the following address:
BankBoston, N.A.
c/o Boston EquiServe, L.P.
Blue Hills Office Park
150 Royall Street
Mail Stop 4502-60
Canton, MA 02021
The BankBoston, N.A. address where shareholders, banks and brokers may deliver
certificates is Securities Transfers and Reporting Services, 55 Broadway in New
York City.
PARENT COMPANY ANNUAL REPORT
To obtain a copy of the 1997 annual report of our parent company or the annual
Form 10-K filed with the Securities and Exchange Commission, call
1-800-225-5160.
INFORMATION VIA THE INTERNET
Internet World Wide Web users can access information on GTE through the
following universal resource:
http://www.gte.com
PRODUCTS AND SERVICES HOTLINE
Shareholders may call 1-800-828-7280 to receive information concerning GTE
products and services.
DIVERSITY AT GTE
The Company and GTE strive to be a workplace of choice in which people of
diverse backgrounds are valued, challenged, acknowledged and rewarded, leading
to higher levels of fulfillment and productivity. A copy of our Diversity at GTE
brochure is available upon request from the GTE Corporate Secretary's Office.
5
<PAGE> 8
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Dollars in Millions)
BUSINESS OPERATIONS
GTE Northwest Incorporated (the Company), a wholly-owned subsidiary of GTE
Corporation (GTE), provides local-exchange, network access and toll services in
the states of California, Idaho, Oregon and Washington. At December 31, 1997,
the Company served 1,773,941 access lines in its service territories.
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------
1997 1996
--------------- ---------------
<S> <C> <C>
Net income $ 249.6 $ 187.4
</TABLE>
Net income for 1997 increased 33% or $62.2. The 1997 increase is primarily due
to continued customer growth reflected by a 7% increase in access lines and
network access minutes of use growth, offset by a reduction in toll revenues.
REVENUES AND SALES
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------
1997 1996
-------------- --------------
<S> <C> <C>
Local services $ 441.2 $ 403.2
Network access services 427.0 378.3
Toll services 93.5 117.0
Other services and sales 181.5 163.5
-------------- --------------
Total revenues and sales $ 1,143.2 $ 1,062.0
</TABLE>
Total revenues and sales increased 8% or $81.2 in 1997.
Local service revenues are based on fees charged to customers for providing
local-exchange service within designated franchise areas. In 1997, local service
revenues increased 9% or $38. Revenues from enhanced customer calling services,
such as SmartCall(R) and CLASS services, contributed $13 to the increase. Access
line growth of 7% generated additional revenues of $11.6 from basic local
services, $4.7 from CentraNet(R) services and $6.1 from Integrated Services
Digital Network (ISDN) and Digital Channel Services (DCS).
Network access service revenues are based on fees charged to interexchange
carriers that use the Company's local-exchange network in providing long
distance services. In addition, business and residential customers pay access
fees to connect to the local network to obtain long distance service. Cellular
service providers and other local-exchange carriers also pay access charges for
cellular and intraLATA (Local Access Transport Area) toll calls hauled or
terminated by the Company. Revenues derived from network access services
increased 13% or $48.7 in 1997. The 1997 increase is primarily due to a $35
growth in network access revenues associated with a 15% upswing in minutes of
use. Demand for increased bandwidth services by Internet Service Providers (ISP)
and other high capacity users generated an additional $15.6 of special access
revenues. The increase also reflects $6.2 of higher support payments received
from the National Exchange Carrier Association (NECA) and $2.6 from meet point
billing arrangements. The revenue growth was partially offset by a $4.8 decline
in revenues associated with the sharing provisions and rate changes relating to
the Federal Communications Commission's (FCC's) 1996 and 1997 price caps. In
addition, a $7.7 decrease resulted from the Company's authorization in January
1997 to operate as the Primary Toll Carrier (PTC) for certain jurisdictions in
Oregon and Washington, which was offset by an increase in toll revenues.
6
<PAGE> 9
Toll service revenues are based on fees charged for service beyond a customer's
local calling area but within the LATA. In 1997, toll service revenues decreased
20% or $23.5. The 1997 decrease is primarily due to lower toll revenues of $29
resulting from intraLATA toll competition, including 10XXX and 1+
presubscription, the expansion of local calling scopes, and the impact of
optional discount calling plans, which effectively lowered intrastate long
distance rates. This decrease was partially offset by $6.1 in favorable toll
settlements relating to the Company's PTC status in Oregon and Washington, as
discussed above.
Other services and sales revenues increased 11% or $18 in 1997. This increase is
due to growth in voice messaging and paging services of $3.4. The payphone
interim compensation order (see Note 11 of the Company's consolidated financial
statements included in Item 8 for more detail) increased revenue by $2.7
compared to 1996. A $1.3 increase in directory advertising, an increase in
billing and collection services of $2.6 and an increase in equipment sales of
$1.3 were additional factors in the overall increase in other services and sales
revenue.
OPERATING COSTS AND EXPENSES
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------
1997 1996
-------------- --------------
<S> <C> <C>
Cost of services and sales $ 365.7 $ 372.1
Selling, general and administrative 148.7 149.4
Depreciation and amortization 201.3 204.0
-------------- --------------
Total operating costs and expenses $ 715.7 $ 725.5
</TABLE>
Total operating costs and expenses decreased 1% or $9.8 in 1997. This decrease
is primarily attributable to the impact of an $18 reserve recorded in 1996 for
potential business and occupational taxes (see Other Matters for additional
information) and a decrease of $6.5 relating to access charges incurred to
terminate intraLATA toll calls outside the Company's territory. Increases in
depreciation related to additions to plant were more than offset by a reduction
in depreciation rates to reflect higher net salvage values related to certain of
the Company's telephone plant and equipment, resulting in a net decrease of
$2.7. Partially offsetting these decreases is an increase in selling costs of
$12.6 which was a result of increased sales and marketing efforts aimed at
stimulating sales of enhanced services and preserving market share in an
increasingly competitive environment. Customer demand for products and services
caused material costs to increase by $5 in 1997.
OTHER (INCOME) EXPENSE
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------
1997 1996
-------------- ---------------
<S> <C> <C>
Other - net $ (4.9) $ (7.5)
Income taxes 129.8 103.8
</TABLE>
Other - net income for 1997 is primarily due to a gain from the sale of three
telephone exchanges in the state of Washington to Pend Oreille Telephone Company
(see Note 3 of the Company's consolidated financial statements included in Item
8 for more detail). The 1996 gain of $7.5 represents the reversal of expired
representation and warranty reserves related to certain 1994 property
dispositions.
Income taxes increased 25% or $26 in 1997, reflecting an increase in pre-tax
income partially offset by adjustments to prior years' tax liabilities.
7
<PAGE> 10
REGULATORY AND COMPETITIVE TRENDS
The Company is subject to regulation by the regulatory bodies of the states of
California, Idaho, Oregon and Washington for its intrastate business operations
and by the Federal Communications Commission (FCC) for its interstate
operations.
Much of the regulatory and legislative activity that occurred in the United
States in 1997 was a direct result of the Telecommunications Act of 1996 (the
Telecommunications Act) adopted by Congress. The Telecommunications Act is
intended to promote competition in all sectors of the telecommunications
marketplace while preserving and advancing universal telephone service.
The Company is a strong supporter of competition in all telecommunications
markets. The Company's position remains constant: the benefits of competition
should not be divided between customers or industry segments. There must be
fair, reasonable rules at the state and federal levels that enable all service
providers to participate equitably in the marketplace and benefit everyone. The
Company believes the FCC and a number of state regulatory agencies did not
establish these comparable conditions. The Company and its parent, GTE, have
consequently exercised their right to challenge regulatory actions they believe
unfairly disadvantage their customers and shareholders.
In July 1997, the U.S. Court of Appeals for the Eighth Circuit (Eighth Circuit)
released its decision on the challenge filed in 1996 by the Company's parent,
GTE, and numerous other parties to rules developed by the FCC to implement the
interconnection provisions of the Telecommunications Act. The Telecommunications
Act required local-exchange carriers (LECs) to make their retail services and
the underlying network elements available to competitors. The FCC required that
prices for both resold services and network elements be set using a methodology
created by the FCC. The court challenge asserted the FCC's rules were
inconsistent with the Telecommunications Act. The July 1997 court decision found
that the FCC overstepped its authority in a number of areas, and upheld GTE's
position that state regulatory agencies bear the primary responsibility for
determining the prices which competing firms must pay when interconnecting their
networks. On January 26, 1998, the U.S. Supreme Court announced that it would
review this decision. Oral argument in the Supreme Court is expected to take
place in October 1998, with a final decision likely to be issued no later than
June 1999.
The favorable ruling by the Eighth Circuit did not impede the progress of
competition. The Company has finalized interconnection agreements with various
competitive LECs in Oregon and Washington. A number of these interconnection
agreements, adopted as a result of the arbitration process established by the
Telecommunications Act, incorporate prices or terms and conditions based upon
the FCC's rules that were overturned by the Eighth Circuit. Thus, the Company
has exercised its right to challenge such agreements in Oregon and Washington. A
number of these complaints have been dismissed without prejudice on the grounds
that they were filed before the arbitrated agreements had received final
approval from state commissions. In such cases, the Company is refiling
complaints after final approval has occurred.
Interim rates for interconnection and unbundled network elements (UNEs) have
been established through negotiation and arbitration decisions. These interim
rates will be used until permanent rates are established through state
commission proceedings investigating cost studies. Cost studies have been filed
in Oregon and Washington and additional studies in California and Idaho are
expected to be filed throughout 1998.
In May 1997, the FCC released two new major decisions related to implementation
of the Telecommunications Act's provisions - the universal service and access
charge reform orders. The universal service order established the support
mechanisms to ensure continued availability of affordable local telephone
service and created new programs to provide discounted telecommunications
services to schools, libraries and rural health care providers. GTE and numerous
other parties have challenged the FCC's decision before the U.S. Court of
Appeals for the Fifth Circuit on the grounds that the FCC did not follow the
requirements of the Telecommunications Act to develop a sufficient, explicit and
competitively neutral universal service program. A decision is expected in 1998.
8
<PAGE> 11
Additional state commission proceedings have begun to establish rules and
procedures to implement state universal service funds (USF). USF proceedings
have begun in California, Idaho, Oregon and Washington and additional
proceedings are scheduled to occur during the remainder of 1998. Separate USF
proceedings to address discount rates for intrastate telecommunications services
to elementary schools, secondary schools and public libraries have also begun in
Oregon.
The FCC access charge reform order, also released in May 1997, revamped the rate
structure through which local and long distance companies charge customers for
using the local phone network to make long distance calls. The FCC ordered
decreases for long distance companies to be accomplished by increasing the
access charges for business and residential customers with more than one phone
line. GTE and numerous other parties also challenged this decision before the
Eighth Circuit based on the belief that the FCC did not eliminate the universal
service subsidies hidden within interstate access charges as directed by the
Telecommunications Act, and that the FCC created additional subsidy charges paid
only by business and multi-line residential customers. Oral argument has been
held and a decision is expected in 1998.
Also in May 1997, the FCC released a decision completing a periodic review of
its price cap regulatory oversight of interstate access charges. GTE and
numerous other LECs have challenged this decision before the Eighth Circuit
based on the belief that the FCC established a fundamentally unfair annual price
reduction formula and required retroactive price reductions. Oral argument has
been held and a decision on this challenge is also expected in 1998.
Federal regulatory activity continued to change the traditional cost-based,
rate-of-return regulatory framework for interstate telephone service. The
regulatory commissions in the states of California, Idaho, Oregon and Washington
continue to remain under the traditional cost-based, rate-of-return regulatory
framework for intrastate telephone service.
For the provision of interstate access services, the Company operates under the
terms of the FCC's price cap incentive plan. The price cap mechanism serves to
limit the rates a carrier may charge, rather than just regulating the rate-of-
return which may be achieved. Under this approach, the maximum prices that the
LEC may charge are increased or decreased each year by a price cap index based
upon inflation less a predetermined productivity target. LECs have limited
pricing flexibility provided they do not exceed the allowed price cap.
In the May 1997 order on its price cap triennial review, the FCC revised the
price cap plan for LECs by adopting a uniform productivity factor of 6.0% with
an additive consumer productivity dividend of 0.5%. The FCC also eliminated the
sharing requirements of the price cap rules.
The Company filed interstate access revisions during 1997 that became effective
June 3, 1997 and July 1, 1997. Overall, these filings resulted in a net annual
price reduction of $6. On December 1, 1997, the FCC issued an Order to file
revised access rates effective January 1, 1998, which resulted in additional
interstate access charge reductions of approximately $2.1. In 1997, the FCC also
ordered significant changes that altered the structure of access charges
collected by the Company, effective January 1, 1998. Generally, the FCC reduced
and restructured the per minute charges paid by long distance carriers and
implemented new per line charges. The FCC also created an access charge
structure that resulted in different access charges for residential primary and
secondary lines and single line and multi-line business lines. In aggregate, the
reductions in usage sensitive access charges of $11.1 paid by long distance
carriers were offset by $9.5 of new per line charges and the charges paid by
end-users.
On June 4, 1996, the FCC issued the first Report and Order implementing Section
276 of the Telecommunications Act. As part of the overall goal of promoting
competition among payphone service providers (PSPs), this order mandated
compensation to all PSPs for all calls originating from payphones, including
"dial-around" access calls and toll-free subscriber calls for which PSPs were
not previously compensated. This compensation was to occur in two separate
phases. During phase one, from April 15, 1997 through October 6, 1997, PSPs were
to be paid a monthly, flat-rate compensation from interexchange carriers (IXCs).
During phase two, beginning October 7, 1997, PSPs were to be compensated on a
per-call basis, with the prevailing local coin rate of 35 cents established as
the default rate.
9
<PAGE> 12
On July 19, 1997, the U.S. Court of Appeals in Washington, D.C. vacated the
FCC's directive concerning per-call compensation, stating that the FCC had not
shown that the 35 cent rate was a reasonable surrogate for fair compensation.
The court also set aside the FCC's flat-rate compensation mandate. Subsequently,
on October 9, 1997, the FCC issued a second Report and Order to address some of
the issues vacated by the court. In this second order, the FCC established a new
per-call rate of 28.4 cents for phase two compensation that all PSPs were
eligible to receive beginning October 9, 1997. The FCC tentatively concluded
that this per-call rate should also be used to calculate phase one compensation.
The Company has recorded approximately $2.7 of payphone revenues associated with
the October 9, 1997 FCC order. It is likely that the phase one compensation
directive will be revisited in a subsequent order.
Further information regarding the Company's activities with the various
regulatory agencies and revenue arrangements with other telephone companies is
discussed in Note 11 of the Company's consolidated financial statements included
in Item 8.
YEAR 2000 CONVERSION
The Year 2000 issue has an industry-wide impact. The Company has had an active
Year 2000 Program in place. The Company's Year 2000 methodology and processes
were certified in 1997 by the Information Technology Association of America.
This program is necessary because the Year 2000 issue could impact systems,
networks and business processes at the Company. This program includes:
inventory; assessment and analysis of systems, networks and business processes;
remediation of any impacted software; and validation testing. The current
estimate for the cost of remediation for the Company is approximately $14.5.
Year 2000 remediation costs are expensed in the year incurred. Through 1997,
expenditures totaled $2. The Company currently has employees and contractors
mobilized to address the Year 2000 issue. Continued success is dependent on the
timely delivery of Year 2000 compliant products and services from the Company's
suppliers. The Company currently believes that its essential processes, systems
and business functions will be ready for the millennium transition.
LOCAL NUMBER PORTABILITY REQUIREMENTS
The Telecommunications Act mandated competition in the local telephone
marketplace. Local Number Portability (LNP) is one vehicle chosen by the FCC to
facilitate local competition. Local Service Provider Portability is the first
phase of LNP, which will allow residential and business customers to change
local service providers without changing their telephone numbers. The FCC has
mandated that Local Service Provider Portability be implemented in the top 100
Metropolitan Service Areas (MSAs) by the end of 1998. The second and third
phases of LNP will allow customers to retain their telephone numbers when they
move from one location to another or change services (e.g. landline to
cellular).
Through December 31, 1997, the Company had recorded approximately $5.8 to
implement Local Service Provider Portability within two of the top 100 MSAs.
As a result of the major investment required to implement LNP, the FCC has
stated that local service providers should be allowed to recover a portion of
their costs. The Company is seeking regulatory recovery of LNP implementation
costs.
OTHER MATTERS
In September 1996, representatives from the Company and the state of Washington
met to discuss issues identified in business and occupational tax audits
covering the period from January 1, 1989 to June 30, 1992. An $18 reserve was
established by the Company in 1996 as a contingency for tax payments related to
these issues. These audit issues are unresolved at this time. Management
believes that the Company has adequately provided for this issue in its
financial statements for the year ended December 31, 1997.
10
<PAGE> 13
Eleven separate class action lawsuits have been brought against GTE and twelve
of its subsidiaries (GTE Defendants), including the Company, relating to the
provision of inside wire maintenance services. On August 6, 1996, the GTE
Defendants and class counsel executed and filed a settlement agreement in one of
the lawsuits. The Court preliminarily approved the agreement and conditionally
certified a national class of plaintiffs for settlement purposes. A fairness
hearing on the settlement was held on December 18, 1996. On January 21, 1997,
the Court approved the settlement as written and issued a permanent injunction
to prohibit future lawsuits covering any claims from 1987 to the date of
settlement. Pursuant to the settlement, a proof of claim form was inserted into
the March 1997 customer bills for the national class to request their benefits
under the settlement. The reserves established in 1996 were adequate for the
processing of all claims during 1997.
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.
11
<PAGE> 14
Item 8. Financial Statements and Supplementary Data
GTE Northwest Incorporated and Subsidiary
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Years Ended December 31 1997 1996 1995
- ----------------------- ------------ ------------ ------------
(Thousands of Dollars)
<S> <C> <C> <C>
REVENUES AND SALES(a)
Local services $ 441,260 $ 403,211 $ 391,068
Network access services 426,978 378,310 355,002
Toll services 93,456 116,974 115,739
Other services and sales 181,482 163,485 159,611
------------ ------------ ------------
Total revenues and sales 1,143,176 1,061,980 1,021,420
------------ ------------ ------------
OPERATING COSTS AND EXPENSES(b)
Cost of services and sales 365,702 372,110 367,072
Selling, general and administrative 148,668 149,425 167,525
Depreciation and amortization 201,347 204,039 205,019
------------ ------------ ------------
Total operating costs and expenses 715,717 725,574 739,616
------------ ------------ ------------
OPERATING INCOME 427,459 336,406 281,804
OTHER (INCOME) EXPENSE
Interest - net(c) 52,917 52,687 54,400
Other - net (4,875) (7,519) --
------------ ------------ ------------
INCOME BEFORE INCOME TAXES 379,417 291,238 227,404
Income taxes 129,825 103,812 77,217
------------ ------------ ------------
INCOME BEFORE EXTRAORDINARY CHARGES 249,592 187,426 150,187
Extraordinary charges -- -- (581,167)
------------ ------------ ------------
NET INCOME (LOSS) $ 249,592 $ 187,426 $ (430,980)
============ ============ ============
</TABLE>
(a) Includes billings to affiliates of $45,138, $43,640 and $43,752 for the
years 1997-1995, respectively.
(b) Includes billings from affiliates of $49,186, $54,098 and $61,631 for the
years 1997-1995, respectively.
(c) Includes interest paid to affiliates of $1,595 in 1997.
See Notes to Consolidated Financial Statements.
12
<PAGE> 15
GTE Northwest Incorporated and Subsidiary
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31 1997 1996
- ----------- ----------- -----------
(Thousands of Dollars)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 1,479 $ 2,074
Receivables, less allowances of $14,515 and $17,384 266,422 258,275
Inventories and supplies 19,570 14,361
Other 7,833 20,493
----------- -----------
Total current assets 295,304 295,203
----------- -----------
Property, plant and equipment, net 1,291,980 1,190,911
Employee benefit plans 92,703 72,179
Other assets 14,127 12,087
----------- -----------
Total assets $ 1,694,114 $ 1,570,380
=========== ===========
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities:
Short-term obligations, including current maturities $ 111,360 $ 60,879
Accounts payable 55,594 47,209
Affiliate payables and accruals 45,231 46,349
Advanced billings and customer deposits 25,637 25,509
Taxes payable 53,741 24,614
Accrued interest 9,245 10,602
Accrued payroll costs 19,738 25,834
Dividends payable 44,689 27,753
Other 43,279 48,177
----------- -----------
Total current liabilities 408,514 316,926
----------- -----------
Long-term debt 683,066 697,242
Deferred income taxes 50,346 45,982
Employee benefit plans 58,791 62,873
Other liabilities 7,425 25,311
----------- -----------
Total liabilities 1,208,142 1,148,334
----------- -----------
Shareholder's equity:
Common stock (17,920,000 shares issued) 448,000 448,000
Additional paid-in capital 57,671 57,671
Retained deficit (19,699) (83,625)
----------- -----------
Total shareholder's equity 485,972 422,046
----------- -----------
Total liabilities and shareholder's equity $ 1,694,114 $ 1,570,380
=========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
13
<PAGE> 16
GTE Northwest Incorporated and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31 1997 1996 1995
- ----------------------- --------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
OPERATIONS
Income before extraordinary charges $ 249,592 $ 187,426 $ 150,187
Adjustments to reconcile income before extraordinary
charges to net cash from operations:
Depreciation and amortization 201,347 204,039 205,019
Deferred income taxes 11,910 39,075 37,184
Gain on disposition of assets (5,101) -- --
Provision for uncollectible accounts 13,346 15,828 23,442
Change in current assets and current liabilities:
Receivables - net (18,721) (60,566) (5,028)
Other current assets (8,315) (529) (2,722)
Accrued taxes and interest 39,007 (18,978) (24,593)
Other current liabilities (29,551) (12,518) (37,953)
Other - net (55,499) (32,695) (5,407)
--------- --------- ---------
Net cash from operations 398,015 321,082 340,129
--------- --------- ---------
INVESTING
Capital expenditures (276,993) (196,986) (208,856)
Proceeds from sale of assets 7,600 -- --
Other - net 3,740 1,726 16
--------- --------- ---------
Net cash used in investing (265,653) (195,260) (208,840)
--------- --------- ---------
FINANCING
Long-term debt issued -- 171,656 --
Long-term debt and preferred stock retired, including
premiums paid on early retirement (34,705) (11,224) (156,028)
Dividends (168,730) (163,854) (118,366)
Increase (decrease) in short-term obligations,
excluding current maturities 70,478 (154,104) 168,497
Other - net -- 17,468 (10,035)
--------- --------- ---------
Net cash used in financing (132,957) (140,058) (115,932)
--------- --------- ---------
Increase (decrease) in cash and cash equivalents (595) (14,236) 15,357
Cash and cash equivalents:
Beginning of year 2,074 16,310 953
--------- --------- ---------
End of year $ 1,479 $ 2,074 $ 16,310
========= ========= =========
Cash paid during the year for:
Interest $ 52,452 $ 53,030 $ 59,899
--------- --------- ---------
Income taxes $ 96,237 $ 84,309 $ 61,578
--------- --------- ---------
</TABLE>
See Notes to Consolidated Financial Statements.
14
<PAGE> 17
GTE Northwest Incorporated and Subsidiary
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY
<TABLE>
<CAPTION>
Additional Retained
Common Paid-In Earnings
Stock Capital (Deficit) Total
--------- --------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C> <C>
Shareholders' equity, December 31, 1994 $ 448,000 $ 57,687 $ 459,209 $ 964,896
Net loss (430,980) (430,980)
Dividends declared (126,813) (126,813)
Premium on redemption of preferred stock,
subject to mandatory redemption (16) -- (16)
--------- --------- --------- ---------
Shareholder's equity, December 31, 1995 448,000 57,671 (98,584) 407,087
Net income 187,426 187,426
Dividends declared (172,467) (172,467)
--------- --------- --------- ---------
Shareholder's equity, December 31, 1996 448,000 57,671 (83,625) 422,046
Net income 249,592 249,592
Dividends declared (185,666) (185,666)
--------- --------- --------- ---------
Shareholder's equity, December 31, 1997 $ 448,000 $ 57,671 $ (19,699) $ 485,972
========= ========= ========= =========
</TABLE>
See Notes to Consolidated Financial Statements.
15
<PAGE> 18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
GTE Northwest Incorporated (the Company) provides a wide variety of
communications services ranging from local telephone service for the home and
office to highly complex voice and data services for various industries. At
December 31, 1997, the Company served 1,773,941 access lines in the states of
California, Idaho, Oregon and Washington. The Company is a wholly-owned
subsidiary of GTE Corporation (GTE).
BASIS OF PRESENTATION
The Company prepares its consolidated 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.
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, GTE West Coast Incorporated. All significant
intercompany amounts have been eliminated.
Reclassifications of prior-year data have been made, where appropriate, to
conform to the 1997 presentation.
TRANSACTIONS WITH AFFILIATES
GTE Supply (100% owned by GTE) provides construction and maintenance equipment,
supplies and electronic repair services to the Company. These purchases and
services amounted to $72.3 million, $59.8 million and $56.2 million for the
years 1997-1995, respectively. Such purchases and services are recorded in the
accounts of the Company, at cost, which includes a return realized by GTE
Supply.
The Company is billed for certain printing and other costs associated with
telephone directories, data processing services and equipment rentals, and
receives management, consulting, research and development and pension management
services from other affiliated companies. These charges amounted to $49.2
million, $54.1 million and $61.6 million for the years 1997-1995, respectively.
The amounts charged for these affiliated transactions are based on a
proportional cost allocation method.
The Company's consolidated financial statements include allocated expenses based
on the sharing of certain executive, administrative, financial, accounting,
marketing, personnel, engineering and other support services being performed at
consolidated work centers among GTE's domestic telephone operating subsidiaries.
The amounts charged for these affiliated transactions are based on proportional
cost allocation methodologies.
GTE Funding Incorporated (an affiliate of the Company) provides short-term
financing and investment vehicles and cash management services for the Company.
The Company is contractually obligated to repay all amounts borrowed on its
behalf by GTE Funding Incorporated. Interest expense on these borrowings
amounted to approximately $1.6 million in 1997.
The Company has an agreement with GTE Directories Corporation (Directories)
(100% owned by GTE), whereby the Company provides its subscriber lists, billing
and collection and other services to Directories. Revenues from these activities
amounted to $45.1 million, $43.6 million and $43.8 million for the years
1997-1995, respectively.
DEPRECIATION AND AMORTIZATION
The Company provides for depreciation on a straight-line basis over the
estimated economic lives of its assets. Prior to 1996, the Company provided for
depreciation on a straight-line basis over asset lives approved by
16
<PAGE> 19
regulators (see Note 2). Maintenance and repairs of property are charged to
income as incurred. Additions to, replacements and renewals of property are
charged to telephone plant accounts. Property retirements are charged in total
to the accumulated depreciation account. No adjustment to depreciation is made
at the time properties are retired or otherwise disposed of, except in the case
of significant sales or extraordinary retirements of property where profit or
loss is recognized.
Franchises, goodwill and other intangibles are amortized on a straight-line
basis over the periods to be benefited, or 40 years, whichever is less.
REVENUE RECOGNITION
Revenues are recognized when earned. This is generally based on usage of the
Company's local-exchange networks or facilities. For other products and
services, revenues are generally recognized when services are rendered or
products are delivered to customers.
INVENTORIES AND SUPPLIES
Inventories and supplies are stated at the lower of cost, determined principally
by the average cost method, or net realizable value.
EMPLOYEE BENEFIT PLANS
Pension and postretirement health care and life insurance benefits earned during
the year as well as interest on projected benefit obligations are accrued
currently. Prior service costs and credits resulting from changes in plan
benefits are amortized over the average remaining service period of the
employees expected to receive benefits. Material curtailment/settlement gains
and losses associated with employee separations are recognized in the period in
which they occur.
INCOME TAXES
The Company's results are included in GTE's consolidated federal income tax
return. The Company participates in a tax-sharing agreement with GTE and remits
tax payments to GTE based on its tax liability on a separate company basis.
Deferred tax assets and liabilities are established for temporary differences
between the way certain income and expense items are reported for financial
reporting and tax purposes and are subsequently adjusted to reflect changes in
tax rates expected to be in effect when the temporary differences reverse. A
valuation allowance is established for deferred tax assets for which realization
is not likely.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include investments in short-term, highly liquid
securities, which have maturities when purchased of three months or less.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (FAS
130). FAS 130 establishes standards for reporting and displaying comprehensive
income and its components in the financial statements. FAS 130 is effective for
fiscal years beginning after December 15, 1997. Reclassification of financial
statements for earlier periods provided for comparative purposes is required.
The adoption of this standard will have no impact on the Company's results of
operations, financial position or cash flows.
17
<PAGE> 20
2. EXTRAORDINARY CHARGES
In response to legislation (see Note 11) and the increasingly competitive
environment, the Company discontinued the use of Statement of Financial
Accounting Standards No. 71, "Accounting for the Effects of Certain Types of
Regulation" (FAS 71) in the fourth quarter of 1995.
As a result of the decision to discontinue FAS 71, the Company recorded a
non-cash, after-tax extraordinary charge of $573.2 million (net of tax benefits
of $331.3 million) in the fourth quarter of 1995. The charge primarily
represented a reduction in the net book value of telephone plant and equipment
through an increase in accumulated depreciation. In addition to the one-time
charge, beginning in 1996, the Company shortened the depreciable lives of its
telephone plant and equipment as follows:
<TABLE>
<CAPTION>
Average Depreciable Lives
-----------------------------------
Asset Category Before After
-------------------------- -------------------- -----------
<S> <C> <C>
Copper 20-30 15
Switching 17-19 10
Circuit 11-13 8
Fiber 25-30 20
</TABLE>
In addition, during 1995, the Company redeemed prior to stated maturity, $140.9
million of long-term debt. These redemptions resulted in an after-tax
extraordinary charge of $8 million (net of tax benefits of $4.7 million).
3. PROPERTY REPOSITIONING
On February 28, 1997, the Company sold three telephone exchanges in the state of
Washington (representing 1,800 access lines) to Pend Oreille Telephone Company
for $7.6 million in cash. A pre-tax gain of $5.1 million was recorded on the
sale.
4. PREFERRED STOCK
In August 1995, the Company retired its remaining shares of preferred stock,
subject to mandatory redemption, with cash from operations.
5. COMMON STOCK
The authorized common stock of the Company consists of 20,000,000 shares without
par value. All 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.
Under the most restrictive terms of the Company's indentures, the Company would
have been prohibited from paying dividends on its common stock due solely to the
recording of the 1995 extraordinary charge discussed in Note 2. However, the
most restrictive indenture contains a provision which allows the trustees and
the holders to modify the agreement. As such, in December 1995, the agreement
was modified allowing the Company to continue to declare and pay dividends on
its common stock.
18
<PAGE> 21
6. DEBT
Long-term debt as of December 31, was as follows:
<TABLE>
<CAPTION>
1997 1996
--------------- --------------
(Thousands of Dollars)
<S> <C> <C>
First mortgage bonds:
6 1/4 % Series Q, due 1998 $ -- $ 13,600
7 1/8 % Series R, due 1999 18,000 18,000
7 7/8 % Series U, due 2002 -- 20,000
8 1/4 % Series W, due 2007 48,000 48,000
8 3/4 % Series BB, due 2016 75,000 75,000
6 1/8 % Series FF, due 1999 125,000 125,000
9.67 % Series HH, due 2010 10,148 11,027
Debentures:
7 3/8 % Series A, due 2001 200,000 200,000
7 7/8 % Series B, due 2026 175,000 175,000
Short-term debt expected to be refinanced on a long-term basis 20,000 --
--------------- --------------
Total principal amount 671,148 685,627
Premium and discount - net 12,800 12,494
--------------- --------------
Total 683,948 698,121
Less: current maturities (882) (879)
--------------- --------------
Total long-term debt $ 683,066 $ 697,242
=============== ==============
</TABLE>
In May and October 1997, the Company redeemed prior to stated maturity, the $20
million 7 7/8% Series U first mortgage bonds and the $13.6 million 6 1/4% Series
Q first mortgage bonds, respectively.
Long-term debt as of December 31, 1997 includes $20 million of short-term
borrowings in the form of affiliate notes payable which the Company anticipates
refinancing during 1998. These affiliate notes payable represent notes payable
to GTE Funding Incorporated, an affiliate company that provides short-term
financing and investment vehicles and cash management services for the Company
and six of its affiliates.
At December 31, 1997, the Company had an existing shelf registration statement
for an additional $175 million of debentures.
In June 1996, the Company issued $175 million of 7 7/8% Series B Debentures, due
2026. Net proceeds were applied toward the repayment of short-term borrowings
incurred in connection with the redemption of long-term debt in December 1995
prior to stated maturity (see Note 2). Net proceeds were also used to finance
the Company's construction program and for general corporate purposes.
The aggregate principal amount of 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 premiums and 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.
19
<PAGE> 22
Estimated payments of long-term debt during the next five years are: $0.9
million in 1998; $143.9 million in 1999; $0.9 million in 2000; $200.9 million in
2001; and $0.9 million in 2002.
Total short-term obligations as of December 31, were as follows:
<TABLE>
<CAPTION>
1997 1996
-------- --------
(Thousands of Dollars)
<S> <C> <C>
Commercial paper - average rate 5.4% $ -- $ 60,000
Notes payable to affiliate - average rate 6.2% 110,478 --
Current maturities of long-term debt 882 879
-------- --------
Total $111,360 $ 60,879
======== ========
</TABLE>
The Company participates with other affiliates in a $1.5 billion, 364-day line
of credit. In December 1997, the Company began participating with its parent,
GTE, and other of its affiliates in a series of five bilateral credit agreements
for an additional $2 billion in credit capacity. These facilities, which are
shared by the participating companies, are aligned with the maturity date of the
existing 364-day line of credit. The additional capacity provides greater
flexibility to incur additional indebtedness of a shorter-term duration during
periods when it may not be desirable to access the capital markets to refinance
short-term debt.
7. FINANCIAL INSTRUMENTS
At December 31, 1997, the Company had entered into forward interest rate swap
agreements to hedge against changes in market interest rates on $20 million of
planned long-term debt issuances expected to be completed within the next twelve
months. Gains and losses recognized upon the expiration or settlement of forward
interest rate swap agreements are amortized over the life of the associated
long-term debt issuance as an offset or addition to interest expense.
The risk associated with these off-balance-sheet financial instruments arises
from the possible inability of counterparties to meet the contract terms and
from movements in interest rates. The Company carefully evaluates and
continually monitors the creditworthiness of its counterparties and believes the
risk of nonperformance is remote.
The fair values of financial instruments, other than long-term debt, closely
approximate their carrying value. As of December 31, 1997, the estimated fair
value of long-term debt based on either reference to quoted market prices or an
option pricing model exceeded the carrying value by approximately $1 million.
The estimated fair value of long-term debt as of December 31, 1996 was lower
than the carrying value by approximately $3 million.
20
<PAGE> 23
8. INCOME TAXES
The income tax provision is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
Current:
Federal $ 116,348 $ 59,492 $ 38,272
State 1,567 5,245 1,761
--------- --------- ---------
117,915 64,737 40,033
--------- --------- ---------
Deferred:
Federal 9,623 37,983 36,659
State 3,488 2,746 4,168
--------- --------- ---------
13,111 40,729 40,827
--------- --------- ---------
Amortization of deferred investment tax credits - net (1,201) (1,654) (3,643)
--------- --------- ---------
Total $ 129,825 $ 103,812 $ 77,217
========= ========= =========
</TABLE>
A reconciliation between taxes computed by applying the statutory federal income
tax rate to pre-tax income and income taxes provided in the consolidated
statements of income is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
Amounts computed at statutory rates $ 132,796 $ 101,933 $ 79,574
State and local income taxes, net of federal income tax
benefits 3,286 5,194 3,854
Amortization of deferred investment tax credits, net of federal
income tax benefits (781) (1,075) (3,643)
Depreciation of telephone plant construction costs
previously deducted for tax purposes - net -- -- 3,651
Rate differentials applied to reversing temporary differences -- -- (972)
Other differences - net (5,476) (2,240) (5,247)
--------- --------- ---------
Total provision $ 129,825 $ 103,812 $ 77,217
========= ========= =========
</TABLE>
The tax effects of temporary differences that give rise to the current deferred
income tax benefits and deferred income tax liabilities at December 31, are
as follows:
<TABLE>
<CAPTION>
1997 1996
-------- --------
(Thousands of Dollars)
<S> <C> <C>
Depreciation and amortization $ 40,094 $ 35,070
Employee benefit obligations (31,353) (26,196)
Prepaid pension cost 34,621 26,542
Investment tax credits 940 1,721
Other - net 10,846 6,101
-------- --------
Total $ 55,148 $ 43,238
======== ========
</TABLE>
21
<PAGE> 24
9. EMPLOYEE BENEFIT PLANS
RETIREMENT PLANS
The Company sponsors noncontributory defined benefit pension plans covering
substantially all employees. The benefits to be paid under these plans are
generally based on years of credited service and average final earnings. The
Company's funding policy, subject to the minimum funding requirements of
employee benefit and tax laws, is to contribute such amounts as are determined
on an actuarial basis to accumulate funds sufficient to meet the plans' benefit
obligation to employees upon their retirement. The assets of the plans consist
primarily of corporate equities, government securities and corporate debt
securities.
The components of the net pension credit for 1997-1995 were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
Benefits earned during the year $ 10,792 $ 10,583 $ 9,394
Interest cost on projected benefit obligations 27,179 25,046 24,358
Return on plan assets:
Actual (116,135) (87,174) (103,066)
Deferred 66,582 41,175 62,076
Other - net (7,322) (8,061) (9,873)
--------- --------- ---------
Net pension credit $ (18,904) $ (18,431) $ (17,111)
========= ========= =========
</TABLE>
The expected long-term rate-of-return on plan assets was 9% for 1997 and 1996
and 8.5% for 1995.
The funded status of the plans and the net prepaid pension cost at December 31,
were as follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(Thousands of Dollars)
<S> <C> <C>
Vested benefit obligations $ 259,968 $ 235,785
========= =========
Accumulated benefit obligations $ 301,978 $ 272,354
========= =========
Plan assets at fair value $ 705,582 $ 626,819
Less: projected benefit obligations 381,783 350,895
--------- ---------
Excess of assets over projected obligations 323,799 275,924
Unrecognized net transition asset (18,269) (22,338)
Unrecognized net gain (212,827) (181,407)
--------- ---------
Net prepaid pension cost $ 92,703 $ 72,179
========= =========
</TABLE>
Assumptions used to develop the projected benefit obligations at December 31,
were as follows:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Discount rate 7.25% 7.50%
Rate of compensation increase 5.00% 5.25%
</TABLE>
22
<PAGE> 25
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
Substantially all of the Company's employees are covered under postretirement
health care and life insurance benefit plans. The determination of benefit cost
for postretirement health plans is generally based on comprehensive hospital,
medical and surgical benefit plan provisions. The Company funds amounts for
postretirement benefits as deemed appropriate from time to time. Plan assets
consist primarily of corporate equities, government securities and corporate
debt securities.
The postretirement benefit cost for 1997-1995 included the following components:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
(Thousands of Dollars)
<S> <C> <C> <C>
Benefits earned during the year $ 1,735 $ 2,513 $ 2,305
Interest on accumulated postretirement benefit obligations 9,803 10,641 10,608
Actual return on plan assets (2,597) (584) (1,488)
Amortization of transition obligation 2,991 4,264 4,652
Other - net 775 (616) 1,157
-------- -------- --------
Postretirement benefit cost $ 12,707 $ 16,218 $ 17,234
======== ======== ========
</TABLE>
The following table sets forth the plan's funded status and the accrued
postretirement benefit obligations as of December 31:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(Thousands of Dollars)
<S> <C> <C>
Accumulated postretirement benefit obligations attributable to:
Retirees $ 106,242 $ 93,471
Fully eligible active plan participants 5,035 4,378
Other active plan participants 44,342 50,892
--------- ---------
Total accumulated postretirement benefit obligations 155,619 148,741
Less: fair value of plan assets 35,695 24,222
--------- ---------
Excess of accumulated obligations over plan assets 119,924 124,519
Unrecognized transition obligation (44,867) (67,058)
Unrecognized net gain (loss) (18,878) 2,713
--------- ---------
Accrued postretirement benefit obligations $ 56,179 $ 60,174
========= =========
</TABLE>
The assumed discount rates used to measure the accumulated postretirement
benefit obligations were 7.25% and 7.5% at December 31, 1997 and 1996,
respectively. The assumed health care cost trend rate was 8.25% in 1997 and
8.75% in 1996 and is assumed to decrease gradually to an ultimate rate of 6.0%
in the year 2004. A one percentage point increase in the assumed health care
cost trend rates for each future year would have increased 1997 costs by
approximately $1 million and the accumulated postretirement benefit obligations
as of December 31, 1997, by approximately $13.7 million.
SAVINGS PLANS
The Company sponsors employee savings plans under section 401(k) of the Internal
Revenue Code. The plans cover substantially all full-time employees. Under the
plans, the Company provides matching contributions in GTE common stock based on
qualified employee contributions. Matching contributions charged to income were
$3.8 million in 1997 and 1996, and $3.4 million in 1995.
23
<PAGE> 26
10. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is summarized as follows at December 31:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
(Thousands of Dollars)
<S> <C> <C>
Land $ 13,488 $ 12,475
Buildings 237,550 220,544
Plant and equipment 2,928,551 2,757,934
Other 239,483 267,315
----------- -----------
Total 3,419,072 3,258,268
Accumulated depreciation (2,127,092) (2,067,357)
----------- -----------
Total property, plant and equipment - net $ 1,291,980 $ 1,190,911
=========== ===========
</TABLE>
Depreciation expense in 1997-1995 was equivalent to a composite average
percentage of 6.0%, 6.4% and 6.7%, respectively. During 1997, depreciation was
partially offset by the effects of a reduction in depreciation rates to reflect
higher net salvage values related to certain telephone plant and equipment.
11. REGULATORY AND COMPETITIVE MATTERS
The Company's intrastate business is regulated by the state regulatory
commissions in California, Idaho, Oregon and Washington. The Company is subject
to regulation by the Federal Communications Commission (FCC) for its interstate
business operations.
INTRASTATE SERVICES
The Company provides local-exchange services to customers within its designated
franchise area. The Company provides toll services within designated geographic
areas called Local Access and Transport Areas (LATAs) under agreements with
connecting local-exchange carriers (LECs) in conformity with individual state
regulatory orders. The Company also provides long distance access services
directly to interexchange carriers and other customers who provide services
between LATAs.
Oregon
The Company has been operating under a Primary Toll Carrier (PTC) plan in its
service areas since 1994. Under this plan, the toll billed to end-users for
intraLATA toll calls originating in the Company's service area are retained by
the Company. The Company, in turn, pays access charges to the company
terminating the call based on that company's approved access charge tariff.
Likewise, the Company will receive access charges for terminating any intraLATA
toll call that originates outside of its service area based on its approved
access charge tariff.
Similarly, beginning in January 1997, the Company began operating as a PTC in
the interstate/intraLATA jurisdictions in Oregon, and temporarily entered into a
"bill and keep" billing arrangement during the period of transition from a
secondary carrier in those jurisdictions to the PTC.
Since 1990, the Oregon Public Utilities Commission (OPUC) has been reviewing the
cost structure of Oregon telecommunications services to determine if network
elements should be unbundled to respond to emerging competition in the
telecommunications markets. On July 19, 1996, the OPUC issued an order in this
proceeding which ordered the unbundling of more than two hundred network
elements. Pricing for the rate elements was established in the order which, in
most cases, includes a contribution to joint and common costs. Tariff prices for
existing bundled services were not changed by the order. On September 23, 1996,
the Company filed for
24
<PAGE> 27
clarification, reconsideration and rehearing of the OPUC's order. The Company's
filing is based on various unresolved legal, operational and pricing issues as
well as the numerous ongoing interconnection negotiations that are in process in
Oregon.
An unbundling order was reissued in the state of Oregon on November 1, 1996. As
in the initial order, the prices for the unbundled network elements (UNEs) were
developed for US West; however, the rates also apply to the Company. On December
16, 1996, a compliance tariff was filed that offered the unbundled services to
alternative local-exchange carriers (ALECs), effective January 30, 1997. On
January 21, 1997, the OPUC approved an extension of the effective date until
April 2, 1997.
An order was issued on January 12, 1996 which granted the application of three
ALECs, Electric Lightwave (ELI), MCI Metro and Metropolitan Fiber Systems, Inc.
(MFS), to provide service in the Company's and US West's exchanges in the
greater Portland area. Subsequently, two more ALECs, AT&T Corp. (AT&T) and
Teleport Communications Group (TCG), also applied for similar rulings. Eight of
the Company's exchanges were designated as competitive. Interconnection is based
on the same terms and conditions that incumbent LECs have used to interconnect
their networks.
On January 13, and 24, and February 3, 1997, the OPUC issued its decision in the
Company's arbitration with AT&T, Western Wireless and MCI, respectively, for
similar local competition issues. The interim discount rates for the Company's
resold services were set at 21% for AT&T, 18.81% (9.405% for volume discount)
for Western Wireless and 15.9% (7.95% for volume discount) for MCI. The Company
has filed a lawsuit in the U.S. District Court challenging portions of the
OPUC's arbitration determinations.
On September 30, 1997, the OPUC opened an earnings investigation docket. The
Company has provided information to assist in the investigation but does not
plan to make a revenue proposal until the second quarter of 1998 at the
earliest. Any potential revenue impact is unknown at this time.
Washington
The Washington Utility and Transportation Commission (WUTC) issued orders in
1996 setting the structure for local interconnection and competition between
LECs and competitive local-exchange carriers (CLECs). The orders established an
interim "bill and keep" compensation for local interconnection and interim
number portability via call forwarding at a discounted price. The FCC order for
permanent number portability requires implementation in the Seattle area by May
15, 1998 and the Portland area by June 30, 1998.
The Company has received WUTC approval of interconnection agreements with 13
CLEC and wireless carriers. The approval of two other carriers is pending.
Agreements with AT&T, MCI and Sprint resulted from WUTC arbitration proceedings.
The interim discount rates for the Company's resold services were set in the
arbitrations at 18.81%, 16.63% and 13.03%, respectively. The Company has filed a
lawsuit in the U.S. District Court challenging portions of the WUTC's
arbitration determinations.
On November 2, 1996, the WUTC opened a generic cost docket to develop a cost
methodology and establish permanent rates for interconnection, UNEs, resale and
number portability. Phase I hearings were held in July 1997. Briefs were filed
in August and the comment period was extended through February 1998. A decision
is expected in April 1998. Phase I will have no revenue impact since this docket
is addressing the adoption of an appropriate cost model.
The Company has been operating under a PTC plan for intraLATA toll calls in
Washington since 1993. Effective January 1, 1997, the Company began operating as
a PTC in the interstate/intraLATA jurisdictions and temporarily entered into a
"bill and keep" billing arrangement during the period of transition from a
secondary carrier in those jurisdictions to the PTC.
25
<PAGE> 28
California
On December 29, 1995, GTE West Coast Incorporated filed a proposal with the
California Public Utilities Commission (CPUC) to restructure certain rates in
compliance with an order from the CPUC that all small LECs file by the end of
that year. The Company requested a return on equity (ROE) of 13.36% and a rate-
of-return (ROR) of 11.30%. On April 23, 1997, the CPUC issued its decision
adopting an authorized ROR of 10.0% which equates to an 11.16% ROE. Accordingly,
the Company was required to reduce rates via surcredit with an annual revenue
impact of $0.3 million.
INTERSTATE SERVICES
Much of the regulatory and legislative activity that occurred in the United
States in 1997 was a direct result of the Telecommunications Act of 1996 (the
Telecommunications Act) adopted by Congress. The Telecommunications Act is
intended to promote competition in all sectors of the telecommunications
marketplace while preserving and advancing universal telephone service.
In July 1997, the U.S. Court of Appeals for the Eighth Circuit (Eighth Circuit)
released its decision on the challenge filed in 1996 by the Company's parent,
GTE, and numerous other parties to rules developed by the FCC to implement the
interconnection provisions of the Telecommunications Act. The Telecommunications
Act required LECs to make their retail services and the underlying network
elements available to competitors. The FCC required that prices for both resold
services and network elements be set using a methodology created by the FCC. The
court challenge asserted the FCC's rules were inconsistent with the
Telecommunications Act. The July 1997 court decision found that the FCC
overstepped its authority in a number of areas and upheld GTE's position that
state regulatory agencies bear the primary responsibility for determining the
prices which competing firms must pay when interconnecting their networks. On
January 26, 1998, the U.S. Supreme Court announced that it would review this
decision. Oral argument in the Supreme Court is expected to take place in
October 1998, with a final decision likely to be issued no later than June 1999.
In May 1997, the FCC released two new major decisions related to implementation
of the Telecommunications Act's provisions - the universal service and access
charge reform orders. The universal service order established the support
mechanisms to ensure continued availability of affordable local telephone
service and created new programs to provide discounted telecommunications
services to schools, libraries and rural health care providers. GTE and numerous
other parties have challenged the FCC's decision before the U.S. Court of
Appeals for the Fifth Circuit on the grounds that the FCC did not follow the
requirements of the Telecommunications Act to develop a sufficient, explicit and
competitively neutral universal service program. A decision is expected in 1998.
The FCC access charge reform order, also released in May 1997, revamped the rate
structure through which local and long distance companies charge customers for
using the local phone network to make long distance calls. The FCC ordered
decreases for long distance companies to be accomplished by increasing the
access charges for business and residential customers with more than one phone
line. GTE and numerous other parties also challenged this decision before the
Eighth Circuit based on the belief that the FCC did not eliminate the universal
service subsidies hidden within interstate access charges as directed by the
Telecommunications Act, and that the FCC created additional subsidy charges paid
only by business and multi-line residential customers. Oral argument has been
held and a decision is expected in 1998.
Also in May 1997, the FCC released a decision completing a periodic review of
its price cap regulatory oversight of interstate access charges. GTE and
numerous other LECs have challenged this decision before the Eighth Circuit
based on the belief that the FCC established a fundamentally unfair annual price
reduction formula, and required retroactive price reductions. Oral argument has
been held and a decision on this challenge is also expected in 1998.
For the provision of interstate services, the Company operates under the terms
of the FCC's price cap incentive plan. The price cap mechanism serves to limit
the rates a carrier may charge, rather than just regulating the rate-of-return
which may be achieved. Under this approach, the maximum price that the LEC may
charge is increased or
26
<PAGE> 29
decreased each year by a price index based upon inflation less a predetermined
productivity target. LECs have limited pricing flexibility provided they do not
exceed the allowed price cap.
In the May 1997 order on its price cap triennial review, the FCC revised the
price cap plan for LECs by adopting a uniform productivity factor of 6.0% with
an additive consumer productivity dividend of 0.5%. The FCC also eliminated the
sharing requirements of the price cap rules.
The Company filed interstate access revisions during 1997 that became effective
June 3, 1997 and July 1, 1997. Overall, these filings resulted in a net annual
price reduction of $6 million. On December 1, 1997, the FCC issued an order to
file revised access rates effective January 1, 1998, which resulted in
additional interstate access charge reductions of approximately $2.1 million. In
1997, the FCC also ordered significant changes that altered the structure of
access charges collected by the Company, effective January 1, 1998. Generally,
the FCC reduced and restructured the per minute charges paid by long distance
carriers and implemented new per line charges. The FCC also created an access
charge structure that resulted in different access charges for residential
primary and secondary lines and single line and multi-line business lines. In
aggregate, the reductions in usage sensitive access charges of $11.1 million
paid by long distance carriers were offset by $9.5 million of new per line
charges and charges paid by end-users.
On June 4, 1996, the FCC issued the first Report and Order implementing Section
276 of the Telecommunications Act. As part of the overall goal of promoting
competition among payphone service providers (PSPs), this order mandated
compensation to all PSPs for all calls originating from payphones, including
"dial-around" access calls and toll-free subscriber calls for which PSPs were
not previously compensated. This compensation was to occur in two separate
phases. During phase one, from April 15, 1997 through October 6, 1997, PSPs were
to be paid a monthly, flat-rate compensation from interexchange carriers (IXCs).
During phase two, beginning October 7, 1997, PSPs were to be compensated on a
per-call basis, with the prevailing local coin rate of 35 cents established as
the default rate.
On July 19, 1997, the U.S. Court of Appeals in Washington, D.C. vacated the
FCC's directive concerning per-call compensation, stating that the FCC had not
shown that the 35 cent rate was a reasonable surrogate for fair compensation.
The court also set aside the FCC's flat-rate compensation mandate. Subsequently,
on October 9, 1997, the FCC issued a second Report and Order to address some of
the issues vacated by the court. In this second order, the FCC established a new
per-call rate of 28.4 cents for phase two compensation that all PSPs were
eligible to receive beginning October 9, 1997. The FCC tentatively concluded
that this per-call rate should also be used to calculate phase one compensation.
The Company has recorded approximately $2.7 million of payphone revenues
associated with the October 9, 1997 FCC order. It is likely that the phase one
compensation directive will be revisited in a subsequent order.
SIGNIFICANT CUSTOMER
Revenues received from AT&T Corp. include amounts for access and billing and
collection during the years 1997-1995 under various arrangements and amounted to
$135.6 million, $126.0 million and $133.4 million, respectively.
27
<PAGE> 30
12. COMMITMENTS AND CONTINGENCIES
The Company has noncancelable leases covering certain buildings, office space
and equipment. Rental expense was $12.4 million, $12.9 million and $12.3 million
in 1997-1995, respectively. Minimum rental commitments for noncancelable leases
through 2002 do not exceed $2.1 million annually and aggregate $3.2 million
thereafter.
The Company is subject to a number of proceedings arising out of the conduct of
its business, including those relating to regulatory actions, commercial
transactions and environmental, safety and health matters. Management believes
that the ultimate resolution of these matters will not have a material adverse
effect on the results of operations or the financial position of the Company.
Recent judicial and regulatory developments, as well as the pace of
technological change, have continued to influence industry trends, including
accelerating and expanding the level of competition. As a result, the Company's
operations face increasing competition in virtually all aspects of its business.
The Company supports greater competition in telecommunications, provided that,
overall, the actions to eliminate existing legal and regulatory barriers allow
an opportunity for all service providers to participate equally in a competitive
marketplace under comparable conditions.
28
<PAGE> 31
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholder of
GTE Northwest Incorporated:
We have audited the accompanying consolidated balance sheets of GTE Northwest
Incorporated (a Washington corporation and wholly-owned subsidiary of GTE
Corporation) and subsidiary as of December 31, 1997 and 1996, and the related
consolidated statements of income, shareholder's equity and cash flows for each
of the three years in the period ended December 31, 1997, as set forth on pages
12 through 15 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 Northwest Incorporated and
subsidiary as of December 31, 1997 and 1996, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1997, in conformity with generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, in 1995, the
Company discontinued applying the provisions of Statement of Financial
Accounting Standards No. 71, "Accounting for the Effects of Certain Types of
Regulation."
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The supporting schedule and exhibit
listed under Item 14 are presented for purposes of complying with the Securities
and Exchange Commission's rules and are not a required part of the basic
financial statements. The supporting schedule and exhibit have been subjected to
the auditing procedures applied in the audits of the basic financial statements
and, in our opinion, fairly state in all material respects the financial data
required to be set forth therein in relation to the basic financial statements
taken as a whole.
ARTHUR ANDERSEN LLP
Dallas, Texas
January 26, 1998
29
<PAGE> 32
MANAGEMENT REPORT
To Our Shareholder:
The management of the Company is responsible for the integrity and objectivity
of the financial and operating information contained in this Annual Report on
Form 10-K, including the consolidated 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.
EILEEN O'NEILL ODUM
President
GERALD K. DINSMORE
Senior Vice President - Finance and Planning
30
<PAGE> 33
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
31
<PAGE> 34
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) Financial Statements - See GTE Northwest Incorporated's
consolidated financial statements and report of independent
accountants thereon in the Financial Statements section included
elsewhere herein.
(2) Financial Statement Schedules - Schedules supporting the consolidated
financial statements for the years ended December 31, 1997-1995 (as
required):
II - Valuation and Qualifying Accounts
Note: Schedules other than the one listed above are omitted as not
applicable, not required, or the information is included in the
consolidated financial statements or notes thereto.
(3) Exhibits - Included in this report or incorporated by reference.
2.1* Agreement of Merger dated November 18, 1992 between Contel of
the Northwest Inc. and GTE Northwest Incorporated (Exhibit
2.1 of the 1993 Form 10-K, File No. 0-2908)
3.1* Articles of Incorporation and amendments are referenced in the
1986 and 1987 Form 10-K's, respectively
3.2* Amended Bylaws (Exhibit 3.2 of the 1995 Form 10-K, File No.
0-2908)
4.1* Indenture dated as of April 1, 1994 between GTE Northwest
Incorporated and Bank of America National Trust and Savings
Association, as Trustee (Exhibit 4.1 of the Company's
Registration Statement on Form S-3, File No. 33-52909)
4.2* First Supplemental Indenture dated as of May 1, 1996 between
GTE Northwest Incorporated and First Trust of California,
National Association, as Trustee (as successor trustee to Bank
of America National Trust and Savings Association) (Exhibit
4.3 of the Company's Registration Statement on Form S-3, File
No. 333-2839)
10.1* Material Contracts - Agreements between GTE and Certain
Executive Officers (Exhibit 10 of the 1995 Form 10-K, File No.
0-2908)
10.2 Material Contracts - Separation Agreement between GTE and
Richard M. Cahill
12 Statements re: Calculation of the Consolidated Ratio of
Earnings to Fixed Charges
23 Consent of Independent Public Accountants
27 Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of 1997.
* Denotes exhibits incorporated herein by reference to previous filings
with the Securities and Exchange Commission as designated.
32
<PAGE> 35
GTE Northwest Incorporated and Subsidiary
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
For The Years Ended December 31, 1997, 1996 and 1995
(Thousands of Dollars)
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E
- --------------------------------------------------------------------------------------------------------------------
Additions
-----------------------------
Deductions
Balance at Charged from
Beginning Charged to (Credited) to Reserves Balance at
Description of Year Income Other Accounts (Note 1) Close of Year
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Allowance for uncollectible accounts
for the years ended:
December 31, 1997 $17,384 $ 13,346 $ 16,728(2) $ 32,943 $14,515
======= ========== ============== ============= =======
December 31, 1996 $13,268 $ 15,828 $ 15,855(2) $ 27,567 $17,384
======= ========== ============== ============= =======
December 31, 1995 $ 7,745 $ 23,442 $ 21,716(2) $ 39,635 $13,268
======= ========== ============== ============= =======
Accrued restructuring costs for the
years ended:
December 31, 1996 $64,315 $ -- $ (15,778)(3) $ 48,537 $ --
======= ========== ============== ============= =======
December 31, 1995 $99,544 $ -- $ -- $ 35,229 $64,315
======= ========== ============== ============= =======
</TABLE>
NOTES:
(1) Charges for which reserve was created.
(2) Recoveries of previously written-off amounts.
(3) Represents amounts necessary to satisfy commitments related to the
re-engineering program that were reclassified to accounts payable and
accrued expenses.
33
<PAGE> 36
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 NORTHWEST INCORPORATED
---------------------------------
(Registrant)
Date March 26, 1998 By /s/ Eileen O'Neill Odum
---------------------- ---------------------------------
Eileen O'Neill Odum
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/ Eileen O'Neill Odum President March 26, 1998
- ---------------------------- (Principal Executive Officer)
Eileen O'Neill Odum
/s/ Gerald K. Dinsmore Senior Vice President - Finance March 26, 1998
- ---------------------------- and Planning
Gerald K. Dinsmore (Principal Financial Officer)
/s/ William M. Edwards, III Vice President - Controller March 26, 1998
- ---------------------------- (Principal Accounting Officer)
William M. Edwards, III
/s/ John C. Appel Director March 26, 1998
- ----------------------------
John C. Appel
/s/ Mateland L. Keith, Jr. Director March 26, 1998
- ----------------------------
Mateland L. Keith, Jr.
/s/ Lawrence R. Whitman Director March 26, 1998
- ----------------------------
Lawrence R. Whitman
</TABLE>
34
<PAGE> 37
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------------------- ----------------------------------------------------------------------------
<S> <C>
10.2 Material Contracts - Separation Agreement between GTE and Richard M. Cahill
12 Statements re: Calculation of the Ratio of Earnings to Fixed Charges
23 Consent of Independent Public Accountants
27 Financial Data Schedule
</TABLE>
<PAGE> 1
Exhibit 10-2
[AS AMENDED JANUARY 23, 1998]
December 24, 1997
Mr. Richard M. Cahill
1158 Hidden Ridge
Apartment 2311
Irving, Texas 75038
Dear Dick:
As we discussed, I want to provide you with an appropriate transition
arrangement prior to your scheduled separation and to enter into a consulting
arrangement with you in accordance with the terms set forth below. This
agreement ("Letter Agreement") supersedes any other agreements you may have with
GTE (as defined below) or may have received from GTE with regard to the subject
matter contained herein, including but not limited to the letter dated August
13, 1997. The terms of this Letter Agreement are as follows:
A. RESIGNATION FROM EMPLOYMENT
1. RESIGNATION - Effective July 31, 1997, you irrevocably resign from your
position as Vice President and General Counsel - GTE Telephone Operations.
Effective no later than December 31, 1997, you also irrevocably resign from any
officer, director, or other positions you hold for GTE Corporation or any
affiliate of GTE Corporation (collectively referred to in this Letter Agreement
as "GTE") and from any internal or external Boards where you represent GTE
effective as of that date.
2. SPECIAL ASSIGNMENT - From August 1, 1997 through June 30, 1998 ("Special
Assignment Period"), you will continue on the GTE Service Corporation (the
"Company") payroll as an active employee in your new special assignment as Vice
President and Associate General Counsel, reporting to me or my successor or
designee. During the Special Assignment Period, you will work on special
projects as assigned by me or my successor or designee. In addition, during the
Special Assignment Period, you will continue to receive your base salary as in
effect on July 31, 1997 and will receive all benefits that active employees
receive, except that your EIP and LTIP participation will be governed by the
terms of this Letter Agreement. Except as otherwise expressly provided herein,
all perquisites provided by the Company will cease at the end of the Special
Assignment Period. In the event the Company offers any new employee plans, any
new, enhanced, or supplemental executive plans, or, except as expressly provided
herein, any new grants, awards, or benefits under existing executive plans on or
after July 31, 1997, you will not participate in such plans or receive such
grants, awards, or benefits. You irrevocably resign from employment with GTE and
the position of Vice President and Associate General Counsel effective June 30,
1998. During and after the Special Assignment Period, you will not seek
reinstatement, recall, or future or other employment with GTE.
3. SEPARATION BENEFITS - At the conclusion of the Special Assignment
Period, you will separate from employment with the Company and you will be
eligible for separation benefits pursuant to the Company's Involuntary
Separation Program ("ISEP") or its equivalent as then in effect, subject to any
applicable release requirements.
4. EIP AWARDS - You will participate in the Executive Incentive Plan
("EIP") at a Salary Grade Level 20 for the full 1997 Plan Year and one half
(1/2) of the 1998 Plan Year in accordance
<PAGE> 2
Mr. Richard M. Cahill
December 24, 1997
Page 2
with the terms of the EIP. Your 1997 EIP award and pro-rated 1998 EIP award will
be the same as the average EIP rating for the Company's Legal Department for
each such year. You will not participate in EIP for the 1999 Plan Year or
thereafter. All EIP awards will be subject to approval by the GTE Corporation
Executive Compensation and Organizational Structure Committee ("ECC"). The EIP
awards will be payable at the same time EIP awards are payable to other EIP
participants. You will be eligible to defer, and thus receive a match pursuant
to the Equity Participation Program ("EPP"), only those of your EIP awards
payable while you are still employed by GTE (in this case, only the 1997 Plan
Year award). Note that the ECC reserves the right not to approve EIP awards in
1997 and/or 1998, and, if so, you will be treated in the same manner as other
executives at your salary level.
5. LTIP - Subject to ECC approval, in the spring of 1998, you will be
eligible for a standard grant of Stock Options, and you also will be eligible
for a Performance Bonus Award for the 1998-2000 award cycle under the GTE
Long-Term Incentive Plan ("LTIP"). You will not receive grants of Stock Options
or Performance Bonus Awards under LTIP after the initial spring of 1998 grants.
Your outstanding Stock Options will vest immediately upon your separation at the
end of the Special Assignment Period (subject to applicable release
requirements), and you will have until the earlier of: (i) five years from your
date of separation or (ii) the expiration date of the Option to exercise those
Stock Options ("Special Exercise Period"). The Special Assignment Period will be
counted for prorating your existing Performance Bonus Awards. As such, your
participation in LTIP Performance Bonus Cycles will be as follows: 1995-1997
(Full Participation), 1996-1998 Cycle (30/36 Participation), 1997-99 (18/36
Participation), and 1998-2000 (6/36 Participation). You will not receive any
Performance Bonus Award in 1999 or thereafter. Achievement of targets,
determination of the amount of Performance Bonus Awards, and determination of
the number of shares covered by your grant of Stock Options will be established
in the sole discretion of the ECC. Each Performance Bonus Award will be payable
at the same time LTIP awards are payable to other LTIP participants. You will be
eligible to defer, and thus receive a match pursuant to the EPP, only those of
your LTIP Performance Bonus Awards payable while you are still employed by GTE
(in this case, only the 1995-97 Performance Bonus Award). For purposes of this
Letter Agreement, your 1998 Stock Option and Performance Bonus Award grants are
collectively referred to as "LTIP Grants." Note that the ECC reserves the right
not to make Stock Option or Performance Bonus Awards in 1998, and, if so, you
will be treated in the same manner as other executives at your salary level.
6. RELEASE - In order to receive full Separation Benefits (including but
not limited to full ISEP and the Special Exercise Period described in paragraph
5 above) and the 1998 EIP Award, and in order for your participation in the LTIP
Performance Bonus Award Cycles to be as described in paragraph 5 above, you will
be required to sign a release upon the expiration of the Special Assignment
Period.
7. VACATION - At the end of the Special Assignment Period, you may elect to
take the remainder of your banked/accrued but unused vacation in a lump sum. In
the alternative, you may elect to use your banked/accrued but unused vacation to
extend your last day as an active employee on payroll; provided that any such
extension shall not affect the payment or pro-ration of your EIP and LTIP awards
as set forth in paragraphs 4 and 5 above.
8. MISCELLANEOUS BENEFITS - During the Special Assignment Period, you will
be entitled to the same level of executive perquisites as other similarly
situated executives in Dallas are accorded, and you will also be entitled to
office space at a location to be determined by GTE in its sole discretion. After
the end of the Special Assignment Period, the Company will pay for tax
preparation services for you for the 1998 calendar year, which would be paid in
1999, up to a maximum of $3,000. The benefits described in this paragraph A.8
are collectively referred to in this Letter Agreement as miscellaneous benefits
("Miscellaneous Benefits").
<PAGE> 3
Mr. Richard M. Cahill
December 24, 1997
Page 3
9. CIRCUMSTANCES WHEN ABOVE PAYMENTS/BENEFITS WILL NOT BE PAID - In the
event any of the following occur prior to the expiration of the Special
Assignment Period (or if applicable after the expiration of the Special
Assignment Period), you will cease to receive any further salary, the Special
Exercise Period will not apply, you will not receive any EIP Payments, LTIP
Grants, payment of Performance Bonus Awards, Separation Benefits (including but
not limited to ISEP), Miscellaneous Benefits, or any other benefits or payments,
and you will not be required to perform, and will not be paid for, any
consulting services:
- you voluntarily terminate your employment for any reason;
- your employment is terminated for cause as determined by me or my
successor or designee; or
- you violate any of the terms of the attached Separation Agreement
and General Release (including but not limited to the provisions
regarding confidentiality and non-embarrassment) or the
non-compete provisions of paragraphs A.10 and B.7 of this Letter
Agreement.
In the event that you die or become disabled (within the meaning of GTE's
Long-Term Disability Plan) during the Special Assignment Period, all further
salary will cease, your eligibility for the Miscellaneous Benefits will cease,
your EIP Payments and Performance Bonus Awards will be pro-rated to the date of
your death or disability (but will not be paid until the date they otherwise
would have been paid had you not died or become disabled), the Special Exercise
Period will not apply, your Separation Benefits (including but not limited to
ISEP) will be treated in accordance with the terms of the relevant plans or
policies, your eligibility for the LTIP Grants will be determined in accordance
with the relevant plan provisions, and you will not be required to perform, and
will not be paid for, any consulting services.
10. MISCELLANEOUS - Since you will remain a GTE employee until the end of
the Special Assignment Period, you will remain subject to all GTE policies,
including but not limited to GTE's policies relating to non-competition and
disclosure of confidential information. You shall be responsible for the payment
of all applicable taxes relating to the benefits described in Paragraph A of
this Letter Agreement, including but not limited to taxes as a result of ISEP or
any ISEP equivalent payment.
B. CONSULTING ARRANGEMENT
1. CONSULTING PERIOD. You will serve as a non-employee consultant for the
period July 1, 1998 through June 30, 2000 (the "Consulting Period"). During the
Consulting Period and thereafter, you will not be entitled to any benefits
provided by GTE to its active employees and, by signing below, you acknowledge
and agree that you shall not be entitled to any such benefits and effectively
waive participation in any such benefits.
2. CONSULTING SERVICES. During the Consulting Period, you will perform
special projects as assigned by me or my successor or designee. All required
services will be performed by you. You will be free at all times to arrange the
time and manner of performance of the consulting services to be rendered
hereunder and will not be expected to maintain or observe a schedule of duties
or assignments. You will not report to the Company on any regular basis, but
will work as you may independently decide. You will not be required to provide
consulting services to the Company for more than 30% of the regularly scheduled
working days in any calendar year during the term of this Letter Agreement. The
Company is entering into this arrangement with the
<PAGE> 4
Mr. Richard M. Cahill
December 24, 1997
Page 4
understanding that the performance of your services will be subject to the
non-compete provisions of paragraph B.7 below. During the Consulting Period and
thereafter, you may, in your discretion, provide services to others without
being constrained by your obligations under this Letter Agreement, provided only
that such services do not prevent you from providing the consulting services
required under this Letter Agreement, and provided further that such services to
others do not cause you to violate your obligations regarding non-competition,
confidentiality, and intellectual property rights as described in this Letter
Agreement and the attached Separation Agreement and General Release.
3. COMPANY CONTACT. I or my successor or designee will be your contact at
the Company during the Consulting Period and will be responsible for
coordinating your assignments. All services must be performed to my satisfaction
or to the satisfaction of my successor or designee.
4. CONSULTING FEES. You will be paid $164,000 per year for your consulting
services during the Consulting Period, payable in equal quarterly installments
of $41,000 in arrears. You also will be entitled to be reimbursed for reasonable
travel expenses you incur in the performance of consulting services for the
Company as approved by me or my successor or designee. Please submit quarterly
invoices to me or to my successor or designee for payment. You will be paid the
full amount of your annual consulting fees during the Consulting Period whether
or not you actually perform consulting services for the Company.
5. PERFORMANCE OF CONSULTING SERVICES. As a non-employee consultant, the
Company does not retain or exercise the right to direct, control, or supervise
you as to the details and means by which the consulting services contracted for
are accomplished. You and the Company agree that, as a non-employee consultant,
you will serve as an independent contractor in the performance of your duties
under this Letter Agreement. As a result, you will be responsible for payment of
all taxes and expenses incurred arising out of the payments under the Letter
Agreement for your activities as a non-employee consultant in accordance with
this Letter Agreement, including but not limited to, federal and state income
taxes, social security taxes, unemployment insurance taxes, and any other taxes
or business license fees as required. Moreover, you agree that, except as
authorized by the Company, you will not represent directly or indirectly that
you are an agent or legal representative of the Company, nor will you incur any
liabilities or obligations of any kind in the name of or on behalf of the
Company, other than those specifically made or approved as part of this Letter
Agreement.
6. OFFICE SPACE. You are responsible for securing your own office space,
office equipment, and clerical support services during the Consulting Period,
but visiting office space and appropriate office equipment will be provided to
you if you are meeting with individuals at GTE's offices.
7. NON-COMPETE PROVISIONS. As a non-employee consultant, you agree that,
among other policies and guidelines, the GTE Conflict of Interest Guidelines and
the Business and Scientific Information Policy or replacement policies will
apply to you. In addition, you agree not to engage directly or indirectly in a
Competitive Business during the Consulting Period, unless the Company approves
such an arrangement in writing in advance. For purposes of this paragraph B.7, a
"Competitive Business" is any inter-exchange carrier (such as MCI Communications
Corporation, Sprint Corporation, AT&T Corp., WorldCom, Inc., LCI International,
Inc., and Cable & Wireless
<PAGE> 5
Mr. Richard M. Cahill
December 24, 1997
Page 5
PLC) and its Affiliates, any local exchange carrier (such as any Regional Bell
Operating Company ("RBOC") and British Telecommunications PLC) and its
Affiliates, or any of the following companies and their Affiliates: Digex,
Incorporated, Qwest Communications International Inc., Netscape Communications
Corporation, Cisco Systems, Inc., Ascend Communications, Inc., Airtouch
Communications, Inc., NEXTEL Communications, Inc., and Teleport Communications
Group, Inc. An Affiliate for purposes of this paragraph B.7 shall mean any
entity, whether or not incorporated, (i) in which a Competitive Business has
equity ownership of 10% or more, or (ii) which provides goods or services
(including but not limited to software, processing, switching, marketing, or
consulting) to a Competitive Business to materially compete with GTE.
You acknowledge that the obligations imposed on you pursuant to this
paragraph B.7 are reasonable in their nature, scope and duration and will not
deprive you of the opportunity to earn a livelihood. During and after the
Consulting Period, you also will remain subject to those GTE policies which
apply following termination of service.
Subject to paragraph B.8, in consideration of your compliance with the
provisions of this paragraph B.7, the Company will pay to you $25,000 per
quarter payable in arrears, commencing with the quarter beginning July 1998 and
ending with the quarter ending June 2000 (or such later date as the parties may
agree in writing). If you fail to comply with the provisions of this paragraph
B.7, you will forfeit your right to receive the payments described in this
paragraph B.7.
8. EARLY TERMINATION OF CONSULTING SERVICES. In the event any of the
following occurs during the Consulting Period, this Letter Agreement will
terminate immediately, and, except as provided in the immediately succeeding
sentence, you will not be entitled to any further payments under paragraphs B.4
or B.7: you violate any of the provisions of this Letter Agreement or the
Separation and General Release referred to below; you die; you become disabled;
or you fail to provide services under this Letter Agreement to the satisfaction
of the Company. Of course you will be entitled to payment of amounts due
pursuant to paragraphs B.4 and B.7 with respect to that portion of the quarter
prior to the termination of your consulting services in an amount equal to the
payment due for the quarter multiplied by a fraction, the numerator of which is
the number of days in the quarter prior to the termination of your consulting
services and the denominator of which is 90.
C. GENERAL PROVISIONS
1. CONFIDENTIALITY. You agree that any information you receive or acquire
during the performance of your obligations in accordance with this Letter
Agreement or have received or acquired from your prior employment with GTE will
be treated by you in the strictest confidence and will not be disclosed to or
used for the benefit of any persons, firms or organizations. This provision will
survive the termination of this Letter Agreement.
2. GTE AS EXCLUSIVE OWNER OF WORK PRODUCT. You agree that GTE will be the
exclusive owner of all works conceived or first produced by you within the scope
of your prior employment with GTE or pursuant to or related to this Letter
Agreement and your services as a consultant, including that GTE will be the
exclusive owner of all copyrights and other intellectual property rights in or
based upon such works. With regard to such copyrightable works, you agree that
GTE will be the "person for whom the work is prepared" and that GTE will be the
exclusive work-for-hire author under the copyright laws of the United States. In
addition, you agree to and to
<PAGE> 6
Mr. Richard M. Cahill
December 24, 1997
Page 6
hereby assign exclusively to GTE such works, copyrights and other intellectual
property rights. This provision will survive the termination of this Letter
Agreement.
The arrangements described above are contingent upon your executing the
attached Separation Agreement and General Release (the "Release"). As you know,
you were given a version of this Letter Agreement dated October 16, 1997 and,
therefore, you have been given twenty-one days to sign the Release (with a
seven-day period to revoke) as required by law. Although not legally required,
we have determined to give you an additional twenty-one day period commencing as
of December 24, 1997 (with a seven-day period to revoke) to sign the Release.
Since the December 24, 1997 version of this Letter Agreement has been modified
based on requests you have made, you continue to have twenty-one days from
December 24, 1997 to sign the Release (with a seven-day period to revoke). If
you fail to sign the Release or if you sign and revoke the Release within seven
days of signing it, this Letter Agreement shall be void, and you will not
receive any of the benefits described in this Letter Agreement.
Dick, your past contributions to GTE are appreciated by me and the entire
GTE management team.
Sincerely,
William P. Barr
Executive Vice President -
Government and Regulatory Advocacy,
General Counsel
I have read, understand, and agree to the terms of this Letter Agreement
including the attached Separation Agreement and General Release.
- ---------------------- ---------------
Richard M. Cahill Date
<PAGE> 7
SEPARATION AGREEMENT AND GENERAL RELEASE
This Agreement is by and between GTE Service Corporation (the "Company")
and Richard M. Cahill ("Cahill").
PART I
In consideration of the provisions in Part II, the Company agrees as
follows:
1. The Company will provide Cahill with the benefits described in William
P. Barr's letter dated December 24, 1997, as amended January 9, 1998 (the
"December 24, 1997 Letter"). (The December 24, 1997 Letter and this Separation
Agreement and General Release are collectively referred to as the "Agreement").
2. By making this Agreement, the Company does not admit that it has done
anything wrong, and the Company specifically states that it has not committed
any tort, breach of contract, or violation of any federal, state, or local
statute or ordinance.
PART II
In consideration of the provisions in Part I, Cahill agrees as follows:
1. Effective July 31, 1997, Cahill irrevocably resigns from his position as
Vice President and General Counsel - GTE Telephone Operations, from any officer,
director, or other positions he holds for GTE Corporation or any of its
affiliates, and from any internal or external Boards where he represents GTE (as
described in paragraph 3 below), at which time Cahill will commence the Special
Assignment described in the December 24, 1997 Letter. Cahill irrevocably resigns
from employment with GTE effective at the end of the Special Assignment Period
described in the December 24, 1997 Letter. Cahill agrees not to seek
reinstatement, recall, or future employment with GTE after the end of the
Special Assignment Period.
Cahill agrees that GTE retains the right to make future organizational changes,
including but not limited to the right to combine, create, and/or fill
positions.
2. Cahill agrees and understands that the payments and the benefits
described in Part I, paragraph 1 above are more than any payments or benefits
due to him under the Company's policies or practices. Cahill waives and forever
discharges GTE (as described in paragraph 3 below) from any liability to provide
any notice of termination, including but not limited to any notice under the
Worker Adjustment and Retraining Notification Act, or to pay any additional
salary continuance, separation pay, severance pay, retention bonus or pay,
retirement incentive, or payments or benefits arising under any other plan,
policy, practice, or program (offered on a qualified or non-qualified or
voluntary or involuntary basis) which may have been payable as a result of the
termination of his employment, except as provided in paragraph 3 below. Cahill
agrees that, should the Company offer any retirement incentive, early
retirement, or voluntary separation program on or after July 31, 1997, Cahill
shall not be eligible to participate. In addition, Cahill has not relied on any
statement, agreement, or promise of eligibility for any benefits, other than
those set forth in this Agreement.
<PAGE> 8
3. Cahill agrees to release GTE Corporation and any related or affiliated
companies, and any and all current and former directors, employees, officers,
agents, and contractors of these companies, and any and all employee pension or
welfare benefit plans of these companies, including current and former trustees
and administrators of these plans, (hereinafter GTE Corporation, the Company,
and the other entities and persons referenced above are collectively referred to
in this Separation Agreement and General Release as "GTE") from all known and
unknown claims, charges, or demands Cahill may have based on his employment with
GTE, including a release of any rights or claims Cahill may have under the Age
Discrimination in Employment Act ("ADEA"), which prohibits age discrimination in
employment; Title VII of the Civil Rights Act of 1964, and the Civil Rights Act
of 1991, which prohibit discrimination in employment based on race, color, sex,
religion, and national origin; the Americans with Disabilities Act, which
prohibits discrimination based upon disability; Section 1981 of the Civil Rights
Act of 1866, which prohibits discrimination based on race; the Employee
Retirement Income Security Act, which governs employee benefits; any state laws
against discrimination; or any other federal, state, or local statute or common
law relating to employment. This includes a release by Cahill of any claims for
wrongful discharge, breach of contract, employment-related torts, or any other
claims in any way related to Cahill's employment with GTE.
This release does not include, however, a waiver of any right to vested benefits
under any pension or savings plan, any right to Worker's Compensation, any right
to receive pay for banked and accrued, but unused, vacation, or any right to
unemployment compensation that Cahill may have.
4. Cahill has not filed and promises not to file, or permit to be filed on
his behalf, any lawsuit or complaint against GTE regarding the claims released
in Part II, paragraph 3 above. Cahill also promises to opt out of and to take
such other steps as he has the power to take to disassociate himself from any
class seeking relief against GTE regarding any claims released in Part II,
paragraph 3. If a court, administrative agency, arbitrator, or any other
decision maker with authority awards Cahill money damages or other relief, with
respect to claims released in Part II, paragraph 3, Cahill hereby assigns to the
Company all rights and interest in such money damages and other relief.
5. Cahill agrees not to disclose the terms of this Agreement, that this
Agreement exists, or that he received any payments from the Company to anyone
except his attorney, his financial planner, or his immediate family (spouse,
children, siblings, parents). If he does disclose the terms of this Agreement to
his immediate family, his financial planner, or his attorney, he will advise
them that they must not disclose the terms of this Agreement.
6. Cahill acknowledges that, during the period he has served as an in-house
attorney with GTE, he has had access to confidential information relating to
GTE. Consistent with the Rules of Professional Conduct, Cahill will not use or
disclose any such confidential information without first obtaining the consent
of the Company.
Cahill agrees to comply with the provisions of GTE H.R. Policy 412 (Attachment
I) provided that, in the event of a conflict between Policy 412 and this
Agreement, the terms of this Agreement shall take precedence. Contemporaneously
with the execution of this Agreement, if Cahill has not executed a copy of the
Business and Scientific Information Agreement, Cahill shall do so (Policy
Attachment A). Upon his termination, Cahill shall execute Policy Attachment D.
<PAGE> 9
Cahill further agrees to take no action that would cause GTE (including its
employees, directors, and shareholders) embarrassment or humiliation or
otherwise cause or contribute to GTE (including its employees, directors, and
shareholders) being held in disrepute by the general public or GTE's clients,
shareholders, customers, federal or state regulatory agencies, employees,
agents, officers, or directors.
Cahill will cooperate and make all reasonable efforts to assist the Company in
any investigation of matters involving GTE. Cahill also agrees to testify as a
witness and be available for interviews and to assist GTE in preparation for any
legal proceedings involving GTE in which Cahill has direct knowledge or specific
expertise. Cahill will be compensated appropriately and reimbursed for
reasonable expenses.
Nothing in this Agreement shall be construed to prevent Cahill from giving
compelled truthful testimony before any federal or state agency or in any
judicial proceeding; provided that, in order to permit GTE to seek an injunction
or other judicial relief, he will timely notify GTE in advance of any such
proceeding in which he expects to be called to testify or for which he has
received a subpoena.
7. Cahill acknowledges and agrees that he has not been discriminated
against in any way during his employment with GTE or with regard to his
separation from employment with the Company.
8. Cahill agrees that GTE will be entitled to recover liquidated damages in
the amount of $75,000 if he breaks his promises in Part II, paragraphs 1-6 of
this Agreement. These liquidated damages are based upon the parties' recognition
that damages to GTE due to Cahill's breaking of these promises are not capable
of measurement with any degree of certainty. The amount specified is not to be
considered a penalty, but solely as liquidated damages. If Cahill breaks his
promise in Part II, paragraph 4 and files a lawsuit or complaint regarding
claims Cahill has released, in addition to the liquidated damages described
above, Cahill will pay for all costs incurred by GTE, including reasonable
attorneys' fees, in defending against his claim.
9. Cahill understands that he has been given 21 days to review and consider
this Agreement before signing it. Cahill further understands that he may use as
much of this 21-day period as he wishes prior to signing this Agreement.
10. Cahill may revoke this Agreement within seven days after he signs it.
If Cahill wishes to revoke this Agreement within this seven-day period, written
notice of revocation should be delivered to the office of Thomas W. Green,
Senior Head of Stamford Transition Team, by the close of business seven days
after Cahill signs the Agreement. This Agreement will not become effective or
enforceable until seven days after Cahill signs it. If Cahill revokes this
Agreement, it will not be effective or enforceable, and he will not receive the
benefits described in Part I, paragraph 1.
11. Cahill agrees that the Company advised Cahill to consult with an
attorney before signing this Agreement.
12. The parties participated jointly in the negotiation of this Agreement,
and each party had the opportunity to obtain the advice of legal counsel and to
review, comment upon, and redraft this Agreement. Accordingly, it is agreed that
no rule of construction shall apply against any party or in
<PAGE> 10
favor of any party, and any uncertainty or ambiguity shall not be interpreted
against any one party and in favor of the other.
13. Cahill and the Company hereby consent that any disputes relating to
this Agreement will be governed by Connecticut law.
14. In the event that any one or more of the provisions contained in this
Agreement shall, for any reason, be held to be invalid, illegal, or
unenforceable in any respect, such invalidity, illegality, or unenforceability
shall not affect any other provision of this Agreement.
15. This Separation Agreement and General Release and the December 24, 1997
Letter constitute the entire Agreement between Cahill and the Company and shall
be binding upon the heirs, successors, and assigns of Cahill and the Company. No
other promises or agreements have been made to Cahill other than those in this
Agreement. Cahill is not relying on any statement, representation, or warranty
that is not contained in this Agreement. Cahill acknowledges that he has read
this Agreement carefully, fully understands the meaning of the terms of this
Agreement, and is signing this Agreement knowingly and voluntarily.
Subscribed and sworn to before ----------------------------
me this____day of____, 1998. Richard M. Cahill
- -------------------------- ----------------------------
Notary Public Date
Subscribed and sworn to before GTE Service Corporation
me this____day of____, 1998.
- -------------------------- ----------------------------
Notary Public By:
Title:
----------------------------
Date
<PAGE> 1
Exhibit 12
GTE Northwest Incorporated and Subsidiary
STATEMENTS OF THE CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------------------------------
1997 1996 1995 1994 1993 1993(a)
-------------------------------------------------------------------------
(Thousands of Dollars)
<S> <C> <C> <C> <C> <C> <C>
Net earnings available for fixed charges:
Income before extraordinary charges $249,592 $187,426 $150,187 $118,649 $ 14,330 $ 96,421
Add - Income tax expense 129,825 103,812 77,217 58,159 5,581 56,193
- Fixed charges 57,585 58,051 60,382 56,089 61,955 61,955
-------- -------- -------- -------- -------- --------
Adjusted earnings: $437,002 $349,289 $287,786 $232,897 $ 81,866 $214,569
======== ======== ======== ======== ======== ========
Fixed charges:
Interest expense $ 53,446 $ 53,745 $ 56,292 $ 52,086 $ 58,185 $ 58,185
Portion of rent expense
representing interest 4,139 4,306 4,090 4,003 3,770 3,770
-------- -------- -------- -------- -------- --------
Adjusted fixed charges: $ 57,585 $ 58,051 $ 60,382 $ 56,089 $ 61,955 $ 61,955
======== ======== ======== ======== ======== ========
RATIO OF EARNINGS TO FIXED
CHARGES: 7.59 6.02 4.77 4.15 1.32 3.46
</TABLE>
(a) Excludes an after-tax restructuring charge of approximately $77 million for
the implementation of a re-engineering plan and a one-time after-tax charge
of approximately $5.1 million related to the enhanced early retirement and
voluntary separation programs offered to eligible employees in 1993.
<PAGE> 1
Exhibit 23
CONSENT OF INDEPENDENT ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation
of our report, dated January 26, 1998, on the financial statements and
supporting schedule and exhibit of GTE Northwest Incorporated included in this
Form 10-K, into the Registration Statement filed on Form S-3 (File No.
333-02839).
ARTHUR ANDERSEN LLP
Dallas, Texas
March 26, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 1,479
<SECURITIES> 0
<RECEIVABLES> 280,937
<ALLOWANCES> 14,515
<INVENTORY> 19,570
<CURRENT-ASSETS> 295,304
<PP&E> 3,419,072
<DEPRECIATION> 2,127,092
<TOTAL-ASSETS> 1,694,114
<CURRENT-LIABILITIES> 408,514
<BONDS> 683,066
0
0
<COMMON> 448,000
<OTHER-SE> 37,972
<TOTAL-LIABILITY-AND-EQUITY> 1,694,114
<SALES> 1,143,176
<TOTAL-REVENUES> 1,143,176
<CGS> 365,702
<TOTAL-COSTS> 715,717
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 52,917
<INCOME-PRETAX> 379,417
<INCOME-TAX> 129,825
<INCOME-CONTINUING> 249,592
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 249,592
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
