<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended March 31, 1998
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 2-36292
GTE SOUTH INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
VIRGINIA 56-0656680
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
600 Hidden Ridge, HQE04B12 - Irving, Texas 75038
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code 972-718-5600
</TABLE>
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
--- ---
The Company had 21,000,000 shares of $25 par value common stock outstanding at
April 30, 1998. The Company's common stock is 100% owned by GTE Corporation.
<PAGE> 2
PART I. FINANCIAL INFORMATION
GTE South Incorporated
CONDENSED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------------
1998 1997
--------- ---------
(Thousands of Dollars)
<S> <C> <C>
REVENUES AND SALES
Local services $ 152,438 $ 131,737
Network access services 161,511 141,941
Toll services 20,027 40,225
Other services and sales 60,967 52,604
--------- ---------
Total revenues and sales 394,943 366,507
--------- ---------
OPERATING COSTS AND EXPENSES
Cost of services and sales 133,325 116,540
Selling, general and administrative 52,452 49,914
Depreciation and amortization 70,729 70,333
--------- ---------
Total operating costs and expenses 256,506 236,787
--------- ---------
OPERATING INCOME 138,437 129,720
Interest - net 14,412 12,586
--------- ---------
INCOME BEFORE INCOME TAXES 124,025 117,134
Income taxes 48,168 44,495
--------- ---------
INCOME BEFORE EXTRAORDINARY CHARGE 75,857 72,639
Extraordinary charge (243) --
--------- ---------
NET INCOME $ 75,614 $ 72,639
========= =========
</TABLE>
Per share data is omitted since the Company's common stock is 100% owned by GTE
Corporation (GTE).
See Notes to Condensed Financial Statements.
1
<PAGE> 3
GTE South Incorporated
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Dollars in Millions)
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended
March 31,
---------------------------------
1998 1997
-------------- --------------
<S> <C> <C>
Net income $75.6 $72.6
</TABLE>
Net income for the three months ended March 31, 1998 includes an after-tax
extraordinary charge of $0.2. Excluding this charge, net income increased 4% or
$3.2 for the three months ended March 31, 1998, compared to the same period in
1997. This increase is primarily the result of an increase in local and network
access service revenues, partially offset by lower toll service revenues and
higher operating costs and expenses.
REVENUES AND SALES
<TABLE>
<CAPTION>
Three Months Ended
March 31,
---------------------------------
1998 1997
-------------- --------------
<S> <C> <C>
Local services $152.4 $131.7
Network access services 161.5 142.0
Toll services 20.0 40.2
Other services and sales 61.0 52.6
-------------- --------------
Total revenues and sales $394.9 $366.5
</TABLE>
Total revenues and sales increased 8% or $28.4 for the three months ended March
31, 1998, compared to the same period in 1997.
Local service revenues increased 16% or $20.7 for the three months ended March
31, 1998, compared to the same period in 1997. Access line growth of 7% in 1998
generated additional revenues of $5.3 from basic local services and $1.8 from
Integrated Services Digital Network (ISDN) and Digital Channel Services (DCS).
Demand for enhanced custom calling features, such as SmartCall(R) services,
contributed $4.5 to the increase. The increase also reflects a $7.5 decline in
local service revenues recorded in the first quarter of 1997 associated with the
sharing provisions from the Virginia Alternative Regulatory Framework.
Network access service revenues increased 14% or $19.5 for the three months
ended March 31, 1998, compared to the same period in 1997. Minutes of use
increased 13% for the three months ended March 31, 1998, generating an
additional $10.6 in revenues. Special access revenues grew $8 due to greater
demand for increased bandwidth services by Internet Service Providers (ISPs) and
other high-capacity users. The impact of interstate access rate changes from the
1997 Federal Communications Commission (FCC) price cap increased revenues by
$3.3. These increases are partially offset by a decrease of $7.1 resulting from
intrastate access price reductions in Alabama, Kentucky, North Carolina, South
Carolina and Virginia.
2
<PAGE> 4
GTE South Incorporated
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Toll service revenues decreased 50% or $20.2 for the three months ended March
31, 1998, compared to the same period in 1997. The decrease is attributable to
lower toll volumes, primarily related to intraLATA (local access transport area)
toll competition, including 10XXX and 1+ presubscription, and the impact from
optional discount calling plans, which effectively lowered intrastate toll
rates. The decrease was also attributable to the impact of unfavorable
settlement activities of $9.4.
Other services and sales revenues increased 16% or $8.4 for the three months
ended March 31, 1998, compared to the same period in 1997. The increase is
primarily attributable to additional revenues of $1.7 from equipment sales, $1.6
resulting from the FCC's order on payphone compensation, $1.3 from billing and
collection services and $1 from directory advertising.
OPERATING COSTS AND EXPENSES
<TABLE>
<CAPTION>
Three Months Ended
March 31,
---------------------------------
1998 1997
-------------- --------------
<S> <C> <C>
Total operating costs and expenses $256.5 $236.8
</TABLE>
Total operating costs and expenses increased 8% or $19.7 for the three months
ended March 31, 1998, compared to the same period in 1997. The increase in
operating costs and expenses is due to a number of factors including higher
labor and benefits costs of $9.7, which were incurred to support access line
growth and customer demand for products and services, and the impact from
pension settlement gains recorded during the first quarter of 1997 of $4.4
resulting from lump-sum payments from the Company's pension plans. A $4.2 rise
in maintenance and repair costs associated with storm damage within the
Company's service territories and higher advertising and promotional costs of
$3.9 aimed at stimulating sales of enhanced services and preserving market share
in an increasingly competitive environment also contributed to the increase in
operating costs and expenses. These increases were partially offset by lower
access charges of $4.5 incurred to terminate customers' intraLATA toll calls
outside of the Company's service territories.
OTHER EXPENSES
<TABLE>
<CAPTION>
Three Months Ended
March 31,
---------------------------------
1998 1997
-------------- --------------
<S> <C> <C>
Interest - net $14.4 $12.6
Income taxes 48.2 44.5
Extraordinary charge 0.2 --
</TABLE>
Interest - net increased 14% or $1.8 for the three months ended March 31, 1998,
compared to the same period in 1997. This increase is primarily due to higher
average short-term debt levels.
Income taxes increased 8% or $3.7 for the three months ended March 31, 1998,
compared to the same period in 1997, primarily due to the corresponding increase
in pre-tax income.
During the first quarter of 1998, the Company recorded an after-tax
extraordinary charge of $0.2, reflecting premiums paid on the redemption of
high-coupon debt prior to stated maturity.
3
<PAGE> 5
GTE South Incorporated
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
CAPITAL RESOURCES AND LIQUIDITY
Management believes that the Company has adequate internal and external
resources available to meet ongoing operating requirements for construction of
new plant, modernization of facilities and payment of dividends. The Company
generally funds its construction program from operations although external
financing is available. Short-term financings can be obtained through borrowings
from the Company's parent, GTE, or GTE Funding Incorporated, an affiliate of the
Company. The Company participates with other affiliates in a $1,500, 364-day
syndicated line of credit. In December 1997, the Company began participating
with GTE and other of its affiliates in a series of five bilateral credit
agreements for an additional $2,000 in credit capacity. These facilities, which
are shared by the participating companies, are aligned with the maturity date of
the 364-day line of credit. The Company has an existing shelf registration
statement for an additional $225 of debentures.
The Company's primary source of funds during the first three months of 1998 was
cash from operations of $171.9 compared to $198.7 for the same period in 1997.
The decrease in cash from operations is primarily the result of an increase in
working capital requirements, partially offset by increased results from
operations.
The Company's capital expenditures during the first three months of 1998 were
$68 compared to $53.4 for the same period in 1997. The 1998 expenditures reflect
the Company's continued growth in primary and secondary access lines and the
modernization of interoffice facilities to mitigate Internet congestion. The
Company's anticipated capital expenditures for 1998 are expected to be
comparable to the total capital expenditures incurred during 1997, reflecting
the continued growth of existing networks.
Net cash used in financing activities was $113 during the first three months of
1998 compared to $136.6 for the same period in 1997. Affiliate payables
increased $7.1 for the first three months of 1998, compared to an increase in
affiliate receivables of $80.4 for the same period in 1997. Dividend payments
for 1998 were $85.2 compared to $46 in 1997. During the first quarter of 1998,
the Company paid a total of $34.9 for the retirement of debt and preferred stock
compared to $10.1 for the same period in 1997. Retirements for 1998 included
$0.4 paid in premiums on the retirement of long-term debt and preferred stock
redeemed prior to stated maturity.
In its April 2, 1998 filing on Form 8-K, the Company's parent, GTE, stated that
because the MCI shareholders had accepted a competing offer, GTE's offer for MCI
was no longer outstanding. As a result, the Company and GTE were removed from
"Credit Watch" by all rating agencies. The Company believes that its present
investment grade credit rating provides ready access to the capital markets at
reasonable rates and provides the Company with the financial flexibility
necessary to pursue growth opportunities as they arise.
OTHER MATTERS
Alabama
On February 12, 1997, the Alabama Public Service Commission (APSC) issued its
decision in the Company's arbitration with AT&T Corp. (AT&T) to determine
interconnection, resale and unbundling terms and conditions. The interim
wholesale discount rate for retail services was set at 23%. The Company filed
for reconsideration of this order. On May 14, 1997, the APSC issued its final
decision, in which no material changes were made to its original order. On June
4, 1997, the Company and AT&T filed a composite agreement pursuant to the APSC's
4
<PAGE> 6
GTE South Incorporated
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
directive. Both parties have filed letters with the APSC objecting to certain
language contained in the composite agreement. The APSC is expected to issue a
final order on the composite agreement in the near future. In December 1997, the
APSC changed the discount rate to 21.1%. In January 1998, the Company filed a
petition asking the APSC to modify the discount rate using updated toll revenue
data. The Company has requested the APSC to modify the discount rate to 13.3% if
1995 data is used or to 11.4% if 1996 data is used.
On February 10, 1998, the APSC held a hearing to set the Company's permanent
unbundled network element (UNE) rates based on total element long run
incremental costs (TELRIC) studies. The Company's position is virtually
uncontested as a result of AT&T withdrawing from the proceeding in January 1998.
The APSC is expected to issue a final decision by mid-1998.
In February 1998, the APSC held hearings to determine the appropriate cost model
and revenue benchmark for purposes of developing an intrastate universal service
fund (USF) mechanism. The APSC is expected to issue its decision in the near
future.
Illinois
On October 6, 1996, the Illinois Commerce Commission (ICC) initiated its
investigation into the Company's TELRIC studies to establish rates for
interconnection, UNEs and transportation and termination of traffic. The
proceeding will address wholesale rates separately from UNEs, with each issue
having a separate procedural schedule. The determination of wholesale rates is
expected to conclude in mid-1998. Cost studies for UNEs were filed during the
first quarter of 1998 and will be refiled during the second quarter of 1998.
Hearings are scheduled to begin during the fourth quarter of 1998.
Kentucky
The Kentucky Public Service Commission (KPSC) has established a competitively
neutral, portable intrastate USF, funded by all telecommunications providers in
Kentucky, to cover the incumbent local-exchange carrier's (LEC's) non-traffic
sensitive (NTS) costs and the cost of a new statewide Lifeline service offering.
As a result, the Company would reduce access and toll rates and recover its NTS
costs from the USF. The details of implementation of the USF were to be
determined during a formal proceeding which began in November 1997. The KPSC
announced that its decision to transfer the LEC's NTS costs to the USF will be
reconsidered during the formal proceeding. Updated cost data and accompanying
testimony were filed in February 1998 and hearings were held in March 1998. The
KPSC is expected to issue its decision in this proceeding by May 26, 1998.
North Carolina
The North Carolina Utilities Commission (NCUC) held hearings during February
1998 to determine the appropriate forward-looking economic cost studies to be
submitted to the FCC for use in the determination of universal service funding
levels and to resolve other USF issues. On April 20, 1998, the NCUC issued an
order adopting version 3.1 of the benchmark cost proxy model (BCPM) as its
preferred forward looking economic cost model.
The NCUC also held hearings in March 1998 to establish permanent prices for
UNEs. The Company filed prices based on its own specific integrated cost model
(ICM).
5
<PAGE> 7
GTE South Incorporated
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
South Carolina
The South Carolina Public Service Commission (SCPSC) held hearings in August
1997 to determine guidelines for an intrastate USF. An order adopting the
guidelines was issued on September 3, 1997. Hearings to finalize other issues,
including the size of the USF and the model to be used and recommended to the
FCC, were held in March 1998. As a result of the hearings, the SCPSC adopted
version 3.1 of the BCPM.
RECENT DEVELOPMENTS
In April 1998, the Company's parent, GTE, announced a series of actions designed
to further sharpen its strategic focus and improve its competitive position by
repositioning non-strategic properties and reducing costs. GTE expects to
generate after-tax proceeds of $2,000 - $3,000 by selling non-strategic or
under- performing operations and plans to reduce annual costs by more than $500
through improved efficiencies and productivity while it continues to invest in
new high-growth opportunities. The impact of this announcement on the Company is
unknown at this time. GTE's management is currently assessing its options and,
as decisions are finalized regarding the sale of non-strategic operations and
cost reductions, the Company could be affected.
6
<PAGE> 8
GTE South Incorporated
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
----------- ------------
(Thousands of Dollars)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 4,053 $ 13,104
Receivables, less allowances of $20,862 and $18,638 288,092 261,545
Inventories and supplies 29,394 24,366
Prepaid insurance 12,771 649
Other 11,048 10,556
----------- -----------
Total current assets 345,358 310,220
----------- -----------
Property, plant and equipment, at cost 4,341,667 4,285,696
Accumulated depreciation (2,721,683) (2,663,988)
----------- -----------
Total property, plant and equipment, net 1,619,984 1,621,708
Prepaid pension costs and other assets 171,421 162,675
----------- -----------
Total assets $ 2,136,763 $ 2,094,603
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term obligations, including current maturities $ 162,423 $ 155,413
Accounts payable 142,008 118,224
Taxes payable 76,893 31,219
Accrued interest 5,184 14,536
Accrued payroll costs 33,916 27,824
Dividends payable 58,129 85,126
Deferred income tax liabilities 44,202 43,419
Other 58,595 61,602
----------- -----------
Total current liabilities 581,350 537,363
----------- -----------
Long-term debt 578,073 609,868
Deferred income taxes 60,718 52,369
Other liabilities, primarily employee benefit plans 231,442 224,540
----------- -----------
Total liabilities 1,451,583 1,424,140
----------- -----------
Preferred stock, subject to mandatory redemption -- 2,678
----------- -----------
Shareholders' equity:
Preferred stock 412 412
Common stock (21,000,000 shares issued) 525,000 525,000
Additional paid-in capital 58,338 58,338
Retained earnings 101,430 84,035
----------- -----------
Total shareholders' equity 685,180 667,785
----------- -----------
Total liabilities and shareholders' equity $ 2,136,763 $ 2,094,603
=========== ===========
</TABLE>
See Notes to Condensed Financial Statements.
7
<PAGE> 9
GTE South Incorporated
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------------
1998 1997
--------- ---------
(Thousands of Dollars)
<S> <C> <C>
OPERATIONS
Income before extraordinary charge $ 75,857 $ 72,639
Adjustments to reconcile income before extraordinary charge
to net cash from operations:
Depreciation and amortization 70,729 70,333
Deferred income taxes 9,132 2,589
Provision for uncollectible accounts 7,152 6,205
Changes in current assets and current liabilities 6,734 55,396
Other - net 2,283 (8,449)
--------- ---------
Net cash from operations 171,887 198,713
--------- ---------
INVESTING
Capital expenditures (68,039) (53,358)
Other - net 61 75
--------- ---------
Net cash used in investing (67,978) (53,283)
--------- ---------
FINANCING
Long-term debt and preferred stock retired,
including premiums paid on early retirement (34,874) (10,134)
Dividends (85,159) (45,988)
Net change in affiliate notes 7,073 (80,436)
--------- ---------
Net cash used in financing (112,960) (136,558)
--------- ---------
Increase (decrease) in cash and cash equivalents (9,051) 8,872
Cash and cash equivalents:
Beginning of period 13,104 16,491
--------- ---------
End of period $ 4,053 $ 25,363
========= =========
</TABLE>
See Notes to Condensed Financial Statements.
8
<PAGE> 10
GTE South Incorporated
NOTES TO CONDENSED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION:
The unaudited condensed financial statements included herein have been
prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. However, in
the opinion of management of the Company, the condensed financial
statements include all adjustments, which consist only of normal recurring
accruals, necessary to present fairly the financial information for such
periods. These condensed financial statements should be read in conjunction
with the financial statements and the notes thereto included in the
Company's 1997 Annual Report on Form 10-K.
Reclassifications of prior year data have been made, where appropriate, to
conform to the 1998 presentation.
(2) EXTRAORDINARY CHARGE:
During the first quarter of 1998, the Company recorded an after-tax
extraordinary charge of $0.2 million, reflecting premiums paid on the
redemption of high-coupon debt prior to stated maturity.
(3) RECENT ACCOUNTING PRONOUNCEMENT:
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use" (SOP 98-1). SOP 98-1
defines internal-use software and establishes accounting standards for the
costs of such software. The Company is currently assessing the impact of
adopting SOP 98-1.
9
<PAGE> 11
GTE South Incorporated
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits required by Item 601 of Regulation S-K.
12 Statement re: Calculation of the Ratio of Earnings to Fixed
Charges
27 Financial Data Schedule
(b) The Company filed no reports on Form 8-K during the first quarter of
1998.
10
<PAGE> 12
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
GTE South Incorporated
--------------------------------
(Registrant)
Date: May 15, 1998 /s/ Stephen L. Shore
----------------------------- --------------------------------
Stephen L. Shore
Controller
(Principal Accounting Officer)
11
<PAGE> 13
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------------------ ----------------------------------------------------------------------------------------
<S> <C>
12 Statement re: Calculation of the Ratio of Earnings to Fixed Charges
27 Financial Data Schedule
</TABLE>
<PAGE> 1
Exhibit 12
GTE South Incorporated
STATEMENT OF THE RATIO OF EARNINGS TO FIXED CHARGES
(Thousands of Dollars)
<TABLE>
<CAPTION>
Three Months
Ended
March 31,
1998
------------
<S> <C>
Net earnings available for fixed charges:
Income before extraordinary charge $ 75,857
Add - Income taxes 48,168
- Fixed charges 17,878
--------
Adjusted earnings $141,903
========
Fixed charges:
Interest expense $ 15,044
Portion of rent expense
representing interest 2,834
--------
Adjusted fixed charges $ 17,878
========
RATIO OF EARNINGS TO FIXED CHARGES 7.94
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 4,053
<SECURITIES> 0
<RECEIVABLES> 308,954
<ALLOWANCES> 20,862
<INVENTORY> 29,394
<CURRENT-ASSETS> 345,358
<PP&E> 4,341,667
<DEPRECIATION> 2,721,683
<TOTAL-ASSETS> 2,136,763
<CURRENT-LIABILITIES> 581,350
<BONDS> 578,073
0
412
<COMMON> 525,000
<OTHER-SE> 159,768
<TOTAL-LIABILITY-AND-EQUITY> 2,136,763
<SALES> 394,943
<TOTAL-REVENUES> 394,943
<CGS> 133,325
<TOTAL-COSTS> 256,506
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 14,412
<INCOME-PRETAX> 124,025
<INCOME-TAX> 48,168
<INCOME-CONTINUING> 75,857
<DISCONTINUED> 0
<EXTRAORDINARY> 243
<CHANGES> 0
<NET-INCOME> 75,614
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
