<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 2-36292
GTE SOUTH INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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
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 21,000,000 SHARES OF $25 PAR VALUE COMMON STOCK OUTSTANDING AT
FEBRUARY 28, 1998. THE COMPANY'S COMMON STOCK IS 100% OWNED BY GTE CORPORATION.
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Item
Part I Page
<S> <C> <C>
1. Business 1
2. Properties 4
3. Legal Proceedings 4
4. Submission of Matters to a Vote of Security Holders 4
Part II
5. Market for the Registrant's Common Equity and Related
Shareholder Matters 5
6. Selected Financial Data 6
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 7
8. Financial Statements and Supplementary Data 15
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 37
Part III
10. Directors and Executive Officers of the Registrant 38
11. Executive Compensation 40
12. Security Ownership of Certain Beneficial Owners and Management 48
13. Certain Relationships and Related Transactions 49
Part IV
14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 50
</TABLE>
<PAGE> 3
PART I
Item 1. Business
GTE South Incorporated (the Company) was incorporated in Virginia on July 29,
1947. The Company is a wholly-owned subsidiary of GTE Corporation (GTE) and
provides communications services in the states of Alabama, Illinois, Kentucky,
North Carolina, South Carolina and Virginia.
The Company's principal line of business is providing communications services
ranging from local telephone service for the home and office to highly complex
voice and data services for various industries. The Company provides local
telephone service within its franchise area and intraLATA (Local Access
Transport Area) toll service between the Company's facilities and the facilities
of other telephone companies within the Company's LATAs. InterLATA service to
other points in and out of the states in which the Company operates is provided
through connection with 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>
Alabama 167,767
Illinois 44,514
Kentucky 608,412
North Carolina 558,151
South Carolina 226,535
Virginia 687,309
----------------
Total
2,292,688
================
</TABLE>
At December 31, 1997, the Company had 4,906 employees.
The Company has written agreements with the Communications Workers of America
(CWA) and International Brotherhood of Electrical Workers (IBEW). The contract
with the IBEW in Kentucky will expire during 1998.
REGULATORY AND COMPETITIVE TRENDS
The Company is subject to regulation by the regulatory bodies of the states of
Alabama, Illinois, Kentucky, North Carolina, South Carolina and Virginia for its
intrastate business operations and by the Federal Communications Commission
(FCC) for its interstate operations.
Advances in technology, together with a number of regulatory, legislative and
judicial actions, continue to accelerate and expand the level of competition and
opportunities available to the Company. The Company continues to face additional
competition from numerous sources, such as competitive local-exchange carriers,
wireless carriers, cable television service providers and long distance
companies.
Much of the regulatory and legislative activity that occurred in the United
States in 1997 was a direct result of the Telecommunications Act of 1996 (the
Telecommunications Act) adopted by Congress. The Telecommunications
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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 Alabama, Illinois, Kentucky, North Carolina, South Carolina
and Virginia. 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 Illinois, Kentucky and Virginia.
In May 1997, the FCC released two new major decisions related to implementation
of the Telecommunications Act's provisions - the universal service and access
charge reform orders. The universal service order established the support
mechanisms to ensure continued availability of affordable local telephone
service and created new programs to provide discounted telecommunications
services to schools, libraries and rural health care providers. GTE and numerous
other parties have challenged the FCC's decision before the U.S. Court of
Appeals for the Fifth Circuit on the grounds that the FCC did not follow the
requirements of the Telecommunications Act to develop a sufficient, explicit and
competitively neutral universal service program. A decision is expected in 1998.
The access charge reform order, also released in May 1997, revamped the rate
structure for use of the local network by interexchange carriers to originate
and complete long distance calls. GTE and numerous other parties also challenged
this decision before the Eighth Circuit based on the belief that the FCC not
only failed to remove all of the universal service subsidies hidden within
interstate access charges, but in fact created additional subsidy charges paid
only by business and multi-line residential customers. Oral argument has been
held and a decision is expected in 1998.
Also in May 1997, the FCC released a decision completing a periodic review of
its price cap regulatory oversight of interstate access charges. GTE and
numerous other LECs have challenged this decision before the Eighth Circuit
based on the belief that the FCC established a fundamentally unfair annual price
reduction formula and required retroactive price reductions. Oral argument has
been held and a decision on this challenge is also expected in 1998.
Federal and state regulatory activity continued to change the traditional
cost-based, rate-of-return regulatory framework for intrastate and interstate
telephone service. Regulatory authorities in Alabama, North Carolina and
Virginia have adopted various forms of alternative regulation, which provide
economic incentives for telephone service providers to improve productivity and
provide the foundation for implementing pricing flexibility necessary to address
competitive entry into the Company's markets. The regulatory commissions in the
states of Illinois,
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Kentucky and South Carolina 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 increase of $12.1 million. On December 1, 1997, the FCC issued an order to
file revised access rates effective January 1, 1998, which resulted in
interstate access charge reductions of approximately $2.8 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 10 of the Company's financial statements included in Item 8.
The Company continues to support greater competition in telecommunications,
provided that, overall, the actions to eliminate existing legal and regulatory
barriers benefit consumers by allowing an opportunity for all service providers
to participate equally in a competitive marketplace under comparable conditions.
The Company intends to continue to respond aggressively to regulatory and legal
developments that allow for increased competition and opportunities in the
marketplace. The Company expects its financial results to benefit from reduced
costs and the introduction of new products and services that will result in
increased usage of its telephone networks. However, it is likely that such
improvements will be offset, in part, by continued strategic pricing reductions
and the effects of increased competition.
INITIATIVES
In 1997, the Company's parent, GTE, continued to position itself to respond
aggressively to competitive developments and benefit from new opportunities.
In May 1997, GTE announced plans to become a leading national provider of data
communications services that included the acquisition of BBN Corporation (BBN),
a leading supplier of end-to-end Internet solutions. BBN brings valuable skills,
a leading position in the Internet market and an impressive list of Fortune 500
clients. In addition, GTE announced a strategic alliance with Cisco Systems,
Inc. to jointly develop enhanced data and Internet services for customers; and
the purchase of a national, state-of-the-art fiber-optic network from Qwest
Communications. This expansion of data services continued in November 1997 with
the announcement of the acquisition of Genuity Inc. (Genuity), a subsidiary of
Bechtel Enterprises. Genuity is a premier value-added provider of distributed
application hosting solutions.
3
<PAGE> 6
ENVIRONMENTAL MATTERS
GTE maintains monitoring and compliance programs related to environmental
matters. The Company's annual expenditures for environmental compliance have not
been and are not expected to be material. Costs incurred include outlays
required to keep existing operations in compliance with environmental
regulations and an underground storage tank replacement program.
Item 2. Properties
The Company's property consists principally of land, structures and equipment
required to provide various telecommunications services. All of these
properties, located in the states of Alabama, Illinois, Kentucky, North
Carolina, South Carolina and Virginia, 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 $1.4 billion for new plant and facilities required to meet
telecommunication service needs and to modernize plant and facilities. These
additions were equal to 33% of gross plant of $4.3 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 of the Company's financial statements included
in Item 8.
Item 3. Legal Proceedings
There are no pending legal proceedings which would have a material impact on the
Company's financial statements.
Item 4. Submission of Matters to a Vote of Security Holders
None.
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 and preferred stock, should be contacted with any questions relating to
shareholder accounts. This includes the following:
o Account information
o Dividends
o Market prices
o Transfer instructions
o Statements and reports
o Change of address
Shareholders may call toll-free at 1-800-225-5160 anytime, seven days a week.
Customer Service Representatives are available Monday through Friday between the
hours of 8 a.m. and 5 p.m. Eastern Time. Outside the United States call
1-718-575-2990.
Or write to:
BankBoston, N.A.
c/o Boston EquiServe, L.P.
P.O. Box 8031
Boston, MA 02206-8031
For overnight delivery services, use the following address:
BankBoston, N.A.
c/o Boston EquiServe, L.P.
Blue Hills Office Park
150 Royall Street
Mail Stop 4502-60
Canton, MA 02021
The BankBoston, N.A. address where shareholders, banks and brokers may deliver
certificates is Securities Transfers and Reporting Services, 55 Broadway in New
York City.
PARENT COMPANY ANNUAL REPORT
To obtain a copy of the 1997 annual report of our parent company or the annual
Form 10-K filed with the Securities and Exchange Commission, call
1-800-225-5160.
INFORMATION VIA THE INTERNET
Internet World Wide Web users can access information on GTE through the
following universal resource:
http://www.gte.com
PRODUCTS AND SERVICES HOTLINE
Shareholders may call 1-800-828-7280 to receive information concerning GTE
products and services.
DIVERSITY AT GTE
The Company and GTE strive to be a workplace of choice in which people of
diverse backgrounds are valued, challenged, acknowledged and rewarded, leading
to higher levels of fulfillment and productivity. A copy of our Diversity at GTE
brochure is available upon request from the GTE Corporate Secretary's Office.
5
<PAGE> 8
Item 6. Selected Financial Data
GTE South Incorporated
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------------------
Selected Income Statement Items (a) 1997 1996 1995 1994 1993(b)(c)
- ----------------------------------- ------------------------------------------------------------
(Thousands of Dollars)
<S> <C> <C> <C> <C> <C>
Revenues and sales $ 1,493,952 $ 1,417,699 $ 1,319,110 $ 1,250,404 $ 1,438,063
Operating costs and expenses 975,180 965,343 956,958 982,056 1,225,452
------------------------------------------------------------------
Operating income 518,772 452,356 362,152 268,348 212,611
Interest - net 54,296 46,307 57,656 57,653 90,276
Gain on disposition of assets -- -- -- -- (63,112)
Other - net 284 (15,123) (20,000) 4,200 --
Income taxes 176,478 160,478 121,897 77,308 85,712
------------------------------------------------------------------
Income before extraordinary charges 287,714 260,694 202,599 129,187 99,735
Extraordinary charges (d) -- -- (509,880) -- --
------------------------------------------------------------------
Net income (loss) $ 287,714 $ 260,694 $ (307,281) $ 129,187 $ 99,735
===================================================================
Dividends declared on common stock $ 298,747 $ 186,952 $ 117,892 $ 168,660 $ 341,998
Dividends declared on preferred stock 147 153 157 171 177
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
As of December 31,
-------------------------------------------------------------------
Selected Balance Sheet Items 1997 1996 1995 1994 1993 (b)
- ---------------------------- -------------------------------------------------------------------
(Thousands of Dollars)
<S> <C> <C> <C> <C> <C>
Property, plant and equipment, net (d) $ 1,621,708 $ 1,588,038 $ 1,566,183 $ 2,402,927 $ 2,379,039
Total assets 2,094,603 2,005,308 1,902,748 2,762,128 3,174,642
Long-term debt and preferred stock,
subject to mandatory redemption 612,546 638,683 726,060 597,213 566,705
Shareholders' equity 667,785 678,947 605,358 1,030,678 1,070,320
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Per share data is omitted since the Company's common stock is 100% owned by
GTE Corporation.
(b) In 1993, the Company sold 329,000 net access lines through property
repositioning.
(c) Operating income in 1993 included a $163 million pre-tax charge for
restructuring costs which reduced net income by $100.4 million.
(d) See Note 2 to the financial statements included in Item 8.
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Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Dollars in Millions)
BUSINESS OPERATIONS
GTE South Incorporated (the Company), a wholly-owned subsidiary of GTE
Corporation (GTE), provides local-exchange, network access and toll services in
the states of Alabama, Illinois, Kentucky, North Carolina, South Carolina and
Virginia. At December 31, 1997, the Company served 2,292,688 access lines in its
service territories.
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------------------
1997 1996 1995
--------------- --------------- ---------------
<S> <C> <C> <C>
Net income (loss) $ 287.7 $ 260.7 $ (307.3)
</TABLE>
Net income increased 10% or $27 in 1997. The 1997 increase is primarily the
result of an increase in local and network access revenues, partially offset by
lower toll service revenues and higher operating costs and expenses.
The net loss for 1995 includes an extraordinary charge (net of tax) of $497.5
for the discontinuance 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 and an extraordinary charge (net of tax) of $12.4 related
to the early retirement of debt. Excluding these extraordinary charges, net
income increased 29% or $58.1 in 1996. The 1996 increase is primarily the result
of an increase in local and network access revenues, partially offset by lower
toll service revenues and higher operating costs and expenses.
REVENUES AND SALES
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------
1997 1996 1995
-------------- -------------- --------------
<S> <C> <C> <C>
Local services $ 566.9 $ 532.5 $ 493.0
Network access services 609.1 562.2 494.9
Toll services 113.5 131.7 149.8
Other services and sales 204.5 191.3 181.4
--------------- --------------- ---------------
Total revenues and sales $ 1,494.0 $ 1,417.7 $ 1,319.1
</TABLE>
Total revenues and sales increased 5% or $76.3 and 7% or $98.6 during 1997 and
1996, respectively.
Local service revenues are based on fees charged to customers for providing
local-exchange service within designated franchise areas. Local service revenues
increased 6% or $34.4 in 1997 and 8% or $39.5 in 1996. Access line growth of 6%
in 1997 generated additional revenues of $15.8 from basic local services and
$6.7 from Integrated Services Digital Network (ISDN) and Digital Channel
Services (DCS). The increase also reflects growth in revenues of $10.1 from
enhanced custom calling features, such as SmartCall(R) services and $4.2 from
directory assistance and operator services. The 1997 increase is partially
offset by the $11.2 unfavorable impact of the sharing provisions from the rate
rebalancing in Virginia (as discussed in Note 10 of the Company's financial
statements included in Item 8). Access line growth of 5% in 1996 generated
additional revenues of $14.7 from
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basic local services, $4.7 from CentraNet(R) services and $5 from ISDN.
Demand for custom calling features contributed $8.8 to the 1996 increase.
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 (LECs) also pay access
charges for cellular and intraLATA (Local Access and Transport Area) toll calls
hauled or terminated by the Company. Network access service revenues increased
8% or $46.9 in 1997 and 14% or $67.3 in 1996. The 1997 increase includes the
effects of an 11% increase in minutes of use, which generated additional
revenues of $31.6. Special access revenues grew $19.2 for 1997 due to greater
demand for increased bandwidth services by Internet Service Providers (ISPs) and
other high-capacity users. The increase in network access revenues is also
attributable to an increase in the universal service fund (USF) support of $7.
These increases are partially offset by the impact of intrastate access price
reductions of $4.2 in Virginia, $3.7 in South Carolina, $2.2 in Alabama and $1.3
in Kentucky. The 1996 increase includes the effects of a 12% increase in minutes
of use, which generated additional revenues of $33.5, a $14.8 growth in
intraLATA access revenues due largely to a change in compensation arrangements
in North Carolina with other LECs, and an $11.3 increase in special access
revenues. Additionally, the 1996 increase reflects $6.8 of favorable access
revenue adjustments, higher end-user access charge revenues of $3.4, and an
increase in the volume of cellular service providers accessing the Company's
network which generated an additional $3.3 in revenues. Partially offsetting
these 1996 increases is the $5.5 unfavorable impact from the 1995 and 1996 FCC
Annual Price Cap Filings which reduced rates.
Toll service revenues are based on fees charged for service beyond a customer's
local calling area but within the LATA. Toll service revenues decreased 14% or
$18.2 in 1997 and 12% or $18.1 in 1996. The decline in revenues for 1997 and
1996 is attributable to lower toll volumes, primarily related to intraLATA toll
competition, including 10XXX and 1+ presubscription, and the impact from
optional discount calling plans, which effectively lowered intrastate toll
rates. Equal access (1+ presubscription) was completed for all states in which
the Company operates effective August 1997. The decrease in revenues for 1997
and 1996 was also attributable to the impact of unfavorable settlement
activities of $4.6 and $9.3, respectively.
Other services and sales revenues increased 7% or $13.2 in 1997 and 5% or $9.9
in 1996. The 1997 increase reflects the favorable impact of the FCC's order on
payphone interim compensation of $4 (as discussed in Note 10 of the Company's
financial statements included in Item 8) and growth in revenues from paging and
voice messaging services of $2.5. The 1996 increase reflects an increase of $5.9
in directory advertising revenue due to the timing of directory publications, an
increase of $2.2 in voice and data equipment sales and growth of $1.7 in sales
of voice messaging services.
OPERATING COSTS AND EXPENSES
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------
1997 1996 1995
--------------- --------------- ---------------
<S> <C> <C> <C>
Cost of services and sales $ 501.9 $ 492.0 $ 479.1
Selling, general and administrative 199.4 194.8 203.5
Depreciation and amortization 273.9 278.5 274.4
--------------- --------------- ---------------
Total operating costs and expenses $ 975.2 $ 965.3 $ 957.0
</TABLE>
Total operating costs and expenses increased 1% or $9.9 during 1997 and 1% or
$8.3 during 1996.
8
<PAGE> 11
The 1997 increase in operating costs and expenses is due to a number of factors
including higher advertising and promotional costs of $16.3 aimed at stimulating
sales of enhanced services and preserving market share in an increasingly
competitive environment, higher access charges of $7.8 incurred to terminate
customers' intraLATA toll calls outside of the Company's service territories,
higher rent expense of $7.8, higher labor and benefits costs of $13, which were
incurred to support access line growth and customer demand for products and
services, and $2.9 in costs associated with implementation of local number
portability. These increases were partially offset by a $6.5 net decrease
resulting from the impact of the Company's pension settlement gains. Pension
settlement gains of $16.5, recorded in 1997, which resulted from lump-sum
payments from the Company's pension plans, were partially offset by settlement
gains of $10 recorded in 1996. The increase in operating costs and expenses is
also offset, in part, by administrative productivity gains of $21.9 achieved
during 1997. A reduction in depreciation rates to reflect higher net salvage
values of certain telephone plant and equipment, was partially offset by higher
depreciation charges associated with additions to plant, which resulted in a
$4.6 net decrease in depreciation charges. The change in operating costs and
expenses also reflect the $2.3 favorable impact of inside wire maintenance
settlement costs that were recorded during 1996.
The 1996 increase in operating costs and expenses is a result of higher material
costs of $10.3 which are directly associated with increased revenues and sales.
In addition, the increase reflects higher operating taxes of $5.9, higher
depreciation costs of $4.1, primarily resulting from increased plant
investments, and a reserve of $2.3 for inside wire maintenance settlement costs
recorded in the third quarter of 1996 (as discussed in Other Matters). Pension
settlement gains of $10, recorded in 1996, were partially offset by settlement
gains of $2.8 recorded in 1995, which resulted in a $7.2 net decrease. In
addition, the 1996 increase is partially offset by the effect of cost-reduction
programs from process re-engineering activities reflected by $5.6 of lower rent
expense and $2.3 of lower data processing costs.
OTHER (INCOME) EXPENSE
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------
1997 1996 1995
--------------- --------------- ---------------
<S> <C> <C> <C>
Interest - net $ 54.3 $ 46.3 $ 57.7
Other - net 0.3 (15.1) (20.0)
Income taxes 176.5 160.5 121.9
</TABLE>
Interest - net increased 17% or $8 in 1997 and decreased 20% or $11.4 in 1996.
The 1997 increase is primarily attributable to higher average short-term debt
levels. The 1996 decrease is primarily attributable to lower interest expense
reflecting lower interest rates associated with the high-coupon debt refinancing
program initiated during the fourth quarter of 1995.
Other - net expense of $0.3 in 1997 is related to premiums paid on the early
retirement of long-term debt. Other - net income of $15.1 in 1996 and $20 in
1995 represents the reversal of expired representation and warranty reserves
related to certain 1993 property dispositions.
Income taxes increased 10% or $16 in 1997 and 32% or $38.6 in 1996. The 1997 and
1996 increases are primarily related to corresponding increases in pre-tax
income. The 1997 increase is partially offset by adjustments in prior years' tax
liabilities.
9
<PAGE> 12
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 $1.5 billion
364-day syndicated line of credit. In December 1997, the Company began
participating with GTE and other of its affiliates in a series of five bilateral
credit agreements for an additional $2 billion in credit capacity. These
facilities, which are shared by the participating companies, are aligned with
the maturity date of the 364-day line of credit. The additional capacity
provides greater flexibility to incur additional indebtedness of a shorter-term
duration during periods when it may not be desirable to access the capital
markets to refinance short-term debt. The Company has an existing shelf
registration statement for an additional $225 of debentures.
The Company's primary source of funds during 1997 was cash from operations of
$509.3 compared to $458 for 1996. The year-to-year increase in cash from
operations is primarily the result of a decrease in working capital
requirements.
The Company's capital expenditures during 1997 were $310.4 compared to $297.7 in
1996. The 1997 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 construction costs for
1998 are expected to increase slightly from the 1997 level, reflecting the
continued growth of existing networks.
Net cash used in financing activities was $202.4 in 1997 compared to $175.6 in
1996. This included dividend payments of $259.7 compared to $141.2 in 1996.
Short-term financings, including the net change in affiliate notes, increased
$178.5 compared to a decrease of $414 in 1996. In 1997, the Company paid a total
of $121.1 for the retirement of long-term debt and preferred stock. This amount
includes $0.3 paid in premiums on the early retirement of $22.3 of long-term
debt in May 1997. The Company retired $4.5 of long-term debt and preferred stock
in 1996. The Company issued $125 of 6.0% debentures in February 1996 and $250 of
7.5% debentures in March 1996 to refinance $248.2 of debt which was called and
redeemed in the fourth quarter of 1995. In 1996, the Company realized a gain of
approximately $15 on the settlement of forward contracts related to the 1996
debt issuances. The gain is being amortized over the life of the refinanced debt
as an offset to interest expense.
On October 15, 1997, the Company's parent, GTE, proposed a merger with MCI
Communications Corporation (MCI) valued at approximately $28 billion. As a
result of the proposed merger, the rating agencies placed GTE, the Company and
its affiliates on "Credit Watch" for possible rating reductions. On November 10,
1997, MCI announced that it had reached an agreement to merge with WorldCom,
Inc.
REGULATORY AND COMPETITIVE TRENDS
The Company is subject to regulation by the regulatory bodies of the states of
Alabama, Illinois, Kentucky, North Carolina, South Carolina and Virginia 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
10
<PAGE> 13
equitably in the marketplace and benefit everyone. The Company believes the FCC
and a number of state regulatory agencies did not establish these comparable
conditions. The Company and its parent, GTE, have consequently exercised their
right to challenge regulatory actions they believe unfairly disadvantage their
customers and shareholders.
In July 1997, the U.S. Court of Appeals for the Eighth Circuit (Eighth Circuit)
released its decision on the challenge filed in 1996 by the Company's parent,
GTE, and numerous other parties to rules developed by the FCC to implement the
interconnection provisions of the Telecommunications Act. The Telecommunications
Act required LECs to make their retail services and the underlying network
elements available to competitors. The FCC required that prices for both resold
services and network elements be set using a methodology created by the FCC. The
court challenge asserted 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 Alabama, Illinois, Kentucky, North Carolina, South Carolina
and Virginia. 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 Illinois, Kentucky and Virginia. Complaints in
Kentucky and Virginia 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 Alabama, Illinois and South Carolina, and additional studies in other states
are expected to be filed throughout 1998.
In May 1997, the FCC released two new major decisions related to implementation
of the Telecommunications Act's provisions - the universal service and access
charge reform orders. The universal service order established the support
mechanisms to ensure continued availability of affordable local telephone
service and created new programs to provide discounted telecommunications
services to schools, libraries and rural health care providers. GTE and numerous
other parties have challenged the FCC's decision before the U.S. Court of
Appeals for the Fifth Circuit on the grounds that the FCC did not follow the
requirements of the Telecommunications Act to develop a sufficient, explicit and
competitively neutral universal service program. A decision is expected in 1998.
Additional state commission proceedings have begun to establish rules and
procedures to implement state universal service funds (USF). USF proceedings
have begun in Alabama, Kentucky, North Carolina and South Carolina and
additional proceedings are scheduled to occur during the remainder of 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.
11
<PAGE> 14
Also in May 1997, the FCC released a decision completing a periodic review of
its price cap regulatory oversight of interstate access charges. GTE and
numerous other LECs have challenged this decision before the Eighth Circuit
based on the belief that the FCC established a fundamentally unfair annual price
reduction formula and required retroactive price reductions. Oral argument has
been held and a decision on this challenge is also expected in 1998.
Federal and state regulatory activity continued to change the traditional
cost-based, rate-of-return regulatory framework for intrastate and interstate
telephone service. Regulatory authorities in Alabama, North Carolina and
Virginia have adopted various forms of alternative regulation, which provide
economic incentives for telephone service providers to improve productivity and
provide the foundation for implementing pricing flexibility necessary to address
competitive entry into the Company's markets. The regulatory commissions in the
states of Illinois, Kentucky and South Carolina 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 increase of $12.1. On December 1, 1997, the FCC issued an order to file
revised access rates effective January 1, 1998, which resulted in interstate
access charge reductions of approximately $2.8. 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 $11.7 paid by long distance
carriers were offset by $10.2 of new per line charges and the charges paid by
end-users.
On June 4, 1996, the FCC issued its first Report and Order implementing Section
276 of the Telecommunications Act. As part of the overall goal of promoting
competition among payphone service providers (PSPs), this order mandated
compensation to all PSPs for all calls originating from payphones, including
"dial-around" access calls and toll-free subscriber calls for which PSPs were
not previously compensated. This compensation was to occur in two separate
phases. During phase one, from April 15, 1997 through October 6, 1997, PSPs were
to be paid a monthly, flat-rate compensation from interexchange carriers (IXCs).
During phase two, beginning October 7, 1997, PSPs were to be compensated on a
per-call basis, with the prevailing local coin rate of 35 cents established as
the default rate.
On July 19, 1997, the U.S. Court of Appeals in Washington, D.C. vacated the
FCC's directive concerning per-call compensation, stating that the FCC had not
shown that the 35 cent rate was a reasonable surrogate for fair compensation.
The court also set aside the FCC's flat-rate compensation mandate. Subsequently,
on October 9, 1997, the FCC issued a second Report and Order to address some of
the issues vacated by the court. In this second order, the FCC established a new
per-call rate of 28.4 cents for phase two compensation that all PSPs were
eligible to receive beginning October 9, 1997. The FCC tentatively concluded
that this per-call rate should also be used to calculate phase one compensation.
The Company has recorded approximately $4 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.
12
<PAGE> 15
Further information regarding the Company's activities with the various
regulatory agencies and revenue arrangements with other telephone companies is
discussed in Note 10 of the Company's financial statements included in Item 8.
YEAR 2000 CONVERSION
The Year 2000 issue has an industry-wide impact. The Company has had an active
Year 2000 Program in place. The Company's Year 2000 methodology and processes
were certified in 1997 by the Information Technology Association of America.
This program is necessary because the Year 2000 issue could impact systems,
networks and business processes at the Company. This program includes:
inventory; assessment and analysis of systems, networks and business processes;
remediation of any impacted software; and validation testing. The current
estimate for the cost of remediation for the Company is approximately $18.5.
Year 2000 remediation costs are expensed in the year incurred. Through 1997,
expenditures totaled $2.6. 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 $7.6 to
implement Local Service Provider Portability within eleven of the top 100 MSAs.
As a result of the major investment required to implement LNP, the FCC has
stated that local service providers should be allowed to recover a portion of
their costs. The Company is seeking regulatory recovery of LNP implementation
costs.
OTHER MATTERS
Eleven separate class action lawsuits were brought against GTE and twelve of its
subsidiaries (GTE Defendants), including the Company, relating to the provision
of inside wire maintenance services. On August 6, 1996, the GTE Defendants and
class counsel executed and filed a settlement agreement in one of the lawsuits.
The Court preliminarily approved the agreement and conditionally certified a
national class of plaintiffs for settlement purposes. A fairness hearing on the
settlement was held on December 18, 1996. On January 21, 1997, the Court
approved the settlement as written and issued a permanent injunction to prohibit
future lawsuits covering any claims from 1987 to the date of settlement.
Pursuant to the settlement, a proof of claim form was inserted into the March
1997 customer bills for the national class to request their benefits under the
settlement. The reserves established in 1996 were adequate for the processing of
all claims during 1997.
13
<PAGE> 16
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.
14
<PAGE> 17
Item 8. Financial Statements and Supplementary Data
GTE South Incorporated
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Years Ended December 31 1997 1996 1995
- ----------------------- ---------------- --------------- ---------------
(Thousands of Dollars)
REVENUES AND SALES (a)
<S> <C> <C> <C>
Local services $ 566,935 $ 532,516 $ 492,975
Network access services 609,096 562,158 494,892
Toll services 113,436 131,694 149,779
Other services and sales 204,485 191,331 181,464
---------------- --------------- ---------------
Total revenues and sales 1,493,952 1,417,699 1,319,110
---------------- --------------- ---------------
OPERATING COSTS AND EXPENSES (b)
Cost of services and sales 501,857 492,003 479,060
Selling, general and administrative 199,399 194,795 203,532
Depreciation and amortization 273,924 278,545 274,366
---------------- --------------- ---------------
Total operating costs and expenses 975,180 965,343 956,958
---------------- --------------- ---------------
OPERATING INCOME 518,772 452,356 362,152
OTHER (INCOME) EXPENSE
Interest - net (c) 54,296 46,307 57,656
Other - net 284 (15,123) (20,000)
---------------- --------------- ---------------
INCOME BEFORE INCOME TAXES 464,192 421,172 324,496
Income taxes 176,478 160,478 121,897
---------------- --------------- ---------------
INCOME BEFORE EXTRAORDINARY CHARGES 287,714 260,694 202,599
Extraordinary charges -- -- (509,880)
---------------- --------------- ---------------
NET INCOME (LOSS) $ 287,714 $ 260,694 $ (307,281)
================ =============== ===============
</TABLE>
(a) Includes billings to affiliates of $43,124, $42,696 and $37,247 for the
years 1997-1995, respectively.
(b) Includes billings from affiliates of $70,677, $77,857 and $85,069 for the
years 1997-1995, respectively.
(c) Includes interest paid to affiliates of $2,860 in 1997.
See Notes to Financial Statements.
15
<PAGE> 18
GTE South Incorporated
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31 1997 1996
- ----------- --------------- ---------------
(Thousands of Dollars)
---------------------------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 13,104 $ 16,491
Receivables, less allowances of $18,638 and $17,884 261,495 213,227
Note receivable from affiliate 50 28,836
Inventories and supplies 24,366 16,054
Other 11,205 15,768
--------------- ---------------
Total current assets 310,220 290,376
--------------- ---------------
Property, plant and equipment, net 1,621,708 1,588,038
Employee benefit plans 149,034 115,939
Other assets 13,641 10,955
--------------- ---------------
Total assets $ 2,094,603 $ 2,005,308
=============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term obligations, including current maturities $ 155,413 $ 98,500
Accounts payable 46,431 58,745
Affiliate payables and accruals 71,793 37,581
Advanced billings and customer deposits 34,362 31,823
Taxes payable 31,219 8,416
Accrued interest 14,536 15,463
Accrued payroll costs 27,824 35,448
Dividends payable 85,126 45,968
Deferred income tax liabilities 43,419 21,156
Other 27,240 55,592
--------------- ---------------
Total current liabilities 537,363 408,692
--------------- ---------------
Long-term debt 609,868 635,944
Deferred income taxes 52,369 88,635
Employee benefit plans 172,728 164,967
Other liabilities 51,812 25,384
--------------- ---------------
Total liabilities 1,424,140 1,323,622
--------------- ---------------
Preferred stock, subject to mandatory redemption 2,678 2,739
--------------- ---------------
Shareholders' equity:
Preferred stock 412 412
Common stock (21,000,000 shares issued) 525,000 525,000
Additional paid-in capital 58,338 58,320
Retained earnings 84,035 95,215
--------------- ---------------
Total shareholders' equity 667,785 678,947
--------------- ---------------
Total liabilities and shareholders' equity $ 2,094,603 $ 2,005,308
=============== ===============
</TABLE>
See Notes to Financial Statements.
16
<PAGE> 19
GTE South Incorporated
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31 1997 1996 1995
- ----------------------- ---------------- --------------- ---------------
(Thousands of Dollars)
OPERATIONS
<S> <C> <C> <C>
Income before extraordinary charges $ 287,714 $ 260,694 $ 202,599
Adjustments to reconcile income before extraordinary
charges to net cash from operations:
Depreciation and amortization 273,924 278,545 274,366
Deferred income taxes (14,003) 44,430 31,719
Provision for uncollectible accounts 23,653 21,361 22,229
Change in current assets and current liabilities:
Receivables - net (60,237) (63,901) 27,373
Other current assets (7,847) 2,074 (7,720)
Accrued taxes and interest 25,974 (24,143) (16,954)
Other current liabilities 2,056 (35,506) (60,521)
Other - net (21,903) (25,568) (36,056)
---------------- --------------- ---------------
Net cash from operations 509,331 457,986 437,035
---------------- --------------- ---------------
INVESTING
Capital expenditures (310,388) (297,683) (248,469)
Other - net 53 521 --
---------------- --------------- ---------------
Net cash used in investing (310,335) (297,162) (248,469)
---------------- --------------- ---------------
FINANCING
Long-term debt issued -- 369,126 --
Long-term debt and preferred stock retired,
including premiums paid on early retirement (121,115) (4,457) (310,652)
Dividends (259,736) (141,155) (118,321)
Increase (decrease) in short-term obligations,
excluding current maturities 178,468 (413,964) 277,900
Other - net -- 14,846 (12,771)
---------------- --------------- ---------------
Net cash used in financing (202,383) (175,604) (163,844)
---------------- --------------- ---------------
Increase (decrease) in cash and cash equivalents (3,387) (14,780) 24,722
Cash and cash equivalents:
Beginning of year 16,491 31,271 6,549
---------------- --------------- ---------------
End of year $ 13,104 $ 16,491 $ 31,271
================ =============== ===============
Cash paid during the year for:
Interest $ 55,349 $ 44,667 $ 62,625
---------------- --------------- ---------------
Income taxes $ 167,720 $ 137,293 $ 95,850
---------------- --------------- ---------------
</TABLE>
See Notes to Financial Statements.
17
<PAGE> 20
GTE South Incorporated
STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Additional
Preferred Common Paid-In Retained
Stock Stock Capital Earnings Total
------------- ------------- ------------- ------------- ---------------
(Thousands of Dollars)
<S> <C> <C> <C> <C> <C>
Shareholders' equity, December 31, 1994 $ 412 $ 525,000 $ 58,310 $ 446,956 $ 1,030,678
Net loss (307,281) (307,281)
Dividends declared (118,049) (118,049)
Redemption of preferred stock below
stated par 10 -- 10
------------ ------------ ------------- ------------- ------------
Shareholders' equity, December 31, 1995 412 525,000 58,320 21,626 605,358
Net income 260,694 260,694
Dividends declared (187,105) (187,105)
------------- ------------- ------------- ------------- ------------
Shareholders' equity, December 31, 1996 412 525,000 58,320 95,215 678,947
Net income 287,714 287,714
Dividends declared (298,894) (298,894)
Redemption of preferred stock below
stated par 18 -- 18
------------- ------------- ------------- ------------- ------------
Shareholders' equity, December 31, 1997 $ 412 $ 525,000 $ 58,338 $ 84,035 $ 667,785
============= ============= ============= ============= ============
</TABLE>
See Notes to Financial Statements.
18
<PAGE> 21
GTE South Incorporated
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
GTE South Incorporated (the Company) provides a wide variety of communications
services ranging from local telephone service for the home and office to highly
complex voice and data services for various industries. At December 31, 1997,
the Company served 2,292,688 access lines in the states of Alabama, Illinois,
Kentucky, North Carolina, South Carolina and Virginia. The Company is a
wholly-owned subsidiary of GTE Corporation (GTE).
BASIS OF PRESENTATION
The Company prepares its financial statements in accordance with generally
accepted accounting principles, which require management to make estimates and
assumptions that affect the reported amounts. Actual results could differ from
those estimates.
Reclassifications of prior-year data have been made, where appropriate, to
conform to the 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 $96.3 million, $91 million and $56.8 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 $70.7
million, $77.9 million and $85.1 million for the years 1997-1995, respectively.
The amounts charged for these affiliated transactions are based on a
proportional cost allocation method.
The Company's financial statements include allocated expenses based on the
sharing of certain executive, administrative, financial, accounting, marketing,
personnel, engineering and other support services being performed at
consolidated work centers among GTE's domestic telephone operating subsidiaries.
The amounts charged for these affiliated transactions are based on proportional
cost allocation methodologies.
GTE Funding Incorporated (an affiliate of the Company) provides short-term
financing and investment vehicles and cash management services for the Company.
The Company is contractually obligated to repay all amounts borrowed on its
behalf by GTE Funding Incorporated. Interest expense on these borrowings
amounted to approximately $2.9 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 $43.1 million, $42.7 million and $37.2 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 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
19
<PAGE> 22
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.
20
<PAGE> 23
2. EXTRAORDINARY CHARGES
In response to legislation (see Note 10) 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 $497.5 million (net of tax benefits
of $323.3 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,
approximately $248.2 million of long-term debt. These redemptions resulted in an
after-tax extraordinary charge of $12.4 million (net of tax benefits of $8.1
million).
3. PREFERRED STOCK
Cumulative preferred stock, not subject to mandatory redemption, consists of
4,119 authorized and outstanding shares of the 5.20%, $100 par value Series, at
December 31, 1997 and 1996. Cumulative preferred stock, subject to mandatory
redemption, exclusive of amounts held in treasury, is as follows:
<TABLE>
<CAPTION>
Shares
---------------
Authorized
<S> <C>
$25 par value 97,200
$50 par value 161,114
---------------
Total 258,314
===============
</TABLE>
<TABLE>
<CAPTION>
December 31
---------------------------------------------------------------
1997 1996
------------------------------ ---------------------------
Shares Amount Shares Amount
------------ ------------- ----------- -------------
Outstanding (Thousands of Dollars) (Thousands of Dollars)
<S> <C> <C> <C> <C> <C>
4.64% $25 par value 68,200 $ 1,705 68,200 $ 1,705
5.00% $50 par value 8,480 424 9,690 485
5.16% $50 par value 10,986 549 10,986 549
------------ ------------- ----------- -------------
Total 87,666 $ 2,678 88,876 $ 2,739
============== ============= ============= =============
</TABLE>
The outstanding preferred stock is redeemable at a premium, at any time, in
whole or in part, on thirty days notice.
21
<PAGE> 24
The Company is also required to purchase and retire shares each year through the
operation of a purchase fund. Shares can be acquired or tendered on a best
efforts basis at not more than $50 per share for the 5.00% and 5.16% Series and
$25 per share for the 4.64% Series. The maximum number of shares that can be
purchased and retired each year are 1,210 and 790 shares of the 5.00% and 5.16%
Series, respectively, and 3,600 shares for the 4.64% Series.
During 1997 and 1996, respectively, 1,210 and 335 shares of the 5.00% Series
were offered to the Company for repurchase. During these same periods, no shares
of the 5.16% Series were offered for repurchase. During 1995, the Company
purchased 1,010 and 790 shares of the 5.00% and 5.16% Series, respectively, and
fulfilled the remainder of the requirement through treasury stock. During 1996,
the Company fulfilled the requirement for the 4.64% Series through treasury
stock. The Company purchased 3,600 shares of the 4.64% Series in 1995. In
addition, 3,600 shares of the 4.64% Series were purchased for treasury stock
during 1995.
The aggregate retirement of preferred stock subject to a purchase fund is
$190,000 in each of the years 1998-2002.
The Company held as treasury shares 3,600 shares of 4.64% Series preferred stock
at December 31, 1995. No shares of preferred stock were reserved for officers or
employees, or for options, warrants, conversions or other rights.
The preferred shareholders are entitled to voting rights (on an equal basis with
the common shareholder) in the event that dividends in arrears are equal to or
exceed the amount of annual dividends. Otherwise, the preferred shareholders
have no voting rights. The Company is not in arrears in its dividend payments at
December 31, 1997.
4. COMMON STOCK
The authorized common stock of the Company consists of 25,000,000 shares with a
par value of $25 per share. 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.
At December 31, 1997, $20.2 million of retained earnings were restricted as to
the payment of cash dividends on common stock under the most restrictive terms
of the Company's Articles of Incorporation.
22
<PAGE> 25
5. DEBT
Long-term debt as of December 31, was as follows:
<TABLE>
<CAPTION>
1997 1996
------------------ ------------------
(Thousands of Dollars)
First mortgage bonds:
<S> <C> <C> <C>
6 1/4 % Series, due 1997 $ -- $ 6,500
5.875 % Series K, maturing through 1997 -- 730
6 3/8 % Series N, due 1997 -- 9,352
5.875 % Series EE, maturing through 1997 -- 1,900
8.0 % Series T, due 2001 -- 20,750
7 5/8 % Series U, due 2002 20,995 20,995
7 3/4 % Series, due 2003 10,886 10,886
8.0 % Series V, maturing through 2003 -- 1,705
10.54 % Series VV, maturing through 2008 19,412 21,177
8.88 % Series WW, maturing through 2009 28,235 30,588
Debentures:
6 1/4 %, due 1997 -- 75,000
7.250 % Series B, due 2002 150,000 150,000
6.0 % Series C, due 2008 125,000 125,000
7.5 % Series D, due 2026 250,000 250,000
Unsecured notes payable:
8.25 % maturing through 1997 -- 680
Other:
Capitalized leases 46 100
------------------ ------------------
Total principal amount 604,574 725,363
Premium and discount - net 9,453 9,081
------------------ ------------------
Total 614,027 734,444
Less: current maturities (4,159) (98,500)
------------------ ------------------
Total long-term debt $ 609,868 $ 635,944
================== ==================
</TABLE>
In May 1997, the Company retired $22.5 million of long-term debt prior to stated
maturity. The Company incurred $0.3 million in premiums associated with this
retirement.
On February 16, 1996, the Company issued $125 million of 6.0%, Series C
debentures, due 2008. On March 22, 1996, the Company issued $250 million of
7.5%, Series D 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 discounts and premiums 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.
23
<PAGE> 26
Estimated payments of long-term debt during the next five years are: $4.2
million in 1998; $4.1 million each year during 1999-2001 and $175.1 million in
2002.
Total short-term obligations as of December 31, were as follows:
<TABLE>
<CAPTION>
1997 1996
------------------- -------------------
(Thousands of Dollars)
<S> <C> <C>
Current maturities of long-term debt $ 4,159 $ 98,500
Notes payable to affiliates - average rate 6.2% 151,254 --
------------------- -------------------
Total $ 155,413 $ 98,500
=================== ===================
</TABLE>
The Company participates with other affiliates in a $1.5 billion 364-day
syndicated line of credit. In December 1997, the Company began participating
with its parent, GTE, and other of its affiliates in a series of five bilateral
credit agreements for an additional $2 billion in credit capacity. These
facilities, which are shared by the participating companies, are aligned with
the maturity date of the 364-day line of credit.
6. FINANCIAL INSTRUMENTS
At December 31, 1995, the Company had entered into forward contracts to sell
$250 million of U.S. Treasury Bonds to hedge against changes in market interest
rates related to the debt the Company called and subsequently refinanced in
March 1996. A gain of approximately $15 million occurred upon settlement of the
forward contracts and is being amortized over the life of the associated
refinanced debt as an offset to interest expense.
The fair values of financial instruments, other than long-term debt, closely
approximate their carrying value. As of December 31, 1997 and 1996, the
estimated fair value of long-term debt based on either reference to quoted
market prices or an option pricing model, was lower than the carrying value by
approximately $7 million and $16 million, respectively.
24
<PAGE> 27
7. INCOME TAXES
The income tax provision (benefit) is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---------------- --------------- ---------------
(Thousands of Dollars)
Current:
<S> <C> <C> <C>
Federal $ 155,679 $ 102,289 $ 75,796
State 34,802 13,759 14,382
---------------- --------------- ---------------
190,481 116,048 90,178
---------------- --------------- ---------------
Deferred:
Federal (6,585) 36,499 30,498
State (4,064) 12,116 6,121
---------------- --------------- ---------------
(10,649) 48,615 36,619
---------------- --------------- ---------------
Amortization of deferred investment tax credits - net (3,354) (4,185) (4,900)
---------------- --------------- ---------------
Total $ 176,478 $ 160,478 $ 121,897
================ =============== ===============
</TABLE>
A reconciliation between taxes computed by applying the statutory federal income
tax rate to pre-tax income and income taxes provided in the statements of income
is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---------------- --------------- ---------------
(Thousands of Dollars)
<S> <C> <C> <C>
Amounts computed at statutory rates $ 162,416 $ 147,357 $ 113,519
State and local income taxes, net of federal income tax 19,980 16,819 13,327
benefits
Amortization of deferred investment tax credits, net of federal
income tax benefits (2,180) (2,720) (4,900)
Depreciation of telephone plant construction costs
previously deducted for tax purposes - net -- -- 3,212
Rate differentials applied to reversing temporary differences -- -- (4,242)
Other differences - net (3,738) (978) 981
---------------- --------------- ---------------
Total provision $ 176,478 $ 160,478 $ 121,897
================ =============== ===============
</TABLE>
The tax effects of temporary differences that give rise to the deferred income
tax benefits and deferred income tax liabilities at December 31, are as follows:
<TABLE>
<CAPTION>
1997 1996
--------------- ---------------
(Thousands of Dollars)
<S> <C> <C>
Depreciation and amortization $ 86,403 $ 93,681
Employee benefit obligations (85,665) (46,531)
Prepaid pension cost 47,015 34,064
Investment tax credits 4,321 6,501
State and local taxes 10,308 10,287
Other - net 33,406 11,789
--------------- ---------------
Total $ 95,788 $ 109,791
=============== ===============
</TABLE>
25
<PAGE> 28
8. 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 $ 12,265 $ 12,075 $ 10,170
Interest cost on projected benefit obligations 36,422 34,644 32,702
Return on plan assets:
Actual (154,942) (119,633) (136,846)
Deferred 90,586 56,427 81,932
Other - net (6,889) (8,732) (11,162)
---------------- --------------- ---------------
Net pension credit $ (22,558) $ (25,219) $ (23,204)
================ =============== ===============
</TABLE>
The expected long-term rate-of-return on plan assets was 9.0% for 1997 and 1996,
and 8.5% for 1995.
The funded status of the plans and the net prepaid pension cost at December 31,
were as follows:
<TABLE>
<CAPTION>
1997 1996
--------------- ---------------
(Thousands of Dollars)
<S> <C> <C>
Vested benefit obligations $ 372,855 $ 367,895
=============== ===============
Accumulated benefit obligations $ 421,944 $ 403,395
=============== ===============
Plan assets at fair value $ 948,413 $ 850,424
Less: projected benefit obligations 513,697 488,658
--------------- ---------------
Excess of assets over projected obligations 434,716 361,766
Unrecognized net transition asset (20,996) (26,985)
Unrecognized net gain (264,686) (218,842)
--------------- ---------------
Net prepaid pension cost $ 149,034 $ 115,939
=============== ===============
</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>
26
<PAGE> 29
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 post-retirement health plans is generally based on comprehensive hospital,
medical and surgical benefit plan provisions. The Company funds amounts for
postretirement benefits as deemed appropriate from time to time. Plan assets
consist primarily of corporate equities, government securities and corporate
debt securities.
The postretirement benefit cost for 1997-1995 included the following components:
<TABLE>
<CAPTION>
1997 1996 1995
---------------- --------------- ---------------
(Thousands of Dollars)
<S> <C> <C> <C>
Benefits earned during the year $ 3,306 $ 3,686 $ 3,632
Interest on accumulated postretirement benefit obligations 19,458 22,294 22,822
Actual return on plan assets (2,836) (709) (1,873)
Amortization of transition obligation 8,289 9,437 9,879
Other - net 862 (523) 1,081
---------------- --------------- ---------------
Postretirement benefit cost $ 29,079 $ 34,185 $ 35,541
================ =============== ===============
</TABLE>
The following table sets forth the plans' funded status and the accrued
postretirement benefit obligations as of December 31:
<TABLE>
<CAPTION>
1997 1996
--------------- ---------------
(Thousands of Dollars)
Accumulated postretirement benefit obligations attributable to:
<S> <C> <C>
Retirees $ 196,665 $ 217,763
Fully eligible active plan participants 23,777 21,962
Other active plan participants 79,252 77,635
--------------- ---------------
Total accumulated postretirement benefit obligations 299,694 317,360
Less: fair value of plan assets 36,268 28,501
--------------- ---------------
Excess of accumulated obligations over plan assets 263,426 288,859
Unrecognized transition obligation (124,334) (147,202)
Unrecognized net loss 29,780 19,664
--------------- ---------------
Accrued postretirement benefit obligations $ 168,872 $ 161,321
=============== ===============
</TABLE>
The assumed discount rates used to measure the accumulated postretirement
benefit obligations were 7.25% and 7.5% at December 31, 1997 and December 31,
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 $2.5 million and the accumulated postretirement benefit
obligations as of December 31, 1997 by approximately $30.7 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
$4.3 million in 1997 and 1996, and $3.8 million in 1995.
27
<PAGE> 30
9. 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 $ 19,284 $ 18,149
Buildings 223,183 207,843
Plant and equipment 3,772,045 3,587,851
Other 271,184 323,019
------------------ -------------------
Total 4,285,696 4,136,862
Accumulated depreciation (2,663,988) (2,548,824)
------------------ -------------------
Total property, plant and equipment - net $ 1,621,708 $ 1,588,038
================== ===================
</TABLE>
Depreciation expense in 1997-1995 was equivalent to a composite average
percentage of 6.5%, 6.9%, and 7.1%, respectively. During 1997, depreciation was
partially offset by a reduction in depreciation rates to reflect higher net
salvage values related to certain telephone plant and equipment.
10. REGULATORY AND COMPETITIVE MATTERS
The Company's intrastate business is regulated by the state regulatory
commissions in Alabama, Illinois, Kentucky, North Carolina, South Carolina and
Virginia. 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) in conformity with state
commission orders. The Company also provides long distance access services
directly to interexchange carriers and other customers who provide service
between LATAs. Provisioning of intrastate long distance services within the
Company is accomplished by either (i) arrangements whereby the Company acts or
is a provider of long distance services directly to the customers (Virginia) or
(ii) participation in an intraLATA compensation plan, called an Originating
Responsibility Plan (ORP) (Alabama, Illinois, Kentucky, North Carolina and South
Carolina). Under the ORP plan, the toll rates billed to end-users for intraLATA
toll calls originating in the Company's service area are retained by the
Company. The Company, in turn, pays access charges to the company hauling and
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. The Company receives transitional support payments from
any revenue loss created by these changes in compensation arrangements under the
terms of various industry agreements. In late 1996, the Company canceled its
intraLATA toll agreement with BellSouth Corporation (BellSouth) in Alabama,
wherein BellSouth served as the primary toll carrier within LATAs, and began to
provide intraLATA toll services directly to its own customers through its own
toll tariff. Alabama converted to an ORP during the fourth quarter of 1996.
Alabama
On September 20, 1995, the Alabama Public Service Commission (APSC) adopted a
mandatory price regulation plan for South Central Bell (SCB) and an optional
price regulation plan for the other local-exchange carriers (LECs), including
the Company. The Company, via a letter dated December 19, 1995, indicated its
intention to
28
<PAGE> 31
participate in the optional plan. This plan includes no earnings limitations.
Basic local-exchange rates are capped at their present level for five years, and
thereafter are adjusted in accordance with a formula utilizing an inflation
factor (measured by GDP-PI) less 1.0%. Intrastate access prices must be reduced
by the plan participants. The Company reduced its intrastate access charges by
$1.5 million on July 1, 1996, and must reduce access charges by an estimated
additional $3 million over the 1996-1998 time period. This order also authorizes
the introduction of local-exchange competition in Alabama. The APSC can now
allow new competitors in SCB's service territory. The Company and other LECs
were granted a three-year grace period from competition in their service
territories. However, the APSC has determined that passage of the
Telecommunications Act of 1996 (the Telecommunications Act) has removed the
protection from competition for the Company. Participants of the optional price
regulation plan were required to reduce intrastate access prices effective July
1, 1997. As such, the Company reduced its annual intrastate access revenues by
$1.5 million.
On February 12, 1997, the 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 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%.
Illinois
On October 6, 1996, the Illinois Commerce Commission (ICC) initiated its
investigation into the Company's total element long run incremental cost
(TELRIC) studies to establish rates for interconnection, unbundled network
elements (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. The filing for UNEs took place during the first quarter
of 1998. Hearings are tentatively scheduled to begin during the second quarter
of 1998.
On December 3, 1996, the ICC issued its decision in the Company's arbitration
with AT&T to determine interconnection, resale, and unbundling terms and
conditions. Interim discount rates for the Company's resold services were set
equal to Ameritech's average rate of 20.07%. Where the Company does not have
services similar to Ameritech's, a default discount of 17.5% is to be used. The
Company's cost studies are to be used in the interim until permanent discounts
are established in a separate generic cost proceeding. The Company has filed a
lawsuit in the U.S. District Court challenging portions of the ICC's arbitration
determinations. AT&T withdrew its arbitration agreement with the Company for the
ICC's consideration causing the time period for an ICC decision to expire.
Negotiations will have to run their course before another request for
arbitration can be submitted to the ICC. The Company remains in negotiations
with AT&T.
Kentucky
On September 26, 1996, the Kentucky Public Service Commission (KPSC) issued an
order pertaining to local competition and universal service concerns in
Kentucky. With regard to the local competition issues of interconnection and
unbundling, the KPSC declined to issue specific rules, instead deferring to the
process of negotiations and arbitration contemplated by the Telecommunications
Act. Regarding the resale of local services, the KPSC adopted some resale
restrictions and adopted the FCC's proposed proxy rates for wholesale pricing
purposes on an interim basis until Kentucky-specific resale discount rates can
be determined. The Company filed a Petition for Rehearing with the KPSC on
October 17, 1996 regarding the use of the FCC's proxy rates, which was denied on
October 31, 1996. The KPSC established a competitively neutral, portable
intrastate universal service fund (USF), funded by all telecommunications
providers in Kentucky, to cover the incumbent 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 timing and details of implementation of
29
<PAGE> 32
the USF were to be determined in industry workshops held during 1997. However,
on April 11, 1997, the KPSC issued an order amending the USF order, stating that
a formal proceeding will be held in lieu of workshops, with hearings beginning
during the fourth quarter of 1997. On June 17, 1997, the KPSC issued a further
order which indicated that its 1996 decision to transfer the LEC's NTS costs to
the USF would be reconsidered in the formal proceedings which began in November
1997. Updated cost data and accompanying testimony was filed in February 1998
and hearings are scheduled to begin during the first half of 1998.
On December 23, 1996, the KPSC issued its decision in the Company's arbitration
with MCI to determine interconnection, resale, and unbundling terms and
conditions. The interim wholesale discount rate was set at 18.81%. The Company
has filed a lawsuit in the U.S. District Court challenging portions of the
KPSC's arbitration determinations. On April 25, 1997, the lawsuit was dismissed
without prejudice to refiling. Pursuant to the KPSC's orders, the Company has
filed a composite agreement with MCI. The KPSC is expected to issue a final
decision on the composite agreement in the near future.
On January 17, 1997, the KPSC issued its decision in the Company's arbitration
with American Communications Services, Inc., and on February 14, 1997, the KPSC
issued its decision in the Company's arbitration with AT&T on many of the same
issues that were submitted by MCI. These decisions reaffirmed the rate issued in
the previous arbitration proceedings. The Company has filed a lawsuit in the
U.S. District Court challenging portions of the KPSC's arbitration
determinations.
Effective October 1, 1997, the Company reduced its intrastate revenues by $10.8
million annually, in response to the KPSC's concerns with the Company's
intrastate earnings levels. The Company reduced its access charges to
interexchange carriers and its intrastate toll rates, and eliminated its monthly
charge for touch calling service to business customers.
On December 29, 1994, the KPSC issued an order requiring the implementation of
intraLATA 1+ pre-subscription. This order required all exchanges within Kentucky
to be converted to intraLATA 1+ within a three-year period extending from July
1995 to June 1998.
North Carolina
On April 6, 1995, local competition and regulatory reform legislation was
enacted in North Carolina. The North Carolina Utilities Commission (NCUC) can
authorize local-exchange competition since a price regulation plan has been
approved for the Company. Effective June 24, 1996, the Company began operating
under an intrastate price regulation plan in North Carolina. The plan eliminates
earnings regulation and regulation of depreciation rates, provides a price index
mechanism to increase service rates, allows contract service arrangements (CSA)
without NCUC approval and shortens the tariff approval period. The NCUC will
review the operation of the plan within five years of its effective date. Also,
the Company may file for a new plan or modifications to the existing plan when
circumstances warrant.
Under the plan, residential basic local service rates are capped at their
initial rates for three years, and switched access and carrier common line rates
are capped in the aggregate for the life of the plan. Increases in rates for
other services are limited to both service category and service specific price
indexes (calculated from an inflation index), except for CentraNet(R), billing
and collection, and enhanced digital switch service rates which are not limited.
For those services subject to the price indexes, the Company may increase prices
at any time, but only one increase per year is permitted. Tariffs must be filed
with documentation demonstrating that all price changes comply with the price
indexes. Also, the Company must file annually to update the indexes.
In February 1997, the Company completed conversion of all capable offices in
North Carolina to 1+ pre-subscription.
30
<PAGE> 33
The NCUC issued its decision in the Company's arbitration with AT&T and MCI on
February 4, 1997, and with Sprint on April 7, 1997, to determine
interconnection, resale and unbundling terms and conditions. The interim
discount rate for the Company's resold services was set at 19.97%. On July 17,
1997, August 1, 1997, and August 15, 1997, the Company filed composite
agreements with Sprint, MCI, and AT&T, respectively, pursuant to the NCUC's
directive. The NCUC is expected to issue a final decision on the composite
agreements in the near future.
The NCUC held hearings during the first quarter of 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. The NCUC has also scheduled hearings during the first half of
1998 to establish permanent prices for UNEs.
South Carolina
On May 29, 1996, the South Carolina legislature amended its laws to allow local
competition and alternative regulation. The amendment establishes certain
requirements regarding interconnection, number portability, unbundling and
resale, consistent with the Telecommunications Act. As required by the
amendment, the South Carolina Public Service Commission (SCPSC) issued
guidelines concerning the provision of universal service during the third
quarter of 1997.
The amendment allows any LEC to elect an alternative regulatory framework (ARF)
if the SCPSC has approved a local interconnection agreement between the LEC and
another carrier. Under the ARF, residential and single-line business rates would
be capped for two years, after which, the rates may be adjusted annually per an
inflation-based index. The Company has not filed for alternative regulation
under this amendment.
Per the amendment, the SCPSC has established an Interim LEC Fund (ILF). As of
April 1, 1997, the Company reduced its intrastate switched access rate to that
of BellSouth's rate in South Carolina, and began receiving payment from the ILF
in an amount equal to the revenue reduction.
In March 1997, the Company completed conversion of all capable offices in South
Carolina to 1+ pre-subscription.
On March 17, 1997, the SCPSC issued its decision in the Company's arbitration
with AT&T to determine interconnection, resale and unbundling terms and
conditions. The interim wholesale discount rate for retail services was set at
18.66%. On May 16, 1997, the Company filed a composite agreement with the SCPSC
incorporating the provisions of the SCPSC's order. On May 28, 1997, the Company
filed a letter with the SCPSC objecting to certain language contained in the
composite agreement. The SCPSC is preparing a new agreement incorporating the
provisions of its original order. Once the agreement has been approved, the
Company will evaluate its options to challenge the implementation of the
agreement.
The 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 fund, are
scheduled to begin during the first half of 1998.
Virginia
On February 23, 1995, legislation was enacted in Virginia which allowed
local-exchange competition, effective January 1, 1996. On June 9, 1995, the
Company filed a rate case application with the Virginia State Corporation
Commission (VSCC) seeking to restructure and rebalance its prices in Virginia in
anticipation of this local competition and the VSCC's impending approval of
intraLATA toll competition. Evidentiary hearings regarding this application were
held in June 1996. On March 14, 1997, the Hearing Examiner appointed by the VSCC
to review the Company's application issued his report to the VSCC. The report
recommended that the Company's annual revenues be reduced by $26.9 million and
that only minimal rebalancing of the Company's local-exchange, access and
intraLATA long distance rates be permitted. The Company filed detailed
exceptions to the report and requested oral argument before the full commission.
On August 7, 1997, the VSCC issued its order in this case.
31
<PAGE> 34
The VSCC adopted the majority of the Hearing Examiner's recommendations, but
also made two minor modifications which changed the revenue reduction amount
from $26.9 million to $27.4 million. New rates reflecting this decrease in
annual revenues became effective October 7, 1997. The Company filed an appeal to
this order to the Supreme Court of Virginia. The VSCC filed a motion to dismiss
the appeal on the grounds that the order had not been finalized. On January 13,
1998, the Court granted the VSCC's motion. A final order is not expected until
late 1998.
The Company elected to operate under the GTE South Alternative Regulatory Plan
(the GTE South Plan), effective January 1, 1989. The GTE South Plan provides
economic incentives for the Company to improve productivity and provides the
foundation for implementing pricing flexibility necessary to address competitive
entry into the Company's markets. The GTE South Plan also has an earnings cap
that requires refunds above a predetermined earnings level. Earnings, as
reflected in the Annual Information Filings (AIF) required in the GTE South
Plan, remain under review for the years 1992 through 1996 and a final decision
may be dependent on the final rate case order discussed above. The Company has
provided for the estimated impact of each AIF in its financial statements.
Several alternative local-exchange companies (ALECs), including AT&T, MCI, MFS
Communications Company, Inc. and Jones Intercable, have been certified to
compete for local-exchange service customers in Virginia.
On December 11, 1996, the VSCC issued its decision in the Company's arbitration
with AT&T to determine interconnection, resale, and unbundling terms and
conditions. The interim discount rate for the Company's resold services was set
at 20.6%, which includes operator service and directory assistance. The Company
filed a lawsuit in the U.S. District Court challenging portions of the VSCC's
arbitration determinations. The lawsuit was dismissed and will be refiled once a
contract between the Company and AT&T has been approved by the VSCC.
On December 16, 1996, the VSCC issued its decision in the Company's arbitration
with Cox Fibernet Commercial Services. On January 3, 1997, the VSCC issued its
decision in the Company's arbitration with MCI and on January 21, 1997, the VSCC
issued its decision in the Company's arbitration with Sprint Corporation on many
of the same issues that were submitted by AT&T. These decisions reaffirmed the
rate issued in the previous arbitration proceedings. The Company has filed a
lawsuit in the U.S. District Court challenging portions of the VSCC's
arbitration determinations.
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
32
<PAGE> 35
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 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 increase of $12.1 million. On December 1, 1997, the FCC issued an order to
file revised access rates effective January 1, 1998, which resulted in
interstate access charge reductions of approximately $2.8 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 $11.7 million paid by long
distance carriers were offset by $10.2 million of new per line charges and
charges paid by end-users.
On June 4, 1996, the FCC issued its first Report and Order implementing Section
276 of the Telecommunications Act. As part of the overall goal of promoting
competition among payphone service providers (PSPs), this order mandated
compensation to all PSPs for all calls originating from payphones, including
"dial-around" access calls and toll-free subscriber calls for which PSPs were
not previously compensated. This compensation was to occur in two separate
phases. During phase one, from April 15, 1997 through October 6, 1997, PSPs were
to be paid a monthly, flat-rate compensation from interexchange carriers (IXCs).
During phase two, beginning October 7, 1997, PSPs were to be compensated on a
per-call basis, with the prevailing local coin rate of 35 cents established as
the default rate.
On July 19, 1997, the U.S. Court of Appeals in Washington, D.C. vacated the
FCC's directive concerning per-call compensation, stating that the FCC had not
shown that the 35 cent rate was a reasonable surrogate for fair compensation.
The court also set aside the FCC's flat-rate compensation mandate. Subsequently,
on October 9,
33
<PAGE> 36
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 $4 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 include amounts for access and billing and
collection during the years 1997-1995 under various arrangements and amounted to
$192.4 million, $188.3 million and $196.7 million, respectively.
11. COMMITMENTS AND CONTINGENCIES
The Company has noncancelable leases covering certain buildings, office space
and equipment. Rental expense was $18.9 million, $11.2 million and $16.8 million
in 1997-1995, respectively. Minimum rental commitments for noncancelable leases
through 2002 do not exceed $2.4 million annually and aggregate $3.9 million
thereafter.
The Company is subject to a number of proceedings arising out of the conduct of
its business, including those relating to regulatory actions, commercial
transactions and environmental, safety and health matters. Management believes
that the ultimate resolution of these matters will not have a material adverse
effect on the results of operations or the financial position of the Company.
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.
12. OTHER - NET
The components of other - net for the years ended December 31, are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------------- -------------- --------------
(Thousands of Dollars)
<S> <C> <C> <C>
Income from the reversal of expired representation
and warranty reserves $ -- $ (15,123) $ (20,000)
Expense associated with the early retirement of debt 284 -- --
--------------- -------------- --------------
Total $ 284 $ (15,123) $ (20,000)
=============== ============== ==============
</TABLE>
34
<PAGE> 37
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
GTE South Incorporated:
We have audited the accompanying balance sheets of GTE South Incorporated (a
Virginia corporation and wholly-owned subsidiary of GTE Corporation) as of
December 31, 1997 and 1996, and the related statements of income, shareholders'
equity and cash flows for each of the three years in the period ended December
31, 1997 as set forth on pages 14 through 17 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 South Incorporated as of
December 31, 1997 and 1996, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1997, in conformity
with generally accepted accounting principles.
As discussed in Note 2 to the financial statements, in 1995, the Company
discontinued applying the provisions of Statement of Financial Accounting
Standards No. 71, "Accounting for the Effects of Certain Types of Regulation."
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The supporting schedule and exhibit
listed under Item 14 are presented for purposes of complying with the Securities
and Exchange Commission's rules and are not a required part of the basic
financial statements. The supporting schedule and exhibit have been subjected to
the auditing procedures applied in the audits of the basic financial statements
and, in our opinion, fairly state in all material respects the financial data
required to be set forth therein in relation to the basic financial statements
taken as a whole.
Dallas, Texas ARTHUR ANDERSEN LLP
January 26, 1998
35
<PAGE> 38
MANAGEMENT REPORT
To Our Shareholders:
The management of the Company is responsible for the integrity and objectivity
of the financial and operating information contained in this Annual Report on
Form 10-K, including the financial statements covered by the Report of
Independent Public Accountants. These statements were prepared in conformity
with generally accepted accounting principles and include amounts that are based
on the best estimates and judgments of management.
The Company has a system of internal accounting controls which provides
management with reasonable assurance that transactions are recorded and executed
in accordance with its authorizations, that assets are properly safeguarded and
accounted for, and that financial records are maintained so as to permit
preparation of financial statements in accordance with generally accepted
accounting principles. This system includes written policies and procedures, an
organizational structure that segregates duties, and a comprehensive program of
periodic audits by the internal auditors. The Company has also instituted
policies and guidelines which require employees to maintain the highest level of
ethical standards.
JOHN C. APPEL
President
GERALD K. DINSMORE
Senior Vice President - Finance and Planning
36
<PAGE> 39
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
37
<PAGE> 40
PART III
Item 10. Directors and Executive Officers of the Registrant
a. Identification of Directors
The names, ages and positions of the directors of the Company as of March 2,
1998 are listed below along with their business experience during the past five
years.
<TABLE>
<CAPTION>
Name Age Director Since Business Experience
- -------------------------- -------- -------------------- -----------------------------------------------------------
<S> <C> <C> <C>
John C. Appel 49 1996 President, GTE Network Services, 1997; Executive Vice
President - Network Operations, GTE Telephone Operations,
1996; Executive Vice President - Network Operations, all
GTE domestic telephone subsidiaries of which he is not
President, 1996; Director, all GTE domestic telephone
subsidiaries, 1996; President, GTE South Incorporated and
GTE North Incorporated, 1995; Senior Vice President -
Regulatory Operations, GTE Telephone Operations, 1994;
President, GTE Southwest Incorporated, 1994; State
President - Texas/New Mexico, 1993.
Mateland L. Keith, Jr. 55 1997 Senior Vice President - Regional Operations, GTE Network
Services, 1997; President, GTE California Incorporated,
1995; Assistant Vice President - Engineering, GTE
Telephone Operations, 1995; Area Vice President - Sales,
GTE North Incorporated, 1993.
Lawrence R. Whitman 46 1997 Vice President - Finance and Planning, Business
Development and Integration, 1997; Controller, GTE
Corporation, 1995; Vice President - Finance, TP&S, 1993.
</TABLE>
Directors are elected annually. There are no family relationships between any of
the directors or executive officers of the Company.
38
<PAGE> 41
b. Identification of Executive Officers
The Company's policies are established not only by the Company's executive
officers, but also by the executive officers of GTE Network Services.
Accordingly, the list below contains the names, ages and positions of the
executive officers of both the Company and GTE Network Services as of March 2,
1998.
<TABLE>
<CAPTION>
Year Assumed
Present Position
----------------------------
Network the
Name Age Services Company Position
- --------------------------- --------- ------------- ------------- ---------------------------------------------
<S> <C> <C> <C> <C>
John C. Appel (1) 49 1997 1995 President of the Company and GTE Network
Services
Mary Beth Bardin 43 -- 1995 Vice President - Public Affairs of the
Company
James A. Diaz (2) 48 -- 1997 Vice President - Virginia Region of the
Company
Gerald K. Dinsmore 48 -- 1993 Senior Vice President - Finance and
Planning of the Company
William M. Edwards, III 49 -- 1993 Vice President - Controller of the Company
Stephen A. Inkrott 55 -- 1996 Vice President - South Region of the Company
Gregory D. Jacobson 46 -- 1994 Treasurer of the Company
Mateland L. Keith, Jr. (3) 55 1997 -- Senior Vice President - Regional Operations
of GTE Network Services
Brad M. Krall 56 1993 1995 Vice President - Centralized Operations of
GTE Network Services and the Company
Robert G. McCoy (4) 53 1997 1997 President - Retail Markets of GTE Network
Services and Vice President - Retail
Markets of the Company
William G. Mundy (5) 48 1997 1998 Vice President and General Counsel of GTE
Network Services and the Company
Barry W. Paulson 46 1996 1996 Vice President - Network Operations
Planning and Support of GTE Network
Services and the Company
Richard L. Schaulin 55 1989 1995 Vice President - Human Resources of GTE
Network Services and the Company
Charles J. Somes 51 -- 1994 Secretary of the Company
Larry J. Sparrow (6) 54 1997 -- President - Wholesale Markets of GTE
Network Services
-- 1995 Vice President - Carrier Markets of the
Company
Edward J. Weise (7) 53 -- 1997 Vice President - North Region of the Company
</TABLE>
(1) John C. Appel was appointed President of GTE Network Services in June 1997
replacing Thomas W. White, who was appointed Senior Executive Vice
President - Market Operations of GTE Service Corporation.
(2) James A. Diaz was appointed Vice President - Virginia Region of the Company
in July 1997 replacing Edward J. Weise.
(3) Mateland L. Keith, Jr. was appointed Senior Vice President - Regional
Operations of GTE Network Services in June 1997, replacing John C. Appel.
(4) Robert G. McCoy was appointed President - Retail Markets of GTE Network
Services and elected Vice President - Retail Markets of the Company in
October 1997 replacing C.F. Bercher, who was appointed and elected
President of GTE Communications Corporation.
(5) William G. Mundy was appointed Vice President and General Counsel of GTE
Network Services in October 1997 and elected Vice President - General
Counsel of the Company in January 1998. Mr. Mundy replaced Richard M.
Cahill, who was appointed Vice President and Associate General Counsel of
GTE Service Corporation.
(6) Larry J. Sparrow was appointed President - Wholesale Markets of GTE Network
Services in June 1997.
(7) Edward J. Weise was appointed Vice President - North Region of the Company
in July 1997 replacing William A. Zielke.
Each of these executive officers has been an employee of the Company or an
affiliated company for the last five years. Except for duly elected officers and
directors, no other employees had a significant role in decision making. All
officers are appointed for a term of one year.
39
<PAGE> 42
Item 11. Executive Compensation
Executive Compensation Tables
The following tables provide information about executive compensation.
SUMMARY COMPENSATION TABLE
The following table sets forth information about the compensation of
the individual who served as Principal Executive Officer of the Company in 1997,
each of the other four most highly compensated executive officers of the Company
(other than the Chief Executive Officer) who served as such and were compensated
by the Company or GTE Network Services at the end of 1997 and the two additional
individuals who served as executive officers of the Company or GTE Network
Services in 1997 but did not serve as such or were not being compensated by the
Company or GTE Network Services at the end of 1997 (collectively, the Named
Executive Officers). The information in this table under the caption "Annual
Compensation" sets forth all compensation paid to the Named Executive Officers
by the Company and GTE Network Services. The caption "Long-Term Compensation"
sets forth all long-term compensation paid to the Named Executive Officers under
employee benefit plans administered by GTE Corporation or GTE Service
Corporation. Footnote 1 to this table sets forth the actual 1997 annual
compensation for each of the Named Executive Officers that was allocated to the
Company.
<TABLE>
<CAPTION>
Long-Term Compensation
------------------------------------------------
Annual Compensation (2) Awards Payouts
--------------------------------- ----------------------- ------------------------
Restricted Securities
Other Annual Stock Underlying LTIP All Other
Name and Principal Salary Bonus Compensation Awards Options/ Payouts Compensation
Position in Group (1) Year ($) (3) ($) (4) ($) ($) (5) SARs (#) ($) ($) (6)
- ---------------------------- ----- --------- -------- -------------- ---------- ----------- --------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
John C. Appel 1997 348,365 399,386 -- 59,881 76,000 548,700 11,320
President 1996 295,977 380,700 -- 51,229 124,400 439,200 10,572
1995 239,600 258,100 -- -- 63,500 162,800 10,194
Larry J. Sparrow 1997 315,565 256,400 -- 39,481 40,700 375,300 11,320
President - 1996 294,812 260,800 -- 41,561 81,400 404,100 10,613
Wholesale Markets 1995 261,866 255,600 -- -- 36,400 211,300 10,613
GTE Network Services
Mateland L. Keith, Jr. 1997 250,413 157,100 -- 16,025 32,700 163,400 10,376
Senior Vice President - 1996 217,762 117,300 -- 5,118 15,200 87,600 9,799
Regional Operations 1995 204,308 104,000 -- -- 12,500 -- 9,111
GTE Network Services
Barry W. Paulson 1997 197,538 141,900 -- 14,706 19,900 93,400 7,200
Vice President - 1996 191,945 112,800 -- 9,231 19,900 34,900 6,750
Network Operations 1995 156,027 73,100 -- -- 6,500 -- 6,750
Planning and Support
GTE Network Services
Brad M. Krall 1997 205,608 107,200 -- 15,956 15,200 148,100 9,252
Vice President - 1996 200,205 113,900 -- -- 15,200 159,600 8,840
Centralized Operations 1995 184,336 106,000 -- -- 12,500 75,600 7,945
GTE Network Services
Thomas W. White (7) 1997 470,776 520,646 -- 84,756 91,700 822,400 11,320
Senior Executive 1996 463,115 533,700 -- 81,511 183,400 770,000 10,613
Vice President - 1995 418,884 443,800 -- -- 98,800 331,800 10,613
Market Operations
GTE Service Corporation
Gerald K. Dinsmore (8) 1997 302,532 314,807 -- 45,906 62,200 411,800 11,320
Senior Vice President - 1996 288,619 263,700 -- 41,751 81,400 404,100 10,613
Finance and Planning 1995 265,125 255,600 -- -- 36,400 211,300 10,613
</TABLE>
40
<PAGE> 43
(1) All persons named in the table are officers of the Company except as
otherwise noted.
(2) Annual Compensation represents the total annual cash compensation of
salaries, bonuses and other compensation. The Company's allocated share for
Messrs. Appel, Sparrow, Keith, Paulson, Krall, White and Dinsmore, for whom
total annual amounts are shown above, is $79,800, $58,581, $16,277,
$34,765, $32,038, $105,290 and $65,513, respectively.
(3) The data in the table includes fees of $7,280, $15,692 and $16,607 received
by Mr. White for serving as director of BC TEL during 1997, 1996 and 1995.
BC TEL, a Canadian company, is an indirectly-owned subsidiary of GTE
Corporation. Mr. White also received BC TEL deferred stock units valued at
$10,695, which amount is included in this column.
(4) The data in this column represents the annual bonus received in 1997 by
each of the Named Executive Officers under the GTE Corporation 1997
Executive Incentive Plan (the EIP) and a similar predecessor plan (the
Executive Incentive Plan). In connection with GTE's Equity Participation
Program (the EPP), a portion of this amount has been deferred into
restricted stock units payable at maturity (generally, a minimum of three
years) in GTE Common Stock (Restricted Stock Units). The number of
Restricted Stock Units received was calculated by dividing the amount of
the annual bonus deferred by the average closing price of GTE Common Stock
on the New York Stock Exchange (NYSE) composite tape for the 20 consecutive
trading days following the release to the public of GTE's financial results
for the fiscal year in which the bonus was earned (the Average Closing
Price). Additional Restricted Stock Units are received on each dividend
payment date based upon the amount of the dividend paid and the closing
price of GTE Common Stock on the composite tape of NYSE issues on the
dividend declaration date.
(5) The data in this column represents the dollar value of the matching
Restricted Stock Units based upon the Average Closing Price. Matching
Restricted Stock Units are received on the basis of one additional
Restricted Stock Unit for every four Restricted Stock Units deferred
through annual bonus deferrals described in footnote 4 above. The matching
Restricted Stock Units were designed as an inducement to encourage full
participation in the EPP and to compensate the executives for their
agreement not to realize the economic value associated with the Restricted
Stock Units representing deferred annual bonus for a minimum of three
years. Additional Restricted Stock Units are received on each dividend
payment date based upon the amount of the dividend paid and the closing
price of GTE Common Stock on the composite tape of NYSE issues on the
dividend declaration date. Messrs. Appel, Sparrow, Keith, Paulson, Krall,
White and Dinsmore hold a total of 11,024, 8,106, 2,025, 2,346, 1,467,
16,568 and 8,716 Restricted Stock Units, respectively, which had a dollar
value of $576,025, $423,517, $105,801, $122,591, $76,641, $865,678 and
$455,397, respectively, based solely upon the closing price of GTE Common
Stock on December 31, 1997.
(6) The column "All Other Compensation" includes, for 1997, Company
contributions to the GTE Savings Plan of $7,200 for each of Messrs. Appel,
Sparrow, Paulson, Krall, White and Dinsmore and $6,731 for Mr. Keith. This
column also includes Company contributions to the GTE Executive Salary
Deferral Plan of $4,120 for each of Messrs. Appel, Sparrow, White and
Dinsmore, $3,645 for Mr. Keith and $2,052 for Mr. Krall.
(7) Mr. White was elected Senior Executive Vice President - Market Operations
of GTE Service Corporation in June 1997. He served as President of GTE
Telephone Operations from July 1995 until June 1997, and before that as an
Executive Vice President of GTE Telephone Operations from 1991.
(8) Mr. Dinsmore was appointed President, Business Development and Integration
(a separate business unit of GTE) in June 1997. Mr. Dinsmore has served as
Senior Vice President - Finance and Planning of the Company since 1993.
Although Mr. Dinsmore has retained his title with the Company, since June
1997 he has been compensated solely through his new position.
41
<PAGE> 44
OPTION GRANTS IN LAST FISCAL YEAR
The following table shows all grants of options to the Named Executive
Officers of the Company in 1997, whether or not specifically allocated to the
Company. The options were granted under the GTE Corporation 1997 Long-Term
Incentive Plan (the 1997 LTIP) and the GTE Corporation 1991 Long-Term Incentive
Plan (the 1991 LTIP). Pursuant to Securities and Exchange Commission rules, the
table also shows the value of the options granted at the end of the option terms
(ten years) if the stock price were to appreciate annually by 5% and 10%,
respectively. There is no assurance that the stock price will appreciate at the
rates shown in the table. The table also indicates that if the stock price does
not appreciate, the potential realizable value of the options granted will be
zero.
<TABLE>
<CAPTION>
Potential Realizable Value at
Assumed Annual Rate of Stock
Price Appreciation for
Individual Grants Option Term
----------------------------------------------------------- --------------------------------
Number of Percent of
Securities Total Options Exercise
Underlying Granted to or Base
Options Employees in Price Expiration
Name Granted (1) Fiscal Year ($/SH) Date 0% 5% 10%
- ---------------------- ------------------ ---------------- ------------- ----------- ------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
John C. Appel 62,200 .29% 48.6250 2/16/07 -- 1,902,076 4,820,234
13,800 .06% 44.1250 6/04/07 -- 382,950 970,470
Larry J. Sparrow 40,700 .19% 48.6250 2/16/07 -- 1,244,606 3,154,076
Mateland L. Keith, Jr. 15,200 .07% 48.6250 2/16/07 -- 464,816 1,177,935
17,500 .08% 44.1250 6/04/07 -- 485,625 1,230,668
Barry W. Paulson 19,900 .09% 48.6250 2/16/07 -- 608,542 1,542,165
Brad M. Krall 15,200 .07% 48.6250 2/16/07 -- 464,816 1,177,935
Thomas W. White 91,700 .43% 48.6250 2/16/07 -- 2,804,186 7,106,358
Gerald K. Dinsmore 40,700 .19% 48.6250 2/16/07 -- 1,244,606 3,154,076
21,500 .10% 44.1250 6/04/07 -- 596,624 1,511,964
</TABLE>
(1) Each option granted may be exercised with respect to one-third of the
aggregate number of shares subject to the grant each year, commencing one
year after the date of grant. No stock appreciation rights (SARs) were
granted to the Named Executive Officers of the Company in 1997.
42
<PAGE> 45
AGGREGATED OPTION/SAR EXERCISES
IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
The following table provides information as to options and SARs
exercised by each of the Named Executive Officers of the Company during 1997.
The table sets forth the value of options and SARs held by such officers at
year-end measured in terms of the closing price of GTE Corporation (GTE) Common
Stock on December 31, 1997.
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options/SARs
Shares Options/SARs at FY-End at FY-End ($)
Acquired Value ----------------------------- -------------------------------
Name On Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable
- --------------------- --------------- ----------------- ------------ --------------- --------------- -------------
<S> <C> <C> <C> <C> <C> <C>
John C. Appel 56,567 600,134 -- 200,834 -- 1,539,141
Larry J. Sparrow -- -- 73,566 120,668 1,234,142 924,580
Mateland L. Keith, Jr. 26,533 450,092 5,066 47,001 40,687 338,674
Barry W. Paulson 6,700 117,281 10,966 35,334 130,074 203,344
Brad M. Krall 17,034 249,251 5,066 29,501 40,687 206,064
Thomas W. White 69,300 1,055,056 132,232 277,468 2,094,451 2,158,179
Gerald K. Dinsmore -- -- 35,999 142,168 531,517 1,089,190
</TABLE>
LONG-TERM INCENTIVE PLAN - AWARDS IN LAST FISCAL YEAR
The 1997 LTIP and 1991 LTIP provide for awards to participating
employees, including stock options, SARs, performance bonuses and other
stock-based awards. The stock options awarded under the 1997 LTIP and 1991 LTIP
to the Named Executive Officers in 1997 are shown in the table on page 42.
<TABLE>
<CAPTION>
Estimated Future Payouts
Under Non-Stock Price Based Plans (1)
Performance ---------------------------------------------------
Number of Or Other Period
Shares, Units Until Maturation Threshold (2) Target (3)
Name Or Other Rights Or Payout (# of Units) (# of Units) Maximum (4)
- ---------------------------- ---------------- ----------------- ---------------------------------- -----------------
<S> <C> <C> <C> <C> <C>
John C. Appel (5) 7,400 3 Years 2,146 8,254
1,380 30 Months 396 1,524
845 18 Months 235 902
290 6 Months 60 299
Larry J. Sparrow 4,900 3 Years 1,421 5,466
Mateland L. Keith, Jr. (6) 1,900 3 Years 551 2,119
1,720 30 Months 494 1,899
1,055 18 Months 293 1,126
310 6 Months 64 319
Barry W. Paulson 2,400 3 Years 696 2,677
Brad M. Krall 1,900 3 Years 551 2,119
Thomas W. White 10,900 3 Years 3,161 12,158
Gerald K. Dinsmore (7) 4,900 3 Years 1,421 5,466
2,155 30 Months 619 2,379
1,320 18 Months 366 1,409
410 6 Months 84 422
</TABLE>
43
<PAGE> 46
(1) An individual's award may not exceed the applicable individual award limit
(the Award Limit), which is expressed as a percentage of the LTIP Award
Pool. The Award Limit depends on the individual's base salary at the end of
the award cycle, and may not exceed 3.5% of the LTIP Award Pool. The
amounts described in footnotes 2 through 4 below are subject to and cannot
exceed the Award Limit. An individual is initially granted a specified
number of GTE Common Stock equivalent units (Equivalent Units) at the
beginning of an award cycle. During the award cycle, additional Equivalent
Units are added based upon the price of GTE Common Stock and the amount of
the per share dividend paid on each dividend payment date. It is not
possible to predict future dividends and, accordingly, estimated Equivalent
Unit accruals in this table are calculated for illustrative purposes only
and are based upon the dividend rate and price of GTE Common Stock at the
close of business on December 31, 1997. The "Target" award or future payout
is the dollar amount derived by multiplying the Equivalent Unit balance
credited to the participant at the end of the award cycle by the average
closing price of GTE Common Stock, as reported on the composite tape of
NYSE issues, during the last 20 business days of the award cycle. The
Target award measures performance attainment as described in footnote 3.
(2) The Threshold represents attainment of minimum acceptable levels of
performance (the Threshold Levels) with respect to the five Long-Term
Performance Bonus Measures (the Measures) adopted for the 1997-1999
Performance Bonus award cycle -- revenue growth; earnings per share (EPS)
growth; earnings before interest, taxes, depreciation and amortization
(EBITDA) growth; average return on investment (ROI) and relative total
shareholder return (TSR). If the Threshold Level is attained with respect
to each of the Measures, the award will be equal to approximately 25% of
the combined Target award (the TSR Threshold is set at 50%, while the
Threshold for the other four Measures is set at 20%). Because performance
is measured separately for each Measure, it is possible to receive an award
if the Threshold Level is achieved with respect to at least one but not all
of the Measures. If the actual results for all Measures are below the
Threshold Levels, no award will be paid.
(3) The Target represents attainment of levels of three-year revenue growth,
EPS growth, EBITDA growth, ROI and TSR established at the beginning of an
award cycle (the Target Levels). If GTE's actual results for each of the
Measures are equivalent to the Target Levels, this would represent
outstanding performance, and the award will be equal to 100% of the
combined Target award. GTE's performance is measured separately for each
Measure. Accordingly, if the actual result for any Measure is at the
applicable Target Levels, the portion of the award determined by that
Measure will be at 100% of the Target award for that Measure. Similarly,
the portion of the award determined by any Measure performing at less than
the applicable Target Level, but above the Threshold, will be less than the
Target award for that Measure.
(4) This column has intentionally been left blank because it is not possible to
determine the maximum number of Equivalent Units until the award cycle has
been completed. Subject to the Award Limit discussed in footnote 1 above,
the maximum amount of the award is limited by the extent to which GTE's
actual results for the five Measures exceed the Target Levels. If GTE's
actual results during the cycle for the five Measures exceed the respective
Target Levels, additional awards may be paid, based on a linear
interpolation. For example, for revenue growth, the schedule is as follows:
<TABLE>
<CAPTION>
Performance Increment Above
Revenue Performance Target Added Percentage to Combined Awards
------------------------------------------- -------------------------------------------
<S> <C>
Each 0.1% improvement in cumulative
revenue growth +2%
</TABLE>
Thus, if the revenue growth Measure exceeds its Target Level by .5% while
the remaining four Measures are precisely at their respective Target
Levels, then the performance bonus will equal 110% of the combined Target
award.
44
<PAGE> 47
(5) The award of 7,400 units to Mr. Appel represents the grant for the
1997-1999 performance period made while he was Executive Vice President of
GTE Telephone Operations. Pursuant to GTE's compensation policies, the
other grants shown are incremental, prorated awards made when he was
promoted to President of GTE Network Services in June 1997. The incremental
units apply to the 1997-1999, 1996-1998 and 1995-1997 performance periods.
(6) The award of 1,900 units to Mr. Keith represents the grant for the
1997-1999 performance period made while he was President of GTE California
Incorporated, an affiliate of the Company. Pursuant to GTE's compensation
policies, the other grants shown are incremental, prorated awards made when
he was promoted to Senior Vice President - Regional Operations of GTE
Network Services in June 1997. The incremental units apply to the
1997-1999, 1996-1998 and 1995-1997 performance periods.
(7) The award of 4,900 units to Mr. Dinsmore represents the grant for the
1997-1999 performance period made while he was Senior Vice President -
Finance and Planning of the Company. Pursuant to GTE's compensation
policies, the other grants shown are incremental, prorated awards made when
he was promoted to President of Business Development and Integration, a
separate business unit of GTE, in June 1997. The incremental units apply to
the 1997-1999, 1996-1998 and 1995-1997 performance periods.
Executive Agreements
GTE has entered into agreements (the Agreements) with Messrs. Appel,
Sparrow, White and Dinsmore regarding benefits to be paid in the event of a
change in control of GTE (a Change in Control).
A Change in Control is deemed to have occurred if (a) any person or group
of persons acquires, other than from GTE or as described below, 20% (or under
certain circumstances, a lower percentage, not less than 10%) of GTE's voting
power, (b) three or more directors are elected in any twelve-month period
without the approval of a majority of the members of GTE's Incumbent Board (as
defined in the Agreements) then serving as members of the Board, (c) the members
of the Incumbent Board no longer constitute a majority of the Board or (d) GTE's
shareholders approve (i) a merger, consolidation or reorganization involving
GTE, (ii) a complete liquidation or dissolution of GTE or (iii) an agreement for
the sale or other disposition of all or substantially all of the assets of the
Corporation to any person other than a subsidiary of GTE. An individual whose
initial assumption of office occurred pursuant to an agreement to avoid or
settle a proxy or other election contest is not considered a member of the
Incumbent Board. In addition, a director who is elected pursuant to such a
settlement agreement will not be deemed a director who is elected or nominated
by the Incumbent Board for purposes of determining whether a Change in Control
has occurred. Notwithstanding the foregoing, a Change in Control will not occur
in the following situations: (1) certain merger transactions in which there is
at least 50% GTE shareholder continuity in the surviving corporation, at least a
majority of the members of the board of directors of the surviving corporation
consists of members of the Board and no person owns more than 20% (or under
certain circumstances, a lower percentage, not less than 10%) of the voting
power of the surviving corporation following the transaction, and (2)
transactions in which GTE's securities are acquired directly from GTE.
The Agreements provide for benefits to be paid in the event these
individuals separate from service and have a "good reason" for leaving or are
terminated without "cause" within two years after a Change in Control of GTE.
Good reason for leaving includes, but is not limited to, the following events:
demotion, relocation or a reduction in total compensation or benefits, or the
new entity's failure to expressly assume obligations under the Agreements.
Termination for cause includes certain unlawful acts on the part of the
executive or a material violation of his or her responsibilities to the
Corporation resulting in material injury to the Corporation.
An executive who experiences a qualifying separation from service will be
entitled to receive up to two times the sum of (i) base salary and (ii) the
average of his or her percentage awards under the EIP for the previous three
years. The executive will also continue to receive medical and life insurance
coverage for up to two years and will be provided with financial and
outplacement counseling.
45
<PAGE> 48
In addition, each executive covered under an Agreement will be considered
to have not less than 76 points and 15 years of accredited service for the
purpose of determining his or her eligibility for early retirement benefits. The
Agreements provide that there will be no duplication of benefits.
Each of the Agreements remains in effect until July 1, 1999 unless
terminated earlier pursuant to its terms. The Agreements will be automatically
renewed on each successive July 1 unless, not later than December 31 of the
preceding year, one of the parties notifies the other that he or she does not
wish to extend his or her respective Agreement. If a Change in Control occurs,
the Agreements will remain in effect until the obligations of GTE (or its
successor) under the Agreements have been satisfied.
Retirement Programs
Pension Plans
The estimated annual benefits payable, calculated on a single life annuity
basis, under GTE's defined benefit pension plans at normal retirement at age 65,
based upon final average earnings (integrated with social security as described
below) and years of service, is illustrated in the following table:
<TABLE>
<CAPTION>
PENSION PLAN TABLE
Years of Service
Final Average ------------------------------------------------------------------------------------
Earnings 15 20 25 30 35
- ----------------------- ------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 200,000 $ 42,182 $ 56,242 $ 70,303 $ 84,363 $ 98,424
300,000 63,932 85,242 106,553 127,863 149,174
400,000 85,682 114,242 142,803 171,363 199,924
500,000 107,432 143,242 179,053 214,863 250,674
600,000 129,182 172,242 215,303 258,363 301,424
700,000 150,932 201,242 251,553 301,863 352,174
800,000 172,682 230,242 287,803 345,363 402,924
900,000 194,432 259,242 324,053 388,863 453,674
1,000,000 216,182 288,242 360,303 432,363 504,424
1,200,000 259,682 346,242 432,803 519,363 605,924
1,500,000 324,932 433,242 541,553 649,863 758,174
2,000,000 433,682 578,242 722,803 867,363 1,011,924
</TABLE>
GTE Service Corporation, a wholly-owned subsidiary of GTE, maintains the
GTE Service Corporation Plan for Employees' Pensions (the Service Corporation
Plan), a noncontributory pension plan for the benefit of all GTE employees who
are not covered by collective bargaining agreements. It provides a benefit based
on a participant's years of service and earnings. Pension benefits to be paid
from the Service Corporation Plan and contributions to the Service Corporation
Plan are related to basic salary and incentive payments exclusive of overtime,
differentials, certain incentive compensation and other similar types of
payments. Under the Service Corporation Plan, pensions are computed on a
two-rate formula basis of 1.15% and 1.45% for each year of service, with the
1.15% service credit being applied to that portion of the average annual salary
for the five highest consecutive years that does not exceed the Social Security
Integration Level (the portion of salary subject to the Federal Social Security
Act), and the 1.45% service credit being applied to that portion of the average
annual salary for the five highest consecutive years that exceeds said level up
to the statutory limit on compensation. As of December 31, 1997, the credited
years of service under the Service Corporation Plan for Messrs. Appel, Sparrow,
Keith, Paulson, Krall, White and Dinsmore are 26, 30, 31, 24, 31, 29 and 22,
respectively.
Under Federal law, an employee's benefits under a qualified pension plan,
such as the Service Corporation Plan, are limited to certain maximum amounts.
GTE maintains the GTE Excess Pension Plan (the Excess Plan), which supplements
the benefits of any participant in the Service Corporation Plan in an amount by
which any
46
<PAGE> 49
participant's benefits under the Service Corporation Plan are limited by law. In
addition, the Supplemental Executive Retirement Plan (SERP) includes a provision
permitting the payment of additional retirement benefits determined in a similar
manner as under the Service Corporation Plan on remuneration accrued under
management incentive plans as determined by the Committee. SERP and Excess Plan
benefits are payable in a lump sum or an annuity.
Executive Retired Life Insurance Plan
The GTE Corporation Executive Retired Life Insurance Plan (ERLIP) provides
Messrs. Appel, Sparrow, Keith, Paulson, White and Dinsmore a postretirement life
insurance benefit of three times final base salary and provides Mr. Krall a
postretirement life insurance benefit of two and one-half times final base
salary. Upon retirement, ERLIP benefits may be paid as life insurance or,
alternatively, an equivalent amount equal to the present value of the life
insurance amount (based on actuarial factors and the interest rate then in
effect), may be paid as a lump sum payment, as an annuity or as installment
payments.
Directors' Compensation
The current directors, all of whom are employees of GTE, are not paid any fees
or remuneration, as such, for service on the Board.
47
<PAGE> 50
Item 12. Security Ownership of Certain Beneficial Owners and Management
(a) Security Ownership of Certain Beneficial Owners as of February 28,
1998:
<TABLE>
<CAPTION>
Name and Address of Shares of
Title of Class Beneficial Owner Beneficial Ownership Percent of Class
--------------------------- ----------------------------- ----------------------- -------------------
<S> <C> <C> <C>
Common Stock of GTE GTE Corporation 21,000,000 100%
South Incorporated One Stamford Forum shares of record
Stamford, Connecticut 06904
</TABLE>
(b) Security Ownership of Management as of December 31, 1997:
<TABLE>
<CAPTION>
Shares
Beneficially
Owned as of
Title of Class Name of Director (1)(2)(3) December 31, 1997
--------------------------- --------------------------------------- ------------------
<S> <C> <C>
Common Stock of GTE John C. Appel 48,159
Corporation Mateland L. Keith, Jr. 21,678
Lawrence R. Whitman 15,211
------------------
85,048
==================
Executive Officers (1) (2) (3)
-----------------------------------------------------------
John C. Appel 48,159
Larry J. Sparrow 127,612
Mateland L. Keith, Jr. 21,678
Barry W. Paulson 19,814
Brad M. Krall 25,150
Thomas W. White 228,845
Gerald K. Dinsmore 55,636
------------------
526,894
==================
All directors and executive
officers as a group (1) (2) (3) 767,292
==================
</TABLE>
(1) Includes shares acquired through participation in the GTE Savings Plan.
(2) Included in the number of shares beneficially owned by Messrs. Appel,
Keith, Whitman, Sparrow, Paulson, Krall, White, Dinsmore and all directors
and executive officers as a group, 41,466, 17,366, 10,900, 112,833, 11,800,
19,366, 214,532, 52,833 and 668,927 shares, respectively, which such
persons have the right to acquire within 60 days pursuant to stock options.
(3) No director or executive officer owns as much as one-tenth of one percent
of the total outstanding shares of GTE Common Stock, and all directors
and executive officers as a group own less than one-fifth of one percent
of the total outstanding shares of GTE Common Stock.
(c) There were no changes in control of the Company during 1997.
48
<PAGE> 51
Item 13. Certain Relationships and Related Transactions
The Company's executive officers or directors were not materially indebted to
the Company or involved in any material transaction in which they had a direct
or indirect material interest. None of the Company's directors were involved in
any business relationships with the Company.
49
<PAGE> 52
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) Financial Statements - See GTE South Incorporated's financial
statements and report of independent accountants thereon in the
Financial Statements section included elsewhere herein.
(2) Financial Statement Schedules - Schedules supporting the financial
statements for the years ended December 31, 1997-1995 (as required):
II - Valuation and Qualifying Accounts
Note: Schedules other than the one listed above are omitted as not
applicable, not required, or the information is included in the
financial statements or notes thereto.
(3) Exhibits - Included in this report or incorporated by reference.
3.1* Restated Articles of Incorporation dated August 24, 1989
(Exhibit 3.1 of the 1989 Form 10-K, File No. 2-36292)
3.2* Amended By-Laws, effective September 20, 1995 (Exhibit 3.1 of
the September 30, 1995 Form 10-Q, File No. 2-36292)
4* Indenture dated as of May 1, 1994 between GTE South
Incorporated and NationsBank of Georgia, National Association,
as Trustee (Exhibit 4.1 of the Company's Registration
Statement on Form S-3, File No. 33-54167)
10.1* Material Contracts - Agreements between GTE and Certain
Executive Officers (Exhibit 10 of the 1995 Form 10-K, File
No. 2-36292)
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
(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.
50
<PAGE> 53
GTE South Incorporated
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
For the Years Ended December 31, 1997, 1996 and 1995
(Thousands of Dollars)
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E
------------------------------------------------------------------------------------------------------------------
Additions
---------------------------------
Deductions
Balance at Charged from
Beginning Charged (Credited) to Reserves Balance at
Description of Year to Income Other Accounts (Note 1) Close of Year
------------------------------------------------------------------------------------------------------------------
Allowance for uncollectible accounts
for the years ended:
<S> <C> <C> <C> <C> <C>
December 31, 1997 $ 17,884 $ 23,653 $ 26,107 (2) $ 49,006 $ 18,638
=====================================================================================
December 31, 1996 $ 17,081 $ 21,361 $ 23,561 (2) $ 44,119 $ 17,884
=====================================================================================
December 31, 1995 $ 24,090 $ 22,229 $ 19,954 (2) $ 49,192 $ 17,081
=====================================================================================
Accrued restructuring costs for the
years ended:
December 31, 1996 $ 74,254 $ -- $ (21,892) (3) $ 52,362 $ --
=====================================================================================
December 31, 1995 $ 127,950 $ -- $ -- $ 53,696 $ 74,254
=====================================================================================
</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.
51
<PAGE> 54
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 SOUTH INCORPORATED
---------------------------------------
(Registrant)
Date March 26, 1998 By /s/ John C. Appel
--------------- --------------------------------------
John C. Appel
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>
<CAPTION>
<S> <C> <C>
/s/ John C. Appel President and Director March 26, 1998
- ----------------------------
John C. Appel (Principal Executive Officer)
/s/ Gerald K. Dinsmore Senior Vice President - Finance and March 26, 1998
- ----------------------------
Gerald K. Dinsmore Planning
(Principal Financial Officer)
/s/ William M. Edwards, III Vice President - Controller March 26, 1998
- ----------------------------
William M. Edwards, III (Principal Accounting Officer)
/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>
52
<PAGE> 55
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:
o you voluntarily terminate your employment for any reason;
o your employment is terminated for cause as determined by me or my
successor or designee; or
o you violate any of the terms of the attached Separation Agreement and
General Release (including but not limited to the provisions regarding
confidentiality and non-embarrassment) or the non-compete provisions of
paragraphs A.10 and B.7 of this Letter Agreement.
In the event that you die or become disabled (within the meaning of GTE's
Long-Term Disability Plan) during the Special Assignment Period, all further
salary will cease, your eligibility for the Miscellaneous Benefits will cease,
your EIP Payments and Performance Bonus Awards will be pro-rated to the date of
your death or disability (but will not be paid until the date they otherwise
would have been paid had you not died or become disabled), the Special Exercise
Period will not apply, your Separation Benefits (including but not limited to
ISEP) will be treated in accordance with the terms of the relevant plans or
policies, your eligibility for the LTIP Grants will be determined in accordance
with the relevant plan provisions, and you will not be required to perform, and
will not be paid for, any consulting services.
10. MISCELLANEOUS - Since you will remain a GTE employee until the end of
the Special Assignment Period, you will remain subject to all GTE policies,
including but not limited to GTE's policies relating to non-competition and
disclosure of confidential information. You shall be responsible for the payment
of all applicable taxes relating to the benefits described in Paragraph A of
this Letter Agreement, including but not limited to taxes as a result of ISEP or
any ISEP equivalent payment.
B. CONSULTING ARRANGEMENT
1. CONSULTING PERIOD. You will serve as a non-employee consultant for the
period July 1, 1998 through June 30, 2000 (the "Consulting Period"). During the
Consulting Period and thereafter, you will not be entitled to any benefits
provided by GTE to its active employees and, by signing below, you acknowledge
and agree that you shall not be entitled to any such benefits and effectively
waive participation in any such benefits.
2. CONSULTING SERVICES. During the Consulting Period, you will perform
special projects as assigned by me or my successor or designee. All required
services will be performed by you. You will be free at all times to arrange the
time and manner of performance of the consulting services to be rendered
hereunder and will not be expected to maintain or observe a schedule of duties
or assignments. You will not report to the Company on any regular basis, but
will 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.
3. Cahill agrees to release GTE Corporation and any related or affiliated
companies, and any and all current and former directors, employees, officers,
agents, and contractors of these companies, and any and all employee pension or
welfare benefit plans of these companies, including current and former
<PAGE> 8
trustees and administrators of these plans, (hereinafter GTE Corporation, the
Company, and the other entities and persons referenced above are collectively
referred to in this Separation Agreement and General Release as "GTE") from all
known and unknown claims, charges, or demands Cahill may have based on his
employment with GTE, including a release of any rights or claims Cahill may have
under the Age Discrimination in Employment Act ("ADEA"), which prohibits age
discrimination in employment; Title VII of the Civil Rights Act of 1964, and the
Civil Rights Act of 1991, which prohibit discrimination in employment based on
race, color, sex, religion, and national origin; the Americans with Disabilities
Act, which prohibits discrimination based upon disability; Section 1981 of the
Civil Rights Act of 1866, which prohibits discrimination based on race; the
Employee Retirement Income Security Act, which governs employee benefits; any
state laws against discrimination; or any other federal, state, or local statute
or common law relating to employment. This includes a release by Cahill of any
claims for wrongful discharge, breach of contract, employment-related torts, or
any other claims in any way related to Cahill's employment with GTE.
This release does not include, however, a waiver of any right to vested benefits
under any pension or savings plan, any right to Worker's Compensation, any right
to receive pay for banked and accrued, but unused, vacation, or any right to
unemployment compensation that Cahill may have.
4. Cahill has not filed and promises not to file, or permit to be filed on
his behalf, any lawsuit or complaint against GTE regarding the claims released
in Part II, paragraph 3 above. Cahill also promises to opt out of and to take
such other steps as he has the power to take to disassociate himself from any
class seeking relief against GTE regarding any claims released in Part II,
paragraph 3. If a court, administrative agency, arbitrator, or any other
decision maker with authority awards Cahill money damages or other relief, with
respect to claims released in Part II, paragraph 3, Cahill hereby assigns to the
Company all rights and interest in such money damages and other relief.
5. Cahill agrees not to disclose the terms of this Agreement, that this
Agreement exists, or that he received any payments from the Company to anyone
except his attorney, his financial planner, or his immediate family (spouse,
children, siblings, parents). If he does disclose the terms of this Agreement to
his immediate family, his financial planner, or his attorney, he will advise
them that they must not disclose the terms of this Agreement.
6. Cahill acknowledges that, during the period he has served as an in-house
attorney with GTE, he has had access to confidential information relating to
GTE. Consistent with the Rules of Professional Conduct, Cahill will not use or
disclose any such confidential information without first obtaining the consent
of the Company.
Cahill agrees to comply with the provisions of GTE H.R. Policy 412 (Attachment
I) provided that, in the event of a conflict between Policy 412 and this
Agreement, the terms of this Agreement shall take precedence. Contemporaneously
with the execution of this Agreement, if Cahill has not executed a copy of the
Business and Scientific Information Agreement, Cahill shall do so (Policy
Attachment A). Upon his termination, Cahill shall execute Policy Attachment D.
Cahill further agrees to take no action that would cause GTE (including its
employees, directors, and shareholders) embarrassment or humiliation or
otherwise cause or contribute to GTE (including its employees, directors, and
shareholders) being held in disrepute by the general public or GTE's clients,
shareholders, customers, federal or state regulatory agencies, employees,
agents, officers, or directors.
<PAGE> 9
Cahill will cooperate and make all reasonable efforts to assist the Company in
any investigation of matters involving GTE. Cahill also agrees to testify as a
witness and be available for interviews and to assist GTE in preparation for any
legal proceedings involving GTE in which Cahill has direct knowledge or specific
expertise. Cahill will be compensated appropriately and reimbursed for
reasonable expenses.
Nothing in this Agreement shall be construed to prevent Cahill from giving
compelled truthful testimony before any federal or state agency or in any
judicial proceeding; provided that, in order to permit GTE to seek an injunction
or other judicial relief, he will timely notify GTE in advance of any such
proceeding in which he expects to be called to testify or for which he has
received a subpoena.
7. Cahill acknowledges and agrees that he has not been discriminated
against in any way during his employment with GTE or with regard to his
separation from employment with the Company.
8. Cahill agrees that GTE will be entitled to recover liquidated damages in
the amount of $75,000 if he breaks his promises in Part II, paragraphs 1-6 of
this Agreement. These liquidated damages are based upon the parties' recognition
that damages to GTE due to Cahill's breaking of these promises are not capable
of measurement with any degree of certainty. The amount specified is not to be
considered a penalty, but solely as liquidated damages. If Cahill breaks his
promise in Part II, paragraph 4 and files a lawsuit or complaint regarding
claims Cahill has released, in addition to the liquidated damages described
above, Cahill will pay for all costs incurred by GTE, including reasonable
attorneys' fees, in defending against his claim.
9. Cahill understands that he has been given 21 days to review and consider
this Agreement before signing it. Cahill further understands that he may use as
much of this 21-day period as he wishes prior to signing this Agreement.
10. Cahill may revoke this Agreement within seven days after he signs it.
If Cahill wishes to revoke this Agreement within this seven-day period, written
notice of revocation should be delivered to the office of Thomas W. Green,
Senior Head of Stamford Transition Team, by the close of business seven days
after Cahill signs the Agreement. This Agreement will not become effective or
enforceable until seven days after Cahill signs it. If Cahill revokes this
Agreement, it will not be effective or enforceable, and he will not receive the
benefits described in Part I, paragraph 1.
11. Cahill agrees that the Company advised Cahill to consult with an
attorney before signing this Agreement.
12. The parties participated jointly in the negotiation of this Agreement,
and each party had the opportunity to obtain the advice of legal counsel and to
review, comment upon, and redraft this Agreement. Accordingly, it is agreed that
no rule of construction shall apply against any party or in favor of any party,
and any uncertainty or ambiguity shall not be interpreted against any one party
and in favor of the other.
13. Cahill and the Company hereby consent that any disputes relating to
this Agreement will be governed by Connecticut law.
<PAGE> 10
14. In the event that any one or more of the provisions contained in this
Agreement shall, for any reason, be held to be invalid, illegal, or
unenforceable in any respect, such invalidity, illegality, or unenforceability
shall not affect any other provision of this Agreement.
15. This Separation Agreement and General Release and the December 24, 1997
Letter constitute the entire Agreement between Cahill and the Company and shall
be binding upon the heirs, successors, and assigns of Cahill and the Company. No
other promises or agreements have been made to Cahill other than those in this
Agreement. Cahill is not relying on any statement, representation, or warranty
that is not contained in this Agreement. Cahill acknowledges that he has read
this Agreement carefully, fully understands the meaning of the terms of this
Agreement, and is signing this Agreement knowingly and voluntarily.
Subscribed and sworn to before
me this____day of____, 1998. --------------------------------
Richard M. Cahill
- ------------------------------ --------------------------------
Notary Public Date
Subscribed and sworn to before GTE Service Corporation
me this____day of____, 1998.
- ------------------------------ --------------------------------
Notary Public By:
Title:
--------------------------------
Date
<PAGE> 1
EXHIBIT 12
GTE South Incorporated
STATEMENTS OF THE 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 $ 287,714 $ 260,694 $ 202,599 $ 129,187 $ 99,735 $ 205,898
Add - Income taxes 176,478 160,478 121,897 77,308 85,712 151,757
- Fixed charges 62,831 55,631 64,164 66,105 99,716 99,716
----------- ----------- ----------- ----------- ---------- -----------
Adjusted earnings $ 527,023 $ 476,803 $ 388,660 $ 272,600 $ 285,163 $ 457,371
=========== =========== =========== =========== ========== ===========
Fixed charges:
Interest expense $ 56,546 $ 51,914 $ 58,553 $ 60,038 $ 92,822 $ 92,822
Portion of rent expense
representing interest 6,285 3,717 5,611 6,067 6,894 6,894
----------- ----------- ----------- ----------- ---------- -----------
Adjusted fixed charges $ 62,831 $ 55,631 $ 64,164 $ 66,105 $ 99,716 $ 99,716
=========== =========== =========== =========== ========== ===========
RATIO OF EARNINGS TO FIXED
CHARGES 8.39 8.57 6.06 4.12 2.86 4.59
</TABLE>
(a) Excludes an after-tax restructuring charge of approximately $100 million
for the implementation of a re-engineering plan and a one-time after-tax
charge of approximately $6 million related to the enhanced early retirement
and voluntary separation programs offered to eligible employees in 1993.
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT PUBLIC 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 South Incorporated included in this Form
10-K, into the Registration Statements previously filed on Form S-3 (File No.
33-65011).
Dallas, Texas ARTHUR ANDERSEN LLP
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> 13,104
<SECURITIES> 0
<RECEIVABLES> 280,183
<ALLOWANCES> 18,638
<INVENTORY> 24,366
<CURRENT-ASSETS> 310,220
<PP&E> 4,285,696
<DEPRECIATION> 2,663,988
<TOTAL-ASSETS> 2,094,603
<CURRENT-LIABILITIES> 537,363
<BONDS> 609,868
2,678
412
<COMMON> 525,000
<OTHER-SE> 142,373
<TOTAL-LIABILITY-AND-EQUITY> 2,094,603
<SALES> 1,493,952
<TOTAL-REVENUES> 1,493,952
<CGS> 501,857
<TOTAL-COSTS> 975,180
<OTHER-EXPENSES> 284
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 54,296
<INCOME-PRETAX> 464,192
<INCOME-TAX> 176,478
<INCOME-CONTINUING> 287,714
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 287,714
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
