<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, 1996
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 2-33059
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
HAWAII 99-0049500
(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:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
NONE
Securities registered pursuant to Section 12(g) of the Act:
NONE
(TITLE OF CLASS)
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 10,000,000 SHARES OF $25 PAR VALUE COMMON STOCK OUTSTANDING AT
FEBRUARY 28, 1997. THE COMPANY'S COMMON STOCK IS 100% OWNED BY GTE
CORPORATION.
THE COMPANY MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION J(1)(a) AND
(b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE
FORMAT.
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Item Page
<S> <C>
Part I
1. Business 1
2. Properties 5
3. Legal Proceedings 5
4. Submission of Matters to a Vote of Security Holders - This item has
been
omitted in accordance with the relief provisions under General
Instruction J of Form 10-K
Part II
5. Market for the Registrant's Common Equity and Related 6
Shareholder Matters
6. Selected Financial Data - This item has been omitted in accordance
with the relief provisions under General Instruction J of Form 10-K
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 7
8. Financial Statements and Supplementary Data 11
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 33
Part III
The following items have been omitted in accordance with the relief provisions under
General Instruction J of Form 10-K:
10. Directors and Executive Officers of the Registrant
11. Executive Compensation
12. Security Ownership of Certain Beneficial Owners and Management
13. Certain Relationships and Related Transactions
Part IV
14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 34
</TABLE>
<PAGE> 3
PART I
Item 1. Business
GTE Hawaiian Telephone Company Incorporated (the Company) (formerly Hawaiian
Telephone Company) was incorporated under the laws of the Kingdom of Hawaii in
1883. The Company is a wholly-owned subsidiary of GTE Corporation (GTE) and
provides communications services in Hawaii and in the Pacific and Asia.
The Company has three wholly-owned subsidiaries: Micronesian Telecommunications
Corporation (MTC), GTE Hawaiian Tel Insurance Company Incorporated and GTE
Hawaiian Tel International Incorporated. MTC, which is headquartered in Saipan
in the Commonwealth of the Northern Marianas, provides local and international
telecommunications services on the islands of Saipan, Tinian and Rota. GTE
Hawaiian Tel Insurance Company Incorporated provides auto liability, general
liability and workers' compensation insurance to the Company on a direct basis.
GTE Hawaiian Tel International Incorporated is an entity established in
accordance with a Federal Communications Commission (FCC) order that allows the
Company to be classified as a nondominant provider of International Message
Telephone Service (IMTS). See Note 10 of the Company's consolidated financial
statements included in Item 8 for further detail.
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 on each island in Hawaii and provides intraLATA (Local Access
and Transport Area) toll service among the islands. InterLATA toll services
between Hawaii and domestic points within the United States are provided by
interexchange carriers (IXCs) which connect the Company's local facilities for
call origination and termination. The IXCs 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 also provides interLATA toll
service between Hawaii and international termination points in competition with
interLATA common carriers. These international revenues are settled between
the Company and interLATA common carriers through revenue sharing arrangements.
The Company earns other revenues by providing such services as billing and
collection and operator services to IXCs. At December 31, 1996, the Company
served 827,561 access lines in its service territories.
At December 31, 1996, the Company had 2,886 employees.
The Company has written agreements with the International Brotherhood of
Electrical Workers (IBEW) covering substantially all non-management employees.
In 1994, the contracts with the IBEW expired. Negotiations continued through
1995, and in 1996, a new three-year agreement was reached.
REGULATORY AND COMPETITIVE TRENDS
The Company is subject to regulation by the Public Utilities Commission (PUC)
of the State of Hawaii as to its intrastate business operations and by the FCC
as to 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. Presently, the Company is subject
to competition from numerous sources, including competitive access providers
(CAPs) for network access services. In addition, competition from alternative
local-exchange carriers (ALECs), IXCs, wireless carriers and cable providers,
as well as more recent entry by media and computer companies, is expected to
increase in the rapidly changing telecommunications marketplace.
1
<PAGE> 4
On February 8, 1996, the Telecommunications Act of 1996 (the Telecommunications
Act) became law. This comprehensive telecommunications reform legislation
addresses a wide range of competitive and regulatory issues that will affect
the future development of local and long distance services, cable television
and information services. The new law removes regulatory and court- ordered
barriers to competition between segments of the industry, enabling
local-exchange, long distance, wireless and cable companies to compete in
offering voice, video and information services.
The Telecommunications Act requires the FCC and state commissions to open
local-exchange markets and to set new guidelines for interconnection, loosens
restrictions barring local telephone companies from entering the cable
television market, and preserves universal service while equalizing the
responsibility for contribution among all carriers.
Following passage of the Telecommunications Act, the FCC has undertaken to
issue rules governing three areas: interconnection, universal service and
access charge reform. In August 1996, the FCC released its rules implementing
the provision of number portability and dialing parity in accord with the
Telecommunications Act. In August 1996, the FCC also adopted its rules
governing interconnection, unbundling of network elements and wholesale prices
and other terms for competitive entry into local-exchange service. These rules
generally require local-exchange carriers (LECs) to make their services
available to competitors at a wholesale discount and to make their network
elements available to competitors at below-cost prices. GTE petitioned for
judicial review of these rules on the grounds that they were inconsistent with
the Telecommunications Act. In October 1996, the U.S. Court of Appeals for the
Eighth Circuit granted GTE's request for stay of the pricing provisions of the
FCC's rules pending the Court's resolution of the merits of GTE's petition.
Oral arguments on the merits were held in January 1997, and the Court's ruling
is expected in the spring of 1997.
GTE is continuing to negotiate with requesting carriers over the terms of
interconnection, unbundled network elements and resale rates. In some cases,
the parties have been unable to agree within the statutory period for
negotiation and have gone to arbitration before various state regulatory
commissions. Since November 1996, a number of state commission decisions
determining the prices and terms of unresolved issues have been released (See
Note 10 of the Company's consolidated financial statements included in Item 8).
Subsequent decisions are expected to be issued over a period extending through
the first half of 1997.
The Company has exercised its right under the Telecommunications Act to
challenge state regulatory commission arbitration orders that govern agreements
between the Company and its competitors. The Company has filed lawsuits in
federal district courts in Hawaii.
In November 1996, the Federal-State Joint Board released its recommended
universal service plan, and in December 1996, the FCC issued its access reform
proposals. Both proposals incorporate a pricing methodology similar to the one
that GTE is appealing in the interconnection case. A final order in the
universal service proceeding must be adopted by early May 1997, and a decision
on the access reform proceeding is expected shortly thereafter.
A key provision of the Telecommunications Act eliminated the legal restraints
of the GTE Consent Decree which kept the Company from providing interLATA long
distance services. This action will simplify GTE's ability to market local,
intraLATA and interLATA service to its customers as a bundled service. In
February 1996, GTE executed an agreement whereby WorldCom, Inc. will provide,
on a non-exclusive basis, a full array of telecommunications services in
support of GTE's entry into the interLATA long distance market. In March 1996,
GTE, through a separate subsidiary, began offering long distance service to its
customers in selected markets. GTE now offers the service, marketed under the
name GTE Easy Savings Plan (sm), in all 50 states.
The Telecommunications Act forbids states from imposing any barriers to entry
into local and toll competition. To date, local competition has been
authorized in all 28 states where GTE currently offers local telephone service,
including Hawaii. In addition, nineteen states, including Hawaii, have
authorized plans that would allow customers to pre-subscribe to a specific
carrier to handle their intraLATA toll calls. Pre- subscribed customers will
simply dial "1" before the telephone number in order to complete intraLATA
calls. GTE has proposals pending in all nine of the states which have not
ordered implementation.
2
<PAGE> 5
Federal regulatory activity has changed the traditional cost-based, rate-of-
return regulatory framework for interstate telephone service. This regulatory
framework provides economic incentives to 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 PUC remains under the traditional cost-based, rate-of-return regulatory
framework for its intrastate telephone service.
For the provision of interstate and international 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 index based upon inflation less a predetermined productivity target.
LECs have limited pricing flexibility provided they do not exceed the allowed
price cap.
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 consolidated financial statements
included in Item 8.
The Company continues to support greater competition in telecommunications,
provided that, overall, the actions to eliminate existing legal and regulatory
barriers benefit consumers by allowing an opportunity for all service providers
to participate equally in a competitive marketplace under comparable
conditions.
The Company intends to continue to respond aggressively to regulatory and legal
developments that allow for increased competition and opportunities in the
marketplace. The Company expects its financial results to benefit from reduced
costs and the introduction of new products and services that will result in
increased usage of its telephone networks. However, it is likely that such
improvements will be offset, in part, by continued strategic pricing reductions
and the effects of increased competition.
INITIATIVES
In 1996, the Company and its parent, GTE, continued to position themselves to
respond aggressively to competitive developments and benefit from new
opportunities.
GTE Hawaiian Telephone Company Incorporated (the Company):
Restructuring and Cost Control
During 1996, the Company substantially completed the implementation of its
three-year $78.3 million re-engineering program. Total costs of the program
included $52.8 million related to improvements in customer service processes,
$19 million related to improvements in administrative processes and $6.5
million related to the consolidation of facilities and operations and other
related costs. These costs were primarily associated with the closure and
relocation of various service centers, software enhancements and separation
benefits related to employee reductions.
GTE Corporation (GTE):
Video Services
The Telecommunications Act eliminates the telephone company programming ban and
allows GTE the flexibility to choose whether it will enter the wireline video
distribution business through an open video platform arrangement or via a
standard cable television operation (Title VI). The legislation also allows
GTE to deploy video networks which are fully integrated with its telephone
operations.
3
<PAGE> 6
GTE, through a separate subsidiary, made its initial entry into the video
market under Title VI. The most technologically-advanced hybrid fiber/coaxial
network available is being deployed. At the end of 1996, GTE had been granted
six franchises, three in California and three in Florida. Construction of the
networks in those markets is underway and approximately 7,000 video subscribers
were acquired in 1996, bringing GTE's total video subscribers to approximately
15,000.
Internet Access
GTE, through a separate subsidiary, was the first local-exchange carrier to
introduce nationwide Internet services to residential and business customers in
1996. By year-end 1996, GTE's Internet access service, marketed as GTE
Internet Solutions, was offered in over 350 cities covering 49 states,
including Hawaii. An agreement with UUNET Technologies provides the Internet
backbone and local dialing capabilities. Over 70,000 customers were
subscribing to GTE Internet Solutions at December 31, 1996.
GTE Long Distance
One of the most significant impacts of the Telecommunications Act's passage was
the removal of certain restrictions previously included in GTE's Consent
Decree. Prior to February 8, 1996, GTE was restricted from jointly marketing
the products and services of the Company with those of GTE's interexchange
subsidiaries. With this joint marketing restriction lifted, GTE can now offer
its customers many services on one monthly bill, with one point of contact.
This opportunity facilitated GTE's entry into the long distance business, as
discussed above. By December 31, 1996, GTE, through a separate subsidiary, was
offering the service, marketed under the name GTE Easy Savings Plan (sm), in
all 50 states and was serving over 825,000 customers.
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.
4
<PAGE> 7
Item 2. Properties
The Company's property consists principally of land, structures and equipment
required to provide various telecommunications services. All of these
properties, located in the state of Hawaii and on the islands of Saipan, Tinian
and Rota, are generally in good operating condition and 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,
1992 to December 31, 1996, the Company made capital expenditures of $782
million for new plant and facilities required to meet telecommunication service
needs and to modernize plant and facilities. These additions were equal to 38%
of gross plant of $2 billion at December 31, 1996.
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
consolidated financial statements included in Item 8.
Item 3. Legal Proceedings
There are no pending legal proceedings which would have a material impact on
the Company's consolidated financial statements.
5
<PAGE> 8
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
The First National Bank of Boston, Transfer Agent and Registrar for GTE and the
Company's common stock, should be contacted with any questions relating to
shareholder accounts. This includes the following:
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-
617-575-2990.
Or write to:
Bank of Boston
c/o Boston EquiServe, L.P.
P.O. Box 9121
Boston, MA 02205-9121
For overnight delivery services, use the following address:
Bank of Boston
c/o Boston EquiServe, L.P.
Blue Hills Office Park
150 Royall Street
Canton, MA 02021
The Bank of Boston address where shareholders, banks and brokers may deliver
certificates is One Exchange Place, 55 Broadway in New York City.
PARENT COMPANY ANNUAL REPORT
To obtain a copy of the 1996 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.
6
<PAGE> 9
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in Millions)
BUSINESS OPERATIONS
GTE Hawaiian Telephone Company Incorporated (the Company), a wholly-owned
subsidiary of GTE Corporation (GTE), provides a full range of
telecommunications products and services in Hawaii and in the Pacific and Asia.
The Company has three wholly-owned subsidiaries. Micronesian
Telecommunications Corporation (MTC) is headquartered in Saipan and provides
local and international telecommunications services on the islands of Saipan,
Tinian and Rota. GTE Hawaiian Tel Insurance Company Incorporated provides auto
liability, general liability and workers' compensation insurance to the Company
on a direct basis. GTE Hawaiian Tel International Incorporated is an entity
established in accordance with a Federal Communications Commission (FCC) order
that allows the Company to be classified as a nondominant provider of
International Message Telephone Service (IMTS). See Note 10 of the Company's
consolidated financial statements included in Item 8 for further detail. At
December 31, 1996, the Company served 827,561 access lines in its service
territories.
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1996 1995
---------- -----------
<S> <C> <C>
Net income (loss) $ 54.7 $ (225.5)
</TABLE>
The net loss for 1995 includes an extraordinary charge (net of tax) of $263.4
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. Excluding this charge, net income increased 44% or
$16.8 in 1996. The 1996 increase is primarily due to higher revenues and sales
reflecting the favorable results of the 1995 Rate Case, continued customer
growth and international service contracts initiated in the second half of
1995, partially offset by higher income tax expense.
REVENUES AND SALES
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------
1996 1995
---------- ----------
<S> <C> <C>
Local services $ 247.6 $ 237.5
Network access services 148.6 134.6
Toll services 88.8 96.3
Other services and sales 149.9 143.4
---------- ----------
Total revenues and sales $ 634.9 $ 611.8
</TABLE>
Total revenues and sales increased 4% or $23.1 in 1996.
Local service revenues are based on fees charged to customers for providing
local-exchange service within designated franchise areas. Local service
revenues increased 4% or $10.1 in 1996. This increase reflects the results of
the 1995 Rate Case, discussed in more detail in Note 10, which increased local
service revenues by $6 in the fourth quarter of 1996. The number of access
lines increased 3.7% in 1996, generating $4.8 in additional revenues which
reflects both customer growth and second line promotions. In addition, revenue
increased $2.4 reflecting growth in sales of custom calling features, such as
SmartCall (R), and increased $2.1 from higher sales of integrated digital
services enabling transmission of voice, data, image and text, such as Internet
access. These increases are partially offset by a reduction of $4.8 in private
line and directory assistance revenues.
7
<PAGE> 10
Network access service revenues are based on fees charged to interexchange
carriers that use the Company's local-exchange network in providing long
distance services. In addition, business and residential customers pay access
fees to connect to the local network to obtain long distance service. Cellular
service providers and other local-exchange carriers also pay access charges for
cellular and intraLATA (Local Access and Transport Area) toll calls hauled or
terminated by the Company. Network access service revenues increased 10% or
$14 in 1996. This increase includes the effects of an 11% increase in minutes
of use, which generated $6.8 in additional revenues, and higher special access
revenues of $6.8 resulting from a growth in dedicated lines. In addition, the
increase reflects higher support payments of $2.2 received from the National
Exchange Carrier Association. Partially offsetting these increases is the net
effect of the 1995 and 1996 Annual Price Cap Filings which reduced rates,
unfavorably impacting revenues by $3.3.
The Company provides intraLATA toll service among the islands. The Company
also provides interLATA toll service between Hawaii and international
termination points in competition with interLATA common carriers. These
international revenues are settled between the Company and interLATA common
carriers through revenue sharing arrangements. Toll service revenues decreased
8% or $7.5 in 1996. This decline includes a $4.1 decrease in revenues which
reflects lower domestic toll volumes from continued competition with long
distance carriers authorized to provide intraLATA toll service on a 10XXX and
1+ basis. The decrease is also due to lower international toll volumes of
$1.7. Other services and sales revenues increased 5% or $6.5 in 1996. This
increase is primarily related to revenue of $3.2 from international service
contracts initiated in the second half of 1995 and growth of $1.6 from sales of
voice messaging services. In addition, the increase is the result of higher
directory advertising revenue of $1.8 due to timing of publications.
OPERATING COSTS AND EXPENSES
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------
1996 1995
------- -------
<S> <C> <C>
Cost of services and sales $ 276.7 $ 273.6
Selling, general and administrative 116.4 122.6
Depreciation and amortization 125.0 123.9
------- -------
Total operating costs and expenses $ 518.1 $ 520.1
</TABLE>
Total operating costs and expenses remained relatively unchanged, decreasing by
$2 in 1996. This slight decrease is primarily driven by a decrease in labor
costs of $5.4 associated with productivity gains from process re-engineering
and other cost containment programs. Partially offsetting this decrease are
higher gross receipts tax of $2.8 and increases in depreciation and
amortization of $1.1 primarily resulting from increased plant investments.
OTHER EXPENSES
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1996 1995
------- -------
<S> <C> <C>
Interest - net $ 38.3 $ 39.5
Income taxes 23.9 15.0
</TABLE>
Interest - net decreased 3% or $1.2 in 1996. This decrease is primarily due to
lower interest expense reflecting lower interest rates associated with a high-
coupon debt refinancing program initiated during the first half of 1996.
Income taxes increased 59% or $8.9 in 1996. This increase is primarily a
result of higher pre-tax income.
8
<PAGE> 11
REGULATORY AND COMPETITIVE TRENDS
The Company is subject to regulation by the Public Utilities Commission (PUC)
of the State of Hawaii as to its intrastate business operations and by the
FCC as to its interstate and international operations.
Significant regulatory and legislative developments occurred during 1996,
including the passage of the Telecommunications Act of 1996 (the
Telecommunications Act). The Telecommunications Act is intended to promote
competition in all sectors of the telecommunications marketplace, while
preserving and advancing universal telephone service.
As a result of the Telecommunications Act, the Company may be faced with
increased competition from numerous sources, including competitive access
providers (CAPs), alternative local-exchange carriers (ALECs), interexchange
carriers (IXCs), wireless carriers, cable providers, media and computer
companies. These companies collectively have the ability to offer a broad
array of voice, video and data services to business and residential customers.
Following passage of the Telecommunications Act, the FCC has undertaken to
issue rules governing three areas: interconnection, universal service and
access charge reform. In August 1996, the FCC adopted its rules governing
interconnection. These rules generally require LECs to make their services
available to competitors at a wholesale discount and to make their network
elements available to competitors at below-cost prices. GTE petitioned for
judicial review of these rules on the grounds that they were inconsistent with
the Telecommunications Act. In October 1996, the U.S. Court of Appeals for the
Eighth Circuit granted GTE's request for a stay of the pricing provisions of
the FCC's rules pending the Court's resolution of the merits of GTE's petition.
Oral arguments on the merits were held in January 1997, and the Court's ruling
is expected in the spring of 1997.
In November 1996, the Federal-State Joint Board released its recommended
universal service plan, and in December 1996, the FCC issued its access reform
proposals. Both proposals incorporate a pricing methodology similar to the one
that GTE is appealing in the interconnection case. A final order in the
universal service proceeding must be adopted by early May 1997, and a decision
on the access reform proceeding is expected shortly thereafter.
A key provision of the Telecommunications Act eliminated the legal restraints
of the GTE Consent Decree which kept the Company from providing interLATA long
distance services. This action will simplify GTE's ability to market local,
intraLATA and interLATA service to its customers as a bundled service. In
February 1996, GTE executed an agreement whereby WorldCom, Inc. will provide,
on a non-exclusive basis, a full array of telecommunications services in
support of GTE's entry into the interLATA long distance market. In March 1996,
GTE, through a separate subsidiary, began offering long distance service to its
customers in selected markets. GTE now offers the service, marketed under the
name GTE Easy Savings Plan (sm), in all 50 states.
The Telecommunications Act forbids states from imposing any barriers to entry
into local and toll competition. To date, local competition has been
authorized in all 28 states where GTE currently offers local telephone service,
including Hawaii. In addition, nineteen states, including Hawaii, have
authorized plans that would allow customers to pre-subscribe to a specific
carrier to handle their intraLATA toll calls. Pre- subscribed customers will
simply dial "1" before the telephone number in order to complete intraLATA
calls. GTE has proposals pending in all nine of the states which have not
ordered implementation.
Federal regulatory activity has changed the traditional cost-based, rate-of-
return regulatory framework for interstate telephone service. This regulatory
framework provides economic incentives to 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 PUC remains under the traditional cost-based, rate- of-return regulatory
framework for its intrastate telephone service.
9
<PAGE> 12
For the provision of interstate and international 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 index based upon inflation less a predetermined productivity target.
LECs have limited pricing flexibility provided they do not exceed the allowed
price cap.
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 consolidated financial statements
included in Item 8.
The Company continues to support greater competition in telecommunications,
provided that, overall, the actions to eliminate existing legal and regulatory
barriers benefit consumers by allowing an opportunity for all service providers
to participate equally in a competitive marketplace under comparable
conditions.
The Company intends to continue to respond aggressively to regulatory and legal
developments that allow for increased competition and opportunities in the
marketplace. The Company expects its financial results to benefit from reduced
costs and the introduction of new products and services that will result in
increased usage of its telephone networks. However, it is likely that such
improvements will be offset, in part, by continued strategic pricing reductions
and the effects of increased competition.
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. Management believes that the Company has
adequately provided for this settlement in its financial statements for the
year ended December 31, 1996.
INITIATIVES
In 1996, the Company and its parent, GTE, continued to position themselves to
respond aggressively to competitive developments and benefit from new
opportunities. Further information regarding these initiatives is discussed in
Item 1.
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.
10
<PAGE> 13
Item 8. Financial Statements and Supplementary Data
GTE Hawaiian Telephone Company Incorporated and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Years Ended December 31 1996 1995 1994
- ----------------------- -------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
REVENUES AND SALES (a)
Local services $ 247,627 $ 237,467 $ 225,913
Network access services 148,598 134,588 128,840
Toll services 88,782 96,252 121,871
Other services and sales 149,914 143,453 127,587
--------- --------- ---------
Total revenues and sales 634,921 611,760 604,211
--------- --------- ---------
OPERATING COSTS AND EXPENSES (b)
Cost of services and sales 276,712 273,636 280,648
Selling, general and administrative 116,398 122,603 128,247
Depreciation and amortization 125,032 123,876 116,478
--------- --------- ---------
Total operating costs and expenses 518,142 520,115 525,373
--------- --------- ---------
OPERATING INCOME 116,779 91,645 78,838
OTHER (INCOME) EXPENSE
Interest - net 38,267 39,500 35,039
Other - net (39) (779) 1,387
--------- --------- ---------
INCOME BEFORE INCOME TAXES 78,551 52,924 42,412
Income taxes 23,850 15,023 12,613
--------- --------- ---------
INCOME BEFORE EXTRAORDINARY CHARGE 54,701 37,901 29,799
Extraordinary charge -- (263,419) --
--------- --------- ---------
NET INCOME (LOSS) $ 54,701 $(225,518) $ 29,799
========= ========= =========
</TABLE>
(a) Includes billings to affiliates of $43,469, $41,958 and $38,420 for the
years 1996-1994, respectively.
(b) Includes billings from affiliates of $39,376, $45,446 and $37,322 for the
years 1996-1994, respectively.
See Notes to Consolidated Financial Statements.
11
<PAGE> 14
GTE Hawaiian Telephone Company Incorporated and Subsidiaries
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31 1996 1995
- ----------- ----------- -----------
(Thousands of Dollars)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 20,154 $ 4,515
Receivables, less allowances of $6,066 and $6,338 144,710 150,560
Inventories and supplies 5,906 8,829
Deferred income tax benefits 6,202 18,157
Prepaid taxes 22,813 11,707
Other 1,800 3,620
----------- -----------
Total current assets 201,585 197,388
----------- -----------
Property, plant and equipment, net 822,473 809,445
Employee benefit plans 171,118 141,083
Other assets 5,809 6,899
----------- -----------
Total assets $ 1,200,985 $ 1,154,815
=========== ===========
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities:
Short-term obligations, including current maturities $ 49,600 $ 123,764
Accounts payable 19,728 19,744
Affiliate payables and accruals 30,733 17,787
Advanced billings and customer deposits 14,771 17,762
Taxes payable 1,797 15,927
Accrued interest 12,793 11,786
Accrued payroll costs 29,070 31,351
Accrued restructuring costs -- 39,353
Other 32,282 13,009
----------- -----------
Total current liabilities 190,774 290,483
----------- -----------
Long-term debt 513,016 482,412
Deferred income taxes 98,687 78,114
Employee benefit plans 44,722 25,461
Other liabilities 14,399 4,917
----------- -----------
Total liabilities 861,598 881,387
----------- -----------
Shareholder's equity:
Common stock (10,000,000 shares issued) 250,000 250,000
Additional paid-in capital 91,146 41,146
Retained deficit (1,759) (17,718)
----------- -----------
Total shareholder's equity 339,387 273,428
----------- -----------
Total liabilities and shareholder's equity $ 1,200,985 $1,154,815
=========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
12
<PAGE> 15
GTE Hawaiian Telephone Company Incorporated and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31 1996 1995 1994
- ----------------------- --------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
OPERATIONS
Income before extraordinary charge $ 54,701 $ 37,901 $ 29,799
Adjustments to reconcile income before extraordinary
charge to net cash from operations:
Depreciation and amortization 125,032 123,876 116,478
Deferred income taxes 28,938 22,112 13,405
Provision for uncollectible accounts 9,761 9,119 5,673
Change in current assets and current liabilities:
Receivables - net (18,411) (13,154) (19,362)
Other current assets 4,743 (1,366) (885)
Accrued taxes and interest (20,640) 5,062 5,225
Other current liabilities (9,554) (23,337) (20,408)
Other - net (12,156) (22,189) (16,043)
--------- --------- ---------
Net cash from operations 162,414 138,024 113,882
--------- --------- ---------
INVESTING
Capital expenditures (131,719) (130,127) (171,667)
Purchase of MTC stock (450) -- --
--------- --------- ---------
Net cash used in investing (132,169) (130,127) (171,667)
--------- --------- ---------
FINANCING
Long-term debt issued 148,353 148,236 --
Long-term debt retired (147,592) (8,301) (12,702)
Dividends (33,415) (23,693) (20,631)
Capital contribution from GTE 50,000 -- --
Increase (decrease) in short-term obligations,
excluding current maturities (41,695) (127,333) 98,019
Other - net 9,743 -- --
--------- --------- ---------
Net cash from (used in) financing (14,606) (11,091) 64,686
--------- --------- ---------
Increase (decrease) in cash and cash equivalents 15,639 (3,194) 6,901
Cash and cash equivalents:
Beginning of year 4,515 7,709 808
--------- --------- ---------
End of year $ 20,154 $ 4,515 $ 7,709
========= ========= =========
Cash paid (refunded) during the year for:
Interest $ 39,924 $ 37,321 $ 35,737
Income taxes 7,388 (9,945) 4,960
</TABLE>
See Notes to Consolidated Financial Statements.
13
<PAGE> 16
GTE Hawaiian Telephone Company Incorporated and Subsidiaries
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY
<TABLE>
<CAPTION>
Additional Retained
Common Paid-In Earnings
Stock Capital (Deficit) Total
-------- --------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C> <C>
Shareholder's equity, December 31, 1993 $250,000 $ 40,821 $ 217,325 $508,146
Net income 29,799 29,799
Dividends declared (15,631) (15,631)
Other 325 325
-------- --------- --------- ----------
Shareholder's equity, December 31, 1994 250,000 41,146 231,493 522,639
Net loss (225,518) (225,518)
Dividends declared (23,693) (23,693)
-------- --------- --------- ----------
Shareholder's equity, December 31, 1995 250,000 41,146 (17,718) 273,428
Net income 54,701 54,701
Dividends declared (38,742) (38,742)
Capital contribution from GTE 50,000 50,000
-------- --------- --------- ----------
Shareholder's equity, December 31, 1996 $250,000 $ 91,146 $ (1,759) $ 339,387
======== ========= ========= ==========
</TABLE>
See Notes to Consolidated Financial Statements.
14
<PAGE> 17
GTE Hawaiian Telephone Company Incorporated and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
GTE Hawaiian Telephone Company Incorporated (the Company) provides a wide
variety of communications services, in Hawaii and in the Pacific and Asia,
ranging from local telephone service for the home and office to highly complex
voice and data services for various industries. At December 31, 1996, the
Company served 827,561 access lines in its service territories. The Company is
a wholly-owned subsidiary of GTE Corporation (GTE).
BASIS OF PRESENTATION
The Company prepares its consolidated financial statements in accordance with
generally accepted accounting principles which require that management make
estimates and assumptions that affect reported amounts. Actual results could
differ from those estimates.
The consolidated financial statements include the accounts of the Company and
its three wholly-owned subsidiaries. The subsidiaries include Micronesian
Telecommunications Corporation (MTC), GTE Hawaiian Tel Insurance Company
Incorporated and GTE Hawaiian Tel International Incorporated, an entity
established in accordance with a Federal Communications Commission (FCC) order
that allows the Company to be classified as a nondominant provider of
International Message Telephone Service (IMTS). All significant intercompany
items have been eliminated.
The Company discontinued applying the provisions 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 (see Note 2).
Reclassifications of prior-year data have been made, where appropriate, to
conform to the 1996 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 $34.3 million, $27.7 million and $27.1 million for the
years 1996-1994, respectively. Such purchases and services are recorded in the
accounts of the Company, at cost, which includes a normal 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
$39.4 million, $45.4 million and $37.3 million for the years 1996-1994,
respectively. The amounts charged for these affiliated transactions are based
on a proportional cost allocation method.
The Company's consolidated financial statements include allocated expenses
based on the sharing of certain executive, administrative, financial,
accounting, marketing, personnel, engineering, and other support services being
performed at consolidated work centers among the domestic GTE Telephone
Operating Companies. The amounts charged for these affiliated transactions are
based on a proportional cost allocation method as filed with the FCC.
15
<PAGE> 18
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 $43.5 million, $42 million and $38.4 million for the
years 1996-1994, respectively.
DEPRECIATION AND AMORTIZATION
In 1996, the Company began providing for depreciation on a straight-line basis
over the estimated economic lives of its assets (see Note 2). The Company had
previously provided for depreciation on a straight-line basis over asset lives
approved by regulators. Maintenance and repairs of property are charged to
income as incurred. Additions to, replacements and renewals of property are
charged to telephone plant accounts. Property retirements are charged in total
to the accumulated depreciation account. No adjustment to depreciation is made
at the time properties are retired or otherwise disposed of, except in the case
of significant sales or extraordinary retirements of property where profit or
loss is recognized.
Franchises, goodwill and other intangibles are amortized on a straight-line
basis over the periods to be benefited, or 40 years, whichever is less.
REVENUE RECOGNITION
Revenues are recognized when earned. This is generally based on usage of the
Company's local-exchange networks or facilities. For other products and
services, revenues are generally recognized when services are rendered or
products are delivered to customers.
INVENTORIES AND SUPPLIES
Inventories and supplies are stated at the lower of cost, determined
principally by the average cost method, or net realizable value.
EMPLOYEE BENEFIT PLANS
Pension and postretirement health care and life insurance benefits earned
during the year as well as interest on accumulated 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.
STOCK OPTION PLANS
In 1995, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (FAS
123). As permitted by FAS 123, the Company continues to apply the recognition
and measurement provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25). The difference between
the recognition and measurement provisions of FAS 123 and APB 25 is not
significant to the Company's results of operations.
16
<PAGE> 19
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 subsequently adjusted to reflect changes in tax
rates expected to be in effect when the temporary differences reverse. A
valuation allowance is established for any deferred tax asset for which
realization is not likely. Deferred income taxes are not provided on
undistributed earnings of the Company's foreign subsidiary, approximately $38
million at December 31, 1996, as such earnings are expected to be permanently
reinvested in the foreign subsidiary.
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.
2. EXTRAORDINARY CHARGE
In response to legislation (see Note 10) and the increasingly competitive
environment, the Company discontinued the use of 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 $263.4 million (net of tax benefits of
$167.8 million) in the fourth quarter of 1995. The charge primarily represents
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>
Depreciable Lives
--------------------------------
Average
Asset Category Before After
- ----------------------- ------------ ----------
<S> <C> <C>
Copper 20-30 15
Switching 17-19 10
Circuit 11-13 8
Fiber 25-30 20
</TABLE>
17
<PAGE> 20
3. RESTRUCTURING COSTS
During 1993, the Company recorded one-time restructuring costs of $78.3
million, which reduced net income by $48.2 million, primarily for incremental
costs related to implementation of the Company's re-engineering plan to improve
customer-responsiveness and product quality, reduce the time necessary to
introduce new products and services and further reduce costs. The
restructuring costs included $52.8 million to re-engineer customer service
processes and $19 million to re-engineer administrative processes. The
restructuring costs also included $6.5 million to consolidate facilities and
operations and other related costs. These expenditures were primarily
associated with the closure and relocation of various service centers, software
enhancements and separation benefits associated with employee reductions. The
re-engineering plan was substantially completed in 1996, consistent with the
original cost estimates.
4. SHAREHOLDER'S EQUITY
COMMON STOCK
The authorized common stock of the Company consists of 18,000,000 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.
ADDITIONAL PAID-IN CAPITAL
Additional paid-in capital includes a capital contribution of $50 million
received in August 1996 from GTE to improve the Company's financial position.
18
<PAGE> 21
5. DEBT
Long-term debt as of December 31, was as follows:
<TABLE>
<CAPTION>
1996 1995
---------- ---------
(Thousands of Dollars)
<S> <C> <C>
First mortgage bonds:
5 5/8% Series R, due 1997 $ 16,000 $ 16,000
6 3/4% Series S, due 1998 20,000 20,000
8 3/4% Series T, due 2000 -- 35,000
8 % Series U, due 2001 20,000 20,000
8 1/2% Series V, due 2006 -- 35,000
9 % Series AA, due 2000 -- 75,000
6 3/4% Series BB, due 2005 125,000 125,000
Debentures:
7 % Series A, due 2006 150,000 150,000
7 3/8% Series B, due 2006 150,000 --
Other:
5% Rural Utilities Services first mortgage bond, due 2018 9,353 9,585
Rural Telephone Bank first mortgage bonds,
maturing through 2021, rates ranging from 5.43% to 7.5% 30,820 31,906
GTE Leasing Corporation financing agreements, maturing
through 2001, rates ranging from 8.23% to 11.99% 3,552 4,831
Other 806 801
---------- ---------
Total principal amount 525,531 523,123
Premium (discount) - net 6,185 (2,911)
---------- ---------
Total 531,716 520,212
Less: current maturities of long-term debt (18,700) (37,800)
---------- ---------
Total long-term debt $ 513,016 $ 482,412
========== =========
</TABLE>
In March, April and June 1996, the Company redeemed prior to stated maturity,
the $35 million 8 3/4% Series T first mortgage bonds, the $35 million 8 1/2%
Series V first mortgage bonds and the $75 million 9% Series AA first mortgage
bonds, respectively. The Company issued $150 million of 7 3/8% Series B
debentures, due 2006, in September 1996 to refinance this high-coupon debt.
Net proceeds were used to finance the Company's construction program and for
general corporate purposes.
In August 1995, the Company issued $150 million of 7% Series A Debentures, due
2006. The net proceeds were used toward the repayment of short-term debt
incurred for the purpose of financing the Company's construction program.
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.
Estimated payments of long-term debt during the next five years are: $18.7
million in 1997; $22 million in 1998; $2.1 million in 1999; $2.3 million in
2000 and $22.3 million in 2001.
19
<PAGE> 22
Total short-term obligations as of December 31, were as follows:
<TABLE>
<CAPTION>
1996 1995
----------- ----------
(Thousands of Dollars)
<S> <C> <C>
Notes payable to affiliate - average rates 5.6% and 6.1% $ 30,900 $ 85,964
Current maturities of long-term debt 18,700 37,800
----------- ----------
Total $ 49,600 $ 123,764
=========== ==========
</TABLE>
6. FINANCIAL INSTRUMENTS
During 1996, the Company entered into forward contracts to sell $150 million of
U.S. Treasury Bonds in order to hedge against future changes in market interest
rates related to the debt the Company called and subsequently refinanced in
September 1996. A gain of approximately $9 million occurred upon the
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, 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 $9
million. The estimated fair value of long-term debt as of December 31, 1995
exceeded the carrying value by approximately $12 million.
20
<PAGE> 23
7. INCOME TAXES
The income tax provision (benefit) is as follows:
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
Current:
Federal $ 9,176 $ 709 $ 3,195
State (14,264) (7,798) (3,987)
-------- -------- ---------
(5,088) (7,089) (792)
-------- -------- ---------
Deferred:
Federal 13,891 14,101 8,253
State 15,545 8,869 5,970
-------- -------- ---------
29,436 22,970 14,223
-------- -------- ---------
Amortization of deferred investment tax credits (498) (858) (818)
-------- -------- ---------
Total $ 23,850 $ 15,023 $ 12,613
======== ======== =========
</TABLE>
A reconciliation between taxes computed by applying the statutory federal
income tax rate to pre-tax income and income taxes provided in the consolidated
statements of income is as follows:
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
Amounts computed at statutory rates $ 27,493 $ 18,523 $ 14,844
State and local income taxes, net of federal income tax
benefits 833 696 1,288
Amortization of deferred investment tax credits, net of
federal income tax benefits (308) (858) (818)
Depreciation of telephone plant construction costs
previously deducted for tax purposes - net -- 1,297 1,516
Rate differentials applied to reversing temporary
differences -- (1,752) (1,267)
Undistributed earnings of foreign subsidiary (3,817) (2,259) (4,154)
Other differences - net (351) (624) 1,204
-------- -------- ---------
Total provision $ 23,850 $ 15,023 $ 12,613
======== ======== =========
</TABLE>
The tax effects of temporary differences that give rise to the current deferred
income tax benefits and deferred income tax liabilities at December 31, are as
follows:
<TABLE>
<CAPTION>
1996 1995
-------- ---------
(Thousands of Dollars)
<S> <C> <C>
Depreciation and amortization $ 21,829 $ 13,207
Employee benefit obligations (22,059) (15,552)
Prepaid pension cost 65,400 52,563
Investment tax credits 1,996 2,320
Capital goods excise tax credits 31,352 30,434
Other - net (6,033) (23,015)
-------- ---------
Total $ 92,485 $ 59,957
======== =========
</TABLE>
21
<PAGE> 24
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 U.S.
employee benefit and tax laws, is to contribute such amounts as are determined
on an actuarial basis to provide the plans with assets sufficient to meet the
benefit obligations of the plans. The assets of the plans consist primarily of
corporate equities, government securities and corporate debt securities.
The components of the net pension credit for 1996-1994 were as follows:
<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- ----------
(Thousands of Dollars)
<S> <C> <C> <C>
Benefits earned during the year $ 11,429 $ 9,915 $ 11,988
Interest cost on projected benefit obligations 29,689 28,421 26,565
Return on plan assets:
Actual (115,011) (130,646) 1,168
Deferred 55,225 79,499 (49,374)
Other - net (11,262) (11,779) (9,087)
--------- ---------- ----------
Net pension credit $ (29,930) $ (24,590) $ (18,740)
========= ========== ==========
</TABLE>
The expected long-term rate of return on plan assets was 9.0% for 1996 and 8.5%
for 1995 and 1994.
The funded status of the plans and the net prepaid pension cost at December
31, were as follows:
<TABLE>
<CAPTION>
1996 1995
--------- ---------
(Thousands of Dollars)
<S> <C> <C>
Vested benefit obligations $311,725 $303,917
======== ========
Accumulated benefit obligations $328,535 $313,751
======== ========
Plan assets at fair value $815,924 $721,656
Less: projected benefit obligations 416,411 402,635
-------- --------
Excess of assets over projected obligations 399,513 319,021
Unrecognized net transition asset (20,104) (28,216)
Unrecognized net gain (208,291) (149,722)
Net prepaid pension cost $171,118 $141,083
======== ========
</TABLE>
Assumptions used to develop the projected benefit obligations at December 31,
were as follows:
<TABLE>
<CAPTION>
1996 1995
-------- -------
<S> <C> <C>
Discount rate 7.50% 7.50%
Rate of compensation increase 5.25% 5.25%
</TABLE>
22
<PAGE> 25
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
Substantially all of the Company's employees are covered under postretirement
health care and life insurance benefit plans. The health care benefits paid
under the plans are generally based on comprehensive hospital, medical and
surgical benefit provisions. The Company funds amounts for postretirement
benefits as deemed appropriate from time to time.
The postretirement benefit cost for 1996-1994 included the following
components:
<TABLE>
<CAPTION>
1996 1995 1994
-------- --------- --------
(Thousands of Dollars)
<S> <C> <C> <C>
Benefits earned during the year $ 2,193 $ 1,862 $ 2,595
Interest on accumulated postretirement benefit obligations 17,070 15,458 16,374
Actual return on plan assets (1,698) (5,705) 1,086
Amortization of transition obligation 7,437 7,500 7,598
Other - net (112) 4,416 (722)
-------- --------- --------
Postretirement benefit cost $ 24,890 $ 23,531 $ 26,931
======== ========= ========
</TABLE>
The following table sets forth the plans' funded status and the accrued
postretirement benefit obligations as of December 31:
<TABLE>
<CAPTION>
1996 1995
-------- --------
(Thousands of Dollars)
<S> <C> <C>
Accumulated postretirement benefit obligations attributable to:
Retirees $110,144 $100,385
Fully eligible active plan participants 109,360 104,801
Other active plan participants 22,028 22,157
-------- --------
Total accumulated postretirement benefit obligations 241,532 227,343
Less: fair value of plan assets 62,750 51,102
-------- --------
Excess of accumulated obligations over plan assets 178,782 176,241
Unrecognized transition obligation (118,678) (126,421)
Unrecognized prior service cost (10,534) (12,252)
Unrecognized net loss (5,939) (13,192)
-------- --------
Accrued postretirement benefit obligations $ 43,631 $ 24,376
======== ========
</TABLE>
The assumed discount rates used to measure the accumulated postretirement
benefit obligations were 7.5% at December 31, 1996 and December 31, 1995. The
assumed health care cost trend rate was 8.75% in 1996 and averaged 9.75% in
1995 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 1996 costs by $3.1
million and the accumulated postretirement benefit obligations as of December
31, 1996 by $37.9 million.
SAVINGS PLANS
The Company sponsors employee savings plans under section 401(k) of the
Internal Revenue Code. The plans cover substantially all full-time employees.
Under the plans, the Company provides matching contributions in GTE common
stock based on qualified employee contributions. Matching contributions
charged to income were $3.1 million in 1996 and $3 million in 1995-1994,
respectively.
23
<PAGE> 26
9. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is summarized as follows at December 31:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
(Thousands of Dollars)
<S> <C> <C>
Land $ 10,725 $ 11,551
Buildings 163,992 155,302
Plant and equipment 1,660,752 1,583,187
Other 213,901 217,761
----------- ----------
Total 2,049,370 1,967,801
Accumulated depreciation (see Note 2) (1,226,897) (1,158,356)
----------- ----------
Total property, plant and equipment - net $ 822,473 $ 809,445
=========== ==========
</TABLE>
Depreciation expense in 1996-1994 was equivalent to a composite average
percentage of 6.1%, 6.3% and 6.5%, respectively.
24
<PAGE> 27
10. REGULATORY AND COMPETITIVE MATTERS
The Company is subject to regulation by the Public Utilities Commission (PUC)
of the State of Hawaii with respect to intrastate business operations and by
the FCC for its interstate and international business operations, earth station
ownership and the use of authorized radio frequencies.
INTRASTATE SERVICES
Rate Matters
On May 11, 1993, the Company filed a general rate increase application with the
PUC, requesting approval to increase intrastate revenues by $50.4 million.
This represented a 15.9% increase over intrastate revenues for 1993 at current
rates, and was the first rate increase application the Company had filed since
1985. The Company's rate restructure proposal and earnings investigation which
were in progress were incorporated into the rate case docket. Hearings took
place in March and April 1994. On June 14, 1994, the PUC ordered that the
Company continue its rates at existing levels and denied the Consumer
Advocate's recommendation for an interim revenue decrease.
On October 14, 1994, the Company filed a Notice of Intent to file another rate
case with the PUC. The Company also filed a Motion for Waiver of Commission
Rules and for approval of 1995 to be the test year. The waiver requested that
the Company be allowed the option to file its rate case application in early
1995 without having to use a split 1995/1996 test year. On November 29, 1994,
the PUC approved the Company's request for the waiver of its test year rules.
On November 29, 1994, the PUC issued an order approving the adoption of accrual
accounting for Postretirement Benefits Other Than Pensions (FAS 106) for
ratemaking purposes. The PUC's order directed the Company to file plans for
reflecting the full impact of FAS 106 in rates to be effective January 1, 1995.
The PUC approved, on January 19, 1995, the Company's plan to reflect an
additional $10.7 million of Postretirement Benefits Other Than Pensions in its
rates, retroactive to January 1, 1995.
On June 9, 1995, the PUC issued a decision on the Company's 1993 Rate Case.
The PUC ordered that the Company's existing rate of return, rate base, and rate
structure remain unchanged until the next rate case. The Company notified the
PUC on July 10, 1995 that it would appeal the decision to the Hawaii Supreme
Court. On March 7, 1997, the Company filed a stipulation to withdraw its
appeal of the PUC's 1993 Rate Case order and focus on an appeal of selected
issues in the 1995 Rate Case discussed below.
On September 29, 1995, the Company filed an application to increase its rates
by $74 million in its 1995 Rate Case. The PUC approved bifurcation of the
proceeding into a revenue requirement phase (Phase I) and a rate design phase
(Phase II). The PUC held public hearings on Phase I in late 1995. The
Department of Defense (DOD), AT&T Communications of Hawaii (AT&T) and Pacwest
Telecommunications Corporation (Pacwest) filed motions to intervene in this
proceeding. On January 12, 1996, the PUC granted the DOD intervention in both
phases but limited AT&T and Pacwest to participating in the formulation of
issues for Phase I. The PUC subsequently allowed AT&T to continue as a
participant in the proceeding for limited issues but denied Pacwest's request
for continued participation.
On July 26, 1996, the Company filed a stipulation with the PUC requesting
approval of an agreement reached with the Division of Consumer Advocate, DOD
and AT&T that resolves most of the issues presented in the Company's Rate Case.
Based on the issues resolved, the parties agreed the Company is entitled to an
interim revenue increase of $17.9 million. This figure is based on $10.1
million for the agreed upon issues plus an additional $7.8 million to allow the
Company to recover depreciation expense at levels currently authorized by the
PUC. On August 1, 1996, the PUC adopted the agreement with the interim revenue
increase of $17.9 million. The four remaining issues before the PUC pending a
final decision were Hurricane Iniki recovery, interisland fiber recovery,
depreciation expense levels and incentive compensation recovery. The Company
received a final award of $23.6 million on January 31, 1997 reflecting a final
decision on Hurricane Iniki recovery with an award of $5.7. On March 3, 1997,
the Company filed a notice of
25
<PAGE> 28
Appeal with the Supreme Court of the State of Hawaii to seek review of the
PUC's Phase I final order regarding interisland fiber recovery, depreciation
expense levels and recovery of incentive based compensation for management
employees.
Arbitration Activity
In August 1996, pursuant to the Telecommunications Act of 1996 (the
Telecommunications Act), AT&T filed a petition with the PUC requesting
arbitration of remaining interconnection, resale, and unbundling issues between
AT&T and the Company. Hearings were held on October 14 to 17, 1996, and
Decision No. 15229 was issued by the PUC on December 12, 1996. In its
decision, the PUC ordered the Company, including many other things, to discount
all retail services at a rate of 15% and offer unbundled network elements at a
price based on the Company's total element long run incremental cost (TELRIC)
increased by 10% for joint and common costs, with both parties filing an
interconnection agreement within 30 days. On January 10, 1997, the Company
filed a complaint for declaratory and injunctive relief in the United States
District Court. However, the Company continued to negotiate with AT&T and
filed, under protest, an interconnection agreement with the PUC on February 26,
1997.
Western Wireless Corporation (Western Wireless) filed a petition for
arbitration with the PUC on September 6, 1996. The PUC held a hearing on
November 12, 1996 and issued Decision No. 15277 on December 24, 1996, ordering
both parties to file an interconnection agreement on January 23, 1997. On
February 21, 1997, the PUC issued an order approving the interconnection
agreement filed January 24, 1997. The Company filed a complaint for
declaratory and injunctive relief in the United States District Court on
February 14, 1997.
On October 16, 1996, GST Telecom Hawaii petitioned the PUC for arbitration
which was ultimately withdrawn on November 8, 1996. On November 27, 1996, an
interconnection agreement between the Company and GST Telecom Hawaii was filed
with approval granted by the PUC in Decision and Order No. 15283. A revised
interconnection agreement was filed with the PUC on January 16, 1997, with the
E911 and Telecommunications Relay Service (TRS) agreements filed on January 16,
and January 24, 1997, respectively.
Sprint Corporation (Sprint) petitioned the PUC for arbitration in September
1996 on many of the same issues that were submitted by AT&T. Hearings were
held on December 2, and 3, 1996, and on January 17, 1997, the PUC issued
Decision No. 15316 which reaffirmed decisions issued in the previous
arbitration proceedings. The Company filed, under protest, an interconnection
agreement with the PUC on February 24, 1997. Sprint is seeking to adopt the
provision of the AT&T agreement in lieu of the negotiated agreement ordered by
the PUC. The Company filed its opposition on February 27, 1997 seeking
approval of the arbitrated agreement submitted in compliance with the PUC's
decision.
Communications Infrastructure
On May 11, 1993, the PUC initiated a communications infrastructure proceeding
which was intended to investigate such issues as: what markets should be
opened to competition; who should be allowed to compete in those markets; and
what rules, if any, should apply. As part of this proceeding, on May 17, 1996,
the PUC formally adopted administrative rules governing telecommunications
competition and establishing a universal service fund in Hawaii. Since June 3,
1996, the effective date of the new rules, the PUC has granted certificates of
authority to numerous applicants to operate as resellers of telecommunications
services and has others pending.
On June 12, 1996, the PUC issued its decision and order implementing its new
administrative rules. Among its provisions, the order approved the Company's
cost recovery tariff and denied interexchange carriers' requests for
"discounted" or impaired intrastate access rates. On June 24, 1996, the
Company filed a motion for reconsideration of portions of the PUC's order. In
its August 30, 1996 ruling, the PUC ruled in the Company's favor on the
majority of issues raised by the Company.
26
<PAGE> 29
In compliance with certain requirements set forth in the June 12, 1996 order,
the Company filed position statements in July 1996 relating to equal access
cost recovery and impaired assets. On August 12, 1996, the Company filed
position statements relating to revenue-neutral rate rebalancing, universal
service, and the classification of services into non-competitive, partially
competitive and fully competitive categories. On September 3, 1996, the
Company filed a position statement on unbundling. Also on November 12, 1996,
the Company filed a tariff application to implement remote call forwarding as
an interim measure pending full number portability. This tariff application
was suspended on December 11, 1996, pending further investigation by the
Commission.
Additionally, the PUC issued draft administrative rules on August 13, 1996
concerning aggregator and operator service, pay telephone service, and shared
tenant service. The parties filed comments on the draft rules on August 28,
1996. Public hearings on these rules are expected in the first quarter of
1997.
On December 12, 1996, the PUC issued a decision on the petition of AT&T for
arbitration with the Company concerning interconnection of AT&T's facilities
and equipment with the Company's network. Pursuant to this ruling, many of the
issues contained in this AT&T arbitration proceeding will be deferred to the
communications infrastructure docket. These issues include: 1) permanent
wholesale rates for resale of telecommunications services by an incumbent local
exchange carrier; 2) the appropriate cost basis for interconnection and
unbundled network elements; 3) the appropriate pricing methodology for
collocation; and 4) costing for access to poles, ducts, conduits and rights-of-
way. Further activity to address these and other issues within the
communications infrastructure proceeding is currently pending PUC action.
Competition
On March 1, 1996, the PUC ordered the Company to implement 1+ and 0+ equal
access within the state by May 1, 1996. On March 11, 1996, the Company filed a
motion for stay of proceedings and for reconsideration of the PUC's order. On
April 19, 1996, the PUC denied the Company's motion for stay of the order.
Effective July 10, 1996, the Company implemented 1+ and 0+ equal access.
During the first quarter of 1995, the PUC authorized AT&T and Sprint to provide
interisland toll service on a 10XXX basis, effective March 1, 1995. The PUC
reserves the right to modify or rescind the authority depending on the impact
to the Company. On February 14, 1995, the PUC approved the Company's request
to lower its toll rates and make changes to its various calling plans to keep
them competitive with AT&T's rates. On February 22, 1995, the PUC granted MCI
Communication Corporations' application to provide interisland toll service on
a 10XXX basis.
Rural Service Plans
In September 1992, the PUC initiated an investigation of the Company's
provision of telephone service in the rural areas in the state. On November 2,
1994, the PUC issued its ruling in this proceeding, requesting the Company to
convert all existing rural multi-party lines to single-party over a three-year
period. The ruling further allowed the Company to collect one-half of the cost
of conversion from existing multi-party customers choosing to convert to
single-party service. The estimated remaining costs of up to $20.2 million
will be recovered from general ratepayers statewide through a three-year
monthly surcharge. On February 24, 1995, the PUC approved the Company's Rural
Service Plan (RSP). On September 1, 1995, the Company began assessing a
three-year general ratepayer surcharge, while issuing its first offers to
convert customers to single-line service in those rural areas that were
upgraded pursuant to the RSP 1995 construction schedule. Construction
activities under the RSP will continue through 1997.
The PUC opened a docket on December 12, 1994, and ordered the Company to show
cause why the PUC should not authorize an alternate telecommunications provider
for the rural areas of the state. On December 13, 1995, the PUC issued a
decision allowing a telecommunications carrier other than the Company to seek
authorization to provide service in the Ka'u area on the island of Hawaii. The
PUC accepted bid proposals through May 15, 1996 from carriers, including the
Company, who were interested in serving the first rural area for which an
alternative telecommunications provider may be authorized. The PUC selected
TelHawaii Incorporated (TelHawaii) as the alternative provider and
27
<PAGE> 30
carrier of last resort (COLR) in the Ka'u area of the island of Hawaii,
effective May 31, 1997. The PUC further required the Company and TelHawaii to
negotiate all necessary agreements including, as required or appropriate, an
agreement for the transfer to or use by TelHawaii of the Company's assets and
agreements for extended area service, directory assistance and publications,
interconnection, enhanced 911, and telecommunications relay services. The
Company intends to continue offering a competitive alternative for Ka'u
customers even after TelHawaii begins providing alternative telecommunications
services as a COLR.
On July 25, 1996, the Company filed a Motion for Reconsideration/Clarification
of the PUC's July 15, 1996 order selecting TelHawaii as the alternative
provider of telecommunications services and as the COLR in the Ka'u area of the
island of Hawaii. On August 16, 1996, the Company filed its Notice of Appeal
of the PUC's orders. The Company is appealing the PUC's order on the basis
that the Company opposes the effective taking of its property by forced sale of
its assets in Ka'u and that the order is contrary to the Telecommunications
Act. On September 5, 1996, the Company filed an Expedited Motion for Stay
Pending Appeal and an Emergency Motion for Temporary Stay Pending Supreme Court
Review of the Expedited Motion.
On September 16, 1996, the PUC ordered the Company to show cause why it should
not pay a fine for not complying with the PUC's prior order to respond to
information requests issued by TelHawaii. A hearing was held on September 30,
1996, with an order from the PUC assessing a $0.3 million fine on the Company.
The Company paid the fine under protest on October 3, 1996, and filed a Motion
for Reconsideration of the PUC's order on October 3, 1996 due to the legal
grounds for noncompliance with the PUC's order. On November 8, 1996, the
Company also filed a motion requesting the PUC consider issuing a clarification
order and an order granting mitigation and abatement of fines and penalties
levied. On December 23, 1996, the PUC issued Order No. 15266 denying the
Company's motion for reconsideration and motion for clarification and directed
the parties to continue negotiation of "sale or use" of the Ka'u facilities.
On January 22, 1997, the Company filed an appeal of this order with the Hawaii
Supreme Court. The PUC has opened two new dockets as a result of petitions
filed by rural area communities on the island of Hawaii to assess the level of
service provided by the Company.
INTERSTATE AND INTERNATIONAL SERVICES
For the provision of interstate and international 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 local-exchange carrier (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 March 1995, the FCC adopted interim rules to be utilized by LECs, including
the Company, for their 1995 Annual Price Cap Filing. The interim rules allowed
LECs to select from three productivity/sharing options for each tariff entity.
Each of the three options reflected an increase to the 3.3% productivity factor
elected by the Company since 1991. The Company selected the following
productivity factors and sharing thresholds for use in the 1996-1997 and 1995-
1996 tariff years:
<TABLE>
<CAPTION>
Sharing Parameters
Tariff Productivity ---------------------------------------
Entity Factor 50% 100%
--------------------- ------------ ------------------ --------------
<S> <C> <C> <C>
1996-1997 Tariff Year
---------------------
Hawaii and Micronesia 4.0% 12.25 - 13.25% ROR Over 13.25% ROR
1995-1996 Tariff Year
---------------------
Hawaii 4.0% 12.25 - 13.25% ROR Over 13.25% ROR
Micronesia 5.3% None None
</TABLE>
28
<PAGE> 31
Since the Company's access fees were priced below the FCC's maximum price, the
near-term impact of productivity increases were not expected to be significant.
Under the interim rules, the Company filed tariffs to reduce rates by $5
million annually, effective August 1, 1995. On September 20, 1995, the FCC
released its proposed rulemaking proceeding on price caps which proposes
specific changes to reflect and encourage emerging competition in local and
access service markets and to establish the path towards decreased regulation
of LECs' services. On September 27, 1995, the FCC solicited comments on a
number of specific issues regarding methods for establishing the price caps,
such as productivity measurements, sharing, the common line formula and
exogenous costs. The Company submitted its 1996 annual interstate access
filing on April 2, 1996, utilizing the FCC interim price cap rules. In doing
so, the Company changed its productivity factor from 5.3% to 4.0% for its
subsidiary, MTC. On June 24, 1996, the FCC ordered all LECs subject to price
cap regulation, including the Company, to update their GDP-PI inflation factors
through the fourth quarter of 1995. Overall, the final 1996 interstate access
filing resulted in an annual price increase of $1 million, effective July 1,
1996.
On February 8, 1996, the Telecommunications Act became law. This comprehensive
telecommunications reform legislation addresses a wide range of competitive and
regulatory issues that will affect the future development of local and long
distance services, cable television and information services. The new law
removes regulatory and court-ordered barriers to competition between segments
of the industry, enabling local-exchange, long distance, wireless and cable
companies to compete in offering voice, video and information services.
The Telecommunications Act requires the FCC and state commissions to open
local-exchange markets and to set new guidelines for interconnection, loosens
restrictions barring local telephone companies from entering the cable
television market, and preserves universal service while equalizing the
responsibility for contribution among all carriers.
On August 8, 1996, the FCC published its First Report and Order (the Order)
containing rules implementing Section 251 of the Telecommunications Act dealing
with interconnection, unbundling of network elements and wholesale prices and
other terms for competitive entry into local-exchange service. On August 9,
1996, the FCC released its Second Report and Order implementing the provision
of number portability and dialing parity in accord with the Telecommunications
Act.
On September 16, 1996, GTE filed an appeal and motion for stay of the Order
with the United States Court of Appeals for the District of Columbia. This
appeal argued that the FCC had no jurisdiction to impose national pricing rules
for what is essentially local service. This appeal was subsequently
transferred to the Court of Appeals for the Eighth Circuit together with
appeals by other LECs and state regulatory commissions. On October 15, 1996,
the Eighth Circuit granted a partial stay. The stay delays implementation of
the Order's pricing provisions and associated rules, as well as the rules
requiring GTE and other LECs to permit requesting carriers to select terms and
conditions from various agreements between them and other carriers for purposes
of interconnection. On November 12, 1996, the Supreme Court denied
applications to vacate the stay filed by the FCC and various companies seeking
to enter the local-exchange business. Additionally, the Court held oral
arguments on the merits on January 17, 1997. The Court's ruling is expected in
the spring of 1997.
While GTE cannot predict the outcome of the Court's final decision, GTE intends
to continue to vigorously present its position in Court.
In November 1996, the Federal-State Joint Board released its recommended
universal service plan, and in December 1996, the FCC issued its access reform
proposals. Both proposals incorporate a pricing methodology similar to the one
that GTE is appealing in the interconnection case. A final order in the
universal service proceeding must be adopted by early May 1997, and a decision
on the access reform proceeding is expected shortly thereafter.
On December 20, 1996, the Company filed an application requesting approval to
transfer certain property to the newly established GTE Hawaiian Tel
International entity. The transfer of property will be done in accordance with
an FCC Order released on October 22, 1996 which allows the Company to be
reclassified as a nondominant provider of International Message Telephone
Service (IMTS), subject to certain safeguards which the Company must first
satisfy.
29
<PAGE> 32
The safeguards include the establishment of a separate legal entity with
separate books of account, no sharing of transmission or switching facilities
with an affiliated LEC, the acquiring of services from the LEC on a tariffed
basis, and the treatment as a nonregulated affiliate under the FCC's joint cost
and affiliate transaction rules. As a nondominant IMTS provider, the Company
will have the ability to effectively compete with other nondominant carriers in
the Hawaii IMTS market. The Company is currently awaiting PUC approval of the
property transfer.
SIGNIFICANT CUSTOMER
Revenues received from AT&T include amounts for access and billing and
collection during the years 1996-1994 under various arrangements and amounted
to $45.9 million, $47.5 million and $46 million, respectively.
11. COMMITMENTS AND CONTINGENCIES
The Company has noncancelable leases covering certain buildings, office space
and equipment. Rental expense was $13.9 million, $12.8 million and $15.7
million in 1996-1994, respectively. Minimum rental commitments under
noncancelable leases through 2001 do not exceed $2.9 million annually and
aggregate $42.4 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/or 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 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 in a competitive marketplace under
comparable conditions.
30
<PAGE> 33
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
GTE Hawaiian Telephone Company Incorporated:
We have audited the accompanying consolidated balance sheets of GTE Hawaiian
Telephone Company Incorporated (a Hawaii corporation and wholly-owned
subsidiary of GTE Corporation) and subsidiaries as of December 31, 1996 and
1995, and the related consolidated statements of income, shareholder's equity
and cash flows for each of the three years in the period ended December 31,
1996. 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 Hawaiian Telephone Company
Incorporated and subsidiaries as of December 31, 1996 and 1995, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1996, in conformity with generally accepted
accounting principles.
As discussed in Note 2 to the consolidated financial statements, in 1995, the
Company discontinued applying the provisions of Statement of Financial
Accounting Standards No. 71, "Accounting for the Effects of Certain Types of
Regulation".
Our audit was 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 audit of the basic financial statements and,
in our opinion, fairly state in all material respects the financial data
required to be set forth therein in relation to the basic financial statements
taken as a whole.
ARTHUR ANDERSEN LLP
Dallas, Texas
January 28, 1997
31
<PAGE> 34
MANAGEMENT REPORT
To Our Shareholder:
The management of the Company is responsible for the integrity and objectivity
of the financial and operating information contained in this Annual Report on
Form 10-K, including the consolidated financial statements covered by the
Report of Independent Public Accountants. These statements were prepared in
conformity with generally accepted accounting principles and include amounts
that are based on the best estimates and judgments of management.
The Company has a system of internal accounting controls which provides
management with reasonable assurance that transactions are recorded and
executed in accordance with its authorizations, that assets are properly
safeguarded and accounted for, and that financial records are maintained so as
to permit preparation of financial statements in accordance with generally
accepted accounting principles. This system includes written policies and
procedures, an organizational structure that segregates duties, and a
comprehensive program of periodic audits by the internal auditors. The Company
has also instituted policies and guidelines which require employees to maintain
the highest level of ethical standards.
WARREN H. HARUKI
President
GERALD K. DINSMORE
Senior Vice President - Finance and Planning
32
<PAGE> 35
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
33
<PAGE> 36
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) Financial Statements - See GTE Hawaiian Telephone Company
Incorporated's consolidated financial statements and report of
independent accountants thereon in the Financial Statements
section included elsewhere herein.
(2) Financial Statement Schedules - Schedules supporting the
consolidated financial statements for the years ended December 31,
1996-1994 (as required):
II - Valuation and Qualifying Accounts
Note: Schedules other than the one listed above are omitted as not
applicable, not required, or the information is included in the
consolidated financial statements or notes thereto.
(3) Exhibits - Included in this report or incorporated by reference.
3.1* Articles of Incorporation and Bylaws (Exhibit 3.2 of the
1987 Form 10-K, File No. 2- 33059)
3.2* Amended By-laws (Exhibit 3.2 of the 1994 Form 10-K, File
No. 2-33059)
4.1* Indenture dated as of February 1, 1995 between GTE
Hawaiian Telephone Company Incorporated and Hawaiian Trust
Company Limited, as Trustee (Exhibit 4.1 of the Company's
Registration Statement of Form S-3, File No. 33-57743,
filed with the Securities and Exchange Commission On
February 17, 1995).
4.2* First Supplemental Indenture dated as of July 1, 1996
between GTE Hawaiian Telephone Company Incorporated and
Hawaiian Trust Company Limited, as Trustee (Exhibit 4.3 of
the Company's Report on Form 8-K, dated July 1, 1996).
10* Material Contracts - Agreements Between GTE and Certain
Executive Officers (Exhibit 10 of the 1995 Form 10-K, File
No. 2-33059)
12 Statements re: Calculation of the Consolidated Ratio of
Earnings to Fixed Charges
26* Revised Form of Invitation for Bids pertaining to
Registration Statement on Form S-3 (File No. 33-57743)
27 Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of
1996.
* Denotes exhibits incorporated herein by reference to previous filings with
the Securities and Exchange Commission as designated.
34
<PAGE> 37
GTE Hawaiian Telephone Company Incorporated and Subsidiaries
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
For the Years Ended December 31, 1996, 1995 and 1994
(Thousands of Dollars)
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E
- --------------------------------------------------------------------------------------------------------------------
Additions
----------------------------
Deductions
Balance at Charged Charged from
Beginning (Credited) (Credited) to Reserves Balance at
Description of Year to Income Other Accounts (Note 1) Close of Year
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Allowance for uncollectible accounts
for the years ended:
December 31, 1996 $ 6,338 $ 9,761 $ 7,001(2) $ 17,034 $ 6,066
==========================================================================
December 31, 1995 $ 9,010 $ 9,119 $ 4,673(2) $ 16,464 $ 6,338
==========================================================================
December 31, 1994 $ 9,072 $ 5,673 $ 8,817(2) $ 14,552 $ 9,010
==========================================================================
Accrued restructuring costs for the
years ended (Note 4):
December 31, 1996 $ 39,353 $ -- $(11,520)(3) $ 27,833 $ --
==========================================================================
December 31, 1995 $ 60,816 $ -- $ -- $ 21,463 $39,353
==========================================================================
December 31, 1994 $ 78,275 $ -- $ -- $ 17,459 $60,816
==========================================================================
</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 have been reclassified to Accounts Payable and
Accrued Expenses.
(4) See Note 3 to the consolidated financial statements included elsewhere
herein.
35
<PAGE> 38
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 HAWAIIAN TELEPHONE COMPANY
INCORPORATED
-------------------------------
(Registrant)
Date March 25, 1997 By Warren H. Haruki
-------------- -------------------------------
Warren H. Haruki
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.
Warren H. Haruki President and Director March 25, 1997
- ------------------------- (Principal Executive Officer)
Warren H. Haruki
Gerald K. Dinsmore Senior Vice President - Finance and March 25, 1997
- ------------------------- Planning and Director
Gerald K. Dinsmore (Principal Financial Officer)
William M. Edwards, III Vice President - Controller March 25, 1997
- ------------------------- (Principal Accounting Officer)
William M. Edwards, III
John C. Appel Director March 25, 1997
- -------------------------
John C. Appel
Richard M. Cahill Director March 25, 1997
- -------------------------
Richard M. Cahill
Michael B. Esstman Director March 25, 1997
- -------------------------
Michael B. Esstman
Thomas W. White Director March 25, 1997
- -------------------------
Thomas W. White
36
<PAGE> 39
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
- --------------- --------------------------------------------------------------------
<S> <C>
12 Statements re: Calculation of the Ratio of Earnings to Fixed Charges
27 Financial Data Schedule
</TABLE>
<PAGE> 1
Exhibit 12
GTE Hawaiian Telephone Company Incorporated and Subsidiaries
STATEMENTS OF THE CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES
(Thousands of Dollars)
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------------------------
1996 1995 1994 1993 1993(a) 1992
-------- -------- -------- -------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Net earnings available for fixed charges:
Income (loss) before extraordinary $ 54,701 $ 37,901 $ 29,799 $ 43,175 $ (5,042) $ 43,590
charges
Add - Income taxes (benefit) 23,850 15,023 12,613 20,193 (9,865) 24,228
- Fixed charges 45,556 46,063 41,328 36,327 36,327 34,214
-------- -------- -------- -------- -------- --------
Adjusted earnings $124,107 $ 98,987 $ 83,740 $ 99,695 $ 21,420 $102,032
======== ======== ======== ======== ======== ========
Fixed charges:
Interest expense $ 40,924 $ 41,789 $ 36,104 $ 31,660 $ 31,660 $ 29,214
Portion of rent expense
representing interest 4,632 4,274 5,224 4,667 4,667 5,000
-------- -------- -------- -------- -------- --------
Adjusted fixed charges $ 45,556 $ 46,063 $ 41,328 $ 36,327 $ 36,327 $ 34,214
======== ======== ======== ======== ======== ========
RATIO OF EARNINGS TO FIXED
CHARGES 2.72 2.15 2.03 2.74 -- 2.98
</TABLE>
(a) Results for 1993 include an after-tax restructuring charge of approximately
$48 million for the implementation of a re-engineering plan. Earnings were
not adequate to cover fixed charges in 1993. The amount of such deficiency
was $15 million for the year ended December 31, 1993.
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 20,154
<SECURITIES> 0
<RECEIVABLES> 150,776
<ALLOWANCES> 6,066
<INVENTORY> 5,906
<CURRENT-ASSETS> 201,585
<PP&E> 2,049,370
<DEPRECIATION> 1,226,897
<TOTAL-ASSETS> 1,200,985
<CURRENT-LIABILITIES> 190,774
<BONDS> 513,016
0
0
<COMMON> 250,000
<OTHER-SE> 89,387
<TOTAL-LIABILITY-AND-EQUITY> 1,200,985
<SALES> 634,921
<TOTAL-REVENUES> 634,921
<CGS> 276,712
<TOTAL-COSTS> 518,142
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 38,267
<INCOME-PRETAX> 78,551
<INCOME-TAX> 23,850
<INCOME-CONTINUING> 54,701
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 54,701
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
