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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended: SEPTEMBER 30, 1998
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from _______ to _______
Commission File Number 2-33059
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)
1255 Corporate Drive, SVC04C08, Irving, Texas 75038
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code 972-507-5000
600 Hidden Ridge, HQE04B12 - Irving, Texas 75038
(Former name, former address and former fiscal
year, if changed since last report)
The registrant, a wholly-owned subsidiary of GTE Corporation, meets the
conditions set forth in General Instruction H(1) (a) and (b) of Form 10-Q and is
therefore filing this form with reduced disclosure format pursuant to General
Instruction H(2).
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
The Company had 10,000,000 shares of $25 par value common stock outstanding at
October 31, 1998. The Company's common stock is 100% owned by GTE Corporation.
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PART I. FINANCIAL INFORMATION
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Condensed Consolidated Statements of Income (Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
1998 1997 1998 1997
-------- -------- -------- --------
(Dollars in Millions)
<S> <C> <C> <C> <C>
REVENUES AND SALES
Local services $ 66.6 $ 66.6 $ 203.6 $ 196.2
Network access services 43.5 38.8 134.1 123.8
Toll services 14.9 13.8 42.7 46.9
Other services and sales 40.7 36.8 123.7 115.3
-------- -------- -------- --------
Total revenues and sales 165.7 156.0 504.1 482.2
-------- -------- -------- --------
OPERATING COSTS AND EXPENSES
Cost of services and sales 63.1 63.9 203.1 190.2
Selling, general and administrative 26.5 27.6 83.8 91.0
Depreciation and amortization 28.5 28.7 87.4 91.3
-------- -------- -------- --------
Total operating costs and expenses 118.1 120.2 374.3 372.5
-------- -------- -------- --------
OPERATING INCOME 47.6 35.8 129.8 109.7
OTHER (INCOME) EXPENSE
Interest - net 10.3 9.3 29.4 27.9
Other - net (1.2) (0.2) (2.1) (0.7)
-------- -------- -------- --------
INCOME BEFORE INCOME TAXES 38.5 26.7 102.5 82.5
Income taxes 12.5 16.5 33.7 37.0
-------- -------- -------- --------
NET INCOME $ 26.0 $ 10.2 $ 68.8 $ 45.5
======== ======== ======== ========
</TABLE>
Per share data is omitted since the Company's common stock is 100% owned by GTE
Corporation.
The accompanying notes are an integral part of these statements.
1
<PAGE> 3
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Condensed Consolidated Balance Sheets (Unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
(Dollars in Millions)
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $ 8.9 $ 0.7
Receivables, less allowances
of $9.4 and $8.6 188.0 189.0
Accounts receivable from affiliate 25.5 2.5
Note receivable from affiliate 3.4 24.4
Inventories and supplies 12.7 15.0
Prepaid taxes 3.2 16.3
Other 3.1 3.8
---------- ----------
Total current assets 244.8 251.7
---------- ----------
Property, plant and equipment, at cost 2,055.9 2,019.2
Accumulated depreciation (1,207.4) (1,173.9)
---------- ----------
Total property, plant and equipment, net 848.5 845.3
---------- ----------
Prepaid pension costs 226.7 202.5
Other assets 19.2 6.6
---------- ----------
Total assets $ 1,339.2 $ 1,306.1
========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
2
<PAGE> 4
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Condensed Consolidated Balance Sheets (Unaudited) - Continued
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
(Dollars in Millions)
<S> <C> <C>
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities
Short-term obligations,
including current maturities $ 74.4 $ 99.7
Accounts payable 48.3 35.1
Affiliate payables 47.3 22.1
Taxes payable 7.1 1.8
Accrued interest 9.4 10.4
Accrued payroll costs 29.0 26.4
Dividends payable 13.5 10.8
Other 33.4 35.3
---------- ----------
Total current liabilities 262.4 241.6
---------- ----------
Long-term debt 468.2 510.2
Deferred income taxes 154.3 130.1
Deferred employee benefit obligations and other 47.1 58.5
---------- ----------
Total liabilities 932.0 940.4
---------- ----------
Shareholder's equity
Common stock (10,000,000 shares issued) 250.0 250.0
Additional paid-in capital 91.1 91.1
Retained earnings 66.1 24.6
---------- ----------
Total shareholder's equity 407.2 365.7
---------- ----------
Total liabilities and shareholder's equity $ 1,339.2 $ 1,306.1
========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
3
<PAGE> 5
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
--------------------
1998 1997
-------- --------
(Dollars in Millions)
<S> <C> <C>
OPERATIONS
Net income $ 68.8 $ 45.5
Adjustments to reconcile net income to net cash
from operations:
Depreciation and amortization 87.4 91.3
Deferred income taxes 20.6 14.3
Provision for uncollectible accounts 9.5 11.3
Changes in current assets and current liabilities 28.4 (78.9)
Other - net (45.4) (22.1)
-------- --------
Net cash from operations 169.3 61.4
-------- --------
INVESTING
Capital expenditures (90.5) (98.1)
-------- --------
Cash used in investing (90.5) (98.1)
-------- --------
FINANCING
Long-term debt retired (1.5) (38.8)
Dividends (24.7) (15.1)
Increase (decrease) in short-term obligations,
excluding current maturities (44.4) 72.8
-------- --------
Net cash from (used in) financing (70.6) 18.9
-------- --------
Increase (decrease) in cash and cash equivalents 8.2 (17.8)
Cash and cash equivalents:
Beginning of period 0.7 20.1
-------- --------
End of period $ 8.9 $ 2.3
======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
4
<PAGE> 6
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 1. Basis Of Presentation
GTE Hawaiian Telephone Company Incorporated (the Company) is incorporated under
the laws of the State of Hawaii and is a subsidiary of GTE Corporation (GTE).
The unaudited condensed consolidated financial statements included herein have
been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations. However, in the opinion of management of the Company, the
condensed consolidated financial statements include all adjustments, which
consist only of normal recurring accruals, necessary to present fairly the
financial information for such periods. These condensed consolidated financial
statements should be read in conjunction with the consolidated financial
statements and the notes thereto included in the Company's 1997 Annual Report on
Form 10-K.
Reclassifications of prior year data have been made, where appropriate, to
conform to the 1998 presentation.
Note 2. Recent Accounting Pronouncements
Employee Benefit Disclosures
In February 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits". This new standard
does not change the measurement or recognition of costs for pension or other
postretirement plans. It standardizes disclosures and eliminates those that are
no longer useful. The Company will provide the new disclosures in the 1998
Annual Report on Form 10-K. The adoption of SFAS No. 132 will have no impact on
the consolidated results of operations or financial condition.
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<PAGE> 7
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued
Computer Software
In March 1998, the American Institute of Certified Public Accountants (AICPA)
issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use". SOP 98-1 defines internal-use
software and requires that the cost of such software be capitalized and
amortized over its useful life. Presently, the Company's practice is to
capitalize initial operating system and certain application software and expense
the cost of other software, including right-to-use fees. The Company is
currently assessing the impact of capitalizing and amortizing the cost of all
types of internal-use software as required by SOP 98-1, effective January 1,
1999.
Costs of Start-Up Activities
In April 1998, the AICPA also issued SOP 98-5, "Reporting on the Costs of
Start-Up Activities" to provide guidance to all non-governmental entities on
financial reporting of costs of start-up activities. SOP 98-5 must be adopted no
later than January 1, 1999, and requires that costs of start-up activities be
expensed as incurred instead of being capitalized and amortized. It applies to
start-up activities and costs of organization of both development stage and
established operating entities. Based on the Company's current policy for costs
of start-up activities, SOP 98-5 will not have an impact on the consolidated
results of operations or financial condition.
Derivative Instruments and Hedging Activities
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. The Company
is assessing the impact of adopting SFAS No. 133 and intends to implement as of
January 1, 2000.
6
<PAGE> 8
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
And Results of Operations
<TABLE>
<CAPTION>
RESULTS OF OPERATIONS
(Dollars in Millions) Nine Months Ended
September 30,
----------------- Increase Percent
1998 1997 (Decrease) Change
------- ------- ---------- -------
<S> <C> <C> <C> <C>
Net income $ 68.8 $ 45.5 $ 23.3 51%
</TABLE>
Net income increased primarily as a result of higher revenues and lower income
taxes.
<TABLE>
<CAPTION>
REVENUES AND SALES
(Dollars in Millions) Nine Months Ended
September 30,
----------------- Increase Percent
1998 1997 (Decrease) Change
------- ------- ---------- -------
<S> <C> <C> <C> <C>
Local services $ 203.6 $ 196.2 $ 7.4 4%
Network access services 134.1 123.8 10.3 8%
Toll services 42.7 46.9 (4.2) (9)%
Other services and sales 123.7 115.3 8.4 7%
------- ------- ----------
Total revenues and sales $ 504.1 $ 482.2 $ 21.9 5%
======= ======= ==========
</TABLE>
Local Services Revenues
Access lines grew 5% over the third quarter in 1997, resulting in additional
revenues of $3.5 million from basic local services and $2.6 million from
Integrated Services Digital Network and Digital Channel Services.
Network Access Services Revenues
The increase in network access services revenues for the nine months ended
September 30, 1998, compared to the same period in 1997, was primarily the
result of increased access rates for dedicated private lines. Minutes of use
increased 6%, which generated $3.8 million of additional revenues. Special
access revenues grew $4.2 million due to greater demand for increased bandwidth
by high-capacity users. Revenues decreased $7.3 million as a result of
interstate access rate changes from the 1997 Federal Communications Commission
(FCC) price cap (for further information on access charges see "FEDERAL
REGULATORY DEVELOPMENTS - Interstate Access Revision").
Toll Services Revenues
Toll services revenues decreased for the nine months ended September 30, 1998,
compared to the same period in 1997, primarily due to a decline in domestic toll
volumes resulting from continued competition with long-distance carriers
7
<PAGE> 9
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
authorized to provide inter-island toll service on a 10-10-XXX basis and 1+
presubscription basis. Additionally, the impacts of inter-island toll price
reductions, which were effective May 7, 1997, contributed to the decline in toll
services revenues.
Other Services and Sales Revenues
Other services and sales revenues increased for the nine months ended September
30, 1998, compared to the same period in 1997, primarily as a result of a $2.7
million increase related to the FCC's order increasing payphone compensation
from interexchange carriers (IXCs) and a $1.8 million increase in equipment
sales. (For further information on payphone compensation see "FEDERAL REGULATORY
DEVELOPMENTS - Payphone Orders"). Higher billing and collection services and
rent revenues also contributed to the increase.
<TABLE>
<CAPTION>
OPERATING COSTS AND EXPENSES
(Dollars in Millions) Nine Months Ended
September 30,
----------------- Increase Percent
1998 1997 (Decrease) Change
------- ------- ---------- -------
<S> <C> <C> <C> <C>
Cost of services and sales $ 203.1 $ 190.2 $ 12.9 7%
Selling, general and administrative 83.8 91.0 (7.2) (8)%
Depreciation and amortization 87.4 91.3 (3.9) (4)%
------- ------- ----------
Total operating costs and expenses $ 374.3 $ 372.5 $ 1.8 1%
======= ======= ==========
</TABLE>
Total operating costs and expenses increased slightly for the nine months ended
September 30, 1998, compared to the same period in 1997. Pension settlement
gains recorded in the third quarter of 1997 contributed $5.1 million to the
increase in operating costs and expenses for the nine months ended September 30,
1998, compared to the same period in 1997. Depreciation expense decreased
primarily as a result of a change in the estimated net salvage values related to
certain telephone plant and equipment, which became effective in the third
quarter of 1997.
OTHER INCOME STATEMENT ITEMS
Interest-net increased 5% or $1.5 million for the nine months ended September
30, 1998, compared to the same period in 1997. The increase is primarily
attributable to incurred expense related to 1998 computer lease contracts and
increases in average outstanding debt balances.
Income taxes decreased 9% or $3.3 million for the nine months ended September
30, 1998, compared to the same period in 1997. This decrease is primarily due
to tax adjustments made in 1997, partially offset by an increase in pretax
income.
8
<PAGE> 10
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
FEDERAL REGULATORY DEVELOPMENTS
Interstate Access Revision
The Company filed interstate access revisions during 1997 that became effective
June 3, 1997 and July 1, 1997. Overall, these filings resulted in a net annual
price reduction of $7.4 million. In December 1997, the FCC issued an order to
file revised access rates effective January 1, 1998, which resulted in
additional interstate access revenue reductions of approximately $1.8 million
annually. In 1997, the FCC also ordered significant changes that altered the
structure of access charges collected by the Company, effective January 1, 1998.
Generally, the FCC reduced and restructured the per minute charges paid by
long-distance carriers and implemented new per-line charges. The FCC also
created an access charge structure that resulted in different access charges for
residential primary and secondary lines and single line and multi-line business
access lines. In aggregate, the annual reductions in usage sensitive access
charges of $6.9 million paid by long-distance carriers were offset by $6.5
million of new per-line charges and the charges paid by end-user customers.
Effective July 1, 1998, access charges were further reduced by $9.3 million
annually in compliance with FCC requirements to reflect the impacts of access
charge reform.
The FCC Access Reform Order released in May 1997 revamped the rate structure
through which local and long-distance companies charge customers for using the
local phone network to make long-distance calls. GTE and numerous other parties
challenged the FCC's decisions in this order before the Eighth Circuit Court of
Appeals based on the belief that the FCC did not eliminate the universal service
subsidies hidden within interstate access charges as directed by the
Telecommunications Act of 1996 (TA96), and that the FCC created additional
subsidy charges paid only by business and multi-line residential customers. In
August 1998, the Eighth Circuit announced its decision on the multiple appeals
of the FCC Access Reform Order. The opinion denies all of the petitions for
review of the access charge order. The Company is considering its options.
In October 1998, the FCC began a proceeding to "refresh the record" used in the
1997 access charge reform proceedings. The FCC will determine whether to retain
or modify its "market based" access charge reform approach, or to adopt a
"prescriptive" approach.
9
<PAGE> 11
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
Universal Service
In May 1997, the FCC released a decision relating to implementation of the
TA96's provision on universal service. GTE and numerous other parties have
challenged the FCC's decision before the U.S. Court of Appeals for the Fifth
Circuit on the grounds that the FCC did not follow the requirements of the TA96
to develop a sufficient, explicit and competitively neutral universal service
program. Oral argument is scheduled for December 1998. A final decision on the
appeal is expected to be issued by mid-1999.
In its Order on Reconsideration dated July 13, 1998, the FCC referred some key
issues back to the Federal-State Joint Board (the Board) on universal service.
The Board's recommendations are due in the fourth quarter of 1998. In its
October 22, 1998 Order, the FCC selected a "synthesis" model platform for
universal service and plans to select cost inputs by the first quarter of 1999
and a revenue benchmark by mid-1999. The implementation date of the new
universal service mechanism for non-rural carriers was moved to July 1999. The
Company is assessing the Order and its options.
The Eighth Circuit Court ruling on FCC access reform (see previous discussion of
"Interstate Access Revision") also impacts universal service. Specifically, the
FCC is not required to eliminate all implicit subsidies before the explicit
universal service mechanism is implemented in July 1999.
Payphone Orders
On June 4, 1996, the FCC issued its first Report and Order implementing the
payphone compensation provisions of the TA96. As part of the overall goal of
promoting competition among payphone service providers (PSPs), this order
mandated compensation to all PSPs for all calls originating from payphones,
including credit card and toll-free calls for which PSPs were not previously
compensated.
Subsequently, on October 9, 1997, the FCC issued a second Report and Order to
address some of the issues vacated by the U.S. Court of Appeals in Washington,
D.C. concerning the FCC's first Order and Report mentioned above. In this second
order, the FCC established a new per-call rate of 28.4 cents for compensation
that all PSPs were eligible to receive beginning October 9, 1997.
On April 3, 1998, the FCC issued an order, which granted the IXCs a waiver of
the per-call compensation requirement so that they may pay per-phone instead of
per-call compensation for the payphones for which the FCC had granted technology
waivers. GTE will receive per-phone compensation under this waiver until the
technology is installed on those payphones that are not currently capable of
measuring per-call detail.
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<PAGE> 12
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
Price Cap
For the provision of interstate services, the Company operates under the terms
of the FCC's price cap incentive plan. This plan limits the rates a carrier may
charge rather than regulating on a traditional rate-of-return basis. The price
caps for a variety of service categories change annually using a price cap index
that is a function of inflation less a predetermined productivity offset. The
FCC's May 1997 Price Cap Order revised the price cap plan for incumbent price
cap local exchange carriers (LECs) by adopting a productivity offset of 6.5%.
This matter is before the FCC as discussed above.
In June 1997, GTE and several other parties challenged the FCC's Price Cap Order
before the Court of Appeals for the District of Columbia Circuit. The issue
presented for review is whether, in computing its new 6.5% productivity offset,
the FCC arbitrarily manipulated the evidence to achieve a predetermined outcome.
Oral arguments are set for the first quarter of 1999 with a decision expected
later in the year. Associated with the FCC's current activity to "refresh the
record" for access reform discussed above, the FCC will decide whether the 6.5%
productivity offset should be changed.
STATE REGULATORY DEVELOPMENTS
Communications Infrastructure
In April 1998, the Public Utilities Commission (PUC) of the State of Hawaii (the
State) adopted an AT&T model as the State's cost study for calculating federal
universal service high cost support. The PUC ordered AT&T to modify this model
to comply with the FCC guidelines. The Company filed a motion with the PUC
requesting that the Company be allowed to provide the input values to any model
submitted to the FCC for calculating federal universal service support and
requesting an opportunity to review and comment on AT&T's model which had been
previously submitted. The PUC denied the Company's motion and submitted the AT&T
model to the FCC. The Company filed comments and reply comments with the FCC in
June and July 1998, respectively. The FCC cost model decision referred to above
may affect this matter.
Arbitration Activity
In November 1997, Western Wireless Corporation (WWC) filed a motion to compel
the Company to implement arbitrated interconnection rates, to provide sanctions
of $6.8 million for alleged failure to comply with the orders issued by the PUC
in its arbitration docket and to suspend the Standard Billing Agreement. In
January 1998, the PUC denied WWC's motion. In March 1998, the PUC denied WWC's
motion for reconsideration of the January 1998 decision.
11
<PAGE> 13
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
In May 1998, TelHawaii filed a petition for arbitration which identified
unbundled loops, subloop unbundling, collocation and number portability as
issues requiring arbitration. The Company filed its response to the petition in
June 1998. The PUC specified the list of issues in August 1998, and briefs and
reply briefs were filed in September 1998. The PUC ruled in the Company's favor.
Rural Service Plans
Briefs were filed in April 1998 related to the petitions filed by rural area
communities to determine the adequacy of the telecommunications services
provided by the Company in the South Kona and Puna districts of the island of
Hawaii. In June 1998, the PUC issued an order granting a motion by TelHawaii to
compel the Company to transfer its assets in Ka'u to TelHawaii but denied
TelHawaii's request for civil penalties against the Company. In July 1998, the
First Circuit Court stayed the order, pending resolution of a motion for
reconsideration and/or motion for stay that the Company must file with the PUC.
The PUC issued an order in July 1998 denying the Company's motion for
reconsideration. A reconsideration of the July 1998 denial was denied in
September 1998. The First Circuit Court entered oral argument on the Company's
appeal in September 1998.
International Services
In July 1997, the Commonwealth of the Northern Mariana Islands (CNMI) served by
Micronesian Telephone Company (MTC), a subsidiary of the Company, was
incorporated into the North American Numbering Plan under the 670 area code.
This area code was CNMI's former country code. With this change, MTC's customers
for the first time are able to dial anywhere within the United States on a 1+
basis instead of the 011+ international access. In addition, customers were able
to dial toll-free numbers nationwide. In August 1997, the CNMI was integrated
into the U.S. domestic rate structure.
Local Payphone Rates
The Company increased local payphone call rates, effective October 1998, from
$.25 to $.35 per phone call. Telephone companies in most other states now charge
$.35 for local payphone calls. This rate change reflects the Company's first
increase since 1986.
RECENT DEVELOPMENTS
Proposed GTE/Bell Atlantic Merger
On July 27, 1998, GTE and Bell Atlantic entered into a merger agreement
providing for the combination of the two companies in a merger of equals
transaction. Under terms of the definitive agreement, which was unanimously
12
<PAGE> 14
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
approved by the board of directors of both companies, GTE shareholders will
receive 1.22 shares of Bell Atlantic stock for each GTE share they own. The
merger is expected to be accounted for as a pooling of interests, is subject to
shareholder and regulatory approval, and is expected to be completed during the
second half of 1999. For additional information regarding the merger, refer to
the Form 8-K filed by GTE dated July 27, 1998.
Property Repositioning
In April 1998, GTE announced a series of actions designed to further sharpen its
strategic focus and improve its competitive position by repositioning
non-strategic properties and reducing costs. GTE expects to generate after-tax
proceeds of $2 billion to $3 billion by selling non-strategic or
under-performing operations and plans to reduce annual costs by more than $500
million through improved efficiencies and productivity while it continues to
invest in new high-growth opportunities. This announcement is expected to have
no impact on the Company, however, GTE's management is currently assessing its
options and, as decisions are finalized regarding the sale of non-strategic
operations and cost reductions, the Company could be affected.
General Excise Use Tax
The State is currently engaged in a general excise use tax audit of the Company.
The Company implements a specific allocation methodology to distribute
interstate revenue and income to taxable and non-taxable categories for
computation of general excise use taxes. It is probable that the State will take
exception to the Company's allocation methodology during their audit of years
1992-1994. At year-end 1997, the State assessed $12 million for unpaid taxes,
which the Company challenged in audit negotiations. Since then, the Company has
analyzed the auditor's position in the notice of assessment, and believes that
it has a reasonable argument that the access charges for interstate
long-distance calls should be characterized as wholesale items subject to the
reduced 0.5% tax rate, instead of the 4% general excise tax rate. The Company is
currently awaiting issuance of a written statement of the State's position from
its technical branch.
YEAR 2000 CONVERSION
General
The Year 2000 issue concerns the potential inability of information systems to
properly recognize and process date-sensitive information beyond January 1,
2000, and has industry-wide implications. GTE has had an active Year 2000
program in place since 1995. This program is necessary because the Year 2000
issue could impact the telecommunications networks, systems and business
processes at GTE. Although GTE maintains a significant portion of its own
13
<PAGE> 15
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
systems and infrastructure, GTE also depends on certain, material external
supplier products that it must verify as Year 2000 compliant in their condition
of use. GTE's program methodology is very similar to the General Accounting
Office (GAO) methodology and in 1997, GTE's Year 2000 methodology and processes
were certified by the Information Technology Industry Association of America.
GTE presently expects that its core operations and essential functions will be
ready for the millennium transition.
State of Readiness
GTE's Year 2000 program is focused on both information technology (IT) and
non-IT systems, including: 1) telecommunications network elements that
constitute the portion of the public switched telephone network (PSTN) for which
GTE is responsible; 2) systems that directly support GTE's telecommunications
network operations and interactions with customers; 3) legacy software that
supports basic business operations, customer premise equipment and
interconnection with other telecommunications carriers; and 4) systems that
support GTE's physical infrastructure, financial operations and facilities.
Corporate wide, essential remediation was approximately 63% complete as of
September 30, 1998. In addition to the essential remediation budget, GTE has set
aside funds equivalent to 12% of GTE's overall Year 2000 budget. These funds are
planned for program closeout and verification in the last six months of 1999 and
to address contingencies and millennium program operations and control through
March 2000. GTE's portion of the PSTN in the United States has been upgraded
substantially for Year 2000; 69% of GTE's digital access lines are already
operational using Year 2000 compliant central office switches. Additionally,
over 75% of GTE's legacy software has been remediated. Over the next nine
months GTE's focus will be the deployment of these systems throughout operations
and the testing of those systems under actual operating conditions.
Using the nomenclature of the GAO, GTE's Year 2000 program can be characterized
as follows: Management, including transition into the Year 2000, is 43%
complete, with a projected end date of March 2000; Awareness is approximately
60% complete and is expected to continue until June 1999; System Assessment is
approximately 62% complete and is expected to be completed by December 1998;
System Renovation, including supplier products, is approximately 76% complete,
with intended completion by December 1998 for essential functions; Validation,
including enterprise testing in operational environments, is 44% complete, with
an expected completion in June 1999; and Implementation, including regional
deployment, is 63% complete, with an expected completion in June 1999.
14
<PAGE> 16
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
In summary, compliant product rollout (deployment) and enterprise testing of
GTE's telecommunications-related businesses, including national and
international interoperability and verification, are presently expected to be
complete by the end of June 1999. Due to its relatively recent acquisition of
BBN Corporation, GTE's data initiative is presently targeting completion of its
key infrastructure systems by the end of September 1999.
Successful conclusion of GTE's Year 2000 program depends upon timely delivery of
Year 2000-compliant products and services from external suppliers. Approximately
1,450 of third-party products used by GTE have been determined to be "vital"
products, critical to GTE's business and operations. As of September 30, 1998,
Year 2000-compliant versions, or suitable alternatives, for 53% of these vital
supplier products have been provided. GTE presently expects that by December 31,
1998, Year 2000-compliant versions, or suitable alternatives, of third-party
supplier products for GTE's critical or major legacy and support systems will
have been delivered.
Use of Independent Verification and Validation
GTE's Year 2000 program management office has established a corporate-wide
quality oversight and control function that reviews and evaluates quality
reports on the Year 2000 issue. Each GTE business unit has access to an
independent quality team that evaluates the conversion and testing of legacy
applications and third-party supplier products. Separately, GTE's corporate
internal and external auditors conduct periodic reviews of each business unit's
Year 2000 activities and report significant findings, if any, to business unit
and corporate management.
Cost to Address Year 2000 Issues
The current estimate for the cost of GTE's Year 2000 Program is approximately
$370 million. Through September 30, 1998, expenditures totaled $177 million.
Year 2000 remediation costs are expensed in the year incurred. These
expenditures constitute approximately 6% of the 1998 IT budget and are projected
to be approximately 4% of the 1999 IT budget. The current estimate for the cost
of remediation for the Company is approximately $9.7 million. Through September
30, 1998, expenditures totaled $4.2 million. GTE has not elected to replace, or
to accelerate the schedule of a planned replacement of, systems due to the Year
2000 issue.
Currently supporting GTE's Year 2000 program worldwide are an estimated 1,000 to
1,200 full-time equivalent workers (both corporate employees and contractors).
Approximately 12% of these full-time equivalent workers are engaged in all
aspects of program management; 30% are engaged in legacy system conversion; 25%
are involved in external supplier management; 30% are involved in testing at all
levels; and 3% are addressing contingency planning and interoperability
operations both nationally and internationally. Approximately 78% of GTE's
program effort involves U.S. domestic operations of all types. Twenty-two
percent (22%) of the effort is dedicated to GTE's international operations.
15
<PAGE> 17
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
Risks of Year 2000 Issues
GTE has begun to examine the risks associated with its "most reasonably likely
worst case Year 2000 scenarios". To date, GTE has no indication that any
specific function or system is so deficient in technical progress as to threaten
GTE's present schedule. GTE's program and plans currently indicate a compliant
network infrastructure to be deployed by the end of June 1999. A general,
unspecific, schedule shift that would erode progress beyond January 1, 2000,
cannot reasonably be calculated. If, however, there were a schedule delay
lasting no more than six months, such schedule erosion would likely affect only
nonessential systems due to the prioritization of work schedules.
Other scenarios might include a possible but presently unforeseen failure of key
supplier or customer business processes or systems. This situation could
conceivably persist for some months after the millennium transition and could
lead to possible revenue losses. GTE's present assessment of its key suppliers
and customers does not indicate that this scenario is likely.
To date, GTE has not encountered any conditions requiring tactical contingency
planning to its existing Year 2000 program; however, contingency planning for
business and network operations and customer contact during 1999 and 2000 is
ongoing.
GTE is bolstering its normal business continuity planning to address potential
Year 2000 interruptions. In addition, GTE's disaster preparedness recovery teams
are including procedures and activities for a "multi-regional" Year 2000
contingency, if it occurs. GTE is also developing its plans with respect to
possible occurrences immediately before, during, and after the millennium
transition. Under consideration are: "follow-the-sun" time-zone impact analysis;
coordination with other (non-PSTN) telecommunications providers; a Year 2000
"war room" operation to provide high priority recovery support, plans for key
personnel availability, command structures, and contingency traffic routing; and
plans for round-the-clock, on-call repair teams.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
Information contained in this Management's Discussion and Analysis with respect
to expected financial results and future events and trends is forward-looking,
based on the Company's estimates and assumptions and is subject to risks and
uncertainties. For those statements, the Company claims
16
<PAGE> 18
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
the protection of the safe harbor for forward-looking statements contained in
the Private Securities Litigation Reform Act of 1995.
The following important factors could affect the future results of the Company
and could cause those results to differ materially from those expressed in the
forward-looking statements: (1) materially adverse changes in economic
conditions in the markets served by the Company; (2) material changes in
available technology; (3) the final resolution of pending and potential future
federal, state and local regulatory initiatives and proceedings, and judicial
review of those initiatives and proceedings pertaining to, among other matters,
the terms of interconnection, access charges, universal service, unbundled
network elements and resale rates; (4) the extent, timing, success and overall
effects of competition from others in the local telephone and intraLATA toll
service markets; (5) the success and expense of our remediation efforts and
those of our suppliers, customers and all interconnecting carriers in achieving
Year 2000 compliance; and (6) the success of new GTE products, services and
businesses such as bundled services through marketing and sales initiatives.
17
<PAGE> 19
PART II. OTHER INFORMATION
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits required by Item 601 of Regulation S-K.
12 Statement re: Calculation of the Consolidated Ratio of Earnings
to Fixed Charges
27 Financial Data Schedule
(b) The Company filed no reports on Form 8-K during the third quarter of
1998.
18
<PAGE> 20
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
GTE Hawaiian Telephone Company
Incorporated
------------------------------
(Registrant)
Date: November 12, 1998 /s/ Stephen L. Shore
----------------- ------------------------------
Stephen L. Shore
Controller
(Principal Accounting Officer)
19
<PAGE> 21
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------- ------------------------------------------------------
<S> <C>
12 Statement re: Calculation of the Consolidated Ratio of
Earnings to Fixed Charges
27 Financial Data Schedule
</TABLE>
<PAGE> 1
EXHIBIT 12
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Statement of the Consolidated Ratio of Earnings to Fixed Charges
(Unaudited)
<TABLE>
<CAPTION>
(Dollars in Millions) Nine Months Ended
September 30, 1998
------------------
<S> <C>
Net earnings available for fixed charges:
Income from continuing operations $ 68.8
Add - Income taxes 33.7
- Fixed charges 34.9
--------
Adjusted earnings $ 137.4
========
Fixed charges:
Interest expense $ 31.7
Portion of rent expense representing interest 3.2
--------
Adjusted fixed charges $ 34.9
========
RATIO OF EARNINGS TO FIXED CHARGES 3.94
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 8,900
<SECURITIES> 0
<RECEIVABLES> 226,300
<ALLOWANCES> 9,400
<INVENTORY> 12,700
<CURRENT-ASSETS> 244,800
<PP&E> 2,055,900
<DEPRECIATION> 1,207,400
<TOTAL-ASSETS> 1,339,200
<CURRENT-LIABILITIES> 262,400
<BONDS> 468,200
0
0
<COMMON> 250,000
<OTHER-SE> 157,200
<TOTAL-LIABILITY-AND-EQUITY> 1,339,200
<SALES> 504,100
<TOTAL-REVENUES> 504,100
<CGS> 203,100
<TOTAL-COSTS> 374,300
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 31,700
<INCOME-PRETAX> 102,500
<INCOME-TAX> 33,700
<INCOME-CONTINUING> 68,800
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 68,800
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
