<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 1997
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission File Number 2-33059
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:
NONE
Securities registered pursuant to Section 12(g) of the Act:
NONE
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES [X] NO [ ]
INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405
OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO
THIS FORM 10-K. [X]
THE COMPANY HAD 10,000,000 SHARES OF $25 PAR VALUE COMMON STOCK OUTSTANDING AT
FEBRUARY 28, 1998. THE COMPANY'S COMMON STOCK IS 100% OWNED BY GTE
CORPORATION.
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
Part I
<S> <C>
1. Business 1
2. Properties 4
3. Legal Proceedings 4
4. Submission of Matters to a Vote of Security Holders - This item has
been omitted in accordance with the relief provisions under General
Instruction J of Form 10-K
Part II
5. Market for the Registrant's Common Equity and Related
Shareholder Matters 5
6. Selected Financial Data - This item has been omitted in accordance
with the relief provisions under General Instruction J of Form 10-K
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 6
8. Financial Statements and Supplementary Data 12
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 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 9 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, 1997, the Company
served 863,249 access lines in its service territories.
At December 31, 1997, the Company had 2,715 employees.
The Company has written agreements with the International Brotherhood of
Electrical Workers (IBEW) covering substantially all non-management employees.
In 1996, a new three-year agreement was reached with the IBEW. No agreements
will expire in 1998.
REGULATORY AND COMPETITIVE TRENDS
The Company is subject to regulation by the Public Utilities Commission (PUC)
of the state of Hawaii for its intrastate business operations and by the FCC
for its interstate operations.
Advances in technology, together with a number of regulatory, legislative and
judicial actions, continue to accelerate and expand the level of competition
and opportunities available to the Company. The Company continues to face
additional competition from numerous sources, such as competitive
local-exchange carriers, wireless carriers, cable television service providers
and long distance companies.
Much of the regulatory and legislative activity that occurred in the United
States in 1997 was a direct result of the Telecommunications Act of 1996 (the
Telecommunications Act) adopted by Congress. The Telecommunications Act is
intended to promote competition in all sectors of the telecommunications
marketplace while preserving and advancing universal telephone service.
1
<PAGE> 4
The Company supports greater competition in telecommunications, provided that
consumers benefit from an opportunity for all service providers to participate
in a competitive marketplace under comparable conditions. The Company believes
that a number of recent FCC and state regulatory agency decisions did not
establish comparable conditions; consequently, the Company and its parent, GTE,
have exercised their right to challenge actions they believe act to increase
competition at the expense of the shareholders of incumbent firms.
In July 1997, the U.S. Court of Appeals for the Eighth Circuit (Eighth Circuit)
released its decision on the challenge filed in 1996 by GTE and numerous other
parties to rules developed by the FCC to implement the interconnection
provisions of the Telecommunications Act. The Telecommunications Act required
local-exchange carriers (LECs) to make their retail services and the underlying
network elements available to competitors. The FCC required that prices for both
resold services and network elements be set using a methodology created by the
FCC. The court challenge asserted that the FCC's rules were inconsistent with
the Telecommunications Act. The July 1997 court decision found that the FCC
overstepped its authority in many instances and upheld GTE's position that state
regulatory agencies bear the primary responsibility for determining the prices
which competing firms must pay when interconnecting their networks. In January
1998, the U.S. Supreme Court announced that it would review this decision. Oral
argument in the Supreme Court is expected to take place in October 1998, with a
final decision likely to be issued no later than June 1999.
The favorable ruling by the Eighth Circuit did not impede the progress of
competition. The Company has finalized interconnection agreements with various
competitive LECs in Hawaii. A number of these interconnection agreements,
adopted as a result of the arbitration process established by the
Telecommunications Act, incorporate prices or terms and conditions based upon
the FCC's rules that were overturned by the Eighth Circuit. Thus, the Company
has exercised its right to challenge such agreements in Hawaii.
In May 1997, the FCC released two new major decisions related to implementation
of the Telecommunications Act's provisions - the universal service and access
charge reform orders. The universal service order established the support
mechanisms to ensure continued availability of affordable local telephone
service and created new programs to provide discounted telecommunications
services to schools, libraries and rural health care providers. GTE and
numerous other parties have challenged the FCC's decision before the U.S. Court
of Appeals for the Fifth Circuit on the grounds that the FCC did not follow the
requirements of the Telecommunications Act to develop a sufficient, explicit
and competitively neutral universal service program. A decision is expected in
1998.
The access charge reform order, also released in May 1997, revamped the rate
structure for use of the local network by interexchange carriers to originate
and complete long distance calls. GTE and numerous other parties also
challenged this decision before the Eighth Circuit based on the belief that the
FCC not only failed to remove all of the universal service subsidies hidden
within interstate access charges, but in fact created additional subsidy
charges paid only by business and multi-line residential customers. Oral
argument has been held and a decision is expected in 1998.
Also in May 1997, the FCC released a decision completing a periodic review of
its price cap regulatory oversight of interstate access charges. GTE and
numerous other LECs have challenged this decision before the Eighth Circuit
based on the belief that the FCC established a fundamentally unfair annual
price reduction formula and required retroactive price reductions. Oral
argument has been held and a decision on this challenge is also expected in
1998.
Federal regulatory activity continued to change the traditional cost-based,
rate-of-return regulatory framework for interstate telephone service. The
regulatory commission in the state of Hawaii continues to remain under the
traditional cost-based, rate-of-return regulatory framework for intrastate
telephone service.
For the provision of interstate access services, the Company operates under the
terms of the FCC's price cap incentive plan. The price cap mechanism serves to
limit the rates a carrier may charge, rather than just regulating the rate-of-
return which may be achieved. Under this approach, the maximum prices that the
LEC may charge are increased or decreased each year by a price cap index based
upon inflation less a predetermined productivity target. LECs have limited
pricing flexibility provided they do not exceed the allowed price cap.
2
<PAGE> 5
In the May 1997 order on its price cap triennial review, the FCC revised the
price cap plan for LECs by adopting a uniform productivity factor of 6.0% with
an additive consumer productivity dividend of 0.5%. The FCC also eliminated
the sharing requirements of the price cap rules.
The Company filed interstate access revisions during 1997 that became effective
June 3, 1997 and July 1, 1997. Overall, these filings resulted in a net annual
price reduction of $7.4 million. On December 1, 1997, the FCC issued an order
to file revised access rates effective January 1, 1998, which resulted in
additional interstate access charge reductions of approximately $1.8 million.
In 1997, the FCC also ordered significant changes that altered the structure of
access charges collected by the Company, effective January 1, 1998. Generally,
the FCC reduced and restructured the per minute charges paid by long distance
carriers and implemented new per line charges. The FCC also created an access
charge structure that resulted in different access charges for residential
primary and secondary lines and for single line and multi-line business lines.
In aggregate, the reductions in usage sensitive access charges paid by long
distance carriers were offset by new per line charges and the charges paid by
end-users.
Further information regarding the Company's activities with the various
regulatory agencies and revenue arrangements with other telephone companies is
discussed in Note 9 of the Company's consolidated financial statements included
in Item 8.
The Company continues to support greater competition in telecommunications,
provided that, overall, the actions to eliminate existing legal and regulatory
barriers benefit consumers by allowing an opportunity for all service providers
to participate equally in a competitive marketplace under comparable
conditions.
The Company intends to continue to respond aggressively to regulatory and legal
developments that allow for increased competition and opportunities in the
marketplace. The Company expects its financial results to benefit from reduced
costs and the introduction of new products and services that will result in
increased usage of its telephone networks. However, it is likely that such
improvements will be offset, in part, by continued strategic pricing reductions
and the effects of increased competition.
INITIATIVES
In 1997, the Company's parent, GTE, continued to position itself to respond
aggressively to competitive developments and benefit from new opportunities.
In May 1997, GTE announced plans to become a leading national provider of data
communications services that included the acquisition of BBN Corporation (BBN),
a leading supplier of end-to-end Internet solutions. BBN brings valuable
skills, a leading position in the Internet market and an impressive list of
Fortune 500 clients. In addition, GTE announced a strategic alliance with
Cisco Systems, Inc. to jointly develop enhanced data and Internet services for
customers; and the purchase of a national, state-of-the-art fiber-optic network
from Qwest Communications. This expansion of data services continued in
November 1997 with the announcement of the acquisition of Genuity Inc.
(Genuity), a subsidiary of Bechtel Enterprises. Genuity is a premier
value-added provider of distributed application hosting solutions.
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.
3
<PAGE> 6
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 are adequate to satisfy
the needs of the business. Substantially all of the Company's property is
subject to the liens of its respective mortgages securing funded debt. From
January 1, 1993 to December 31, 1997, the Company made capital expenditures of
$762.8 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, 1997.
In the fourth quarter of 1995, the Company discontinued the use of Statement of
Financial Accounting Standards No. 71, "Accounting for the Effects of Certain
Types of Regulation" (FAS 71). In general, FAS 71 required the Company to
depreciate its telephone plant and equipment over lives approved by regulators
which, in many cases, extended beyond the assets' economic lives. FAS 71 also
required the deferral of certain costs based upon approvals received from
regulators to recover such costs in the future. As a result of these
requirements, the recorded net book value of certain assets and liabilities,
primarily telephone plant and equipment, were in many cases higher than that
which would otherwise have been recorded based on their economic lives. See
Note 2 to the Company's consolidated financial statements included in Item 8.
Item 3. Legal Proceedings
There are no pending legal proceedings which would have a material impact on
the Company's consolidated financial statements.
4
<PAGE> 7
PART II
Item 5. Market for the Registrant's Common Equity and Related Shareholder
Matters
Market information is omitted since the Company's common stock is wholly-owned
by GTE Corporation (GTE).
SHAREHOLDER SERVICES
BankBoston, N.A., Transfer Agent and Registrar for GTE and the Company's common
stock, should be contacted with any questions relating to shareholder accounts.
This includes the following:
o Account information
o Dividends
o Market prices
o Transfer instructions
o Statements and reports
o Change of address
Shareholders may call toll-free at 1-800-225-5160 anytime, seven days a week.
Customer Service Representatives are available Monday through Friday between
the hours of 8 a.m. and 5 p.m. Eastern Time. Outside the United States call
1-718-575-2990.
Or write to:
BankBoston, N.A.
c/o Boston EquiServe, L.P.
P.O. Box 8031
Boston, MA 02206-8031
For overnight delivery services, use the following address:
BankBoston, N.A.
c/o Boston EquiServe, L.P.
Blue Hills Office Park
150 Royall Street
Mail Stop 4502-60
Canton, MA 02021
The BankBoston, N.A. address where shareholders, banks and brokers may deliver
certificates is Securities Transfers and Reporting Services, 55 Broadway in New
York City.
PARENT COMPANY ANNUAL REPORT
To obtain a copy of the 1997 annual report of our parent company or the annual
Form 10-K filed with the Securities and Exchange Commission, call
1-800-225-5160.
INFORMATION VIA THE INTERNET
Internet World Wide Web users can access information on GTE through the
following universal resource: http://www.gte.com
PRODUCTS AND SERVICES HOTLINE
Shareholders may call 1-800-828-7280 to receive information concerning GTE
products and services.
DIVERSITY AT GTE
The Company and GTE strive to be a workplace of choice in which people of
diverse backgrounds are valued, challenged, acknowledged and rewarded, leading
to higher levels of fulfillment and productivity. A copy of our Diversity at
GTE brochure is available upon request from the GTE Corporate Secretary's
Office.
5
<PAGE> 8
Item 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 9 of the Company's
consolidated financial statements included in Item 8 for further detail. At
December 31, 1997, the Company served 863,249 access lines in its service
territories.
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1997 1996
--------- --------
<S> <C> <C>
Net income $61.0 $54.7
</TABLE>
Net income increased 12% or $6.3 in 1997. This increase is largely the result
of growth in revenues from local and network access services and lower overall
operating costs and expenses, offset by lower toll revenues and an increase in
taxes.
REVENUES AND SALES
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1997 1996
--------- -------
<S> <C> <C>
Local services $267.7 $238.0
Network access services 162.7 148.6
Toll services 61.2 88.8
Other services and sales 150.7 159.5
------ ------
Total revenues and sales $642.3 $634.9
</TABLE>
Total revenues and sales increased 1% or $7.4 in 1997.
Local service revenues are based on fees charged to customers for providing
local-exchange service within designated franchise areas. Local service
revenues increased 12% or $29.7 in 1997. Demand for custom calling features,
such as SmartCall(R), contributed $6.4 to the increase. Access line growth of
3% generated additional revenues of $1.5 from basic local services and $2.9 from
Integrated Services Digital Network (ISDN) and Digital Channel Services (DCS).
Additionally, an increase of $17.1 is associated with the final award for the
1995 Rate Case, discussed in more detail in Note 9 of the Company's consolidated
financial statements included in Item 8.
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 9% or
$14.1 in 1997. This increase includes the effects of a 13% increase in minutes
of use, which generated $7.1 in additional revenues, and higher special access
revenues of $7.8 resulting from greater demand for increased bandwidth services
by Internet
6
<PAGE> 9
Service Providers (ISPs) and other high-capacity users. The revenue growth was
partially offset by a $4.9 decline in revenues associated with the rate changes
and sharing provisions of the Federal Communications Commission's (FCC's) 1996
and 1997 price cap filings.
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 31% or $27.6 in
1997 primarily due to lower domestic toll volumes from continued competition
with long distance carriers authorized to provide intraLATA toll service on a
10XXX and 1+ presubscription basis. The decrease in revenues is also due to the
impact of promotional reductions in interisland toll rates and optional discount
calling plans which effectively lowered intrastate long distance rates.
Other services and sales revenues decreased 6% or $8.8 in 1997. This decrease
is primarily related to lower equipment sales of $11.9 resulting from the
completion of the Osan Base System and other international service contracts in
1996. This decrease is partially offset by an increase of $2.8 related to the
payphone interim compensation order (see Note 9 of the Company's consolidated
financial statements included in Item 8) and a $1.3 increase in wireless
activation commissions and related accessory sales.
OPERATING COSTS AND EXPENSES
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1997 1996
------ -------
<S> <C> <C>
Cost of services and sales $262.2 $276.7
Selling, general and administrative 118.7 116.4
Depreciation and amortization 121.4 125.0
------ ------
Total operating costs and expenses $502.3 $518.1
</TABLE>
Total operating costs and expenses decreased 3% or $15.8 in 1997. Depreciation
expense decreased $3.6 in 1997. Increases in depreciation related to additions
to plant were more than offset by a reduction in depreciation rates to reflect
higher net salvage values related to certain of the Company's telephone plant
and equipment. Pension settlement gains in 1997 which resulted from lump-sum
payments from the Company's pension plans of $5.9 were partially offset by
settlement gains of $1.1 which were recorded in 1996. Also contributing to the
overall decrease in operating costs and expenses is $6.3 of administrative
productivity gains and an $8.5 reduction of expense associated with
international service contracts that were completed in 1996. These decreases
were partially offset by selling and marketing costs, aimed at stimulating
sales of enhanced services and preserving market share in an increasingly
competitive environment, which increased by $10.9.
OTHER EXPENSES
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------
1997 1996
--------- ---------
<S> <C> <C>
Income taxes $ 42.3 $ 23.9
</TABLE>
Income taxes increased 77% or $18.4 in 1997. This increase is primarily due to
an increase in pre-tax income and adjustments to prior years' tax liabilities.
7
<PAGE> 10
REGULATORY AND COMPETITIVE TRENDS
The Company is subject to regulation by the Public Utilities Commission (PUC)
of the state of Hawaii for its intrastate business operations and by the FCC
for its interstate and international operations.
Much of the regulatory and legislative activity that occurred in the United
States in 1997 was a direct result of the Telecommunications Act of 1996 (the
Telecommunications Act) adopted by Congress. The Telecommunications Act is
intended to promote competition in all sectors of the telecommunications
marketplace while preserving and advancing universal telephone service.
The Company is a strong supporter of competition in all telecommunications
markets. The Company's position remains constant: the benefits of competition
should not be divided between customers or industry segments. There must be
fair, reasonable rules at the state and federal levels that enable all service
providers to participate equitably in the marketplace and benefit everyone.
The Company believes the FCC and a number of state regulatory agencies did not
establish these comparable conditions. The Company and its parent, GTE, have
consequently exercised their right to challenge regulatory actions they believe
unfairly disadvantage their customers and shareholders.
In July 1997, the U.S. Court of Appeals for the Eighth Circuit (Eighth Circuit)
released its decision on the challenge filed in 1996 by the Company's parent,
GTE, and numerous other parties to rules developed by the FCC to implement the
interconnection provisions of the Telecommunications Act. The
Telecommunications Act required local-exchange carriers (LECs) to make their
retail services and the underlying network elements available to competitors.
The FCC required that prices for both resold services and network elements be
set using a methodology created by the FCC. The court challenge asserted that
the FCC's rules were inconsistent with the Telecommunications Act. The July
1997 court decision found that the FCC overstepped its authority in a number of
areas and upheld GTE's position that state regulatory agencies bear the primary
responsibility for determining the prices which competing firms must pay when
interconnecting their networks. On January 26, 1998, the U.S. Supreme Court
announced that it would review this decision. Oral argument in the Supreme
Court is expected to take place in October 1998, with a final decision likely to
be issued no later than June 1999.
The favorable ruling by the Eighth Circuit did not impede the progress of
competition. The Company has finalized interconnection agreements with various
competitive LECs in Hawaii. A number of these interconnection agreements,
adopted as a result of the arbitration process established by the
Telecommunications Act, incorporate prices or terms and conditions based upon
the FCC's rules that were overturned by the Eighth Circuit. Thus, the Company
has exercised its right to challenge such agreements in Hawaii.
Interim rates for interconnection and unbundled network elements (UNEs) have
been established through negotiation and arbitration decisions. These interim
rates will be used until permanent rates are established through state
commission proceedings investigating cost studies. Cost studies have been
filed in Hawaii.
In May 1997, the FCC released two new major decisions related to implementation
of the Telecommunications Act's provisions - the universal service and access
charge reform orders. The universal service order established the support
mechanisms to ensure continued availability of affordable local telephone
service and created new programs to provide discounted telecommunications
services to schools, libraries and rural health care providers. GTE and
numerous other parties have challenged the FCC's decision before the U.S. Court
of Appeals for the Fifth Circuit on the grounds that the FCC did not follow the
requirements of the Telecommunications Act to develop a sufficient, explicit
and competitively neutral universal service program. A decision is expected in
1998.
Additional state commission proceedings have begun to establish rules and
procedures to implement state universal service funds (USF). USF proceedings
have begun in Hawaii and proceedings are scheduled to continue during the
remainder of 1998.
8
<PAGE> 11
The FCC access charge reform order, also released in May 1997, revamped the
rate structure through which local and long distance companies charge customers
for using the local phone network to make long distance calls. The FCC ordered
decreases for long distance companies to be accomplished by increasing the
access charges for business and residential customers with more than one phone
line. GTE and numerous other parties also challenged this decision before the
Eighth Circuit based on the belief that the FCC did not eliminate the universal
service subsidies hidden within interstate access charges as directed by the
Telecommunications Act, and that the FCC created additional subsidy charges
paid only by business and multi-line residential customers. Oral argument has
been held and a decision is expected in 1998.
Also in May 1997, the FCC released a decision completing a periodic review of
its price cap regulatory oversight of interstate access charges. GTE and
numerous other LECs have challenged this decision before the Eighth Circuit
based on the belief that the FCC established a fundamentally unfair annual
price reduction formula and required retroactive price reductions. Oral
argument has been held and a decision on this challenge is also expected in
1998.
Federal regulatory activity continued to change the traditional cost-based,
rate-of-return regulatory framework for interstate telephone service. The
regulatory commission in the state of Hawaii continues to remain under the
traditional cost-based, rate-of-return regulatory framework for intrastate
telephone service.
For the provision of interstate access services, the Company operates under the
terms of the FCC's price cap incentive plan. The price cap mechanism serves to
limit the rates a carrier may charge, rather than just regulating the rate-of-
return which may be achieved. Under this approach, the maximum prices that the
LEC may charge are increased or decreased each year by a price cap index based
upon inflation less a predetermined productivity target. LECs have limited
pricing flexibility provided they do not exceed the allowed price cap.
In the May 1997 order on its price cap triennial review, the FCC revised the
price cap plan for LECs by adopting a uniform productivity factor of 6.0% with
an additive consumer productivity dividend of 0.5%. The FCC also eliminated
the sharing requirements of the price cap rules.
The Company filed interstate access revisions during 1997 that became effective
June 3, 1997 and July 1, 1997. Overall, these filings resulted in a net annual
price reduction of $7.4. On December 1, 1997, the FCC issued an order to file
revised access rates effective January 1, 1998, which resulted in additional
interstate access charge reductions of approximately $1.8. In 1997, the FCC
also ordered significant changes that altered the structure of access charges
collected by the Company, effective January 1, 1998. Generally, the FCC
reduced and restructured the per minute charges paid by long distance carriers
and implemented new per line charges. The FCC also created an access charge
structure that resulted in different access charges for residential primary and
secondary lines and single line and multi-line business lines. In aggregate,
the reductions in usage sensitive access charges of $6.9 paid by long distance
carriers were offset by $6.5 of new per line charges and the charges paid by
end-users.
On June 4, 1996, the FCC issued its first Report and Order implementing Section
276 of the Telecommunications Act. As part of the overall goal of promoting
competition among payphone service providers (PSPs), this order mandated
compensation to all PSPs for all calls originating from payphones, including
"dial-around" access calls and toll-free subscriber calls for which PSPs were
not previously compensated. This compensation was to occur in two separate
phases. During phase one, from April 15, 1997 through October 6, 1997, PSPs
were to be paid a monthly, flat-rate compensation from interexchange carriers
(IXCs). During phase two, beginning October 7, 1997, PSPs were to be
compensated on a per- call basis, with the prevailing local coin rate of 35
cents established as the default rate.
On July 19, 1997, the U.S. Court of Appeals in Washington, D.C. vacated the
FCC's directive concerning per-call compensation, stating that the FCC had not
shown that the 35 cent rate was a reasonable surrogate for fair compensation.
The court also set aside the FCC's flat-rate compensation mandate.
Subsequently, on October 9, 1997, the FCC issued a second Report and Order to
address some of the issues vacated by the court. In this second order, the FCC
established a new per-call rate of 28.4 cents for phase two compensation that
all PSPs were eligible to receive beginning October 9, 1997. The FCC
tentatively concluded that this per-call rate should also be used to
9
<PAGE> 12
calculate phase one compensation. The Company has recorded approximately $2.8
of payphone revenues associated with the October 9, 1997 FCC order. It is
likely that the phase one compensation directive will be revisited in a
subsequent order.
Further information regarding the Company's activities with the various
regulatory agencies and revenue arrangements with other telephone companies is
discussed in Note 9 of the Company's consolidated financial statements included
in Item 8.
YEAR 2000 CONVERSION
The Year 2000 issue has an industry-wide impact. The Company has had an active
Year 2000 Program in place. The Company's Year 2000 methodology and processes
were certified in 1997 by the Information Technology Association of America.
This program is necessary because the Year 2000 issue could impact systems,
networks and business processes at the Company. This program includes:
inventory; assessment and analysis of systems, networks and business processes;
remediation of any impacted software; and validation testing. The current
estimate for the cost of remediation for the Company is approximately $9.7.
Year 2000 remediation costs are expensed in the year incurred. Through 1997,
expenditures totaled $1.4. The Company currently has employees and contractors
mobilized to address the Year 2000 issue. Continued success is dependent on
the timely delivery of Year 2000 compliant products and services from the
Company's suppliers. The Company currently believes that its essential
processes, systems and business functions will be ready for the millennium
transition.
LOCAL NUMBER PORTABILITY REQUIREMENTS
The Telecommunications Act mandated competition in the local telephone
marketplace. Local Number Portability (LNP) is one vehicle chosen by the FCC
to facilitate local competition. Local Service Provider Portability is the
first phase of LNP, which will allow residential and business customers to
change local service providers without changing their telephone numbers. The
FCC has mandated that Local Service Provider Portability be implemented in the
top 100 Metropolitan Service Areas (MSAs) by the end of 1998. The second and
third phases of LNP will allow customers to retain their telephone numbers when
they move from one location to another or change services (e.g. landline to
cellular).
Through December 31, 1997, the Company had recorded approximately $1.3 to
implement Local Service Provider Portability within one of the top 100 MSAs.
As a result of the major investment required to implement LNP, the FCC has
stated that local service providers should be allowed to recover a portion of
their costs. The Company is seeking regulatory recovery of LNP implementation
costs.
OTHER MATTERS
Eleven separate class action lawsuits were brought against GTE and twelve of
its subsidiaries (GTE Defendants), including the Company, relating to the
provision of inside wire maintenance services. On August 6, 1996, the GTE
Defendants and class counsel executed and filed a settlement agreement in one
of the lawsuits. The Court preliminarily approved the agreement and
conditionally certified a national class of plaintiffs for settlement purposes.
A fairness hearing on the settlement was held on December 18, 1996. On January
21, 1997, the Court approved the settlement as written and issued a permanent
injunction to prohibit future lawsuits covering any claims from 1987 to the
date of settlement. Pursuant to the settlement, a proof of claim form was
inserted into the March 1997 customer bills for the national class to request
their benefits under the settlement. The reserves established in 1996 were
adequate for the processing of all claims during 1997.
10
<PAGE> 13
INFLATION
The Company's management generally does not believe inflation has a significant
impact on the Company's earnings. However, increases in costs or expenses not
otherwise offset by increases in revenues could have an adverse effect on
earnings.
11
<PAGE> 14
Item 8. Financial Statements and Supplementary Data
GTE Hawaiian Telephone Company Incorporated and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Years Ended December 31 1997 1996 1995
- ----------------------- --------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
REVENUES AND SALES (a)
Local services $ 267,707 $ 238,035 $ 227,732
Network access services 162,713 148,598 134,588
Toll services 61,225 88,782 96,252
Other services and sales 150,712 159,506 153,188
--------- --------- ---------
Total revenues and sales 642,357 634,921 611,760
--------- --------- ---------
OPERATING COSTS AND EXPENSES (b)
Cost of services and sales 262,210 276,712 273,636
Selling, general and administrative 118,678 116,398 122,603
Depreciation and amortization 121,387 125,032 123,876
--------- --------- ---------
Total operating costs and expenses 502,275 518,142 520,115
--------- --------- ---------
OPERATING INCOME 140,082 116,779 91,645
OTHER (INCOME) EXPENSE
Interest - net 37,490 38,267 39,500
Other - net (698) (39) (779)
--------- --------- ---------
INCOME BEFORE INCOME TAXES 103,290 78,551 52,924
Income taxes 42,292 23,850 15,023
--------- --------- ---------
INCOME BEFORE EXTRAORDINARY CHARGE 60,998 54,701 37,901
Extraordinary charge -- -- (263,419)
--------- --------- ---------
NET INCOME (LOSS) $ 60,998 $ 54,701 $(225,518)
========= ========= =========
</TABLE>
(a) Includes billings to affiliates of $39,512, $43,469 and $41,958 for the
years 1997-1995, respectively.
(b) Includes billings from affiliates of $34,283, $39,376 and $45,446 for the
years 1997-1995, respectively.
See Notes to Consolidated Financial Statements.
12
<PAGE> 15
GTE Hawaiian Telephone Company Incorporated and Subsidiaries
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31 1997 1996
- ----------- ----------- -----------
(Thousands of Dollars)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 672 $ 20,154
Receivables, less allowances of $8,596 and $6,066 191,478 144,047
Note receivable from affiliate 24,450 663
Inventories and supplies 15,030 5,906
Deferred income tax benefits -- 6,202
Prepaid taxes 16,264 22,813
Other 3,775 1,800
----------- -----------
Total current assets 251,669 201,585
----------- -----------
Property, plant and equipment, net 845,352 822,473
Employee benefit plans 202,473 171,118
Other assets 6,619 5,809
----------- -----------
Total assets $ 1,306,113 $ 1,200,985
=========== ===========
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities:
Short-term obligations, including current maturities $ 99,702 $ 49,600
Accounts payable 35,150 19,728
Affiliate payables and accruals 22,071 30,733
Advanced billings and customer deposits 17,824 14,771
Taxes payable 1,818 1,797
Accrued interest 10,375 12,793
Accrued payroll costs 26,434 29,070
Accrued dividends 10,803 5,327
Other 17,427 26,955
----------- -----------
Total current liabilities 241,604 190,774
----------- -----------
Long-term debt 510,184 513,016
Deferred income taxes 130,065 98,687
Employee benefit plans 40,938 44,722
Other liabilities 17,558 14,399
----------- -----------
Total liabilities 940,349 861,598
----------- -----------
Shareholder's equity:
Common stock (10,000,000 shares issued) 250,000 250,000
Additional paid-in capital 91,146 91,146
Retained earnings (deficit) 24,618 (1,759)
----------- -----------
Total shareholder's equity 365,764 339,387
----------- -----------
Total liabilities and shareholder's equity $ 1,306,113 $ 1,200,985
=========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
13
<PAGE> 16
GTE Hawaiian Telephone Company Incorporated and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31 1997 1996 1995
----------------------- --------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
OPERATIONS
Income before extraordinary charge $ 60,998 $ 54,701 $ 37,901
Adjustments to reconcile income before extraordinary
charge to net cash from operations:
Depreciation and amortization 121,387 125,032 123,876
Deferred income taxes 38,087 28,938 22,112
Provision for uncollectible accounts 12,869 9,761 9,119
Change in current assets and current liabilities:
Receivables - net (60,983) (18,411) (13,154)
Other current assets (11,099) 4,743 (1,366)
Accrued taxes and interest 4,152 (20,640) 5,062
Other current liabilities 2,399 (9,554) (23,337)
Other - net (42,512) (12,156) (22,189)
--------- --------- ---------
Net cash from operations 125,298 162,414 138,024
--------- --------- ---------
INVESTING
Capital expenditures (138,687) (131,719) (130,127)
Purchase of MTC stock -- (450) --
--------- --------- ---------
Net cash used in investing (138,687) (132,169) (130,127)
--------- --------- ---------
FINANCING
Long-term debt issued -- 148,353 148,236
Long-term debt retired, including premiums paid
on early retirement (59,107) (147,592) (8,301)
Dividends (29,145) (33,415) (23,693)
Capital contribution from GTE -- 50,000 --
Increase (decrease) in short-term obligations,
excluding current maturities 82,159 (41,695) (127,333)
Other - net -- 9,743 --
--------- --------- ---------
Net cash used in financing (6,093) (14,606) (11,091)
--------- --------- ---------
Increase (decrease) in cash and cash equivalents (19,482) 15,639 (3,194)
Cash and cash equivalents:
Beginning of year 20,154 4,515 7,709
--------- --------- ---------
End of year $ 672 $ 20,154 $ 4,515
========= ========= =========
Cash paid (refunded) during the year for:
Interest $ 41,959 $ 39,924 $ 37,321
--------- --------- ---------
Income taxes $ 256 $ 7,388 $ (9,945)
--------- --------- ---------
</TABLE>
See Notes to Consolidated Financial Statements.
14
<PAGE> 17
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, 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
Net income 60,998 60,998
Dividends declared (34,621) (34,621)
--------- --------- --------- ---------
Shareholder's equity, December 31, 1997 $ 250,000 $ 91,146 $ 24,618 $ 365,764
========= ========= ========= =========
</TABLE>
See Notes to Consolidated Financial Statements.
15
<PAGE> 18
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, 1997, the
Company served 863,249 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 management to make
estimates and assumptions that affect the reported amounts. Actual results
could differ from those estimates.
The consolidated financial statements include the accounts of the Company and
its 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
amounts have been eliminated.
Reclassifications of prior-year data have been made, where appropriate, to
conform to the 1997 presentation.
TRANSACTIONS WITH AFFILIATES
GTE Supply (100% owned by GTE) provides construction and maintenance equipment,
supplies and electronic repair services to the Company. These purchases and
services amounted to $30.5 million, $34.3 million and $27.7 million for the
years 1997-1995, respectively. Such purchases and services are recorded in the
accounts of the Company, at cost, which includes a return realized by GTE
Supply.
The Company is billed for certain printing and other costs associated with
telephone directories, data processing services and equipment rentals, and
receives management, consulting, research and development and pension
management services from other affiliated companies. These charges amounted to
$34.3 million, $39.4 million and $45.4 million for the years 1997-1995,
respectively. The amounts charged for these affiliated transactions are based
on a proportional cost allocation method.
The Company's consolidated financial statements include allocated expenses
based on the sharing of certain executive, administrative, financial,
accounting, marketing, personnel, engineering and other support services being
performed at consolidated work centers among GTE's domestic telephone operating
subsidiaries. The amounts charged for these affiliated transactions are based
on proportional cost allocation methodologies.
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 $39.5 million, $43.5 million and $42 million for the
years 1997-1995, respectively.
DEPRECIATION AND AMORTIZATION
The Company provides for depreciation on a straight-line basis over the
estimated economic lives of its assets. Prior to 1996, the Company provided
for depreciation on a straight-line basis over asset lives approved by
16
<PAGE> 19
regulators (see Note 2). Maintenance and repairs of property are charged to
income as incurred. Additions to, replacements and renewals of property are
charged to telephone plant accounts. Property retirements are charged in total
to the accumulated depreciation account. No adjustment to depreciation is made
at the time properties are retired or otherwise disposed of, except in the case
of significant sales or extraordinary retirements of property where profit or
loss is recognized.
Franchises, goodwill and other intangibles are amortized on a straight-line
basis over the periods to be benefited, or 40 years, whichever is less.
REVENUE RECOGNITION
Revenues are recognized when earned. This is generally based on usage of the
Company's local-exchange networks or facilities. For other products and
services, revenues are generally recognized when services are rendered or
products are delivered to customers.
INVENTORIES AND SUPPLIES
Inventories and supplies are stated at the lower of cost, determined
principally by the average cost method, or net realizable value.
EMPLOYEE BENEFIT PLANS
Pension and postretirement health care and life insurance benefits earned
during the year as well as interest on projected benefit obligations are
accrued currently. Prior service costs and credits resulting from changes in
plan benefits are amortized over the average remaining service period of the
employees expected to receive benefits. Material curtailment/settlement gains
and losses associated with employee separations are recognized in the period in
which they occur.
INCOME TAXES
The Company's results are included in GTE's consolidated federal income tax
return. The Company participates in a tax-sharing agreement with GTE and
remits tax payments to GTE based on its tax liability on a separate company
basis.
Deferred tax assets and liabilities are established for temporary differences
between the way certain income and expense items are reported for financial
reporting and tax purposes and are subsequently adjusted to reflect changes in
tax rates expected to be in effect when the temporary differences reverse. A
valuation allowance is established for deferred tax assets for which
realization is not likely. Deferred income taxes are not provided on
undistributed earnings of the Company's foreign subsidiary, approximately $48
million at December 31, 1997, 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.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (FAS
130). FAS 130 establishes standards for reporting and displaying comprehensive
income and its components in the financial statements. FAS 130 is effective for
fiscal years beginning after December 15, 1997. Reclassification of financial
statements for earlier periods provided for comparative purposes is required.
The
17
<PAGE> 20
adoption of this standard will have no impact on the Company's results of
operations, financial position or cash flows.
2. EXTRAORDINARY CHARGE
In response to legislation (see Note 9) and the increasingly competitive
environment, the Company discontinued the use of Statement of Financial
Accounting Standards No. 71, "Accounting for the Effects of Certain Types of
Regulation" (FAS 71) in the fourth quarter of 1995.
As a result of the decision to discontinue FAS 71, the Company recorded a
non-cash, after-tax extraordinary charge of $263.4 million (net of tax benefits
of $167.8 million) in the fourth quarter of 1995. The charge primarily
represented a reduction in the net book value of telephone plant and equipment
through an increase in accumulated depreciation. In addition to the one-time
charge, beginning in 1996, the Company shortened the depreciable lives of its
telephone plant and equipment as follows:
<TABLE>
<CAPTION>
Average Depreciable Lives
--------------------------------
Asset Category Before After
---------------------------------- ---------- ---------
<S> <C> <C>
Copper 20-30 15
Switching 17-19 10
Circuit 11-13 8
Fiber 25-30 20
</TABLE>
3. 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.
At December 31, 1997, $19 million of retained earnings were restricted as to
the payment of cash dividends on common stock under the terms of the Company's
Articles of Incorporation.
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
4. DEBT
Long-term debt as of December 31, was as follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(Thousands of Dollars)
<S> <C> <C>
First mortgage bonds:
5 5/8 % Series R, due 1997 $ -- $ 16,000
6 3/4 % Series S, due 1998 -- 20,000
8 % Series U, due 2001 -- 20,000
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 150,000 150,000
Other:
5% Rural Utilities Services first mortgage bond, due 2018 9,109 9,353
Rural Telephone Bank first mortgage bonds,
maturing through 2021, rates ranging from 5.43% to 7.5% 29,670 30,820
GTE Leasing Corporation financing agreements, maturing
through 2001, rates ranging from 8.23% to 11.99% 2,723 3,552
Other 112 806
Short-term debt expected to be refinanced on a long-term basis 40,000 --
--------- ---------
Total principal amount 506,614 525,531
Premium and discount - net 5,763 6,185
--------- ---------
Total 512,377 531,716
Less: current maturities of long-term debt (2,193) (18,700)
--------- ---------
Total long-term debt $ 510,184 $ 513,016
========= =========
</TABLE>
In September and October 1997, the Company redeemed prior to stated maturity,
the $20 million 8% Series U first mortgage bonds and the $20 million 6 3/4%
Series S first mortgage bonds, respectively.
Long-term debt as of December 31, 1997 includes $40 million of short-term
borrowings in the form of affiliate notes payable which the Company anticipates
refinancing during 1998.
In September 1996, the Company issued $150 million of 7 3/8% Series B
debentures, due 2006. Net proceeds were used to finance the Company's
construction program and for general corporate purposes.
The aggregate principal amount of bonds and debentures that may be issued is
subject to the restrictions and provisions of the Company's indentures. None
of the securities shown above were held in sinking or other special funds of
the Company or pledged by the Company. Debt discounts and premiums on the
Company's outstanding long-term debt are amortized over the lives of the
respective issues. Substantially all of the Company's telephone plant is
subject to the liens of the indentures under which the bonds listed above were
issued.
Estimated payments of long-term debt during the next five years are: $2.2
million in 1998; $2.2 million in 1999; $2.4 million in 2000; $2.4 million in
2001; and $1.8 million in 2002.
19
<PAGE> 22
Total short-term obligations as of December 31, were as follows:
<TABLE>
<CAPTION>
1997 1996
------- -------
(Thousands of Dollars)
<S> <C> <C>
Notes payable to affiliate - average rates 6.0% and 5.6% $97,509 $30,900
Current maturities of long-term debt 2,193 18,700
------- -------
Total $99,702 $49,600
======= =======
</TABLE>
5. FINANCIAL INSTRUMENTS
At December 31, 1997, the Company had entered into forward interest rate swap
agreements to hedge against changes in market interest rates on $40 million of
planned long-term debt issuances expected to be completed within the next
twelve months. Gains and losses recognized upon the expiration or settlement
of forward interest rate swap agreements are amortized over the life of the
associated long-term debt issuance as an offset or addition to interest
expense.
The risk associated with these off-balance-sheet financial instruments arises
from the possible inability of counterparties to meet the contract terms and
from movements in interest rates. The Company carefully evaluates and
continually monitors the creditworthiness of its counterparties and believes
the risk of nonperformance is remote.
The fair values of financial instruments, other than long-term debt, closely
approximate their carrying value. As of December 31, 1997, the estimated fair
value of long-term debt based on either reference to quoted market prices or an
option pricing model, exceeded the carrying value by approximately $3 million.
The estimated fair value of long-term debt as of December 31, 1996 was lower
than the carrying value by approximately $9 million.
20
<PAGE> 23
6. INCOME TAXES
The income tax provision (benefit) is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
(Thousands of Dollars)
<S> <C> <C> <C>
Current:
Federal $ 4,438 $ 9,176 $ 709
State (233) (14,264) (7,798)
-------- -------- --------
4,205 (5,088) (7,089)
-------- -------- --------
Deferred:
Federal 35,943 13,891 14,101
State 2,946 15,545 8,869
-------- -------- --------
38,889 29,436 22,970
-------- -------- --------
Amortization of deferred investment tax credits - net (802) (498) (858)
-------- -------- --------
Total $ 42,292 $ 23,850 $ 15,023
======== ======== ========
</TABLE>
A reconciliation between taxes computed by applying the statutory federal
income tax rate to pre-tax income and income taxes provided in the consolidated
statements of income is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
(Thousands of Dollars)
<S> <C> <C> <C>
Amounts computed at statutory rates $ 32,533 $ 27,493 $ 18,523
State and local income taxes, net of federal income tax 1,763 833 696
benefits
Amortization of deferred investment tax credits, net of
federal income tax benefits (521) (308) (858)
Depreciation of telephone plant construction costs
previously deducted for tax purposes - net -- -- 1,297
Rate differentials applied to reversing temporary -- -- (1,752)
differences
Undistributed earnings of foreign subsidiary (3,654) (3,817) (2,259)
Other differences - net 12,171 (351) (624)
-------- -------- --------
Total provision $ 42,292 $ 23,850 $ 15,023
======== ======== ========
</TABLE>
The tax effects of temporary differences that give rise to the current deferred
income tax benefits and deferred income tax liabilities at December 31, are as
follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(Thousands of Dollars)
<S> <C> <C>
Depreciation and amortization $ 47,435 $ 21,829
Employee benefit obligations (22,955) (22,059)
Prepaid pension cost 78,257 65,400
Investment tax credits 1,475 1,996
Capital goods excise tax credits 26,348 31,352
Other - net 12 (6,033)
--------- ---------
Total $ 130,572 $ 92,485
========= =========
</TABLE>
21
<PAGE> 24
7. EMPLOYEE BENEFIT PLANS
RETIREMENT PLANS
The Company sponsors noncontributory defined benefit pension plans covering
substantially all employees. The benefits to be paid under these plans are
generally based on years of credited service and average final earnings. The
Company's funding policy, subject to the minimum funding requirements of
employee benefit and tax laws, is to contribute such amounts as are determined
on an actuarial basis to accumulate funds sufficient to meet the plans' benefit
obligation to employees upon their retirement. The assets of the plans consist
primarily of corporate equities, government securities and corporate debt
securities.
The components of the net pension credit for 1997-1995 were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
(Thousands of Dollars)
<S> <C> <C> <C>
Benefits earned during the year $ 12,308 $ 11,429 $ 9,915
Interest cost on projected benefit obligations 33,231 29,689 28,421
Return on plan assets:
Actual (152,556) (115,011) (130,646)
Deferred 88,162 55,225 79,499
Other - net (7,996) (11,262) (11,779)
--------- --------- ---------
Net pension credit $ (26,851) $ (29,930) $ (24,590)
========= ========= =========
</TABLE>
The expected long-term rate-of-return on plan assets was 9.0% for 1997 and 1996,
and 8.5% for 1995.
The funded status of the plans and the net prepaid pension cost at December 31,
were as follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(Thousands of Dollars)
<S> <C> <C>
Vested benefit obligations $ 355,084 $ 311,725
========= =========
Accumulated benefit obligations $ 383,079 $ 328,535
========= =========
Plan assets at fair value $ 935,784 $ 815,924
Less: projected benefit obligations 478,783 416,411
--------- ---------
Excess of assets over projected obligations 457,001 399,513
Unrecognized net transition asset (13,144) (20,104)
Unrecognized net gain (241,384) (208,291)
--------- ---------
Net prepaid pension cost $ 202,473 $ 171,118
========= =========
</TABLE>
Assumptions used to develop the projected benefit obligations at December 31,
were as follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
Discount rate 7.25% 7.50%
Rate of compensation increase 5.00% 5.25%
</TABLE>
22
<PAGE> 25
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
Substantially all of the Company's employees are covered under postretirement
health care and life insurance benefit plans. The determination of benefit
cost for postretirement health plans is generally based on comprehensive
hospital, medical and surgical benefit plan provisions. The Company funds
amounts for postretirement benefits as deemed appropriate from time to time.
Plan assets consist primarily of corporate equities, government securities and
corporate debt securities.
The postretirement benefit cost for 1997-1995 included the following
components:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
(Thousands of Dollars)
<S> <C> <C> <C>
Benefits earned during the year $ 1,827 $ 2,193 $ 1,862
Interest on accumulated postretirement benefit obligations 11,845 17,070 15,458
Actual return on plan assets (7,209) (1,698) (5,705)
Amortization of transition obligation 3,110 7,437 7,500
Other - net 2,294 (112) 4,416
-------- -------- --------
Postretirement benefit cost $ 11,867 $ 24,890 $ 23,531
======== ======== ========
</TABLE>
The following table sets forth the plans' funded status and the accrued
postretirement benefit obligations as of December 31:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(Thousands of Dollars)
<S> <C> <C>
Accumulated postretirement benefit obligations attributable to:
Retirees $ 113,804 $ 110,144
Fully eligible active plan participants 35,940 109,360
Other active plan participants 30,786 22,028
--------- ---------
Total accumulated postretirement benefit obligations 180,530 241,532
Less: fair value of plan assets 78,466 62,750
--------- ---------
Excess of accumulated obligations over plan assets 102,064 178,782
Unrecognized transition obligation (46,652) (118,678)
Unrecognized prior service cost -- (10,534)
Unrecognized net loss (15,093) (5,939)
--------- ---------
Accrued postretirement benefit obligations $ 40,319 $ 43,631
========= =========
</TABLE>
The assumed discount rates used to measure the accumulated postretirement
benefit obligations were 7.25% and 7.5% at December 31, 1997 and 1996,
respectively. The assumed health care cost trend rate was 8.25% in 1997 and
8.75% in 1996 and is assumed to decrease gradually to an ultimate rate of 6.0%
in the year 2004. A one percentage point increase in the assumed health care
cost trend rates for each future year would have increased 1997 costs by
approximately $1 million and the accumulated postretirement benefit obligations
as of December 31, 1997 by approximately $11 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 1997 and 1996, and $3 million in 1995.
23
<PAGE> 26
8. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is summarized as follows at December 31:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
(Thousands of Dollars)
<S> <C> <C>
Land $ 11,728 $ 10,725
Buildings 192,118 163,992
Plant and equipment 1,595,445 1,660,752
Other 219,961 213,901
----------- -----------
Total 2,019,252 2,049,370
Accumulated depreciation (1,173,900) (1,226,897)
----------- -----------
Total property, plant and equipment - net $ 845,352 $ 822,473
=========== ===========
</TABLE>
Depreciation expense in 1997-1995 was equivalent to a composite average
percentage of 5.8%, 6.1% and 6.3%, respectively. During 1997, depreciation
was partially offset by the effects of a reduction in depreciation rates to
reflect higher net salvage values related to certain telephone plant and
equipment.
9. REGULATORY AND COMPETITIVE MATTERS
The Company is subject to regulation by the Public Utilities Commission (PUC)
of the state of Hawaii for its intrastate business operations and by the
Federal Communications Commission (FCC) for its interstate and international
business operations, earth station ownership and the use of authorized radio
frequencies.
INTRASTATE SERVICES
Rate Matters
In May 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. In June 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.
In October 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. In November 1994, the PUC
approved the Company's request for the waiver of its test year rules.
In November 1994, the PUC issued an order approving the adoption of Statement of
Financial Accounting Standards No. 106, "Employers' 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, in
January 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.
In June 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
24
<PAGE> 27
notified the PUC 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.
In September 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 million. On March
3, 1997, the Company filed a Notice of Appeal with the Hawaii Supreme Court 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. On May 15, 1997, the Hawaii Supreme
Court dismissed the appeal on the grounds that the appeal was premature and the
Court lacked jurisdiction. On June 12, 1997, the Hawaii Supreme Court denied
the Company's motion for reconsideration of its May 15, 1997 order of
dismissal.
On October 6, 1997, the PUC issued an order in the Company's 1995 Rate Case
proceeding approving the Company's calculation of a revenue requirement
adjustment to include Rural Service Plan (RSP) costs in its rate base.
Effective October 13, 1997, the Company began recovery of this adjustment
through an increase in its Intrastate Surcharge from 10.63% to 11.23%, to
produce additional annual revenues of $1.3 million.
On November 18, 1997, the Company submitted a request to the PUC to incorporate
the record from the communications infrastructure docket discussed below
related to rate rebalancing into the rate design phase (Phase II) of the 1995
Rate Case. Because rate rebalancing was initially included as an issue to be
addressed in the communications infrastructure docket, the Company had filed
testimony in that proceeding on its rate design proposal which incorporated the
$23.6 million award from Phase I of the 1995 Rate Case. Subsequently, however,
the PUC determined in the communications infrastructure docket that the setting
of specific retail rates would be deferred to Phase II of the 1995 Rate Case.
A decision on the request to incorporate part of the record from the
communications infrastructure docket into Phase II of the 1995 Rate Case is
pending from the PUC.
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 (USF) 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 September 22, 1997, the PUC issued its final rules under which services,
such as aggregator and operator service, pay telephone service, and shared
tenant service, would be provided in a competitive environment.
25
<PAGE> 28
On April 2, 1997, the PUC issued a prehearing order to resolve all remaining
issues in the communications infrastructure proceeding on an accelerated time
frame. These issues are: 1) total service resale and wholesale pricing; 2)
unbundled network elements; 3) transport and termination; 4) physical and
virtual collocation; 5) access to poles, ducts, conduits and rights-of-way; 6)
"most favored nation clause"; 7) intrastate access tariff; 8) undepreciated
plant balance; 9) rate rebalancing; and 10) USF program. In October 1997,
the PUC held evidentiary hearings on these issues with industry
participants. Opening and reply briefs were filed by the parties in December
1997. A decision and order is expected in second quarter 1998.
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. On December 12, 1996, 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. On January 10, 1997, the Company filed a complaint for
declaratory and injunctive relief in the U.S. District Court. On April 18,
1997, the PUC issued its decision, which resolved the differences between the
parties. An executed agreement was filed on May 8, 1997, in accordance with
this decision. The PUC approved the arbitrated agreement on June 6, 1997. A
U.S. District Court decision is expected in the near future.
Western Wireless Corporation (Western Wireless) filed a petition for
arbitration with the PUC on September 6, 1996. The PUC issued a decision 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 U.S. District Court on
February 14, 1997. On November 25, 1997, Western Wireless filed a motion to
compel the Company to implement the arbitrated interconnection rates, to
provide sanctions of $6.8 million for failure to comply with the orders issued
by the PUC in the arbitration docket, and to suspend the Standard Billing
Agreement. On January 23, 1998, the PUC denied Western Wireless' motion.
Sprint Corporation (Sprint) petitioned the PUC for arbitration in September
1996 on many of the same issues that were submitted by AT&T. The PUC issued a
decision on January 17, 1997, which reaffirmed the AT&T arbitration rulings and
on March 7, 1997, the PUC ordered that an interconnection agreement be filed
with the PUC in the same format as the Company's interconnection agreement with
AT&T along with each parties' proposals on disputed issues. Both companies
filed their individually proposed agreements on April 11, 1997. On April 25,
1997, the Company and Sprint filed a revised interconnection agreement with the
PUC, which contained unresolved language. On July 28, 1997, Sprint filed a
motion to elect the AT&T arbitrated agreement under Section 252 (I) of the
Telecommunications Act. The Company filed an opposition to the motion on
August 6, 1997. On August 21, 1997, the PUC approved Sprint's adoption of the
AT&T agreement and on September 17, 1997, Sprint filed the executed agreement
as ordered.
On November 27, 1996, an interconnection agreement between the Company and GST
Telecom Hawaii (GST) was filed with approval granted by the PUC. 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. On May 5, 1997, GST petitioned the PUC for
arbitration on two issues, the establishment of performance standards and
remedies and the prices for unbundled loops. On August 11, 1997, GST and the
Company jointly informed the PUC that a negotiated agreement had resolved the
outstanding arbitration issues and on August 22, 1997, an amendment to the
original interconnection agreement was filed with the PUC for approval. On
October 9, 1997, the PUC approved the amendment.
Toll Competition
During the first quarter of 1995, the PUC authorized AT&T, Sprint and MCI to
provide interisland toll service on a 10XXX basis, and reserved the right to
modify or rescind the authority depending on the impact to the Company.
26
<PAGE> 29
Since then, the PUC has granted certificates of authority to approximately 140
carriers to provide for interexchange telecommunications services in Hawaii,
including Time Warner Communications and GST Pacwest. As ordered by the PUC,
effective July 10, 1996, the Company implemented 1+ and 0+ equal access.
Rural Service Plans
In September 1992, the PUC initiated an investigation of the Company's
provision of telephone service in the rural areas of 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 remaining costs, estimated up to $20.2 million, will
be recovered from general ratepayers through a three- year monthly surcharge
that began September 1, 1995. Acting on the Company's request, the PUC
approved elimination of the monthly recurring charge to rural customers and a
restructuring of the recovery of the $20.2 million previously authorized. The
monthly customer surcharge of 62 cents will continue through August
1998, with any remaining portion of the costs to be recovered through the
revenue requirement of the 1995 Rate Case, discussed previously. On October 6,
1997, the PUC approved the Company's proposal for a $1.3 million adjustment to
the revenue requirement in the Rate Case, allowing an increase in the current
Rate Case surcharge from 10.63% to 11.23%, effective October 13, 1997.
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 selected TelHawaii Incorporated
(TelHawaii) as the alternative provider and carrier of last resort (COLR) in
the Ka'u area of the island of Hawaii, requiring service delivery by May 31,
1997. The PUC's order 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. In the
summer of 1996, the Company appealed the PUC's selection of TelHawaii as the
alternative provider of telecommunications services and as the COLR in the Ka'u
area of the island of Hawaii. The Company opposes the effective taking of its
property by forced sale of its assets in Ka'u and objects on the basis 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 Hawaii Supreme Court Review of the Expedited
Motion.
In September 1996, the Company was fined for noncompliance with the PUC's
order, 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 to
consider issuing a clarification order and an order granting mitigation and
abatement of fines and penalties levied. On December 23, 1996, the PUC denied
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 27, 1997, TelHawaii filed an application requesting the
PUC exercise its power of eminent domain for the acquisition of the Company's
assets in the Ka'u area. On May 23, 1997, the PUC issued its decision stating
that TelHawaii's proposal to initiate a court condemnation proceeding is
necessary and in the public interest. On June 16, 1997, the Company appealed
the PUC's ruling with the Hawaii Supreme Court. On October 16, 1997, TelHawaii
filed and was granted a motion to dismiss the Company's appeal on the grounds
that the Court lacks jurisdiction. The Company appealed this decision with the
First Circuit Court on October 23, 1997. On December 16, 1997, the Circuit
Court issued an order denying TelHawaii's motion to dismiss the Company's
appeal and finding that the Court may exercise appellate jurisdiction over the
Company's appeal of the PUC's orders.
On May 13, 1997, the PUC approved TelHawaii's request that it be excused from
complying with the May 31, 1997 deadline for providing service in the Ka'u
area. On May 27, 1997, the Company filed a motion for reconsideration of the
extension of time granted to TelHawaii, which was denied on June 10, 1997.
On July 16, 1997, the FCC issued an order allowing TelHawaii to establish a new
study area, allowing TelHawaii to operate under rate-of-return regulation, and
denying TelHawaii's request to receive immediate USF support. In
27
<PAGE> 30
August 1997, TelHawaii filed a Petition for Reconsideration requesting the FCC
to allow TelHawaii to receive immediate USF support effective with the transfer
of the Company's assets to TelHawaii. The Company filed an opposition to
TelHawaii's petition on August 25, 1997. On September 18, 1997, TelHawaii
filed a motion requesting the PUC identify any subsidies that the Company
should transfer to TelHawaii. On September 30, 1997, the PUC issued an order
deferring TelHawaii's motion until after the PUC issues a decision and order in
the infrastructure proceeding.
On January 31, 1997, the PUC instituted investigations, as a result of
petitions filed by rural area communities, to determine whether the
telecommunications service provided by the Company in the South Kona and Puna
districts of the island of Hawaii is adequate. In April and May, the Company
and other parties filed direct testimonies, respectively. Rebuttal testimony
was filed on August 18, 1997. Hearings were held in January 1998. Briefs are
expected to be filed in the first half of 1998.
INTERSTATE AND INTERNATIONAL SERVICES
The Company's interexchange (international and interstate) operations were
moved to GTE Hawaiian Tel International Incorporated (HTI), a wholly-owned
subsidiary of the Company, to comply with requirements in the FCC's order
reclassifying the Company as a nondominant provider of international services.
The existing FCC tariff was withdrawn and a new tariff for HTI was filed,
effective September 1, 1997. HTI's services are no longer regulated under the
FCC's price cap incentive plan.
Micronesian Telecommunications Corporation (MTC), a wholly-owned subsidiary of
the Company, moved its interexchange (international and interstate) operations
to GTE Pacifica Incorporated (a wholly-owned subsidiary of MTC) to comply with
a subsequent FCC order. MTC's international tariff was withdrawn and a new
tariff for GTE Pacifica was filed with the FCC, effective January 1, 1998. GTE
Pacifica's services are no longer regulated under the FCC's price cap incentive
plan. Both the Company and MTC's interstate access services are regulated
under the FCC's price cap incentive plan.
Much of the regulatory and legislative activity that occurred in the United
States in 1997 was a direct result of the Telecommunications Act adopted by
Congress. The Telecommunications Act is intended to promote competition in all
sectors of the telecommunications marketplace while preserving and advancing
universal telephone service.
In July 1997, the U.S. Court of Appeals for the Eighth Circuit (Eighth Circuit)
released its decision on the challenge filed in 1996 by the Company's parent,
GTE, and numerous other parties to rules developed by the FCC to implement the
interconnection provisions of the Telecommunications Act. The
Telecommunications Act required local-exchange carriers (LECs) to make their
retail services and the underlying network elements available to competitors.
The FCC required that prices for both resold services and network elements be
set using a methodology created by the FCC. The court challenge asserted that
the FCC's rules were inconsistent with the Telecommunications Act. The July
1997 court decision found that the FCC overstepped its authority in a number of
areas and upheld GTE's position that state regulatory agencies bear the primary
responsibility for determining the prices which competing firms must pay when
interconnecting their networks. On January 26, 1998, the U.S. Supreme Court
announced that it would review this decision. Oral argument in the Supreme
Court is expected to take place in October 1998, with a final decision likely
to be issued no later than June 1999.
In May 1997, the FCC released two new major decisions related to implementation
of the Telecommunications Act's provisions - the universal service and access
charge reform orders. The universal service order established the support
mechanisms to ensure continued availability of affordable local telephone
service and created new programs to provide discounted telecommunications
services to schools, libraries and rural health care providers. GTE and
numerous other parties have challenged the FCC's decision before the U.S. Court
of Appeals for the Fifth Circuit on the grounds that the FCC did not follow the
requirements of the Telecommunications Act to develop a sufficient, explicit
and competitively neutral universal service program. A decision is expected in
1998.
28
<PAGE> 31
The FCC access charge reform order, also released in May 1997, revamped the
rate structure through which local and long distance companies charge customers
for using the local phone network to make long distance calls. The FCC ordered
decreases for long distance companies to be accomplished by increasing the
access charges for business and residential customers with more than one phone
line. GTE and numerous other parties also challenged this decision before the
Eighth Circuit based on the belief that the FCC did not eliminate the universal
service subsidies hidden within interstate access charges as directed by the
Telecommunications Act, and that the FCC created additional subsidy charges
paid only by business and multi-line residential customers. Oral argument has
been held and a decision is expected in 1998.
Also in May 1997, the FCC released a decision completing a periodic review of
its price cap regulatory oversight of interstate access charges. GTE and
numerous other LECs have challenged this decision before the Eighth Circuit
based on the belief that the FCC established a fundamentally unfair annual
price reduction formula, and required retroactive price reductions. Oral
argument has been held and a decision on this challenge is also expected in
1998.
For the provision of interstate services, the Company operates under the terms
of the FCC's price cap incentive plan. The price cap mechanism serves to limit
the rates a carrier may charge, rather than just regulating the rate-of-return
which may be achieved. Under this approach, the maximum price that the LEC may
charge is increased or decreased each year by a price index based upon
inflation less a predetermined productivity target. LECs have limited pricing
flexibility provided they do not exceed the allowed price cap.
In the May 1997 order on its price cap triennial review, the FCC revised the
price cap plan for LECs by adopting a uniform productivity factor of 6.0% with
an additive consumer productivity dividend of 0.5%. The FCC also eliminated
the sharing requirements of the price cap rules.
The Company filed interstate access revisions during 1997 that became effective
June 3, 1997 and July 1, 1997. Overall, these filings resulted in a net annual
price reduction of $7.4 million. On December 1, 1997, the FCC issued an order
to file revised access rates effective January 1, 1998, which resulted in
additional interstate access charge reductions of approximately $1.8 million.
In 1997, the FCC also ordered significant changes that altered the structure of
access charges collected by the Company, effective January 1, 1998. Generally,
the FCC reduced and restructured the per minute charges paid by long distance
carriers and implemented new per line charges. The FCC also created an access
charge structure that resulted in different access charges for residential
primary and secondary lines and single line and multi-line business lines. In
aggregate, the reductions in usage sensitive access charges of $6.9 million
paid by long distance carriers were offset by $6.5 million of new per line
charges and charges paid by end-users.
On June 4, 1996, the FCC issued its first Report and Order implementing Section
276 of the Telecommunications Act. As part of the overall goal of promoting
competition among payphone service providers (PSPs), this order mandated
compensation to all PSPs for all calls originating from payphones, including
"dial-around" access calls and toll-free subscriber calls for which PSPs were
not previously compensated. This compensation was to occur in two separate
phases. During phase one, from April 15, 1997 through October 6, 1997, PSPs
were to be paid a monthly, flat-rate compensation from interexchange carriers
(IXCs). During phase two, beginning October 7, 1997, PSPs were to be
compensated on a per- call basis, with the prevailing local coin rate of 35
cents established as the default rate.
On July 19, 1997, the U.S. Court of Appeals in Washington, D.C. vacated the
FCC's directive concerning per-call compensation, stating that the FCC had not
shown that the 35 cent rate was a reasonable surrogate for fair compensation.
The court also set aside the FCC's flat-rate compensation mandate.
Subsequently, on October 9, 1997, the FCC issued a second Report and Order to
address some of the issues vacated by the court. In this second order, the FCC
established a new per-call rate of 28.4 cents for phase two compensation that
all PSPs were eligible to receive beginning October 9, 1997. The FCC
tentatively concluded that this per-call rate should also be used to calculate
phase one compensation. The Company has recorded approximately $2.8 million of
payphone revenues associated with the October 9, 1997 FCC order. It is likely
that the phase one compensation directive will be revisited in a subsequent
order.
29
<PAGE> 32
10. COMMITMENTS AND CONTINGENCIES
The Company has noncancelable leases covering certain buildings, office space
and equipment. Rental expense was $14.3 million, $13.9 million and $12.8
million in 1997-1995, respectively. Minimum rental commitments under
noncancelable leases through 2002 do not exceed $5.1 million annually and
aggregate $19.6 million thereafter.
The Company is subject to a number of proceedings arising out of the conduct of
its business, including those relating to regulatory actions, commercial
transactions and environmental, safety and health matters. Management believes
that the ultimate resolution of these matters will not have a material adverse
effect on the results of operations or the financial position of the Company.
Recent judicial and regulatory developments, as well as the pace of
technological change, have continued to influence industry trends, including
accelerating and expanding the level of competition. As a result, the
Company's operations face increasing competition in virtually all aspects of
its business. The Company supports greater competition in telecommunications,
provided that, overall, the actions to eliminate existing legal and regulatory
barriers allow an opportunity for all service providers to participate equally
in a competitive marketplace under comparable conditions.
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, 1997 and
1996, and the related consolidated statements of income, shareholder's equity
and cash flows for each of the three years in the period ended December 31,
1997, as set forth on pages 12 through 15 and Schedule II of this report.
These financial statements and the schedule and exhibit referred to below are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements and the schedule and exhibit
based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of GTE Hawaiian Telephone Company
Incorporated and subsidiaries as of December 31, 1997 and 1996, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted
accounting principles.
As discussed in Note 2 to the consolidated financial statements, in 1995, the
Company discontinued applying the provisions of Statement of Financial
Accounting Standards No. 71, "Accounting for the Effects of Certain Types of
Regulation."
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The supporting schedule and exhibit
listed under Item 14 are presented for purposes of complying with the
Securities and Exchange Commission's rules and are not a required part of the
basic financial statements. The supporting schedule and exhibit have been
subjected to the auditing procedures applied in the audits of the basic
financial statements and, in our opinion, fairly state in all material respects
the financial data required to be set forth therein in relation to the basic
financial statements taken as a whole.
Dallas, Texas ARTHUR ANDERSEN LLP
January 26, 1998
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,
1997-1995 (as required):
II - Valuation and Qualifying Accounts
Note: Schedules other than the one listed above are omitted as not
applicable, not required, or the information is included in the
consolidated financial statements or notes thereto.
(3) Exhibits - Included in this report or incorporated by reference.
3.1* Articles of Incorporation and Bylaws (Exhibit 3.2 of the 1987
Form 10-K, File No. 2-33059)
3.2* Amended Bylaws (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 on 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)
10.1* Material Contracts - Agreements between GTE and Certain
Executive Officers (Exhibit 10 of the 1995 Form 10-K, File No.
2-33059)
10.2 Material Contracts - Separation Agreement between GTE and
Richard M. Cahill
12 Statements re: Calculation of the Consolidated Ratio of Earnings
to Fixed Charges
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 1997.
* 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, 1997, 1996 and 1995
(Thousands of Dollars)
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E
- ---------------------------------------------------------------------------------------------------------------
Additions
------------------------
Deductions
Balance at Charged from
Beginning Charged (Credited) to Reserves Balance at
Description of Year to Income Other Accounts (Note 1) Close of Year
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Allowance for uncollectible accounts
for the years ended:
December 31, 1997 $ 6,066 $12,869 $ 9,593 (2) $19,932 $ 8,596
===========================================================
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
===========================================================
Accrued restructuring costs for the
years ended:
December 31, 1996 $39,353 $ -- $(11,520)(3) $27,833 $ --
===========================================================
December 31, 1995 $60,816 $ -- $ -- $21,463 $39,353
===========================================================
</TABLE>
NOTES:
(1) Charges for which reserve was created.
(2) Recoveries of previously written-off amounts.
(3) Represents amounts necessary to satisfy commitments related to the
re-engineering program that were reclassified to accounts payable and
accrued expenses.
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 27, 1998 By /s/ 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.
<TABLE>
<S> <C> <C>
/s/ Warren H. Haruki President and Director March 27, 1998
- --------------------------- (Principal Executive Officer)
Warren H. Haruki
/s/ Gerald K. Dinsmore Senior Vice President - Finance March 27, 1998
- --------------------------- and Planning
Gerald K. Dinsmore (Principal Financial Officer)
/s/ William M. Edwards, III Vice President - Controller March 27, 1998
- --------------------------- (Principal Accounting Officer)
William M. Edwards, III
/s/ John C. Appel Director March 27, 1998
- ---------------------------
John C. Appel
/s/ Mateland L. Keith, Jr. Director March 27, 1998
- ---------------------------
Mateland L. Keith, Jr.
/s/ Lawrence R. Whitman Director March 27, 1998
- ---------------------------
Lawrence R. Whitman
</TABLE>
36
<PAGE> 39
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
------- ---------------------------------------------------------------------------
<S> <C>
10.2 Material Contracts - Separation Agreement between GTE and Richard M. Cahill
12 Statements re: Calculation of the Ratio of Earnings to Fixed Charges
27 Financial Data Schedule
</TABLE>
<PAGE> 1
Exhibit 10-2
[AS AMENDED JANUARY 23, 1998]
December 24, 1997
Mr. Richard M. Cahill
1158 Hidden Ridge
Apartment 2311
Irving, Texas 75038
Dear Dick:
As we discussed, I want to provide you with an appropriate
transition arrangement prior to your scheduled separation and to enter into a
consulting arrangement with you in accordance with the terms set forth below.
This agreement ("Letter Agreement") supersedes any other agreements you may
have with GTE (as defined below) or may have received from GTE with regard to
the subject matter contained herein, including but not limited to the letter
dated August 13, 1997. The terms of this Letter Agreement are as follows:
A. RESIGNATION FROM EMPLOYMENT
1. RESIGNATION - Effective July 31, 1997, you irrevocably
resign from your position as Vice President and General Counsel - GTE Telephone
Operations. Effective no later than December 31, 1997, you also irrevocably
resign from any officer, director, or other positions you hold for GTE
Corporation or any affiliate of GTE Corporation (collectively referred to in
this Letter Agreement as "GTE") and from any internal or external Boards where
you represent GTE effective as of that date.
2. SPECIAL ASSIGNMENT - From August 1, 1997 through June 30,
1998 ("Special Assignment Period"), you will continue on the GTE Service
Corporation (the "Company") payroll as an active employee in your new special
assignment as Vice President and Associate General Counsel, reporting to me or
my successor or designee. During the Special Assignment Period, you will work
on special projects as assigned by me or my successor or designee. In
addition, during the Special Assignment Period, you will continue to receive
your base salary as in effect on July 31, 1997 and will receive all benefits
that active employees receive, except that your EIP and LTIP participation will
be governed by the terms of this Letter Agreement. Except as otherwise
expressly provided herein, all perquisites provided by the Company will cease
at the end of the Special Assignment Period. In the event the Company offers
any new employee plans, any new, enhanced, or supplemental executive plans, or,
except as expressly provided herein, any new grants, awards, or benefits under
existing executive plans on or after July 31, 1997, you will not participate in
such plans or receive such grants, awards, or benefits. You irrevocably resign
from employment with GTE and the position of Vice President and Associate
General Counsel effective June 30, 1998. During and after the Special
Assignment Period, you will not seek reinstatement, recall, or future or other
employment with GTE.
3. SEPARATION BENEFITS - At the conclusion of the Special
Assignment Period, you will separate from employment with the Company and you
will be eligible for separation benefits pursuant to the Company's Involuntary
Separation Program ("ISEP") or its equivalent as then in effect, subject to any
applicable release requirements.
4. EIP AWARDS - You will participate in the Executive
Incentive Plan ("EIP") at a Salary Grade Level 20 for the full 1997 Plan Year
and one half (1/2) of the 1998 Plan Year in accordance
<PAGE> 2
Mr. Richard M. Cahill
December 24, 1997
Page 2
with the terms of the EIP. Your 1997 EIP award and pro-rated 1998 EIP award
will be the same as the average EIP rating for the Company's Legal Department
for each such year. You will not participate in EIP for the 1999 Plan Year or
thereafter. All EIP awards will be subject to approval by the GTE Corporation
Executive Compensation and Organizational Structure Committee ("ECC"). The EIP
awards will be payable at the same time EIP awards are payable to other EIP
participants. You will be eligible to defer, and thus receive a match pursuant
to the Equity Participation Program ("EPP"), only those of your EIP awards
payable while you are still employed by GTE (in this case, only the 1997 Plan
Year award). Note that the ECC reserves the right not to approve EIP awards in
1997 and/or 1998, and, if so, you will be treated in the same manner as other
executives at your salary level.
5. LTIP - Subject to ECC approval, in the spring of 1998, you
will be eligible for a standard grant of Stock Options, and you also will be
eligible for a Performance Bonus Award for the 1998-2000 award cycle under the
GTE Long-Term Incentive Plan ("LTIP"). You will not receive grants of Stock
Options or Performance Bonus Awards under LTIP after the initial spring of 1998
grants. Your outstanding Stock Options will vest immediately upon your
separation at the end of the Special Assignment Period (subject to applicable
release requirements), and you will have until the earlier of: (i) five years
from your date of separation or (ii) the expiration date of the Option to
exercise those Stock Options ("Special Exercise Period"). The Special
Assignment Period will be counted for prorating your existing Performance Bonus
Awards. As such, your participation in LTIP Performance Bonus Cycles will be
as follows: 1995-1997 (Full Participation), 1996-1998 Cycle (30/36
Participation), 1997-99 (18/36 Participation), and 1998-2000 (6/36
Participation). You will not receive any Performance Bonus Award in 1999 or
thereafter. Achievement of targets, determination of the amount of Performance
Bonus Awards, and determination of the number of shares covered by your grant
of Stock Options will be established in the sole discretion of the ECC. Each
Performance Bonus Award will be payable at the same time LTIP awards are
payable to other LTIP participants. You will be eligible to defer, and thus
receive a match pursuant to the EPP, only those of your LTIP Performance Bonus
Awards payable while you are still employed by GTE (in this case, only the
1995-97 Performance Bonus Award). For purposes of this Letter Agreement, your
1998 Stock Option and Performance Bonus Award grants are collectively referred
to as "LTIP Grants." Note that the ECC reserves the right not to make Stock
Option or Performance Bonus Awards in 1998, and, if so, you will be treated in
the same manner as other executives at your salary level.
6. RELEASE - In order to receive full Separation Benefits
(including but not limited to full ISEP and the Special Exercise Period
described in paragraph 5 above) and the 1998 EIP Award, and in order for your
participation in the LTIP Performance Bonus Award Cycles to be as described in
paragraph 5 above, you will be required to sign a release upon the expiration
of the Special Assignment Period.
7. VACATION - At the end of the Special Assignment Period,
you may elect to take the remainder of your banked/accrued but unused vacation
in a lump sum. In the alternative, you may elect to use your banked/accrued
but unused vacation to extend your last day as an active employee on payroll;
provided that any such extension shall not affect the payment or pro-ration of
your EIP and LTIP awards as set forth in paragraphs 4 and 5 above.
8. MISCELLANEOUS BENEFITS - During the Special Assignment
Period, you will be entitled to the same level of executive perquisites as
other similarly situated executives in Dallas are accorded, and you will also
be entitled to office space at a location to be determined by GTE in its sole
discretion. After the end of the Special Assignment Period, the Company will
pay for tax preparation services for you for the 1998 calendar year, which
would be paid in 1999, up to a maximum of $3,000. The benefits described in
this paragraph A.8 are collectively referred to in this Letter Agreement as
miscellaneous
<PAGE> 3
Mr. Richard M. Cahill
December 24, 1997
Page 3
benefits ("Miscellaneous Benefits").
9. CIRCUMSTANCES WHEN ABOVE PAYMENTS/BENEFITS WILL NOT BE
PAID - In the event any of the following occur prior to the expiration of the
Special Assignment Period (or if applicable after the expiration of the Special
Assignment Period), you will cease to receive any further salary, the Special
Exercise Period will not apply, you will not receive any EIP Payments, LTIP
Grants, payment of Performance Bonus Awards, Separation Benefits (including but
not limited to ISEP), Miscellaneous Benefits, or any other benefits or
payments, and you will not be required to perform, and will not be paid for,
any consulting services:
o you voluntarily terminate your employment for any reason;
o your employment is terminated for cause as determined by me
or my successor or designee; or
o you violate any of the terms of the attached Separation
Agreement and General Release (including but not limited to
the provisions regarding confidentiality and
non-embarrassment) or the non-compete provisions of
paragraphs A.10 and B.7 of this Letter Agreement.
In the event that you die or become disabled (within the
meaning of GTE's Long-Term Disability Plan) during the Special Assignment
Period, all further salary will cease, your eligibility for the Miscellaneous
Benefits will cease, your EIP Payments and Performance Bonus Awards will be
pro-rated to the date of your death or disability (but will not be paid until
the date they otherwise would have been paid had you not died or become
disabled), the Special Exercise Period will not apply, your Separation Benefits
(including but not limited to ISEP) will be treated in accordance with the
terms of the relevant plans or policies, your eligibility for the LTIP Grants
will be determined in accordance with the relevant plan provisions, and you
will not be required to perform, and will not be paid for, any consulting
services.
10. MISCELLANEOUS - Since you will remain a GTE employee
until the end of the Special Assignment Period, you will remain subject to all
GTE policies, including but not limited to GTE's policies relating to non-
competition and disclosure of confidential information. You shall be
responsible for the payment of all applicable taxes relating to the benefits
described in Paragraph A of this Letter Agreement, including but not limited to
taxes as a result of ISEP or any ISEP equivalent payment.
B. CONSULTING ARRANGEMENT
1. CONSULTING PERIOD. You will serve as a non-employee
consultant for the period July 1, 1998 through June 30, 2000 (the "Consulting
Period"). During the Consulting Period and thereafter, you will not be
entitled to any benefits provided by GTE to its active employees and, by
signing below, you acknowledge and agree that you shall not be entitled to any
such benefits and effectively waive participation in any such benefits.
2. CONSULTING SERVICES. During the Consulting Period,
you will perform special projects as assigned by me or my successor or
designee. All required services will be performed by you. You will be free at
all times to arrange the time and manner of performance of the consulting
services to be rendered hereunder and will not be expected to maintain or
observe a schedule of duties or assignments. You will not report to the
Company on any regular basis, but will work as you may independently decide.
You will not be required to provide consulting services to the Company for more
than 30% of the regularly scheduled working days in any calendar year
<PAGE> 4
Mr. Richard M. Cahill
December 24, 1997
Page 4
during the term of this Letter Agreement. The Company is entering into this
arrangement with the understanding that the performance of your services will
be subject to the non-compete provisions of paragraph B.7 below. During the
Consulting Period and thereafter, you may, in your discretion, provide services
to others without being constrained by your obligations under this Letter
Agreement, provided only that such services do not prevent you from providing
the consulting services required under this Letter Agreement, and provided
further that such services to others do not cause you to violate your
obligations regarding non-competition, confidentiality, and intellectual
property rights as described in this Letter Agreement and the attached
Separation Agreement and General Release.
3. COMPANY CONTACT. I or my successor or designee will
be your contact at the Company during the Consulting Period and will be
responsible for coordinating your assignments. All services must be performed
to my satisfaction or to the satisfaction of my successor or designee.
4. CONSULTING FEES. You will be paid $164,000 per year
for your consulting services during the Consulting Period, payable in equal
quarterly installments of $41,000 in arrears. You also will be entitled to be
reimbursed for reasonable travel expenses you incur in the performance of
consulting services for the Company as approved by me or my successor or
designee. Please submit quarterly invoices to me or to my successor or
designee for payment. You will be paid the full amount of your annual
consulting fees during the Consulting Period whether or not you actually
perform consulting services for the Company.
5. PERFORMANCE OF CONSULTING SERVICES. As a
non-employee consultant, the Company does not retain or exercise the right to
direct, control, or supervise you as to the details and means by which the
consulting services contracted for are accomplished. You and the Company agree
that, as a non-employee consultant, you will serve as an independent contractor
in the performance of your duties under this Letter Agreement. As a result,
you will be responsible for payment of all taxes and expenses incurred arising
out of the payments under the Letter Agreement for your activities as a
non-employee consultant in accordance with this Letter Agreement, including but
not limited to, federal and state income taxes, social security taxes,
unemployment insurance taxes, and any other taxes or business license fees as
required. Moreover, you agree that, except as authorized by the Company, you
will not represent directly or indirectly that you are an agent or legal
representative of the Company, nor will you incur any liabilities or
obligations of any kind in the name of or on behalf of the Company, other than
those specifically made or approved as part of this Letter Agreement.
6. OFFICE SPACE. You are responsible for securing your
own office space, office equipment, and clerical support services during the
Consulting Period, but visiting office space and appropriate office equipment
will be provided to you if you are meeting with individuals at GTE's offices.
7. NON-COMPETE PROVISIONS. As a non-employee
consultant, you agree that, among other policies and guidelines, the GTE
Conflict of Interest Guidelines and the Business and Scientific Information
Policy or replacement policies will apply to you. In addition, you agree not
to engage directly or indirectly in a Competitive Business during the
Consulting Period, unless the Company approves such an arrangement in writing
in advance. For purposes of this paragraph B.7, a "Competitive Business" is
any inter-exchange carrier (such as MCI Communications Corporation,
<PAGE> 5
Mr. Richard M. Cahill
December 24, 1997
Page 5
Sprint Corporation, AT&T Corp., WorldCom, Inc., LCI International, Inc., and
Cable & Wireless PLC) and its Affiliates, any local exchange carrier (such as
any Regional Bell Operating Company ("RBOC") and British Telecommunications
PLC) and its Affiliates, or any of the following companies and their
Affiliates: Digex, Incorporated, Qwest Communications International Inc.,
Netscape Communications Corporation, Cisco Systems, Inc., Ascend
Communications, Inc., Airtouch Communications, Inc., NEXTEL Communications,
Inc., and Teleport Communications Group, Inc. An Affiliate for purposes of
this paragraph B.7 shall mean any entity, whether or not incorporated, (i) in
which a Competitive Business has equity ownership of 10% or more, or (ii) which
provides goods or services (including but not limited to software, processing,
switching, marketing, or consulting) to a Competitive Business to materially
compete with GTE.
You acknowledge that the obligations imposed on you pursuant
to this paragraph B.7 are reasonable in their nature, scope and duration and
will not deprive you of the opportunity to earn a livelihood. During and after
the Consulting Period, you also will remain subject to those GTE policies which
apply following termination of service.
Subject to paragraph B.8, in consideration of your compliance
with the provisions of this paragraph B.7, the Company will pay to you $25,000
per quarter payable in arrears, commencing with the quarter beginning July 1998
and ending with the quarter ending June 2000 (or such later date as the parties
may agree in writing). If you fail to comply with the provisions of this
paragraph B.7, you will forfeit your right to receive the payments described in
this paragraph B.7.
8. EARLY TERMINATION OF CONSULTING SERVICES. In the
event any of the following occurs during the Consulting Period, this Letter
Agreement will terminate immediately, and, except as provided in the
immediately succeeding sentence, you will not be entitled to any further
payments under paragraphs B.4 or B.7: you violate any of the provisions of this
Letter Agreement or the Separation and General Release referred to below; you
die; you become disabled; or you fail to provide services under this Letter
Agreement to the satisfaction of the Company. Of course you will be entitled
to payment of amounts due pursuant to paragraphs B.4 and B.7 with respect to
that portion of the quarter prior to the termination of your consulting
services in an amount equal to the payment due for the quarter multiplied by a
fraction, the numerator of which is the number of days in the quarter prior to
the termination of your consulting services and the denominator of which is 90.
C. GENERAL PROVISIONS
1. CONFIDENTIALITY. You agree that any information you
receive or acquire during the performance of your obligations in accordance
with this Letter Agreement or have received or acquired from your prior
employment with GTE will be treated by you in the strictest confidence and will
not be disclosed to or used for the benefit of any persons, firms or
organizations. This provision will survive the termination of this Letter
Agreement.
2. GTE AS EXCLUSIVE OWNER OF WORK PRODUCT. You agree
that GTE will be the exclusive owner of all works conceived or first produced
by you within the scope of your prior employment with GTE or pursuant to or
related to this Letter Agreement and your services as a consultant, including
that GTE will be the exclusive owner of all copyrights and other intellectual
property rights in or based upon such works. With regard to such copyrightable
works, you agree that GTE will be the "person for whom the work is prepared"
and that GTE will be the exclusive
<PAGE> 6
Mr. Richard M. Cahill
December 24, 1997
Page 6
work-for-hire author under the copyright laws of the United States. In
addition, you agree to and to hereby assign exclusively to GTE such works,
copyrights and other intellectual property rights. This provision will survive
the termination of this Letter Agreement.
The arrangements described above are contingent upon your
executing the attached Separation Agreement and General Release (the
"Release"). As you know, you were given a version of this Letter Agreement
dated October 16, 1997 and, therefore, you have been given twenty-one days to
sign the Release (with a seven-day period to revoke) as required by law.
Although not legally required, we have determined to give you an additional
twenty-one day period commencing as of December 24, 1997 (with a seven-day
period to revoke) to sign the Release. Since the December 24, 1997 version of
this Letter Agreement has been modified based on requests you have made, you
continue to have twenty-one days from December 24, 1997 to sign the Release
(with a seven-day period to revoke). If you fail to sign the Release or if you
sign and revoke the Release within seven days of signing it, this Letter
Agreement shall be void, and you will not receive any of the benefits described
in this Letter Agreement.
Dick, your past contributions to GTE are appreciated by me and
the entire GTE management team.
Sincerely,
William P. Barr
Executive Vice President -
Government and Regulatory Advocacy,
General Counsel
I have read, understand, and agree to the terms of this Letter Agreement
including the attached Separation Agreement and General Release.
- --------------------------- ---------------
Richard M. Cahill Date
<PAGE> 7
SEPARATION AGREEMENT AND GENERAL RELEASE
This Agreement is by and between GTE Service Corporation (the
"Company") and Richard M. Cahill ("Cahill").
PART I
In consideration of the provisions in Part II, the Company agrees as
follows:
1. The Company will provide Cahill with the benefits described in
William P. Barr's letter dated December 24, 1997, as amended January 9, 1998
(the "December 24, 1997 Letter"). (The December 24, 1997 Letter and this
Separation Agreement and General Release are collectively referred to as the
"Agreement").
2. By making this Agreement, the Company does not admit that it
has done anything wrong, and the Company specifically states that it has not
committed any tort, breach of contract, or violation of any federal, state, or
local statute or ordinance.
PART II
In consideration of the provisions in Part I, Cahill agrees as
follows:
1. Effective July 31, 1997, Cahill irrevocably resigns from his
position as Vice President and General Counsel - GTE Telephone Operations, from
any officer, director, or other positions he holds for GTE Corporation or any
of its affiliates, and from any internal or external Boards where he represents
GTE (as described in paragraph 3 below), at which time Cahill will commence the
Special Assignment described in the December 24, 1997 Letter. Cahill
irrevocably resigns from employment with GTE effective at the end of the
Special Assignment Period described in the December 24, 1997 Letter. Cahill
agrees not to seek reinstatement, recall, or future employment with GTE after
the end of the Special Assignment Period.
Cahill agrees that GTE retains the right to make future organizational changes,
including but not limited to the right to combine, create, and/or fill
positions.
2. Cahill agrees and understands that the payments and the
benefits described in Part I, paragraph 1 above are more than any payments or
benefits due to him under the Company's policies or practices. Cahill waives
and forever discharges GTE (as described in paragraph 3 below) from any
liability to provide any notice of termination, including but not limited to
any notice under the Worker Adjustment and Retraining Notification Act, or to
pay any additional salary continuance, separation pay, severance pay, retention
bonus or pay, retirement incentive, or payments or benefits arising under any
other plan, policy, practice, or program (offered on a qualified or
non-qualified or voluntary or involuntary basis) which may have been payable as
a result of the termination of his employment, except as provided in paragraph
3 below. Cahill agrees that, should the Company offer any retirement
incentive, early retirement, or voluntary separation program on or after July
31, 1997, Cahill shall not be eligible to participate. In addition, Cahill has
not relied on any statement, agreement, or promise of eligibility for any
benefits, other than those set forth in this Agreement.
3. Cahill agrees to release GTE Corporation and any related or
affiliated companies, and any and all current and former directors, employees,
officers, agents, and contractors of these companies, and any and all employee
pension or welfare benefit plans of these companies, including current and
former trustees and administrators of these plans, (hereinafter GTE
Corporation, the Company, and the other
<PAGE> 8
entities and persons referenced above are collectively referred to in this
Separation Agreement and General Release as "GTE") from all known and unknown
claims, charges, or demands Cahill may have based on his employment with GTE,
including a release of any rights or claims Cahill may have under the Age
Discrimination in Employment Act ("ADEA"), which prohibits age discrimination
in employment; Title VII of the Civil Rights Act of 1964, and the Civil Rights
Act of 1991, which prohibit discrimination in employment based on race, color,
sex, religion, and national origin; the Americans with Disabilities Act, which
prohibits discrimination based upon disability; Section 1981 of the Civil
Rights Act of 1866, which prohibits discrimination based on race; the Employee
Retirement Income Security Act, which governs employee benefits; any state laws
against discrimination; or any other federal, state, or local statute or common
law relating to employment. This includes a release by Cahill of any claims
for wrongful discharge, breach of contract, employment-related torts, or any
other claims in any way related to Cahill's employment with GTE.
This release does not include, however, a waiver of any right to vested
benefits under any pension or savings plan, any right to Worker's Compensation,
any right to receive pay for banked and accrued, but unused, vacation, or any
right to unemployment compensation that Cahill may have.
4. Cahill has not filed and promises not to file, or permit to be
filed on his behalf, any lawsuit or complaint against GTE regarding the claims
released in Part II, paragraph 3 above. Cahill also promises to opt out of and
to take such other steps as he has the power to take to disassociate himself
from any class seeking relief against GTE regarding any claims released in Part
II, paragraph 3. If a court, administrative agency, arbitrator, or any other
decision maker with authority awards Cahill money damages or other relief, with
respect to claims released in Part II, paragraph 3, Cahill hereby assigns to
the Company all rights and interest in such money damages and other relief.
5. Cahill agrees not to disclose the terms of this Agreement,
that this Agreement exists, or that he received any payments from the Company
to anyone except his attorney, his financial planner, or his immediate family
(spouse, children, siblings, parents). If he does disclose the terms of this
Agreement to his immediate family, his financial planner, or his attorney, he
will advise them that they must not disclose the terms of this Agreement.
6. Cahill acknowledges that, during the period he has served as
an in-house attorney with GTE, he has had access to confidential information
relating to GTE. Consistent with the Rules of Professional Conduct, Cahill
will not use or disclose any such confidential information without first
obtaining the consent of the Company.
Cahill agrees to comply with the provisions of GTE H.R. Policy 412 (Attachment
I) provided that, in the event of a conflict between Policy 412 and this
Agreement, the terms of this Agreement shall take precedence.
Contemporaneously with the execution of this Agreement, if Cahill has not
executed a copy of the Business and Scientific Information Agreement, Cahill
shall do so (Policy Attachment A). Upon his termination, Cahill shall execute
Policy Attachment D.
Cahill further agrees to take no action that would cause GTE (including its
employees, directors, and shareholders) embarrassment or humiliation or
otherwise cause or contribute to GTE (including its employees, directors, and
shareholders) being held in disrepute by the general public or GTE's clients,
shareholders, customers, federal or state regulatory agencies, employees,
agents, officers, or directors.
<PAGE> 9
Cahill will cooperate and make all reasonable efforts to assist the Company in
any investigation of matters involving GTE. Cahill also agrees to testify as a
witness and be available for interviews and to assist GTE in preparation for
any legal proceedings involving GTE in which Cahill has direct knowledge or
specific expertise. Cahill will be compensated appropriately and reimbursed
for reasonable expenses.
Nothing in this Agreement shall be construed to prevent Cahill from giving
compelled truthful testimony before any federal or state agency or in any
judicial proceeding; provided that, in order to permit GTE to seek an
injunction or other judicial relief, he will timely notify GTE in advance of
any such proceeding in which he expects to be called to testify or for which he
has received a subpoena.
7. Cahill acknowledges and agrees that he has not been
discriminated against in any way during his employment with GTE or with regard
to his separation from employment with the Company.
8. Cahill agrees that GTE will be entitled to recover liquidated
damages in the amount of $75,000 if he breaks his promises in Part II,
paragraphs 1-6 of this Agreement. These liquidated damages are based upon the
parties' recognition that damages to GTE due to Cahill's breaking of these
promises are not capable of measurement with any degree of certainty. The
amount specified is not to be considered a penalty, but solely as liquidated
damages. If Cahill breaks his promise in Part II, paragraph 4 and files a
lawsuit or complaint regarding claims Cahill has released, in addition to the
liquidated damages described above, Cahill will pay for all costs incurred by
GTE, including reasonable attorneys' fees, in defending against his claim.
9. Cahill understands that he has been given 21 days to review
and consider this Agreement before signing it. Cahill further understands that
he may use as much of this 21-day period as he wishes prior to signing this
Agreement.
10. Cahill may revoke this Agreement within seven days after he
signs it. If Cahill wishes to revoke this Agreement within this seven-day
period, written notice of revocation should be delivered to the office of
Thomas W. Green, Senior Head of Stamford Transition Team, by the close of
business seven days after Cahill signs the Agreement. This Agreement will not
become effective or enforceable until seven days after Cahill signs it. If
Cahill revokes this Agreement, it will not be effective or enforceable, and he
will not receive the benefits described in Part I, paragraph 1.
11. Cahill agrees that the Company advised Cahill to consult with
an attorney before signing this Agreement.
12. The parties participated jointly in the negotiation of this
Agreement, and each party had the opportunity to obtain the advice of legal
counsel and to review, comment upon, and redraft this Agreement. Accordingly,
it is agreed that no rule of construction shall apply against any party or in
favor of any party, and any uncertainty or ambiguity shall not be interpreted
against any one party and in favor of the other.
13. Cahill and the Company hereby consent that any disputes
relating to this Agreement will be governed by Connecticut law.
<PAGE> 10
14. In the event that any one or more of the provisions contained
in this Agreement shall, for any reason, be held to be invalid, illegal, or
unenforceable in any respect, such invalidity, illegality, or unenforceability
shall not affect any other provision of this Agreement.
15. This Separation Agreement and General Release and the December
24, 1997 Letter constitute the entire Agreement between Cahill and the Company
and shall be binding upon the heirs, successors, and assigns of Cahill and the
Company. No other promises or agreements have been made to Cahill other than
those in this Agreement. Cahill is not relying on any statement,
representation, or warranty that is not contained in this Agreement. Cahill
acknowledges that he has read this Agreement carefully, fully understands the
meaning of the terms of this Agreement, and is signing this Agreement knowingly
and voluntarily.
Subscribed and sworn to before ------------------------------
me this____day of____, 1998. Richard M. Cahill
- ------------------------------ ------------------------------
Notary Public Date
Subscribed and sworn to before GTE Service Corporation
me this____day of____, 1998.
- ------------------------------ ------------------------------
Notary Public By:
Title:
------------------------------
Date
<PAGE> 1
Exhibit 12
GTE Hawaiian Telephone Company Incorporated and Subsidiaries
STATEMENTS OF THE CONSOLIDATED RATIO OF EARNINGS TO FIXED CHARGES
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------------------------------
1997 1996 1995 1994 1993 1993(a)
--------------------------------------------------------------------------
(Thousands of Dollars)
<S> <C> <C> <C> <C> <C> <C>
Net earnings available for fixed charges:
Income (loss) before extraordinary
charges $ 60,998 $ 54,701 $ 37,901 $ 29,799 $ (5,042) $ 43,175
Add - Income taxes (benefit) 42,292 23,850 15,023 12,613 (9,865) 20,193
- Fixed charges 45,989 45,556 46,063 41,328 36,327 36,327
-------- -------- -------- -------- -------- --------
Adjusted earnings $149,279 $124,107 $ 98,987 $ 83,740 $ 21,420 $ 99,695
======== ======== ======== ======== ======== ========
Fixed charges:
Interest expense $ 41,223 $ 40,924 $ 41,789 $ 36,104 $ 31,660 $ 31,660
Portion of rent expense
representing interest 4,766 4,632 4,274 5,224 4,667 4,667
-------- -------- -------- -------- -------- --------
Adjusted fixed charges $ 45,989 $ 45,556 $ 46,063 $ 41,328 $ 36,327 $ 36,327
======== ======== ======== ======== ======== ========
RATIO OF EARNINGS TO FIXED
CHARGES 3.25 2.72 2.15 2.03 -- 2.74
</TABLE>
(a) Excludes an after-tax restructuring charge of approximately $48 million for
the implementation of a re-engineering plan in 1993. 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-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 672
<SECURITIES> 0
<RECEIVABLES> 224,524
<ALLOWANCES> 8,596
<INVENTORY> 15,030
<CURRENT-ASSETS> 251,669
<PP&E> 2,019,252
<DEPRECIATION> 1,173,900
<TOTAL-ASSETS> 1,306,113
<CURRENT-LIABILITIES> 241,604
<BONDS> 510,184
0
0
<COMMON> 250,000
<OTHER-SE> 115,764
<TOTAL-LIABILITY-AND-EQUITY> 1,306,113
<SALES> 642,357
<TOTAL-REVENUES> 642,357
<CGS> 262,210
<TOTAL-COSTS> 502,275
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 37,490
<INCOME-PRETAX> 103,290
<INCOME-TAX> 42,292
<INCOME-CONTINUING> 60,998
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 60,998
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
