-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, H2w3I5HPKGOdI9f2Vk65Fag06Hl2p5alTRST4ONoNenKHkbdNiYh80+ATUnzwJq/ krk6ivZ7+hGZcfbWB0gW6Q== 0000950134-96-000899.txt : 19960327 0000950134-96-000899.hdr.sgml : 19960327 ACCESSION NUMBER: 0000950134-96-000899 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19951231 FILED AS OF DATE: 19960326 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: CONTEL OF CALIFORNIA INC CENTRAL INDEX KEY: 0000024186 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 951789511 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-01245 FILM NUMBER: 96538525 BUSINESS ADDRESS: STREET 1: 600 HIDDEN RIDGE STREET 2: HQE04B12 CITY: IRVING STATE: TX ZIP: 75038 BUSINESS PHONE: 2147185600 FORMER COMPANY: FORMER CONFORMED NAME: CONTINENTAL TELEPHONE CO OF CALIFORNIA DATE OF NAME CHANGE: 19880519 FORMER COMPANY: FORMER CONFORMED NAME: CALIFORNIA INTERSTATE TELEPHONE CO DATE OF NAME CHANGE: 19750501 10-K405 1 FORM 10-K FISCAL YEAR END 12-31-95 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 [Fee Required] For the fiscal year ended December 31, 1995 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 [No Fee Required] For the transition period from to Commission File Number 0-1245 CONTEL OF CALIFORNIA, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) CALIFORNIA 95-1789511 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.) INCORPORATION OR ORGANIZATION) 16071 Mojave Drive, Victorville, California 92392 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) Registrant's telephone number, including area code 619-245-0511 Securities registered pursuant to Section 12(b) of the act: NAME OF EACH EXCHANGE ON TITLE OF EACH CLASS WHICH REGISTERED NONE Securities registered pursuant to Section 12(g) of the Act: NONE (TITLE OF CLASS) INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO ------- ------- INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405 OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS FORM 10-K. X ------- THE COMPANY HAD 2,503,667 SHARES OF $5 PAR VALUE COMMON STOCK OUTSTANDING AT FEBRUARY 29, 1996. 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. 2 TABLE OF CONTENTS
Item Page Part I 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 11 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 30 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 31
3 PART I Item 1. Business Contel of California, Inc. (the Company) is a wholly-owned subsidiary of GTE Corporation (GTE), and provides communications services in California, Nevada and Arizona. The Company was incorporated in California in 1954. Since its incorporation, twenty-three independent telephone companies have been merged into the Company to form the present entity. On April 20, 1994, the California Public Service Commission (CPUC) issued a decision giving final approval to the merger of the Company into GTE California. The decision requires the merging companies to flow through to their ratepayers all of the estimated savings that would be produced from the merger. This flow through requirement is based on the CPUC's interpretation of certain statutory requirements. The CPUC, however, provided the parties with the opportunity to supplement the evidentiary record to show why the estimated merger savings should be apportioned between ratepayers and shareholders. That filing was made on April 29, 1994. By making the filing, the effective date of the decision approving the merger was delayed. The Company and other interested parties have filed reports and comments pursuant to this proceeding. On October 5, 1995, the Governor of the State of California signed a law which clarifies the authority of the CPUC to allocate utility merger benefits between ratepayers and shareholders with not less than 50% going to the ratepayers. The new law became effective January 1, 1996. A decision approving the merger under the terms of the amended legislation is expected during the second quarter of 1996. 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 industry. The Company provides local telephone service within its franchise area and intraLATA (Local Access Transport Area) toll service between the Company's facilities and the facilities of other telephone companies within the Company's LATAs. InterLATA service to other points in and out of the states in which the Company operates is provided through connection with interexchange (long distance) common carriers. These common carriers are charged fees (access charges) for interconnection to the Company's local facilities. Business and residential customers also pay access charges to connect to the local network to obtain long distance service. The Company earns other revenues by leasing interexchange plant facilities and providing such services as billing and collection and operator services to interexchange carriers. At December 31, 1995, the Company served 389,603 access lines in its service territories. At December 31, 1995, the Company had 1,192 employees. The Company has written agreements with the Communications Workers of America (CWA) and the International Brotherhood of Electrical Workers (IBEW). The current agreements with the CWA and the IBEW units expire on September 6, 1996. REGULATORY AND COMPETITIVE TRENDS The Company is subject to regulation by the regulatory bodies of the states of California, Nevada and Arizona as to its intrastate business operations and by the Federal Communications Commission (FCC) as to its interstate operations. Advances in technology, together with a number of regulatory, legislative and judicial actions, continue to accelerate and expand the level of competition and opportunities available to the Company. Presently, the Company is subject to competition from numerous sources, including competitive access providers (CAPs) for network access services and specialized communications companies that have constructed new systems in certain markets to bypass 1 4 the local-exchange network. In addition, competition from alternative local-exchange carriers (ALECs), interexchange carriers (IXCs), wireless and cable TV companies, as well as more recent entry by media and computer companies, is expected to increase in the rapidly changing telecommunications marketplace. On February 8, 1996, the Telecommunications Act of 1996 (the Telecommunications Act) became law. This comprehensive telecommunications reform legislation addresses a wide range of competitive and regulatory issues that will affect the future development of local and long distance services, cable television and information services. The Telecommunications Act overhauls 62 years of telecommunications law, replacing government regulation with competition as the chief way of assuring that telecommunications services are delivered to customers. The new law removes many of the statutory and court-ordered barriers to competition between segments of the industry, enabling local-exchange, long distance, wireless and cable companies to compete in offering voice, video and information services. The Telecommunications Act requires the FCC and state commissions to set new guidelines to open local-exchange markets and to set new guidelines for interconnection, loosens restrictions barring local telephone companies from entering the cable television market, and preserves Universal Service while equalizing the responsibility for contribution among all carriers. A key provision of the Telecommunications Act also eliminates the legal restraints of the GTE Consent Decree which has kept the Company from providing interLATA services. This action will simplify GTE's ability to market local intraLATA and interLATA service to its customers as a bundled service. In February 1996, GTE executed an agreement whereby WorldCom, Inc. will provide, on a non-exclusive basis, a full array of telecommunications services in support of GTE's entry into the interLATA long distance market. In March 1996, GTE, through a separate subsidiary, began offering long distance to its customers in selected markets. GTE plans to offer the service, marketed under the name GTE Easy Savings Plan(SM), in all 28 states where it currently offers local telephone service by December 1996. The Telecommunications Act forbids states from imposing any barriers to entry into local and toll competition. Through 1995, local competition has been authorized in fifteen states, including California and Nevada. In addition, eight states, including Arizona, have concluded that intraLATA 1+ competition is in the public interest. These states have authorized plans that would allow customers to pre-subscribe to a specific carrier to handle their intraLATA toll calls. Pre-subscribed customers will simply dial "1" before the telephone number in order to complete intraLATA calls. The Telecommunications Act requires GTE to negotiate intraLATA dialing parity provisions with its competitors. In subsequent negotiations, GTE will address implementation of 1+ in those states which have not previously ordered implementation. Federal and state regulatory activity directed toward changing the traditional cost-based, rate-of-return regulatory framework for intrastate and interstate telephone service has continued. Regulatory authorities have adopted various forms of alternative regulation, which provide economic incentives to telephone service providers to improve productivity and provide the foundation for implementing pricing flexibility necessary to address competitive entry into GTE markets. On January 1, 1995, pursuant to an order issued by the California Public Utilities Commission (CPUC), competition in toll services (without customer pre-subscription) became effective in California. The order also provided for rate rebalancing with significant rate reductions for toll services and access charges while increasing basic local service rates closer to the actual cost of providing such service. Although this rate rebalancing was intended by the CPUC to be revenue neutral, the actual increase in volumes did not fully compensate for the toll and access rate reductions. As expected, revenues decreased by approximately $38 million in 1995 as a result of the implementation of this order. 2 5 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 local-exchange carrier (LEC) may charge are increased or decreased each year by a price index based upon inflation less a predetermined productivity target. LECs have limited pricing flexibility provided they do not exceed the allowed price cap. The FCC is considering how the price cap plan should be modified in the future in order to adapt the system to the emergence of competition. Further information regarding the Company's activities with the various regulatory agencies and revenue arrangements with other telephone companies is discussed in Note 11 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 1995, the Company continued to position itself to respond aggressively to competitive developments and benefit from new opportunities. Restructuring and Cost Control During 1995, the Company continued the implementation of its $49 million re-engineering program. Since the program began in 1994, costs of $28.5 million have been charged to the restructuring reserve -- $17.3 million related to customer service processes, $8.1 million related to administrative processes and $3.1 million related to the consolidation of facilities and operations and other related costs. These costs were primarily associated with the closure and relocation of various centers, software enhancements and separation benefits associated with workforce reductions. The continued implementation of this program positions the Company to accelerate delivery of a full array of voice, video and data services and to reach its stated objective of being the easiest company to do business with in the industry. 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 6 Item 2. Properties The Company's property consists principally of land, structures and equipment required to provide various telecommunications services. All of the aforementioned properties, located in the states of California, Nevada and Arizona, 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, 1991 to December 31, 1995, the Company made capital expenditures of $283.2 million for new plant and facilities required to meet telecommunication service needs and to modernize plant and facilities. These additions were equal to 31% of gross plant of $915.3 million at December 31, 1995. In response to recently enacted and pending legislation 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. 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 elsewhere herein for further detail. Item 3. Legal Proceedings There are no pending legal proceedings, either for or against the Company, which would have a material impact on the Company's consolidated financial statements. 4 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 The First National Bank of Boston, Transfer Agent and Registrar for GTE and the Company's common stock, should be contacted with any questions relating to shareholder accounts. This includes the following: o Account information o Dividends o Market prices o Transfer instructions o Statements and reports o Change of address Shareholders may call toll-free at 1-800-225-5160 anytime, seven days a week. Customer Service Representatives are available Monday through Friday between the hours of 8 a.m. and 5 p.m. Eastern Time. Outside the United States call 1-617-575-2990. Or write to: Bank of Boston c/o Boston EquiServe, L.P. P.O. Box 9121 Mail Stop 52-02-60 Boston, MA 02205-9121 For overnight delivery services, use the following address: Bank of Boston c/o Boston EquiServe, L.P. Blue Hills Office Park 150 Royall Street Canton, MA 02021 The Bank of Boston address where shareholders, banks, and brokers may deliver certificates is One Exchange Place, 55 Broadway in New York City. PARENT COMPANY ANNUAL REPORT To obtain a copy of the 1995 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 5 8 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Dollars in Millions) BUSINESS OPERATIONS Contel of California, Inc. (the Company), a wholly-owned subsidiary of GTE Corporation (GTE), provides local-exchange, network access and toll services in the states of California, Nevada and Arizona. At December 31, 1995, the Company served 389,603 access lines in its service territories. RESULTS OF OPERATIONS
Years Ended December 31, ------------------------ 1995 1994 ------ ----- Net income (loss) $(77.9) $65.7
The net loss for 1995 includes an extraordinary after-tax charge of $127.6 for the discontinuance of Statement of Financial Accounting Standards No. 71 "Accounting for the Effects of Certain Types of Regulation" (FAS 71) in the fourth quarter of 1995. Excluding this charge, net income decreased 24% or $16 in 1995. The decrease is primarily due to the Implementation Rate Design (IRD) discussed below, partially offset by a one-time support payment of $31.9 from the California High Cost Fund received in December 1995, as discussed below. On January 1, 1995, pursuant to an order issued by the California Public Utilities Commission (CPUC), competition in toll services (without customer pre-subscription) became effective in California. The order also provided for rate rebalancing with significant rate reductions for toll service and network access service while increasing basic local service rates closer to the actual cost of providing such service. Although this rate rebalancing was intended by the CPUC to be revenue neutral, the actual increase in volumes did not fully compensate for the toll and access rate reductions. Total revenues decreased approximately $38 in 1995 as a result of the implementation of this order. REVENUES AND SALES
Years Ended December 31, ------------------------ 1995 1994 ------ ------ Local services $149.2 $ 97.3 Network access services 103.8 136.8 Toll services 61.9 108.0 Other services and sales 28.6 29.8 ------ ------ Total revenues and sales $343.5 $371.9
Total revenues and sales decreased 8% or $28.4 in 1995. Local service revenues are based on fees charged to customers for providing local-exchange service within designated franchise areas. Local service revenues increased 53% or $51.9 in 1995. This increase is primarily the result of a one-time support payment of $31.9 recorded in December 1995 from the California High Cost Fund, a fund established to subsidize rural providers for the costs of providing universal service, and $17.3 in rate increases associated with the IRD. This increase is also due to a 3% growth in access lines, which generated $2.4 of additional revenues. 6 9 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. Network access service revenues decreased 24% or $33 in 1995. This decrease is primarily the result of $24 in rate reductions associated with the previously mentioned IRD, $5.1 of lower revenues attributable to the interstate sharing requirements of the FCC price cap plan for the 1994-1995 tariff year and $3 of lower support payments received from the Universal Service Fund. These decreases are partially offset by a 10% increase in minutes of use, which generated $3.1 of additional revenues. Toll service revenues are based on fees charged for service beyond a customer's local calling area but within the local access transport area (LATA). Toll service revenues decreased 43% or $46.1 in 1995. This decrease is primarily the result of $31.4 in rate reductions associated with the previously mentioned IRD and $8.1 of lower transitional support payments received from Pacific Bell as a result of the Company's exit from the California state intraLATA toll pool in 1994. Transitional support payments will continue through 1997 with increasingly lower payments in each of the years 1996 and 1997. Other services and sales revenues decreased 4% or $1.2 in 1995. This decrease is primarily due to lower rent revenues of $0.7 due to the cancellation of interexchange carrier facility leases by AT&T Corp. in 1994. OPERATING COSTS AND EXPENSES
Years Ended December 31, ------------------------ 1995 1994 ------ ------ Cost of services and sales $121.8 $123.8 Selling, general and administrative 55.7 60.3 Depreciation and amortization 69.5 64.6 ------ ------ Total operating costs and expenses $247.0 $248.7
Total operating costs and expenses decreased 1% or $1.7 in 1995. This decrease is primarily related to $10.7 of lower labor and benefits costs associated with the Company's re-engineering plan and a $2.1 decrease in end user uncollectibles. These decreases are partially offset by $7.4 in nonrecurring favorable settlement activities recorded in 1994 and a $4.9 increase in depreciation expenses, primarily related to increased gross plant balances. OTHER EXPENSES Income taxes were $35.8 and $46.1 for 1995 and 1994, respectively, reflecting a decrease of 22% or $10.3. This decrease is primarily related to the decrease in pre-tax income. REGULATORY AND COMPETITIVE TRENDS The Company is subject to regulation by the regulatory bodies of the states of California, Nevada and Arizona as to its intrastate business operations and by the Federal Communications Commission (FCC) as to its interstate operations. Advances in technology, together with a number of regulatory, legislative and judicial actions, continue to accelerate and expand the level of competition and opportunities available to the Company. Presently, the Company is subject to competition from numerous sources, including competitive access providers (CAPs) for network access services and specialized communications companies that have constructed new systems in certain markets to bypass 7 10 the local-exchange network. In addition, competition from alternative local-exchange carriers (ALECs), interexchange carriers (IXCs), wireless and cable TV companies, as well as more recent entry by media and computer companies, is expected to increase in the rapidly changing telecommunications marketplace. On February 8, 1996, the Telecommunications Act of 1996 (the Telecommunications Act) became law. This comprehensive telecommunications reform legislation addresses a wide range of competitive and regulatory issues that will affect the future development of local and long distance services, cable television and information services. The Telecommunications Act overhauls 62 years of telecommunications law, replacing government regulation with competition as the chief way of assuring that telecommunications services are delivered to customers. The new law removes many of the statutory and court-ordered barriers to competition between segments of the industry, enabling local-exchange, long distance, wireless and cable companies to compete in offering voice, video and information services. The Telecommunications Act requires the FCC and state commissions to set new guidelines to open local-exchange markets and to set new guidelines for interconnection, loosens restrictions barring local telephone companies from entering the cable television market, and preserves Universal Service while equalizing the responsibility for contribution among all carriers. A key provision of the Telecommunications Act also eliminates the legal restraints of the GTE Consent Decree which has kept the Company from providing interLATA services. This action will simplify GTE's ability to market local intraLATA and interLATA service to its customers as a bundled service. In February 1996, GTE executed an agreement whereby WorldCom, Inc. will provide, on a non-exclusive basis, a full array of telecommunications services in support of GTE's entry into the interLATA long distance market. In March 1996, GTE, through a separate subsidiary, began offering long distance to its customers in selected markets. GTE plans to offer the service, marketed under the name GTE Easy Savings Plan(SM), in all 28 states where it currently offers local telephone service by December 1996. The Telecommunications Act forbids states from imposing any barriers to entry into local and toll competition. Through 1995, local competition has been authorized in fifteen states, including California and Nevada. In addition, eight states, including Arizona, have concluded that intraLATA 1+ competition is in the public interest. These states have authorized plans that would allow customers to pre-subscribe to a specific carrier to handle their intraLATA toll calls. Pre-subscribed customers will simply dial "1" before the telephone number in order to complete intraLATA calls. The Telecommunications Act requires GTE to negotiate intraLATA dialing parity provisions with its competitors. In subsequent negotiations, GTE will address implementation of 1+ in those states which have not previously ordered implementation. Federal and state regulatory activity directed toward changing the traditional cost-based, rate-of-return regulatory framework for intrastate and interstate telephone service has continued. Regulatory authorities have adopted various forms of alternative regulation, which provide economic incentives to telephone service providers to improve productivity and provide the foundation for implementing pricing flexibility necessary to address competitive entry into GTE markets. On January 1, 1995, pursuant to an order issued by the California Public Utilities Commission (CPUC), competition in toll services (without customer pre-subscription) became effective in California. The order also provided for rate rebalancing with significant rate reductions for toll services and access charges while increasing basic local service rates closer to the actual cost of providing such service. Although this rate rebalancing was intended by the CPUC to be revenue neutral, the actual increase in volumes did not fully compensate for the toll and access rate reductions. As expected, revenues decreased by approximately $38 million in 1995 as a result of the implementation of this order. 8 11 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 index based upon inflation less a predetermined productivity target. LECs have limited pricing flexibility provided they do not exceed the allowed price cap. The FCC is considering how the price cap plan should be modified in the future in order to adapt the system to the emergence of competition. Further information regarding the Company's activities with the various regulatory agencies and revenue arrangements with other telephone companies is discussed in Note 11 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 1995, the Company continued to position itself to respond aggressively to competitive developments and benefit from new opportunities. Restructuring and Cost Control During 1995, the Company continued the implementation of its $49 re-engineering program. Since the program began in 1994, costs of $28.5 have been charged to the restructuring reserve -- $17.3 related to customer service processes, $8.1 related to administrative processes and $3.1 related to the consolidation of facilities and operations and other related costs. These costs were primarily associated with the closure and relocation of various centers, software enhancements and separation benefits associated with workforce reductions. The continued implementation of this program positions the Company to accelerate delivery of a full array of voice, video and data services and to reach its stated objective of being the easiest company to do business with in the industry. 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. 9 12 RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" (FAS 121) in March 1995, which is effective January 1, 1996. FAS 121 requires that an impairment loss be recognized when circumstances indicate that the carrying amount of an asset may not be recoverable. Historically, the Company has used a methodology similar to FAS 121 in determining the amount of an impairment. Accordingly, the issuance of FAS 121 will not have a significant impact on the Company's consolidated financial statements. In October 1995, the FASB issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (FAS 123). As permitted by FAS 123, the Company will continue to apply the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and adopt the disclosure requirements of FAS 123 beginning in 1996. Accordingly, the issuance of FAS 123 will not impact the Company's financial position or results of operations. INFLATION The Company's management generally does not believe inflation has a significant impact on the Company's earnings. However, increases in costs or expenses not otherwise offset by increases in revenues could have an adverse effect on earnings. 10 13 Item 8. Financial Statements and Supplementary Data Contel of California, Inc. and Subsidiary CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31 1995 1994 1993 - ----------------------- --------- -------- -------- (Thousands of Dollars) Revenues and sales: Local services $ 149,205 $ 97,349 $ 94,586 Network access services 103,825 136,769 139,822 Toll services 61,854 108,008 124,780 Other services and sales 28,599 29,798 31,779 --------- -------- -------- Total revenues and sales 343,483 371,924 390,967 --------- -------- -------- Operating costs and expenses (a): Cost of services and sales 121,841 123,777 121,927 Selling, general and administrative 55,663 60,323 58,448 Depreciation and amortization 69,496 64,637 58,431 Restructuring -- -- 48,987 --------- -------- -------- Total operating costs and expenses 247,000 248,737 287,793 --------- -------- -------- Operating income 96,483 123,187 103,174 Other expense: Interest - net 10,913 11,321 10,708 --------- -------- -------- Income before income taxes 85,570 111,866 92,466 Income taxes 35,831 46,120 37,397 --------- -------- -------- Income before extraordinary charge 49,739 65,746 55,069 Extraordinary charge (127,620) -- -- --------- -------- -------- Net income (loss) $(77,881) $ 65,746 $ 55,069 ========= ======== ========
(a) Includes billings from affiliates of $16,442, $13,929 and $14,305 for the years 1995-1993, respectively. See Notes to Consolidated Financial Statements. 11 14 Contel of California, Inc. and Subsidiary CONSOLIDATED BALANCE SHEETS
December 31 1995 1994 - ----------- -------- -------- (Thousands of Dollars) ASSETS Current assets: Cash and temporary investments $ 2,139 $ 2,244 Receivables, less allowances of $4,895 and $3,523 120,872 75,579 Inventories and supplies 652 2,134 Deferred income tax benefits 18,432 6,793 Other 841 228 -------- -------- Total current assets 142,936 86,978 -------- -------- Property, plant and equipment, net 280,157 524,215 Deferred income tax benefits and other assets 16,331 39,883 -------- -------- Total assets $439,424 $651,076 ======== ======== LIABILITIES AND SHAREHOLDER'S EQUITY Current liabilities: Notes payable to affiliates $ 51,838 $ 67,703 Accounts payable 32,318 26,825 Affiliate payables and accruals 3,173 6,341 Advanced billings and customer deposits 5,633 4,069 Taxes payable 21,943 6,814 Accrued interest 2,389 2,697 Accrued payroll costs 9,369 7,280 Dividends payable -- 15,261 Accrued restructuring costs 20,455 12,730 Other 21,986 13,509 -------- -------- Total current liabilities 169,104 163,229 -------- -------- Non-current liabilities: Long-term debt 90,000 90,000 Deferred income taxes and investment tax credits 5,781 108,402 Employee benefit obligations 60,516 57,564 Restructuring costs -- 9,580 Other liabilities 5,828 5,562 -------- -------- Total non-current liabilities 162,125 271,108 -------- -------- Shareholder's equity: Common stock (2,503,667 shares issued) 12,518 12,518 Additional paid-in capital 78,917 78,917 Retained earnings 16,760 125,304 -------- -------- Total shareholder's equity 108,195 216,739 -------- -------- Total liabilities and shareholder's equity $439,424 $651,076 ======== ========
See Notes to Consolidated Financial Statements. 12 15 Contel of California, Inc. and Subsidiary CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31 1995 1994 1993 - ----------------------- -------- -------- -------- (Thousands of Dollars) Operations: Income before extraordinary charge $ 49,739 $ 65,746 $ 55,069 Adjustments to reconcile income before extraordinary charge to net cash from operations: Depreciation and amortization 69,496 64,637 58,431 Deferred income taxes (3,447) 24,767 (19,678) Restructuring costs -- -- 48,987 Provision for uncollectible accounts 5,072 4,788 6,479 Change in current assets and current liabilities: Receivables - net (50,365) 1,725 (24,129) Other current assets 869 654 348 Accrued taxes and interest 14,821 (27,871) (28,443) Other current liabilities 12,828 (44,982) (11,132) Other - net 1,854 36,116 51,704 -------- -------- -------- Net cash from operations 100,867 125,580 137,636 -------- -------- -------- Investing: Capital expenditures (39,183) (52,317) (60,400) -------- -------- -------- Cash used in investing (39,183) (52,317) (60,400) -------- -------- -------- Financing: Long-term debt and preferred stock retired -- (8,010) (27,630) Dividends (45,924) (61,906) (91,519) Net change in affiliate notes (15,865) (1,171) 40,504 -------- -------- -------- Net cash used in financing (61,789) (71,087) (78,645) -------- -------- -------- Increase (decrease) in cash and temporary investments (105) 2,176 (1,409) Cash and temporary investments: Beginning of year 2,244 68 1,477 -------- -------- -------- End of year $ 2,139 $ 2,244 $ 68 ======== ======== ======== Cash paid during the year for: Interest $ 11,685 $ 11,999 $ 12,370 Income taxes 22,823 49,129 70,895
See Notes to Consolidated Financial Statements. 13 16 Contel of California, Inc. and Subsidiary CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY
Additional Common Paid-In Retained Stock Capital Earnings Total ------- ---------- --------- --------- (Thousands of Dollars) Shareholder's equity, December 31, 1992 $12,518 $78,917 $ 146,075 $ 237,510 Net income 55,069 55,069 Dividends declared (106,572) (106,572) ------- ------- --------- --------- Shareholder's equity, December 31, 1993 12,518 78,917 94,572 186,007 Net income 65,746 65,746 Dividends declared (35,014) (35,014) ------- ------- --------- --------- Shareholder's equity, December 31, 1994 12,518 78,917 125,304 216,739 Net loss (77,881) (77,881) Dividends declared (30,663) (30,663) ------- ------- --------- --------- Shareholder's equity, December 31, 1995 $12,518 $78,917 $ 16,760 $ 108,195 ======= ======= ========= =========
See Notes to Consolidated Financial Statements. 14 17 Contel of California, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS Contel of California, Inc. (the Company) provides a wide variety of communications services ranging from local telephone service for the home and office to highly complex voice and data services for various industries. At December 31, 1995, the Company served 389,603 access lines in the states of California, Nevada and Arizona. The Company is a wholly-owned subsidiary of GTE Corporation (GTE). BASIS OF PRESENTATION The Company prepares its consolidated financial statements in accordance with generally accepted accounting principles which require that management make estimates and assumptions that affect the reported amounts. Actual results could differ from those estimates. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Contel Advanced Systems, Inc. All significant intercompany transactions have been eliminated. The Company discontinued applying the provisions of Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation" (FAS 71), in the fourth quarter of 1995 (see Note 2). The 1995 financial presentation reflects account classifications consistent with unregulated enterprises operating in a competitive environment. Specifically, uncollectible revenue accounts have been reclassified from revenues and sales to selling, general and administrative expenses. Reclassifications of prior-year data have been made, where appropriate, to conform to the 1995 presentation. TRANSACTIONS WITH AFFILIATES Certain affiliated companies, which are not subsidiaries of the Company, supply construction and maintenance equipment, supplies and electronic repair services to the Company. These purchases and services amounted to $9.8 million, $11.5 million and $11.7 million for the years 1995-1993, respectively. Such purchases and services are recorded in the accounts of the Company at cost which includes a normal profit realized by the affiliates. The Company is billed for 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 $16.4 million, $13.9 million and $14.3 million for the years 1995-1993, respectively. The amounts charged for these affiliated transactions are based on a proportional cost allocation method. The Company's consolidated financial statements include allocated expenses based on the sharing of certain executive, administrative, financial, accounting, marketing, personnel, engineering and other support services being performed at consolidated work centers among the domestic GTE Telephone Operating Companies. The amounts charged for these affiliated transations are based on a proportional cost allocation method as filed with the Federal Communications Commission (FCC). TELEPHONE PLANT The Company has historically provided for depreciation on a straight-line basis over asset lives approved by regulators. Beginning in 1996, the Company will provide for depreciation on a straight-line basis over the estimated economic lives of its assets (see Note 2). Maintenance and repairs are charged to income as incurred. Additions to, 15 18 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. REVENUE RECOGNITION Revenues are recognized when earned. This is generally based on usage of the Company's local-exchange networks or facilities. For other products and services, revenues are generally recognized when services are rendered or products are delivered to customers. INVENTORIES AND SUPPLIES Inventories and supplies are stated at the lower of cost, determined principally by the average cost method, or net realizable value. EMPLOYEE BENEFIT PLANS Pension and postretirement health care and life insurance benefits earned during the year as well as interest on accumulated benefit obligations are accrued currently. Prior service costs and credits resulting from changes in plan benefits are amortized over the average remaining service period of the employees expected to receive benefits. Material curtailment/settlement gains and losses associated with employee separations are recognized in the period in which they occur. The Company adopted Statement of Financial Accounting Standards No. 112, "Employers' Accounting for Postemployment Benefits" (FAS 112), effective January 1, 1993. FAS 112 requires employers to accrue the future cost of benefits provided to former or inactive employees and their dependents after employment but before retirement. Previously, the cost of these benefits was charged to expense as paid. The impact of this change in accounting on the Company's results of operations was immaterial. 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 financial and tax reporting bases 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 any deferred tax asset for which realization is not likely. COMPUTER SOFTWARE The cost of computer software for internal use, except initial operating system software, is charged to expense as incurred. Initial operating system software is capitalized and amortized over the life of the related hardware. CASH AND TEMPORARY INVESTMENTS Cash and temporary investments include investments in short-term, highly liquid securities, which have maturities when purchased of three months or less. 16 19 RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" (FAS 121) in March 1995, which is effective January 1, 1996. FAS 121 requires that an impairment loss be recognized when circumstances indicate that the carrying amount of an asset may not be recoverable. Historically, the Company has used a methodology similar to FAS 121 in determining the amount of an impairment. Accordingly, the issuance of FAS 121 will not have a significant impact on the Company's consolidated financial statements. In October 1995, the FASB issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (FAS 123). As permitted by FAS 123, the Company will continue to apply the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and adopt the disclosure requirements of FAS 123 beginning in 1996. Accordingly, the issuance of FAS 123 will not impact the Company's financial position or results of operations. 2. EXTRAORDINARY CHARGE In response to recently enacted and pending legislation (see Note 11) and the increasingly competitive environment, the Company discontinued the use of FAS 71 in the fourth quarter of 1995. 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. As a result of the decision to discontinue FAS 71, the Company recorded a non-cash, after-tax extraordinary charge of $127.6 million (net of tax benefits of $87.8 million) in the fourth quarter of 1995. The charge primarily represents a reduction in the net book value of telephone plant and equipment through an increase in accumulated depreciation. The amount of the charge was based on an analysis of the discounted cash flows expected to be generated by the embedded telephone plant and equipment over their remaining economic lives. In addition to the one-time charge, the Company, beginning in 1996, will shorten the depreciable lives of its telephone plant and equipment as follows as a result of the discontinuance of FAS 71:
Depreciable Lives ----------------------------- Average Asset Category Before After -------------- ------- ----- Copper 20-30 15 Switching 17-19 10 Circuit 11-13 8 Fiber 25-30 20
17 20 3. RESTRUCTURING COSTS Results for 1993 include one-time pre-tax restructuring costs of $49 million, which reduced net income by $30.2 million, primarily for incremental costs related to implementation of the Company's three-year re-engineering plan. The re-engineering plan will redesign and streamline processes to improve customer-responsiveness and product quality, reduce the time necessary to introduce new products and services and further reduce costs. The implementation of the plan is expected to result in costs of $33.8 million to re-engineer customer service processes and $12.1 million to re-engineer administrative processes. The restructuring costs also include $3.1 million primarily for the consolidation of facilities and operations and other related costs. Implementation of the re-engineering plan began during 1994 and is expected to be substantially completed by the end of 1996. Costs of $28.5 million have been incurred since the plan's inception including $17.3 million related to customer service processes, $8.1 million related to administrative processes and $3.1 million related to the consolidation of facilities and operations and other related costs. These expenditures were primarily associated with the closure and relocation of various service centers, software enhancements and separation benefits related to employee reductions. During 1993, the Company offered various voluntary separation programs to its employees. These programs resulted in a pre-tax charge of $3 million which reduced 1993 net income by $1.8 million. 4. PREFERRED STOCK On March 1, 1994, the Company redeemed all outstanding shares of preferred stock with cash from operations. 5. COMMON STOCK The authorized common stock of the Company at December 31, 1995 and 1994 consisted of 3,000,000 shares with a par value of $5 per share. All outstanding shares of common stock are held by the Parent Company. 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, 1995, all retained earnings were restricted as to the payment of cash dividends on common stock under the most restrictive terms of the Company's indentures. In addition, as a result of the discontinuance of FAS 71 discussed in Note 2, the Company is currently restricted from making a full payment of cash dividends on common stock. 18 21 6. DEBT Long-term debt as of December 31 was as follows:
1995 1994 ------- ------- (Thousands of Dollars) First mortgage bonds: 7.625 % Series J, due 1997 $10,000 $10,000 9.45 % Series V, due 1997 10,000 10,000 9.41 % Series W, maturing through 2014 40,000 40,000 9.44 % Series X, due 2015 30,000 30,000 ------- ------- Total 90,000 90,000 Less: current maturities of long-term debt -- -- ------- ------- Total long-term debt $90,000 $90,000 ======= =======
During 1994, the Company retired $2.8 million of 9.25% First Mortgage Bonds due 2001 and $3 million of 8.75% Sinking Fund Debentures. 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. 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 aggregate to $22.5 million. The Company finances part of its construction program through the use of short-term notes payable to affiliates which are generally refinanced at a later date by issues of long-term debt or equity. During 1995, the Company supplemented its internal generation of cash with funds borrowed from GTE. These arrangements require payment of interest based on prevailing commercial paper rates. As of December 31, 1995 and 1994, the short-term notes payable with GTE were $51.8 million and $67.7 million, respectively, with average interest rates of 6.1% and 3.3%. 7. FINANCIAL INSTRUMENTS The fair values of financial instruments, other than long-term debt, closely approximate their carrying value. As of December 31, 1995 and 1994, 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 $15 million and $4 million, respectively. 19 22 8. INCOME TAXES The income tax provision is as follows:
1995 1994 1993 -------- -------- -------- (Thousands of Dollars) Current: Federal $ 29,677 $ 16,621 $ 46,368 State 9,601 4,732 12,442 -------- -------- -------- 39,278 21,353 58,810 -------- -------- -------- Deferred: Federal (1,702) 20,919 (14,218) State (59) 5,612 (5,343) -------- -------- -------- (1,761) 26,531 (19,561) -------- -------- -------- Amortization of deferred investment tax credits (1,686) (1,764) (1,852) -------- -------- -------- Total $ 35,831 $ 46,120 $ 37,397 ======== ======== ========
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:
1995 1994 1993 -------- -------- -------- (Thousands of Dollars) Amounts computed at statutory rates $ 29,950 $ 39,153 $ 32,363 State income taxes, net of federal income tax benefits 6,202 6,724 4,615 Amortization of deferred investment tax credits (1,686) (1,764) (1,852) Depreciation of telephone plant construction costs previously deducted for tax purposes - net 2,047 2,189 1,822 Rate differentials applied to reversing temporary (692) (932) (453) differences Other differences - net 10 750 902 -------- -------- -------- Total provision $ 35,831 $ 46,120 $ 37,397 ======== ======== ========
The tax effects of temporary differences that give rise to the deferred income tax benefits and deferred income tax liabilities at December 31 are as follows:
1995 1994 --------- --------- (Thousands of Dollars) Depreciation and amortization $ 3,300 $ 129,401 Employee benefit obligations (15,124) (14,659) Prepaid pension costs (5,183) (2,816) Restructuring costs (8,339) (9,094) Investment tax credits 5,782 8,695 Other - net (9,282) (9,918) --------- --------- Total $(28,846) $ 101,609 ========= =========
20 23 9. EMPLOYEE BENEFIT PLANS RETIREMENT PLANS The Company sponsors noncontributory defined benefit pension plans covering substantially all employees. The benefits to be paid under these plans are generally based on years of credited service and average final earnings. The Company's funding policy, subject to the minimum funding requirements of U.S. employee benefit and tax laws, is to contribute such amounts as are determined on an actuarial basis to provide the plans with assets sufficient to meet the benefit obligations of the plans. The assets of the plans consist primarily of corporate equities, government securities and fixed income investments. The components of the net pension (credit) expense for 1995-1993 were as follows:
1995 1994 1993 -------- -------- -------- (Thousands of Dollars) Benefits earned during the year $ 2,143 $ 4,325 $ 4,238 Interest cost on projected benefit obligations 13,782 10,770 10,839 Return on plan assets: Actual (31,238) 489 (27,181) Deferred 15,920 (15,482) 13,990 Other - net (781) (2,168) (1,525) -------- -------- -------- Net pension (credit) expense $ (174) $(2,066) $ 361 ======== ======== ========
The expected long-term rate of return on plan assets was 8.5% for 1995 and 1994, and 8.25% for 1993. The funded status of the plans and the pension liability at December 31 were as follows:
1995 1994 --------- --------- (Thousands of Dollars) Vested benefit obligations $ 103,006 $ 143,683 ========= ========= Accumulated benefit obligations $ 114,666 $ 155,290 ========= ========= Plan assets at fair value $ 166,053 $ 205,743 Less: projected benefit obligations 133,577 181,918 --------- --------- Excess of assets over projected benefit obligations 32,476 23,825 Unrecognized net transition asset (1,079) (1,931) Unrecognized net gain (45,450) (36,321) --------- --------- Total - net $(14,053) $(14,427) ========= =========
Assumptions used to develop the projected benefit obligations at December 31 were as follows:
1995 1994 ---- ---- Discount rate 7.50% 8.25% Rate of compensation increase 5.25% 5.50%
21 24 POSTRETIREMENT BENEFITS OTHER THAN PENSIONS Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" (FAS 106). FAS 106 requires that the expected costs of these benefits be charged to expense during the years that the employees render service. The Company elected to adopt FAS 106 on the delayed recognition method and commencing January 1, 1993, began amortizing the estimated unrecorded accumulated postretirement benefit obligation over twenty years. Prior to the adoption of FAS 106, the cost of these benefits was charged to expense as paid. Substantially all of the Company's employees are covered under postretirement health care and life insurance benefit plans. The health care benefits paid under the plans are generally based on comprehensive hospital, medical and surgical benefit provisions. The Company funds amounts for postretirement benefits as deemed appropriate from time to time. The postretirement benefit cost for 1995-1993 included the following components:
1995 1994 1993 ------- ------- ------- (Thousands of Dollars) Benefits earned during the year $ 938 $ 1,532 $ 2,153 Interest cost on accumulated postretirement benefit 8,748 7,577 8,372 obligations Actual return on plan assets (3,090) 593 -- Amortization of transition obligation 3,315 4,003 4,622 Other - net 1,102 (4,871) -- ------- ------- ------- Total - net $11,013 $ 8,834 $15,147 ======= ======= =======
The following table sets forth the plans' funded status and the accrued postretirement benefit obligations as of December 31:
1995 1994 -------- -------- (Thousands of Dollars) Accumulated postretirement benefit obligations attributable to: Retirees $ 94,670 $105,165 Fully eligible active plan participants 3,338 6,225 Other active plan participants 17,142 10,802 -------- -------- Total accumulated postretirement benefit obligations 115,150 122,192 Less: fair value of plan assets 27,509 19,111 -------- -------- Excess of accumulated obligations over plan assets 87,641 103,081 Unrecognized transition obligation (55,149) (59,675) Unrecognized net gain (loss) 9,591 (4,683) -------- -------- Total $ 42,083 $ 38,723 ======== ========
The assumed discount rates used to measure the accumulated postretirement benefit obligations were 7.5% at December 31, 1995 and 8.25% at December 31, 1994. The assumed health care cost trend rates in 1995 and 1994 were 11% and 12%, respectively, for pre-65 participants and 8.5% and 9.0%, respectively, for post-65 retirees, each rate declining on a graduated basis to an ultimate rate in the year 2004 of 6%. A one percentage point increase in the assumed health care cost trend rates for each future year would have increased 1995 costs by $0.8 million and the accumulated postretirement benefit obligations at December 31, 1995 by $9.3 million. 22 25 During 1993, the Company made certain changes to its postretirement health care and life insurance benefits for non-union employees retiring on or after January 1, 1995. These changes include, among others, newly established limits to the Company's annual contribution to postretirement medical costs and a revised cost sharing schedule based on a retiree's years of service. 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 $0.7 million in each of the years 1995-1993. 10. PROPERTY, PLANT AND EQUIPMENT The Company's property, plant and equipment is summarized as follows at December 31:
1995 1994 -------- -------- (Thousands of Dollars) Land $ 4,046 $ 4,043 Buildings 50,197 49,863 Plant and equipment 804,958 796,047 Other 56,090 59,273 -------- -------- Total 915,291 909,226 Accumulated depreciation (see Note 2) 635,134 385,011 -------- -------- Total property, plant and equipment - net $280,157 $524,215 ======== ========
Depreciation provisions in 1995-1993 were equivalent to a composite annual percentage of 7.6%, 7.3% and 6.9%, respectively. 23 26 11. REGULATORY AND COMPETITIVE MATTERS The Company's intrastate business is regulated by the state regulatory commissions in California, Nevada and Arizona. The Company is subject to regulation by the Federal Communications Commission (FCC) for its interstate business operations. INTRASTATE SERVICES The Company provides local-exchange services to customers within its designated franchise area. The Company provides toll services within designated geographic areas called Local Access and Transport Areas (LATAs) under agreements with connecting local-exchange carriers (LECs) in conformity with state regulatory orders. The Company also provides long distance access services directly to interexchange carriers (IXCs) and other customers who provide service between LATAs. New Regulatory Framework (NRF) Effective January 1, 1990 the California Public Utilities Commission (CPUC) adopted the NRF for GTE in Phase II of the Alternative Regulatory Proceeding. The new framework replaced the traditional "rate case" process with a framework that centers around a Price Cap Index (PCI) mechanism with "sharing" of intrastate earnings (those earnings subject to CPUC regulation) above a benchmark rate of return. This plan is designed to stimulate productivity and efficiencies with a portion of these gains flowing directly to the customer. During 1993, the CPUC approved a NRF settlement agreement allowing GTE California Incorporated (GTE California) to retain 100% of any earnings up to 15.5% beginning in 1994. Under its prior agreement, GTE California was required to share 50% of any earnings over a 13% rate of return and refund 100% of any earnings over 16.5%. A policy order issued by the CPUC on July 24, 1991, urged the Company to adopt the NRF for the Company's operations to be effective no later than January 1, 1994. The Company has requested that it be allowed to adopt GTE California's NRF. Under the NRF, rates are adjusted annually by the PCI, which is based on inflation minus a productivity improvement factor. Rates for partially competitive services (i.e. Centrex and custom calling features) may be priced below the price cap within a range set by the CPUC. Rates are also adjusted for exogenous events that are beyond the control of management as defined in this plan. Fully competitive services (e.g., directory advertising) are not subject to pricing limits set by the CPUC. Several regulatory proceedings are underway in California to determine terms and conditions for unbundling of GTE's network, to consider additional pricing flexibility under the CPUC's NRF, to modify the NRF to reflect the new competitive marketplace, to institute intraLATA 1+ dialing parity provisions and to establish final rules and obligations for Universal Service funding. Implementation Rate Design (IRD) In September 1994, the CPUC issued a final order that authorized intraLATA toll competition (without customer pre-subscription) in California, effective January 1, 1995, associated with the IRD. The final order also provides for rate rebalancing with significant rate reductions for toll service and access charges while increasing basic local-exchange rates closer to the actual cost of providing such service. Although this rate rebalancing was intended by the CPUC to be revenue neutral, the actual increase in volumes did not fully compensate for the toll and access rate reductions. The decision did not permit rate increases to compensate for competitive losses of market share. Toll revenues decreased approximately $38 million in 1995 as a result of the implementation of this order. In compliance with CPUC decision D.94-09-065 (IRD), the Company filed a general rate case on December 6, 1995. The Company proposes to recover $45.3 million of revenue requirement from a combination of increases to basic exchange rates and universal high cost fund which is currently under review by the CPUC. 24 27 Competition In December 1994, the CPUC issued a decision which adopted an initial procedural plan to facilitate opening local-exchange telecommunications markets to competition by January 1, 1997. On April 26, 1995, the CPUC issued a formal rulemaking proceeding and investigation as a procedural vehicle to develop and adopt rules for local competition. The rulemaking document contained proposed interim rules which authorized competitive LECs to seek authority to offer local-exchange services beginning in June 1995. The parties filed comments on the proposed rules on May 24, 1995. The Company's comments asserted the need for evidentiary hearings to address critical issues such as regulatory parity and interconnection prior to the authorization of local competition. On July 19, 1995, the CPUC issued interim Universal Service rules and obligations as a precursor to local competition. The CPUC is expected to adopt final Universal Service rules and obligations by July 1996. On July 24, 1995, the CPUC issued interim rules for local competition which permit facilities-based local competition in Pacific Bell and GTE California franchised service areas effective January 1, 1996, with resale authority granted two months later. The CPUC reiterated its goal of opening the service areas of small and mid-sized LECs, including the Company's service areas, to full competition, effective January 1, 1997. Local competition in the Company's service areas could occur earlier depending on the final effective date of the pending merger discussed below. Merger In March 1991, the merger of Contel Corporation (Contel) and GTE was consummated. In an interim decision issued on March 13, 1991, the CPUC approved a stipulation agreement which tentatively approved the merger of GTE and Contel. The interim decision also established a second phase of the proceeding in which GTE was directed to show that the merger meets certain California statutory requirements. GTE was also ordered to submit a plan for the merger of any of the Contel and GTE regulated California subsidiaries. On September 14, 1992, the Company and GTE California joined with GTE and Contel and filed a comprehensive plan with the CPUC to merge the Company into GTE California. On April 20, 1994, the CPUC issued a decision giving final approval to the merger of the Company into GTE California. The decision requires the merging companies to flow through to their ratepayers all of the estimated savings that would be produced from the merger. This flow through requirement is based on the CPUC's interpretation of certain statutory requirements. The CPUC, however, provided the parties with the opportunity to supplement the evidentiary record to show why the estimated merger savings should be apportioned between ratepayers and shareholders. That filing was made on April 29, 1994. By making the filing, the effective date of the decision approving the merger was delayed. The Company and other interested parties have filed reports and comments pursuant to this proceeding. On October 5, 1995, the Governor of the State of California signed a law which clarifies the authority of the CPUC to allocate utility merger benefits between ratepayers and shareholders with not less than 50% going to the ratepayers. The new law became effective January 1, 1996. A decision approving the merger under the terms of the amended legislation is expected during the second quarter of 1996. In addition, merger applications were filed with the Arizona Corporation Commission (ACC) on October 4, 1993 and the Nevada Public Service Commission (NPSC) on April 2, 1993. These applications were approved during 1994 but were made subject to final approval in California. The Company currently anticipates, subject to receipt of the final approval from the CPUC, that the merger will be consummated in the second half of 1996. 25 28 INTERSTATE SERVICES 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 may, within certain ranges, price individual services above or below the overall cap. In March 1995, the FCC adopted interim rules to be utilized by LECs, including the Company, for their 1995 Annual Price Cap Filing. The interim rules allowed LECs to select from three productivity/sharing options for each tariff entity. Each of the three options reflected an increase to the 3.3% productivity factor used since 1991. The Company selected a 5.3% productivity factor, with no sharing required, in each of its tariff entities for use in the 1995-1996 tariff year. Under the interim rules, the Company filed tariffs to reduce rates by $1.5 million annually, effective August 1, 1995. On September 20, 1995, the FCC released its proposed rulemaking proceeding on price caps which proposes specific changes to reflect and encourage emerging competition in local and access services markets and to establish the path towards decreased regulation of LECs' services. On September 27, 1995, the FCC solicited comments on a number of specific issues regarding methods for establishing the price caps, such as productivity measurements, sharing, the common line formula and exogenous costs. The Company anticipates the FCC will issue an order prior to the July 1996 annual filing. On February 8, 1996, the Telecommunications Act of 1996 (the Telecommunications Act) became law. This comprehensive telecommunications reform legislation addresses a wide range of competitive and regulatory issues that will affect the future development of local and long distance services, cable television and information services. The Telecommunications Act overhauls 62 years of telecommunications law, replacing government regulation with competition as the chief way of assuring that telecommunications services are delivered to customers. The new law removes many of the statutory and court-ordered barriers to competition between segments of the industry, enabling local-exchange, long distance, wireless and cable companies to compete in offering voice, video and information services. The Telecommunications Act requires the FCC and state commissions to set new guidelines to open local-exchange markets and to set new guidelines for interconnection, loosens restrictions barring local telephone companies from entering the cable television market, and preserves Universal Service while equalizing the responsibility for contribution among all carriers. A key provision of the Telecommunications Act also eliminates the legal restraints of the GTE Consent Decree which has kept the Company from providing interLATA services. This action will simplify GTE's ability to market local intraLATA and interLATA service to its customers as a bundled service. In February 1996, GTE executed an agreement whereby WorldCom, Inc. will provide, on a non-exclusive basis, a full array of telecommunications services in support of GTE's entry into the interLATA long distance market. In March 1996, GTE, through a separate subsidiary, began offering long distance to its customers in selected markets. GTE plans to offer the service, marketed under the name GTE Easy Savings Plan(SM), in all 28 states where it currently offers local telephone service by December 1996. SIGNIFICANT CUSTOMER Revenues received from AT&T Corp. include amounts for access, billing and collection and interexchange leased facilities during the years 1995-1993 under various arrangements and amounted to $39.3 million, $50.2 million and $33 million, respectively. 26 29 12. COMMITMENTS AND CONTINGENCIES The Company has noncancelable leases covering certain buildings, office space and equipment. Rental expense was $4.5 million, $3.5 million and $3.2 million in 1995-1993, respectively. Minimum rental commitments for noncancelable leases through 2000 do not exceed $0.1 million annually and aggregate $0.1 million thereafter. The Company is subject to a number of proceedings arising out of the conduct of its business, including those relating to regulatory actions, commercial transactions and/or environmental, safety and health matters. Management believes that the ultimate resolution of these matters will not have a material adverse effect on the results of operations or the financial position of the Company. Recent judicial and regulatory developments, as well as the pace of technological change, have continued to influence industry trends, including accelerating and expanding the level of competition. As a result, the Company's operations face increasing competition in virtually all aspects of its business. The Company 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. 27 30 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors of Contel of California, Inc.: We have audited the accompanying consolidated balance sheets of Contel of California, Inc. (a California corporation) and subsidiary as of December 31, 1995 and 1994, 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, 1995. These financial statements and the schedule 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 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 Contel of California, Inc. and subsidiary as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. As discussed in Note 2 to the consolidated financial statements, in 1995 the Company discontinued applying the provisions of Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation". Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The supporting schedule listed under Item 14 is presented for purposes of complying with the Securities and Exchange Commission's rules and is not a required part of the basic financial statements. The supporting schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Dallas, Texas January 24, 1996 28 31 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. JAMES F. MILES President MICHAEL W. BOLLINGER Assistant Vice President - Controller 29 32 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. 30 33 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) (1) Financial Statements - See Contel of California, Inc.'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 financial statements for the years ended December 31, 1995-1993 (as required): II - Valuation and Qualifying Accounts Note: Schedules other than the one listed above are omitted as not applicable, not required, or the information is included in the financial statements or notes thereto. (3) Exhibits - Included in this report or incorporated by reference. 2.1* Agreement of Merger, dated September 10, 1992 between GTE California Incorporated and Contel of California, Inc. (Exhibit 2.1 of the 1993 Form 10-K. File No. 0-1245) 3* Articles of Incorporation and Bylaws (incorporated by reference from the Registration Statement of the Company, File No. 2-52487, effective January 14, 1975) 10 Material Contracts - Agreements Between GTE and Certain Executive Officers 27 Financial Data Schedule (b) Reports on Form 8-K On November 13, 1995, the Company filed a report on Form 8-K dated November 9, 1995, under Item 5 "Other Events". Financial information was filed with this report. * Denotes exhibits incorporated herein by reference to previous filings with the Securities and Exchange Commission as designated. 31 34 Contel of California, Inc. and Subsidiary SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS For the Years Ended December 31, 1995, 1994 and 1993 (Thousands of Dollars)
- ---------------------------------------------------------------------------------------------------------------------- Column A Column B Column C Column D Column E - ---------------------------------------------------------------------------------------------------------------------- Additions ------------------------------ Deductions Balance at from Beginning Charged to Charged to Reserves Balance at Description of Year Income Other Accounts (Note 1) Close of Year - ---------------------------------------------------------------------------------------------------------------------- Allowance for uncollectible accounts for the years ended: December 31, 1995 $ 3,523 $ 5,072 $2,795 (2) $ 6,495 $ 4,895 ========================================================================== December 31, 1994 $ 3,592 $ 4,788 $1,220 (2) $ 6,077 $ 3,523 ========================================================================== December 31, 1993 $ 3,321 $ 6,479 $6,196 (2) $12,404 $ 3,592 ========================================================================== Accrued restructuring costs for the years ended (Note 3): December 31, 1995 $22,310 $ -- $ -- $ 1,855 $20,455 ========================================================================== December 31, 1994 $48,987 $ -- $ -- $26,677 $22,310 ========================================================================== December 31, 1993 $ -- $48,987 $ -- $ -- $48,987 ==========================================================================
NOTES: (1) Charges for purpose for which reserve was created. (2) Recoveries of previously written-off amounts. (3) See Note 3 to the consolidated financial statements included elsewhere herein. 32 35 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. CONTEL OF CALIFORNIA, INC. ------------------------------------ (Registrant) Date March 26, 1996 By James F. Miles -------------- ------------------------------------ James F. Miles 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. James F. Miles President and Director March 26, 1996 - ---------------------- (Principal Executive Officer) James F. Miles Michael W. Bollinger Assistant Vice President - Controller March 26, 1996 - ---------------------- (Principal Financial and Accounting Michael W. Bollinger Officer) Michael B. Esstman Director March 26, 1996 - ---------------------- Michael B. Esstman Geoffrey C. Gould Director March 26, 1996 - ---------------------- Geoffrey C. Gould 33 36 EXHIBIT INDEX
Exhibit Number Description - ---------------- ------------------------------------------------------ 10 Material Contracts - Agreements Between GTE and Certain Executive Officers 27 Financial Data Schedule
EX-10 2 MATERIAL CONTRACTS 1 Exhibit 10 EXECUTIVE SEVERANCE AGREEMENT This AGREEMENT ("Agreement") dated as of January 8, 1996, by and between GTE Service Corporation, a New York corporation (the "Company"), and the "Executive". W I T N E S S E T H: WHEREAS, the Company recognizes the valuable services that the Executive has rendered thereto and desires to be assured that the Executive will continue to attend to the business and affairs of the Company without regard to any potential or actual change in control of GTE Corporation, a New York corporation and the Company's sole shareholder ("GTE"); and WHEREAS, the Executive is willing to continue to serve the Company, but desires assurance that he will not be materially disadvantaged by a change in control of GTE; NOW, THEREFORE, in consideration of the Executive's continued service to the Company and the mutual agreements herein contained, the Company and the Executive hereby agree as follows: ARTICLE I ELIGIBILITY FOR BENEFITS Section 1.1. Qualifying Termination. The Company shall not be required to provide any benefits to the Executive pursuant to this Agreement unless a Qualifying Termination occurs before the Agreement expires in accordance with Section 6.1 hereof. For purposes of this Agreement, a Qualifying Termination shall occur only if (a) a Change in Control occurs, and (b) (i) within two years after the Change in Control, the Company terminates the Executive's employment other than for Cause; or (ii)(A) within two years after the Change in Control, a Good Reason arises, and (B) the Executive terminates employment with the Company within (I) six months after the Good Reason arises or (II) two years after the Change in Control, whichever occurs later; provided, that a Qualifying Termination shall not occur if the Executive's employment with the Company terminates by reason of the Executive's Retirement, Disability, or death. A Qualifying Termination may occur even though the Executive retires from employment with the Company other than by reason of Retirement or Disability. Section 1.2. Change in Control. Except as provided below, a Change in Control shall be deemed to occur when and only when the first of the following events occurs: (a) an acquisition (other than directly from GTE) of securities of GTE by any Person, immediately after which such Person, together with all Affiliates and Associates of such Person, shall be the Beneficial Owner of securities of GTE representing 20 percent or more of the Voting Power or such lower percentage of the Voting Power that, from time to time, would cause the Person to constitute an "Acquiring Person" (as such term is defined in the Rights Plan); provided that, in determining whether a Change in Control has occurred, the acquisition of securities of GTE in a Non-Control Acquisition shall not constitute an acquisition that would cause a Change in Control; or (b) three or more directors, whose election or nomination for election is not approved by a majority of the members of the "Incumbent Board" (as defined below) then serving as members of the Board, are elected within any single 12-month period to serve on the Board; provided that an individual whose election or nomination for election is approved as a result of either an actual or threatened "Election Contest" (as described in Rule 14a-11 promulgated under the Securities Exchange Act of 1934, as amended from time to time) or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board (a "Proxy Contest"), including by 2 reason of any agreement intended to avoid or settle any Election Contest or Proxy Contest, shall be deemed not to have been approved by a majority of the Incumbent Board for purposes hereof; or (c) members of the Incumbent Board cease for any reason to constitute at least a majority of the Board; "Incumbent Board" shall mean individuals who, as of the close of business on April 19, 1995, are members of the Board; provided that, if the election, or nomination for election by GTE's shareholders, of any new director was approved by a vote of at least three-quarters of the Incumbent Board, such new director shall, for purposes of this Agreement, be considered as a member of the Incumbent Board; provided further that no individual shall be considered a member of the Incumbent Board if such individual initially assumed office as a result of either an actual or threatened Election Contest or other actual or threatened Proxy Contest, including by reason of any agreement intended to avoid or settle any Election Contest or Proxy Contest; or (d) approval by shareholders of GTE of: (i) a merger, consolidation, or reorganization involving unless (A) the shareholders of GTE, immediately before the merger, consolidation, or reorganization, own, directly or indirectly immediately following such merger, consolidation, or reorganization, at least 50 percent of the combined voting power of the outstanding voting securities of the corporation resulting from such merger, consolidation, or reorganization (the "Surviving Corporation") in substantially the same proportion as their ownership of the voting securities immediately before such merger, consolidation, or reorganization; (B) individuals who were members of the Incumbent Board immediately prior to the execution of the agreement providing for such merger, consolidation, or reorganization constitute at least a majority of the board of directors of the Surviving Corporation; and (C) no Person (other than GTE or any subsidiary of GTE, any employee benefit plan (or any trust forming a part thereof) maintained by GTE, the Surviving Corporation, or any subsidiary of GTE, or any Person who, immediately prior to such merger, consolidation, or reorganization, had Beneficial Ownership of securities representing 20 percent (or such lower percentage the acquisition of which would cause a Change in Control pursuant to paragraph (a) of this definition of "Change in Control") or more of the Voting Power) has Beneficial Ownership of securities representing 20 percent (or such lower percentage the acquisition of which would cause a Change in Control pursuant to paragraph (a) of this definition of "Change in Control") or more of the combined Voting Power of the Surviving Corporation's then outstanding voting securities; (ii) a complete liquidation or dissolution of GTE; or (iii) an agreement for the sale or other disposition of all or substantially all of the assets of GTE to any Person (other than a transfer to a subsidiary of GTE). For purposes of this Section, the following terms shall have the definitions set forth below: "Affiliate" and "Associate" shall have the respective meanings ascribed to such terms in Rule 12b-2 of the General Rules and Regulations under the Securities Exchange Act of 1934, as amended from time to time. "Board" means the Board of Directors of GTE. "Non-Control Acquisition" means an acquisition by (1) an employee benefit plan (or a trust forming a part thereof) maintained by GTE or any of its subsidiaries, (2) GTE or any of its subsidiaries, or (3) any Person in connection with a "Non-Control Transaction." "Non-Control Transaction" means a transaction described in clauses (A) through (C) of paragraph (d)(i) of the definition of "Change in Control" herein. "Person" shall mean any individual, firm, corporation, partnership, joint venture, association, trust, or other entity. A Person shall be deemed the "Beneficial Owner" of, and shall be deemed to "beneficially own," any securities: (x) which such Person or any of such Person's Affiliates or Associates beneficially owns, directly or indirectly; (y) which such Person or any of such Person's Affiliates or Associates has (i) the right or obligation to acquire (whether such right or obligation is exercisable or effective immediately or only after the passage of time) pursuant to any agreement, arrangement, or understanding (whether or not in 3 writing) or upon the exercise of conversion rights, exchange rights, rights (other than the rights granted pursuant to the Rights Plan), warrants or options, or otherwise; provided that a Person shall not be deemed the "Beneficial Owner" of, or to "beneficially own," securities tendered pursuant to a tender or exchange offer made by such Person or any of such Person's Affiliates or Associates until such tendered securities are accepted for purchase or exchange; or (ii) the right to vote pursuant to any agreement, arrangement, or understanding (whether or not in writing); provided that a Person shall not be deemed the "Beneficial Owner" of, or to "beneficially own," any security under this clause (ii) if the agreement, arrangement, or understanding to vote such security (A) arises solely from a revocable proxy given in response to a public proxy or consent solicitation made pursuant to, and in accordance with, the applicable rules and regulations of the Securities Exchange Act of 1934, as amended from time to time, and (B) is not also then reported by such person on Schedule 13D under the Securities Exchange Act of 1934, as amended from time to time (or any comparable or successor report); or (z) which are beneficially owned, directly or indirectly, by any other Person (or any Affiliate or Associate thereof) with which such Person or any of such Person's Affiliates or Associates has any agreement, arrangement, or understanding (whether or not in writing), or with which such Person or any of such Person's Affiliates or Associates have otherwise formed a group for the purpose of acquiring, holding, voting (except pursuant to a revocable proxy as described in clause (ii)(A) of subparagraph (y), above), or disposing of any securities of GTE. "Rights Plan" means the Rights Agreement, dated as of December 7, 1989, between GTE and State Street Bank and Trust Company (now administered by the First National Bank of Boston), as it may be amended from time to time, or any successor thereto. "Voting Power" means the voting power of all securities of GTE then outstanding generally entitled to vote for the election of directors of GTE. Section 1.3. Termination for Cause. The Company shall have Cause to terminate the Executive for purposes of Section 1.1 hereof only if the Executive (a) engages in unlawful acts intended to result in the substantial personal enrichment of the Executive at the Company's expense, or (b) engages (except by reason of incapacity due to illness or injury) in a material violation of his responsibilities to the Company that results in a material injury to the Company. Notwithstanding the foregoing, the Executive shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to him a notice, consisting of a copy of a resolution duly adopted by the affirmative vote of not less than three quarters of the entire membership of GTE's Board of Directors at a duly held meeting of the Board of Directors (with reasonable notice to the Executive and an opportunity for the Executive, together with counsel, to be heard before the Board of Directors) ("Notice of Termination"), finding that the Executive has engaged in the conduct set forth above in this Section 1.3 and specifying the particulars thereof in detail. GTE's Board of Directors may not delegate or assign its duties under this Section 1.3. Section 1.4. Termination for Good Reason. The Executive shall have a Good Reason for terminating employment with the Company only if one or more of the following occurs after a Change in Control: (a) a change in the Executive's status or position(s) with the Company that, in the Executive's reasonable judgment, represents a demotion from the Executive's status or position(s) in effect immediately before the Change in Control; (b) the assignment to the Executive of any duties or responsibilities that, in the Executive's reasonable judgment, are inconsistent with the Executive's status or position(s) in effect immediately before the Change in Control; (c) layoff or involuntary termination of the Executive's employment, except in connection with the termination of the Executive's employment for Cause or as a result of the Executive's Retirement, Disability, or death; (d) a reduction by the Company in the Executive's total compensation (which shall be deemed, for this purpose, to be equal to his base salary plus the greater of (i) the most recent award that he has earned under the GTE Corporation Executive Incentive Plan, as amended from time to time, or any successor thereto (the "EIP"), or (ii) an EIP award equal to the Executive's Average Percentage of the annual value (i.e., the dollar amount) of the normal payment under the EIP for the Executive's salary level (such annual value and normal payment being those that are in effect under the EIP immediately before the date on which the Change in Control occurs for the Executive's salary level immediately before the date on which the Change in Control occurs)). For 4 purposes of this paragraph (d), the Executive's "Average Percentage" means the average of the Executive's Annual Percentages for the Determination Years. For purposes of this paragraph (d), the Executive's "Annual Percentage" for each Determination Year means a fraction (expressed as a percentage), the numerator of which is the EIP award earned by the Executive for such Determination Year, and the denominator of which is the annual value of the normal payment under the EIP for the Executive's salary level (such annual value and normal payment being those that were in effect under the EIP for such Determination Year for the Executive's salary level for such Determination Year). For purposes of this paragraph (d), a "Determination Year" means each of the last three EIP plan years ending before the date on which the Change in Control occurs (or, if less, the number of those three plan years during which the Executive was a participant in the EIP); (e) a material increase in the Executive's responsibilities or duties without a commensurate increase in total compensation; (f) the failure by the Company to continue in effect any Plan in which the Executive is participating at the time of the Change in Control (or plans or arrangements providing the Executive with substantially equivalent benefits) other than as a result of the normal expiration of any such Plan in accordance with its terms as in effect at the time of the Change in Control; (g) any action or inaction by the Company that would adversely affect the Executive's continued participation in any Plan on at least as favorable a basis as was the case on the date of the Change in Control, or that would materially reduce the Executive's benefits in the future under the Plan or deprive him of any material benefits that he enjoyed at the time of the Change in Control, except to the extent that such action or inaction by the Company is required by the terms of the Plan as in effect immediately before the Change in Control, or is necessary to comply with applicable law or to preserve the qualification of the Plan under section 401(a) of the Internal Revenue Code, and except to the extent that the Company provides the Executive with substantially equivalent benefits; (h) the Company's failure to provide and credit the Executive with the number of days of paid vacation, holiday, or leave to which he is then entitled in accordance with the Company's normal vacation, holiday, or leave policy in effect immediately before the Change in Control; (i) the imposition of any requirement that the Executive be based anywhere other than within 25 miles of where his principal office was located immediately before the Change in Control; (j) a material increase in the frequency or duration of the Executive's business travel; (k) the Company's failure to obtain the express assumption of this Agreement by any successor to the Company as provided by Section 6.3 hereof; (l) any attempt by the Company to terminate the Executive's employment that is not effected pursuant to a Notice of Termination satisfying the requirements of Section 1.3 hereof or that does not afford the Executive the procedural protections prescribed by that Section; or (m) any violation by the Company of any agreement (including this Agreement) between it and the Executive. Notwithstanding the foregoing, no action by the Company shall give rise to a Good Reason if it results from the Executive's termination for Cause, Retirement, or death, and no action by the Company specified in paragraphs (a) through (d) of the preceding sentence shall give rise to a Good Reason if it results from the Executive's Disability. A Good Reason shall not be deemed to be waived by reason of the Executive's continued employment as long as the termination of the Executive's employment occurs within the time prescribed by Section 1.1(b)(ii)(B) hereof. For purposes of this Section 1.4, "Plan" means any compensation plan, such as an incentive, stock option, or restricted stock plan, or any employee benefit plan, such as a thrift, pension, profit-sharing, stock bonus, long-term performance award, medical, disability, accident, or life insurance plan, or a relocation plan or policy, or any other plan, program or policy of the Company that is intended to benefit employees. Section 1.5. Retirement. For purposes of this Agreement, "Retirement" shall mean the Executive's termination of employment upon or after attaining age 65. Section 1.6. Disability. For purposes of this Agreement, "Disability" shall mean an illness or injury that prevents the Executive from performing his duties (as they existed immediately before the illness or injury) on a full- time basis for six consecutive months. Section 1.7. Notice. If a Change in Control occurs, the Company shall notify the Executive of the 5 occurrence of the Change in Control within two weeks after the Change in Control. ARTICLE II BENEFITS AFTER A QUALIFYING TERMINATION Section 2.1. Basic Severance Payment. (a) If the Executive incurs a Qualifying Termination, the Company shall pay to the Executive a cash amount equal to 200% of the Base Amount. The Base Amount shall be an amount equal to the greater of: (A) the sum of (I) the Executive's base annual salary immediately before the Change in Control plus (II) the Executive's Average Percentage of the annual value (i.e., the dollar amount) of the normal payment under the EIP for the Executive's salary level (such annual value and normal payment being those that are in effect under the EIP immediately before the date on which the Change in Control occurs for the Executive's salary level immediately before the date on which the Change in Control occurs). For purposes of this paragraph (A), the Executive's "Average Percentage" means the average of the Executive's Annual Percentages for the Determination Years. For purposes of this paragraph (A), the Executive's "Annual Percentage" for each Determination Year means a fraction (expressed as a percentage), the numerator of which is the EIP award earned by the Executive for such Determination Year, and the denominator of which is the annual value of the normal payment under the EIP for the Executive's salary level (such annual value and normal payment being those that were in effect under the EIP for such Determination Year for the Executive's salary level for such Determination Year). For purposes of this paragraph (A), a "Determination Year" means each of the last three EIP plan years ending before the date on which the Change in Control occurs (or, if less, the number of those three plan years during which the Executive was a participant in the EIP); or (B) the sum of (I) the Executive's base annual salary immediately before the Qualifying Termination plus (II) the Executive's Average Percentage of the annual value (i.e., the dollar amount) of the normal payment under the EIP for the Executive's salary level (such annual value and normal payment being those that are in effect under the EIP immediately before the date on which the Qualifying Termination occurs for the Executive's salary level immediately before the date on which the Qualifying Termination occurs). For purposes of this paragraph (B), the Executive's "Average Percentage" means the average of the Executive's Annual Percentages for the Determination Years. For purposes of this paragraph (B), the Executive's "Annual Percentage" for each Determination Year means a fraction (expressed as a percentage), the numerator of which is the EIP award earned by the Executive for such Determination Year, and the denominator of which is the annual value of the normal payment under the EIP for the Executive's salary level (such annual value and normal payment being those that were in effect under the EIP for such Determination Year for the Executive's salary level for such Determination Year). For purposes of this paragraph (B), a "Determination Year" means each of the last three EIP plan years ending before the date on which the Qualifying Termination occurs (or, if less, the number of those three plan years during which the Executive was a participant in the EIP). (b) The Company shall make the payment to the Executive pursuant to subsection (a) of this Section 2.1 in a lump sum within 30 days of the Qualifying Termination. Section 2.2. Insurance. If the Executive incurs a Qualifying Termination, the Company shall provide the Executive, at the Company's expense, for a period beginning on the date of the Qualifying Termination, the same medical insurance and life insurance coverage as was in effect immediately before the Change in Control (or, if greater, as in effect immediately before the Qualifying Termination occurs); such coverage shall end upon the earlier of (a) the expiration of 24 months after the Qualifying Termination or (b)(i) with respect to medical insurance coverage, the date on which the Executive first becomes eligible for medical insurance coverage provided by a firm that employs him following the Qualifying Termination, or (ii) with respect to life insurance coverage, the date on which the Executive first becomes eligible for life insurance coverage provided by such firm. 6 Section 2.3. Outplacement Counseling. If the Executive incurs a Qualifying Termination, the Company shall make available to the Executive, at the Company's expense, outplacement counseling that is at least equivalent to the outplacement counseling that the Company provided to its terminated senior executives during 1995. Subject to the foregoing, the Executive may select the organization that will provide the outplacement counseling; provided, that this sentence shall not require the Company to provide the Executive with outplacement counseling that is more costly to the Company than the outplacement counseling that this Section 2.3 otherwise requires the Company to provide to the Executive. Section 2.4. Financial Counseling. If the Executive incurs a Qualifying Termination, the Company shall, within 30 days of the Qualifying Termination, make available to the Executive three individual financial counseling sessions, of at least two hours each and at times and locations that are convenient to the Executive, with a nationally recognized financial counseling firm. At the financial counseling sessions, the financial counseling firm shall provide the Executive with detailed financial advice that is tailored to the Executive's particular personal and financial situation. The Company shall specify to the Executive the information regarding his personal and financial situation that he must provide to the financial counseling firm in order for the firm to provide the counseling services required by this Section 2.4. The Company shall take all reasonable and appropriate measures to assure that the financial counseling firm preserves the confidentiality of all information conveyed by the Executive to the counseling firm. Section 2.5. Benefit Credit. If the Executive incurs a Qualifying Termination, (a) the Executive shall receive service credit, for the purpose of receiving benefits and for vesting, retirement eligibility, benefit accrual, and all other purposes, under all employee benefit plans sponsored by the Company (including, but not limited to, health, life insurance, pension, savings, stock, and stock ownership plans, but excluding the Company's short-term and long-term disability plans) in which he participated immediately before the Change in Control, for 24 months; (b) for purposes of determining the Executive's benefits under all defined benefit pension plans maintained by the Company, including the GTE Service Corporation Supplemental Executive Retirement Plan ("SERP"), the Executive's compensation shall include the amount payable to the Executive pursuant to Section 2.1 hereof, and for purposes of this subsection (b), the Executive shall be deemed to have received such amount in monthly installments, each equal to 1/24th of the amount payable to the Executive pursuant to Section 2.1 hereof; and (c) the Executive shall be considered to have not less than 76 points and 15 years of Accredited Service for purposes of determining his eligibility for early retirement benefits under the Company's defined benefit pension plans (including, but not limited to, the SERP) and for purposes of determining his eligibility for benefits under the GTE Executive Retired Life Insurance Plan (or any predecessor or successor thereto). Notwithstanding the service credit granted under subsection (a) of this Section 2.5 and the compensation recognized under subsection (b) of this Section 2.5, nothing in this Section 2.5 shall prevent the Executive from receiving any benefits to which the Executive is entitled under any defined benefit or defined contribution pension plan maintained by the Company, including the SERP (as such benefits are modified by this Agreement) in any form permitted by such plans (including but not limited to a lump-sum distribution) immediately following the Executive's Qualifying Termination. To the extent that the Company's tax-qualified retirement plans cannot provide the benefits specified by this Section 2.5 without jeopardizing the tax qualification of such plans, the Company shall provide such benefits under the SERP. Section 2.6. Nonduplication. (a) Nothing in this Agreement shall require the Company to make any payment or to provide any benefit or service credit that GTE or the Company is otherwise required to provide under any other contract, agreement, policy, plan, or arrangement. Section 2.7. Prior Agreement. This Agreement supersedes any prior Executive Severance Agreement entered into between the Company and the Executive ("Prior Agreement"). On and after the date of this Agreement, such Prior Agreement shall have no force or effect. 7 ARTICLE III EFFECT ON HUMAN RESOURCES POLICY 104 Section 3.1. Effect on Policy 104. If the Executive becomes entitled to receive benefits hereunder, the Executive shall not be entitled to any benefits under GTE Human Resources Policy 104, as amended from time to time, or any successor policy, or under any other Company severance or salary continuation policy (including but not limited to any benefits pursuant to an involuntary separation program or similar program maintained under a pension plan sponsored by the Company). ARTICLE IV TAX MATTERS Section 4.1. Withholding. The Company may withhold from any amounts payable to the Executive hereunder all federal, state, city or other taxes that the Company may reasonably determine are required to be withheld pursuant to any applicable law or regulation. ARTICLE V COLLATERAL MATTERS Section 5.1. Nature of Payments. All payments to the Executive under this Agreement shall be considered either payments in consideration of his continued service to the Company or severance payments in consideration of his past services thereto. Section 5.2. Legal Expenses. The Company shall pay all legal fees and expenses that the Executive may incur as a result of the Company's contesting the validity, the enforceability or the Executive's interpretation of, or determinations under, this Agreement; provided, that this Section 5.2 shall be operative only if and to the extent that (a) the Company fails to establish a trust that defrays all such legal fees and expenses or (b) the Company establishes such a trust, but the trust fails to pay all such legal fees and expenses. Section 5.3. Mitigation. The Executive shall not be required to mitigate the amount of any payment provided for in this Agreement either by seeking other employment or otherwise. The amount of any payment provided for herein shall not be reduced by any remuneration that the Executive may earn from employment with another employer or otherwise following his Qualifying Termination. Section 5.4. Interest. If the Company fails to make, or cause to be made, any payment provided for herein within 30 days of the date on which the payment is due, the Company shall make such payment together with interest thereon. The interest shall accrue and be compounded monthly. The interest rate shall be equal to 120 percent of the prime rate as reported by The Wall Street Journal for the first business day of each month, effective for the ensuing month. The interest rate shall be adjusted at the beginning of each month. Section 5.5. Authority. The execution of this Agreement has been authorized by the Board of Directors of the Company and by the Board of Directors of GTE. ARTICLE VI GENERAL PROVISIONS Section 6.1. Term of Agreement. This Agreement shall become effective on the date hereof and shall continue in effect until the earliest of (a) July 1, 1999, if no Change in Control has occurred before that date; (b) the termination of the Executive's employment with the Company for any reason prior to a Change in Control; (c) the Company's termination of the Executive's employment for Cause, or the Executive's resignation for other than Good 8 Reason, following a Change in Control and the Company's and the Executive's fulfillment of all of their obligations hereunder; and (d) the expiration following a Change in Control of two years and six months and the fulfillment by the Company and the Executive of all of their obligations hereunder. Notwithstanding the foregoing, commencing on July 1, 1999, and on July 1 of each year thereafter, the expiration date prescribed by clause (a) of the preceding sentence shall automatically be extended for an additional year unless, not later than December 31 of the immediately preceding year, one of the parties hereto shall have given notice to the other party hereto that it (or he) does not wish to extend the term of this Agreement. Furthermore, nothing in this Article VI shall cause this Agreement to terminate before both the Company and the Executive have fulfilled all of their obligations hereunder. Section 6.2. Governing Law. Except as otherwise expressly provided herein, this Agreement and the rights and obligations hereunder shall be construed and enforced in accordance with the laws of the State of New York. Section 6.3. Successors to the Company. This Agreement shall inure to the benefit of and shall be binding upon and enforceable by the Company and any successor thereto, including, without limitation, any corporation or corporations acquiring directly or indirectly all or substantially all of the business or assets of the Company, whether by merger, consolidation, sale or otherwise, but shall not otherwise be assignable by the Company. Without limitation of the foregoing sentence, the Company shall require any successor (whether direct or indirect, by merger, consolidation, sale or otherwise) to all or substantially all of the business or assets of the Company, by agreement in form satisfactory to the Executive, expressly, absolutely and unconditionally to assume and to agree to perform this Agreement in the same manner and to the same extent as the Company would have been required to perform it if no such succession had taken place. As used in this Agreement, "Company" shall mean the Company as heretofore defined and any successor to all or substantially all of its business or assets that executes and delivers the agreement provided for in this Section 6.3 or that becomes bound by this Agreement either pursuant to this Agreement or by operation of law. As used in this Agreement, "GTE" shall mean GTE as heretofore defined and any successor to all or substantially all of its business or assets. Section 6.4. Noncorporate Entities. If any provision of this Agreement refers to the board of directors of an entity that has no board of directors, the reference to board of directors shall be deemed to refer to the body, committee, or person that has duties and responsibilities with respect to the entity that most closely approximate those of a board of directors of a corporation. Section 6.5. Successor to the Executive. This Agreement shall inure to the benefit of and shall be binding upon and enforceable by the Executive and his personal and legal representatives, executors, administrators, heirs, distributees, legatees and, subject to Section 6.6 hereof, his designees ("Successors"). If the Executive should die while amounts are or may be payable to him under this Agreement, references hereunder to the "Executive" shall, where appropriate, be deemed to refer to his Successors; provided, that nothing in this Section 6.5 shall supersede the terms of any plan or arrangement (other than this Agreement) that is affected by this Agreement. Section 6.6. Nonalienability. No right of or amount payable to the Executive under this Agreement shall be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, hypothecation, encumbrance, charge, execution, attachment, levy or similar process or to setoff against any obligations or to assignment by operation of law. Any attempt, voluntary or involuntary, to effect any action specified in the immediately preceding sentence shall be void. However, this Section 6.6 shall not prohibit the Executive from designating one or more persons, on a form satisfactory to the Company, to receive amounts payable to him under this Agreement in the event that he should die before receiving them. Section 6.7. Notices. All notices provided for in this Agreement shall be in writing. Notices to the Company shall be deemed given when personally delivered or sent by certified or registered mail or overnight delivery service to GTE Service Corporation, One Stamford Forum, Stamford, Connecticut 06904, Attention: Corporate Secretary. Notices to the Executive shall be deemed given when personally delivered or sent by certified or registered mail or overnight delivery service to the last address for the Executive shown on the records of the Company. Either the Company or the Executive may, by notice to the other, designate an address other than the foregoing for the receipt of subsequent notices. Section 6.8. Amendment. No amendment to this Agreement shall be effective unless in writing and signed by both the Company and the Executive. Section 6.9. Waivers. No waiver of any provision of this Agreement shall be valid unless approved in writing by the party giving such waiver. No waiver of a breach under any provision of this Agreement shall be deemed to be a waiver of such provision or any other provision of this Agreement or any subsequent breach. No failure on the part of either the Company or the Executive to exercise, and no delay in exercising, any right or remedy 9 conferred by law or this Agreement shall operate as a waiver of such right or remedy, and no exercise or waiver, in whole or in part, of any right or remedy conferred by law or herein shall operate as a waiver of any other right or remedy. Section 6.10. Severability. If any provision of this Agreement shall be held unlawful or otherwise invalid or unenforceable in whole or in part, such unlawfulness, invalidity or unenforceability shall not affect any other provision of this Agreement or part thereof, each of which shall remain in full force and effect. If the making of any payment or the provision of any other benefit required under this Agreement shall be held unlawful or otherwise invalid or unenforceable, such unlawfulness, invalidity or unenforceability shall not prevent any other payment or benefit from being made or provided under this Agreement, and if the making of any payment in full or the provision of any other benefit required under this Agreement in full would be unlawful or otherwise invalid or unenforceable, then such unlawfulness, invalidity or unenforceability shall not prevent such payment or benefit from being made or provided in part, to the extent that it would not be unlawful, invalid or unenforceable, and the maximum payment or benefit that would not be unlawful, invalid or unenforceable shall be made or provided under this Agreement. Section 6.11. Agents. The Company may make arrangements to cause any agent or other party, including an affiliate of the Company, to make any payment or to provide any benefit that the Company is required to make or to provide hereunder; provided, that no such arrangement shall relieve or discharge the Company of its obligations hereunder except to the extent that such payments or benefits are actually made or provided. Section 6.12. Definitions. All upper case terms used herein shall have the meaning set forth in this Agreement. Section 6.13. Captions. The captions to the respective articles and sections of this Agreement are intended for convenience of reference only and have no substantive significance. Section 6.14. Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be deemed to be an original but all of which together shall constitute a single instrument. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written. GTE SERVICE CORPORATION By: J. Randall MacDonald ---------------------- J. Randall MacDonald Senior VP-Human Resources and Administration By: Marianne Drost ---------------------- Marianne Drost VP and Associate General Counsel-Finance & Corporate Secretary EX-27 3 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1995 JAN-01-1995 DEC-31-1995 2,139 0 125,767 4,895 652 142,936 915,291 635,134 439,424 169,104 90,000 12,518 0 0 95,677 439,424 343,483 343,483 121,841 247,000 0 0 10,913 85,570 35,831 49,739 0 127,620 0 (77,881) 0 0
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