SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report:
August 31, 2000
(Date of earliest event reported)
CITIZENS COMMUNICATIONS COMPANY
(Exact name of Registrant as specified in charter)
Delaware 001-11001 06-0619596
(State or other jurisdiction (Commission File Number) (IRS Employer
of incorporation) Identification No.)
3 High Ridge Park, P.O. Box 3801, Stamford, Connecticut 06905
- ------------------------------------------------------- -----
(Address of principal executive offices) (Zip Code)
(203) 614-5600
(Registrant's telephone number, including area code)
No change since last report
(Former name or address, if changed since last report)
Item 7. Financial Statements, Exhibits.
(a) Financial Statements of Businesses acquired
*GTE Combined Entities for the six months ended June 30, 2000 and 1999
(unaudited)
*GTE Combined Entities for the years ended December 31, 1999, 1998 and 1997
*Contel of Minnesota, Inc. for the six months ended June 30, 2000 and 1999
(unaudited)
*Contel of Minnesota, Inc. for the years ended December 31, 1999 and 1998
*Contel of Minnesota, Inc. for the years ended December 31, 1998 and 1997
(b) Pro forma Financial Information
* Pro forma Balance Sheet as of June 30, 2000 and Pro forma Income Statements
for the six months ended June 30, 2000 and for the year ended December 31, 1999.
(c) Exhibits
23.1 Consent of KPMG
23.2 Consent of Arthur Andersen
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
CITIZENS COMMUNICATIONS COMPANY
Registrant
By:/s/ Livingston E. Ross
-------------------------------
Livingston E. Ross
Vice President, Reporting and Audit
Date: November 14, 2000
PROFORMA FINANCIAL INFORMATION
On May 27, September 21, and December 16, 1999, we announced that we had
entered into definitive agreements to purchase from Verizon Communications,
formerly GTE Corp., approximately 366,000 telephone access lines (as of
December 31, 1999) in Arizona, California, Illinois, Minnesota and Nebraska
(GTE Acquisitions) for approximately $1.171 billion in cash. The
acquisitions are subject to various state and federal regulatory approvals.
The Nebraska and Minnesota purchases closed on June 30, 2000 and August 31,
2000, respectively. The attached pro forma financial statements include
the effect of all the GTE Acquisitions to illustrate the financial
characteristics of the entire transaction. We expect that the remainder
of these transactions will close throughout the next 9 months.
On June 16, 1999, we announced that we had entered into a series of
definitive agreements to purchase from Qwest Communications, formerly US
West, approximately 545,000 telephone access lines (as of December 31, 1999)
in Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, North
Dakota and Wyoming (US West Acquisitions) for approximately $1.65 billion in
cash. The acquisitions are subject to various state and federal regulatory
approvals. The North Dakota purchase closed on October 31, 2000. We expect
that the remainder of these transactions will close throughout the next 9
months. The US West Acquisition is not included in these pro forma financial
statements.
On July 12, 2000, we announced that we had agreed to acquire approximately
1.1 million telephone access lines for $3.65 billion, including $136 million
in debt, through the purchase of Frontier (the Frontier Acquisition), the
trade name of the local exchange carrier operations of Global Crossing, Ltd.
The access lines are in New York, Minnesota, Iowa, Wisconsin, Pennsylvania,
Alabama, Georgia, Michigan, Illinois, Mississippi and Indiana . The
transaction is subject to various state and federal regulatory approvals and
is expected to be completed in the first half of 2001. The Frontier
Acquisition is not included in these pro forma financial statements.
The following unaudited pro forma condensed combined financial information
of Citizens Communications Company and the GTE Acquisitions, which are
referred to as "Pro Forma Citizens Communications Company," has been
prepared to illustrate the effects of the GTE Acquisitions and related
financing had it been completed as of June 30, 2000 or at the beginning of
the periods presented. This pro forma information does not give effect to
the other pending acquisitions and the related financing.
Citizens Communications Company has prepared the pro forma financial
information using the purchase method of accounting. Citizens Communications
Company expects that it will continue to have increased expenses until all
acquisitions are fully integrated, and expects to achieve economies of scale
through the acquired properties that will both expedite its ability to
provide new and differentiated services and make those services more
economically efficient. We expect that these acquisitions will therefore
provide us the opportunity to increase revenue and decrease cost per access
line. The unaudited pro forma information does not reflect these increased
expenses and economies of scale.
Our regulated telecommunications operations are subject to the provisions of
Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for
the Effects of Certain Types of Regulation." SFAS 71 requires regulated
entities to record regulatory assets and liabilities as a result of actions
of regulators. We are currently evaluating the continued applicability of
SFAS 71. The operations acquired in the GTE Acquisition is not accounted for
under SFAS 71 and we will continue to account for these properties as
non-regulated entities pending the outcome of our evaluation.
The pro forma information, while helpful in illustrating the financial
characteristics of the combined company, does not attempt to predict or
suggest future results. The pro forma information also does not attempt to
show how the combined company would actually have performed had the
companies been combined throughout these periods. If the companies had
actually been combined in prior periods, these companies and businesses
might have performed differently. You should not rely on pro forma financial
information as an indication of the results that would have been achieved if
the GTE Acquisitions had taken place earlier or the future results that the
companies will experience after completion of these transactions.
These unaudited pro forma condensed combined financial statements should be
read in conjunction with the historical financial statements of the GTE
Acquisitions included in this document and the historical financial
statements of Citizens Communications Company incorporated by reference in
this document.
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
PROFORMA BALANCE SHEET DATA
AS OF JUNE 30, 2000
(UNAUDITED)
PROFORMA
CITIZENS ---------------------------------
(AMOUNTS IN THOUSANDS) 6/30/2000 ADJUSTMENTS ADJUSTED
- ---------------------- --------- ----------- --------
Cash $ 49,150 $ -- $ 49,150
Accounts receivable, net 214,421 -- 214,421
Other 35,286 -- 35,286
---------- ---------- ----------
Total current assets 298,857 -- 298,857
Net Property, Plant & Equipment 3,264,007 288,132(1) 3,552,139
Excess of Cost over Net Assets Acquired -- 882,868(1) 882,868
Investments 493,444 (493,444)(1) -
Regulatory assets 182,847 -- 182,847
Deferred debits and other assets 154,346 -- 154,346
Assets of discontinued operations 1,679,821 -- 1,679,821
---------- ---------- ----------
Total assets $6,073,322 $ 677,556 $6,750,878
========== ========== ==========
Long-term debt due within one year $ 33,540 $ -- $ 33,540
Accounts payable and other current liabilities 305,422 -- 305,422
---------- ---------- ----------
Total current liabilities 338,962 -- 338,962
Deferred income taxes 445,661 -- 445,661
Customer advances for contruction
and contributions in aid of construction 182,470 -- 182,470
Deferred credits and other liabilities 68,387 -- 68,387
Regulatory liabilities 25,835 -- 25,835
Long-term debt 2,530,370 677,556(1) 3,207,926
Liabilities of discontinued operations 400,807 -- 400,807
---------- ---------- ----------
Total liabilities 3,992,492 677,556 4,670,048
Company Obligated Mandatorily Redeemable
Convertible Preferred Securities * 201,250 -- 201,250
Minority interest in subsidiary -- -- --
Shareholders' equity 1,879,580 -- 1,879,580
---------- ---------- ----------
Total liabilities and shareholders' equity $6,073,322 $ 677,556 $6,750,878
========== ========== ==========
*Represents securities of a subsidiary trust, the sole assets of which are
securities of a subsidiary partnership, substantially all the assets of which
are convertible debentures of the Company.
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
PROFORMA INCOME STATEMENT DATA
FOR THE SIX MONTHS ENDED JUNE 30, 2000
(UNAUDITED)
PROFORMA
CITIZENS TOTAL -------------------------------
(AMOUNTS IN THOUSANDS - EXCEPT PER-SHARE AMOUNTS) 6/30/2000 ACQUISITIONS ADJUSTMENTS ADJUSTED
- ------------------------------------------------- --------- ------------ ----------- --------
Revenue $569,779 $117,409 $687,188
Operating expenses 364,649 37,809 402,458
Depreciation and amortization 157,179 17,247 29,429(2) 213,306
-- 9,451(3)
Acquisition assimilation expenses 11,591 -- 11,591
-------------------------------------------------------------
Income from operations 36,360 62,353 (38,880) 59,833
Investment and other income, net 10,075 -- (11,110)(4) (1,035)
Minority interest 12,222 -- 12,222
Interest expense 62,315 3,328 25,705 (5) 91,348
Income tax expense (benefit) (1,254) 23,879 (26,008)(6) (3,383)
Convertible preferred dividends 3,104 -- 3,104
-------------------------------------------------------------
Income (loss) from continuing operations $ (5,508) $ 35,146 $(49,687) $(20,049)
=============================================================
Weighted average shares outstanding -Basic 263,246 263,246
Weighted average shares outstanding -Diluted 267,561 267,561
Income (loss) from continuing operations per basic share $ (0.02) $ (0.08)
Income (loss) from continuing operations per diluted share $ (0.02) $ (0.08)
CITIZENS COMMUNICATIONS COMPANY AND SUBSIDIARIES
PROFORMA INCOME STATEMENT DATA
FOR THE YEAR ENDED DECEMBER 31, 1999
(UNAUDITED)
PROFORMA
CITIZENS TOTAL ------------------------------
(AMOUNTS IN THOUSANDS - EXCEPT PER-SHARE AMOUNTS) 12/31/1999 ACQUISITIONS ADJUSTMENTS ADJUSTED
- ------------------------------------------------- --------------------------------------------------------------
Revenue $1,087,428 $233,492 $1,320,920
Operating expenses (7) 816,930 90,221 907,151
Depreciation and amortization 262,430 36,043 58,858(2) 376,731
19,400(3)
--------------------------------------------------------------
Income from operations 8,068 107,228 (78,258) 37,038
Investment and other income, net 243,601 - (22,533)(4) 221,068
Minority interest 23,227 - 23,227
Interest expense 86,972 7,939 50,128 (5) 145,039
Income tax expense 64,587 40,498 (51,636)(6) 53,449
Convertible preferred dividends 6,210 - 6,210
--------------------------------------------------------------
Income (loss) from continuing operations $ 117,127 $ 58,791 $(99,283) $ 76,635
==============================================================
Weighted average shares outstanding -Basic 260,613 260,613
Weighted average shares outstanding -Diluted 262,392 262,392
Income (loss) from continuing operations per basic share $ 0.45 $ 0.29
Income (loss) from continuing operations per diluted share $ 0.45 $ 0.29
NOTES TO PRO FORMA CONDENSED FINANCIAL STATEMENTS
(1) Reflects the use of proceeds from the sales of investments and issuance of
long-term debt at an assumed interest rate of 8.57% to fund the aggregate
purchase price of the GTE Acquisitions. For purposes of the accompanying pro
forma combined financial statements, we have recorded the acquired assets
and assets to be acquired at their historical carrying values and have
reflected the excess of cost over such amounts as excess of cost over net
assets acquired. The final allocation of purchase price to assets and
liabilities acquired will depend upon the final purchase prices and the
final estimates of fair values of assets and liabilities as of the various
closing dates. We will undertake a study to determine the fair values of
assets acquired and will allocate the purchase price accordingly. We believe
that the excess of cost over historical net assets acquired and to be
acquired will be allocated to property, plant and equipment, goodwill and
other identifiable intangibles. However, there can be no assurance that the
actual allocation will not differ significantly from the pro forma
allocation.
(2) Reflects the amortization expense of the excess of cost over historical net
assets acquired in the GTE acquisition by use of the straight-line method
over 15 years. Should the allocation of such excess of cost over historical
net assets acquired differ significantly as described in Note 1,
amortization expense could increase since the depreciable lives of assets
other than goodwill may be shorter.
(3) Represents an adjustment for depreciation expense related to GTE Minnesota.
(4) Represents the elimination of investment income associated with the
investment portfolio used to partially fund the GTE Acquisition.
(5) Represents the effect of the transaction on interest expense since
January 1.
(6) Adjustments to income taxes based on income before income taxes using the
applicable incremental income tax rate.
(7) During 1999, we recorded a pre-tax charge of $5,760,000 in other operating
expenses in connection with a plan to restructure our corporate office
activities. These costs are not expected to have a continuing impact on our
operations.
GTE COMBINED ENTITIES
(WHOLLY OWNED PROPERTIES OF GTE CORPORATION)
COMBINED FINANCIAL STATEMENTS
JUNE 30, 2000 AND 1999
UNAUDITED
GTE COMBINED ENTITIES
(WHOLLY OWNED PROPERTIES OF GTE CORPORATION)
CONSOLIDATED INCOME STATEMENT
UNAUDITED
FOR THE SIX MONTHS ENDED
(IN 000'S) 2000 1999
REVENUES AND SALES
Local services $32,742 $30,055
Network access services 30,441 32,188
Toll services 3,529 3,011
Other services and sales 7,263 8,772
------- -------
Total revenue and sales 73,975 74,026
------- -------
OPERATING COSTS AND EXPENSES
Cost of services and sales 21,078 23,212
Selling, general and administrative 1,315 10,814
Depreciation and amortization 16,843 16,857
------- -------
Total operating costs and expenses 39,236 50,883
------- -------
OPERATING INCOME 34,739 23,143
OTHER EXPENSE
Interest - net 1,972 2,788
------- -------
INCOME BEFORE INCOME TAXES 32,767 20,355
Income taxes 13,077 8,118
------- -------
NET INCOME $19,690 $12,237
======= =======
GTE Combined Entities
(wholly owned properties of GTE Corporation)
Consolidated Balance Sheets
Unaudited
June 30, December 31,
(in 000's) 2000 1999
------- -------
ASSETS
Current assets:
Cash and cash equivalents $ -- $ --
Receivables 27,122 33,434
Allowance for doubtful accounts (2,053) (1,926)
-------- --------
Receivables, net of allowance 25,069 31,508
Other current assets 3,990 2,767
-------- --------
Total current assets 29,059 34,275
-------- --------
Property, plant and equipment, net 140,980 141,916
Employee benefit plans 28,479 22,090
Other assets 999 648
-------- --------
Total assets $199,517 $198,929
======== ========
LIABILITIES AND PARENT FUNDING
Current liabilities:
Accounts payable 5,466 5,332
Accrued expenses 25,507 15,310
-------- --------
Total current liabilities 30,973 20,642
-------- --------
Employee benefit plans 14,573 12,888
Other liabilities 350 545
-------- --------
Total liabilities 14,923 34,075
-------- --------
Parent funding $153,621 $164,854
-------- --------
Total liabilities and parent funding $199,517 $198,929
======== ========
GTE Combined Entities
(wholly owned properties of GTE Corporation)
Consolidated Cash Flows
For the six months ended June 30, 2000 and 1999
Unaudited
For the six months ended June 30,
(in 000's) 2000 1999
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES $ 50,094 $ 35,574
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (15,907) (18,747)
CASH FLOWS FROM FINANCING ACTIVITIES
Parent funding (34,187) (16,827)
-------- --------
DECREASE IN CASH AND CASH EQUIVALENTS -- --
CASH AND CASH EQUIVALENTS, beginning of period -- --
-------- --------
CASH AND CASH EQUIVALENTS, end of period $ -- $ --
======== ========
(1) BASIS OF PRESENTATION
The accompanying unaudited combined financial statements include the
accounts of GTE Combined Entities and have been prepared in conformity
with generally accepted accounting principles. These unaudited combined
financial statements should be read in conjunction with the 1999
audited combined financial statements and notes thereto of the GTE
Combined Entities. These unaudited combined financial statements
include all adjustments, which consist of normal recurring accruals,
necessary to present fairly the results for the interim periods shown.
Certain information and footnote disclosures have been condensed
pursuant to Securities and Exchange Commission rules and regulations.
The results for the interim periods are not necessarily indicative of
results for the full year.
(2) BELL ATLANTIC - GTE MERGER
On June 30, 2000, Bell Atlantic and GTE completed a merger of equals
under a definitive merger agreement dated July 27, 1998. Under the
terms of the agreement, GTE became a wholly-owned subsidiary of Bell
Atlantic. With the closing of the merger, the combined company began
doing business as Verizon Communications. The merger had no impact on
the financial statements of the GTE Combined Entities presented herein.
(3) EMPLOYEE PENSION PLANS
During the first six months of 2000, selling, general and
administrative costs significantly decreased as compared to the first
six months of 1999. The decrease was primarily the result of a pretax
gain associated with lump-sum settlements of pension obligations for
former employees electing deferred vested pension cash-outs. These
employees were terminated during 1999 and in 1999 GTE Combined Entities
recorded an estimated obligation to pay out the lump sum settlements.
However, during the first six months of 2000, the GTE Combined Entities
adjusted downward the obligation recorded during fiscal year 1999 due
to the fact that not all the employees expected to elect to receive
lump sum settlements so elected. As such, the GTE Combined Entities
recognized a pretax gain of approximately $9 million in the period
ended June 30, 2000, which amount was recorded in selling, general and
administrative costs.
GTE COMBINED ENTITIES
(wholly owned properties of GTE Corporation)
Combined Financial Statements
December 31, 1999, 1998 and 1997
(With Independent Auditors' Report Thereon)
INDEPENDENT AUDITORS' REPORT
GTE Combined Entities
We have audited the accompanying combined balance sheets of the GTE Combined
Entities (as described in note 1 to the combined financial statements) as of
December 31, 1999 and 1998, and the related combined statements of income and
cash flows for each of the years in the three-year period ended December 31,
1999. These combined financial statements are the responsibility of management.
Our responsibility is to express an opinion on these combined financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the combined financial statements
are free of material misstatements. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the combined 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 combined financial statements referred to above present
fairly, in all material respects, the combined financial position of the GTE
Combined Entities as of December 31, 1999 and 1998, and the combined results of
their operations and cash flows for each of the years in the three-year period
ended December 31, 1999, in conformity with accounting principles generally
accepted in the United States.
/s/ KPMG LLP
June 2, 2000
New York, New York
GTE COMBINED ENTITIES
(wholly owned properties of GTE Corporation)
COMBINED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
(in $000's)
1999 1998
---- ----
ASSETS
Current assets:
Receivables, net of allowance for doubtful
accounts $1,926 and $2,138 $ 31,508 $ 29,683
Other 2,767 3,203
-------- --------
Total current assets 34,275 32,886
-------- --------
Property, plant and equipment, net 141,916 154,598
Pension assets in excess of projected benefit obligations 22,090 15,720
Other assets 648 1,879
-------- --------
Total assets $198,929 $205,083
======== ========
LIABILITIES AND PARENT FUNDING
Current liabilities:
Accounts payable $ 5,332 $ 3,718
Accrued expenses 15,310 15,111
-------- --------
Total current liabilities 20,642 18,829
-------- --------
Post retirement benefit obligations 12,888 12,165
Other liabilities 545 2,369
-------- --------
Total liabilities 34,075 33,363
-------- --------
Parent funding 164,854 171,720
-------- --------
Total liabilities and parent funding $198,929 $205,083
======== ========
See the accompanying notes to the combined financial statements
GTE COMBINED ENTITIES
(WHOLLY OWNED PROPERTIES OF GTE CORPORATION)
COMBINED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(IN $000's)
1999 1998 1997
---- ---- ----
REVENUES AND SALES
Local services $ 60,082 $ 56,005 $ 57,215
Network access services 64,023 67,330 60,488
Toll services 7,753 9,053 17,702
Other services and sales 15,786 17,194 12,998
-------- -------- --------
Total revenues and sales 147,644 149,582 148,403
-------- -------- --------
OPERATING COSTS AND EXPENSES
Cost of services and sales 44,969 54,092 47,664
Selling, general and administrative 14,954 26,179 21,801
Depreciation and amortization 35,272 30,342 32,711
-------- -------- --------
Total operating costs and expenses 95,195 110,613 102,176
-------- -------- --------
OPERATING INCOME 52,449 38,969 46,227
OTHER EXPENSE
Interest - net 5,509 5,398 5,123
-------- -------- --------
INCOME BEFORE INCOME TAXES AND EXTRAORDINARY CHARGE 46,940 33,571 41,104
Income taxes 18,978 12,998 16,117
-------- -------- --------
NET INCOME BEFORE EXTRAORDINARY CHARGE 27,962 20,573 24,987
Extraordinary charge - net - 108 -
-------- -------- --------
NET INCOME $ 27,962 $ 20,465 $ 24,987
======== ======== ========
See the accompanying notes to the combined financial statements
GTE COMBINED ENTITIES
(WHOLLY OWNED PROPERTIES OF GTE CORPORATION)
COMBINED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
(IN $000'S)
1999 1998 1997
---- ---- ----
OPERATIONS
Net income $ 27,962 $ 20,465 $ 24,987
Adjustments to reconcile net income
to net cash from operations:
Extraordinary charge -- 108 --
Depreciation and amortization 35,272 30,342 32,711
Provision for (recovery of) uncollectible accounts (212) 377 (46)
Change in current assets and current liabilities:
Receivables - gross (2,121) (179) 430
Other current assets 436 (1,601) (176)
Accounts payable 1,614 (4,526) 771
Accrued expenses 199 (5,015) (3,600)
Other - net (6,240) (4,159) (3,149)
-------- -------- --------
Net cash provided from operations 56,910 35,812 51,928
-------- -------- --------
INVESTING
Capital expenditures (22,082) (37,863) (38,691)
Net cash used in investing activities (22,082) (37,863) (38,691)
-------- -------- --------
FINANCING
Change in parent funding (34,828) 2,051 (13,237)
-------- -------- --------
Net cash provided from financing activities (34,828) 2,051 (13,237)
-------- -------- --------
Decrease in cash and cash equivalents -- -- --
Cash and cash equivalents:
Beginning of year -- -- --
-------- -------- --------
End of year $ -- $ -- $ --
======== ======== ========
See the accompanying notes to the combined financial statements
(1) DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES
(A) DESCRIPTION OF BUSINESS
Certain subsidiaries (collectively "GTE") of GTE Corporation
entered into four separate, definitive Asset Purchase Agreements
with Citizens Communications Company (formerly Citizens Utilities
Company, Inc.) ("Citizens") whereby GTE intends to sell
substantially all of the operating assets of certain local
telephone exchanges to Citizens for $730 million in cash. The sale
includes the exchanges' telephone plant, certain accounts
receivables, inventories, a portion of the pension plan assets,
and the transfer of certain liabilities, including obligations
under employee benefit plans, and certain leases and contracts.
Liabilities that will be retained by GTE include debt, accounts
payable and income tax liabilities. Upon closing, GTE will
transfer the pension benefit liability for transferred employees
to replacement plans that are sponsored by Citizens. GTE will also
transfer a portion of the pension assets (in the form of cash or
marketable securities) to the Citizens replacement plans at an
amount that is required to be transferred by Section 414(1) of the
Internal Revenue Code and the related regulations thereunder
determined using the assumptions used by the Pension Benefit
Guaranty Corporation with respect to a plan termination.
Obligations under postretirement benefits other than pensions
earned by employees prior to the closing date will also be
transferred to Citizens. Consummation of the transactions are
expected to occur before the end of 2000.
The accompanying financial statements of GTE Combined Entities
("Combined Entities") represent the local telephone exchanges that
are subject to the above mentioned Asset Purchase Agreements.
These local exchanges serve access lines in the states of Arizona,
California, Nebraska and Illinois.
(B) BASIS OF PRESENTATION
The accompanying combined financial statements include the assets,
liabilities and related operations of the local exchanges subject
to the Asset Purchase Agreements and have been prepared using
exchange-specific information where available and allocations from
GTE where data is not maintained on an exchange-specific basis.
GTE Corporation and GTE incur certain costs that relate to the
Combined Entities. To prepare these combined financial statements,
management allocated certain assets, liabilities, revenues and
expenses to the Combined Entities on a basis that approximates
actual cost. Management believes such allocations are reasonable;
however, the allocations could differ from amounts that would be
incurred if the Combined Entities operated on a stand-alone basis.
Because of the Combined Entities' relationship with GTE
Corporation and GTE, the assets, liabilities, revenues and
expenses are not necessarily indicative of what would have
occurred had the Combined Entities operated as a stand-alone
entity. These combined financial statements are not necessarily
indicative of future financial position or results of operations
of the combined entities.
Parent Funding reflects GTE Corporation's investment in the
exchanges, accumulated earnings and losses of the exchanges and
net intercompany activity with GTE Corporation and GTE.
(C) USE OF ESTIMATES
The combined financial statements were prepared in accordance with
accounting principles generally accepted in the United States,
which require management to make assumptions and estimates that
affect the reported amounts. Management believes that these
estimates (including allocations) and assumptions are based on
reasonable methodologies, and that the resulting combined
financial statement amounts properly present the financial
position and the results of operations of the Combined Entities.
Furthermore, the accompanying combined financial statements
reflect historical GTE ownership and operation, with no pro-forma
adjustments for specific contract terms governing transfer to a
specific buyer or for any anticipated change in methods of
operation. Therefore, actual results could differ significantly if
the Combined Entities operate as a separate entity or as part of
an entity other than GTE.
(D) CASH
GTE funds and disburses, through centrally managed bank accounts,
the Combined Entities' cash requirements. In addition, cash
receipts from the collection of accounts receivable are remitted
directly to bank accounts controlled by GTE. As a result, all cash
is maintained at the GTE level and no cash is allocated to the
Combined Entities. The net changes to cash are reflected in Parent
Funding.
(E) ACCOUNTS RECEIVABLE
Accounts Receivable is comprised of end-user and carrier access
receivables. End-user receivables are primarily associated with
billings to the end-user customer, while carrier access
receivables are primarily associated with billings to
inter-exchange carriers for access. End-user receivables are
tracked by GTE at the exchange level. Thus, end-user receivables
included in the combined financial statements represent actual
receivables associated with all exchanges of the Combined
Entities. Carrier access receivables are not tracked by GTE at the
exchange level. Therefore, carrier access receivables included in
the combined financial statements are allocated to the Combined
Entities by GTE based on the carrier access revenue associated
with the exchanges of the Combined Entities.
(F) ACCOUNTS PAYABLE
Accounts payable are not tracked by GTE at the exchange level.
Therefore, the accounts payable included in the combined financial
statements are allocated to the Combined Entities from GTE based
on operating expenses and capital expenditures associated with the
exchanges of the Combined Entities.
(G) ACCRUED EXPENSES
Accrued expenses are not tracked by GTE at the exchange level.
Therefore, the accrued expenses included in the financial
statements are allocated to the Combined Entities from GTE based
on number of employees, operating income, total revenue or access
lines as appropriate. The allocation factor depends on the nature
of the accrued expense.
7
(H) REVENUES
Revenue for the Combined Entities is comprised of direct and
indirect revenue. Direct revenue is tracked by GTE at the exchange
level, while indirect revenue is tracked by GTE at the state
level. Indirect revenue for the Combined Entities' exchanges in
Illinois and California was allocated at the state level to the
Combined Entities' exchanges primarily based on the relationship
of the exchanges' direct revenue to total state direct revenue.
Indirect revenue allocated to the Combined Entities for the years
1999, 1998 and 1997 were $7.2 million , $8.4 million , and $10.2
million respectively.
LOCAL SERVICES - Monthly recurring local line charges are billed
to end users in advance with any portion that is billed but
unearned recorded as deferred revenue on the balance sheet as part
of accrued expenses. Non-recurring local services are billed in
arrears. Earned but unbilled local service revenues are accrued
for and are included in receivables and revenues.
NETWORK ACCESS SERVICES - Monthly recurring network access service
charges are billed in advance with any portion that is billed but
unearned recorded as deferred revenue on the balance sheet as part
of accrued expenses. Non-recurring network access services are
billed in arrears. Earned but unbilled network access service
revenues are accrued for and are included in receivables and
revenues. Network access revenue primarily consists of switched
access revenue billed to other carriers. Switched access revenue
is billed in arrears based on originating and terminating minutes
of use. Network access revenue also contains special access
revenue. Special access revenue is billed in arrears based on
recurring fees.
TOLL SERVICES - Monthly recurring toll services are billed in
advance with any portion that is billed but unearned recorded as
deferred revenue on the balance sheet as part of accrued expenses.
Non-recurring toll service revenues are billed in arrears. Earned
but unbilled toll service revenues are accrued for and are
included in receivables and revenues.
OTHER SERVICES AND PRODUCTS - Revenue is recognized when services
are provided or when products are delivered to customers.
(I) DEPRECIATION
Property, plant and equipment is carried at cost. The Combined
Entities depreciate property, plant and equipment using the
composite remaining life methodology and straight-line
depreciation rates. The composite remaining life methodology
depreciates the remaining net investment in property, plant and
equipment, less anticipated net salvage value, over the remaining
economic asset lives by asset category.
The economic asset lives used by the Combined Entities are as
follows:
AVERAGE LIVES (IN YEARS)
Buildings 30
Fiber-optic cable 20
Copper wire 15
Office equipment 10
Switching equipment 10
Circuit equipment 8
Vehicles 8
Computers 5
8
When depreciable property, plant and equipment is retired in the
normal course of business, the amount of such plant is deducted
from the respective plant and accumulated depreciation accounts.
(J) ALLOCATION OF COSTS AND EXPENSES
The combined financial statements include allocated cost of
revenues and sales, selling, general and administrative expenses
resulting from the sharing of certain executive, administrative,
accounting, marketing, personnel, engineering and other support
services being performed at consolidated work centers within GTE
and GTE Corporation. The amounts charged for these affiliated
transactions are based on proportional cost allocation
methodologies. These costs are primarily allocated based on the
Combined Entities' net plant in service, access lines, or in
certain instances, direct revenues and expenses relative to the
aggregate of all GTE telephone properties that contribute to the
related expenses. Management believes that the allocated costs and
expenses are reasonable and that amounts allocated to the Combined
Entities for these services do not exceed comparable amounts that
would be charged by an unaffiliated third party for these
services. Also, management believes that the accompanying
financial statements include all costs of doing business. The
allocated expenses correspond to substantial back-office support
and overhead functions which will not transfer to a new operator,
but that a new operator will need to replace in some form in order
to operate the Combined Entities. The level of allocated expenses
may not be representative of a buyer's ongoing expenses for these
functions. These charges amounted to $ 40.8 million, $46.9 million
and $33.9 million for the years ended 1999, 1998 and 1997,
respectively. All other operating costs and expenses represent
either allocations from GTE, primarily based on access lines, or
are directly attributable to the Combined Entities. Depreciation
is directly attributable to the Combined Entities.
(K) INTEREST
No specific debt instruments are directly associated with the
Combined Entities. For purposes of these combined financial
statements, all funding requirements have been summarized as
parent funding without regard to whether the funding represents
debt or equity. The interest expense shown on the combined
statements of income is an allocation of GTE amounts based on the
ratio of average parent funding for the Combined Entities to
average total capital (debt plus equity) for GTE.
Capitalized interest represents the borrowing costs of funds used
to finance construction. Interest is capitalized as a component of
additions to property, plant and equipment ($61,339, $151,784,
$166,469 for 1999, 1998 and 1997 respectively).
(L) TRANSACTIONS WITH AFFILIATES
GTE Supply (100% owned by GTE) provides construction and
maintenance equipment, supplies and electronic repair services to
the Combined Entities. These purchases amounted to $9.6 million,
$10.9 million and $12.2 million for the years 1999, 1998 and 1997
respectively.
The Combined Entities have agreements with GTE Directories
Corporation (GTE Directories) (100% owned by GTE) whereby the
Combined Entities provide billing and collection and other
services to GTE Directories. In addition, the Combined Entities
provide their subscriber lists to GTE Directories and when GTE
Directories sells Yellow Page directory advertising to
9
such customers within the Combined Entities' franchise area,
GTE Directories remits an agreed upon portion of this revenue
to the Combined Entities. Revenues for these activities from
GTE Directories amounted to $2.3 million, $1.7 million, and
$2.3 million for the years 1999, 1998 and 1997 respectively.
In addition, the Combined Entities are billed for certain
printing and other costs associated with telephone
directories, including the cost of customer contact
information pages which are included in the Combined Entities
White Pages directories. These charges amounted to $1.8
million, $.9 million and $.5 million for the years 1999, 1998
and 1997 respectively. A new operator of the Combined Entities
will not be subject to the current agreement between the
Combined Entities and GTE Directories.
(M) EMPLOYEE BENEFIT PLANS
Employee benefit costs represent a combination of allocations
based on the number of employees and specific benefit costs
directly attributable to the Combined Entities. Pension and
postretirement health care and life insurance benefits earned by
employees during the year as well as interest on projected benefit
obligations are accrued currently. Prior year service costs and
credits resulting from changes in plan benefits are amortized over
the average remaining service periods of the employees expected to
receive such benefits. Curtailment gains and losses associated
with employee separations are recognized when they occur.
Settlement gains and losses associated with employee separations
are recognized when the pension obligations are settled and the
gain or loss is determinable.
(N) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE
DISPOSED OF
GTE reviews long-lived assets and certain identifiable intangibles
for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to
future net cash flows expected to be generated by the asset. If
such assets are considered to be impaired, the impairment is
measured by the amount by which the carrying amount of the assets
exceed the fair value. GTE's policy is to record asset impairment
losses as a component of operating income. No such losses were
incurred in 1999, 1998 or 1997.
(O) INCOME TAXES
The Combined Entities are not a taxable entity. The Combined
Entities' operating results are included in GTE's consolidated
federal income tax return. Although the Combined Entities
contribute significant plant-related temporary differences
(including investment tax credits) to GTE's deferred tax balances,
GTE does not allocate income tax payables or deferred income taxes
to the Combined Entities. The provisions for income taxes included
in the accompanying combined financial statements were calculated
based on the income on the Combined Entities using GTE's effective
tax rate adjusted for permanent differences not attributable to
the Combined Entities.
(P) FINANCIAL INSTRUMENTS
The fair values of financial instruments closely approximate their
carrying values.
10
(2) EXTRAORDINARY CHARGE
During the first quarter of 1998 GTE recorded an after-tax extraordinary
charge reflecting premiums paid on the redemption of high-coupon debt
prior to stated maturity. The accompanying financial statements included
an allocation of the charge based on the ratio of parent funding for the
Combined Entities' exchanges included in GTE's results to total capital
for GTE. This extraordinary charge of $108,000 is presented net of taxes
of $39,000.
(3) PROPERTY, PLANT AND EQUIPMENT, CAPITAL EXPENDITURES AND DEPRECIATION
The Combined Entities maintain continuous property records which identify
specific property, plant and equipment balances, depreciation reserves
and annual capital expenditure amounts for the Combined Entities. The
balances in the accompanying combined financial statements are based on
exchange-specific amounts and do not include any allocations of common
assets utilized in providing the centralized services described in Note
1.
Property, plant and equipment is summarized as follows at December 31 (in
thousands):
1999 1998
--------- ---------
Land $ 1,410 $ 1,503
Buildings 31,506 31,100
Plant and equipment 511,694 501,304
Other 26,122 21,798
--------- ---------
Total 570,732 555,705
Less accumulated depreciation (428,816) (401,107)
--------- ---------
$ 141,916 $ 154,598
========= =========
(4) EMPLOYEE BENEFIT PLANS
The FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and
Other Postretirement Benefits," in February 1998. Certain disclosures are
required to be made of the components of pension credits, postretirement
benefit costs and the funded status of the plans, including the actuarial
present value of accumulated plan benefits, accumulated or projected
benefit obligation and the fair value of plan assets. We do not present
such disclosures because the structure of the GTE plans does not permit
the plans' data to be readily disaggregated.
The assets and liabilities relating to employee benefit plans represent a
combination of allocations of GTE state level amounts based on the number
of employees and specific benefit costs directly attributable to the
Combined Entities. The asset amount represents the Combined Entities'
allocable portion of pension plan assets in excess of the projected
benefit obligation. The liability amount represents the Combined
Entities' allocable portion of the projected benefit obligation for
postretirment benefits other than pensions.
PENSION PLANS
GTE participates in non-contributory defined benefit pension plans
sponsored by GTE Corporation. Net periodic benefit credit for the
Combined Entities was $6.5 million, $2.0 million and $2.4 million for
1999, 1998 and 1997, respectively. The credits represent a combination of
allocations of GTE state level amounts based on the number of employees
and specific benefit credits directly
11
attributable to the Combined Entities. The significant weighted-average
assumptions used by GTE Corporation for the pension measurements were
as follows at December 31:
1999 1998 1997
---- ---- ----
Discount rate 8.0% 7.0% 7.2%
Rate of compensation increase 5.5% 4.7% 5.0%
Expected return on plan assets 9.0% 9.0% 9.0%
The GTE Corporation plans are currently funded at levels significantly in
excess of projected benefit obligations. In addition, the plans have
recognized significant curtailment gains associated with workforce
reductions. Because GTE does not plan to transfer surplus pension assets
to the buyer, and given the non-recurring nature of the curtailment
gains, amounts included in the accompanying combined financial statements
related to pension benefits are not likely to be representative of
amounts that would be recorded by a buyer upon acquisition or be
recognized by a buyer in future operations.
POST-RETIREMENT BENEFITS OTHER THAN PENSIONS (OPEB)
Substantially all of the Combined Entities' employees are covered under
postretirement healthcare and life insurance benefit plans sponsored by
GTE Corporation.
Postretirement benefit cost for the Combined Entities was $1.7 million,
$0.8 million, and $1.8 million for 1999, 1998 and 1997, respectively.
These costs represent allocations of GTE amounts based on the number of
employees and specific benefit costs directly attributable to the
Combined Entities. As of December 31, 1999 and 1998, $12.9 million and
$12.2 million, respectively, were accrued for post-retirement benefits.
The weighted-average assumptions used by GTE Corporation in the actuarial
computations for post-retirement benefits were as follows at December 31:
1999 1998 1997
---- ---- ----
Discount rate 8.0% 7.0% 7.2%
Expected return on plan assets 8.0% 9.0% 9.0%
GTE funds amounts for OPEB liabilities as appropriate.
SAVINGS PLANS
GTE sponsors employee savings plans under Section 401(k) of the Internal
Revenue Code. The plans cover substantially all full-time employees.
Under the plans, GTE provides matching contributions in GTE Corporation
common stock based on qualified employee contributions. Matching
contributions charged to income for 1999, 1998 and 1997 were $274,008,
$228,898 and $276,671 respectively.
12
(5) INCOME TAXES
The income tax provision (benefit) is as follows:
1999 1998 1997
---- ---- ----
Current:
Federal $ 7,800 $ 3,439 $10,943
State 704 1,575 1,312
------- ------- -------
Total 8,504 5,014 12,255
Deferred:
Federal - net of investment tax credit 8,132 6,968 3,108
State 2,342 1,016 754
------- ------- -------
Total 10,474 7,984 3,862
------- ------- -------
Total provision $18,978 $12,998 $16,117
======= ======= =======
A reconciliation between taxes computed and by applying the statutory
federal income tax rate to pretax income and income taxes provided in the
combined statements of income is as follows:
1999 1998 1997
---- ---- ----
Amounts computed at statutory rates $ 16,625 $ 11,246 $ 14,785
State and local income taxes, net of
federal income tax benefit 1,980 1,684 1,342
Amortization of deferred investment
tax credits (222) (342) (478)
Other - net 595 410 468
-------- -------- --------
Total $ 18,978 $ 12,998 $ 16,117
======== ======== ========
(6) SIGNIFICANT CUSTOMER
Revenues received from AT&T Corp. included amounts for network access and
billings and collection during 1999, 1998 and 1997 under various
arrangements and amounted to $11.7 million, $15.0 million and $14.9
million, respectively.
13
(7) COMMITMENTS AND CONTINGENCIES
The Combined Entities have noncancelable leases covering certain
buildings, office space and equipment. Rental expense was $2.6 million ,
$2.3 million and $2.0 million in 1999, 1998 and 1997 respectively.
Minimum rental commitments under noncancelable leases are as follows:
(in thousands)
2000 $ 105
2001 90
2002 45
2003 26
2004 19
Thereafter 77
-----
$ 362
=====
GTE is subject to a number of proceedings arising out of the conduct of
its business, including those relating to regulatory actions, commercial
transactions and environmental, safety and health matters. Management
believes that the ultimate resolution of these matters will not have a
material adverse effect on the results of operations or the financial
position of the Combined Entities operations.
(8) ACCRUED EXPENSES
Accrued expenses included in the combined financial statements are
allocated to the Combined Entities from GTE based on number of employees,
operating income, total revenue or access lines as appropriate. Accrued
expenses as of December 31, 1999 and 1998 consist of the following (in
thousands):
1999 1998
------- -------
Advance billings and customer deposits $ 3,352 $ 3,173
Taxes other than income taxes payable 5,363 5,577
Accrued interest 1,181 1,254
Accrued payroll costs 2,133 2,045
Other 3,281 3,062
------- -------
Total accrued expenses $15,310 $15,111
======= =======
14
(9) PARENT FUNDING
Parent Funding represents GTE Corporation's investment in the exchanges,
accumulated earnings and losses of the exchanges and net intercompany
activity with GTE Corporation and GTE.
Parent Funding from January 1, 1997 through December 31, 1999 consists of
the following:
(in thousands)
Balance January 1, 1997 $ 137,454
Net Income 24,987
Change In Due To/From Parent (13,237)
---------
Balance December 31, 1997 149,204
Net Income 20,465
Change In Due To/From Parent 2,051
---------
Balance December 31, 1998 171,720
Net Income 27,962
Change In Due To/From Parent (34,828)
---------
Balance December 31, 1999 $ 164,854
=========
Changes In Due To/From Parent include amounts for taxes and interest,
both of which were allocated by the parent.
15
UNAUDITED FINANCIAL STATEMENTS FOR
CONTEL OF MINNESOTA, INCORPORATED
AS OF JUNE 30, 2000 AND 1999
CONTEL OF MINNESOTA
STATEMENTS OF INCOME (unaudited)
Six Months Ended
June June
2000 1999
----------------------
(Thousands of Dollars)
REVENUE AND SALES
Local services $19,032 $18,322
Network access services 20,800 19,808
Toll services 12 (18)
Other services and sales 3,592 4,403
------- -------
Total revenue and sales 43,436 42,515
OPERATING COSTS AND EXPENSES 15,820 15,852
------- -------
OPERATING INCOME 27,616 26,663
OTHER EXPENSE
Interest - net 1,356 1,248
------- -------
INCOME BEFORE INCOME TAXES 26,260 25,415
Income taxes 10,803 10,430
------- -------
INCOME BEFORE EXTRAORDINARY ITEMS 15,457 14,985
Extraordinary items (16) --
------- -------
NET INCOME $15,441 $14,985
======= =======
CONTEL OF MINNESOTA
BALANCE SHEETS (unaudited)
June 30, December 31,
2000 1999
------------------------
(Thousands of Dollars)
ASSETS
Current assets:
Cash and cash equivalents $ 788 $ 956
Receivables, less allowances of $562 and $519 19,157 15,966
Notes receivable, affiliate 2,694 --
Net assets held for sale 147,152 132,069
Other 1,318 2,089
-------- --------
Total current assets 171,109 151,080
Employee benefit plans and other assets 2,666 1,829
-------- --------
Total assets $173,775 $152,909
======== ========
LIABILITIES AND PARENT FUNDING
Current liabilities:
Short-term obligations, including current maturities $ -- $ 9,012
Accounts payable 4,466 5,862
Affiliate payables and accruals 1,366 1,711
Advance billings and customer deposits 1,872 1,894
Taxes payable 4,047 2,005
Accrued payroll costs 963 1,035
Dividends payable 3,600 7,800
Other 646 39
-------- --------
Total current liabilities 16,960 29,358
Long-term debt -- 35,001
Deferred income taxes 30,487 25,971
Other liabilities 1,250 1,199
-------- --------
Total liabilities 48,697 91,529
SHAREHOLDER'S EQUITY 125,078 61,380
-------- --------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $173,775 $152,909
======== ========
CONTEL OF MINNESOTA
STATEMENTS OF CASH FLOWS
For the six months ended June 30,
2000 1999
---------------------
(Thousands of Dollars)
CASH FLOWS FROM OPERATING ACTIVITIES $ 17,458 $11,957
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (14,950) (5,704)
CASH FLOWS FROM FINANCING ACTIVITIES
Long-term debt retirements (3,665) (149)
Affiliated long-term debt retirements (35,000) --
Net change in affiliate notes 50,105 3,778
Common dividends paid (14,100) (9,100)
Other (16) --
------- -------
Net cash used in financing activities (2,676) (5,471)
DECREASE IN CASH AND CASH EQUIVALENTS (168) 782
CASH AND CASH EQUIVALENTS, beginning of period 956 2
------- -------
CASH AND CASH EQUIVALENTS, end of period $ 788 $ 784
======= ======
(1) BASIS OF PRESENTATION
The accompanying unaudited combined financial statements include the
accounts of Contel of Minnesota, Inc. and have been prepared in
conformity with generally accepted accounting principles. These
unaudited combined financial statements should be read in conjunction
with the 1999 audited combined financial statements and notes thereto
of Contel of Minnesota, Inc. These unaudited combined financial
statements include all adjustments, which consist of normal recurring
accruals, necessary to present fairly the results for the interim
periods shown. Certain information and footnote disclosures have been
condensed pursuant to Securities and Exchange Commission rules and
regulations. The results for the interim periods are not necessarily
indicative of results for the full year.
(2) BELL ATLANTIC - GTE MERGER
On June 30, 2000, Bell Atlantic and GTE completed a merger of equals
under a definitive merger agreement dated July 27, 1998. Under the
terms of the agreement, GTE became a wholly-owned subsidiary of Bell
Atlantic. With the closing of the merger, the combined company began
doing business as Verizon Communications. The merger had no impact on
the financial statements of the GTE Combined Entities presented herein.
[LOGO OF ARTHUR ANDERSEN]
CONTEL OF MINNESOTA, INC
Financial Statements
As Of December 31, 1999 And 1998
Together With Report Of Independent Public Accountants
[LETTERHEAD OF ARTHUR ANDERSEN]
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Contel of Minnesota, Inc.:
We have audited the accompanying balance sheets of Contel Minnesota, Inc., d/b/a
GTE Minnesota (the "Company") (a Minnesota corporation), as of December 31, 1999
and 1998, and the related statements of income, shareholder's equity and cash
flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. 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 the Company as of December 31,
1999 and 1998, and the results of its operations and its cash flows for the
years then ended in conformity with accounting principles generally accepted in
the United States.
/s/ Arthur Andersen LLP
Dallas, Texas,
January 27, 2000
CONTEL OF MINNESOTA, INC
BALANCE SHEETS - DECEMBER 31, 1999 AND 1998
ASSETS 1999 1998
-------- --------
(Thousands of Dollars)
CURRENT ASSETS:
Cash and cash equivalents $ 956 $ 2
Receivables, less allowances of $519 and $526 15,966 20,760
Net assets held for sale (Notes 3 and 10) 132,069 --
Prepayments and other 2,089 1,178
-------- --------
Total current assets 151,080 21,940
-------- --------
Property, plant and equipment, net (Notes 3 and 10) -- 115,142
Prepaid pension costs and other assets 1,829 1,803
-------- --------
Total assets $152,909 $138,885
======== ========
LIABILITIES AND SHAREHOLDER'S EQUITY
CURRENT LIABILITIES:
Short-term obligations, including current maturities $ 9,012 $ 3,300
Accounts payable 5,862 13,332
Affiliate payables and accruals 1,711 1,529
Advanced billings and customer deposits 1,894 1,792
Taxes payable 2,005 1,884
Accrued payroll costs 1,035 1,568
Dividends payable 7,800 5,000
Other 39 990
-------- --------
Total current liabilities 29,358 29,395
-------- --------
NON-CURRENT LIABILITIES:
Long-term debt 35,001 38,665
Deferred income taxes 25,971 16,930
Other liabilities 1,199 2,764
-------- --------
Total liabilities 91,529 87,754
-------- --------
SHAREHOLDER'S EQUITY:
Common stock (154,096 shares issued) 3,852 3,852
Additional paid-in-capital 16,139 16,019
Retained earnings 41,389 31,260
-------- --------
Total shareholder's equity 61,380 51,131
-------- --------
Total liabilities and shareholder's equity $152,909 $138,885
======== ========
The accompanying notes are an integral part of these financial statements.
CONTEL OF MINNESOTA, INC.
STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
1999 1998
------------ ------------
(Thousands of Dollars)
REVENUES AND SALES:
Local services $37,345 $35,152
Network access services 39,777 39,744
Other services and sales 8,726 8,430
------- -------
Total revenues and sales 85,848 83,326
------- -------
OPERATING COSTS AND EXPENSES:
Cost of services and sales 21,318 20,473
Selling, general and administrative 8,980 13,587
Depreciation and amortization 771 13,849
------- -------
Total operating costs and expenses 31,069 47,909
------- -------
OPERATING INCOME 54,779 35,417
OTHER EXPENSES:
Interest - net 2,430 2,365
Other - net -- 55
------- -------
INCOME BEFORE INCOME TAXES 52,349 32,997
INCOME TAXES 21,520 11,203
------- -------
INCOME BEFORE EXTRAORDINARY ITEM 30,829 21,794
EXTRAORDINARY ITEM -- 400
------- -------
NET INCOME $30,829 $21,394
======= =======
The accompanying notes are an integral part of these financial statements.
CONTEL OF MINNESOTA, INC.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
1999 1998
------------ -----------
(Thousands of Dollars)
CASH FLOWS FROM OPERATING ACTIVITIES:
Income before extraordinary item $ 30,829 $ 21,794
Adjustments to reconcile income before extraordinary item to
net cash from operations-
Depreciation and amortization 771 13,849
Deferred income taxes 7,514 8,125
Employee retirement benefits (1,339) (2,074)
Provision for uncollectible accounts 740 744
Changes in current assets and current liabilities-
Receivables, net 4,054 (704)
Other current assets (383) (155)
Accrued taxes and interest 253 (1,315)
Other current liabilities (7,580) 1,209
Other, net (951) (1,405)
-------- --------
Net cash from operating activities 33,908 40,068
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (17,201) (24,014)
Other, net 99 15
-------- --------
Net cash used in investing activities (17,102) (23,999)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt retired (290) (19,268)
Affiliated long-term debt issued -- 35,000
Dividends (17,900) (9,300)
Net change in affiliate notes 2,338 (22,499)
-------- --------
Net cash used in financing activities (15,852) (16,067)
-------- --------
INCREASE IN CASH AND CASH EQUIVALENTS 954 2
CASH AND CASH EQUIVALENTS, beginning of year 2 --
-------- --------
CASH AND CASH EQUIVALENTS, end of year $ 956 $ 2
======== ========
CASH PAID DURING THE YEAR FOR:
Interest $ 2,503 $ 2,186
-------- --------
Income taxes $ 13,589 $ 4,240
-------- --------
The accompanying notes are an integral part of these financial statements.
CONTEL OF MINNESOTA, INC.
STATEMENTS OF SHAREHOLDER'S EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
Additional
Common Paid-in Retained
Stock Capital Earnings Total
-------- -------- -------- --------
(Thousands of Dollars)
SHAREHOLDER'S EQUITY, December 31, 1997 $ 3,852 $ 16,019 $ 24,166 $ 44,037
Net income -- -- 21,394 21,394
Dividends declared -- -- (14,300) (14,300)
-------- -------- -------- --------
SHAREHOLDER'S EQUITY, December 31, 1998 3,852 16,019 31,260 51,131
Net income -- -- 30,829 30,829
Tax benefit from exercise of stock options -- 120 -- 120
Dividends declared -- -- (20,700) (20,700)
-------- -------- -------- --------
SHAREHOLDER'S EQUITY, December 31, 1999 $ 3,852 $ 16,139 $ 41,389 $ 61,380
======== ======== ======== ========
The accompanying notes are an integral part of these financial statements.
CONTEL OF MINNESOTA, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
DESCRIPTION OF BUSINESS
Contel of Minnesota, Inc. d/b/a GTE Minnesota (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, 1999, the Company served approximately 146,505
access lines in the state of Minnesota. The Company is a wholly owned subsidiary
of GTE Corporation (GTE).
BASIS OF PRESENTATION
The Company prepares its financial statements in accordance with accounting
principles generally accepted in the United States, which require management to
make estimates and assumptions that affect reported amounts. Actual results
could differ from those estimates.
Reclassifications of prior-year data have been made, where appropriate, to
conform to the 1999 presentation.
TRANSACTIONS WITH AFFILIATES
GTE Supply (100% owned by GTE) provides construction and maintenance equipment,
supplies and electronic repair services to the Company. These purchases and
services amounted to $1.9 million and $2.4 million for the years 1999 and 1998,
respectively. Such purchases and services are recorded in the accounts of the
Company at the lower of cost, including a return realized by GTE Supply, or fair
market value.
The Company is billed for data processing services, software development and
equipment rentals, and receives management, consulting, research and development
and pension management services from other affiliated companies. The Company's
financial statements also include allocated expenses resulting from the sharing
of certain executive, administrative, financial, accounting, marketing,
personnel, engineering and other support services being performed at
consolidated work centers within GTE. The amounts charged for these affiliated
transactions are based on proportional cost allocation methodologies. These
charges amounted to $5.8 million and $8.1 million for the years 1999 and 1998,
respectively.
The Company has an agreement with GTE Directories Corporation (GTE Directories)
(100% owned by GTE), whereby the Company provides its subscriber lists, billing
and collection and other services to GTE Directories. In addition, when GTE
Directories sells Yellow Page directory advertising to customers within the
Company's franchise area, the Company records a portion of the sale as revenue.
Revenues from these activities amounted to $1.3 million and $1.2 million for the
years 1999 and 1998,
-2-
respectively. Also, the Company is billed for certain printing and other costs
associated with telephone directories, including the cost of customer contact
information pages which are included in the Company's White Pages directories.
These charges amounted to $0.9 million and $3.5 million for the years 1999 and
1998, respectively.
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.
DEPRECIATION AND AMORTIZATION
Property, plant and equipment of the Company is depreciated on a straight-line
basis over the following estimated useful asset lives:
AVERAGE LIVES (IN YEARS)
Buildings 20 - 40
Inside communications plant 5 - 10
Outside communications plant 8 - 40
Furniture, vehicles and other equipment 3 - 10
The Company depreciates assets using the remaining life methodology. This method
depreciates the net investment in telephone plant, less anticipated net salvage
value, over remaining useful asset lives and requires the periodic review and
revision of depreciation rates.
When depreciable plant of the Company is retired in the normal course of
business, the amount of such plant is deducted from the respective plant and
accumulated depreciation accounts. Gains or losses on disposition are amortized
with the remaining net investment in telephone plant. When depreciable telephone
plant is retired outside the normal course of business, for example if a local
exchange is sold, any resulting gain or loss is included in operating income.
EMPLOYEE BENEFIT PLANS
Pension and postretirement health care and life insurance benefits earned during
the year as well as interest on projected benefit obligations are accrued
currently. Prior service costs and credits resulting from changes in plan
benefits are amortized over the average remaining service period of the
employees expected to receive benefits. Curtailment gains and losses associated
with employee separations are recognized when they occur. Settlement gains and
losses are recognized when significant pension obligations are settled and the
gain or loss is determinable.
VALUATION OF ASSETS
The impairment of tangible and intangible assets is assessed when changes in
circumstances indicate that their carrying value may not be recoverable. Under
the Financial Accounting Standards Board's (FASB) Statement of Financial
Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," a determination
of impairment, if any, is made based on estimated future cash flows, salvage
value or expected net sales proceeds depending on
-3-
the circumstances. In instances where goodwill has been recorded in connection
with impaired assets, the carrying amount of the goodwill is first eliminated
before any reduction to the carrying value of tangible or identifiable
intangible assets. The Company's policy is to record asset impairment losses,
and any subsequent adjustments to such losses as initially recorded, as well as
net gains or losses on sales of assets as a component of operating income.
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 income taxes are recorded to reflect the tax consequences in future
years of differences between the tax bases of assets and liabilities and their
financial reporting amounts at each reporting period. Deferred tax assets and
liabilities are subsequently adjusted, to the extent necessary, to reflect tax
rates expected to be in effect when the temporary differences reverse. A
valuation allowance is established for deferred tax assets for which realization
is not likely.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include investments in short-term, highly liquid
securities, which have maturities, when purchased, of three months or less.
FINANCIAL INSTRUMENTS
The Company uses a variety of financial instruments to hedge its exposure to
fluctuations in interest rates. The Company does not use financial instruments
for speculative or trading purposes, nor is the Company a party to leveraged
derivatives. Amounts to be paid or received under interest rate swaps are
accrued as interest expense.
INVENTORIES AND SUPPLIES
Inventories and supplies are stated at the lower of cost, determined principally
by the average cost method, or net realizable value.
SOFTWARE
Software costs are recognized in accordance with the American Institute of
Certified Public Accountants Statement of Position (SOP) 98-1, "Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use," which
became effective in January 1999. The Company capitalizes costs associated with
externally acquired software (including right-to-use fees) for internal use.
Capitalized software is generally amortized on a straight-line basis over its
useful life, not to exceed five years for non-network software or three years
for network software. As a result of adopting SOP 98-1, the Company capitalized
software expenditures of $1.0 million and $3.0 million, respectively, for 1999
and 1998, which would have previously been expensed.
-4-
COMPREHENSIVE INCOME
The Company had no comprehensive income components for the years ended December
31, 1999 and 1998, therefore, comprehensive income is the same as net income for
both periods.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. The statement requires
entities that use derivative instruments to measure these instruments at fair
value and record them as assets or liabilities on the balance sheet. It also
requires entities to reflect the gains or losses associated with changes in the
fair value of these derivatives, either in earnings or as a separate component
of comprehensive income, depending on the nature of the underlying contract or
transaction. The Company is currently assessing the impact of adopting SFAS No.
133, as amended, which is effective January 1, 2001.
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements," which currently must be adopted by June 30, 2000. SAB No. 101
provides additional guidance on revenue recognition as well as criteria for when
revenue is generally realized and earned and also requires the deferral of
incremental direct selling costs. The Company is currently assessing the impact
of SAB No. 101.
2. PROPOSED MERGER WITH BELL ATLANTIC CORPORATION:
Bell Atlantic and GTE have announced a proposed merger of equals under a
definitive merger agreement dated July 27, 1998. Under the terms of the
agreement, GTE shareholders will receive 1.22 shares of Bell Atlantic common
stock for each share of GTE common stock that they own. Bell Atlantic
shareholders will continue to own their existing shares after the merger.
The merger is expected to qualify as a pooling of interests, which means that
for accounting and financial reporting purposes the companies will be treated as
if they had always been combined. The completion of the merger is subject to a
number of conditions, including certain regulatory approvals and receipt of
opinions that the merger will be tax-free. At annual meetings held in May 1999,
the shareholders of each company approved the merger. All state regulatory
commissions have now approved the merger and the only remaining approval is
required from the Federal Communications Commission (FCC). Both companies are
working diligently to complete the merger and are targeting completion of the
merger in the second quarter of 2000.
3. PLANNED ASSET SALES:
During May 1999, the Company entered into an agreement to sell all of the
switched access lines located in Minnesota to Citizens Utilities Company. This
agreement consummates the Company's previously announced 1998 plan to sell all
access lines located in Minnesota. This sale will be subject to regulatory
approval and is expected to close during 2000. The associated net assets, which
approximate $132.1 million, consist of property, plant and equipment, and have
been reclassified as "Net assets held for sale" in the balance sheets at
December 31, 1999. The net book value of these access lines is reflected in
"Property, plant and equipment, net" in the balance sheets at December 31, 1998
(see Note 10). The Company intends to continue to operate all of these assets
until sold. Based on the decision to sell,
-5-
however, the Company stopped recording depreciation expense for these assets.
Accordingly, depreciation expense was lowered by $19.4 million in 1999 and $4.4
million in 1998. No charges were recorded for the access lines to be sold
because their estimated fair values were in excess of their carrying values.
4. EXTRAORDINARY CHARGE:
During the first quarter of 1998, the Company recorded an after-tax
extraordinary charge of $0.4 million (net of tax benefits of $0.2 million),
reflecting premiums paid on the redemption of high-coupon debt prior to stated
maturity.
5. COMMON STOCK:
The authorized common stock of the Company consists of 192,000 shares with a
stated value of $25 per share. All 154,096 outstanding shares of common stock
are held by GTE. There were no shares of common stock held by or for the account
of the Company and no shares were reserved for officers and employees, or for
options, warrants, conversions or other rights. At December 31, 1999, $20.6
million of the Company's retained earnings were restricted as to the payment of
cash dividends on common stock under the most restrictive terms of the Company's
indentures.
6. DEBT:
Long-term debt as of December 31, was as follows:
1999 1998
-------- ------
(Dollars in Thousands)
Rural Utilities Service (RUS)
2.00% due 2011 $ 736 $ 902
Rural Telephone Bank (RTB)
6.50% due 2013 2,929 3,053
Affiliate note
5.61% due 2001 35,000 35,000
-------- --------
Total principal amount 38,665 38,955
Less- Current maturities (3,664) (290)
--------- ----------
Total long-term debt $35,001 $38,665
======= =======
In January 2000, the Company retired $3.7 million of long-term debt (RUS and
RTB) prior to stated maturity.
In March 2000, the Company retired a $35.0 million affiliate note with GTE prior
to state maturity.
In March 1998, the Company retired, prior to stated maturity, $18.4 million of
long-term debt. The Company incurred $0.4 million (net of tax benefits of $0.2
million) in premiums associated with this retirement.
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.
-6-
Total short-term obligations as of December 31, were as follows:
1999 1998
------- --------
(Dollars in Thousands)
Note payable to affiliate - average rates 6.2% and 5.7% $5,348 $3,010
Current maturities of long-term debt 3,664 290
------- --------
Total $9,012 $3,300
====== ======
The Company finances part of its construction program through the use of interim
short-term notes payable to affiliates. During 1999 and 1998, the Company
supplemented its internal generation of cash with funds borrowed from GTE. These
arrangements require payment of interest based on GTE's daily intercompany
interest rate (which is based primarily on the costs associated with the
issuance of commercial paper).
7. FINANCIAL INSTRUMENTS:
The fair values of financial instruments, other than long-term debt, closely
approximate their carrying values. As of December 31, 1999, the estimated fair
value of long-term debt based on either reference to quoted market prices or an
option pricing model, was lower than the carrying value by approximately $1.1
million. As of December 31, 1998, the estimated fair value of long-term debt
exceeded the carrying value by approximately $0.2 million.
8. INCOME TAXES:
The income tax provision (benefit) is as follows:
1999 1998
-------- ------
(Thousands of Dollars)
Current:
Federal $10,697 $ 2,741
State 3,309 313
-------- ---------
14,006 3,054
------- --------
Deferred:
Federal 5,911 6,598
State 1,815 1,973
-------- --------
7,726 8,571
-------- --------
Amortization of deferred investment tax credits (212) (422)
--------- ---------
Total provision $21,520 $11,203
======= =======
-7-
A reconciliation between taxes computed by applying the statutory federal income
tax rate to pretax income and income taxes provided in the statements of income
is as follows:
1999 1998
-------- --------
(Thousands of Dollars)
Amounts computed at statutory rates $ 18,322 $ 11,549
State and local income taxes, net of federal income tax
benefits 3,331 1,486
Amortization of deferred investment tax credits (212) (422)
Other differences - net 79 (1,410)
-------- --------
Total provision $ 21,520 $ 11,203
======== ========
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:
1999 1998
---- ----
(Thousands of Dollars)
Depreciation and amortization $ 25,147 $ 16,280
Employee benefit obligations (1,065) (862)
Prepaid pension costs 1,130 819
Investment tax credits 119 331
Other - net 239 1,464
-------- --------
Net deferred tax liability $ 25,570 $ 18,032
======== ========
9. EMPLOYEE BENEFIT PLANS:
The FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits," in February 1998. Certain disclosures are required to
be made of the components of pension credits, postretirement benefit costs and
the funded status of the plans, including the actuarial present value of
accumulated plan benefits, accumulated or projected benefit obligation and the
fair value of plan assets. We do not present such disclosures because the
structure of the GTE plans does not permit the plans' data to be readily
disaggregated.
PENSION PLANS
The Company participates in noncontributory defined benefit pension plans
sponsored by GTE covering substantially all employees. The benefits to be paid
under these plans are generally based on years of credited service and average
final earnings. GTE's funding policy, subject to the minimum funding
requirements of employee benefit and tax laws, is to contribute such amounts as
are determined on an actuarial basis to accumulate funds sufficient to meet the
plans' benefit obligation to employees upon their retirement. The assets of the
plans consist primarily of corporate equities, government securities and
corporate debt securities.
-8-
The significant weighted-average assumptions used by GTE for the pension
measurements were as follows at December 31:
1999 1998
-------- ------
Discount rate 8.00% 7.00%
Rate of compensation increase 5.50% 4.75%
Expected return on plan assets 9.00% 9.00%
Net periodic benefit credit was $0.5 million and $0.4 million for the years 1999
and 1998, respectively.
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
Substantially all of the Company's employees are covered under postretirement
healthcare and life insurance benefit plans sponsored by GTE. The determination
of benefit cost for postretirement health plans is generally based on
comprehensive hospital, medical and surgical benefit plan provisions. The
Company intends to fund amounts for postretirement benefits as deemed
appropriate.
Postretirement benefit cost was $1.0 million and $0.3 million for the years 1999
and 1998, respectively. The weighted-average assumptions used by GTE in the
actuarial computations for postretirement benefits were as follows at December
31:
1999 1998
-------- ------
Discount rate 8.00% 7.00%
Expected return on plan assets 8.00% 8.00%
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
$0.1 million in both 1999 and 1998.
10. PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment is summarized as follows at December 31:
1999 1998
-------- --------
(Thousands of Dollars)
Land $ -- $ 914
Buildings -- 18,845
Plant and equipment -- 258,987
Other -- 7,534
Total -- 286,280
Less- Accumulated depreciation -- (171,138)
-------- --------
Total property, plant and equipment - net $ -- $ 115,142
======== ========
At December 31, 1999, all property, plant and equipment is being held for sale
(See Note 3).
-9-
11. REGULATORY AND COMPETITIVE MATTERS:
The Company's intrastate business is regulated by the Minnesota Public Utilities
Commission (MPUC). The Company is subject to regulation by the FCC for its
interstate business operations.
The Company provides local-exchange services to customers within its designated
franchise area. The Company also 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
individual state regulatory orders. The Company also provides long distance
access services directly to interexchange carriers and other customers who
provide services between LATAs.
During 1999, regulatory and legislative activity at both the state and federal
levels continued to be a direct result of the Telecommunications Act of 1996
(Telecommunications Act). Along with promoting competition in all segments of
the telecommunications industry, the Telecommunications Act was intended to
preserve and advance universal service.
INTERSTATE SERVICES
GTE continued in 1999 to meet the wholesale requirements of new competitors. GTE
has signed interconnection agreements with other carriers, providing them the
capability to purchase unbundled network elements (UNEs), resell retail services
and interconnect facilities-based networks. Several of these interconnection
agreements were the result of the arbitration process established by the
Telecommunications Act, and incorporated prices or terms and conditions based
upon the FCC rules that were subsequently appealed to the U. S. Supreme Court
(Supreme Court). GTE challenged a number of such agreements in federal district
courts during 1997.
GTE's position in these challenges was supported by a decision of the Eighth
Circuit Court (Eighth Circuit) in July 1997 which stated the FCC had overstepped
its authority in several areas concerning implementation of the interconnection
provisions of the Telecommunications Act. In January 1999, the Supreme Court
reversed in part and affirmed in part the Eighth Circuit's decisions. The
Supreme Court reversed the Eighth Circuit's determination that the FCC had no
jurisdiction over pricing. As a result, the pricing rules established by the FCC
are now subject to review on their merits by the Eighth Circuit. In addition,
the Supreme Court vacated the FCC rule setting forth the UNEs that incumbent
local exchange carriers (ILECs) are required to provide to competitive local
exchange carriers (CLECs). This latter ruling led to a proceeding before the FCC
concerning what elements had to be offered and under what conditions.
In November 1999, the FCC reaffirmed that incumbents must provide unbundled
access to five of the original seven network elements, which must be available
on either a stand-alone basis, or as a combined local service "platform" if the
elements have been previously combined by the ILEC. ILECs are no longer required
to provide unbundled operator services, including directory assistance where
alternate routing is available. In addition, in certain circumstances, local and
tandem switching need not be unbundled. However, the FCC expanded the definition
of some UNEs by specifying that components of the loop UNE must be made
available in sub-loop components, and augmenting the types of call-related
databases that must be unbundled as UNEs. The FCC also found that state
commissions can require ILECs to unbundle additional elements as long as they
are consistent with the requirements of the Telecommunications Act and the
national policy framework instituted in the FCC's order. Furthermore,
-10-
the order precludes states from removing network elements from the FCC's list of
unbundling obligations. The United States Telecom Association (USTA) has
appealed this order and GTE will participate.
In December 1999, the FCC released another order that requires ILECs to provide
line sharing to CLECs by unbundled access to the high-frequency portion of the
local loop over which the ILEC provides voice services. The FCC's stated intent
in adopting the line sharing order is to enable competitive carriers to provide
digital subscriber line (DSL) services over the same lines simultaneously used
by ILECs to provide basic phone services.
In June 1999, the Eighth Circuit established a schedule for addressing the
issues it did not decide in 1998. Parties to this action have filed briefs and
participated in oral arguments in September 1999. The major issues are: (1) the
FCC's cost methodology used to set prices, (2) its methodology for setting
wholesale discounts, (3) the "proxy rates" it set for interconnection, UNEs, and
wholesale discounts, (4) whether ILECs should be required to combine UNEs that
are not already combined, and (5) whether the FCC can require ILECs to provide
"superior quality" to competitors than what the ILEC provides to itself. A court
decision is expected during the first half of 2000.
UNIVERSAL SERVICE
GTE is active before both state and federal regulators advocating development
and implementation of measures that will meet the requirements of the universal
service provisions of the Telecommunications Act. Specifically, GTE urges
regulators to identify and remove all hidden subsidies and to provide explicit
universal service subsidies.
In October 1998, the FCC issued an order selecting a cost model for universal
service. In July 1999, the United States Court of Appeals for the Fifth Circuit
(Fifth Circuit) affirmed in part, reversed in part, and remanded in part the
FCC's universal service regime. In October 1999, the FCC released two orders in
response to the Fifth Circuit decision. One order permits ILECs to continue to
recover their universal service contributions from access charges or to
establish end-user charges. The second order changed the contribution basis for
school/library funding to eliminate calculations based upon intrastate revenues.
In January 2000, GTE requested the Supreme Court to review the Fifth Circuit
decision allowing the FCC to base universal service support from the results of
a hypothetical cost model rather than historical costs that were incurred to
provide local service. GTE argued that the Fifth Circuit ignored long standing
legal precedent in permitting a major revision to ILEC cost recovery mechanisms
without ensuring the new process would not result in a constitutionally
prohibited "taking".
In November 1999, the FCC released an order selecting the cost inputs for the
federal universal service cost model. GTE is seeking reconsideration. Since the
FCC moved the implementation date of the new universal service mechanism for
non-rural carriers to January 2000, many state regulators awaited FCC action
before they began designing their universal service programs.
In November 1999, the FCC released an order dealing with implementation of the
new FCC federal high cost support mechanism for non-rural ILECs, including GTE.
The effective date for the new federal universal service plan is January 1,
2000. This plan will distribute federal high cost funds to states with higher
than average costs. The role of state commissions is to ensure reasonable
comparability within the borders of a state. Federal high cost support will be
calculated by comparing the nationwide average cost with each state's average
cost per line, and providing federal support for only states that exceed 135% of
the nationwide average. To guard against rate shock, the FCC also adopted a
"hold harmless"
-11-
approach so that the amount of support provided to each non-rural carrier under
the new plan will not be less than the amount provided today. U S WEST has
appealed this order on the basis that it fails to provide a sufficient amount of
support. This FCC order also established a May 1, 2000 deadline by which state
commissions must create at least three deaveraged price zones for UNEs. In
January 2000, GTE requested the FCC grant a one year delay to give state
commissions ample opportunity to implement deaveraged retail rates and establish
state universal service funds in concert with UNE deaveraging.
In December 1999, the FCC asked for comment on requests made by the North Dakota
and South Dakota state commissions and the Rural Utilities Service (RUS) asking
the FCC to redefine "voice grade access" in the FCC's universal service rules.
The FCC requires that, in order to be eligible for universal service support, a
carrier must offer, among other things, voice grade access to the public
switched telephone network. Current FCC rules specify that voice grade access
should occur in a frequency range between approximately 300 Hertz (Hz) to 3,000
Hz. The petitioners requested the frequency range be changed to 200 Hz to 3,500
Hz. GTE participated in this proceeding and opposed any change in FCC
requirements. The network is not designed for the proposed ubiquitous
requirement and would require a significant infrastructure investment and at
least a decade to implement.
PRICE CAP
The federal price cap regime allows access prices to change each year by a
measure of inflation minus a productivity factor offset. In May 1999, the U.S.
Court of Appeals for the District of Columbia (Court) released a decision
regarding the FCC's choice of a 6.5% price cap productivity factor in a 1997
order. The Court found the FCC's choice of a 6.0% base factor and a 0.5%
Consumer Productivity Dividend to be inadequately supported. The Court remanded
the matter back to the FCC for further action and established an April 2000 date
by which the FCC must issue a revised decision. As a result, in November 1999,
the FCC initiated a rulemaking proposal requesting comments on the interstate
price cap productivity factor. Currently, it is unknown whether the single price
cap productivity factor will be applied retroactively to July 1, 1997 and remain
in effect until the next price cap performance review in 2003, or whether one
factor will apply from 1997 to 2000 and another factor apply from 2000 to 2003.
INTERSTATE ACCESS REVISION
Effective July 1999, access charges were further reduced using a 6.5%
productivity factor in compliance with FCC requirements to reflect the impacts
of access charge reform and in making GTE's 1999 Annual Filing. The total annual
financial impact of the reduction was $113 million. Similar filings during 1997
and 1998 had already resulted in price reductions.
In August 1999, GTE, along with a coalition of local exchange and long-distance
companies (CALLS), submitted a proposal for interstate access charge and
universal service reform to the FCC. The proposal would accelerate the shift in
non-usage sensitive access revenue recovery from per-minute to flat-rated
charges, set a schedule for elimination of the price cap productivity factor,
and provide more explicit support for universal service. The coalition filed a
revised plan in March 2000 and the FCC has offered the plan for comments. A
decision by the FCC is expected in 2000.
In August 1999, the FCC released an order pertaining to access reform and
pricing flexibility. The order grants price cap LECs immediate flexibility under
certain circumstances to deaverage certain access services and permits the
introduction of new services on a streamlined basis, without prior FCC approval.
-12-
ADVANCED TELECOMMUNICATIONS SERVICES
The Telecommunications Act required the FCC to "encourage the deployment on a
reasonable and timely basis of advanced telecommunications capability to all
Americans." Further, the FCC was required to conduct a proceeding aimed at
determining the availability of advanced telecommunications, and to take action
to remove barriers to infrastructure investment and to promote competition.
In March 1999, the FCC released an order adopting a number of new collocation
rules designed to make competitive entry easier and less costly. These rules
specify how ILECs will manage such items as alternate collocation arrangements,
security, space preparation cost allocation, provisioning intervals, and space
exhaustion. GTE asked the Court to review this order. In March 2000, the Court
issued a ruling granting, in part, challenges raised by GTE to the FCC's March
1999 order. The Court ruled that the FCC failed to justify its requirement that
ILECs must permit collocation of any CLEC equipment that was "used or useful"
for interconnection or access to network elements. The Court remanded this
portion of the decision back to the FCC for further deliberation.
In November 1999, the FCC released an order concluding that an ILEC's offering
of DSL services to Internet Service Providers (ISPs) pursuant to volume and term
discount plans that are a component of the ISPs high-speed Internet service are
not a retail offering, and thus not subject to the discounted resale obligation.
The order also concluded that an ILECs DSL offering to end users is a retail
offering if the ILEC performs certain consumer-oriented functions, such as
provisioning of customer premises equipment and wiring, marketing, billing and
collection, and accepting repair requests directly from the end user. The FCC
concluded that these services are subject to discounted resale obligation,
regardless of whether the service is classified as telephone exchange service
(local tariff) or exchange access service (access tariff).
NUMBER PORTABILITY
In December 1998, the FCC released an order establishing cost recovery rules for
local number portability (LNP) that permitted the recovery of carrier-specific
costs directly related to the provision of long-term LNP via a federally
tariffed end-user monthly charge. GTE subsequently filed an LNP tariff with the
FCC, and in March 1999 instituted an end-user number portability fee. This
charge is levied on all business and residential customers. In June 1999, GTE's
tariffed LNP charge was reviewed and accepted by the FCC at $0.36 per access
line per month.
INTERNET SERVICE TRAFFIC
ILECs are required to provide open access to all ISPs, while cable television
operators are not. Several major cable television operators providing Internet
access through cable modem facilities are only offering their affiliated ISPs to
consumers. Cable television operators that do allow customers to select
non-affiliated ISPs often require the customer to also pay for their affiliated
ISP's service (i.e., to pay twice for the same service). GTE has been active in
encouraging municipalities engaged in reviewing cable television mergers or
franchise renewals to require cable modem open access as a condition for
approval. The City of Portland, Oregon was first to adopt such a requirement and
AT&T Corp. has appealed that decision. Arguments took place in November 1999
before the Ninth Circuit Court.
-13-
In October 1999, GTE filed an antitrust lawsuit contending that cable TV
providers' refusal to provide ISPs with "open access" to cable modem platforms
is a violation of federal antitrust law. The lawsuit filed in the U.S. District
Court in Pittsburgh, names Tele-Communications, Inc., (now a unit of AT&T
Corp.), Comcast Corp., and Excite@Home and seeks an injunction to require open
access and damages.
GTE's interconnection contracts with CLECs specify that parties compensate each
other for the exchange of local traffic, defined as traffic that is originated
by an end user of one party and terminating to the end user of the other party
within GTE's current local serving area. It is GTE's position that ISP traffic
does not satisfy the definition of local traffic, and that no compensation
should be paid to CLECs that carry this traffic to their ISP customers. In a
recent ruling, the FCC has clarified that ISP traffic is largely interstate and
is not local traffic. Nevertheless, the FCC permitted state commissions to
arbitrate whether ILECs should pay as reciprocal compensation for ISP-bound
traffic, based upon existing interconnection agreements, until the FCC reaches a
decision on a long-term compensation scheme. GTE challenged this FCC conclusion
in federal district court. In March 2000, the Court vacated and remanded the
FCC's ruling that ISP-bound calls are interstate since the FCC failed to provide
a satisfactory explanation to support its ruling. As a result, the Court did not
address GTE's argument that the Telecommunications Act preempts state commission
authority to arbitrate disputes over non-local traffic.
INTRASTATE SERVICES
UNBUNDLED NETWORK ELEMENTS
In December 1996, the MPUC issued its order resolving arbitration issues between
the Company and AT&T Communications of the Midwest, Inc. (AT&T). The order
included the establishment of a resale discount rate of 24.9% and interim rates
for unbundled network elements based on a modified Hatfield Cost Model presented
by AT&T. A separate cost proceeding was initiated by the MPUC to review the
Company's costs for purposes of establishing permanent rates, but was closed in
April 1999.
INFORMAL EARNINGS INVESTIGATION
In June 1999, the Minnesota Department of Commerce (MDOC) initiated an informal
earnings investigation. The Company has agreed to a $4.087 million revenue
reduction and is continuing to negotiate with the MDOC and Office of Attorney
General to reach a settlement regarding the rate design to achieve this
reduction.
ELIGIBLE TELECOMMUNICATIONS CARRIER
In August 1998, some consumers in an unassigned territory (area within Minnesota
that is not included within the exchange boundaries of any existing telephone
company) in northern Minnesota petitioned the MPUC for assignment of an eligible
telecommunications carrier (ETC) to provide service. This unassigned territory
is bordered by the Ely exchange in which the Company is the telephone service
carrier. The MPUC has instructed the Company to serve this territory in an order
issued July 1999. Service was required to be provided by December 31, 1999. In
November 1999, the Company filed a request for extension for several customers
whom the Company will not be able to serve by December 31, 1999 due to permit
requirements. The MPUC approved the Company's request with conditions. One of
these conditions was that the Company must provide the affected customers with
an interim wireless local loop solution no later than March 22, 2000.
-14-
SIGNIFICANT CUSTOMER
Revenues received from AT&T Corp. included amounts for access and billing and
collection during 1999 and 1998 under various arrangements and amounted to $11.4
million and $13.7 million, respectively.
12. COMMITMENTS AND CONTINGENCIES:
The Company has noncancelable leases covering certain buildings, office space
and equipment. Rental expense was $716,000 and $726,000 in 1999 and 1998,
respectively. Minimum rental commitments under noncancelable leases are $60,000,
$31,000, $15,000, $4,000 and $4,000 for the years 2000-2004, respectively, and
aggregate $15,000 thereafter.
The Company is subject to a number of proceedings arising out of the conduct of
its business, including those relating to regulatory actions, commercial
transactions and environmental, safety and health matters. Management believes
that the ultimate resolution of these matters will not have a materially adverse
effect on the results of operations or the financial position of the Company.
CONTEL OF MINNESOTA, INC.
FINANCIAL STATEMENTS
AS OF DECEMBER 31,1998 AND 1997
TOGETHER WITH REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
ARTHUR ANDERSEN LLP
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Contel of Minnesota, Inc.:
We have audited the accompanying balance sheets of Contel Minnesota, Inc., d/b/a
GTE Minnesota (the Company) (a Minnesota corporation), as of December 31, 1998
and 1997, and the related statements of income, shareholder's equity and cash
flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements 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 the Company as of December 31,
1998 and 1997, and the results of its operations and its cash flows for the
years then ended in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
Dallas, Texas,
January 28, 1999
CONTEL OF MINNESOTA, INC.
BALANCE SHEETS - DECEMBER 31,1998 AND 1997
1998 1997
-------- --------
(Thousands of dollars)
ASSETS
Current assets:
Cash & cash equivalents $ 2 $ -
Receivables, less allowances of $526 and $474 20,760 20,800
Prepaid taxes and other 1,178 1,023
Total current assets 21,940 21,823
Property, plant and equipment, net (Note 10) 115,142 104,124
Prepaid pension costs and other assets 1,803 1,467
-------- --------
Total assets $138,885 $127,414
======== ========
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities:
Short-term obligations, including current maturites $ 3,300 $ 26,466
Accounts payable 13,332 8,917
Affiliate payables and accruals 1,529 5,056
Advanced billings and customer deposits 1,792 1,692
Taxes payable 1,884 3,291
Accrued payroll costs 1,568 991
Dividends payable 5,000 --
Other 990 1,278
-------- --------
Total current liabilities 29,395 47,691
-------- --------
Long-term debt 38,665 21,766
Deferred income taxes 16,930 8,981
Other liabilities 2,764 4,939
-------- --------
Total liabilities 87,754 83,377
-------- --------
Shareholder's equity:
Common stock (154,096 shares issued) 3,852 3,852
Additional paid-in capital 16,019 16,019
Retained earnings 31,260 24,166
-------- --------
Total shareholder's equity 51,131 44,037
V -------- --------
Total liabilities and shareholder's equity $138,885 $127,414
======== ========
The accompanying notes are an integral part of these financial statements.
2
CONTEL OF MINNESOTA, INC.
STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31,1998 AND 1997
1998 1997
---------- --------
(Thousands of Dollars)
REVENUES AND SALES
Local services $35,152 $32,927
Network access services 39,744 38,645
Other services and sales 8,430 8,213
---------- --------
Total revenues and sales 83,326 79,785
---------- --------
OPERATING COSTS AND EXPENSES
Cost of services and sales 20,473 22,982
Selling, general and administrative 13,587 9,503
Depreciation and amortization 13,849 17,804
---------- --------
Total operating costs and expenses 47,909 50,289
---------- --------
OPERATING INCOME 35,417 29,496
OTHER EXPENSE
Interest-net 2,365 3,043
Other-net 55 --
---------- --------
INCOME BEFORE INCOME TAXES 32,997 26,453
Income taxes 11,203 12,713
---------- --------
INCOME BEFORE EXTRAORDINARY ITEM 21,794 13,740
Extraordinary item 400 --
---------- --------
NET INCOME $21,394 $13,740
========== ========
The accompanying notes are an integral part of these financial statements.
3
CONTEL OF MINNESOTA, INC.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,1998 AND 1997
1998 1997
---- ----
(Thousands of Dollars)
OPERATIONS
Income before extraordinary item $ 21,794 $ 13,740
Adjustments to reconcile income before extraordinary item to
net cash from operations
Depreciation and amortization 13,849 17,804
Deferred income taxes 8,125 (1,812)
Provision for uncollectible accounts 744 542
Change in current assets and current liabilities:
Receivables - net (704) (2,264)
Other current assets (155) (414)
Accrued taxes and interest (1,315) 2,476
Other current liabilities 1,209 (2,897)
Other - net (3,479) 3,220
-------- --------
Net cash from operations 40,068 30,395
-------- --------
INVESTING
Capital expenditures (24,014) (22,523)
Sale of fixed assets 15 --
-------- --------
Net cash used in investing (23,999) (22,523)
-------- --------
FINANCING
Long-term debt retired (19,268) (950)
Affiliate long-term debt issued 35,000 --
Dividends (9,300) (16,664)
Net change in affiliate notes (22,499) 9,742
-------- --------
Net cash used in financing (16,067) (7,872)
-------- --------
Increase in cash and cash equivalents 2 --
Cash and cash equivalents:
Beginning of year -- --
-------- --------
End of year $ 2 $ --
======== ========
Cash paid during the year for:
Interest $ 2,186 $ 3,084
-------- --------
Income taxes $ 4,240 $ 6,868
-------- --------
The accompanying notes are an integral part of these financial statements.
4
CONTEL OF MINNESOTA, INC.
STATEMENTS OF SHAREHOLDER'S EQUITY
FOR THE YEARS ENDED DECEMBER 31,1998 AND 1997
Additional
Common Paid-In Retained
Stock Capital Earnings Total
---------- ------------ -------------- ----------
(Thousands of Dollars)
Shareholder's equity, December 31, 1996 $ 3,852 $ 16,019 $ 20,665 $ 40,536
Net income 13,740 13,740
Dividends declared (10,239) (10,239)
--------- --------- ---------- ---------
Shareholder's equity, December 31, 1997 3,852 16,019 24,166 44,037
Net income 21,394 21,394
Dividends declared (14,300) (14,300)
--------- --------- ---------- ---------
Shareholder's equity, December 31, 1998 $ 3,852 $ 16,019 $ 31,260 $ 51,131
========= ========= ========== =========
The accompanying notes are an integral part of these financial statements.
5
CONTEL OF MINNESOTA, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31,1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Contel of Minnesota, Inc. d/b/a GTE Minnesota (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, 1998, the Company served approximately 138,810
access lines in the state of Minnesota. The Company is a wholly-owned subsidiary
of GTE Corporation (GTE).
On June 10, 1997, the Company entered into an Agreement of Merger with
Continental Telephone Business Systems, Inc., a Delaware corporation
(Continental Telephone). The agreement provided that Continental Telephone would
merge with and into the Company, with the Company to be the surviving
corporation in the merger (the Merger). The Merger became effective on July 1,
1997, and has been accounted for in a manner similar to a "pooling of
interests." Accordingly, the financial statements include the combined
historical results of operations and financial position of the Company and
Continental Telephone as though the Merger had occurred at the beginning of 1997
and reflect the elimination of significant intercompany transactions.
BASIS OF PRESENTATION
The Company prepares its financial statements in accordance with generally
accepted accounting principles, which require management to make estimates and
assumptions that affect the reported amounts. Actual results could differ from
those estimates.
Reclassifications of prior-year data have been made, where appropriate, to
conform to the 1998 presentation.
TRANSACTIONS WITH AFFILIATES
GTE Supply (100% owned by GTE) provides construction and maintenance equipment,
supplies and electronic repair services to the Company. These purchases and
services amounted to $2.4 million and $2.6 million for the years 1998 and 1997,
respectively. Such purchases and services are recorded in the accounts of the
Company at the lower of cost, including a return realized by GTE Supply, or fair
market value.
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. The Company's financial statements
also include allocated expenses resulting from the sharing of certain executive,
administrative, financial, accounting, marketing, personnel, engineering and
other support services being performed at consolidated work centers within GTE.
The amounts charged for these affiliated transactions are based on proportional
cost allocation methodologies. These charges amounted to $8.1 million and $3.5
million for the years 1998 and 1997, respectively. The significant increase in
1998 charges is due to a reorganization of support functions within GTE. The
cost of these support functions, which was previously recorded directly by the
Company, is now allocated to the Company on a proportional cost basis.
The Company has an agreement with GTE Directories Corporation (GTE Directories)
(100% owned by GTE), whereby the Company provides its subscriber lists, billing
and collection and other services to GTE Directories. In addition, when GTE
Directories sells Yellow Page directory advertising to customers within the
Company's franchise area, the Company records a portion of the sale as revenue.
Revenues from these activities amounted to $1.2 million and $1.2 million for
the years 1998 and 1997, respectively. Also, the Company is billed for certain
printing and other costs associated with telephone directories, including the
cost of customer contact information pages which are included in the
6
Company's White Pages directories. These charges amounted to $3.5 million and
$0.4 million for the years 1998 and 1997, respectively.
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.
DEPRECIATION AND AMORTIZATION
The Company depreciates assets using the remaining life methodology and
straight-line depreciation rates. This method depreciates the remaining net
investment in telephone plant, less anticipated net salvage value, over
remaining economic asset lives. This method requires the periodic review and
revision of depreciation rates.
The economic asset lives used by the Company are as follows:
Average lives (in years)
------------------------
Fiber-optic cable 20
Copper wire 15
Switching equipment 10
Circuit equipment 8
When depreciable telephone plant is retired in the normal course of business,
the amount of such plant is deducted from the respective plant and accumulated
depreciation accounts. Gains or losses on disposition are amortized with the
remaining net investment in telephone plant.
EMPLOYEE BENEFIT PLANS
Pension and postretirement health care and life insurance benefits earned during
the year as well as interest on projected benefit obligations are accrued
currently. Prior service costs and credits resulting from changes in plan
benefits are amortized over the average remaining service period of the
employees expected to receive benefits. Curtailment gains and losses associated
with employee separations are recognized when they occur. Settlement gains and
losses associated with employee separations are recognized when the pension
obligations are settled and the gain or loss is determinable.
VALUATION OF ASSETS
The impairment of tangible or intangible assets is assessed when changes in
circumstances indicate that their carrying value may not be recoverable. Under
the Financial Accounting Standards Board's (FASB) Statement of Financial
Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," a determination
of impairment, if any, is made based on estimated future cash flows, salvage
value or expected net sales proceeds depending on the circumstances. In
instances where goodwill has been recorded in connection with impaired assets,
the carrying amount of the goodwill is first eliminated before any reduction to
the carrying value of tangible or identifiable intangible assets. The Company's
policy is to record asset impairment losses, and any subsequent adjustments to
such losses as initially recorded, as well as net gains or losses on sales of
assets as a component of operating income. Under Accounting Principles Board
Opinion No. 17, "Intangible Assets," the Company also annually evaluates the
future period over which the benefit of goodwill will be received, based on
future cash flows, and changes the amortization life accordingly.
7
INCOME TAXES
The Company's results are included in GTE's consolidated Federal income tax
return. The Company participates in a tax-sharing agreement with GTE and remits
tax payments to GTE based on its tax liability on a separate company basis.
Deferred tax assets and liabilities are established for temporary differences
between the way certain income and expense items are reported for financial
reporting and tax purposes. Deferred tax assets and liabilities are subsequently
adjusted, to the extent necessary, to reflect tax rates expected to be in effect
when the temporary differences reverse. A valuation allowance is established for
deferred tax assets for which realization is not likely.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include investments in short-term, highly liquid
securities, which have maturities when purchased of three months or less.
FINANCIAL INSTRUMENTS
The Company uses a variety of financial instruments to hedge its exposure to
fluctuations in interest. The Company does not use financial instruments for
speculative or trading purposes, nor is the Company a parry to leveraged
derivatives. Amounts to be paid or received under interest rate swaps are
accrued as interest expense.
INVENTORIES AND SUPPLIES
Inventories and supplies are stated at the lower of cost, determined
principally by the average cost method, or net realizable value.
SOFTWARE
The Company classifies software as either network related or non-network
related. For network related software, initial operating systems software is
capitalized and amortized over the life of the related hardware. All other
network related software, including right-to-use fees, is expensed as incurred.
Non-network related software, which includes billing and administrative systems,
is capitalized and amortized over 5 years. Software maintenance costs are
expensed as incurred. In 1998 and 1997, $3.0 million and $0.5 million,
respectively, of software expenditures were capitalized associated with the
implementation of new administrative systems within the Company.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." Under the provisions of this
SOP, effective January 1, 1999, the Company will be required to capitalize and
amortize the cost of all internal-use software, including network related
software it previously expensed. During 1998, the Company expensed network
related software of approximately $0.9 million.
Effective January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income." During the years ended December 31, 1998 and 1997, there
were no differences between net income and comprehensive income.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. The Company is
currently assessing the impact of adopting SFAS No. 133 which is effective
January 1, 2000.
2. PROPOSED MERGER WITH BELL ATLANTIC CORPORATION
On July 27, 1998, GTE and Bell Atlantic entered into a merger agreement
providing for the combination of the two companies. Under the terms of the
agreement, which was unanimously approved by the boards of directors of both
8
companies, GTE shareholders will receive 1.22 shares of Bell Atlantic stock for
each GTE share they own. The merger is subject to shareholder and regulatory
approvals.
3. PLANNED ASSET SALES
During the first quarter of 1998, the Company committed to a plan that resulted
in a decision to sell approximately 128,000 switched access lines. Due to the
regulatory approvals that are required, it is projected that most of the sales
of local access lines will close in 2000. As a result, the net book value of
these lines, which approximates $115.1 million, continues to be reported in
"Property, plant and equipment, net" in the balance sheets. Until sold, the
Company intends to continue to operate all of these assets. Based on the
decision to sell, however, the Company stopped recording depreciation expense
for these assets.
Due to the centralized manner in which GTE's local telephone companies are
managed and since the access lines to be sold represent portions of states
rather than entire operating companies, revenues and operating income applicable
to the access lines to be sold are not readily determinable. The 128,000 access
lines represent 100% of the switched access lines that the Company had in
service during 1998.
4. EXTRAORDINARY CHARGE
During the first quarter of 1998, the Company recorded an after-tax
extraordinary charge of $0.4 million (net of tax benefits of $0.2 million),
reflecting premiums paid on the redemption of high-coupon debt prior to stated
maturity.
5. COMMON STOCK
The authorized common stock of the Company consists of 192,000 shares with a
stated value of $25 per share. All outstanding shares of common stock are held
by GTE.
There were no shares of common stock held by or for the account of the Company
and no shares were reserved for officers and employees, or for options,
warrants, conversions or other rights.
At December 31, 1998, $17.1 million of the Company's retained earnings were
restricted as to the payment of cash dividends on common stock under the most
restrictive terms of the Company's indentures.
9
6. DEBT
Long-term debt as of December 31, was as follows:
1998 1997
------- -------
(Dollars in Thousands)
Rural Utilities Service
2.0% due 2011 $ 902 $ 1,110
Rural Telephone Bank
6.5% to 8.0%, maturing through 2015 3,053 16,266
Federal Financing Bank
8.015% to 8.683%, maturing through 2011 -- 5,347
Affiliate note
5.61 % due 2001 35,000 --
------- -------
Total 38,955 22,723
Less: current maturities (290) (957)
------- -------
Total long-term debt $38,665 $21,766
======= =======
In March 1998, the Company retired, prior to stated maturity, $18.4 million of
long-term debt. The Company incurred $0.4 million (net of tax benefits of $0.2
million) in premiums associated with this retirement.
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 are: $0.3
million in 1999, $0.3 million in 2000, $35.3 million in 2001, $0.3 million in
2002 and $0.2 million in 2003.
Total short-term obligations as of December 31, were as follows:
1998 1997
--------- ---------
(Dollars in Thousands)
Notes payable to affiliate - average rates 5.7% and 6.0% $ 3,010 $25,509
Current maturities of long-term debt 290 957
------- -------
Total $ 3,300 $26,466
======= =======
The Company finances part of its construction program through the use of interim
short-term notes payable to affiliates. During 1998 and 1997, the Company
supplemented its internal generation of cash with funds borrowed from GTE. These
arrangements require payment of interest based on GTE's daily intercompany
interest rate (which is based primarily on the costs associated with the
issuance of commercial paper).
7. FINANCIAL INSTRUMENTS
The fair values of financial instruments, other than long-term debt, closely
approximate their carrying value. As of December 31, 1998 and 1997, the
estimated fair value of long-term debt based on either reference to quoted
market prices or an option pricing model, exceeded the carrying value by
approximately $0.2 million and $0.3 million, respectively.
10
8. INCOME TAXES
The income tax provision (benefit) is as follows:
1998 1997
------- -------
(Thousands of Dollars)
Current:
Federal $ 2,741 $ 11,327
State 313 3,198
------- -------
3,054 14,525
------- -------
Deferred:
Federal 6,598 (636)
State 1,973 (587)
------- -------
8,571 (1,223)
------- -------
Amortization of deferred investment tax credits (422) (589)
------- -------
Total provision $11,203 $12,713
======= =======
A reconciliation between taxes computed by applying the statutory federal income
tax rate to pretax income and income taxes provided in the statements of income
is as follows:
1998 1997
-------- --------
(Thousands of Dollars)
Amounts computed at statutory rates $ 11,549 $ 9,259
State and local income taxes, net of federal income tax benefits 1,486 1,697
Amortization of deferred investment tax credits (422) (589)
Other differences - net (1,410) 2,346
-------- --------
Total provision $ 11,203 $ 12,713
======== ========
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:
1998 1997
-------- --------
(Thousands of Dollars)
Depreciation and amortization $ 16,280 $ 9,862
Employee benefit obligations (862) (2,477)
Prepaid pension costs 819 645
Investment tax credits 331 753
Other - net 1,464 1,124
-------- --------
Net deferred tax liability $ 18,032 $ 9,907
======== ========
9. EMPLOYEE BENEFIT PLANS
The FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits," in February 1998. The new standard does not change the
measurement or recognition of costs for pension or other postretirement plans.
It standardizes disclosures and eliminates those that are no longer useful.
Certain disclosures are required to be made of the components of pension
credits, postretirement benefit costs and the funded status of the plans,
including the actuarial present value of accumulated plan benefits, accumulated
or projected
11
benefit obligation and the fair value of plan assets. We do not present such
disclosures because the structure of the GTE plans does not permit the plans'
data to be readily disaggregated.
PENSION PLANS
The Company participates in noncontributory defined benefit pension plans
sponsored by GTE covering substantially all employees. The benefits to be paid
under these plans are generally based on years of credited service and average
final earnings. GTE's funding policy, subject to the minimum funding
requirements of employee benefit and tax laws, is to contribute such amounts as
are determined on an actuarial basis to accumulate funds sufficient to meet the
plans' benefit obligation to employees upon their retirement. The assets of the
plans consist primarily of corporate equities, government securities and
corporate debt securities.
The significant weighted-average assumptions used by GTE for the pension
measurements were as follows at December 31:
1998 1997
------- -------
Discount rate 7.00% 7.25%
Rate of compensation increase 4.75% 5.00%
Expected return on plan assets 9.00% 9.00%
The net periodic benefit credit was $0.4 million and $0.5 million for the years
1998 and 1997, respectively.
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
Substantially all of the Company's employees are covered under postretirement
healthcare and life insurance benefit plans sponsored by GTE. The determination
of benefit cost for postretirement health plans is generally based on
comprehensive hospital, medical and surgical benefit plan provisions. The
Company intends to fund amounts for postretirement benefits as deemed
appropriate.
Postretirement benefit cost was $0.3 million and $1.2 million for the years 1998
and 1997, respectively. The weighted average assumptions used by GTE in the
actuarial computations for postretirement benefits were as follows at December
31:
1998 1997
------- -------
Discount rate 7.00% 7.25%
Expected return on plan assets 8.00% 8.00%
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 $0.1 million and $0.1 million in 1998 and 1997, respectively.
12
10. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is summarized as follows at December 31:
1998 1997
---- ----
(Thousands of Dollars)
Land $ 914 $ 906
Buildings 18,845 18,177
Plant and equipment 258,987 238,589
Other 7,534 13,300
--------- ---------
Total 286,280 270,972
Less: Accumulated depreciation (171,138) (166,848)
--------- ---------
Total property, plant and equipment - net $ 115,142 $ 104,124
========= =========
At December 31, 1998, all property, plant and equipment is being held for sale
(See Note 3).
11. REGULATORY AND COMPETITIVE MATTERS
The Company's intrastate business is regulated by the Minnesota Public Utilities
Commission (MPUC). The Company is subject to regulation by the Federal
Communications Commission (FCC) for its interstate business operations.
The Company provides local exchange services to customers within its designated
franchise area. The Company also provides long-distance access services directly
to interexchange carriers and other customers who provide services between Local
Access and Transport Areas (LATAs).
As was the case in 1997, much of 1998's regulatory and legislative activity at
both the state and federal levels was a direct result of the Telecommunications
Act of 1996 (Telecommunications Act). Along with promoting competition in all
segments of the telecommunications industry, the Telecommunications Act was
intended to preserve and advance universal service.
INTERSTATE SERVICES
The Company has finalized interconnection agreements with various competitive
local exchange carriers (LECs). A number of these interconnection agreements
were the result of the arbitration process established by the Telecommunications
Act, and incorporated prices or terms and conditions based upon the FCC rules
that were subsequently overturned by the Eighth Circuit Court (Eighth Circuit)
in July 1997. The Company challenged a number of such agreements in 1997. The
Company's position in these challenges was supported by the Eighth Circuit's
July 1997 decision stating that the FCC had overstepped its authority in several
areas concerning implementation of the interconnection provisions of the
Telecommunications Act. In January 1999, the U.S. Supreme Court (Supreme Court)
reversed in part and affirmed in part the Eighth Circuit's decisions. The
Supreme Court reversed the Eighth Circuit on many of the FCC rules related to
pricing and costing, which had been previously reversed by the Eighth Circuit on
jurisdictional grounds. The pricing rules established by the FCC will now be
remanded back to the Eighth Circuit for a determination on the merits. On the
other hand, the Supreme Court vacated the FCC rules requiring incumbent LECs to
provide unbundled network elements (UNES) to competitive LECs. This latter
ruling will be the subject of continued proceedings before the FCC and the state
commissions concerning what elements will have to be offered and under what
conditions. Pending the final rulemaking by the FCC on the provisions of UNEs,
the Company will continue to provide individual UNEs under existing
interconnection agreements.
Interstate Access Revision
Access charge reform continued to be a major issue in 1998. Effective January
1998, the FCC altered the structure of access charges that the Company collects
by reducing and restructuring the per minute charges paid by long-distance
13
carriers and implementing new per-line charges. The FCC also created an access
charge structure that resulted in different access charges for primary and
secondary residential access lines and single and multi-line business access
lines. In aggregate, the annual reductions in usage sensitive access charges
paid by long-distance carriers were intended to be offset by new per-line
charges and the charges paid by end-user customers. Effective July 1998, access
charges were further reduced in compliance with FCC requirements to reflect the
impacts of access charge reform and in making the Company's 1998 Annual Filing.
Similar filings during 1997 had already resulted in annual price reductions.
The FCC Access Reform Order released in May 1997 revamped the rate structure
through which local and long-distance companies charge customers for using the
local phone network to make long-distance calls. GTE and numerous other parties
challenged the FCC's May 1997 Access Reform Order before the Eighth Circuit
based on the premise that the FCC did not eliminate the universal service
subsidies hidden within interstate access charges (as directed by the
Telecommunications Act), and the FCC created additional subsidy charges paid
only by business and multi-line residential customers. In August 1998, the
Eighth Circuit denied all of the petitions for review of the Access Reform
Order.
In October 1998, the FCC began a proceeding to refresh the record used in the
1997 access charge reform proceedings. The FCC will determine whether to retain
or modify its market-based access charge reform approach, or to adopt a
prescriptive approach. In addition, the FCC will decide whether the 6.5%
productivity offset should be changed. An order is expected to be released prior
to July 1999.
Universal Service
In May 1997, the FCC released a decision relating to implementation of the
Telecommunications Act's provisions on universal service. GTE and numerous other
parties have challenged the FCC's decision before the U.S. Court of Appeals for
the Fifth Circuit on the grounds that the FCC did not follow the requirements of
the Telecommunications Act to develop a sufficient, explicit and competitively
neutral universal service program. Oral arguments were held in December 1998. A
final decision on the appeal is expected in 1999.
In its Order on Reconsideration of the May 1997 decision dated July 1998, the
FCC referred some key issues back to the Federal-State Joint Board (Joint Board)
on universal service. The Joint Board issued its Second Recommended Decision in
November 1998. The recommendations were generic in nature and require further
development. Comments and reply comments on the Joint Board's recommendations
were filed in late December 1998 and January 1999, respectively. An order from
the FCC is expected in the second quarter of 1999, which may reject or change
the Joint Board's recommendations.
In October 1998, the FCC issued an order selecting a cost model for universal
service and plans to select cost inputs by the first quarter of 1999 and a
revenue benchmark by mid- 1999. For this reason, the FCC moved the
implementation date of the new universal service mechanism for non-rural
carriers to July 1999. The Company filed a Petition for Reconsideration in
December 1998, stating that the adopted model is incomplete and requires
additional time for proper evaluation. GTE is currently awaiting action from the
FCC.
Payphone Orders
In June 1996, the FCC issued its first Report and Order implementing the
payphone compensation provisions of the Telecommunications Act. As part of the
overall goal of promoting competition among payphone service providers (PSPs),
this order mandated compensation to all PSPs for calls for which they were not
previously compensated originating from payphones, including credit card and
toll-free calls.
Subsequently, in October 1997, the FCC issued a second Report and Order to
address some of the issues vacated by the U.S. Court of Appeals in Washington,
D.C. concerning the FCC's first Report and Order mentioned above. In this second
Order, the FCC established a new non-coin per-call rate of 28.4 cents for
compensation that all PSPs were eligible to receive beginning in October 1997.
In February 1999, after a court remand, the FCC ordered a new per-call rate of
24.0 cents for compensation that all PSPs were eligible to receive beginning in
the second quarter of 1999. GTE will appeal the order.
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In April 1998, the FCC issued an order, which granted the long-distance carriers
a waiver of the per-call compensation requirement so that they may pay per-phone
instead of per-call compensation for the payphones for which the FCC had granted
technology waivers. The Company will receive per-phone compensation under this
waiver until the technology is installed on those payphones that are not
currently capable of measuring per-call detail.
Price Cap
For the provision of interstate services, the Company operates under the terms
of the FCC's price cap incentive plan. This plan limits the rates a carrier may
charge rather than regulating on a traditional rate-of-return basis. The price
caps for a variety of service categories change annually using a price cap index
that is a function of inflation less a predetermined productivity offset. The
FCC's May 1997 Price Cap Order revised the price cap plan for incumbent price
cap LECs by adopting a productivity offset of 6.5%. In June 1997, GTE and
several other parties challenged the FCC's Price Cap Order before the Court of
Appeals for the District of Columbia Circuit. The issue presented for review was
whether, in computing its new 6.5% productivity offset, the FCC arbitrarily
manipulated the evidence to achieve a predetermined outcome. Oral arguments are
set for the first quarter of 1999 with a decision expected later in the year.
Advanced Data Service
In August 1998, the FCC released a Memorandum Opinion and Order finding that the
pro-competitive provisions of the Telecommunications Act apply equally to
advanced services and to circuit-switched voice services. In comments filed in
September 1998, GTE outlined a comprehensive plan to rapidly deploy advanced
data services, such as asymmetric digital subscriber line (ADSL) service, in a
framework that pemits real competition between incumbents and competitors. The
matter is pending before the FCC. In October 1998, the FCC found in favor of
GTE's position that ADSL service is interstate in nature and properly tariffed
at the federal level. The FCC specifically concluded that traffic to an Internet
Service Provider (ISP) does not terminate at the ISP's local server but
continues on to the ultimate destination or destinations at distant interstate
or international websites accessed by the end user.
Number Portability
In December 1998, the FCC released a Memorandum Opinion and Order regarding
cost recovery for the deployment of local number portability (LNP). This
order follows the FCC's Third Report and Order, which determined that
carriers may recover carrier specific costs directly related to the provision
of long-term LNP via a federally tariffed end-user monthly charge beginning
no earlier than February 1999. GTE filed a LNP tariff and instituted an
end-user number portability fee per line, which began appearing on customer
bills after February 1, 1999. The FCC is investigating the costs supporting
the filing.
Internet Service Traffic
In February 1999, the FCC adopted an order finding that dial-up ISP-bound
traffic is largely interstate based on a traditional examination of the
end-to-end nature of the communication. In this ruling the FCC made it clear
that its actions will not subject the Internet to regulation or eliminate the
current Enhanced Service Provider exemption. The order stated that in the
absence of a federal rule, existing state arbitration decisions on the issue may
be appropriate under certain conditions. GTE is currently reviewing its existing
contracts and FCC orders and will take further action as necessary. The order
also contained a Notice of Proposed Rulemaking to consider the appropriate
compensation for this traffic in the future. GTE has appealed the FCC's
conclusion that it does not have to set a rate after it funds the traffic to be
jurisdictionally interstate.
INTRASTATE SERVICES
In December 1996, the MPUC issued its order resolving arbitration issues
between the Company and AT&T Communications of the Midwest, Inc. (AT&T). The
order included the establishment of a resale discount rate of 24.9% and
interim rates for unbundled network elements based on a modified Hatfield
Cost Model presented by AT&T. A separate cost proceeding has been initiated
by the MPUC to review the Company's costs for purposes of establishing
permanent rates. The cost proceeding is expected to be completed by year end
1999.
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SIGNIFICANT CUSTOMER
Revenues received from AT&T Corp. included amounts for access and billing and
collection during 1998 and 1997 under various arrangements and amounted to $13.7
million and $12.5 million, respectively.
12. COMMITMENTS AND CONTINGENCIES
The Company has noncancelable leases covering certain buildings, office space
and equipment. Rental expense was $726,000 and $415,000 in 1998 and 1997,
respectively. Minimum rental commitments under noncancelable leases are $26,000,
$14,000, $10,000, $7,000 and $4,000 for the years 1999-2003, respectively, and
aggregate $19,000 thereafter.
The Company is subject to a number of proceedings arising out of the conduct of
its business, including those relating to regulatory actions, commercial
transactions and environmental, safety and health matters. Management believes
that the ultimate resolution of these matters will not have a material adverse
effect on the results of operations or the financial position of the Company.
Recent judicial and regulatory developments, as well as the pace of
technological change, have continued to influence industry trends, including
accelerating and expanding the level of competition. As a result, the Company's
operations face increasing competition in virtually all aspects of its business.
The Company continues to support greater competition in telecommunications,
provided that, overall, the actions to eliminate existing legal and regulatory
barriers benefit consumers by allowing an opportunity for all service providers
to participate in a competitive marketplace under comparable conditions.
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