Exhibit 13
ANNUAL REPORT TO SHAREHOLDERS
of
CONTEL OF CALIFORNIA, INC.
For the year ended December 31, 1993
BOARD OF DIRECTORS EXECUTIVE OFFICES
16071 Mojave Drive
JAMES F. MILES Victorville, California 92392-3699
President
Contel of California, Inc. TRANSFER AGENT AND REGISTRAR
GEOFFREY C. GOULD GTE Corporation
Vice President - Regulatory and C/O Bank of Boston
Governmental Affairs P.O. Box 9191
GTE Telephone Operations Boston, Massachusetts 02205-9191
THOMAS W. WHITE FOR A COPY OF THE 1993 ANNUAL REPORT
Executive Vice President OF GTE, PLEASE WRITE TO:
GTE Telephone Operations
GTE Service Corporation
One Stamford Forum
OFFICERS Stamford, Connecticut 06904
JAMES F. MILES FOR A COPY OF THE 1993 ANNUAL FORM
President 10-K FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION, PLEASE WRITE
MICHAEL W. BOLLINGER TO:
Assistant Vice President -
Controller GTE Telephone Operations
Financial Reporting
MICHAEL E. BURKE P.O. Box 407, MC INAAACG
Vice President - Network Design Westfield, Indiana 46074
(317) 896-6464
JEFFREY B. CUTHERELL
Vice President - Regulatory and
Governmental Affairs and
Treasurer
JOHN A. FERRELL
Vice President - Customer Services
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31 1993 1992 1991
- ----------------------- ----------- ---------- ----------
(Thousands of Dollars)
OPERATING REVENUES:
Local network services $ 94,586 $ 93,752 $ 88,631
Network access services 139,822 139,171 146,577
Long distance services 124,780 133,926 126,746
Equipment sales and services 13,134 37,220 12,468
Other 12,315 9,893 16,282
--------- --------- ----------
384,637 413,962 390,704
--------- --------- ----------
OPERATING EXPENSES (a):
Cost of sales and services 72,300 92,485 76,451
Depreciation and amortization 58,431 53,440 50,762
Marketing, selling, general and
administrative 100,863 101,786 100,435
Restructuring costs 48,987 -- --
--------- --------- ----------
280,581 247,711 227,648
--------- --------- ----------
NET OPERATING INCOME 104,056 166,251 163,056
--------- --------- ----------
OTHER (INCOME) DEDUCTIONS:
Interest expense 12,097 13,419 14,596
Other - net (507) (1,599) (2,027)
--------- --------- ----------
INCOME BEFORE INCOME TAXES 92,466 154,431 150,487
INCOME TAXES 37,397 60,733 59,855
--------- --------- ----------
NET INCOME $ 55,069 $ 93,698 $ 90,632
========= ========== ==========
(a) Includes billings from affiliates of $31,215, $22,663 and $42,995 for the
years 1993-1991, respectively.
CONSOLIDATED STATEMENTS OF REINVESTED EARNINGS
Years ended December 31 1993 1992 1991
- ----------------------- ----------- ---------- ----------
(Thousands of Dollars)
BALANCE AT BEGINNING OF YEAR $ 146,075 $ 137,489 $ 139,972
ADD -
Net income 55,069 93,698 90,632
DEDUCT -
Cash dividends declared
on common stock 106,471 85,000 93,000
Cash dividends declared
on preferred stock 101 112 115
--------- --------- ----------
BALANCE AT END OF YEAR $ 94,572 $ 146,075 $ 137,489
========= ========== ==========
See Notes to Consolidated Financial Statements.
CONSOLIDATED BALANCE SHEETS
December 31 1993 1992
----------- ----------- -----------
(Thousands of Dollars)
ASSETS
CURRENT ASSETS:
Cash $ 68 $ 1,477
Accounts receivable
Customers (including
unbilled revenues) 55,462 44,946
Affiliated companies 288 1,280
Other 29,934 24,547
Allowance for uncollectible accounts (3,592) (3,321)
Materials and supplies, at average cost 2,566 2,400
Deferred income tax benefits 7,783 1,320
Prepayments and other 450 261
----------- -----------
92,959 72,910
----------- -----------
PROPERTY, PLANT AND EQUIPMENT:
Original cost 876,420 847,480
Accumulated depreciation (343,195) (318,170)
----------- -----------
533,225 529,310
----------- -----------
OTHER ASSETS 32,898 26,356
----------- -----------
TOTAL ASSETS $ 659,082 $ 628,576
=========== ===========
See Notes to Consolidated Financial Statements.
December 31 1993 1992
------------ --------- ------------
(Thousands of Dollars)
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable to affiliates $ 68,873 $ 28,369
Current maturities of long-term debt 500 500
Accounts payable 51,269 32,177
Due to affiliated companies 8,048 6,462
Advanced billings and customer deposits 4,013 3,841
Accrued taxes 34,726 46,977
Accrued interest 2,656 3,005
Accrued payroll and vacations 8,177 5,171
Accrued dividends 42,152 27,099
Accrued restructuring costs and other 36,299 14,631
----------- -----------
256,713 168,232
----------- -----------
LONG-TERM DEBT 95,800 123,300
----------- -----------
DEFERRED CREDITS:
Deferred income taxes 51,620 65,646
Deferred investment tax credits 10,459 12,310
Restructuring costs and other 56,773 19,738
----------- -----------
118,852 97,694
----------- -----------
PREFERRED STOCK, SUBJECT TO MANDATORY
REDEMPTION 1,710 1,840
----------- -----------
SHAREHOLDER'S EQUITY:
Common stock (2,503,667 shares
outstanding) 12,518 12,518
Other capital 78,917 78,917
Reinvested earnings 94,572 146,075
----------- -----------
186,007 237,510
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' ----------- -----------
EQUITY $ 659,082 $ 628,576
=========== ===========
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31 1993 1992 1991
- ----------------------- ---------- ---------- ----------
(Thousands of Dollars)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 55,069 $ 93,698 $ 90,632
Adjustments to reconcile net income to
net cash from operating activities:
Depreciation and amortization 58,431 53,440 50,762
Restructuring costs 48,987 -- --
Deferred income taxes and investment
tax credits (21,413) 2,474 7,551
Provision for uncollectible accounts 6,478 8,083 5,871
Change in current assets and current
liabilities (8,198) (2,854) (32,632)
Other - net (1,718) (2,821) 1,110
---------- ---------- ----------
Net cash from operating activities 137,636 152,020 123,294
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (60,894) (63,657) (67,656)
Other - net 494 715 3,848
---------- ---------- ----------
Net cash used in investing
activities (60,400) (62,942) (63,808)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt and preferred stock
retired (27,630) (21,050) (12,298)
Dividends paid to shareholders (91,519) (58,036) (93,116)
Increase (decrease) in notes payable
to affiliates 40,504 (8,806) 35,375
---------- ---------- ----------
Net cash used in financing
activities (78,645) (87,892) (70,039)
---------- ---------- ----------
INCREASE (DECREASE) IN CASH (1,409) 1,186 (10,553)
CASH:
Beginning of year 1,477 291 10,844
---------- ---------- ----------
End of year $ 68 $ 1,477 $ 291
========== ========== ==========
See Notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF ACCOUNTING POLICIES
The consolidated financial statements include the accounts of Contel of
California, Inc. (the Company) and its wholly-owned subsidiary, Contel Advanced
Systems, Inc. All significant intercompany transactions have been eliminated.
The Company is a wholly-owned subsidiary of Contel Corporation (the Parent
Company), a wholly-owned subsidiary of GTE Corporation (GTE).
TRANSACTIONS WITH AFFILIATES
Certain affiliated companies, including GTE and Contel affiliated companies,
supply construction and maintenance materials, supplies and equipment to the
Company. These purchases amounted to $11.7 million, $15.4 million and $27.4
million for the years 1993-1991, respectively. Such purchases are recorded in
the accounts of the Company at cost including a normal return realized by the
affiliates.
The Company is billed for costs for data processing and equipment rentals, and
receives management, consulting, research and development and pension
management services from other affiliated companies. These charges amounted to
$31.2 million, $22.7 million and $43.0 million for the years 1993-1991,
respectively. The amounts charged for these affiliated transactions are based
on a proportional cost allocation method which reflects management's best
estimate.
TELEPHONE PLANT
Maintenance and repairs are charged to income as incurred. Additions to,
replacements and renewals of property are charged to telephone plant accounts.
Property retirements are charged in total to the accumulated depreciation
account. No adjustment to depreciation is made at the time properties are
retired or otherwise disposed of, except in the case of significant sales of
property where profit or loss is recognized.
The Company provides for depreciation on telephone plant over the estimated
useful lives of the assets using the straight-line method, based upon rates
prescribed by the Federal Communications Commission (FCC) and the state
regulatory commissions. The provisions for depreciation and amortization were
equivalent to composite annual rates of 6.9%, 6.7% and 7.0% for the years 1993-
1991, respectively.
REGULATORY ACCOUNTING
The Company follows the accounting prescribed by the Uniform System of Accounts
of the FCC and the regulatory commissions in each of the Company's operating
jurisdictions and Statement of Financial Accounting Standards (SFAS) No. 71,
"Accounting for the Effects of Certain Types of Regulation." This accounting
recognizes the economic effects of rate regulation by recording costs and a
return on investment as such amounts are recovered through rates authorized by
regulatory authorities. The Company annually reviews the continued
applicability of SFAS No. 71 based upon the current regulatory and competitive
environment.
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, revenue is recognized when products are delivered or services are
rendered to customers. Long-term contracts are generally accounted for using
the completed contract method.
MATERIAL AND SUPPLIES
Material and supplies are stated at the lower of cost or market value.
EMPLOYEE BENEFIT PLANS
Effective January 1, 1993, the Company adopted SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions." The new standard
requires that the expected costs of postretirement benefits be charged to
expense during the years that the employees render service. The Company
elected to adopt this new accounting standard on the delayed recognition method
and commencing January 1, 1993, began amortizing the estimated unrecorded
accumulated post-retirement benefit obligation over twenty years. Prior to the
adoption of SFAS No. 106, the cost of these benefits was charged to expense as
paid.
The Company also adopted SFAS No. 112, "Employers' Accounting for
Postemployment Benefits," effective January 1, 1993. SFAS No. 112 requires
employers to accrue the future cost of benefits provided to former or inactive
employees and their dependents after employment but before retirement.
Previously, the cost of these benefits was charged to expense as paid. The
impact of this change in accounting on the Company's results of operations was
immaterial.
INCOME TAXES
Investment tax credits were repealed by the Tax Reform Act of 1986 (the Act).
Those credits claimed prior to the Act were deferred and are being amortized
over the lives of the properties giving rise to the credits.
As further explained in Note 7, during the fourth quarter of 1992, the Company
adopted SFAS No. 109, "Accounting for Income Taxes," retroactive to
January 1, 1992. SFAS No. 109 changed the method by which companies account
for income taxes. Among other things, the Statement requires that deferred tax
balances be adjusted to reflect new tax rates when they are enacted into law.
The impact of this change in accounting on the Company's results of operations
was immaterial.
FINANCIAL INSTRUMENTS
The fair values of financial instruments, other than long-term debt, closely
approximate their carrying value. The estimated fair value of long-term debt
at December 31, 1993 and 1992, based on either reference to quoted market
prices or an option pricing model, exceeded the carrying value by approximately
$19 million and $14 million, respectively.
PRIOR YEARS' FINANCIAL STATEMENTS
Reclassifications of prior year data have been made in the financial statements
to conform to the 1993 presentation.
2. RESTRUCTURING AND MERGER COSTS
Results for 1993 include a one-time pretax restructuring charge of $49.0
million related to the Company's re-engineering plan over the next three years.
The re-engineering plan will redesign and streamline processes to improve
customer-responsiveness and product quality, reduce the time necessary to
introduce new products and services and further reduce costs. The re-
engineering plan includes $20.0 million to upgrade or replace existing customer
service and administrative systems and enhance network software, $22.6 million
for employee separation benefits associated with workforce reductions and $6.1
million primarily for the consolidation of facilities and operations and other
related costs.
During 1993, the Company offered various voluntary separation programs to its
employees. These programs resulted in a pretax charge of $3.0 million which
reduced net income by $1.8 million.
In March 1991, the merger of the Company's parent and GTE was consummated. In
a decision issued on March 13, 1991, the California Public Utilities Commission
(CPUC) issued a decision that approved a stipulation agreement which
tentatively approved the merger of GTE and Contel. The decision also
established a second phase of the proceeding in which GTE was directed to file
a complete showing that the merger meets certain California statutory
requirements. GTE was also ordered to submit a plan for the merger of any of
the Contel and GTE regulated California subsidiaries. On September 14, 1992,
the Company and GTE California Incorporated joined with GTE and Contel and
filed a comprehensive plan with the CPUC to merge the Company into GTE
California Incorporated. The filing also contained detailed information to
demonstrate that the parent company merger should be approved.
On December 23, 1993, an Administrative Law Judge issued a proposed Phase II
order allowing the merger of the Company and GTE California Incorporated. The
order is expected to be finalized in the first quarter of 1994. The proposed
order would add a third phase to the merger proceeding in which the issues of a
start-up revenue requirement for Contel's pre-merger operations and rate
integration of the respective company tariffs will be considered.
In addition, merger applications were filed with the Arizona Corporation
Commission on October 4, 1993 and the Nevada Public Service Commission on April
2, 1993. Final orders in these merger proceedings are also expected to be
issued in 1994.
3. PREFERRED STOCK
Cumulative preferred stock, subject to mandatory redemption, is as follows:
December 31 1993 1992
- ----------- ------------------ ------------------
SHARES AMOUNT* Shares Amount*
--------- ------- -------- --------
AUTHORIZED 1,500,000 1,500,000
========= =========
OUTSTANDING
$20 Par Value--
5.250% Series 12,000 $ 240 13,000 $ 260
4.750% Series A 13,500 270 16,500 330
5.950% Series B 60,000 1,200 62,500 1,250
--------- ------- --------- -------
Total 85,500 $ 1,710 92,000 $ 1,840
========= ======= ========= =======
* Thousands of Dollars
The Company is required to make cash deposits to purchase at specified prices a
portion of its outstanding preferred stock each year. The specified price is
generally par value. In each of the years 1993 through 1991, the Company
purchased $0.1 million of preferred stock. The redemption requirements are
$0.1 million for each of the five years subsequent to December 31, 1993
representing 1,000 shares of the 5.25% Series, 3,000 shares of 4.75% Series
(1,500 shares in 1998) and 2,500 shares of the 5.95% Series.
In the event of failure to pay certain preferred dividends and redemption
requirements, the holders of the Company's redeemable preferred stock are
entitled to elect a certain number of directors until all preferred dividend
and redemption requirement amounts in arrears have been paid. The Company is
not in arrears in its dividend payments at December 31, 1993.
Holders of the 5.25% Series are entitled to one vote per share with the right
to vote cumulatively in the election of directors. Otherwise, the preferred
shareholders have no voting rights.
No shares of preferred stock were reserved for officers and employees, or for
options, warrants, conversions or other rights.
4. COMMON STOCK
The authorized common stock of the Company at December 31, 1993 and 1992
consisted of 3,000,000 shares with a par value of $5 per share. All
outstanding shares of common stock are held by the Parent Company.
There were no shares of common stock held by or for the account of the Company
and no shares were reserved for officers and employees, or for options,
warrants, conversions or other rights.
At December 31, 1993, $80.7 million of reinvested earnings were restricted as
to the payment of cash dividends on common stock under the most restrictive
terms of the Company's indentures.
5. LONG-TERM DEBT
Long-term debt outstanding, exclusive of current maturities, is as follows:
December 31 1993 1992
- ----------- ----------- -----------
(Thousands of Dollars)
FIRST MORTGAGE BONDS:
7.625%, due 1997 $ 10,000 $ 10,000
8.0% to 9.450%, through 2015 82,800 95,200
10.83%, due 1995 -- 15,000
----------- -----------
92,800 120,200
SINKING FUND DEBENTURES:
8.75%, due 1999 3,000 3,100
----------- -----------
Total long-term debt $ 95,800 $ 123,300
=========== ===========
During 1993, the Company retired $12 million of 8% First Mortgage Bonds due
1996 and $15 million of 10.83% First Mortgage Bonds due 1995.
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.
Maturities, installments and sinking fund requirements for the five-year period
from January 1, 1994 are summarized below (in thousands of dollars):
1994 $ 500
1995 500
1996 500
1997 20,500
1998 500
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. NOTES PAYABLE TO AFFILIATES
The Company finances part of its construction program through the use of short-
term notes payable to affiliates which are generally refinanced at a later date
by issues of long-term debt or equity. During 1993, the Company supplemented
its internal generation of cash with funds borrowed from GTE. These
arrangements require payment of interest based on prevailing commercial paper
rates. In addition, lines of credit of $2.3 billion are available to the
Company through shared lines of credit with GTE and other affiliates. Most of
these arrangements require payment of annual commitment fees of .1% of unused
lines of credit.
7. INCOME TAXES
The provision for income taxes is as follows:
1993 1992 1991
---------- --------- ---------
(Thousands of Dollars)
CURRENT
Federal $ 46,368 $ 45,669 $ 37,284
State 12,442 12,590 15,020
---------- --------- ---------
Total 58,810 58,259 52,304
---------- --------- ---------
DEFERRED
Federal (14,218) 3,910 9,236
State (5,343) 498 247
---------- --------- ---------
Total (19,561) 4,408 9,483
---------- --------- ---------
AMORTIZATION OF DEFERRED
INVESTMENT TAX CREDITS (1,852) (1,934) (1,932)
---------- --------- ---------
Total $ 37,397 $ 60,733 $ 59,855
========== ========= =========
The components of deferred income tax expense (benefit) are as follows:
1993 1992 1991
---------- --------- ---------
(Thousands of Dollars)
Depreciation and amortization $ 1,122 $ 10,175 $ 9,629
Employee benefit obligations (2,634) (219) (904)
Prepaid pension cost (1,669) (949) --
Restructuring cost (18,727) -- --
Other - net 2,347 (4,599) 758
---------- --------- ---------
Total $ (19,561) $ 4,408 $ 9,483
========== ========= =========
A reconciliation between the statutory Federal income tax rate and the
effective income tax rate is as follows:
1993 1992 1991
------ ------ ------
STATUTORY FEDERAL INCOME TAX RATE 35.0% 34.0% 34.0%
State and local income taxes, net
of Federal income tax benefits 5.0 5.6 6.7
Amortization of deferred investment
tax credits (2.0) (1.3) (1.3)
Depreciation of telephone plant
construction costs previously
deducted for tax purposes - net 1.9 1.9 1.9
Rate differentials applied to
reversing temporary differences (0.5) (0.6) (0.3)
Other differences - net 1.0 (0.3) (1.2)
----- ----- -----
EFFECTIVE INCOME TAX RATE 40.4% 39.3% 39.8%
===== ===== =====
As a result of implementing SFAS No. 109, the Company recorded additional
deferred income tax liabilities primarily related to temporary differences
which had not previously been recognized in accordance with established rate-
making practices. Since the manner in which income taxes are treated for rate-
making has not changed, pursuant to SFAS No. 71 a corresponding regulatory
asset was also established. In addition, deferred income taxes were adjusted
and a regulatory liability established to give effect to the current statutory
Federal income tax rate and for unamortized investment tax credits. The
unamortized regulatory asset and regulatory liability balances at December 31,
1993 amounted to $16.6 million and $0.1 million, respectively. The unamortized
regulatory asset and regulatory liability balances at December 31, 1992
amounted to $19.4 million and $0.3 million, respectively. The regulatory
assets and liabilities are reflected as other assets and other deferred
credits, respectively, in the accompanying Consolidated Balance Sheets. These
amounts are being amortized over the lives of the related depreciable assets
concurrent with recovery in rates and in conformance with the provisions of the
Internal Revenue Code. The assets and liabilities established in accordance
with SFAS No. 71 have been increased for the tax effect of future revenue
requirements.
The tax effects of all temporary differences that give rise to the deferred tax
liability and deferred tax asset at December 31 are as follows:
1993 1992
--------- ----------
(Thousands of Dollars)
Depreciation and amortization $ 105,896 $ 72,114
Employee benefit obligations (10,817) (6,560)
Prepaid pension cost (2,539) (1,044)
Restructuring cost (18,727) --
Other reserves (22,806) --
Other - net (7,170) (184)
--------- ---------
Total $ 43,837 $ 64,326
========= =========
8. EMPLOYEE BENEFIT PLANS
RETIREMENT PLANS
The Company participates in the Parent Company's trusteed pension plan (the
Plan), which covers substantially all employees. The benefits paid under this
plan are based on an employee's years of service and average earnings for the
five highest consecutive calendar years preceding retirement. Effective
January 1, 1987, the Company adopted SFAS No. 87, "Employers' Accounting for
Pensions", for its pension plans and for financial reporting purposes. In a
1988 order, the CPUC disallowed SFAS No. 87 for ratemaking purposes.
Consequently, the Company has recorded an additional $1.4 million, $1.5 million
and $1.5 million to reflect pension expense in accordance with Accounting
Principles Board Opinion No. 8 for the years ended December 31, 1993-1991,
respectively. This additional expense represents a liability to the ratepayers
of $4.8 million and $6.3 million at December 31, 1993 and 1992, respectively,
and is reflected in other deferred credits in the accompanying Consolidated
Balance Sheets. The Company's policy is to fund pension cost in accordance
with applicable regulations. Total pension costs for 1993-1991 were $0.4
million, $2.1 million and $3.1 million, respectively.
The net assets available for benefits are maintained for the total Plan, but
not by subsidiary. The Plan's net assets available for benefits exceeded
projected benefit obligations as computed under SFAS No. 87 as of the last
actuarial valuation.
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
As described in Note 1, effective January 1, 1993, the Company adopted SFAS No.
106, "Employers' Accounting for Postretirement Benefits Other Than Pensions."
Substantially all of the Company's employees are covered under postretirement
health care and life insurance benefit plans. The health care benefits paid
under the plans are generally based on comprehensive hospital, medical and
surgical benefit provisions, while the life insurance benefits are currently
based on annual earnings at the time of retirement. The Company funds amounts
for postretirement benefits as deemed appropriate from time to time.
The postretirement benefit cost for 1993 includes the following components (in
thousands of dollars):
1993
---------
Service cost-benefits earned during the period $ 2,153
Interest cost on accumulated postretirement benefit
obligation 8,372
Amortization of transition obligation 4,622
---------
Postretirement benefit cost $ 15,147
=========
During 1992 and 1991, the cost of postretirement health care and life insurance
benefits on a pay-as-you-go basis was $3.7 million and $3.2 million,
respectively.
The following table sets forth the plans' funded status and the accrued
obligation as of December 31, 1993 (in thousands of dollars):
1993
---------
Accumulated postretirement benefit obligation
attributable to:
Retirees $ 66,965
Fully eligible active plan participants 6,851
Other active plan participants 25,459
---------
Total accumulated postretirement benefit obligation 99,275
Fair value of plan assets 12,880
---------
Excess of accumulated obligation over plan assets 86,395
Unrecognized transition obligation (70,689)
Unrecognized net loss (2,824)
---------
Accrued postretirement benefit obligation $ 12,882
=========
The assumed discount rate used to measure the accumulated postretirement
benefit obligation was 7.5% at December 31, 1993. The expected long-term rate
of return on plan assets was 8.25% for 1993. The assumed health care cost
trend rate in 1993 was 13% for pre-65 participants and 9.5% for post-65
retirees, each rate declining on a graduated basis to an ultimate rate in the
year 2004 of 6%. A one percentage point increase in the assumed health care
cost trend rate for each future year would have increased 1993 costs by $1.7
million and the accumulated postretirement benefit obligation at December 31,
1993 by $11.2 million.
During 1993, the Company made certain changes to its postretirement health care
and life insurance benefits for non-union employees that are effective January
1, 1995. These changes include, among others, newly established limits to the
Company's contribution to postretirement medical costs and a revised sharing
schedule based on a retiree's years of service. The net effect of these
changes reduced the accumulated benefit obligation at December 31, 1993 by
$21.2 million.
SAVINGS PLANS
The Company sponsors savings plans under section 401(k) of the Internal Revenue
Code. The plans cover substantially all full-time employees. Under the plans,
the Company provides matching contributions in GTE common stock based on
qualified employee contributions. Matching contributions charged to income
were $0.7 million, $0.7 million and $0.6 million in the years 1993-1991,
respectively.
9. COMMITMENTS AND CONTINGENCIES
The Company's anticipated construction costs for 1994 are approximately $60
million, for which the Company had substantial purchase commitments as of
December 31, 1993.
The Company has noncancelable lease contracts covering certain buildings,
office space and equipment. The lease contracts contain varying renewal
options for terms up to three years.
The total amount of rents charged to expense was $3.2 million, $3.2 million and
$2.9 million for the years 1993-1991, respectively.
10. REGULATORY MATTERS
The Company is subject to regulation by the FCC for its interstate business.
Intrastate operations are regulated by the NPSC and Arizona Corporation
Commission (ACC).
INTRASTATE SERVICES
Effective January 1, 1990 the CPUC adopted a new regulatory framework (NRF) for
GTE and Pacific Bell in Phase II of the Alternative Regulatory Proceeding. The
new framework replaced the traditional "rate case" process with a framework
that is based on a Price Cap Index mechanism with "sharing" of earnings above a
benchmark rate of return. The new plan is designed to stimulate productivity
and efficiencies with a portion of those gains flowing directly to the
customer. A policy order issued by the CPUC on July 24, 1991, urged the
Company to adopt the NRF for the Company's operations to be effective no later
than January 1, 1994. The Company has requested to adopt the NRF concurrent
with the approval of the legal entity merger of the Company and GTE California
Incorporated.
Under the new plan, rates for services essential to basic communication would
be subject to a revenue cap, set annually, based on inflation minus a
productivity improvement factor. Rates for partially competitive services
(e.g. Centrex and custom calling features) are subject to the flexibility
within a price floor and ceiling as set by the CPUC. In addition, fully
competitive services (e.g. directory advertising and inside wire installation)
are not subject to pricing limits set by the CPUC. Rates are also adjusted for
exogenous events that are beyond the control of management as defined in the
new plan.
A final CPUC decision was approved for the Company's 1991 financial attrition.
The decision authorized an overall rate of return of 10.75% The Company was
not required to file a financial attrition application for 1992.
On November 21, 1990, the CPUC issued a final order in the proceeding
evaluating the elimination of charges for touchtone service, effective February
1, 1991, and expansion of the local calling area, effective June 1, 1991. The
annual impact of these items reduces revenue by approximately $3 million and
$10 million, respectively.
A proceeding is currently underway to change the price structure of intraLATA
services to reduce cross-subsidies and to align the Company's prices closer to
their underlying costs. This proceeding, which should be concluded in 1994, is
expected to lower the Company's toll and access prices and raise local rates,
thereby placing the Company in a better position for future competition in the
intraLATA market.
During 1991, the Company participated in pooling arrangements, retroactive to
January 1, 1991, for certain access services and was reimbursed for costs of
service incurred, including a return on investment for providing these services
to subscribers and long distance carriers. These arrangements were based on
the Company's estimated cost of providing these services and a rate of return
on the telephone plant utilized for this network access traffic. During 1992,
the Company withdrew from these pooling arrangements and is recording revenues
on a bill and keep basis.
INTERSTATE SERVICES
For the provision of interstate services, the Company operates under the terms
of the FCC's price cap incentive plan. The "price cap" mechanism serves to
limit the rates a carrier may charge, rather than just regulating the rate of
return which may be achieved. Under this approach, the maximum price that the
local exchange carrier (LEC) may charge is increased or decreased each year by
a price index based upon inflation less a predetermined productivity target.
LECs may within certain ranges price individual services above or below the
overall cap.
As a safeguard under its new price cap regulatory plan, the FCC has also
adopted a productivity sharing feature. Because of this feature, under the
minimum productivity-gain option, the Company must share equally with its
ratepayers any realized interstate return above 12.25% up to 16.25%, and all
returns higher than 16.25%, by temporarily lowering prospective prices. During
1994, the FCC is scheduled to review the LEC price cap plan to determine
whether it should be continued or modified.
On December 30, 1993, Contel implemented FCC order 91-213 which restructured
local transport access rates. The order unbundled the interstate local
transport switched access rates into the following elements: 1.) Flat Rate
Entrance Facility charge; 2.) Flat Rate Direct Trunked Transport charge; 3.)
Usage Sensitive Tandem Switched Transport charges (2) and; 4.) Usage Sensitive
Interconnect charge.
SIGNIFICANT CUSTOMER
Revenues received from AT&T include amounts for access, billing and collection
and interexchange leased facilities during the years 1993-1991 under various
arrangements and amounted to $33.0 million, $62.2 million and $112.9 million,
respectively.
11. SUPPLEMENTAL CASH FLOW DISCLOSURES
Set forth below is information with respect to changes in current assets and
current liabilities, and cash paid for interest and income taxes:
1993 1992 1991
---------- --------- -----------
(Thousands of Dollars)
(INCREASE) DECREASE IN CURRENT
ASSETS:
Accounts receivable - net $ (21,118) $ (20,605) $ (8,367)
Materials and supplies (166) 17,433 (17,005)
Other current assets (189) 9,859 (11,311)
INCREASE (DECREASE) IN CURRENT
LIABILITIES:
Accounts payable 19,092 (9,630) (29,715)
Due to affiliated companies 1,586 (2,559) 1,322
Advanced billings and customer
deposits 172 183 (964)
Accrued liabilities (9,683) 5,162 18,743
Other 2,108 (2,697) 14,665
---------- --------- -----------
Total $ (8,198) $ (2,854) $ (32,632)
========== ========== ==========
CASH PAID DURING THE YEAR FOR:
Interest $ 12,370 $ 13,997 $ 13,889
Income taxes 70,895 52,414 35,377
12. QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized 1993 and 1992 quarterly financial data is as follows:
Operating Net Operating
Revenues Income Net Income
----------- ------------- ------------
(Thousands of Dollars)
1993
FIRST QUARTER $ 95,435 $ 40,425 $ 22,403
SECOND QUARTER 93,042 35,054 18,879
THIRD QUARTER 99,344 44,822 24,430
FOURTH QUARTER (a) 96,816 (16,245) (10,643)
----------- ---------- ----------
TOTAL $ 384,637 $ 104,056 $ 55,069
=========== ========== ==========
1992
First Quarter $ 88,687 $ 31,561 $ 16,597
Second Quarter 118,284 36,940 19,904
Third Quarter 104,319 50,378 27,484
Fourth Quarter 102,672 47,372 29,713
----------- ---------- ----------
Total $ 413,962 $ 166,251 $ 93,698
=========== ========== ==========
(a) Net operating income includes a $49.0 million pretax charge for
restructuring costs which reduces net income by $30.2 million.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
Contel of California, Inc.:
We have audited the accompanying consolidated balance sheets of Contel of
California, Inc. (a California corporation) and subsidiary as of December 31,
1993 and 1992, and the related consolidated statements of income, reinvested
earnings and cash flows for each of the three years in the period ended
December 31, 1993. 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 Contel of California, Inc. and
subsidiary as of December 31, 1993 and 1992, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1993, in conformity with generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, effective
January 1, 1993, the Company changed its method of accounting for
postretirement benefits other than pensions. Also as discussed in Note 1,
effective January 1, 1992, the Company changed its method of accounting for
income taxes.
ARTHUR ANDERSEN & CO.
Dallas, Texas
January 28, 1994.
MANAGEMENT REPORT
To Our Shareholders:
The management of the Company is responsible for the integrity and objectivity
of the financial and operating information contained in this Annual Report,
including the consolidated financial statements covered by the Report of
Independent Public Accountants. These statements were prepared in conformity
with generally accepted accounting principles and include amounts that are
based on the best estimates and judgments of management.
The Company has a system of internal accounting controls which provides
management with reasonable assurance that transactions are recorded and
executed in accordance with its authorizations, that assets are properly
safeguarded and accounted for, and that financial records are maintained so as
to permit preparation of financial statements in accordance with generally
accepted accounting principles. This system includes written policies and
procedures, an organizational structure that segregates duties, and a
comprehensive program of periodic audits by the internal auditors. The Company
has also instituted policies and guidelines which require employees to maintain
the highest level of ethical standards.
JAMES F. MILES
President
MICHAEL W. BOLLINGER
Asst. Vice President - Controller
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
BUSINESS OPERATIONS
Contel of California, Inc. (the Company) provides local exchange, network
access and long distance telecommunications services throughout California,
Nevada and Arizona. The Company serves over 360,000 access lines.
RESULTS OF OPERATIONS
Net income decreased 41% or $38.6 million for the year ended December 31, 1993
and increased 3% or $3.1 million for the year ended December 31, 1992. The
1993 results include a one-time restructuring charge of $30.2 million, net of
tax, related primarily to a re-engineering plan. The re-engineering plan will
redesign and streamline processes in order to improve customer-responsiveness
and product quality, reduce the time necessary to introduce new products and
services and further reduce costs. Excluding this charge, net income decreased
9% or $8.4 million. The 1993 decrease reflects higher expenses associated with
the implementation of SFAS No. 106, "Employers' Accounting for Postretirement
Benefits Other Than Pensions" effective January 1, 1993. These increases are
partially offset by lower data processing costs, lower operating expenses as a
result of the completion of a large contract in 1992 partially offset by lower
revenues related to the contract. The 1992 increase reflects higher operating
revenues from the large contract partially offset by higher operating expenses
related to the contract. A restructuring charge of $13.4 million in 1991
associated with the merger of the Company's parent, Contel Corporation, and GTE
also contributed to the 1992 increase.
Local network service revenues which are comprised mainly of fees charged to
customers for providing local exchange service, increased 1% or $0.8 million
for the year ended December 31, 1993 and 6% or $5.1 million for the year ended
December 31, 1992. Both increases are primarily the result of continued
customer growth, as experienced through an increase in access lines.
Network access service revenues represent the local telephone companies' charge
to end users for access to the facilities of long distance carriers and the
charge to long distance carriers for interconnection to local facilities.
Network access service revenues increased less than 1% or $0.7 million during
1993 and decreased 5% or $7.4 million during 1992. The 1993 increase is
primarily due to a growth in network minutes of use. The 1992 decrease is
primarily attributable to lower revenues from various pooling arrangements,
partially offset by the growth in network minutes of use.
The Company's revenues for long distance services from designated geographical
areas are provided under settlement arrangements with various telephone
companies. Long distance service revenues decreased 7% or $9.1 million in 1993
and increased 6% or $7.2 million in 1992. The 1993 decrease is due to
adjustments made to reserves in 1992. The 1992 increase was due to the growth
in toll message revenue from the bill and keep arrangement with Pacific Bell.
Equipment sales and services revenues decreased $24.1 million in 1993 and
increased $24.8 million in 1992. Both variances are the result of revenues
recorded in 1992 related to a completed government contract. The related work-
in-process account decreased in 1992 accordingly to reflect the completed
contract.
Other revenues increased 24% or $2.4 million in 1993 and decreased 39% or $6.4
million in 1992. The 1993 increase is due to higher directory revenues and
lower provisioning for uncollectible accounts. The 1992 decrease was a result
of lower revenues for billing and collection services to interexchange
carriers, lower directory revenues and higher provisioning for uncollectible
accounts.
Cost of sales and services decreased 22% or $20.2 million in 1993 and increased
21% or $16.0 million in 1992. Both variances are due to expenses related to
the completed government contract mentioned above. The 1993 results also
include lower software fees offset by higher expenses associated with the
adoption of SFAS No. 106.
Depreciation and amortization expense increased 9% or $5.0 million in 1993 and
5% or $2.7 million in 1992. The 1993 increase is primarily due to higher plant
investments in addition to a rate order effective July 1, 1993. The 1992
increase was primarily due to higher plant investments.
Marketing, selling and general and administrative expenses decreased 1% or $0.9
million in 1993 and increased 1% or $1.4 million in 1992. The 1993 decrease is
due to lower data system and programming costs as many merger related processes
were completed, lower contractor costs and internal telecommunication expenses.
This decrease was offset by higher expenses related to SFAS No. 106. The 1992
increase was primarily due to higher data system and programming costs
reflecting greater utilization of general purpose computer and operating
systems. During the fourth quarter of 1992, updates to the actuarial valuation
on the early retirement plan portion of the restructuring costs recorded in
1991 associated with the merger of Contel Corporation and GTE resulted in an
additional $6.4 million charge.
Restructuring costs reflect a one-time charge related to the Company's re-
engineering plan over the next three years. The re-engineering plan will
redesign and streamline processes in order to improve customer-responsiveness
and product quality, reduce the time necessary to introduce new products and
services, resulting in cumulative savings in excess of the one-time charge.
The re-engineering plan includes $20 million to upgrade or replace existing
customer service and administrative systems and enhance network software, $23
million for employee separation benefits associated with workforce reductions
and $6 million primarily for the consolidation of facilities and operations and
other related costs. The charge for employee separation benefits includes $11
million related to the recognition of previously deferred postretirement health
and life insurance costs for separating employees.
Income tax expense decreased $23.3 million in 1993 and increased $0.9 million
in 1992. The changes in income tax expense are primarily due to corresponding
changes in pretax income.
CAPITAL RESOURCES AND LIQUIDITY
Management believes that the Company has adequate internal and external
resources available to meet ongoing operating requirements for construction of
new plant, modernization of facilities and payment of dividends. The Company
generally funds its construction program from operations, although external
financing is available. Short-term borrowings can be obtained through
commercial paper borrowings or borrowings from GTE. In addition, a $2.3
billion line of credit is available to the Company through shared lines of
credit with GTE and other affiliates to support short-term financing needs.
The Company's primary source of funds during 1993 was cash flow from operations
of $137.6 million compared to $152.0 million for 1992. The decrease is
primarily due to higher income tax payments made in 1993 compared to 1992.
Capital expenditures represent a significant use of funds during 1993 and 1992,
reflecting the Company's continued growth in access lines and modernization of
current facilities and introduction of new products and services. Cash
requirements to implement the re-engineering plan are expected to be largely
offset by cost savings. The Company's capital expenditures during 1993 were
$60.9 million compared to $63.7 million during 1992. The Company's anticipated
construction costs for 1994 are approximately $60 million.
Cash used for financing activities was $78.6 million in 1993 compared to $87.9
million in 1992. This included dividend payments of $91.5 million in 1993
compared to $58.0 million in 1992. External financing included short-term
borrowings of $40.5 million in 1993 to supplement funds from operations whereas
in 1992 the Company paid down $8.8 million in short-term debt. The Company
retired $27.6 million of long-term debt in 1993, including the early retirement
of 8.0% and 10.83% First Mortgage Bonds, compared to $21.1 million in 1992.
COMPETITION AND REGULATORY TRENDS
The year was marked by important changes in the U.S. telecommunications
industry. Rapid advances in technology, together with government and industry
initiatives to eliminate certain legal and regulatory barriers are accelerating
and expanding the level of competition and opportunities available to the
Company. As a result, the Company faces increasing competition in virtually
all aspects of its business. Specialized communications companies have
constructed new systems in certain markets to bypass the local-exchange
network. Additional competition from interexchange carriers as well as
wireless companies continues to evolve for both intrastate and interstate
communications.
Implementation of its re-engineering plan will allow the Company to continue to
respond aggressively to these competitive and regulatory developments through
reduced costs, improved service quality, competitive prices and new product
offerings. Moreover, implementation of this program will position the Company
to accelerate delivery of a full array of voice, video and data services.
During the year, the Company continued to introduce new business and consumer
services utilizing advanced technology, offering new features and pricing
options while at the same time reducing costs and prices.
During 1993, the Federal Communications Commission (FCC) announced its decision
to auction licenses during 1994 in 51 major markets and 492 basic trading areas
across the United States to encourage the development of a new generation of
wireless personal communications services (PCS). These services will both
complement and compete with the Company's traditional wireline services. The
Company will be permitted to fully participate in the license auctions in areas
outside of GTE's existing cellular service areas. Limited participation will be
permitted in areas in which GTE has an existing cellular presence.
In Cerritos, California, GTE is testing and comparing the capabilities of
copper wire, coaxial cable and fiber optics. The Cerritos test has enhanced
GTE's expertise in the areas of pay-per-view video service, video-on demand and
local video conferencing, and led to a new interactive video service, GTE Main
Street, which allows customers to shop, bank and access various other
information services from their homes. In 1992, the FCC issued a "video
dialtone" ruling that allows telephone companies to transmit video signals over
their networks. The FCC also recommended that Congress amend the Cable Act of
1984 to permit telephone companies to supply video programming in their service
areas.
During 1993, the California Public Utilities Commission (CPUC) approved a New
Regulatory Framework (NRF) settlement agreement allowing GTE California to
retain 100% of any earnings up to a 15.5% rate of return on investment and
refund 100% of any earnings above 15.5% beginning in 1994. Under its prior
agreement, GTE California was required to share 50% of any earnings over a 13%
rate of return and refund 100% of any earnings over 16.5%. The Company has
requested that it be allowed to adopt GTE California's NRF concurrent with the
approval of the legal entity merger of the Company and GTE California
Incorporated. Additionally, the CPUC is expected to issue a final decision in
early 1994 generally authorizing intralata toll competition and ordering
significant rate restructuring in California. Although intended to be revenue
neutral, the ultimate effect on revenue will depend, in part, on the extent to
which toll and access rate reductions result in increased calling volumes.
In September 1993, the FCC released an order allowing competing carriers to
interconnect to the local-exchange network for the purpose of providing
switched access transport services. This ruling complements similar
interconnect arrangements for private line services ordered during 1992. The
order encourages competition for the transport of telecommunications traffic
between local exchange carriers' (LECs) switching offices and interexchange
carrier locations. In addition, the order allows LECs flexibility in pricing
competitive services.
These and other actions to eliminate the existing legal and regulatory
barriers, together with rapid advances in technology, are facilitating a
convergence of the computer, media and telecommunications industries. In
addition to allowing new forms of competition, these developments are also
creating new opportunities to develop interactive communications networks. The
Company supports these initiatives to assure greater competition in
telecommunications, provided that overall the changes allow an opportunity for
all service providers to participate equally in a competitive marketplace under
comparable conditions.
The Company follows the accounting for regulated enterprises prescribed by
Statement of Financial Accounting Standards No. 71, "Accounting for the Effects
of Certain Types of Regulation" (SFAS No. 71). In general, SFAS No. 71
requires companies to depreciate plant and equipment over lives approved by
regulators. It also requires deferral of certain costs and obligations based
upon approvals received from regulators. In the event that recoverability of
these costs becomes unlikely or uncertain, whether resulting from actual or
anticipated competition or specific regulatory, legislative or judicial
actions, continued application of SFAS No. 71 would no longer be appropriate.
If the Company no longer qualifies for the provisions of SFAS No. 71, the
financial effects of the required accounting change (which would be non-cash)
could be material.
INFLATION
The Company's management generally does not believe inflation has a significant
impact on the Company's earnings. However, increases in costs or expenses not
otherwise offset by increases in revenues could have an adverse effect on
earnings.
SELECTED FINANCIAL DATA
1993 1992 1991 1990 1989
----------- ------------ ---------- ----------- -----------
(Thousands of Dollars)
SELECTED INCOME STATEMENT ITEMS (a)
Total operating revenues $ 384,637 $ 413,962 $ 390,704 $ 372,128 $ 367,572
Total operating expenses 280,581 247,711 227,648 219,973 224,184
----------- ---------- ---------- ----------- ----------
Net operating income 104,056 166,251 163,056 152,155 143,388
Interest expense 12,097 13,419 14,596 15,279 16,293
Other - net (507) (1,599) (2,027) (3,304) (2,928)
Income taxes 37,397 60,733 59,855 62,229 56,736
----------- ---------- ---------- ----------- ----------
Net income $ 55,069 $ 93,698 $ 90,632 $ 77,951 $ 73,287
=========== ========== ========== ========== ==========
Dividends declared on common
stock $ 106,471 $ 85,000 $ 93,000 $ 83,000 $ 69,906
Dividends declared on
preferred stock 101 112 115 130 137
- ----------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
SELECTED BALANCE SHEET ITEMS
Investment in property, plant
and equipment - net $ 533,225 $ 529,310 $ 519,875 $ 513,685 $ 483,159
Total assets 659,082 628,576 624,198 581,992 593,490
Long-term debt and preferred
stock, subject to mandatory
redemption 97,510 125,140 139,087 146,825 141,115
Common stock, reinvested earnings
and other capital 186,007 237,510 228,924 231,407 236,583
- ----------------------------------------------------------------------------------------------------------
SELECTED STATISTICS
Access lines 362,905 355,014 344,186 332,054 313,340
Access line gain 7,891 10,828 12,132 18,714 21,237
Net investment in property,
plant and equipment per
access line $ 1,469 $ 1,491 $ 1,510 $ 1,547 $ 1,542
Number of employees 1,592 1,578 1,624 1,730 1,853
Access lines per employee 228 225 212 192 169
Gross plant additions
(thousands) $ 60,894 $ 63,657 $ 67,656 $ 67,835 $ 74,838
- ----------------------------------------------------------------------------------------------------------
(a) Per share data is omitted since the Company's common stock is 100% owned by Contel Corporation.