1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 [Fee Required]
For the fiscal year ended December 31, 1995
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 [No Fee Required]
For the transition period from to
Commission File Number 0-1245
CONTEL OF CALIFORNIA, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 95-1789511
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
16071 Mojave Drive, Victorville, California 92392
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code 619-245-0511
Securities registered pursuant to Section 12(b) of the act:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
NONE
Securities registered pursuant to Section 12(g) of the Act:
NONE
(TITLE OF CLASS)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS.
YES X NO
------- -------
INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405
OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO
THIS FORM 10-K. X
-------
THE COMPANY HAD 2,503,667 SHARES OF $5 PAR VALUE COMMON STOCK OUTSTANDING AT
FEBRUARY 29, 1996. THE COMPANY'S COMMON STOCK IS 100% OWNED BY GTE
CORPORATION.
THE COMPANY MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION J(1)(a) AND
(b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE
FORMAT.
2
TABLE OF CONTENTS
Item Page
Part I
1. Business 1
2. Properties 4
3. Legal Proceedings 4
4. Submission of Matters to a Vote of Security Holders - This item has
been omitted in accordance with the relief provisions under General
Instruction J of Form 10-K
Part II
5. Market for the Registrant's Common Equity and Related
Shareholder Matters 5
6. Selected Financial Data - This item has been omitted in accordance
with the relief provisions under General Instruction J of Form 10-K
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 6
8. Financial Statements and Supplementary Data 11
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 30
Part III
The following items have been omitted in accordance with the relief
provisions under General Instruction J of Form 10-K:
10. Directors and Executive Officers of the Registrant
11. Executive Compensation
12. Security Ownership of Certain Beneficial Owners and Management
13. Certain Relationships and Related Transactions
Part IV
14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 31
3
PART I
Item 1. Business
Contel of California, Inc. (the Company) is a wholly-owned subsidiary of GTE
Corporation (GTE), and provides communications services in California, Nevada
and Arizona.
The Company was incorporated in California in 1954. Since its incorporation,
twenty-three independent telephone companies have been merged into the Company
to form the present entity.
On April 20, 1994, the California Public Service Commission (CPUC) issued a
decision giving final approval to the merger of the Company into GTE
California. The decision requires the merging companies to flow through to
their ratepayers all of the estimated savings that would be produced from the
merger. This flow through requirement is based on the CPUC's interpretation of
certain statutory requirements. The CPUC, however, provided the parties with
the opportunity to supplement the evidentiary record to show why the estimated
merger savings should be apportioned between ratepayers and shareholders. That
filing was made on April 29, 1994. By making the filing, the effective date of
the decision approving the merger was delayed. The Company and other
interested parties have filed reports and comments pursuant to this proceeding.
On October 5, 1995, the Governor of the State of California signed a law which
clarifies the authority of the CPUC to allocate utility merger benefits between
ratepayers and shareholders with not less than 50% going to the ratepayers.
The new law became effective January 1, 1996. A decision approving the merger
under the terms of the amended legislation is expected during the second
quarter of 1996.
The Company's principal line of business is providing communications services
ranging from local telephone service for the home and office to highly complex
voice and data services for industry. The Company provides local telephone
service within its franchise area and intraLATA (Local Access Transport Area)
toll service between the Company's facilities and the facilities of other
telephone companies within the Company's LATAs. InterLATA service to other
points in and out of the states in which the Company operates is provided
through connection with interexchange (long distance) common carriers. These
common carriers are charged fees (access charges) for interconnection to the
Company's local facilities. Business and residential customers also pay access
charges to connect to the local network to obtain long distance service. The
Company earns other revenues by leasing interexchange plant facilities and
providing such services as billing and collection and operator services to
interexchange carriers. At December 31, 1995, the Company served 389,603
access lines in its service territories.
At December 31, 1995, the Company had 1,192 employees.
The Company has written agreements with the Communications Workers of America
(CWA) and the International Brotherhood of Electrical Workers (IBEW). The
current agreements with the CWA and the IBEW units expire on September 6, 1996.
REGULATORY AND COMPETITIVE TRENDS
The Company is subject to regulation by the regulatory bodies of the states of
California, Nevada and Arizona as to its intrastate business operations and by
the Federal Communications Commission (FCC) as to its interstate operations.
Advances in technology, together with a number of regulatory, legislative and
judicial actions, continue to accelerate and expand the level of competition
and opportunities available to the Company. Presently, the Company is subject
to competition from numerous sources, including competitive access providers
(CAPs) for network access services and specialized communications companies
that have constructed new systems in certain markets to bypass
1
4
the local-exchange network. In addition, competition from alternative
local-exchange carriers (ALECs), interexchange carriers (IXCs), wireless and
cable TV companies, as well as more recent entry by media and computer
companies, is expected to increase in the rapidly changing telecommunications
marketplace.
On February 8, 1996, the Telecommunications Act of 1996 (the Telecommunications
Act) became law. This comprehensive telecommunications reform legislation
addresses a wide range of competitive and regulatory issues that will affect
the future development of local and long distance services, cable television
and information services. The Telecommunications Act overhauls 62 years of
telecommunications law, replacing government regulation with competition as the
chief way of assuring that telecommunications services are delivered to
customers. The new law removes many of the statutory and court-ordered
barriers to competition between segments of the industry, enabling
local-exchange, long distance, wireless and cable companies to compete in
offering voice, video and information services.
The Telecommunications Act requires the FCC and state commissions to set new
guidelines to open local-exchange markets and to set new guidelines for
interconnection, loosens restrictions barring local telephone companies from
entering the cable television market, and preserves Universal Service while
equalizing the responsibility for contribution among all carriers.
A key provision of the Telecommunications Act also eliminates the legal
restraints of the GTE Consent Decree which has kept the Company from providing
interLATA services. This action will simplify GTE's ability to market local
intraLATA and interLATA service to its customers as a bundled service. In
February 1996, GTE executed an agreement whereby WorldCom, Inc. will provide,
on a non-exclusive basis, a full array of telecommunications services in
support of GTE's entry into the interLATA long distance market. In March 1996,
GTE, through a separate subsidiary, began offering long distance to its
customers in selected markets. GTE plans to offer the service, marketed under
the name GTE Easy Savings Plan(SM), in all 28 states where it currently offers
local telephone service by December 1996.
The Telecommunications Act forbids states from imposing any barriers to entry
into local and toll competition. Through 1995, local competition has been
authorized in fifteen states, including California and Nevada. In addition,
eight states, including Arizona, have concluded that intraLATA 1+ competition
is in the public interest. These states have authorized plans that would allow
customers to pre-subscribe to a specific carrier to handle their intraLATA toll
calls. Pre-subscribed customers will simply dial "1" before the telephone
number in order to complete intraLATA calls. The Telecommunications Act
requires GTE to negotiate intraLATA dialing parity provisions with its
competitors. In subsequent negotiations, GTE will address implementation of 1+
in those states which have not previously ordered implementation.
Federal and state regulatory activity directed toward changing the traditional
cost-based, rate-of-return regulatory framework for intrastate and interstate
telephone service has continued. Regulatory authorities have adopted various
forms of alternative regulation, which provide economic incentives to telephone
service providers to improve productivity and provide the foundation for
implementing pricing flexibility necessary to address competitive entry into
GTE markets.
On January 1, 1995, pursuant to an order issued by the California Public
Utilities Commission (CPUC), competition in toll services (without customer
pre-subscription) became effective in California. The order also provided for
rate rebalancing with significant rate reductions for toll services and access
charges while increasing basic local service rates closer to the actual cost of
providing such service. Although this rate rebalancing was intended by the
CPUC to be revenue neutral, the actual increase in volumes did not fully
compensate for the toll and access rate reductions. As expected, revenues
decreased by approximately $38 million in 1995 as a result of the
implementation of this order.
2
5
For the provision of interstate access services, the Company operates under
the terms of the FCC's price cap incentive plan. The "price cap" mechanism
serves to limit the rates a carrier may charge, rather than just regulating the
rate of return which may be achieved. Under this approach, the maximum prices
that the local-exchange carrier (LEC) may charge are increased or decreased
each year by a price index based upon inflation less a predetermined
productivity target. LECs have limited pricing flexibility provided they do not
exceed the allowed price cap. The FCC is considering how the price cap plan
should be modified in the future in order to adapt the system to the emergence
of competition.
Further information regarding the Company's activities with the various
regulatory agencies and revenue arrangements with other telephone companies is
discussed in Note 11 of the Company's consolidated financial statements
included in Item 8.
The Company continues to support greater competition in telecommunications,
provided that, overall, the actions to eliminate existing legal and regulatory
barriers benefit consumers by allowing an opportunity for all service providers
to participate equally in a competitive marketplace under comparable
conditions.
The Company intends to continue to respond aggressively to regulatory and legal
developments that allow for increased competition and opportunities in the
marketplace. The Company expects its financial results to benefit from reduced
costs and the introduction of new products and services that will result in
increased usage of its telephone networks. However, it is likely that such
improvements will be offset, in part, by continued strategic pricing reductions
and the effects of increased competition.
INITIATIVES
In 1995, the Company continued to position itself to respond aggressively to
competitive developments and benefit from new opportunities.
Restructuring and Cost Control
During 1995, the Company continued the implementation of its $49 million
re-engineering program. Since the program began in 1994, costs of $28.5
million have been charged to the restructuring reserve -- $17.3 million
related to customer service processes, $8.1 million related to administrative
processes and $3.1 million related to the consolidation of facilities and
operations and other related costs. These costs were primarily associated with
the closure and relocation of various centers, software enhancements and
separation benefits associated with workforce reductions. The continued
implementation of this program positions the Company to accelerate delivery of
a full array of voice, video and data services and to reach its stated
objective of being the easiest company to do business with in the industry.
ENVIRONMENTAL MATTERS
GTE maintains monitoring and compliance programs related to environmental
matters. The Company's annual expenditures for environmental compliance have
not been and are not expected to be material. Costs incurred include outlays
required to keep existing operations in compliance with environmental
regulations and an underground storage tank replacement program.
3
6
Item 2. Properties
The Company's property consists principally of land, structures and equipment
required to provide various telecommunications services. All of the
aforementioned properties, located in the states of California, Nevada and
Arizona, are generally in good operating condition and are adequate to satisfy
the needs of the business. Substantially all of the Company's property is
subject to the liens of its respective mortgages securing funded debt. From
January 1, 1991 to December 31, 1995, the Company made capital expenditures of
$283.2 million for new plant and facilities required to meet telecommunication
service needs and to modernize plant and facilities. These additions were
equal to 31% of gross plant of $915.3 million at December 31, 1995.
In response to recently enacted and pending legislation and the increasingly
competitive environment, the Company discontinued the use of Statement of
Financial Accounting Standards No. 71, "Accounting for the Effects of Certain
Types of Regulation" (FAS 71) in the fourth quarter of 1995.
In general, FAS 71 required the Company to depreciate its telephone plant and
equipment over lives approved by regulators which, in many cases, extended
beyond the assets' economic lives. FAS 71 also required the deferral of
certain costs based upon approvals received from regulators to recover such
costs in the future. As a result of these requirements, the recorded net book
value of certain assets and liabilities, primarily telephone plant and
equipment, were in many cases higher than that which would otherwise have been
recorded based on their economic lives. See Note 2 to the Company's
consolidated financial statements included elsewhere herein for further detail.
Item 3. Legal Proceedings
There are no pending legal proceedings, either for or against the Company,
which would have a material impact on the Company's consolidated financial
statements.
4
7
PART II
Item 5. Market for the Registrant's Common Equity and Related Shareholder
Matters
Market information is omitted since the Company's common stock is wholly-owned
by GTE Corporation (GTE).
SHAREHOLDER SERVICES
The First National Bank of Boston, Transfer Agent and Registrar for GTE and the
Company's common stock, should be contacted with any questions relating to
shareholder accounts. This includes the following:
o Account information
o Dividends
o Market prices
o Transfer instructions
o Statements and reports
o Change of address
Shareholders may call toll-free at 1-800-225-5160 anytime, seven days a week.
Customer Service Representatives are available Monday through Friday between
the hours of 8 a.m. and 5 p.m. Eastern Time. Outside the United States call
1-617-575-2990.
Or write to:
Bank of Boston
c/o Boston EquiServe, L.P.
P.O. Box 9121
Mail Stop 52-02-60
Boston, MA 02205-9121
For overnight delivery services, use the following address:
Bank of Boston
c/o Boston EquiServe, L.P.
Blue Hills Office Park
150 Royall Street
Canton, MA 02021
The Bank of Boston address where shareholders, banks, and brokers may deliver
certificates is One Exchange Place, 55 Broadway in New York City.
PARENT COMPANY ANNUAL REPORT
To obtain a copy of the 1995 annual report of our parent company or the annual
Form 10-K filed with the Securities and Exchange Commission, call
1-800-225-5160.
INFORMATION VIA THE INTERNET
Internet World Wide Web users can access information on GTE through the
following universal resource:
http://www.gte.com
5
8
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in Millions)
BUSINESS OPERATIONS
Contel of California, Inc. (the Company), a wholly-owned subsidiary of GTE
Corporation (GTE), provides local-exchange, network access and toll services in
the states of California, Nevada and Arizona. At December 31, 1995, the
Company served 389,603 access lines in its service territories.
RESULTS OF OPERATIONS
Years Ended December 31,
------------------------
1995 1994
------ -----
Net income (loss) $(77.9) $65.7
The net loss for 1995 includes an extraordinary after-tax charge of $127.6 for
the discontinuance of Statement of Financial Accounting Standards No. 71
"Accounting for the Effects of Certain Types of Regulation" (FAS 71) in the
fourth quarter of 1995. Excluding this charge, net income decreased 24% or $16
in 1995. The decrease is primarily due to the Implementation Rate Design (IRD)
discussed below, partially offset by a one-time support payment of $31.9 from
the California High Cost Fund received in December 1995, as discussed below.
On January 1, 1995, pursuant to an order issued by the California Public
Utilities Commission (CPUC), competition in toll services (without customer
pre-subscription) became effective in California. The order also provided for
rate rebalancing with significant rate reductions for toll service and network
access service while increasing basic local service rates closer to the actual
cost of providing such service. Although this rate rebalancing was intended by
the CPUC to be revenue neutral, the actual increase in volumes did not fully
compensate for the toll and access rate reductions. Total revenues decreased
approximately $38 in 1995 as a result of the implementation of this order.
REVENUES AND SALES
Years Ended December 31,
------------------------
1995 1994
------ ------
Local services $149.2 $ 97.3
Network access services 103.8 136.8
Toll services 61.9 108.0
Other services and sales 28.6 29.8
------ ------
Total revenues and sales $343.5 $371.9
Total revenues and sales decreased 8% or $28.4 in 1995.
Local service revenues are based on fees charged to customers for providing
local-exchange service within designated franchise areas. Local service
revenues increased 53% or $51.9 in 1995. This increase is primarily the result
of a one-time support payment of $31.9 recorded in December 1995 from the
California High Cost Fund, a fund established to subsidize rural providers for
the costs of providing universal service, and $17.3 in rate increases
associated with the IRD. This increase is also due to a 3% growth in access
lines, which generated $2.4 of additional revenues.
6
9
Network access service revenues are based on fees charged to interexchange
carriers that use the Company's local exchange network in providing long
distance services. In addition, business and residential customers pay access
fees to connect to the local network to obtain long distance service. Network
access service revenues decreased 24% or $33 in 1995. This decrease is
primarily the result of $24 in rate reductions associated with the previously
mentioned IRD, $5.1 of lower revenues attributable to the interstate sharing
requirements of the FCC price cap plan for the 1994-1995 tariff year and $3 of
lower support payments received from the Universal Service Fund. These
decreases are partially offset by a 10% increase in minutes of use, which
generated $3.1 of additional revenues.
Toll service revenues are based on fees charged for service beyond a customer's
local calling area but within the local access transport area (LATA). Toll
service revenues decreased 43% or $46.1 in 1995. This decrease is primarily
the result of $31.4 in rate reductions associated with the previously mentioned
IRD and $8.1 of lower transitional support payments received from Pacific Bell
as a result of the Company's exit from the California state intraLATA toll pool
in 1994. Transitional support payments will continue through 1997 with
increasingly lower payments in each of the years 1996 and 1997.
Other services and sales revenues decreased 4% or $1.2 in 1995. This decrease
is primarily due to lower rent revenues of $0.7 due to the cancellation of
interexchange carrier facility leases by AT&T Corp. in 1994.
OPERATING COSTS AND EXPENSES
Years Ended December 31,
------------------------
1995 1994
------ ------
Cost of services and sales $121.8 $123.8
Selling, general and administrative 55.7 60.3
Depreciation and amortization 69.5 64.6
------ ------
Total operating costs and expenses $247.0 $248.7
Total operating costs and expenses decreased 1% or $1.7 in 1995. This decrease
is primarily related to $10.7 of lower labor and benefits costs associated with
the Company's re-engineering plan and a $2.1 decrease in end user
uncollectibles. These decreases are partially offset by $7.4 in nonrecurring
favorable settlement activities recorded in 1994 and a $4.9 increase in
depreciation expenses, primarily related to increased gross plant balances.
OTHER EXPENSES
Income taxes were $35.8 and $46.1 for 1995 and 1994, respectively, reflecting a
decrease of 22% or $10.3. This decrease is primarily related to the decrease
in pre-tax income.
REGULATORY AND COMPETITIVE TRENDS
The Company is subject to regulation by the regulatory bodies of the states of
California, Nevada and Arizona as to its intrastate business operations and by
the Federal Communications Commission (FCC) as to its interstate operations.
Advances in technology, together with a number of regulatory, legislative and
judicial actions, continue to accelerate and expand the level of competition
and opportunities available to the Company. Presently, the Company is subject
to competition from numerous sources, including competitive access providers
(CAPs) for network access services and specialized communications companies
that have constructed new systems in certain markets to bypass
7
10
the local-exchange network. In addition, competition from alternative
local-exchange carriers (ALECs), interexchange carriers (IXCs), wireless and
cable TV companies, as well as more recent entry by media and computer
companies, is expected to increase in the rapidly changing telecommunications
marketplace.
On February 8, 1996, the Telecommunications Act of 1996 (the Telecommunications
Act) became law. This comprehensive telecommunications reform legislation
addresses a wide range of competitive and regulatory issues that will affect
the future development of local and long distance services, cable television
and information services. The Telecommunications Act overhauls 62 years of
telecommunications law, replacing government regulation with competition as the
chief way of assuring that telecommunications services are delivered to
customers. The new law removes many of the statutory and court-ordered
barriers to competition between segments of the industry, enabling
local-exchange, long distance, wireless and cable companies to compete in
offering voice, video and information services.
The Telecommunications Act requires the FCC and state commissions to set new
guidelines to open local-exchange markets and to set new guidelines for
interconnection, loosens restrictions barring local telephone companies from
entering the cable television market, and preserves Universal Service while
equalizing the responsibility for contribution among all carriers.
A key provision of the Telecommunications Act also eliminates the legal
restraints of the GTE Consent Decree which has kept the Company from providing
interLATA services. This action will simplify GTE's ability to market local
intraLATA and interLATA service to its customers as a bundled service. In
February 1996, GTE executed an agreement whereby WorldCom, Inc. will provide,
on a non-exclusive basis, a full array of telecommunications services in
support of GTE's entry into the interLATA long distance market. In March 1996,
GTE, through a separate subsidiary, began offering long distance to its
customers in selected markets. GTE plans to offer the service, marketed under
the name GTE Easy Savings Plan(SM), in all 28 states where it currently offers
local telephone service by December 1996.
The Telecommunications Act forbids states from imposing any barriers to entry
into local and toll competition. Through 1995, local competition has been
authorized in fifteen states, including California and Nevada. In addition,
eight states, including Arizona, have concluded that intraLATA 1+ competition
is in the public interest. These states have authorized plans that would allow
customers to pre-subscribe to a specific carrier to handle their intraLATA toll
calls. Pre-subscribed customers will simply dial "1" before the telephone
number in order to complete intraLATA calls. The Telecommunications Act
requires GTE to negotiate intraLATA dialing parity provisions with its
competitors. In subsequent negotiations, GTE will address implementation of 1+
in those states which have not previously ordered implementation.
Federal and state regulatory activity directed toward changing the traditional
cost-based, rate-of-return regulatory framework for intrastate and interstate
telephone service has continued. Regulatory authorities have adopted various
forms of alternative regulation, which provide economic incentives to telephone
service providers to improve productivity and provide the foundation for
implementing pricing flexibility necessary to address competitive entry into
GTE markets.
On January 1, 1995, pursuant to an order issued by the California Public
Utilities Commission (CPUC), competition in toll services (without customer
pre-subscription) became effective in California. The order also provided for
rate rebalancing with significant rate reductions for toll services and access
charges while increasing basic local service rates closer to the actual cost of
providing such service. Although this rate rebalancing was intended by the
CPUC to be revenue neutral, the actual increase in volumes did not fully
compensate for the toll and access rate reductions. As expected, revenues
decreased by approximately $38 million in 1995 as a result of the
implementation of this order.
8
11
For the provision of interstate access services, the Company operates under
the terms of the FCC's price cap incentive plan. The "price cap" mechanism
serves to limit the rates a carrier may charge, rather than just regulating the
rate of return which may be achieved. Under this approach, the maximum prices
that the LEC may charge are increased or decreased each year by a price index
based upon inflation less a predetermined productivity target. LECs have
limited pricing flexibility provided they do not exceed the allowed price cap.
The FCC is considering how the price cap plan should be modified in the future
in order to adapt the system to the emergence of competition.
Further information regarding the Company's activities with the various
regulatory agencies and revenue arrangements with other telephone companies is
discussed in Note 11 of the Company's consolidated financial statements
included in Item 8.
The Company continues to support greater competition in telecommunications,
provided that, overall, the actions to eliminate existing legal and regulatory
barriers benefit consumers by allowing an opportunity for all service providers
to participate equally in a competitive marketplace under comparable
conditions.
The Company intends to continue to respond aggressively to regulatory and legal
developments that allow for increased competition and opportunities in the
marketplace. The Company expects its financial results to benefit from reduced
costs and the introduction of new products and services that will result in
increased usage of its telephone networks. However, it is likely that such
improvements will be offset, in part, by continued strategic pricing reductions
and the effects of increased competition.
INITIATIVES
In 1995, the Company continued to position itself to respond aggressively to
competitive developments and benefit from new opportunities.
Restructuring and Cost Control
During 1995, the Company continued the implementation of its $49 re-engineering
program. Since the program began in 1994, costs of $28.5 have been charged to
the restructuring reserve -- $17.3 related to customer service processes, $8.1
related to administrative processes and $3.1 related to the consolidation of
facilities and operations and other related costs. These costs were primarily
associated with the closure and relocation of various centers, software
enhancements and separation benefits associated with workforce reductions. The
continued implementation of this program positions the Company to accelerate
delivery of a full array of voice, video and data services and to reach its
stated objective of being the easiest company to do business with in the
industry.
ENVIRONMENTAL MATTERS
GTE maintains monitoring and compliance programs related to environmental
matters. The Company's annual expenditures for environmental compliance have
not been and are not expected to be material. Costs incurred include outlays
required to keep existing operations in compliance with environmental
regulations and an underground storage tank replacement program.
9
12
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of" (FAS 121) in March 1995,
which is effective January 1, 1996. FAS 121 requires that an impairment loss
be recognized when circumstances indicate that the carrying amount of an asset
may not be recoverable. Historically, the Company has used a methodology
similar to FAS 121 in determining the amount of an impairment. Accordingly,
the issuance of FAS 121 will not have a significant impact on the Company's
consolidated financial statements.
In October 1995, the FASB issued Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation" (FAS 123). As permitted by
FAS 123, the Company will continue to apply the recognition and measurement
provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" and adopt the disclosure requirements of FAS 123 beginning
in 1996. Accordingly, the issuance of FAS 123 will not impact the Company's
financial position or results of operations.
INFLATION
The Company's management generally does not believe inflation has a significant
impact on the Company's earnings. However, increases in costs or expenses not
otherwise offset by increases in revenues could have an adverse effect on
earnings.
10
13
Item 8. Financial Statements and Supplementary Data
Contel of California, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31 1995 1994 1993
- ----------------------- --------- -------- --------
(Thousands of Dollars)
Revenues and sales:
Local services $ 149,205 $ 97,349 $ 94,586
Network access services 103,825 136,769 139,822
Toll services 61,854 108,008 124,780
Other services and sales 28,599 29,798 31,779
--------- -------- --------
Total revenues and sales 343,483 371,924 390,967
--------- -------- --------
Operating costs and expenses (a):
Cost of services and sales 121,841 123,777 121,927
Selling, general and administrative 55,663 60,323 58,448
Depreciation and amortization 69,496 64,637 58,431
Restructuring -- -- 48,987
--------- -------- --------
Total operating costs and expenses 247,000 248,737 287,793
--------- -------- --------
Operating income 96,483 123,187 103,174
Other expense:
Interest - net 10,913 11,321 10,708
--------- -------- --------
Income before income taxes 85,570 111,866 92,466
Income taxes 35,831 46,120 37,397
--------- -------- --------
Income before extraordinary charge 49,739 65,746 55,069
Extraordinary charge (127,620) -- --
--------- -------- --------
Net income (loss) $(77,881) $ 65,746 $ 55,069
========= ======== ========
(a) Includes billings from affiliates of $16,442, $13,929 and $14,305 for the
years 1995-1993, respectively.
See Notes to Consolidated Financial Statements.
11
14
Contel of California, Inc. and Subsidiary
CONSOLIDATED BALANCE SHEETS
December 31 1995 1994
- ----------- -------- --------
(Thousands of Dollars)
ASSETS
Current assets:
Cash and temporary investments $ 2,139 $ 2,244
Receivables, less allowances of $4,895 and $3,523 120,872 75,579
Inventories and supplies 652 2,134
Deferred income tax benefits 18,432 6,793
Other 841 228
-------- --------
Total current assets 142,936 86,978
-------- --------
Property, plant and equipment, net 280,157 524,215
Deferred income tax benefits and other assets 16,331 39,883
-------- --------
Total assets $439,424 $651,076
======== ========
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities:
Notes payable to affiliates $ 51,838 $ 67,703
Accounts payable 32,318 26,825
Affiliate payables and accruals 3,173 6,341
Advanced billings and customer deposits 5,633 4,069
Taxes payable 21,943 6,814
Accrued interest 2,389 2,697
Accrued payroll costs 9,369 7,280
Dividends payable -- 15,261
Accrued restructuring costs 20,455 12,730
Other 21,986 13,509
-------- --------
Total current liabilities 169,104 163,229
-------- --------
Non-current liabilities:
Long-term debt 90,000 90,000
Deferred income taxes and investment tax credits 5,781 108,402
Employee benefit obligations 60,516 57,564
Restructuring costs -- 9,580
Other liabilities 5,828 5,562
-------- --------
Total non-current liabilities 162,125 271,108
-------- --------
Shareholder's equity:
Common stock (2,503,667 shares issued) 12,518 12,518
Additional paid-in capital 78,917 78,917
Retained earnings 16,760 125,304
-------- --------
Total shareholder's equity 108,195 216,739
-------- --------
Total liabilities and shareholder's equity $439,424 $651,076
======== ========
See Notes to Consolidated Financial Statements.
12
15
Contel of California, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31 1995 1994 1993
- ----------------------- -------- -------- --------
(Thousands of Dollars)
Operations:
Income before extraordinary charge $ 49,739 $ 65,746 $ 55,069
Adjustments to reconcile income before extraordinary
charge to net cash from operations:
Depreciation and amortization 69,496 64,637 58,431
Deferred income taxes (3,447) 24,767 (19,678)
Restructuring costs -- -- 48,987
Provision for uncollectible accounts 5,072 4,788 6,479
Change in current assets and current liabilities:
Receivables - net (50,365) 1,725 (24,129)
Other current assets 869 654 348
Accrued taxes and interest 14,821 (27,871) (28,443)
Other current liabilities 12,828 (44,982) (11,132)
Other - net 1,854 36,116 51,704
-------- -------- --------
Net cash from operations 100,867 125,580 137,636
-------- -------- --------
Investing:
Capital expenditures (39,183) (52,317) (60,400)
-------- -------- --------
Cash used in investing (39,183) (52,317) (60,400)
-------- -------- --------
Financing:
Long-term debt and preferred stock retired -- (8,010) (27,630)
Dividends (45,924) (61,906) (91,519)
Net change in affiliate notes (15,865) (1,171) 40,504
-------- -------- --------
Net cash used in financing (61,789) (71,087) (78,645)
-------- -------- --------
Increase (decrease) in cash and temporary investments (105) 2,176 (1,409)
Cash and temporary investments:
Beginning of year 2,244 68 1,477
-------- -------- --------
End of year $ 2,139 $ 2,244 $ 68
======== ======== ========
Cash paid during the year for:
Interest $ 11,685 $ 11,999 $ 12,370
Income taxes 22,823 49,129 70,895
See Notes to Consolidated Financial Statements.
13
16
Contel of California, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY
Additional
Common Paid-In Retained
Stock Capital Earnings Total
------- ---------- --------- ---------
(Thousands of Dollars)
Shareholder's equity, December 31, 1992 $12,518 $78,917 $ 146,075 $ 237,510
Net income 55,069 55,069
Dividends declared (106,572) (106,572)
------- ------- --------- ---------
Shareholder's equity, December 31, 1993 12,518 78,917 94,572 186,007
Net income 65,746 65,746
Dividends declared (35,014) (35,014)
------- ------- --------- ---------
Shareholder's equity, December 31, 1994 12,518 78,917 125,304 216,739
Net loss (77,881) (77,881)
Dividends declared (30,663) (30,663)
------- ------- --------- ---------
Shareholder's equity, December 31, 1995 $12,518 $78,917 $ 16,760 $ 108,195
======= ======= ========= =========
See Notes to Consolidated Financial Statements.
14
17
Contel of California, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Contel of California, Inc. (the Company) provides a wide variety of
communications services ranging from local telephone service for the home and
office to highly complex voice and data services for various industries. At
December 31, 1995, the Company served 389,603 access lines in the states of
California, Nevada and Arizona. The Company is a wholly-owned subsidiary of
GTE Corporation (GTE).
BASIS OF PRESENTATION
The Company prepares its consolidated financial statements in accordance with
generally accepted accounting principles which require that management make
estimates and assumptions that affect the reported amounts. Actual results
could differ from those estimates.
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, Contel Advanced Systems, Inc. All significant
intercompany transactions have been eliminated.
The Company discontinued applying the provisions of Statement of Financial
Accounting Standards No. 71, "Accounting for the Effects of Certain Types of
Regulation" (FAS 71), in the fourth quarter of 1995 (see Note 2). The 1995
financial presentation reflects account classifications consistent with
unregulated enterprises operating in a competitive environment. Specifically,
uncollectible revenue accounts have been reclassified from revenues and sales
to selling, general and administrative expenses. Reclassifications of
prior-year data have been made, where appropriate, to conform to the 1995
presentation.
TRANSACTIONS WITH AFFILIATES
Certain affiliated companies, which are not subsidiaries of the Company, supply
construction and maintenance equipment, supplies and electronic repair services
to the Company. These purchases and services amounted to $9.8 million, $11.5
million and $11.7 million for the years 1995-1993, respectively. Such
purchases and services are recorded in the accounts of the Company at cost
which includes a normal profit realized by the affiliates.
The Company is billed for data processing services and equipment rentals, and
receives management, consulting, research and development and pension
management services from other affiliated companies. These charges amounted to
$16.4 million, $13.9 million and $14.3 million for the years 1995-1993,
respectively. The amounts charged for these affiliated transactions are based
on a proportional cost allocation method.
The Company's consolidated financial statements include allocated expenses
based on the sharing of certain executive, administrative, financial,
accounting, marketing, personnel, engineering and other support services being
performed at consolidated work centers among the domestic GTE Telephone
Operating Companies. The amounts charged for these affiliated transations are
based on a proportional cost allocation method as filed with the Federal
Communications Commission (FCC).
TELEPHONE PLANT
The Company has historically provided for depreciation on a straight-line basis
over asset lives approved by regulators. Beginning in 1996, the Company will
provide for depreciation on a straight-line basis over the estimated economic
lives of its assets (see Note 2). Maintenance and repairs are charged to
income as incurred. Additions to,
15
18
replacements and renewals of property are charged to telephone plant accounts.
Property retirements are charged in total to the accumulated depreciation
account. No adjustment to depreciation is made at the time properties are
retired or otherwise disposed of, except in the case of significant sales or
extraordinary retirements of property where profit or loss is recognized.
REVENUE RECOGNITION
Revenues are recognized when earned. This is generally based on usage of the
Company's local-exchange networks or facilities. For other products and
services, revenues are generally recognized when services are rendered or
products are delivered to customers.
INVENTORIES AND SUPPLIES
Inventories and supplies are stated at the lower of cost, determined
principally by the average cost method, or net realizable value.
EMPLOYEE BENEFIT PLANS
Pension and postretirement health care and life insurance benefits earned
during the year as well as interest on accumulated benefit obligations are
accrued currently. Prior service costs and credits resulting from changes in
plan benefits are amortized over the average remaining service period of the
employees expected to receive benefits. Material curtailment/settlement gains
and losses associated with employee separations are recognized in the period in
which they occur.
The Company adopted Statement of Financial Accounting Standards No. 112,
"Employers' Accounting for Postemployment Benefits" (FAS 112), effective
January 1, 1993. FAS 112 requires employers to accrue the future cost of
benefits provided to former or inactive employees and their dependents after
employment but before retirement. Previously, the cost of these benefits was
charged to expense as paid. The impact of this change in accounting on the
Company's results of operations was immaterial.
INCOME TAXES
The Company's results are included in GTE's consolidated federal income tax
return. The Company participates in a tax- sharing agreement with GTE and
remits tax payments to GTE based on its tax liability on a separate company
basis.
Deferred tax assets and liabilities are established for temporary differences
between financial and tax reporting bases and are subsequently adjusted to
reflect changes in tax rates expected to be in effect when the temporary
differences reverse. A valuation allowance is established for any deferred tax
asset for which realization is not likely.
COMPUTER SOFTWARE
The cost of computer software for internal use, except initial operating system
software, is charged to expense as incurred. Initial operating system software
is capitalized and amortized over the life of the related hardware.
CASH AND TEMPORARY INVESTMENTS
Cash and temporary investments include investments in short-term, highly liquid
securities, which have maturities when purchased of three months or less.
16
19
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of" (FAS 121) in March 1995,
which is effective January 1, 1996. FAS 121 requires that an impairment loss
be recognized when circumstances indicate that the carrying amount of an asset
may not be recoverable. Historically, the Company has used a methodology
similar to FAS 121 in determining the amount of an impairment. Accordingly,
the issuance of FAS 121 will not have a significant impact on the Company's
consolidated financial statements.
In October 1995, the FASB issued Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation" (FAS 123). As permitted by
FAS 123, the Company will continue to apply the recognition and measurement
provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" and adopt the disclosure requirements of FAS 123 beginning
in 1996. Accordingly, the issuance of FAS 123 will not impact the Company's
financial position or results of operations.
2. EXTRAORDINARY CHARGE
In response to recently enacted and pending legislation (see Note 11) and the
increasingly competitive environment, the Company discontinued the use of FAS
71 in the fourth quarter of 1995.
In general, FAS 71 required the Company to depreciate its telephone plant and
equipment over lives approved by regulators which, in many cases, extended
beyond the assets' economic lives. FAS 71 also required the deferral of
certain costs based upon approvals received from regulators to recover such
costs in the future. As a result of these requirements, the recorded net book
value of certain assets and liabilities, primarily telephone plant and
equipment, were in many cases higher than that which would otherwise have been
recorded based on their economic lives.
As a result of the decision to discontinue FAS 71, the Company recorded a
non-cash, after-tax extraordinary charge of $127.6 million (net of tax benefits
of $87.8 million) in the fourth quarter of 1995. The charge primarily
represents a reduction in the net book value of telephone plant and equipment
through an increase in accumulated depreciation. The amount of the charge was
based on an analysis of the discounted cash flows expected to be generated by
the embedded telephone plant and equipment over their remaining economic lives.
In addition to the one-time charge, the Company, beginning in 1996, will
shorten the depreciable lives of its telephone plant and equipment as follows
as a result of the discontinuance of FAS 71:
Depreciable Lives
-----------------------------
Average
Asset Category Before After
-------------- ------- -----
Copper 20-30 15
Switching 17-19 10
Circuit 11-13 8
Fiber 25-30 20
17
20
3. RESTRUCTURING COSTS
Results for 1993 include one-time pre-tax restructuring costs of $49 million,
which reduced net income by $30.2 million, primarily for incremental costs
related to implementation of the Company's three-year re-engineering plan. The
re-engineering plan will redesign and streamline processes to improve
customer-responsiveness and product quality, reduce the time necessary to
introduce new products and services and further reduce costs. The
implementation of the plan is expected to result in costs of $33.8 million to
re-engineer customer service processes and $12.1 million to re-engineer
administrative processes. The restructuring costs also include $3.1 million
primarily for the consolidation of facilities and operations and other related
costs. Implementation of the re-engineering plan began during 1994 and is
expected to be substantially completed by the end of 1996.
Costs of $28.5 million have been incurred since the plan's inception including
$17.3 million related to customer service processes, $8.1 million related to
administrative processes and $3.1 million related to the consolidation of
facilities and operations and other related costs. These expenditures were
primarily associated with the closure and relocation of various service
centers, software enhancements and separation benefits related to employee
reductions.
During 1993, the Company offered various voluntary separation programs to its
employees. These programs resulted in a pre-tax charge of $3 million which
reduced 1993 net income by $1.8 million.
4. PREFERRED STOCK
On March 1, 1994, the Company redeemed all outstanding shares of preferred
stock with cash from operations.
5. COMMON STOCK
The authorized common stock of the Company at December 31, 1995 and 1994
consisted of 3,000,000 shares with a par value of $5 per share. All
outstanding shares of common stock are held by the Parent Company.
There were no shares of common stock held by or for the account of the Company
and no shares were reserved for officers and employees, or for options,
warrants, conversions or other rights.
At December 31, 1995, all retained earnings were restricted as to the payment
of cash dividends on common stock under the most restrictive terms of the
Company's indentures. In addition, as a result of the discontinuance of FAS 71
discussed in Note 2, the Company is currently restricted from making a full
payment of cash dividends on common stock.
18
21
6. DEBT
Long-term debt as of December 31 was as follows:
1995 1994
------- -------
(Thousands of Dollars)
First mortgage bonds:
7.625 % Series J, due 1997 $10,000 $10,000
9.45 % Series V, due 1997 10,000 10,000
9.41 % Series W, maturing through 2014 40,000 40,000
9.44 % Series X, due 2015 30,000 30,000
------- -------
Total 90,000 90,000
Less: current maturities of long-term debt -- --
------- -------
Total long-term debt $90,000 $90,000
======= =======
During 1994, the Company retired $2.8 million of 9.25% First Mortgage Bonds due
2001 and $3 million of 8.75% Sinking Fund Debentures.
The aggregate principal amount of bonds and debentures that may be issued is
subject to the restrictions and provisions of the Company's indentures. None
of the securities shown above were held in sinking or other special funds of
the Company or pledged by the Company. Substantially all of the Company's
telephone plant is subject to the liens of the indentures under which the bonds
listed above were issued.
Estimated payments of long-term debt during the next five years aggregate to
$22.5 million.
The Company finances part of its construction program through the use of
short-term notes payable to affiliates which are generally refinanced at a
later date by issues of long-term debt or equity. During 1995, the Company
supplemented its internal generation of cash with funds borrowed from GTE.
These arrangements require payment of interest based on prevailing commercial
paper rates. As of December 31, 1995 and 1994, the short-term notes payable
with GTE were $51.8 million and $67.7 million, respectively, with average
interest rates of 6.1% and 3.3%.
7. FINANCIAL INSTRUMENTS
The fair values of financial instruments, other than long-term debt, closely
approximate their carrying value. As of December 31, 1995 and 1994, the
estimated fair value of long-term debt based on either reference to quoted
market prices or an option pricing model, exceeded the carrying value by
approximately $15 million and $4 million, respectively.
19
22
8. INCOME TAXES
The income tax provision is as follows:
1995 1994 1993
-------- -------- --------
(Thousands of Dollars)
Current:
Federal $ 29,677 $ 16,621 $ 46,368
State 9,601 4,732 12,442
-------- -------- --------
39,278 21,353 58,810
-------- -------- --------
Deferred:
Federal (1,702) 20,919 (14,218)
State (59) 5,612 (5,343)
-------- -------- --------
(1,761) 26,531 (19,561)
-------- -------- --------
Amortization of deferred investment tax credits (1,686) (1,764) (1,852)
-------- -------- --------
Total $ 35,831 $ 46,120 $ 37,397
======== ======== ========
A reconciliation between taxes computed by applying the statutory federal
income tax rate to pre-tax income and income taxes provided in the consolidated
statements of income is as follows:
1995 1994 1993
-------- -------- --------
(Thousands of Dollars)
Amounts computed at statutory rates $ 29,950 $ 39,153 $ 32,363
State income taxes, net of federal income tax benefits 6,202 6,724 4,615
Amortization of deferred investment tax credits (1,686) (1,764) (1,852)
Depreciation of telephone plant construction costs
previously deducted for tax purposes - net 2,047 2,189 1,822
Rate differentials applied to reversing temporary (692) (932) (453)
differences
Other differences - net 10 750 902
-------- -------- --------
Total provision $ 35,831 $ 46,120 $ 37,397
======== ======== ========
The tax effects of temporary differences that give rise to the deferred income
tax benefits and deferred income tax liabilities at December 31 are as follows:
1995 1994
--------- ---------
(Thousands of Dollars)
Depreciation and amortization $ 3,300 $ 129,401
Employee benefit obligations (15,124) (14,659)
Prepaid pension costs (5,183) (2,816)
Restructuring costs (8,339) (9,094)
Investment tax credits 5,782 8,695
Other - net (9,282) (9,918)
--------- ---------
Total $(28,846) $ 101,609
========= =========
20
23
9. EMPLOYEE BENEFIT PLANS
RETIREMENT PLANS
The Company sponsors noncontributory defined benefit pension plans covering
substantially all employees. The benefits to be paid under these plans are
generally based on years of credited service and average final earnings. The
Company's funding policy, subject to the minimum funding requirements of U.S.
employee benefit and tax laws, is to contribute such amounts as are determined
on an actuarial basis to provide the plans with assets sufficient to meet the
benefit obligations of the plans. The assets of the plans consist primarily of
corporate equities, government securities and fixed income investments.
The components of the net pension (credit) expense for 1995-1993 were as
follows:
1995 1994 1993
-------- -------- --------
(Thousands of Dollars)
Benefits earned during the year $ 2,143 $ 4,325 $ 4,238
Interest cost on projected benefit obligations 13,782 10,770 10,839
Return on plan assets:
Actual (31,238) 489 (27,181)
Deferred 15,920 (15,482) 13,990
Other - net (781) (2,168) (1,525)
-------- -------- --------
Net pension (credit) expense $ (174) $(2,066) $ 361
======== ======== ========
The expected long-term rate of return on plan assets was 8.5% for 1995 and
1994, and 8.25% for 1993.
The funded status of the plans and the pension liability at December 31 were as
follows:
1995 1994
--------- ---------
(Thousands of Dollars)
Vested benefit obligations $ 103,006 $ 143,683
========= =========
Accumulated benefit obligations $ 114,666 $ 155,290
========= =========
Plan assets at fair value $ 166,053 $ 205,743
Less: projected benefit obligations 133,577 181,918
--------- ---------
Excess of assets over projected benefit obligations 32,476 23,825
Unrecognized net transition asset (1,079) (1,931)
Unrecognized net gain (45,450) (36,321)
--------- ---------
Total - net $(14,053) $(14,427)
========= =========
Assumptions used to develop the projected benefit obligations at December 31
were as follows:
1995 1994
---- ----
Discount rate 7.50% 8.25%
Rate of compensation increase 5.25% 5.50%
21
24
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
Effective January 1, 1993, the Company adopted Statement of Financial
Accounting Standards No. 106, "Employers' Accounting for Postretirement
Benefits Other Than Pensions" (FAS 106). FAS 106 requires that the expected
costs of these benefits be charged to expense during the years that the
employees render service. The Company elected to adopt FAS 106 on the delayed
recognition method and commencing January 1, 1993, began amortizing the
estimated unrecorded accumulated postretirement benefit obligation over twenty
years. Prior to the adoption of FAS 106, the cost of these benefits was
charged to expense as paid.
Substantially all of the Company's employees are covered under postretirement
health care and life insurance benefit plans. The health care benefits paid
under the plans are generally based on comprehensive hospital, medical and
surgical benefit provisions. The Company funds amounts for postretirement
benefits as deemed appropriate from time to time.
The postretirement benefit cost for 1995-1993 included the following
components:
1995 1994 1993
------- ------- -------
(Thousands of Dollars)
Benefits earned during the year $ 938 $ 1,532 $ 2,153
Interest cost on accumulated postretirement benefit 8,748 7,577 8,372
obligations
Actual return on plan assets (3,090) 593 --
Amortization of transition obligation 3,315 4,003 4,622
Other - net 1,102 (4,871) --
------- ------- -------
Total - net $11,013 $ 8,834 $15,147
======= ======= =======
The following table sets forth the plans' funded status and the accrued
postretirement benefit obligations as of December 31:
1995 1994
-------- --------
(Thousands of Dollars)
Accumulated postretirement benefit obligations attributable to:
Retirees $ 94,670 $105,165
Fully eligible active plan participants 3,338 6,225
Other active plan participants 17,142 10,802
-------- --------
Total accumulated postretirement benefit obligations 115,150 122,192
Less: fair value of plan assets 27,509 19,111
-------- --------
Excess of accumulated obligations over plan assets 87,641 103,081
Unrecognized transition obligation (55,149) (59,675)
Unrecognized net gain (loss) 9,591 (4,683)
-------- --------
Total $ 42,083 $ 38,723
======== ========
The assumed discount rates used to measure the accumulated postretirement
benefit obligations were 7.5% at December 31, 1995 and 8.25% at December 31,
1994. The assumed health care cost trend rates in 1995 and 1994 were 11% and
12%, respectively, for pre-65 participants and 8.5% and 9.0%, respectively, for
post-65 retirees, each rate declining on a graduated basis to an ultimate rate
in the year 2004 of 6%. A one percentage point increase in the assumed health
care cost trend rates for each future year would have increased 1995 costs by
$0.8 million and the accumulated postretirement benefit obligations at December
31, 1995 by $9.3 million.
22
25
During 1993, the Company made certain changes to its postretirement health care
and life insurance benefits for non-union employees retiring on or after
January 1, 1995. These changes include, among others, newly established limits
to the Company's annual contribution to postretirement medical costs and a
revised cost sharing schedule based on a retiree's years of service.
SAVINGS PLANS
The Company sponsors employee savings plans under section 401(k) of the
Internal Revenue Code. The plans cover substantially all full-time employees.
Under the plans, the Company provides matching contributions in GTE Common
Stock based on qualified employee contributions. Matching contributions
charged to income were $0.7 million in each of the years 1995-1993.
10. PROPERTY, PLANT AND EQUIPMENT
The Company's property, plant and equipment is summarized as follows at
December 31:
1995 1994
-------- --------
(Thousands of Dollars)
Land $ 4,046 $ 4,043
Buildings 50,197 49,863
Plant and equipment 804,958 796,047
Other 56,090 59,273
-------- --------
Total 915,291 909,226
Accumulated depreciation (see Note 2) 635,134 385,011
-------- --------
Total property, plant and equipment - net $280,157 $524,215
======== ========
Depreciation provisions in 1995-1993 were equivalent to a composite annual
percentage of 7.6%, 7.3% and 6.9%, respectively.
23
26
11. REGULATORY AND COMPETITIVE MATTERS
The Company's intrastate business is regulated by the state regulatory
commissions in California, Nevada and Arizona. The Company is subject to
regulation by the Federal Communications Commission (FCC) for its interstate
business operations.
INTRASTATE SERVICES
The Company provides local-exchange services to customers within its designated
franchise area. The Company provides toll services within designated
geographic areas called Local Access and Transport Areas (LATAs) under
agreements with connecting local-exchange carriers (LECs) in conformity with
state regulatory orders. The Company also provides long distance access
services directly to interexchange carriers (IXCs) and other customers who
provide service between LATAs.
New Regulatory Framework (NRF)
Effective January 1, 1990 the California Public Utilities Commission (CPUC)
adopted the NRF for GTE in Phase II of the Alternative Regulatory Proceeding.
The new framework replaced the traditional "rate case" process with a framework
that centers around a Price Cap Index (PCI) mechanism with "sharing" of
intrastate earnings (those earnings subject to CPUC regulation) above a
benchmark rate of return. This plan is designed to stimulate productivity and
efficiencies with a portion of these gains flowing directly to the customer.
During 1993, the CPUC approved a NRF settlement agreement allowing GTE
California Incorporated (GTE California) to retain 100% of any earnings up to
15.5% beginning in 1994. Under its prior agreement, GTE California was
required to share 50% of any earnings over a 13% rate of return and refund 100%
of any earnings over 16.5%. A policy order issued by the CPUC on July 24,
1991, urged the Company to adopt the NRF for the Company's operations to be
effective no later than January 1, 1994. The Company has requested that it be
allowed to adopt GTE California's NRF.
Under the NRF, rates are adjusted annually by the PCI, which is based on
inflation minus a productivity improvement factor. Rates for partially
competitive services (i.e. Centrex and custom calling features) may be priced
below the price cap within a range set by the CPUC. Rates are also adjusted
for exogenous events that are beyond the control of management as defined in
this plan. Fully competitive services (e.g., directory advertising) are not
subject to pricing limits set by the CPUC.
Several regulatory proceedings are underway in California to determine terms
and conditions for unbundling of GTE's network, to consider additional pricing
flexibility under the CPUC's NRF, to modify the NRF to reflect the new
competitive marketplace, to institute intraLATA 1+ dialing parity provisions
and to establish final rules and obligations for Universal Service funding.
Implementation Rate Design (IRD)
In September 1994, the CPUC issued a final order that authorized intraLATA toll
competition (without customer pre-subscription) in California, effective
January 1, 1995, associated with the IRD. The final order also provides for
rate rebalancing with significant rate reductions for toll service and access
charges while increasing basic local-exchange rates closer to the actual cost of
providing such service. Although this rate rebalancing was intended by the CPUC
to be revenue neutral, the actual increase in volumes did not fully compensate
for the toll and access rate reductions. The decision did not permit rate
increases to compensate for competitive losses of market share. Toll revenues
decreased approximately $38 million in 1995 as a result of the implementation of
this order.
In compliance with CPUC decision D.94-09-065 (IRD), the Company filed a general
rate case on December 6, 1995. The Company proposes to recover $45.3 million
of revenue requirement from a combination of increases to basic exchange rates
and universal high cost fund which is currently under review by the CPUC.
24
27
Competition
In December 1994, the CPUC issued a decision which adopted an initial
procedural plan to facilitate opening local-exchange telecommunications
markets to competition by January 1, 1997. On April 26, 1995, the CPUC issued
a formal rulemaking proceeding and investigation as a procedural vehicle to
develop and adopt rules for local competition. The rulemaking document
contained proposed interim rules which authorized competitive LECs to seek
authority to offer local-exchange services beginning in June 1995. The
parties filed comments on the proposed rules on May 24, 1995. The Company's
comments asserted the need for evidentiary hearings to address critical issues
such as regulatory parity and interconnection prior to the authorization of
local competition. On July 19, 1995, the CPUC issued interim Universal Service
rules and obligations as a precursor to local competition. The CPUC is
expected to adopt final Universal Service rules and obligations by July 1996.
On July 24, 1995, the CPUC issued interim rules for local competition which
permit facilities-based local competition in Pacific Bell and GTE California
franchised service areas effective January 1, 1996, with resale authority
granted two months later. The CPUC reiterated its goal of opening the service
areas of small and mid-sized LECs, including the Company's service areas, to
full competition, effective January 1, 1997. Local competition in the
Company's service areas could occur earlier depending on the final effective
date of the pending merger discussed below.
Merger
In March 1991, the merger of Contel Corporation (Contel) and GTE was
consummated. In an interim decision issued on March 13, 1991, the CPUC
approved a stipulation agreement which tentatively approved the merger of GTE
and Contel. The interim decision also established a second phase of the
proceeding in which GTE was directed to show that the merger meets certain
California statutory requirements. GTE was also ordered to submit a plan for
the merger of any of the Contel and GTE regulated California subsidiaries. On
September 14, 1992, the Company and GTE California joined with GTE and Contel
and filed a comprehensive plan with the CPUC to merge the Company into GTE
California.
On April 20, 1994, the CPUC issued a decision giving final approval to the
merger of the Company into GTE California. The decision requires the merging
companies to flow through to their ratepayers all of the estimated savings that
would be produced from the merger. This flow through requirement is based on
the CPUC's interpretation of certain statutory requirements. The CPUC,
however, provided the parties with the opportunity to supplement the
evidentiary record to show why the estimated merger savings should be
apportioned between ratepayers and shareholders. That filing was made on April
29, 1994. By making the filing, the effective date of the decision approving
the merger was delayed. The Company and other interested parties have filed
reports and comments pursuant to this proceeding. On October 5, 1995, the
Governor of the State of California signed a law which clarifies the authority
of the CPUC to allocate utility merger benefits between ratepayers and
shareholders with not less than 50% going to the ratepayers. The new law
became effective January 1, 1996. A decision approving the merger under the
terms of the amended legislation is expected during the second quarter of 1996.
In addition, merger applications were filed with the Arizona Corporation
Commission (ACC) on October 4, 1993 and the Nevada Public Service Commission
(NPSC) on April 2, 1993. These applications were approved during 1994 but were
made subject to final approval in California. The Company currently
anticipates, subject to receipt of the final approval from the CPUC, that the
merger will be consummated in the second half of 1996.
25
28
INTERSTATE SERVICES
For the provision of interstate services, the Company operates under the terms
of the FCC's price cap incentive plan. The "price cap" mechanism serves to
limit the rates a carrier may charge, rather than just regulating the rate of
return which may be achieved. Under this approach, the maximum price that the
LEC may charge is increased or decreased each year by a price index based upon
inflation less a predetermined productivity target. LECs may, within certain
ranges, price individual services above or below the overall cap.
In March 1995, the FCC adopted interim rules to be utilized by LECs, including
the Company, for their 1995 Annual Price Cap Filing. The interim rules allowed
LECs to select from three productivity/sharing options for each tariff entity.
Each of the three options reflected an increase to the 3.3% productivity factor
used since 1991. The Company selected a 5.3% productivity factor, with no
sharing required, in each of its tariff entities for use in the 1995-1996
tariff year. Under the interim rules, the Company filed tariffs to reduce
rates by $1.5 million annually, effective August 1, 1995. On September 20,
1995, the FCC released its proposed rulemaking proceeding on price caps which
proposes specific changes to reflect and encourage emerging competition in
local and access services markets and to establish the path towards decreased
regulation of LECs' services. On September 27, 1995, the FCC solicited
comments on a number of specific issues regarding methods for establishing the
price caps, such as productivity measurements, sharing, the common line formula
and exogenous costs. The Company anticipates the FCC will issue an order prior
to the July 1996 annual filing.
On February 8, 1996, the Telecommunications Act of 1996 (the Telecommunications
Act) became law. This comprehensive telecommunications reform legislation
addresses a wide range of competitive and regulatory issues that will affect
the future development of local and long distance services, cable television
and information services. The Telecommunications Act overhauls 62 years of
telecommunications law, replacing government regulation with competition as the
chief way of assuring that telecommunications services are delivered to
customers. The new law removes many of the statutory and court-ordered
barriers to competition between segments of the industry, enabling
local-exchange, long distance, wireless and cable companies to compete in
offering voice, video and information services.
The Telecommunications Act requires the FCC and state commissions to set new
guidelines to open local-exchange markets and to set new guidelines for
interconnection, loosens restrictions barring local telephone companies from
entering the cable television market, and preserves Universal Service while
equalizing the responsibility for contribution among all carriers.
A key provision of the Telecommunications Act also eliminates the legal
restraints of the GTE Consent Decree which has kept the Company from providing
interLATA services. This action will simplify GTE's ability to market local
intraLATA and interLATA service to its customers as a bundled service. In
February 1996, GTE executed an agreement whereby WorldCom, Inc. will provide,
on a non-exclusive basis, a full array of telecommunications services in
support of GTE's entry into the interLATA long distance market. In March 1996,
GTE, through a separate subsidiary, began offering long distance to its
customers in selected markets. GTE plans to offer the service, marketed under
the name GTE Easy Savings Plan(SM), in all 28 states where it currently offers
local telephone service by December 1996.
SIGNIFICANT CUSTOMER
Revenues received from AT&T Corp. include amounts for access, billing and
collection and interexchange leased facilities during the years 1995-1993 under
various arrangements and amounted to $39.3 million, $50.2 million and $33
million, respectively.
26
29
12. COMMITMENTS AND CONTINGENCIES
The Company has noncancelable leases covering certain buildings, office space
and equipment. Rental expense was $4.5 million, $3.5 million and $3.2 million
in 1995-1993, respectively. Minimum rental commitments for noncancelable
leases through 2000 do not exceed $0.1 million annually and aggregate $0.1
million thereafter.
The Company is subject to a number of proceedings arising out of the conduct of
its business, including those relating to regulatory actions, commercial
transactions and/or environmental, safety and health matters. Management
believes that the ultimate resolution of these matters will not have a material
adverse effect on the results of operations or the financial position of the
Company.
Recent judicial and regulatory developments, as well as the pace of
technological change, have continued to influence industry trends, including
accelerating and expanding the level of competition. As a result, the
Company's operations face increasing competition in virtually all aspects of
its business. The Company supports greater competition in telecommunications
provided that, overall, the actions to eliminate existing legal and regulatory
barriers allow an opportunity for all service providers to participate equally
in a competitive marketplace under comparable conditions.
27
30
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Contel of California, Inc.:
We have audited the accompanying consolidated balance sheets of Contel of
California, Inc. (a California corporation) and subsidiary as of December 31,
1995 and 1994, and the related consolidated statements of income, shareholder's
equity and cash flows for each of the three years in the period ended December
31, 1995. These financial statements and the schedule referred to below are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements and the schedule based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Contel of California, Inc. and
subsidiary as of December 31, 1995 and 1994, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1995, in conformity with generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, in 1995 the
Company discontinued applying the provisions of Statement of Financial
Accounting Standards No. 71, "Accounting for the Effects of Certain Types of
Regulation".
Our audit was made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The supporting schedule listed under Item 14 is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not a required part of the basic financial
statements. The supporting schedule has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
ARTHUR ANDERSEN LLP
Dallas, Texas
January 24, 1996
28
31
MANAGEMENT REPORT
To Our Shareholder:
The management of the Company is responsible for the integrity and objectivity
of the financial and operating information contained in this Annual Report on
Form 10-K, including the consolidated financial statements covered by the
Report of Independent Public Accountants. These statements were prepared in
conformity with generally accepted accounting principles and include amounts
that are based on the best estimates and judgments of management.
The Company has a system of internal accounting controls which provides
management with reasonable assurance that transactions are recorded and
executed in accordance with its authorizations, that assets are properly
safeguarded and accounted for, and that financial records are maintained so as
to permit preparation of financial statements in accordance with generally
accepted accounting principles. This system includes written policies and
procedures, an organizational structure that segregates duties, and a
comprehensive program of periodic audits by the internal auditors. The Company
has also instituted policies and guidelines which require employees to maintain
the highest level of ethical standards.
JAMES F. MILES
President
MICHAEL W. BOLLINGER
Assistant Vice President - Controller
29
32
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
30
33
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) Financial Statements - See Contel of California, Inc.'s
consolidated financial statements and report of independent
accountants thereon in the Financial Statements section
included elsewhere herein.
(2) Financial Statement Schedules - Schedules supporting the
financial statements for the years ended December 31,
1995-1993 (as required):
II - Valuation and Qualifying Accounts
Note: Schedules other than the one listed above are omitted as not
applicable, not required, or the information is included in
the financial statements or notes thereto.
(3) Exhibits - Included in this report or incorporated by reference.
2.1* Agreement of Merger, dated September 10, 1992 between
GTE California Incorporated and Contel of California,
Inc. (Exhibit 2.1 of the 1993 Form 10-K. File No.
0-1245)
3* Articles of Incorporation and Bylaws (incorporated by
reference from the Registration Statement of the
Company, File No. 2-52487, effective January 14,
1975)
10 Material Contracts - Agreements Between GTE and
Certain Executive Officers
27 Financial Data Schedule
(b) Reports on Form 8-K
On November 13, 1995, the Company filed a report on Form 8-K dated
November 9, 1995, under Item 5 "Other Events". Financial
information was filed with this report.
* Denotes exhibits incorporated herein by reference to previous filings
with the Securities and Exchange Commission as designated.
31
34
Contel of California, Inc. and Subsidiary
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
For the Years Ended December 31, 1995, 1994 and 1993
(Thousands of Dollars)
- ----------------------------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E
- ----------------------------------------------------------------------------------------------------------------------
Additions
------------------------------
Deductions
Balance at from
Beginning Charged to Charged to Reserves Balance at
Description of Year Income Other Accounts (Note 1) Close of Year
- ----------------------------------------------------------------------------------------------------------------------
Allowance for uncollectible accounts
for the years ended:
December 31, 1995 $ 3,523 $ 5,072 $2,795 (2) $ 6,495 $ 4,895
==========================================================================
December 31, 1994 $ 3,592 $ 4,788 $1,220 (2) $ 6,077 $ 3,523
==========================================================================
December 31, 1993 $ 3,321 $ 6,479 $6,196 (2) $12,404 $ 3,592
==========================================================================
Accrued restructuring costs for the
years ended (Note 3):
December 31, 1995 $22,310 $ -- $ -- $ 1,855 $20,455
==========================================================================
December 31, 1994 $48,987 $ -- $ -- $26,677 $22,310
==========================================================================
December 31, 1993 $ -- $48,987 $ -- $ -- $48,987
==========================================================================
NOTES:
(1) Charges for purpose for which reserve was created.
(2) Recoveries of previously written-off amounts.
(3) See Note 3 to the consolidated financial statements included elsewhere
herein.
32
35
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
CONTEL OF CALIFORNIA, INC.
------------------------------------
(Registrant)
Date March 26, 1996 By James F. Miles
-------------- ------------------------------------
James F. Miles
President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report is signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
James F. Miles President and Director March 26, 1996
- ---------------------- (Principal Executive Officer)
James F. Miles
Michael W. Bollinger Assistant Vice President - Controller March 26, 1996
- ---------------------- (Principal Financial and Accounting
Michael W. Bollinger Officer)
Michael B. Esstman Director March 26, 1996
- ----------------------
Michael B. Esstman
Geoffrey C. Gould Director March 26, 1996
- ----------------------
Geoffrey C. Gould
33
36
EXHIBIT INDEX
Exhibit
Number Description
- ---------------- ------------------------------------------------------
10 Material Contracts - Agreements Between GTE and
Certain Executive Officers
27 Financial Data Schedule