1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended: SEPTEMBER 30, 1999
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from _______ to _______
Commission File Number 2-33059
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
HAWAII 99-0049500
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
1255 Corporate Drive, SVC04C08, Irving, Texas 75038
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code 972-507-5000
(Former name, former address and former fiscal year,
if changed since last report)
The registrant, a wholly-owned subsidiary of GTE Corporation, meets the
conditions set forth in General Instruction H(1) (a) and (b) of Form 10-Q and is
therefore filing this form with reduced disclosure format pursuant to General
Instruction H(2).
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 [ ]
The Company had 10,000,000 shares of $25 par value common stock outstanding at
October 31, 1999. The Company's common stock is 100% owned by GTE Corporation.
================================================================================
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Condensed Consolidated Statements of Income (Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
(Dollars in Millions)
REVENUES AND SALES
Local services $ 69.4 $ 66.6 $ 208.2 $ 203.6
Network access services 42.4 43.5 134.5 134.1
Other services and sales 49.8 55.6 163.4 166.4
------------ ------------ ------------ ------------
Total revenues and sales 161.6 165.7 506.1 504.1
------------ ------------ ------------ ------------
OPERATING COSTS AND EXPENSES
Cost of services and sales 64.6 63.1 183.8 203.1
Selling, general and administrative 25.9 26.5 93.7 83.8
Depreciation and amortization 30.1 28.5 92.6 87.4
------------ ------------ ------------ ------------
Total operating costs and expenses 120.6 118.1 370.1 374.3
------------ ------------ ------------ ------------
OPERATING INCOME 41.0 47.6 136.0 129.8
OTHER (INCOME) EXPENSE
Interest - net 9.2 10.3 27.7 29.4
Other - net (0.6) (1.2) (1.4) (2.1)
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES 32.4 38.5 109.7 102.5
Income taxes 10.8 12.5 36.4 33.7
------------ ------------ ------------ ------------
NET INCOME $ 21.6 $ 26.0 $ 73.3 $ 68.8
============ ============ ============ ============
Per share data is omitted since the Company's common stock is 100% owned by GTE
Corporation.
The accompanying notes are an integral part of these statements.
1
3
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Condensed Consolidated Balance Sheets (Unaudited)
September 30, December 31,
1999 1998
------------- ------------
(Dollars in Millions)
ASSETS
Current assets
Cash and cash equivalents $ 6.2 $ 1.3
Receivables, less allowances of $8.7 million and $6.5 million 173.4 179.1
Affiliate receivables 7.5 13.0
Inventories and supplies 10.7 11.0
Prepayments and other 2.7 22.9
------------ ------------
Total current assets 200.5 227.3
------------ ------------
Property, plant and equipment, at cost 2,044.2 2,045.7
Accumulated depreciation (1,215.3) (1,191.5)
------------ ------------
Total property, plant and equipment, net 828.9 854.2
------------ ------------
Prepaid pension costs 288.3 234.8
Other assets 9.2 12.1
------------ ------------
Total assets $ 1,326.9 $ 1,328.4
============ ============
The accompanying notes are an integral part of these statements.
2
4
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Condensed Consolidated Balance Sheets (Unaudited) - Continued
September 30, December 31,
1999 1998
------------- ------------
(Dollars in Millions)
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities
Current maturities of long-term debt $ 2.4 $ 2.3
Notes payable to affiliate 93.8 93.7
Accounts payable 61.2 47.7
Affiliate payables 21.2 30.6
Other 77.2 105.0
------------ ------------
Total current liabilities 255.8 279.3
------------ ------------
Long-term debt 461.7 467.5
Deferred income taxes 185.5 150.8
Employee benefit plans and other 29.8 38.1
------------ ------------
Total liabilities 932.8 935.7
------------ ------------
Shareholder's equity
Common stock (10,000,000 shares issued) 250.0 250.0
Additional paid-in capital 92.9 91.1
Retained earnings 51.2 51.6
------------ ------------
Total shareholder's equity 394.1 392.7
------------ ------------
Total liabilities and shareholder's equity $ 1,326.9 $ 1,328.4
============ ============
The accompanying notes are an integral part of these statements.
3
5
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
Nine Months Ended
September 30,
--------------------------
1999 1998
---------- ----------
(Dollars in Millions)
OPERATIONS
Net income $ 73.3 $ 68.8
Adjustments to reconcile net income to net cash from operations:
Depreciation and amortization 92.6 87.4
Provision for uncollectible accounts 12.7 9.5
Changes in current assets and current liabilities (22.4) 28.4
Deferred taxes and other - net (11.3) (24.8)
---------- ----------
Net cash from operations 144.9 169.3
---------- ----------
INVESTING
Capital expenditures (66.3) (90.5)
Other - net 0.6 --
---------- ----------
Net cash used in investing (65.7) (90.5)
---------- ----------
FINANCING
Long-term debt retired (5.3) (1.5)
Dividends (74.5) (24.7)
Increase (decrease) in short-term obligations,
excluding current maturities 5.5 (44.4)
---------- ----------
Net cash used in financing (74.3) (70.6)
---------- ----------
Increase in cash and cash equivalents 4.9 8.2
Cash and cash equivalents:
Beginning of period 1.3 0.7
---------- ----------
End of period $ 6.2 $ 8.9
========== ==========
The accompanying notes are an integral part of these statements.
4
6
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
NOTE 1. BASIS OF PRESENTATION
GTE Hawaiian Telephone Company Incorporated (the Company) is incorporated under
the laws of the State of Hawaii and is a subsidiary of GTE Corporation (GTE).
The unaudited condensed consolidated financial statements included herein have
been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations. However, in the opinion of management of the Company, the
condensed consolidated financial statements include all adjustments, which
consist only of normal recurring accruals, necessary to present fairly the
financial information for such periods. These condensed consolidated financial
statements should be read in conjunction with the consolidated financial
statements and the notes thereto included in the Company's 1998 Annual Report on
Form 10-K.
Reclassifications of prior year data have been made, where appropriate, to
conform to the 1999 presentation.
NOTE 2. CAPITALIZED SOFTWARE
Effective January 1, 1999, the Company adopted Statement of Position (SOP) 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." As a result of adopting SOP 98-1, the Company capitalized
software expenditures of $3.2 million and $6.9 million, respectively, for the
three and nine months ended September 30, 1999, which would have previously been
expensed.
NOTE 3. SPECIAL CHARGE
In 1999, GTE continued the review of its operations and cost structure to ensure
they were consistent with its growth objectives. In connection with this ongoing
review, GTE initiated employee separation programs that resulted in a one-time
charge for GTE during the first quarter of 1999. The charge pertaining to the
Company totaled $7.2 million and is reflected as "Selling, general and
administrative" costs and expenses in the condensed consolidated income
statements. The components of the charge include separation programs and related
benefits such as outplacement and benefit continuation costs. These programs
were completed during the first quarter of 1999.
NOTE 4. RECENT ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. The Company is
currently assessing the impact of adopting SFAS No. 133, as amended, which is
effective January 1, 2001.
5
7
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued
NOTE 5. PROPOSED MERGER WITH BELL ATLANTIC CORPORATION
Bell Atlantic and GTE have announced a proposed merger of equals under a
definitive merger agreement dated as of July 27, 1998. Under the terms of the
agreement, GTE shareholders will receive 1.22 shares of Bell Atlantic common
stock for each share of GTE common stock that they own.
The merger is expected to qualify as a pooling of interests, which means that
for accounting and financial reporting purposes the companies will be treated as
if they had always been combined. The completion of the merger is subject to a
number of conditions, including certain regulatory approvals and receipt of
opinions that the merger will be tax-free. At annual meetings held in May 1999,
the shareholders of each company approved the merger.
6
8
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition
And Results of Operations
(Abbreviated pursuant to General Instruction H(2).)
RESULTS OF OPERATIONS
Net income increased 7% or $4.5 million for the nine months ended September 30,
1999, compared to the same period in 1998, primarily due to an overall increase
in revenues and sales as well as a decline in total operating costs and
expenses.
REVENUES AND SALES
(Dollars in Millions) Nine Months Ended
September 30,
--------------------- Increase Percent
1999 1998 (Decrease) Change
-------- -------- ---------- --------
Local services $ 208.2 $ 203.6 $ 4.6 2%
Network access services 134.5 134.1 0.4 --
Other services and sales 163.4 166.4 (3.0) (2)%
-------- -------- --------
Total revenues and sales $ 506.1 $ 504.1 $ 2.0 --
======== ======== ========
Local Services Revenues
Local services revenues grew $4.6 million for the first nine months of 1999
compared to the same period in 1998. The increase was primarily the result of
enhanced custom calling features which contributed $2.2 million in revenue
growth. In addition, demand for operator and directory assistance services added
$1.3 million to the increase.
Network Access Services Revenues
Network access services revenues increased for the first nine months of 1999
driven by a 10% increase in minutes of use, which generated additional revenues
of $4.6 million. Special access revenues grew by $8.0 million as a result of
greater demand for increased bandwidth services by high-capacity users. End user
surcharges, primarily as a result of implementation of the local number
portability surcharge, also contributed $1.2 million to the increase. Partially
offsetting these increases was a decrease of $13.6 million reflecting the impact
of interstate and intrastate access price changes.
Other Services and Sales Revenues
Other services and sales revenues decreased $3.0 million in the first nine
months of 1999 primarily due to the timing of directory advertising revenues and
lower toll revenues, which contributed $4.6 million and $1.5 million,
respectively, to the decrease. This decline was partially offset by increased
revenues from rental activity of $3.5 million.
7
9
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition
And Results of Operations
(Abbreviated pursuant to General Instruction H(2).)
OPERATING COSTS AND EXPENSES
(Dollars in Millions) Nine Months Ended
September 30,
------------------------- Increase Percent
1999 1998 (Decrease) Change
---------- ---------- ---------- ----------
Cost of services and sales $ 183.8 $ 203.1 $ (19.3) (10)%
Selling, general and administrative 93.7 83.8 9.9 12%
Depreciation and amortization 92.6 87.4 5.2 6%
---------- ---------- ----------
Total operating costs and expenses $ 370.1 $ 374.3 $ (4.2) (1)%
========== ========== ==========
Total operating costs and expenses decreased for the nine months ended September
30, 1999, compared to the same period in 1998. Due to the employee-reduction
program initiated earlier this year and the resulting settlement of pension
obligations, the Company was able to immediately recognize pension plan gains
that have accumulated in excess of the employee obligations. These favorable
pension settlement gains were $26.6 million in the first nine months of 1999 and
contributed to the decrease in operating costs and expenses. Partially
offsetting this reduction in cost was a one-time special charge of $7.2 million
associated with employee separation programs completed in the first quarter of
1999, and favorable adjustments in the third quarter of 1998 of certain employee
benefits and other liabilities in the amount of $5.2 million. These reductions
were further offset by a $3.5 million increase in material costs reflecting
customer and access line growth and increased telecommunications equipment sales
volume. Depreciation expense increased $1.6 million in the first nine months of
1999 compared to the same period in 1998 as a result of higher average plant
balances. The increase in depreciation and amortization expense was also
attributable to the amortization of previously capitalized software associated
with the implementation of new administrative systems within the Company.
OTHER INCOME STATEMENT ITEMS
Income tax expense increased 8% or $3 million for the nine months ended
September 30, 1999 compared to the same period in 1998, primarily due to an
increase in pretax income.
INTERSTATE REGULATORY DEVELOPMENTS
During the third quarter of 1999, regulatory and legislative activity at both
the state and federal levels continued to be a direct result of the
Telecommunications Act of 1996 (Telecommunications Act). Along with promoting
competition in all segments of the telecommunications industry, the
Telecommunications Act was intended to preserve and advance universal service.
GTE continued in the third quarter of 1999, to meet the wholesale requirements
of new competitors. To date, GTE has signed interconnection agreements with
other carriers, providing them the capability to purchase individual unbundled
network elements (UNEs), resell retail services and interconnect
facilities-based networks. Several of these interconnection agreements were the
result of the arbitration process established by the Telecommunications Act, and
incorporated prices or terms and conditions based upon the Federal
Communications Commission (FCC) rules that were subsequently overturned by the
Eighth Circuit Court (Eighth Circuit) in July 1997. GTE challenged a number of
such agreements in federal district courts during 1997.
GTE's position in these challenges was supported by the Eighth Circuit's July
1997 decision stating that the FCC had overstepped its authority in several
areas concerning implementation of the interconnection provisions of the
8
10
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
(Abbreviated pursuant to General Instruction H(2).)
Telecommunications Act. In January 1999, the U.S. Supreme Court (Supreme Court)
reversed in part and affirmed in part the Eighth Circuit's decisions. The
Supreme Court reversed the Eighth Circuit's determination that the FCC had no
jurisdiction over pricing. As a result, the pricing rules established by the FCC
are now subject to review on their merits by the Eighth Circuit. On the other
hand, the Supreme Court vacated the FCC rule setting forth the UNEs that
incumbent local exchange carriers (ILECs) are required to provide to competitive
local exchange carriers (CLECs). This latter ruling has led to a proceeding
before the FCC concerning what elements had to be offered and under what
conditions.
In September 1999, the FCC voted on the matter and the order was issued on
November 5, 1999. The FCC reaffirmed that incumbents must provide unbundled
access to five of the original seven network elements. ILECs are no longer
required to provide unbundled operator services, including directory assistance.
In addition, in certain circumstances, local and tandem switching need not be
unbundled. The FCC also found that state commissions can require ILECs to
unbundle additional elements as long as they are consistent with the
requirements of the Telecommunications Act and the national policy framework
instituted in the FCC's order. Furthermore, the order precludes states from
removing network elements from the FCC's list of unbundling obligations.
In June 1999, the Eighth Circuit established a schedule for addressing the
issues it did not decide in 1998. The major issues are: (1) the FCC's cost
methodology used to set prices, (2) its methodology for setting wholesale
discounts, (3) the "proxy rates" it set for interconnection, UNEs, and wholesale
discounts, (4) whether ILECs should be required to combine UNEs that are not
already combined, and (5) whether the FCC can require ILECs to provide "superior
quality" to competitors than what the ILEC provides to itself. Parties to this
action have filed briefs and participated in oral arguments on September 17,
1999. A court decision is expected during the first quarter of 2000.
Universal Service
GTE is active before both state and federal regulators advocating development
and implementation of measures that will meet the requirements of the universal
service provisions of the Telecommunications Act. Specifically, GTE urges
regulators to identify and remove all hidden subsidies and to provide an
explicit replacement mechanism.
In October 1998, the FCC issued an order selecting a cost model for universal
service. On October 22, 1999, the FCC adopted an order selecting the cost inputs
for the federal universal service cost model. Due to unforeseen delays, the FCC
has now moved the implementation date of the new universal service mechanism for
non-rural carriers to January 2000. As a result, many state regulators are
awaiting FCC action so they can design their universal service programs to be
complementary with the FCC program.
In July 1999, the United States Court of Appeals for the Fifth Circuit (Fifth
Circuit) affirmed in part, reversed in part, and remanded in part the FCC's
universal service regime. The FCC filed a Motion For Stay of the Fifth Circuit's
mandate so that additional time could be granted to address the implementation
issues associated with changing its existing methods of assessment and carrier
recovery of universal service contributions. GTE and several other parties also
asked the Fifth Circuit for rehearing on several issues. However, in September
1999 the Fifth Circuit denied all motions for stay and/or rehearing, and
established November 1, 1999 as the effective date for the original decision.
On October 8, 1999, the FCC released two orders in response to the Fifth Circuit
decision. One order permits ILECs to continue to recover their universal service
contributions from access charges or to establish end user charges. The second
order changed the contribution basis for school/library funding to eliminate
calculations based upon intrastate revenues.
On November 4, 1999, the FCC released an order dealing with implementation of
the new FCC federal high cost
9
11
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
(Abbreviated pursuant to General Instruction H(2).)
support mechanism for non-rural ILECs. The effective date for the new federal
universal service plan is January 1, 2000. This plan will take contributions to
the federal fund and distribute them to states with higher than average costs.
The role of state commissions is to ensure reasonable comparability within the
borders of a state. Federal high cost support will be calculated by comparing
the nationwide average cost with each state's average cost per line, and
providing federal support for only states that exceed 135% of the nationwide
average. To guard against rate shock, the FCC also adopted a "hold harmless"
approach so that the amount of support provided to each non-rural carrier under
the new plan will not be less than the amount provided today.
Price Cap
In May 1999, the U.S. Court of Appeals for the District of Columbia (Court)
released a decision regarding the FCC's choice of a 6.5% price cap productivity
factor in a 1997 order. The Court found the FCC's choice of a 6.0% base factor
and a 0.5% Consumer Productivity Dividend to be inadequately supported. The
Court remanded the matter back to the FCC for further action and established an
April 2000 date by which the FCC must complete its deliberations. The Court also
stayed application of its order, allowing the status quo use of the 6.5%
productivity factor pending conclusion of the FCC's further review.
Interstate Access Revision
Effective July 1999, access charges were further reduced using a 6.5%
productivity factor in compliance with FCC requirements to reflect the impacts
of access charge reform and in making the Company's 1999 Annual Filing. The
total annual financial impact of the reduction was $113 million. Similar filings
during 1997 and 1998 had already resulted in price reductions.
In July 1999, GTE, along with a coalition of local exchange and long-distance
companies, submitted a proposal for interstate access charge and universal
service reform to the FCC. The proposal would accelerate the shift in access
revenue recovery from per-minute to flat-rated charges, set a schedule for
elimination of the price cap productivity factor, and provide more explicit
support for universal service. In September 1999, the FCC put the coalition's
proposal out for public comment.
In August 1999, the FCC released an order pertaining to access reform and
pricing flexibility. The order grants price cap LECs immediate flexibility under
certain circumstances to deaverage certain access services and permits the
introduction of new services on a streamlined basis, without prior FCC approval.
Advanced Telecommunications Services
The Telecommunications Act required the FCC to "encourage the deployment on a
reasonable and timely basis of advanced telecommunications capability to all
Americans." Further, the FCC was required to conduct a proceeding aimed at
determining the availability of advanced telecommunications, and to take action
to remove barriers to infrastructure investment and to promote competition.
In March 1999, the FCC released an order adopting a number of new collocation
rules designed to make competitive entry easier and less costly. These rules
specify how ILECs will manage such items as alternate collocation arrangements,
security, space preparation cost allocation, provisioning intervals, and space
exhaustion. GTE has appealed this order to federal court. The FCC also released
a Further Notice of Proposed Rulemaking (FNPRM) seeking comment on spectrum
compatibility issues and line sharing. Line sharing is a concept wherein two or
more service providers are allowed to use the same local loop (e.g., voice and
xDSL). An order from the FCC on line sharing is expected in the fourth quarter
of 1999.
10
12
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
(Abbreviated pursuant to General Instruction H(2).)
Number Portability
In December 1998, the FCC released an order establishing cost recovery rules for
local number portability (LNP) that permitted the recovery of carrier-specific
costs directly related to the provision of long-term LNP via a federally
tariffed end-user monthly charge. GTE subsequently filed an LNP tariff with the
FCC, and in March 1999 instituted an end-user number portability fee. This
charge is levied on all business and residence customers because all customers
benefit from the competitive environment created by LNP capability. In June
1999, GTE's tariffed LNP charge was reviewed and accepted by the FCC at $0.36
per access line.
Internet Service Traffic
ILECs are required to provide open access to all Internet service providers
(ISPs), while cable television operators are not. Several major cable television
operators providing Internet access through cable modem facilities are only
offering their affiliated ISPs to consumers. Cable television operators that do
allow customers to select non-affiliated ISPs often require the customer to also
pay for their affiliated ISP's service (i.e., to pay twice for the same
service). GTE has been active in encouraging municipalities engaged in reviewing
cable television mergers or franchise renewals to require cable modem open
access as a condition for approval. The City of Portland, Oregon was first to
adopt such a requirement and AT&T has appealed that decision. Arguments took
place November 1, 1999 before the Ninth Circuit Court.
In October 1999, GTE's Internetworking unit filed an antitrust lawsuit
contending that cable TV providers' refusal to provide ISPs with "open access"
to cable modem platforms is a violation of federal antitrust law. The lawsuit
filed in the U.S. District Court in Pittsburgh, names Tele-Communications, Inc.,
(now a unit of AT&T Corp.), Comcast Corp., and Excite@Home and seeks an
injunction to require open access and damages.
GTE's interconnection contracts with CLECs specify that parties compensate each
other for the exchange of local traffic, defined as traffic that is originated
by an end user of one party and terminating to the end user of the other party
within GTE's current local serving area. It is GTE's position that ISP traffic
does not satisfy the definition of local traffic, and that no compensation
should be paid to CLECs that switch this traffic to their ISP customers. In a
recent ruling, the FCC has clarified that ISP traffic is largely interstate,
does not "terminate" in GTE's local serving area, and based on an end-to-end
analysis of the call, is not local traffic. Consistent with this recent ruling,
GTE has been disputing and litigating bills from CLECs on these calls.
INTRASTATE REGULATORY DEVELOPMENTS
In January 1999, the Public Utilities Commission (PUC) issued a decision and
order establishing rules and procedures for a framework that will govern
telecommunications competition in Hawaii. Some of the order's significant
rulings are: (1) the Company must offer its retail services to other
telecommunications providers at a 15% discount, (2) all telecommunications
providers will contribute to support a universal service fund, (3) the Company
must recalculate its costs and prices for UNEs, and (4) reciprocal compensation
will be provided to transport and terminate local calls, including calls for all
ISPs. The Company also sought to have ISP traffic declared interstate and not
subject to reciprocal compensation based on the FCC's ruling, but in May 1999,
the PUC issued a ruling denying the Company's request.
In June 1999, the Company filed a rate rebalancing proposal in the rate design
phase of its 1995 rate case. Included in the filing is a proposal to eliminate
an 11.23% intrastate surcharge that is currently being applied to recover the
revenue increase granted in the rate case. In July 1999, in response to a PUC
order, the Company filed comments urging the PUC to proceed with the rate design
phase of the rate case. The PUC sought the comments because of its concerns
regarding the revenue requirement being based on 1995 test year data. In
September 1999, the PUC issued
11
13
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
(Abbreviated pursuant to General Instruction H(2).)
an order closing the 1995 Rate Case and making the intrastate surcharge
permanent. It further ordered the Company to submit a new rate application and
provide a schedule for a new rate proceeding which was submitted in October
1999.
Briefs were filed in April 1998 related to the petitions filed by rural area
communities to determine the adequacy of the telecommunications services
provided by the Company in the South Kona and Puna districts of the island of
Hawaii. In June 1998, the PUC issued an order granting a motion by TelHawaii to
compel the Company to transfer its assets in Ka'u to TelHawaii. In April 1999,
the First Circuit Court (Circuit Court) ruled that a forced sale or condemnation
was illegal and violated both state and federal law. TelHawaii appealed the
Circuit Court decision to the Hawaii Supreme Court (Supreme Court). In July
1999, the Supreme Court denied TelHawaii's appeal. Also in July 1999, TelHawaii
filed a motion to dismiss their secondary appeal with the Supreme Court,
indicating their intention to cease operations in the state of Hawaii. This
motion was subsequently granted by the Supreme Court.
OTHER DEVELOPMENTS
Proposed Merger with Bell Atlantic Corporation
On July 27, 1998, GTE and Bell Atlantic entered into a merger agreement
providing for the combination of the two companies. Under the terms of the
agreement, which was unanimously approved by the boards of directors of both
companies, GTE shareholders will receive 1.22 shares of Bell Atlantic stock for
each GTE share they own.
The merger is expected to qualify as a pooling of interests, which means that
for accounting and financial reporting purposes the companies will be treated as
if they had always been combined. The completion of the merger is subject to a
number of conditions, including certain regulatory approvals and receipt of
opinions that the merger will be tax-free. At annual meetings held in May 1999,
the shareholders of each company approved the merger.
Both companies are working diligently to complete the merger and are targeting
completion of the merger around the end of the first quarter of 2000. However,
Bell Atlantic and GTE must obtain the approval of a variety of state and federal
regulatory agencies and, given the inherent uncertainties of the regulatory
process, the closing of the merger may be delayed.
Tax Audits
In 1997, the State of Hawaii (the State) issued proposed notices of assessment
to the Company for a $12 million tax deficiency pertaining to general excise tax
and public service company tax audits of years 1992 through 1994. In June 1999,
a settlement was reached with the State. The Company had provided adequate
reserve for the issue and the settlement did not have a material impact on the
Company's results of operations or financial condition.
YEAR 2000 CONVERSION
State of Readiness
GTE has completed Year 2000 remediation, conducted system testing and returned
to production the essential systems that support its domestic telecommunications
businesses. GTE's portion of the public switched telephone network (PSTN) in the
United States has been upgraded for Year 2000, and all of GTE's access lines are
now operating using Year 2000 compliant central office switches and network
elements. All other GTE business units are substantially complete in Year 2000
conversion and testing and are expected to be 100% complete by the end of
November 1999.
12
14
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
(Abbreviated pursuant to General Instruction H(2).)
GTE's remaining efforts continue through March 2000 and consist of quality
assurance and validation of Year 2000 efforts across businesses; assuring
forward compliance of systems and services; planning for reasonably foreseeable
contingencies associated with the millennium rollover; and operation of our
corporate Year 2000 communications watch center.
Cost to Address Year 2000 Issues
The estimated total multi-year cost of GTE's Year 2000 Program remains unchanged
and is not expected to exceed $400 million. Through September 30, 1999,
expenditures totaled $358 million. The current estimate for the cost of
remediation for the Company is approximately $9.7 million. Through September 30,
1999, expenditures totaled $6.4 million. Year 2000 remediation costs are
expensed in the year incurred. Approximately 68% of GTE's program effort
involves U.S. domestic operations. GTE's majority-owned subsidiaries have not
elected to replace or accelerate the planned replacement of any systems due to
the Year 2000 issue. GTE has begun to reduce the staff assigned to the Year 2000
program. From a program peak of over 1,200 full-time equivalent workers, we are
currently staffed with an estimated 500 full-time equivalent workers (both
company employees and contractors) worldwide.
Risks of Year 2000 Issues
With the completion of conversion and system testing, GTE believes that the risk
of multiple, simultaneous Year 2000 disruptions affecting GTE's ability to
provide basic services has been substantially eliminated. While isolated system
issues may arise, the "most reasonably likely worse case scenario" would be any
disruptions resulting from interoperability issues with other international
carriers that have not completed their Year 2000 efforts or other circumstances
outside of GTE's control.
Contingency Planning
GTE continues to enhance its normal business continuity planning to address
potential Year 2000 interruptions. GTE's disaster preparedness recovery plans
include procedures and activities for a "multi-regional" Year 2000 contingency,
if it occurs. GTE has established a corporate Year 2000 communications watch
center that is now operational. Located in Dallas, Texas, the watch center will
remain operational (as required) through March 1, 2000. The initial versions of
our contingency plans were completed during the second quarter of 1999. These
contingency plans will be kept current through the millennium rollover, and are
being tested (as appropriate). As of September 30, 1999, 79% of the contingency
plans have completed testing, and the remaining plans are expected to complete
testing by the end of November 1999. GTE's Year 2000 contingency plans include
business continuity planning; disaster recovery/emergency preparedness;
millennium rollover planning; post millennium degradation tracking; a network
and information technology freeze period; employee availability and logistics
backup planning; "follow-the-sun" time-zone impact analysis; and coordination
with other (non-PSTN) telecommunications providers.
RECENT ACCOUNTING PRONOUNCEMENT
Derivative Instruments and Hedging Activities
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. The statement requires
entities that use derivative instruments to measure these instruments at fair
value and record them as assets or liabilities on the
13
15
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition
And Results of Operations - Continued
(Abbreviated pursuant to General Instruction H(2).)
balance sheet. It also requires entities to reflect the gains or losses
associated with changes in the fair value of these derivatives, either in
earnings or as a separate component of comprehensive income, depending on the
nature of the underlying contract or transaction. The Company is currently
assessing the impact of adopting SFAS No. 133, as amended, which is effective
January 1, 2001.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
In this Management's Discussion and Analysis, the Company has made
forward-looking statements. These statements are based on the Company's
estimates and assumptions and are subject to certain risks and uncertainties.
Forward-looking statements include the information concerning possible or
assumed future results of operations of the Company, as well as those statements
preceded or followed by the words "anticipates," "believes," "estimates,"
"expects," "hopes," "targets" or similar expressions. For each of these
statements, the Company claims the protection of the safe harbor for
forward-looking statements contained in the Private Securities Litigation Reform
Act of 1995.
The future results of the Company could be affected by subsequent events and
could differ materially from those expressed in the forward-looking statements.
If future events and actual performance differ from the Company's assumptions,
the actual results could vary significantly from the performance projected in
the forward-looking statements.
The following important factors could affect the future results of the Company
and could cause those results to differ materially from those expressed in the
forward-looking statements: (1) materially adverse changes in economic
conditions in the markets served by the Company; (2) material changes in
available technology; (3) the final resolution of federal, state and local
regulatory initiatives and proceedings, including arbitration proceedings, and
judicial review of those initiatives and proceedings, pertaining to, among other
matters, the terms of interconnection, access charges, universal service, UNEs
and resale rates; (4) the extent, timing, success and overall effects of
competition from others in the local telephone and intraLATA (local access
transport area) toll service markets; and (5) the success and expense of our
remediation efforts and those of our suppliers, customers and all
interconnecting carriers in achieving Year 2000 compliance.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There has been no material change in the Company's market risks since December
31, 1998.
14
16
PART II. OTHER INFORMATION
GTE HAWAIIAN TELEPHONE COMPANY INCORPORATED AND SUBSIDIARIES
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits required by Item 601 of Regulation S-K.
12 Statement re: Calculation of the Consolidated Ratio of
Earnings to Fixed Charges
27 Financial Data Schedule
(b) The Company filed no reports on Form 8-K during the third quarter of
1999.
15
17
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
GTE Hawaiian Telephone Company Incorporated
-------------------------------------------
(Registrant)
Date: November 10, 1999 /s/ Stephen L. Shore
-------------------- -------------------------------------------
Stephen L. Shore
Controller
(Principal Accounting Officer)
18
EXHIBIT INDEX
Exhibit
Number Description
------- -----------
12 Statement re: Calculation of the Consolidated
Ratio of Earnings to Fixed Charges
27 Financial Data Schedule