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: MARCH 31, 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 1-2755 GTE CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) NEW YORK 13-1678633 (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) 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 971,718,818 shares of $.05 par value common stock outstanding (excluding 21,580,442 treasury shares) at April 30, 1999. ================================================================================
2 PART I. FINANCIAL INFORMATION GTE CORPORATION AND SUBSIDIARIES Condensed Consolidated Statements of Income (Unaudited) <TABLE> <CAPTION> Three Months Ended March 31, ------------------------------ 1999 1998 ------------ ------------ (Dollars in Millions, Except Per-Share Amounts) <S> <C> <C> REVENUES AND SALES $ 5,879 $ 5,885 OPERATING COSTS AND EXPENSES Cost of services and sales 2,617 2,498 Selling, general and administrative 981 1,071 Depreciation and amortization 920 969 Special items (321) 755 ------------ ------------ Total operating costs and expenses 4,197 5,293 ------------ ------------ OPERATING INCOME 1,682 592 OTHER (INCOME) EXPENSE Interest - net 309 289 Other - net (70) 23 ------------ ------------ Income before income taxes 1,443 280 Income taxes 531 138 ------------ ------------ Income before extraordinary charges 912 142 Extraordinary charges (30) (320) ------------ ------------ NET INCOME (LOSS) $ 882 $ (178) ============ ============ BASIC EARNINGS (LOSS) PER COMMON SHARE Before extraordinary charges $ .94 $ .15 Extraordinary charges (.03) (.33) ------------ ------------ NET INCOME (LOSS) $ .91 $ (.18) ============ ============ DILUTED EARNINGS (LOSS) PER COMMON SHARE Before extraordinary charges $ .93 $ .15 Extraordinary charges (.03) (.33) ------------ ------------ NET INCOME (LOSS) $ .90 $ (.18) ============ ============ AVERAGE COMMON SHARES OUTSTANDING (IN MILLIONS) Basic 969 959 Diluted 976 968 </TABLE> The accompanying notes are an integral part of these statements. 1
3 GTE CORPORATION AND SUBSIDIARIES Condensed Consolidated Balance Sheets (Unaudited) <TABLE> <CAPTION> March 31, December 31, 1999 1998 ------------ ------------ (Dollars in Millions) <S> <C> <C> ASSETS Current Assets Cash and cash equivalents $ 441 $ 467 Receivables, less allowances of $489 and $395 4,481 4,785 Inventories and supplies 690 668 Net assets held for sale 294 274 Other 561 587 ------------ ------------ Total current assets 6,467 6,781 ------------ ------------ Property, plant and equipment, at cost 55,027 59,689 Accumulated depreciation (31,871) (34,823) ------------ ------------ Total property, plant and equipment, net (including $1,600 held for sale) 23,156 24,866 ------------ ------------ Prepaid pension costs 5,019 4,927 Franchises, goodwill and other intangibles, net of accumulated amortization of $866 and $819 3,144 3,144 Investments in unconsolidated companies 3,706 2,210 Other assets 1,609 1,687 ------------ ------------ Total assets $ 43,101 $ 43,615 ============ ============ </TABLE> The accompanying notes are an integral part of these statements. 2
4 GTE CORPORATION AND SUBSIDIARIES Condensed Consolidated Balance Sheets (Unaudited) - Continued <TABLE> <CAPTION> March 31, December 31, 1999 1998 ------------ ------------ (Dollars in Millions) <S> <C> <C> LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Short-term obligations, including current maturities $ 4,326 $ 4,148 Accounts payable and accrued expenses 4,016 4,138 Taxes payable 1,147 1,071 Other 918 998 ------------ ------------ Total current liabilities 10,407 10,355 ------------ ------------ Long-term debt 14,320 15,418 Employee benefit plans 4,331 4,404 Deferred income taxes 2,541 1,948 Minority interests in equity of subsidiaries 1,468 1,984 Other liabilities 713 740 ------------ ------------ Total liabilities 33,780 34,849 ------------ ------------ Shareholders' Equity Common stock (992,641,879 and 991,374,778 shares issued) 50 50 Additional paid-in capital 7,969 7,884 Retained earnings 3,168 2,740 Accumulated other comprehensive loss (396) (375) Guaranteed ESOP obligations (495) (509) Treasury stock (22,264,866 and 23,377,388 shares, at cost) (975) (1,024) ------------ ------------ Total shareholders' equity 9,321 8,766 ------------ ------------ Total liabilities and shareholders' equity $ 43,101 $ 43,615 ============ ============ </TABLE> The accompanying notes are an integral part of these statements. 3
5 GTE CORPORATION AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (Unaudited) <TABLE> <CAPTION> Three Months Ended March 31, ------------------------------ 1999 1998 ------------ ------------ (Dollars in Millions) <S> <C> <C> OPERATIONS Income before extraordinary charges $ 912 $ 142 Adjustments to reconcile income before extraordinary charges to net cash from operations: Depreciation and amortization 920 969 Special items (321) 755 Changes in current assets and current liabilities, excluding the effects of acquisitions and dispositions (28) (437) Deferred income taxes and other - net 46 (96) ------------ ------------ Net cash from operations 1,529 1,333 ------------ ------------ INVESTING Capital expenditures (935) (1,079) Acquisitions and investments (373) (35) Other - net 44 59 ------------ ------------ Net cash used in investing (1,264) (1,055) ------------ ------------ FINANCING Common stock issued 135 137 Long-term debt issued 222 846 Long-term debt and preferred securities retired (864) (1,711) Dividends paid (454) (451) Increase in short-term obligations, excluding current maturities 724 1,251 Other - net (54) (54) ------------ ------------ Net cash from (used in) financing (291) 18 ------------ ------------ Increase (decrease) in cash and cash equivalents (26) 296 Cash and cash equivalents: Beginning of period 467 551 ------------ ------------ End of period $ 441 $ 847 ============ ============ </TABLE> The accompanying notes are an integral part of these statements. 4
6 GTE CORPORATION AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) NOTE 1. BASIS OF PRESENTATION The unaudited condensed consolidated financial statements included herein have been prepared by GTE Corporation (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. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board 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 which is effective January 1, 2000. NOTE 3. SPECIAL ITEMS 1999 SPECIAL ITEMS Reported results for 1999 include a pretax gain of $513 million associated with the merger of BC TELECOM and TELUS, as described in Note 7. The after-tax impact of this gain is $308 million, or $.31 per diluted share. Reported results for 1999 also include special charges of $192 million ($119 million after-tax, or $.12 per diluted share) associated with voluntary and involuntary employee separation programs completed in early April 1999. The components of the charge include separation and related benefits such as outplacement and benefit continuation costs for approximately 3,000 employees. 1998 SPECIAL ITEMS During the first quarter of 1998, the Company committed to a plan to sell or exit various business activities and reduce costs through employee reductions and related actions. As a result of these actions, during the first quarter of 1998, the Company recorded a pretax charge of $755 million, $482 million after-tax, or $.50 per diluted share, for the year. During the first quarter of 1998, the Company decided to sell GTE Government Systems Corporation, GTE Airfone Incorporated, and approximately 1.6 million domestic access lines located in 13 states. The sales of GTE Government Systems and GTE Airfone are expected to close in 1999 and, accordingly, their net assets have been reclassified to "Net assets held for sale" in the condensed consolidated balance sheets. It is projected that most of the sales of local access lines will close in 2000. As a result, the net book value of these lines, which approximates $1.6 billion, continues to be reported in "Property, plant and equipment, net" in the condensed consolidated balance sheets. Based on the decision to sell, the Company stopped recording depreciation expense for these assets. The Company recorded a pretax charge of $200 million to reduce the carrying value of GTE Airfone's assets to estimated net sales proceeds. No charge was recorded for GTE Government Systems or the access lines to be sold because their estimated fair values were in excess of their carrying values. 5
7 GTE CORPORATION AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued During the first quarter of 1998, the Company also committed to a plan to exit a number of other nonstrategic business activities and took other strategic actions that resulted in additional pretax charges of $555 million. The following summarizes the total 1998 special charges by major category and by business unit affected: <TABLE> <CAPTION> Remaining Liability Initial Charge Cash Payments as of March 31, 1999 ------------------- ------------------- ------------------- (Dollars in Millions) <S> <C> <C> <C> Major Category: Asset impairments $ 483 $ -- $ -- Exit costs 34 11 23 Employee related and other actions Severance 77 49 28 Other 30 26 4 Other actions 131 113 18 ------------------- ------------------- ------------------- Total $ 755 $ 199 $ 73 =================== =================== =================== Business Unit: National Operations Network Services $ 171 $ 143 $ 18 Wireless Products and Services 91 14 21 Other National Operations 397 7 -- International Operations 38 -- 11 Corporate and other 58 35 23 ------------------- ------------------- ------------------- Total $ 755 $ 199 $ 73 =================== =================== =================== </TABLE> The strategic actions to which the charges relate were substantially completed as planned or will be completed during 1999. There have been no adjustments to the liability as originally recorded in the first quarter of 1998. NOTE 4. EXTRAORDINARY CHARGES During the first quarter of 1999, GTE repurchased $338 million of high-coupon debt through a public tender offer prior to the maturity date, resulting in a one-time, after-tax extraordinary charge of $30 million (net of tax benefits of $16 million), or $.03 per diluted share. During the first quarter of 1998, GTE recorded after-tax extraordinary charges of $320 million (net of tax benefits of $256 million), or $.33 per diluted share, resulting from the discontinued use of SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation," by GTE's Canadian operations, and the early retirement of long-term debt and preferred securities. 6
8 GTE CORPORATION AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued NOTE 5. COMPREHENSIVE INCOME The components of total comprehensive income (loss) are presented in the following table: <TABLE> <CAPTION> Three Months Ended March 31, ------------------------------ 1999 1998 ------------ ------------ (Dollars in Millions) <S> <C> <C> Net income (loss) $ 882 $ (178) Other comprehensive income (loss): Foreign currency translation adjustments (9) 14 Unrealized gains (losses) on securities, net of taxes of $(6) and $3 (12) 5 ------------ ------------ Subtotal (21) 19 ------------ ------------ Total comprehensive income (loss) $ 861 $ (159) ============ ============ </TABLE> NOTE 6. CAPITALIZED SOFTWARE Effective January 1, 1999, the Company adopted the American Institute of Certified Public Accountants' Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." Under the provisions of this SOP, GTE capitalizes and amortizes the cost of all internal-use software, including network-related software it previously expensed. The net book value of capitalized software at March 31, 1999 and December 31, 1998, respectively, is as follows: <TABLE> <CAPTION> March 31, 1999 December 31, 1998 ----------------- ----------------- (Dollars in Millions) <S> <C> <C> Capitalized software, net book value Network $ 35 $ -- Non-network 348 301 ----------------- ----------------- Total $ 383 $ 301 ================= ================= </TABLE> NOTE 7. ACCOUNTING FOR INTERNATIONAL INVESTMENTS At December 31, 1998, GTE had a 50.8% ownership interest in BC TELECOM, Inc. (BC TELECOM), a full-service telecommunications provider in the province of British Columbia, Canada. On January 31, 1999, BC TELECOM and TELUS Corporation merged to form a public company called BCT.TELUS Communications, Inc. GTE's ownership interest in the merged company, BCT.TELUS, is 26.7% and, as such, during the first quarter of 1999, the Company changed the accounting for its investment from full consolidation to the equity method. CTI Holdings, S.A. (CTI), is a consortium providing cellular services in the north and south interior regions of Argentina. During the fourth quarter of 1998, GTE increased its ownership interest in CTI and changed the accounting for its investment from the equity method to full consolidation. NOTE 8. SEGMENT REPORTING GTE has four reportable segments. As described below, three reportable segments are within GTE's National Operations unit and the fourth reportable segment is the International Operations unit. The three major product segments (reportable segments) within National Operations are Network Services, Wireless Products and Services, and Data Products and Services. See Note 7 describing changes in accounting for investments at GTE's International Operations. 7
9 GTE CORPORATION AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued For the most part, the National and the International Operations are independent of each other and the various countries comprising the International Operations are independent of each other. Within National Operations, the costs of certain activities which are managed on a common basis are allocated to the segments based on usage, where possible, or other factors depending on the nature of the activity. Affiliated transactions that occur are based on market prices. Operating income includes profit on sales to affiliates. The related intersegment eliminations for National Operations are included in Other National Operations. The following table represents segment income statement results for the three months ended March 31, and balance sheet results as of March 31, 1999 and December 31, 1998. <TABLE> <CAPTION> 1999 1998 ------------ ------------ (Dollars in Millions) <S> <C> <C> NATIONAL OPERATIONS: NETWORK SERVICES Revenues and sales Local services $ 1,467 $ 1,423 Network access services 1,333 1,293 Toll services 178 239 Directory services and other 705 644 ------------ ------------ Total revenues 3,683 3,599 Intersegment revenues (91) (44) ------------ ------------ Total external revenues $ 3,592 $ 3,555 ============ ============ Operating income (a) $ 1,147 $ 1,043 Special charges (b) 113 171 Depreciation and amortization 646 659 Capital expenditures 652 725 Total assets 23,329 23,287 WIRELESS PRODUCTS AND SERVICES Revenues and sales Service revenues $ 714 $ 650 Equipment sales and other 102 92 ------------ ------------ Total revenues $ 816 $ 742 ============ ============ Operating income (a) $ 136 $ 89 Special charges (b) 24 91 Depreciation and amortization 114 108 Capital expenditures 64 55 Total assets 5,736 5,783 DATA PRODUCTS AND SERVICES (c) Revenues and sales Data revenues $ 223 $ 123 Intersegment revenues (20) (6) ------------ ------------ Total external revenues $ 203 $ 117 ============ ============ Operating loss $ (121) $ (131) Depreciation and amortization 41 31 Capital expenditures 93 62 Total assets 2,041 1,925 </TABLE> 8
10 GTE CORPORATION AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued <TABLE> <CAPTION> 1999 1998 ------------ ------------ (Dollars in Millions) <S> <C> <C> OTHER NATIONAL OPERATIONS (c) Revenues and sales GTE Technology and Systems $ 352 $ 339 GTE Communications 341 215 Other, including eliminations 93 147 ------------ ------------ Total revenues $ 786 $ 701 ============ ============ Operating loss (a) $ (153) $ (499) Special charges (b) 42 397 Depreciation and amortization 54 47 Capital expenditures 48 121 Total assets 2,619 2,521 INTERNATIONAL OPERATIONS: (d) Revenues and sales Local services $ 80 $ 307 Toll services 72 240 Wireless services 151 69 Directory services and other 101 151 ------------ ------------ Total revenues $ 404 $ 767 ============ ============ Operating income (a) $ 586 $ 141 Special items (b) (513) 38 Depreciation and amortization 62 122 Equity income 82 15 Capital expenditures 62 118 Investments in unconsolidated companies 3,303 1,820 Revenues by country Dominican Republic $ 148 $ 129 Argentina 128 -- Canada 84 595 Other 44 43 ------------ ------------ Total revenues $ 404 $ 767 ============ ============ Assets by country Venezuela $ 1,770 $ 1,727 Canada 1,468 2,979 Argentina 1,207 1,129 Dominican Republic 931 907 Other 839 543 ------------ ------------ Total assets $ 6,215 $ 7,285 ============ ============ CONSOLIDATED REVENUES $ 5,879 $ 5,885 CONSOLIDATED OPERATING INCOME (a) 1,682 592 TOTAL SPECIAL ITEMS (b) (321) 755 CONSOLIDATED ASSETS 43,101 43,615 </TABLE> (a) Includes special items in 1999 and 1998. (b) See Note 3 for a description of special items. (c) BBN Technologies, previously reported as a component of Data Products and Services, is now included with Other National Operations. Prior period amounts conform to the 1999 presentation. (d) See Note 7 for a description of changes in accounting for international investments and the resulting impact on the financial statements. 9
11 GTE CORPORATION AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued NOTE 9. PROPOSED MERGER WITH BELL ATLANTIC CORPORATION Bell Atlantic and GTE Corporation have announced a proposed merger of equals under a definitive merger agreement dated July 27, 1998. Under the terms of the agreement, GTE shareholders will receive 1.22 shares of Bell Atlantic common stock for each share of GTE common stock that they own. We expect the merger 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, receipt of opinions that the merger will be tax-free, and the approval of the shareholders of both Bell Atlantic and GTE. Special meetings to vote on the merger will be held on May 18, 1999 for GTE shareholders and on May 19, 1999 for Bell Atlantic shareholders. We have provided unaudited pro forma combined condensed financial statements of income for the years ended December 31, 1998, 1997 and 1996 and a pro forma combined condensed balance sheet at December 31, 1998 in a joint proxy statement and prospectus filed with the Securities and Exchange Commission and dated April 13, 1999. In this interim report, we have presented the following unaudited combined condensed pro forma financial statements for the period ended March 31, 1999. These financial statements are presented assuming that the merger will be accounted for as a pooling of interests, and include certain reclassifications to conform to the presentation that will be used by the combined company and certain pro forma adjustments that conform the companies' methods of accounting. This information is presented for illustration purposes only and is not necessarily indicative of the operating results or financial position that would have occurred if the merger had been completed at the date indicated. The information does not necessarily indicate the future operating results or financial position of the combined company. For a more complete discussion of pro forma adjustments and other financial information, you should refer to the pro forma financial information presented in the joint proxy statement and prospectus. <TABLE> <CAPTION> Pro Forma Combined Condensed Statement of Income Three Months Ended (Unaudited) March 31, 1999 ------------------------- (Dollars in Millions, Except Per-Share Amounts) <S> <C> Operating revenues $ 13,846 Operating expenses 10,077 ------------ Operating income 3,769 Income from unconsolidated businesses 139 Other income and (expense), net (1) Interest expense 639 Provision for income taxes 1,208 ------------ Income from continuing operations $ 2,060 ============ Basic Earnings Per Common Share Income from continuing operations per common share $ .75 ------------ Weighted-average shares outstanding (in millions) 2,736 ------------ Diluted Earnings Per Common Share Income from continuing operations per common share $ .74 ------------ Weighted-average shares-diluted (in millions) 2,774 ------------ </TABLE> 10
12 GTE CORPORATION AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued <TABLE> <CAPTION> Pro Forma Combined Condensed Balance Sheet At March 31, 1999 (Unaudited) --------------------- (Dollars in Millions) <S> <C> Assets Current assets Cash and temporary cash investments $ 1,422 Receivables, net 11,016 Other current assets 2,964 -------------- 15,402 -------------- Plant, property and equipment, net 60,254 Investments in unconsolidated businesses 7,405 Other assets 14,817 -------------- Total assets $ 97,878 ============== Liabilities and Shareowners' Investment Current liabilities Debt maturing within one year $ 6,612 Accounts payable and accrued liabilities 11,396 Other current liabilities 2,593 -------------- 20,601 -------------- Long-term debt 32,027 Employee benefit obligations 14,516 Deferred credits and other liabilities 8,343 Shareowners' investment Common stock (2,760,106,281 shares) 276 Contributed capital 20,328 Reinvested earnings 4,583 Accumulated other comprehensive loss (1,125) -------------- 24,062 Less common stock in treasury, at cost 649 Less deferred compensation - employee stock ownership plans 1,022 -------------- 22,391 -------------- Total liabilities and shareowners' investment $ 97,878 ============== </TABLE> 11
13 GTE CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition And Results of Operations OVERVIEW CONSOLIDATED OPERATIONS - ----------------------- CONSOLIDATED NET INCOME Consolidated net income for the first quarter of 1999 was $882 million, or $.90 per diluted share. This represents an increase of $1.08 per diluted share compared with the consolidated net loss for the first quarter of 1998 of $178 million, or $.18 per diluted share. The Company's reported results for both periods were affected by one-time items. Net income for 1999 includes the effects of an after-tax gain of $189 million, or $.19 per diluted share, and an after-tax extraordinary charge of $30 million, or $.03 per diluted share. The net loss for 1998 includes the effects of after-tax special charges of $482 million, or $.50 per diluted share, and after-tax extraordinary charges of $320 million, or $.33 per diluted share. The table below summarizes these one-time items, which are described in further detail in this "Overview" section. <TABLE> <CAPTION> Three Months Ended March 31, ------------------------------ 1999 1998 ------------ ------------ (Dollars in Millions) <S> <C> <C> Reported net income (loss) $ 882 $ (178) ============ ============ Special items - pretax, as reflected in operating income: Gain on merger of BC TELECOM and TELUS (513) -- Special charges 192 755 ------------ ------------ Total special items - pretax (321) 755 Tax effect - expense (benefit) 132 (273) ------------ ------------ Total special items - after-tax (189) 482 ============ ============ Extraordinary charges, net of tax: Discontinued use of SFAS No. 71 at Canadian operations -- 300 Early retirement of debt and preferred securities 30 20 ------------ ------------ Total extraordinary charges, net of tax $ 30 $ 320 ============ ============ </TABLE> 1999 One-time Items SPECIAL ITEMS Reported results for 1999 include a pretax gain of $513 million associated with the merger of BC TELECOM and TELUS. The after-tax impact of this gain is $308 million, or $.31 per diluted share. See "Accounting for International Investments" for additional information. Reported results for 1999 also include special charges of $192 million ($119 million after-tax, or $.12 per diluted share) associated with voluntary and involuntary employee separation programs completed in early April 1999. The components of the charge include separation and related benefits such as outplacement and benefit continuation costs for approximately 3,000 employees. EXTRAORDINARY CHARGE During the first quarter of 1999, GTE repurchased $338 million of high-coupon debt through a public tender offer prior to the maturity date, resulting in a one-time, after-tax extraordinary charge of $30 million (net of tax benefits of $16 million), or $.03 per diluted share. 12
14 GTE CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition And Results of Operations - Continued 1998 One-time Items SPECIAL ITEMS During the first quarter of 1998, the Company committed to a plan to sell or exit various business activities and reduce costs through employee reductions and related actions. As a result of these actions, during the first quarter of 1998, the Company recorded a pretax charge of $755 million, $482 million after-tax, or $.50 per diluted share, for the year. During the first quarter of 1998, the Company decided to sell GTE Government Systems Corporation, GTE Airfone Incorporated, and approximately 1.6 million domestic access lines located in 13 states. The sales of GTE Government Systems and GTE Airfone are expected to close in 1999 and, accordingly, their net assets have been reclassified to "Net assets held for sale" in the condensed consolidated balance sheets. It is projected that most of the sales of local access lines will close in 2000. As a result, the net book value of these lines, which approximates $1.6 billion, continues to be reported in "Property, plant and equipment, net" in the condensed consolidated balance sheets. Based on the decision to sell, the Company stopped recording depreciation expense for these assets. The Company recorded a pretax charge of $200 million to reduce the carrying value of GTE Airfone's assets to estimated net sales proceeds. No charge was recorded for GTE Government Systems or the access lines to be sold because their estimated fair values were in excess of their carrying values. During the first quarter of 1998, the Company also committed to a plan to exit a number of other nonstrategic business activities and took other strategic actions that resulted in additional pretax charges of $555 million. The following summarizes the total 1998 special charges by major category and by business unit affected: <TABLE> <CAPTION> Remaining Liability Initial Charge Cash Payments as of March 31, 1999 -------------- ------------- -------------------- (Dollars in Millions) <S> <C> <C> <C> Major Category: Asset impairments $ 483 $ -- $ -- Exit costs 34 11 23 Employee related and other actions Severance 77 49 28 Other 30 26 4 Other actions 131 113 18 ------------ ------------ ------------ Total $ 755 $ 199 $ 73 ============ ============ ============ Business Unit: National Operations Network Services $ 171 $ 143 $ 18 Wireless Products and Services 91 14 21 Other National Operations 397 7 -- International Operations 38 -- 11 Corporate and other 58 35 23 ------------ ------------ ------------ Total $ 755 $ 199 $ 73 ============ ============ ============ </TABLE> The strategic actions to which the charges relate were substantially completed as planned or will be completed during 1999. There have been no adjustments to the liability as originally recorded in the first quarter of 1998. 13
15 GTE CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition And Results of Operations - Continued EXTRAORDINARY CHARGES During the first quarter of 1998, GTE recorded after-tax extraordinary charges of $320 million (net of tax benefits of $256 million), or $.33 per diluted share, resulting from the discontinued use of SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation," by GTE's Canadian operations, and the early retirement of long-term debt and preferred securities. CONSOLIDATED REVENUES AND SALES Consolidated revenues in the first quarter of 1999 grew $413 million or 7.6% as compared with adjusted revenues for the same period in 1998. This growth was primarily driven by growth in domestic access lines and minutes of use, domestic and international wireless subscribers, as well as increased demand for data and long-distance service offerings. The table below summarizes revenues by business unit. See "Accounting for International Investments" below for an explanation of the first quarter 1998 comparative adjustments. <TABLE> <CAPTION> Three Months Ended March 31, -------------------------------------------------------------------- Percent 1999 % 1998 % Change -------------- ------- -------------- ------- ----------- (Dollars in Millions) <S> <C> <C> <C> <C> <C> Revenues and Sales Network Services $ 3,683 63 $ 3,599 61 Wireless Products and Services 816 14 742 13 Data Products and Services 223 4 123 2 Other National Operations 786 13 701 12 -------------- ------- -------------- ------- Total National Operations 5,508 94 5,165 88 International Operations 404 7 767 13 Corporate and other, including eliminations (33) (1) (47) (1) -------------- ------- -------------- ------- Total reported revenues 5,879 100 5,885 100 ======= ======= Adjustments (described below) -- (419) -------------- -------------- Adjusted revenues $ 5,879 $ 5,466 7.6% ============== ============== ====== </TABLE> ACCOUNTING FOR INTERNATIONAL INVESTMENTS At December 31, 1998, GTE had a 50.8% ownership interest in BC TELECOM, a full-service telecommunications provider in the province of British Columbia, Canada. On January 31, 1999, BC TELECOM and TELUS Corporation merged to form a public company called BCT.TELUS Communications, Inc. GTE's ownership interest in the merged company, BCT.TELUS, is approximately 26.7% and, as such, during the first quarter of 1999, the Company changed the accounting for its investment from full consolidation to the equity method. BC TELECOM's results of operations for 1998 are reflected in reported revenues and expenses, while for 1999 the BCT.TELUS net results are reported as a component of equity income. CTI Holdings, S.A. (CTI), is a consortium providing cellular services in the north and south interior regions of Argentina. During the fourth quarter of 1998, GTE increased its ownership interest in CTI and changed the accounting for its investment from the equity method to full consolidation. The CTI net results for 1998 are reflected in equity income, while for 1999 CTI's results of operations are reflected in reported revenues and expenses. 14
16 GTE CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition And Results of Operations - Continued The first quarter 1998 comparative adjustments to reflect the deconsolidation of BC TELECOM and the consolidation of CTI, consistent with 1999 reporting, are more fully described in the discussion of "Segment Results of Operations - International Operations." For comparative discussion purposes only, first quarter 1998 consolidated revenues, as previously shown, have been adjusted to reflect the current method of accounting for these international investments. Consolidated net income and earnings per share are not affected by these changes in accounting methods. 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. We expect the merger 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, receipt of opinions that the merger will be tax-free, and the approval of the shareholders of both Bell Atlantic and GTE. Special meetings to vote on the merger will be held on May 18, 1999 for GTE shareholders and on May 19, 1999 for Bell Atlantic shareholders. This Management's Discussion and Analysis is based on GTE's own historical financial results. It does not reflect the impact that the proposed merger will have on future financial performance of the post-merger combined company. Information about the proposed merger is provided in Note 9 to the condensed consolidated financial statements. 15
17 GTE CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition And Results of Operations - Continued SEGMENT RESULTS OF OPERATIONS GTE has four reportable segments. Three reportable segments are within GTE's National Operations and the fourth reportable segment is GTE's International Operations. Additional information about the segments is located in Note 8 to the condensed consolidated financial statements. NATIONAL OPERATIONS - ------------------- The results of GTE's National Operations include the Network Services, Wireless Products and Services, and Data Products and Services reportable segments, as well as smaller business units comprising Other National Operations, including GTE Technology and Systems, GTE Communications Corporation, GTE Directories Corporation and GTE Airfone. NETWORK SERVICES Network Services provides wireline communication services within its operating areas, including local telephone service, toll calls within franchised areas and access services that enable long-distance carriers to complete calls to or from locations outside of GTE's operating areas. Network Services also provides complex voice and data services to businesses, billing and collection, operator-assistance and inventory management services to other telecommunications companies. Revenues and Sales <TABLE> <CAPTION> Three Months Ended March 31, -------------------------------- Increase Percent 1999 1998 (Decrease) Change --------------- --------------- --------------- -------------- (Dollars in Millions) <S> <C> <C> <C> <C> Local services $ 1,467 $ 1,423 $ 44 3% Network access services 1,333 1,293 40 3% Toll services 178 239 (61) (26)% Directory services and other 705 644 61 9% ------------- ------------- ------------- Total revenues 3,683 3,599 84 2% Intersegment revenues (91) (44) (47) -- ------------- ------------- ------------- Total external revenues $ 3,592 $ 3,555 $ 37 1% ============= ============= ============= </TABLE> Local services The increase in local services revenues for the first quarter of 1999 compared with the same period in 1998 was primarily generated by an increase in switched access lines in service of 4.8%. Access line growth reflects higher demand by Internet Service Providers (ISPs) and additional residential lines, including second lines. Revenue growth for the first quarter of 1999 was also attributable to increased revenues from value-added services of $15 million in the first quarter of 1999 compared with the same period of 1998. Network access services The increase in network access services revenues for the first three months of 1999 compared with the same period in 1998 was the result of higher customer demand, reflected by growth in access minutes of use of 8.5%, driven in part by higher network usage by alternative providers of intraLATA toll services. Special access revenues, driven by growing demand for increased bandwidth by high-capacity users, contributed $61 million to the 1999 increase. These increases were partially offset by price reductions of $69 million, mandated by federal and state regulation. 16
18 GTE CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition And Results of Operations - Continued Toll services Toll services revenues decreased in the first quarter of 1999 compared with the same period in 1998 due to lower toll volumes resulting from continued competition from alternative providers of intraLATA toll services. Toll minutes of use declined 23% in first quarter 1999 over the prior year quarter. Revenue reductions from intraLATA toll competition were partially offset by increased network access revenues for usage of our network by alternative providers of intraLATA toll services. Directory services and other Directory services revenues result primarily from publication rights received from GTE Directories Corporation (included in the discussion of "Other National Operations") for sales of Yellow Pages advertising to customers in Network Services' operating areas. Directory services revenues remained relatively constant. Telecommunications service revenues and equipment sales contributed $35 million in revenue growth for the first quarter of 1999 compared with the same period in 1998. Billing and collection services revenues also increased $20 million in the first quarter of 1999 versus the same period of 1998. Intersegment revenues Intersegment revenues at Network Services primarily represent sales of inventory management services provided to the telephone company affiliates, and telecommunications services provided at market rates to GTE Communications, which provides long-distance service and markets bundled telecommunications services. Operating Costs and Expenses <TABLE> <CAPTION> Three Months Ended March 31, -------------------------------- Increase Percent 1999 1998 (Decrease) Change --------------- --------------- --------------- -------------- (Dollars in Millions) <S> <C> <C> <C> <C> Cost of services and sales $ 1,267 $ 1,277 $ (10) (1)% Selling, general and administrative 510 449 61 14% Depreciation and amortization 646 659 (13) (2)% Special charges 113 171 (58) (34)% ------------- ------------- ------------- Total operating costs and expenses $ 2,536 $ 2,556 $ (20) (1)% ============= ============= ============= </TABLE> Operating costs and expenses, excluding special charges, increased slightly in the first quarter of 1999 compared with the same quarter last year. This increase was attributable to customer and access line growth, increased telecommunications equipment sales volumes and higher promotional and marketing expenditures for enhanced services. Partially offsetting these increases were lower labor, benefits and contractor costs due to ongoing productivity improvements, reduced advertising expenditures, and the adoption of Statement of Position (SOP) 98-1, "Accounting for Costs of Computer Software Developed or Obtained for Internal Use." In 1999, the Company began capitalizing right-to-use (RTU) software associated with network switching equipment. In the first quarter of 1999, $35 million of RTU software was capitalized. The decrease in depreciation and amortization expense in the first quarter of 1999 compared with the first quarter of 1998 was primarily driven by a $65 million decrease in depreciation expense resulting from the discontinuation of depreciation on approximately 1.6 million nonstrategic access lines held for sale (see "1998 One-time Items-Special Items"). This decrease was partially offset by a $42 million increase in depreciation expense primarily driven by an investment of $1.6 billion in network facilities resulting from increased demand for switched access lines. 17
19 GTE CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition And Results of Operations - Continued WIRELESS PRODUCTS AND SERVICES Wireless Products and Services provides wireless voice and data communications services within licensed areas in the U.S., sells cellular telephones and accessories and provides support services to other cellular telephone companies. Revenues and Sales <TABLE> <CAPTION> Three Months Ended March 31, -------------------------------- Percent 1999 1998 Increase Change --------------- --------------- --------------- ------------ (Dollars in Millions) <S> <C> <C> <C> <C> Service revenues $ 714 $ 650 $ 64 10% Equipment sales and other 102 92 10 11% ------------- ------------- ------------- Total revenues $ 816 $ 742 $ 74 10% ============= ============= ============= </TABLE> GTE's wireless customer base grew 7.6% in the first quarter of 1999 compared with the same period in 1998, which contributed $48 million to the increase in service revenues as total U.S. customers served reached approximately 4.9 million at March 31, 1999. In addition, service revenues increased due to a change in the manner of reporting customer roaming revenue. Previously, the Company netted these revenues with roaming charges settled with other carriers (see offsetting increase in "Operating Costs and Expenses" below). These increases were partially offset by a decline in revenues per customer per month, reflecting the increasing level of competition in the wireless industry. The increase in equipment sales and other revenues was primarily due to growth of retail customers. Operating Costs and Expenses <TABLE> <CAPTION> Three Months Ended March 31, -------------------------------- Increase Percent 1999 1998 (Decrease) Change --------------- --------------- --------------- -------------- (Dollars in Millions) <S> <C> <C> <C> <C> Cost of services and sales $ 339 $ 261 $ 78 30% Selling, general and administrative 203 193 10 5% Depreciation and amortization 114 108 6 6% Special charges 24 91 (67) (74)% ------------- ------------- ------------- Total operating costs and expenses $ 680 $ 653 $ 27 4% ============= ============= ============= </TABLE> The increase in cost of services and sales for the first quarter of 1999 resulted from increased equipment costs due to customer growth and a change in the reporting of customer roaming revenues (see offsetting increase in "Revenues and Sales" above). The increase in selling, general and administrative expenses for the first quarter of 1999 compared with the same period in 1998 was primarily attributable to higher customer acquisition and retention costs. Depreciation and amortization increased in the first quarter of 1999 compared with the same period in 1998 as a result of continued investment in the wireless network to provide greater capacity. 18
20 GTE CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition And Results of Operations - Continued DATA PRODUCTS AND SERVICES The Data Products and Services segment offers a wide range of advanced data and Internet-related services, including dedicated and dial-up access to the Internet, managed network security, Web-server hosting, application development and systems integration services. Data Products and Services also includes the investment in GTE's nationwide fiber-optic network. More than two thirds of the planned 17,000 miles of this network is operational. Additional investments in undersea cable expand the reach of the nationwide network into Europe, Asia and Latin America. This segment does not include the results of GTE's traditional local data businesses, such as T-1 connections and ISDN dedicated access, which continue to be reflected in the Company's Network Services segment. Revenues and Sales <TABLE> <CAPTION> Three Months Ended March 31, -------------------------------- Increase Percent 1999 1998 (Decrease) Change --------------- --------------- --------------- -------------- (Dollars in Millions) <S> <C> <C> <C> <C> Revenues and sales $ 223 $ 123 $ 100 81% Intersegment revenues (20) (6) (14) -- ------------- ------------- ------------- Total external revenues $ 203 $ 117 $ 86 74% ============= ============= ============= </TABLE> Data revenues for the first quarter of 1999 increased over the first quarter of 1998 due to customer growth and revenues derived from consumer and business Internet-based products and services. The increase also reflects the expanded relationship with America Online (AOL), for which GTE provides national network deployment services in support of AOL's dial-up network. Intersegment revenues reflect affiliate activity between Data Products and Services and other entities within National Operations. Operating Costs and Expenses <TABLE> <CAPTION> Three Months Ended March 31, -------------------------------- Increase Percent 1999 1998 (Decrease) Change --------------- --------------- --------------- -------------- (Dollars in Millions) <S> <C> <C> <C> <C> Cost of services and sales $ 223 $ 134 $ 89 66% Selling, general and administrative 80 89 (9) (10)% Depreciation and amortization 41 31 10 32% ------------- ------------- ------------- Total operating costs and expenses $ 344 $ 254 $ 90 35% ============= ============= ============= </TABLE> The increase in cost of services and sales for the first quarter of 1999 compared with the same period in 1998 reflects growth in the cost of the network infrastructure and personnel to support a growing customer base and new service offerings, as well as the continued expansion of dial-up networks operated for AOL. Selling, general and administrative costs decreased in the first quarter of 1999 compared with the first quarter of 1998 due to increased efficiencies, partially offset by increased selling expenses associated with customer growth. Depreciation and amortization expenses increased for the first quarter of 1999 compared with the same period in 1998 primarily due to the continued investment in building the network infrastructure. 19
21 GTE CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition And Results of Operations - Continued OTHER NATIONAL OPERATIONS GTE's Other National Operations include: GTE Technology and Systems, GTE Communications Corporation, GTE Directories Corporation and GTE Airfone. Eliminations for intersegment activity occurring within National Operations are also included in Other National Operations. Revenues and Sales <TABLE> <CAPTION> Three Months Ended March 31, -------------------------------- Increase Percent 1999 1998 (Decrease) Change --------------- --------------- --------------- -------------- (Dollars in Millions) <S> <C> <C> <C> <C> Technology and Systems $ 352 $ 339 $ 13 4% Communications 341 215 126 59% Other, including eliminations 93 147 (54) (37)% ------------- ------------- ------------- Total revenues $ 786 $ 701 $ 85 12% ============= ============= ============= </TABLE> Operating Costs and Expenses <TABLE> Three Months Ended March 31, -------------------------------- Increase Percent 1999 1998 (Decrease) Change --------------- --------------- --------------- -------------- (Dollars in Millions) <S> <C> <C> <C> <C> Cost of services and sales $ 646 $ 602 $ 44 7% Selling, general and administrative 197 154 43 28% Depreciation and amortization 54 47 7 15% Special charges 42 397 (355) (89)% ------------- ------------- ------------- Total operating costs and expenses $ 939 $ 1,200 $ (261) (22)% ============= ============= ============= </TABLE> Technology and Systems is primarily composed of GTE Government Systems. The Company has committed to a plan to sell its Government Systems unit, which the Company expects to consummate during 1999. GTE Communications Corporation includes GTE's national sales and marketing organization, which enables GTE to expand its business beyond its traditional operating boundaries. GTE Communications Corporation also includes GTE Long Distance, which provides long-distance services to customers in all 50 states, and GTE Video Services, which provides video services to residential and business customers primarily in California, Florida and Hawaii. The increase in GTE Communications Corporation's revenues was primarily due to revenues from long-distance operations, which grew $62 million, or 51%, due to a 40% increase in the number of customers. The revenue increase also resulted from $41 million in higher contract sales to strategic national accounts. In addition, GTE's competitive local exchange carrier (CLEC) generated revenue growth by providing bundled local, long-distance, wireless, paging and Internet services to more than 108,000 customers by March 31, 1999, an increase of 184% since the first quarter of 1998. Total operating costs and expenses, excluding depreciation, amortization and special charges, were higher in the first quarter of 1999 compared with the same period in 1998 due to increased capacity costs associated with GTE Communications Corporation's revenue growth as well higher data processing and contractor costs related to customer growth. 20
22 GTE CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition And Results of Operations - Continued INTERNATIONAL OPERATIONS - ------------------------ GTE's International Operations provide telecommunications services in the Dominican Republic, Argentina and Canada and operate directory advertising companies in Europe and Central America through consolidated subsidiaries. GTE also participates in ventures/consortia that are accounted for on the equity basis. These investments include a full-service telecommunications company in Venezuela, a paging network in China and a nationwide digital-cellular network in Taiwan. In March 1999 GTE completed the acquisition of 40% of the Puerto Rico Telephone Company (PRTC). PRTC is a full service telecommunications provider serving the Commonwealth of Puerto Rico. BC TELECOM, a majority-owned Canadian subsidiary of GTE, merged with TELUS on January 31, 1999. GTE's ownership interest in the merged company, BCT.TELUS Communications, Inc., is 26.7%; therefore, beginning in 1999, GTE has deconsolidated BC TELECOM and now accounts for the investment in BCT.TELUS using the equity method of accounting. In addition, during the fourth quarter of 1998, GTE increased its ownership interest in CTI Holdings, an Argentine wireless company, and began accounting for CTI Holdings on a consolidated basis. The tables below represent reported and adjusted financial results, including the impact of the changes in accounting methods described above. For comparative purposes, the financial results are discussed on an adjusted basis. Reported Revenues and Sales <TABLE> <CAPTION> Three Months Ended March 31, ------------------------------- 1999 1998 --------------- -------------- (Dollars in Millions) <S> <C> <C> Local services $ 80 $ 307 Toll services 72 240 Wireless services 151 69 Directory services and other 101 151 ------------- ------------- Total reported revenues and sales $ 404 $ 767 ============= ============= </TABLE> The following table provides supplemental detail for GTE's International Operations revenues. The results for the three months ended March 31, 1998 have been adjusted to reflect the deconsolidation of BC TELECOM and the consolidation of CTI, consistent with 1999 reporting. Adjusted Revenues and Sales <TABLE> <CAPTION> Three Months Ended March 31, -------------------------------- Increase Percent 1999 1998 (Decrease) Change --------------- --------------- --------------- -------------- (Dollars in Millions) <S> <C> <C> <C> <C> Local services $ 80 $ 69 $ 11 16% Toll services 72 78 (6) (8)% Wireless services 151 128 23 18% Directory services and other 101 73 28 38% ------------- ------------- ------------- Total adjusted revenues and sales $ 404 $ 348 $ 56 16% ============= ============= ============= </TABLE> Local services Local rate increases, as part of an overall rate rebalancing effort in the Dominican Republic, combined with increased access lines in service contributed to the increase in the first quarter of 1999 compared with the same period in 1998. 21
23 GTE CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition And Results of Operations - Continued Toll services Rate reductions in Latin America and Canada stemming from rebalancing programs and competitive pressures led to overall lower toll revenues. These rate reductions are partially offset by increased toll volumes. Wireless services Wireless services revenues primarily represent cellular, PCS and paging services. Wireless subscriber increases of 58%, including significant increases in prepaid cellular subscribers within the Latin American operations, contributed to the 1999 revenue increase. Directory services and other Directory services and other revenues result primarily from sales of Yellow Pages advertising to local and national businesses, along with equipment and other product sales. Increased product sales and higher Yellow Pages advertising revenues in Canada and Europe, combined with a change in reporting for publication-right fees paid to local exchange carriers, contributed to the increase (see "Adjusted operating costs and expenses" below). Reported Operating Costs and Expenses <TABLE> <CAPTION> Three Months Ended March 31, ------------------------------ 1999 1998 ------------- ------------- (Dollars in Millions) <S> <C> <C> Cost of services and sales $ 154 $ 266 Selling, general and administrative 115 200 Depreciation and amortization 62 122 Special items (513) 38 ------------- ------------- Total reported operating costs and expenses $ (182) $ 626 ============= ============= </TABLE> The 1999 special item represents a pretax gain of $513 million associated with the merger of BC TELECOM and TELUS, as previously described. The after-tax impact of this gain is $308 million, or $.31 per diluted share. The following table provides supplemental detail for GTE's International Operations operating costs and expenses. The results for the three months ended March 31, 1998 have been adjusted to exclude the special items and reflect the deconsolidation of BC TELECOM and the consolidation of CTI, consistent with 1999 reporting. Adjusted Operating Costs and Expenses <TABLE> <CAPTION> Three Months Ended March 31, -------------------------------- Increase Percent 1999 1998 (Decrease) Change --------------- --------------- --------------- -------------- (Dollars in Millions) <S> <C> <C> <C> <C> Cost of services and sales $ 154 $ 123 $ 31 25% Selling, general and administrative 115 121 (6) (5)% Depreciation and amortization 62 58 4 7% ------------- ------------- ------------- Total adjusted operating costs and expenses $ 331 $ 302 $ 29 10% ============= ============= ============= </TABLE> Higher network and customer support costs related to the increased service revenues, combined with higher equipment cost of sales, contributed to the increase in cost of services and sales. The classification change for directory publication-right fees also contributed to the increase in costs for the first quarter of 1999 compared with 22
24 GTE CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition And Results of Operations - Continued the same period in 1998 (see "Directory services and other" above). The decrease in selling, general and administrative expenses primarily reflects lower selling and commission expenses related to cellular customer acquisitions within the Latin American operations. Investments in Latin American cellular networks contributed to the increase in depreciation and amortization. Equity Income <TABLE> <CAPTION> Three Months Ended March 31, -------------------------------- Percent 1999 1998 Increase Change --------------- --------------- --------------- -------------- (Dollars in Millions) <S> <C> <C> <C> <C> Reported Equity Income $ 82 $ 15 $ 67 -- Adjusted Equity Income 82 51 31 61% </TABLE> Equity earnings increased $31 million, or 61%, for the first quarter of 1999 compared with the same period in 1998, after adjusting for the changes in accounting method previously described. The Taiwan cellular consortium, Pacific Cellular Corporation, became operational in January 1998 and has added over one million customers to date. This strong increase in customer growth coupled with increased earnings from our investment in CANTV, the Venezuela telephone company, contributed to the equity earnings increase. CONSOLIDATED FINANCIAL CONDITION <TABLE> <CAPTION> Three Months Ended March 31, --------------------------------- 1999 1998 -------------- -------------- (Dollars in Millions) <S> <C> <C> Cash flows from (used in): Operations $ 1,529 $ 1,333 Investing (1,264) (1,055) Financing (291) 18 </TABLE> OPERATIONS The increase in cash from operations primarily reflects continued strong earnings and a decrease in the Company's working capital requirements. INVESTING Capital expenditures totaled $935 million in the first quarter of 1999, a 13% decrease from the $1.1 billion spent in the first quarter of 1998. The primary driver for this variance was the deconsolidation of BC TELECOM to the equity method of accounting. The majority of the 1999 new investments were made to acquire facilities and develop and install applications necessary to support the growth in demand for GTE's core services, facilitate the introduction of new products and services, and increase operating efficiency and productivity. Significant investments are also being made to build and expand GTE's national fiber-optic data network. As previously announced, GTE has committed to a plan to sell GTE Government Systems, GTE Airfone and approximately 1.6 million domestic access lines over the next two years. These transactions are expected to generate after-tax proceeds in excess of $3 billion. Cash generated from these dispositions will be partially used to fund the Company's growth strategy. As announced in April 1999, the Company will acquire approximately half of Ameritech's wireless properties. GTE will pay $3.27 billion in cash for the properties. The completion of the acquisition is contingent on the closing of the proposed merger between Ameritech and SBC Communications, which is expected in mid-1999. In March 23
25 GTE CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition And Results of Operations - Continued 1999, the Company completed its purchase of approximately 40% of the Puerto Rico Telephone Company (PRTC) for approximately $360 million. FINANCING Cash used in financing activities totaled $291 million during the first quarter of 1999 compared with cash provided of $18 million for the same period in 1998. The Company retired $864 million of long-term debt in the first quarter of 1999 compared with long-term debt and preferred security retirements of $1.7 billion in the first quarter of 1998. The net change in short-term debt provided cash of $724 million in the first quarter of 1999 compared with $1.3 billion in the first quarter of 1998. The Company issued $222 million of long-term debt in the first quarter of 1999 compared with $846 million in the first quarter of 1998. During the first quarter of 1999, GTE maintained its two syndicated credit facilities totaling $4.0 billion, including a five-year line of $2.5 billion for GTE and a 364-day line of $1.5 billion for certain domestic telephone operating subsidiaries. Under current terms and conditions, the $2.5 billion line will mature in June 2002 and the $1.5 billion line, which the Company expects to renew, will mature in June 1999. Fifty-four banks representing 12 countries participate in these syndicated facilities, which are used primarily to back up commercial paper borrowings. In August 1998, GTE negotiated bilateral credit agreements for an additional $1.0 billion. These facilities, which are shared by GTE and certain domestic telephone operating subsidiaries, are aligned with the maturity date of the existing 364-day line. GTE and certain of its domestic telephone operating subsidiaries have shelf registration statements filed with the Securities and Exchange Commission that total $2.2 billion as of March 31, 1999. The Company believes that its present investment grade credit rating and those of its subsidiaries provide ready access to the capital markets at reasonable rates and provide the Company with the financial flexibility necessary to pursue growth opportunities as they arise. At March 31, 1999, the Company had $5.0 billion of unused bank lines of credit available to back up commercial paper borrowings and for working capital requirements. OTHER FACTORS THAT MAY AFFECT FUTURE RESULTS REGULATORY AND COMPETITIVE TRENDS During the first 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 first quarter of 1999 to meet the wholesale requirements of new competitors. To date, GTE has signed more than 800 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. The Company's position in these challenges was supported by the Eighth Circuit's July 1997 decision stating that the FCC had overstepped its authority in several areas concerning implementation of the interconnection provisions of the Telecommunications Act. In January 1999, the U.S. Supreme Court (Supreme Court) reversed in part and affirmed in part the Eighth Circuit's decisions. The Supreme Court reversed the Eighth Circuit on many of the FCC rules related to pricing and costing, that had previously been reversed by the Eighth Circuit on jurisdictional grounds. The pricing rules established by the FCC will now be remanded back to the Eighth Circuit for a 24
26 GTE CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition And Results of Operations - Continued determination on the merits. On the other hand, the Supreme Court vacated the FCC rule requiring incumbent local exchange carriers (LECs) to provide unbundled network elements to competitive LECs. This latter ruling will be the subject of continued proceedings before the FCC and the state commissions concerning what elements will have to be offered under what conditions. Pending the final rulemaking by the FCC on the provisions of unbundled network elements, GTE will continue to provide individual unbundled network elements set forth in existing interconnection agreements even though the Company is not legally obligated to do so. Concurrent with competitors' entry into GTE markets, the Company has continued its own expansion into local, long-distance, Internet-access, wireless and video services both within and outside its traditional operating areas. GTE now provides long-distance and dial-up Internet-access services to approximately 2.8 million and 600,000 customers, respectively. UNIVERSAL SERVICE In October 1998, the FCC issued an order selecting a cost model for universal service and plans to select cost inputs in the second quarter of 1999. For this reason, the FCC moved the implementation date of the new universal service mechanism for nonrural carriers to July 1999. The Company filed a Petition for Reconsideration in December 1998, stating that the adopted model is incomplete and requires additional time for proper evaluation. GTE is currently awaiting action from the FCC. ADVANCED TELECOMMUNICATIONS SERVICES Section 706 of 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 an Order and Notice of Proposed Rule Making (NPRM) released in August 1998, the FCC clarified that advanced services offered by an incumbent LEC are subject to the unbundling and resale requirements of the Telecommunications Act. In the NPRM, the FCC sought comment on extensive, new separate affiliate rules under which an incumbent LEC's affiliate could offer advanced services free from the unbundling and resale obligations of the Telecommunications Act. In addition, the NPRM sought comment on a number of issues regarding collocation, local loops and unbundling and resale obligations for network facilities needed for advanced services. On March 31, 1999, the FCC released an Order stemming from the August 1998 NPRM. In the Order the FCC adopted a number of new collocation rules designed to make competitive entry easier and less costly. These rules specify how incumbent LECs will manage such items as alternate collocation arrangements, security, space preparation cost allocation, provisioning intervals, and space exhaustion. The FCC also released a Further NPRM 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). GTE will vigorously oppose line sharing. The FCC has yet to release an order addressing separate affiliates, local loops, unbundling and resale. YEAR 2000 CONVERSION General The Year 2000 issue concerns the potential inability of information systems to properly recognize and process date-sensitive information beyond January 1, 2000, and has industry-wide implications. GTE has had an active Year 2000 program in place since 1995. This program is necessary because the Year 2000 issue could impact telecommunications networks, systems and business processes at GTE. Although GTE maintains a significant 25
27 portion of its own systems and infrastructure, the Company also depends on certain, material external supplier products that GTE must verify as Year 2000 compliant in their condition of use. In 1997, GTE's Year 2000 methodology and processes were certified by the Information Technology Industry Association of America. GTE presently expects that the essential functions of its domestic wireline telecommunications business will complete Year 2000 testing by June 30, 1999, and remaining businesses will complete before October 1999. State of Readiness GTE's Year 2000 program is focused on both information technology (IT) and non-IT systems, including: 1) telecommunications network elements that constitute the portion of the public switched telephone network (PSTN) for which GTE is responsible; 2) systems that directly support GTE's telecommunications network operations and interactions with customers; 3) systems and products that support GTE's national and international business units; 4) software that supports basic business operations, customer premise equipment and interconnection with other telecommunications carriers; and 5) systems that support GTE's physical infrastructure, financial operations and facilities. Company-wide, essential remediation was approximately 88% complete as of March 31, 1999. In addition to the essential remediation budget, GTE has set aside funds equivalent to approximately 11% of the Company's overall Year 2000 budget. These funds are planned for verification, problem resolution and administrative program closeout in the last six months of 1999 and to address contingencies and millennium program operations and control through March 2000. GTE's portion of the PSTN in the United States has been upgraded substantially for Year 2000; 97% of GTE's access lines are already operational using Year 2000 compliant central office switches. Additionally, over 98% of the Company's essential software has been remediated. GTE's focus continues to be on deployment and testing of these systems throughout GTE's operations. GTE's Year 2000 program has been organized into five phases as follows: Awareness: program definition and general education; Assessment: analysis and prioritization of systems supporting the core business; Renovation: rectifying Year 2000 issues; Validation: testing the Year 2000 solutions; and Implementation: placing the tested systems into production. Awareness and Assessment are more than 95% complete; System Renovation, including supplier products, is approximately 91% complete; Validation, including enterprise testing in operational environments, and Implementation, including regional deployment, are approximately 73% complete. It is anticipated that the Renovation, Validation and Implementation phases for essential functions will be substantially complete in June 1999. In summary, compliant product deployment and enterprise testing for GTE's domestic telecommunications-related business, including national and international interoperability and validation, are presently expected to be complete by the end of June 1999. The remaining domestic and international businesses are on schedule for completing testing before October 1999. Successful conclusion of GTE's Year 2000 program depends upon timely delivery of Year 2000 compliant products and services from external suppliers. With the addition of new products, approximately 1,500 of third-party products used by GTE have been determined to be "vital" products, critical to GTE's business and operations. As of March 31, 1999, Year 2000 compliant versions, or suitable alternatives, for 95% of these vital supplier products have been provided and are currently undergoing certification testing by GTE. Use of Independent Verification and Validation Independent verification and validation is the final step in GTE's process. As part of independent verification and validation, GTE's Year 2000 program management office has established a company-wide quality oversight and control function that reviews and evaluates quality reports on the Year 2000 issue. Each GTE business unit has access to an independent quality team that evaluates the conversion and testing of applications and third-party supplier products. This quality assurance process is expected to be completed in October 1999. Separately, GTE's corporate internal auditors conduct periodic reviews and report significant findings, if any, to business unit and 26
28 GTE CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition And Results of Operations - Continued corporate management and the audit committee of the Board of Directors. Program status is also reported each quarter to the Company's external auditors. Cost to Address Year 2000 Issues The previous estimate for the cost of GTE's Year 2000 Program was $370 million; with the incorporation of the TELUS Year 2000 program, the current estimate for program cost is expected not to exceed $400 million. Through March 31, 1999, expenditures totaled $283 million. Year 2000 remediation costs are expensed in the year incurred. GTE has not elected to replace or accelerate the planned replacement of systems due to the Year 2000 issue. Currently supporting GTE's Year 2000 program worldwide are an estimated 1,000 to 1,200 full-time equivalent workers (both company employees and contractors). Approximately 10% of these full-time equivalent workers are engaged in all aspects of program management; 4% are engaged in system conversion; 27% are involved in external supplier management; 54% are involved in testing at all levels; and 5% are addressing contingency planning and interoperability operations both nationally and internationally. Approximately 66% of GTE's program effort involves U.S. domestic operations of all types. Risks of Year 2000 Issues GTE has begun to examine the risks associated with its "most reasonably likely worst case Year 2000 scenarios." To date, GTE has no indication that any specific function or system is so deficient in technical progress as to threaten GTE's present schedule. GTE's program and plans currently indicate a compliant network infrastructure to be deployed by the end of June 1999. A general, unspecific, schedule shift that would erode progress beyond January 1, 2000, cannot reasonably be calculated. If, however, there were a schedule delay lasting no more than six months, such schedule erosion would likely affect only nonessential systems due to the prioritization of work schedules. Other scenarios might include a possible but presently unforeseen failure of key supplier or customer business processes or systems. This situation could conceivably persist for some months after the millennium transition and could lead to possible revenue losses. GTE's present assessment of its key suppliers and customers does not indicate that this scenario is likely. To date, GTE has not encountered any conditions requiring tactical contingency planning to its existing Year 2000 program; however, contingency planning for business and network operations and customer contact during 1999 and 2000 is ongoing. GTE is bolstering its normal business continuity planning to address potential Year 2000 interruptions. In addition, GTE's disaster preparedness recovery teams are including procedures and activities for a "multi-regional" Year 2000 contingency, if it occurs. GTE is also developing its plans with respect to possible occurrences immediately before, during, and after the millennium transition. These plans are expected to be completed by June 30, 1999, and tested (as appropriate) by the end of September 1999. This contingency plan includes: business continuity planning; disaster recovery/emergency preparedness; millennium rollover planning; post millennium degradation tracking; a network and information technology "stabilization" period; employee availability and logistics backup planning; "follow-the-sun" time-zone impact analysis; coordination with other (non-PSTN) telecommunications providers; a Year 2000 "war room" operation to provide high-priority recovery support, plans for key personnel availability, command structures and contingency traffic routing; and plans for round-the-clock, on-call repair teams. 27
29 GTE CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition And Results of Operations - Continued RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board 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 statement requires entities that use derivative instruments to measure these instruments at fair value and record them as assets or liabilities on the balance sheet. It also requires entities to reflect the gains or losses associated with changes in the fair value of these derivatives, either in earnings or as a separate component of comprehensive income, depending on the nature of the underlying contract or transaction. The Company is currently assessing the impact of adopting SFAS No. 133, which is effective January 1, 2000. CAUTIONARY STATEMENT REGARDING 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 or by companies in which GTE has substantial investments; 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, unbundled network elements and resale rates; 4) the extent, timing, success and overall effects of competition from others in the local telephone and intraLATA toll service markets; and 5) the success and expense of our remediation efforts and those of our suppliers, customers, joint ventures, noncontrolled investments and all interconnecting carriers in achieving Year 2000 compliance. In addition, GTE has embarked on a major initiative to expand its service capability in the data communication, long-distance and enhanced services segments of the telecommunications marketplace and to provide a bundle of products and services both in and outside of its traditional service territories. Whether the Company realizes the benefits of these initiatives depends on GTE's ability to successfully develop the network facilities and systems required to provide these enhanced services, the success of its marketing initiatives, the levels of demand that are created for these services and the level of competition the Company faces as it seeks to penetrate new markets and emerging markets for new products and services. While GTE's management believes that it will be successful in implementing these new initiatives, there are uncertainties associated with its ability to increase revenue and income growth rates to the levels targeted through these initiatives and its ability to do so within the planned timeframes or investment levels. 28
30 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits required by Item 601 of Regulation S-K. 11 Statement re: Calculation of Earnings per Common Share 12 Statement re: Calculation of the Consolidated Ratio of Earnings to Fixed Charges 27 Financial Data Schedule (b) The Company filed a report on Form 8-K dated January 19, 1999 under Item 7, "Financial Statements and Exhibits." No financial statements were included with this report. The Company filed a report on Form 8-K dated January 25, 1999 under Item 7, "Financial Statements and Exhibits." No financial statements were included with this report. 29
31 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 Corporation ----------------------------------- (Registrant) Date: May 12, 1999 /s/ Paul R. Shuell --------------------------- ----------------------------------- Paul R. Shuell Vice President and Controller Date: May 12, 1999 /s/ Marianne Drost --------------------------- ----------------------------------- Marianne Drost Secretary 30
32 EXHIBIT INDEX <TABLE> <CAPTION> Exhibit Number Description - ------------------- ---------------------------------------------------------------------------------- <S> <C> 11 Statement re: Calculation of Earnings per Common Share 12 Statements re: Calculation of the Consolidated Ratio of Earnings to Fixed Charges 27 Financial Data Schedule </TABLE>