Annual Report (Form 10-K), fiscal year 1994

Item 1. Business
GTE North Incorporated (the Company) was incorporated in Wisconsin on January 27, 1987 and was the successor to the merger of eight telephone companies into the Company on March 31, 1987. All of the common stock of the Company was owned by GTE Corporation (GTE). Prior to March 31, 1993, the Company provided communication services in the states of Illinois, Indiana, Iowa, Michigan, Minnesota, Missouri, Nebraska, Ohio, Pennsylvania and Wisconsin. On March 31, 1993, the Company transferred its assets and operations in Iowa, Minnesota, Missouri and Nebraska to GTE Midwest Incorporated, which is a wholly-owned subsidiary of GTE (the Midwest Transfer).
Contel North Incorporated was incorporated in Wisconsin on June 22, 1992. Prior to April 1, 1993, Contel North Incorporated had no business operations and no material assets. On April 1, 1993, the Company, along with Contel of Illinois, Inc., Contel of Indiana, Inc. and Contel of Pennsylvania, Inc. (the Contel Subsidiaries), merged with and into Contel North Incorporated. On April 2, 1993, Contel North Incorporated changed its name to GTE North Incorporated. The Contel Subsidiaries were wholly-owned subsidiaries of GTE. They provided communication services in the states of Illinois, Indiana and Pennsylvania. The Contel Subsidiaries were, individually and in the aggregate, significantly smaller in terms of operating revenues, net income and total assets than the Company prior to the Midwest Transfer.
Additional information related to the above transactions can be found in Note 3 of the Company's consolidated financial statements included in Item 8. All previously issued financial data included herein has been restated to reflect the combined historical results of GTE North Incorporated excluding operations transferred to GTE Midwest Incorporated and including Contel of Illinois, Inc., Contel of Indiana, Inc. and Contel of Pennsylvania, Inc.
There is no public trading market for the common stock of the Company because all of the common stock is owned by GTE, a New York corporation. The Company has one wholly-owned subsidiary, GTW Telephone Systems Incorporated, which markets and services telecommunications customer premises equipment.
The Company provides a wide variety of communications services ranging from local telephone service for the home and office to highly complex voice and data services for industry. The Company provides local telephone service within its franchise areas and intraLATA (Local Access Transport Area) long distance service between the Company's facilities and the facilities of other telephone companies within the Company's LATAs. InterLATA service to other points in and out of the states in which the Company operates is provided through connection with interexchange (long distance) common carriers. These common carriers are charged fees (access charges) for interconnection to the Company's local facilities. End user business and residential customers are also charged access charges for access to the facilities of the long distance carriers. The Company also earns other revenues by leasing interexchange plant facilities and providing such services as billing and collection and operator services to interexchange carriers, primarily AT&T Corp. The number of access lines served has grown steadily from 3,617,577 on January 1, 1990 to 4,191,915 on December 31, 1994.
The number of access lines in the states in which the Company operates as of December 31, 1994, was as follows:
The Company's principal line of business is providing telecommunication services. These services fall into five major classes: local network, network access, long distance, equipment sales and services and other. Revenues from each of these classes over the last three years are as follows:
At December 31, 1994, the Company had 17,765 employees. In 1994, agreements were reached on six contracts with the International Brotherhood of Electrical Workers (IBEW) and two contracts with the Communication Workers of America (CWA). During 1995, two contracts with the CWA, one contract with the IBEW, one contract with the International Association of Machinists (IAM), and one contract with the United Steelworkers of America (USWA) will expire.
Telephone Competition and Regulatory Developments
The Company holds franchises, licenses and permits adequate for the conduct of its business in the territories which it serves.
The Company is subject to regulation by the regulatory bodies of the states of Illinois, Indiana, Michigan, Ohio, Pennsylvania and Wisconsin as to its intrastate business operations and by the Federal Communications Commission (FCC) as to its interstate business operations. Information regarding the Company's activities with the various regulatory agencies and revenue arrangements with other telephone companies can be found in Note 12 of the Company's consolidated financial statements included in Item 8.
During 1994, the Company began implementation of a three-year $375 million re-engineering plan. In the initial year of the plan, $144 million was expended to implement this program. These expenditures were primarily associated with the consolidation of certain customer service centers, separation benefits associated with employee reductions and incremental expenditures to redesign and streamline systems and processes. The overall re-engineering plan remains on schedule and is expected to be completed by the end of 1996. Continued implementation of this program will position the Company to accelerate delivery of a full array of voice, video and data services and to reach its stated objective of being the easiest company to do business with in the industry.
In late 1994, the FCC began to auction new licenses for radio spectrum in 51 major markets and 492 basic trading areas across the United States to encourage the development of a new generation of wireless voice, data and messaging services which are generally referred to as broadband Personal Communication Services (PCS). PCS will compete with the Company's traditional wireline services.
In 1992, the FCC issued a "video dialtone" ruling that allows telephone companies to transmit video signals over their networks. The FCC also recommended that Congress amend the Cable Act of 1984 to permit telephone companies to supply video programming in their service areas. On January 13, 1995, the United States District Court for the Eastern District of Virginia issued an injunction declaring that GTE has the right to provide video programming to its in-franchise customers. The court's decision means that GTE is now permitted to offer video programming over its own video dialtone networks, as well as to compete as a franchised cable operator in the Company's telephone territories.
During 1994, GTE unveiled its World Class Network in eight key markets, including Fort Wayne, Indiana, to provide advanced communications for business customers. This program includes sophisticated high-speed, digital fiber-optic rings, a high-capacity switching network (known as SONET), and a new centralized operations center that monitors the entire network. These SONET rings are an integral part of the high-speed information network that enables GTE to provide advanced services such as high-speed data transmission and video conferencing.
Federal and state regulatory activity directed toward changing the traditional cost-based rate of return regulatory framework for intrastate and interstate telephone services has continued. Regulatory authorities have adopted various forms of alternative regulation, which provide economic incentives to telephone service providers to improve productivity and provide the foundation for implementing pricing flexibility necessary to address competitive entry into the markets the Company serves.
Many states are currently investigating whether to authorize local and toll competition. Several have concluded that competition is in the public interest and five states, including Michigan, have authorized plans that would allow customers to pre-subscribe to a specific carrier to handle intraLATA toll calls. GTE is challenging these orders primarily based on the lack of equality since the Company is prohibited from providing interLATA toll service.
For the provision of interstate services, the Company operates under the terms of the FCC's price cap incentive plan. The "price cap" mechanism serves to limit the rates a carrier may charge, rather than just regulating the rate of return which may be achieved. Under this approach, the maximum prices that the Company may charge are increased or decreased each year by a price index based upon inflation less a predetermined productivity target. The Company may, within certain ranges, price individual services above or below the overall cap.
Under its price cap regulatory plan, the FCC adopted a productivity sharing feature. Because of this feature, under the minimum productivity-gain option, the Company must share equally with its ratepayers any realized interstate return above 12.25% up to 16.25%, and all returns higher than 16.25%, by temporarily lowering prospective prices.
During 1992-1994, the FCC took a number of steps to increase competition for local exchange carrier (LEC) access services. These steps, known as Expanded Interconnection requirements, allow competing communications carriers to interconnect to the local exchange network for the purpose of providing switched access transport services and private line services. Expanded Interconnection requires LECs to permit competitors to connect directly to LEC central offices and the LEC network under terms and conditions as negotiated. Competitors are thereby able to compete more effectively than previously to replace LEC services between large users and interexchange carriers (IXCs), or between large users and the LEC switch. The FCC accompanied its Expanded Interconnection mandate with a slight relaxation of the rigid pricing rules that govern how LECs price their access services. In 1994, the FCC also reaffirmed the switched access rate structure changes adopted in 1993 that allow LECs to better reflect the actual cost characteristics of transport services and improve the LEC's ability to compete with alternative access providers.
The GTE Consent Decree, which was issued in connection with the 1983 acquisition of GTE Sprint and GTE Spacenet (both since divested), prohibits GTE's domestic telephone operating subsidiaries from providing long distance service beyond the boundaries of the LATA. This prohibition restricts the Company's direct provision of long distance service to relatively short distances. The degree of competition allowed in the intraLATA market is subject to state regulation. However, regulatory constraints on intraLATA competition are gradually being relaxed.
These and other actions to eliminate the existing legal and regulatory barriers, together with rapid advances in technology, are facilitating a convergence of the computer, media and telecommunications industries. In addition to allowing new forms of competition, these developments are also creating new opportunities to develop interactive communications networks. The Company intends to continue to respond aggressively to regulatory and legal developments that allow for increased competition and opportunities in the marketplace. The Company expects its financial results to benefit from reduced costs and the introduction of new products and services that will result in increased usage of its networks. However, it is likely that such improvements will be offset, in part, by continued strategic pricing reductions and the effects of increased competition.
Item 2.



Item 2. Properties
The Company's property consists of network facilities (82%), company facilities (14%), customer premises equipment (1%) and other (3%). From January 1, 1990 to December 31, 1994, the Company made gross property additions in the amount of $2.9 billion and property retirements of $1.6 billion. Substantially all of the Company's property is subject to liens securing long-term debt. In the opinion of management, the Company's telephone plant is substantially in good repair.
Item 3.

Item 3. Legal Proceedings
There are no pending legal proceedings, either for or against the Company, which would have a material impact on the Company's financial statements.
Item 4.

Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5.

Item 5. Market for the Registrant's Common Equity and Related Shareholder Matters
Market information is omitted since the Company's common stock is wholly-owned by GTE Corporation.
TRANSFER AGENT AND REGISTRAR The Transfer Agent and Registrar for the Company's common stock, preferred stock and no par preferred stock is the First National Bank of Boston.
GTE Corporation C/O Bank of Boston P.O. Box 9191 Boston, MA 02205-9191
10-K REPORT A copy of the 1994 annual report on Form 10-K filed with the Securities and Exchange Commission may be obtained by writing to:
GTE Telephone Operations External Reporting P.O. Box 407, MC: INAAACG Westfield, IN 46074 (317)896-6464
PARENT COMPANY ANNUAL REPORT A copy of the 1994 annual report of our parent company may be obtained by writing to:
GTE Corporation Corporate Secretary's Office One Stamford Forum Stamford, CT 06904
Item 6.

Item 6. Selected Financial Data
GTE North Incorporated and Subsidiary
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(a) Per share data is omitted since the Company's common stock is 100% owned by GTE Corporation.
(b) Net operating income in 1993 included a $374.6 million pretax charge for restructuring costs, which reduced net income by $230.8 million.
Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
BUSINESS OPERATIONS
GTE North Incorporated (the Company), a wholly-owned subsidiary of GTE Corporation (GTE), provides local exchange, network access and long distance services to customers in six Midwestern and Great Lakes states: Illinois, Indiana, Michigan, Ohio, Pennsylvania and Wisconsin. The Company serves over 4 million access lines.
On April 1, 1993, the Company merged with Contel of Illinois, Inc., Contel of Indiana, Inc. and Contel of Pennsylvania, Inc. (indirect, wholly-owned subsidiaries of GTE). Prior to the merger, the properties of the Company located in Iowa, Minnesota, Missouri and Nebraska were transferred to a newly created entity, GTE Midwest Incorporated. The merger was accounted for in a manner consistent with a transfer of entities under common control which is similar to that of a "pooling of interests." Accordingly, all previously issued financial statements have been restated to reflect the combined historical results of operation, financial position, and cash flows of the Company excluding operations transferred to GTE Midwest Incorporated and including Contel of Illinois, Inc., Contel of Indiana, Inc. and Contel of Pennsylvania, Inc. All comparative data presented in this discussion reflects such restatement.
RESULTS OF OPERATIONS
Net income was $476 million in 1994 and $91 million in 1993. The 1994 results include pension settlement gains associated with lump sum payments from the Company's pension plans. The 1993 results included one-time charges of $288 million, net of tax, to restructure operations and complete enhanced early retirement and voluntary separation programs and for the early retirement of high-coupon debt.
Excluding these special items, net income increased 29% or $97 million in 1994 compared to a decrease of 8% or $30 million in 1993. The 1994 increase relates primarily to customer growth and lower operating and interest costs. The 1993 decrease reflected higher operating expenses due to the impact of the adoption of Statement of Financial Accounting Standards (SFAS) No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," effective January 1, 1993, partially offset by higher operating revenues reflecting continued customer growth.
OPERATING REVENUES
Operating revenues were $2.8 billion in 1994 and $2.6 billion in 1993. Operating revenues increased 6% or $158 million in 1994 and 2% or $42 million in 1993.
Local network services revenues are comprised mainly of fees charged to customers for providing local exchange service. Local network service revenues were $1.04 billion and $980 million in 1994 and 1993, respectively. This represents increases of 6% or $60 million in 1994 and 4% or $35 million in 1993. The 1994 and 1993 increases are due to growth in access lines and increases in custom calling, special operator services and E911 surcharges. Access lines increased 4% in 1994 compared to a 3% increase in 1993.
Network access services revenues are fees charged to interexchange carriers that use the local telecommunication network to provide long-distance services to their customers. In addition, end users pay access fees to connect to the local network to obtain long-distance service. Network access services revenues were $1.03 billion and $964 million in 1994 and 1993, respectively. Revenues derived from network access services increased 7% or $69 million in 1994 compared to a decrease of 1% or $10 million in 1993. The 1994 increase reflects increased minutes of use reflecting greater network usage by interexchange carriers and end users. The 1993 decrease reflected rate reductions in Wisconsin effective April 17, 1993 and lower interstate rates. The Company's interstate rates were lowered $11 million effective July 1, 1992 and $19 million effective October 2, 1992. Also contributing to the decrease was an Indiana toll provider order effective January 1, 1993 which is revenue neutral but reduced access revenue by $18 million annually with an offset in long distance revenues and expense. These reductions were partially offset by increased network usage.
The Company's revenues for long distance services from designated geographical areas are provided under bill and keep arrangements or settlement arrangements with various telephone companies. Long distance services revenues were $396 million and $391 million in 1994 and 1993, respectively. This represents increases of 1% or $5 million in 1994 and 18% or $59 million in 1993. The 1994 increase is primarily due to an increase in toll usage reflecting customer growth partially offset by unfavorable intrastate settlement activity and a decrease in private network revenues. The 1993 increase was primarily due to the Indiana toll provider order discussed above which resulted in increased toll revenues of $44 million annually plus growth in toll usage.
Equipment sales and services revenues were $144 million and $106 million in 1994 and 1993, respectively. This represents increases of 36% or $38 million in 1994 and 3% or $3 million in 1993. The 1994 increase is attributable to growth in revenue from continuation of services agreements associated with non-strategic dispositioned properties and wiring maintenance agreements. The 1993 increase reflected higher maintenance agreement revenue and single-line telephone product sales and rent revenue partially offset by lower single-line peripheral sales.
Other operating revenues were $147 million and $161 million in 1994 and 1993, respectively. This represents decreases of 9% or $14 million in 1994 and 22% or $44 million in 1993. The 1994 decrease is primarily due to a decrease in rental revenue from shared facilities, a decline in directory advertising revenue and lower revenue from carrier billing and collections. These decreases are partially offset by an increase in 800 directory services and operator service revenues. The 1993 decrease was primarily due to lower directory advertising revenues and lower billing and collection revenue. In addition, the 1993 decrease reflected lower revenues as a result of the Indiana toll provider order discussed above.
OPERATING EXPENSES
Cost of sales and services were $576 million and $602 million for 1994 and 1993, respectively. This represents a decrease of 4% or $26 million in 1994 compared to an increase of 3% or $17 million in 1993. The 1994 decrease is primarily associated with lower charges for inventory obsolescence, decreased installation and maintenance and network administration costs. The decrease is also attributable to lower costs reflecting continued cost reduction
efforts. The 1993 increase reflected higher costs associated with the adoption of SFAS No. 106 effective January 1, 1993. As a result of the adoption of the new standard, cost of sales and services increased $39 million. This increase was partially offset by lower right-to-use fees and lower costs reflecting cost reduction efforts.
Depreciation and amortization expense was $534 million and $502 million in 1994 and 1993, respectively. This represents increases of 6% or $32 million in 1994 and 2% or $11 million in 1993. The increases in 1994 and 1993 are due to rate adjustments and an increase in plant balances.
Expenses for marketing, selling, general and administrative were $776 million and $857 million in 1994 and 1993, respectively. This represents a decrease of 9% or $81 million in 1994 compared to an increase of 7% or $56 million in 1993. The 1994 decrease is primarily due to settlement gains associated with lump sum payments from the Company's pension plans. The decrease is also due to lower computer systems costs reflecting efficiencies gained from the re-engineering efforts and lower labor and benefits costs associated with the reduction of employees derived from the early enhanced retirement and voluntary separation packages offered in 1993. The 1993 increase reflected costs of $35 million associated with the adoption of SFAS No. 106. The increase was also due to a one-time charge of $7 million associated with the enhanced early retirement and voluntary separation programs offered to eligible employees during the second quarter of 1993. These increases were partially offset by lower computer expenses due to program reductions and continuing cost reduction efforts.
OTHER DEDUCTIONS
Interest costs were $113 million and $124 million in 1994 and 1993, respectively. Interest expense decreased 9% or $11 million in 1994 and remained relatively unchanged in 1993. The 1994 decrease is primarily due to the retirement of $316 million of high-coupon first mortgage bonds in late 1993 with proceeds from commercial paper. The commercial paper was refinanced on a long-term basis at lower interest rates in early 1994.
Income tax expense was $284 million and $35 million in 1994 and 1993, respectively. This reflects an increase of $249 million in 1994 compared to a decrease of $153 million in 1993. The changes are primarily due to corresponding changes in pretax income.
CAPITAL RESOURCES AND LIQUIDITY
Management believes that the Company has adequate internal and external resources available to meet ongoing operating requirements for construction of new plant, modernization of facilities and payment of dividends. The Company generally funds its construction program from operations, although external financing is available. Short-term borrowings can be obtained through commercial paper borrowings or borrowings from GTE. In addition, a $2.8 billion line of credit is available to the Company through shared lines of credit with GTE and other affiliates to support short-term financing needs.
The Company's primary source of funds during 1994 was cash flow from operations of $876 million compared to $822 million for 1993. The increase in cash flow from operations is primarily the result of improved operations and is partially offset by an increase of tax payments.
Capital expenditures represent a significant use of funds during 1994 and 1993 reflecting the Company's continued growth in access lines and modernization of current facilities and introduction of new products and services. The Company's capital expenditures during 1994 were $656 million compared to $567 million in 1993. In 1995, capital expenditures are expected to increase slightly from the 1994 level.
Cash used for financing activities was $206 million in 1994 compared to $269 million in 1993. This included dividend payments of $235 million in 1994 compared to $290 million in 1993. In November 1993, the Company called $316 million of high-coupon first mortgage bonds with proceeds from commercial paper borrowings. These bonds had coupons ranging from 9.00% to 9.375%. The cost of calling these bonds is reflected as an extraordinary after-tax charge of $14 million in the Consolidated Statements of Income. In February 1994, the Company issued $200 million of 5.5% Debentures, due 1999 to refinance a portion of the bonds called. In January 1994, the Company issued $250 million of 6% Debentures, Series A, due 2004 toward the payment of short-term debt.
REGULATORY AND COMPETITIVE TRENDS
REGULATORY DEVELOPMENTS
Fundamental changes continue to significantly impact the telecommunications industry. During 1994, telecommunications legislation that would have changed the way the industry does business passed the House of Representatives, but was subsequently withdrawn from consideration. Telecommunications legislation has been introduced again in 1995.
Federal and state regulatory activity directed toward changing the traditional cost-based rate of return regulatory framework for intrastate and interstate telephone services has also continued. Regulatory authorities have adopted various alternative forms of regulation, which provide economic incentives to telephone service providers to improve productivity and provide the foundation for implementing pricing flexibility necessary to address competitive entry into the markets the Company serves.
During 1992-1994, the FCC took a number of steps to increase competition for local exchange carrier (LEC) access services. These steps, known as Expanded Interconnection requirements, allow competing communications carriers to interconnect to the local exchange network for the purpose of providing switched access transport services and private line services. Expanded Interconnection requires LECs to permit competitors to connect directly to LEC central offices and the LEC network under terms and conditions as negotiated. Competitors are thereby able to compete more effectively than previously to replace LEC services between large users and interexchange carriers (IXCs), or between large users and the LEC switch. The FCC accompanied its Expanded Interconnection mandate with a slight relaxation of the rigid pricing rules that govern how LECs price their access services. In 1994, the FCC also reaffirmed the switched access rate structure changes adopted in 1993 that allow LECs to better reflect the actual cost characteristics of transport services and improve the LEC's ability to compete with alternative access providers.
Further information regarding the Company's activities with the various regulatory agencies is discussed in Note 12 of the Company's consolidated financial statements included in Item 8.


Item 8. Financial Statements and Supplementary Data
(a) Includes billings to affiliates of $92,406, $94,545 and $115,100 for the years 1994-1992, respectively.
(b) Includes billings from affiliates of $155,446, $137,519 and $150,316 for the years 1994-1992, respectively.
See Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS GTE North Incorporated and Subsidiary
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of GTE North Incorporated (the Company) and its wholly-owned subsidiary. All significant intercompany transactions have been eliminated. The Company is a wholly-owned subsidiary of GTE Corporation (GTE).
TRANSACTIONS WITH AFFILIATES
Certain affiliated companies supply construction and maintenance equipment and supplies to the Company. These purchases amounted to $167.4 million, $185.7 million and $224.9 million for the years 1994-1992, respectively. Such purchases are recorded in the accounts of the Company at cost which includes a normal return realized by the affiliates.
The Company is billed for certain printing and other costs associated with telephone directories, data processing services and equipment rentals, and receives management, consulting, research and development and pension management services from other affiliated companies. These charges amounted to $155.4 million, $137.5 million and $150.3 million for the years 1994-1992, respectively. The amounts charged for these affiliated transactions are based on a proportional cost allocation method.
The Company has an agreement with GTE Directories Corporation (Directories) (100% owned by GTE), whereby the Company provides its subscriber lists, billing and collection and other services to Directories. Revenues from these activities amounted to $92.4 million, $94.5 million and $115.1 million for the years 1994-1992, respectively.
TELEPHONE PLANT
Maintenance and repairs are charged to income as incurred. Additions to, replacements and renewals of property are charged to telephone plant accounts. Property retirements are charged in total to the accumulated depreciation account. No adjustment to depreciation is made at the time properties are retired or otherwise disposed of, except in the case of significant sales of property where profit or loss is recognized.
The Company provides for depreciation on telephone plant on a straight-line basis over asset lives approved by regulators. Depreciation is based upon rates prescribed by the Federal Communications Commission (FCC) and the state regulatory commissions. The provisions for depreciation and amortization were equivalent to composite annual rates of 6.4%, 6.2% and 6.4% for the years 1994-1992, respectively.
REGULATORY ACCOUNTING
The Company follows the accounting prescribed by the Uniform System of Accounts of the FCC and the regulatory commissions in each of the Company's operating jurisdictions and Statement of Financial Accounting Standards (SFAS)
No. 71, "Accounting for the Effects of Certain Types of Regulation." This accounting recognizes the economic effects of rate regulation by recording costs and a return on investment as such amounts are recovered through rates authorized by regulatory authorities. Accordingly, SFAS No. 71 requires companies to depreciate plant and equipment over lives approved by regulators. It also requires deferral of certain costs and obligations based upon approvals received from regulators to permit recovery of such amounts in future years. The Company annually reviews the continued applicability of SFAS No. 71 based upon the current regulatory and competitive environment.
REVENUE RECOGNITION
Revenues are recognized when earned. This is generally based on usage of the Company's local exchange networks or facilities. For other products and services, revenue is recognized when services are rendered or products are delivered to customers.
MATERIALS AND SUPPLIES
Materials and supplies are stated at the lower of cost (average cost) or market value.
EMPLOYEE BENEFIT PLANS
Effective January 1, 1993, the Company adopted SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." The new standard requires that the expected costs of postretirement benefits be charged to expense during the years that the employees render service. The Company elected to adopt this new accounting standard on the delayed recognition method and commencing January 1, 1993, began amortizing the estimated unrecorded accumulated postretirement benefit obligation over twenty years. Prior to the adoption of SFAS No. 106, the cost of these benefits was charged to expense as paid.
The Company adopted SFAS No. 112, "Employers' Accounting for Postemployment Benefits," effective January 1, 1993. SFAS No. 112 requires employers to accrue the future cost of benefits provided to former or inactive employees and their dependents after employment but before retirement. Previously, the cost of these benefits was charged to expense as paid. The impact of this change in accounting on the Company's results of operations was immaterial.
INCOME TAXES
Income tax expense is based on reported earnings before income taxes. Deferred income taxes are established for all temporary differences between the amount of assets and liabilities recognized for financial reporting purposes and for tax purposes.
As further explained in Note 8, during the fourth quarter of 1992, the Company adopted SFAS No. 109, "Accounting for Income Taxes," retroactive to January 1, 1992. SFAS No. 109 changed the method by which companies account for income taxes. Among other things, the Statement requires that deferred tax balances be adjusted to reflect new tax rates when they are enacted into law. The impact of this change in accounting on the Company's results of operations was immaterial.
Investment tax credits were repealed by the Tax Reform Act of 1986 (the Act). Those credits claimed prior to the Act were deferred and are being amortized over the lives of the properties giving rise to the credits.
FINANCIAL INSTRUMENTS
The fair values of financial instruments, other than long-term debt, closely approximate their carrying value. As of December 31, 1994, the estimated fair value of long-term debt based on either quoted market prices or an option pricing model was lower than the carrying value by approximately $86 million. The estimated fair value of long-term debt as of December 31, 1993, exceeded the carrying value by approximately $58 million.
COMPUTER SOFTWARE
The cost of computer software for internal use, except initial operating system software, is charged to expense as incurred. Initial operating system software is capitalized and amortized over the life of the related hardware.
PRIOR YEARS' FINANCIAL STATEMENTS
Reclassifications of prior year data have been made in the financial statements where appropriate to conform to the 1994 presentation.
2. RESTRUCTURING COSTS
Results for 1993 included a one-time pretax restructuring charge of $374.6 million, which reduced net income by $230.8 million, primarily for incremental costs related to implementation of the Company's three-year re-engineering plan. The re-engineering plan will redesign and streamline processes to improve customer-responsiveness and product quality, reduce the time necessary to introduce new products and services and further reduce costs. The re-engineering plan included $148.8 million to upgrade or replace existing customer service and administrative systems and enhance network software, $169.4 million for employee separation benefits associated with workforce reductions and $45.6 million primarily for the consolidation of facilities and operations and other related costs.
Implementation of the re-engineering plan began during 1994 and is expected to be completed by the end of 1996. During 1994, expenditures of $143.5 million were made in connection with the implementation of the re-engineering plan. These expenditures were primarily associated with the consolidation of customer contact, network operations and operator service centers, separation benefits from employee reductions and incremental expenditures to redesign and streamline processes.
During 1993, the Company offered various voluntary separation programs to its employees. These programs resulted in a pretax charge of $6.9 million which reduced net income by $4.3 million.
3. LEGAL ENTITY MERGER
On April 1, 1993, GTE North Incorporated (the Predecessor Corporation), as well as Contel of Illinois, Inc., Contel of Indiana, Inc. and Contel of Pennsylvania, Inc. (collectively, the Contel Companies), merged with and into Contel North Incorporated (the Registrant). The common stock of the Predecessor Corporation was owned by GTE. The Registrant, whose common stock is also owned by GTE, had no business operations or material assets prior to this merger (the Merger). The Contel Companies were indirect, wholly-owned subsidiaries of GTE and were, individually and in the aggregate, significantly smaller in terms of operating revenues, net income and total assets than the Predecessor Corporation immediately prior to the Merger.
Prior to the Merger, the properties of the Predecessor Corporation located in Iowa, Minnesota, Missouri and Nebraska were transferred to a newly created entity, GTE Midwest Incorporated (the Midwest Transfer), which is a wholly-owned subsidiary of GTE. On April 2, 1993, the name of the Registrant was changed to GTE North Incorporated, the name of the Predecessor Corporation.
The Merger was accounted for in a manner consistent with a transfer of entities under common control which is similar to that of a "pooling of interests." Accordingly, the financial statements and the notes include the results of operations and financial position of the Predecessor Corporation excluding operations transferred to GTE Midwest and including Contel of Illinois, Inc., Contel of Indiana, Inc. and Contel of Pennsylvania, Inc. for all periods. Operating revenues and net income for the year ended December 31, 1992 for each of these entities are as follows (in thousands of dollars):
(a) Represents operations included in the Predecessor Corporation which were transferred to GTE Midwest Incorporated prior to the Merger.
4. PREFERRED STOCK
Cumulative preferred stock, not subject to mandatory redemption, exclusive of amounts held in treasury, as of December 31, 1994 and 1993 is as follows:
Cumulative preferred stock, subject to mandatory redemption, exclusive of amounts held in treasury, is as follows:
* Thousands of Dollars
Certain outstanding preferred stock is redeemable at any time, in whole or in part, upon notice at a premium, and certain issues may be redeemed without premiums through sinking funds. The Company purchased for treasury 3,985 and 46 shares of cumulative preferred stock, not subject to mandatory redemption, in 1993 and 1992, respectively, and redeemed 8,045 shares in 1993. Cumulative preferred stock, not subject to mandatory redemption, held as treasury shares by the Company were 46 shares at December 31, 1994 and 1993.
The Company is required to redeem up to 23,626 shares of preferred stock, subject to mandatory redemption, each year. The Company met this requirement through treasury stock and the purchase of 22,387; 16,699; and 16,560 shares in 1994 through 1992, respectively. The aggregate redemption requirements of preferred stock subject to mandatory redemption are $900,000 in each of the years 1995 through 1999.
At December 31, 1994 and 1993, the Company held no treasury stock compared to 38 shares held at December 31, 1993, to cover future redemption requirements. No shares were reserved for officers or employees or for options, warrants, conversions or other rights. The preferred shareholders have no voting rights.
5. COMMON STOCK
The authorized common stock of the Company consists of 2,200,000 shares with a par value of $1,000 per share. All outstanding shares of common stock are held by GTE.
There were no shares of common stock held by or for the account of the Company and no shares were reserved for officers and employees, or for options, warrants, conversions or other rights.
At December 31, 1994, $514.8 million of reinvested earnings was restricted as to the payment of cash dividends on common stock under the terms of the Rural Utilities Services mortgage covenants.
6. LONG-TERM DEBT
Long-term debt outstanding, exclusive of current maturities, is as follows:
In November 1993, the Company called $316 million of high-coupon first mortgage bonds with proceeds from commercial paper borrowings. These bonds had coupons ranging from 9.00% to 9.375%. The cost of calling these bonds is reflected as an extraordinary after-tax charge of $14.3 million in the Consolidated Statements of Income. In February 1994, the Company issued $200 million of 5.5% Debentures, due 1999 to refinance a portion of the bonds called.
In January 1994, the Company issued $250 million of 6% Debentures, due 2004 toward the payment of short-term debt incurred for the purpose of financing the Company's construction program in 1993.
None of the securities shown above were held in sinking or other special funds of the Company, pledged by the Company or held by affiliates, except for the promissory notes held by GTE Finance Corporation.
Debt discount and premium on the Company's outstanding long-term debt are amortized over the lives of the respective issues.
Maturities, installments and sinking fund requirements for the five-year period from January 1, 1995 are summarized below (in thousands of dollars):
Substantially all of the Company's telephone plant is subject to the liens of the indentures under which the bonds listed above were issued.
7. SHORT-TERM DEBT
The Company finances part of its construction program through the use of interim short-term loans, primarily commercial paper or notes payable to affiliates, which are generally refinanced at a later date by issues of long-term debt or equity. Information relating to short-term borrowings is as follows:
Unused lines of credit available to the Company to support outstanding commercial paper and other short-term financing needs are $9.1 million. In addition, a $2.8 billion credit line is available through shared lines of credit with GTE and other affiliates. Most of these arrangements require payment of annual commitment fees of .1% of the unused lines of credit.
8. INCOME TAXES
The provision for income taxes is as follows:
The components of deferred income tax provision (benefit) are as follows:
A reconciliation between the taxes computed by applying statutory federal income tax rate to pretax income and income taxes provided in the Consolidated Statements of Income is as follows:
As a result of implementing SFAS No. 109, the Company recorded additional deferred income tax liabilities primarily related to temporary differences which had not previously been recognized in accordance with established rate-making practices. Since the manner in which income taxes are treated for rate-making has not changed, pursuant to SFAS No. 71 a corresponding regulatory asset was also established. In addition, deferred income taxes were adjusted and a regulatory liability established to give effect to the current statutory federal income tax rate and for unamortized investment tax credits. The unamortized regulatory asset and regulatory liability balances at December 31, 1994 amounted to $22.1 million and $39.5 million, respectively, and the unamortized regulatory asset and regulatory liability balances at December 31, 1993 amounted to $19.2 million and $44.6 million, respectively, and are reflected as other assets and other deferred credits in the accompanying Consolidated Balance Sheets. These amounts are being amortized over the lives of the related depreciable assets concurrent with recovery in rates and in conformance with the provisions of the Internal Revenue Code. The assets and liabilities established in accordance with SFAS No. 71 have been increased for the tax effect of future revenue requirements.
The tax effects of all temporary differences that give rise to the deferred tax liability and deferred tax asset at December 31 are as follows:
9. EMPLOYEE BENEFIT PLANS
RETIREMENT PLANS
The Company has trusteed, noncontributory, defined benefit pension plans covering substantially all employees. The benefits to be paid under these plans are generally based on years of credited service and average final earnings. The Company's funding policy, subject to the minimum funding requirements of U.S. employee benefit and tax laws, is to contribute such amounts as are determined on an actuarial basis to provide the plans with assets sufficient to meet the benefit obligations of the plans. The assets of the plans consist primarily of corporate equities, government securities and fixed income investments.
The components of the net pension credit for 1994-1992 were as follows (in thousands of dollars):
The expected long-term rate of return on plan assets was 8.5% for 1994 and 8.25% for 1993 and 1992.
The funded status of the plans and the prepaid pension costs at December 31, 1994 and 1993 were as follows (in thousands of dollars):
The projected benefit obligations at December 31, 1994 and 1993 include accumulated benefit obligations of $950.6 million and $1.1 billion and vested benefit obligations of $832.4 million and $934.3 million, respectively.
Assumptions used to develop the projected benefit obligations at December 31, 1994 and 1993 were as follows:
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
As described in Note 1, effective January 1, 1993, the Company adopted SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions."
Substantially all of the Company's employees are covered under postretirement health care and life insurance benefit plans. The health care benefits paid under the plans are generally based on comprehensive hospital, medical and surgical benefit provisions. The Company funds amounts for postretirement benefits as deemed appropriate from time to time.
The postretirement benefit cost for 1994 and 1993 included the following components (in thousands of dollars):
During 1992, the cost of postretirement health care and life insurance benefits on a pay-as-you-go basis was $15.9 million.
The following table sets forth the plans' funded status and the accrued obligations as of December 31, 1994 and 1993 (in thousands of dollars):
The assumed discount rates used to measure the accumulated postretirement benefit obligations were 8.25% at December 31, 1994 and 7.5% at December 31, 1993. The assumed health care cost trend rates in 1994 and 1993 were 12% and 13% for pre-65 participants and 9.0% and 9.5% for post-65 retirees, each rate declining on a graduated basis to an ultimate rate in the year 2004 of 6%. A one percentage point increase in the assumed health care cost trend rate for each future year would have increased 1994 costs by $5.5 million and the accumulated postretirement benefit obligations at December 31, 1994 by $54.0 million.
During 1993, the Company made certain changes to its postretirement health care and life insurance benefits for non-union employees retiring on or after January 1, 1995. These changes, among others, include newly established limits to the Company's annual contribution to postretirement medical costs and a revised cost sharing schedule based on a retiree's years of service. The net effect of these changes reduced the accumulated postretirement benefit obligations at December 31, 1993 by $72.7 million.
SAVINGS PLANS
The Company sponsors employee savings plans under section 401(k) of the Internal Revenue Code. The plans cover substantially all full-time employees. Under the plans, the Company provides matching contributions in GTE common stock based on qualified employee contributions. Matching contributions charged to income were $14.4 million, $9.7 million and $6.0 million in 1994-1992, respectively.
10. LEASE COMMITMENTS
The Company has noncancelable leases covering certain land, buildings, office space and equipment that contain varying renewal options for terms up to 24 years. The majority of lease commitments relate to the lease for the centralized GTE Telephone Operations general facilities entered into in 1991. The lease agreement requires rental payments over 30 years (beginning in 1992) sufficient to pay scheduled principal and interest payments for $210 million of Telephone Facility Lease Bonds issued by the lessor. The lease expense is shared by all GTE Telephone operating companies.
Rental expense was $27.2 million, $38.1 million and $39.3 million in 1994-1992, respectively. Minimum rental commitments under noncancelable leases through 1999 do not exceed $11.5 million annually and aggregate $12.8 million thereafter.
11. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment, which is stated at cost, is summarized as follows at December 31:
12. REGULATORY MATTERS
The Company's interstate operations are subject to regulation by the FCC. Intrastate business is regulated by the state regulatory commissions in Illinois, Indiana, Michigan, Ohio, Pennsylvania and Wisconsin.
INTRASTATE SERVICES
The Company provides long distance services within designated geographic areas called Local Access and Transport Areas (LATAs) directly to the customers in their exchanges in conformity with state commission orders. Provisioning of intrastate long distance services by the Company is accomplished by either bill and keep arrangements or by participation with other exchange carriers in settlement arrangements. A portion of intrastate long distance compensation is earned through access rates which are billed to other exchange carriers for completing long distance calls.
On March 13, 1990, the Michigan Public Service Commission (MPSC) authorized an incentive regulation plan for the Company for a four- year trial period. On December 23, 1991, the Governor signed Senate Bill 124 enacting the Michigan Telecommunications Act (MTA). MTA is a four year plan effective January 1, 1992, that replaced the provisions of the existing incentive regulation plan by eliminating rate of return regulation for local exchange carriers (LECs) and providing increased pricing flexibility for all services. However, local service rates were frozen for two years (four years for customers 60 years or older). The Company may request local rate increases in 1995 equal to the Detroit consumer price index less 1%.
On August 18, 1994, the MPSC issued an order approving the Company's application to increase basic exchange rates by 1.81%, which will have an annualized revenue impact of approximately $1.2 million. The rate increase was effective September 1, 1994, and was applied uniformly across all rate components including business and residential customers. Michigan law exempts residential customers 60 years of age or older from the rate increase.
On February 24, 1994, the MPSC issued an order on the rehearing matter of intraLATA 1+ dialing parity. The order requires that intraLATA dialing parity, using one-PIC or two-PIC technology, shall be implemented when the Company is authorized and able to provide interLATA toll service, but no later than January 1, 1996. The Company has appealed the MPSC's order to the Michigan Court of Appeals.
Effective August 10, 1992, the Pennsylvania Public Utility Commission approved rate reductions totaling $8.2 million.
On July 22, 1992, the Illinois Commerce Commission (ICC) issued an order to reduce the Company's rates $12.3 million effective August 14, 1992. This reduction was a result of the legal entity merger filing on July 1, 1992 (see Note 3).
On April 16, 1993 the Wisconsin Public Service Commission (WPSC) reached a decision in the 1992 rate case proceeding and ordered the Company to reduce its intrastate revenues by $4.4 million, effective April 17, 1993. On May 6, 1993 the Company filed a request for reconsideration of certain aspects of the WPSC's decision. On June 6, 1993 the WPSC denied the Company's request on all issues. On July 2, 1993 the Company filed an appeal with the
Circuit Court in Wisconsin. On May 10, 1994, the Circuit Court denied the Company's appeal on the basis of a technicality. The Court did not examine any of the issues of this case on their merits. In June 1994, the Company filed an appeal of this ruling with the Wisconsin Court of Appeals.
On July 5, 1994, regulatory reform legislation was signed into law in Wisconsin. Effective September 1, 1994, this legislation allows LEC's to choose to be regulated under price cap regulation or remain under traditional rate of return regulation. Regardless of the LEC's choice, the new legislation opens the LEC's local exchange franchises to competition and requires interconnection with competitors and provision of basic local services on an unbundled basis. If a LEC chooses to operate under the price cap plan, it is required to file a network modernization plan. On November 2, 1994, the Company formally notified the Wisconsin Commission that it would elect price cap regulation as of January 1, 1995. On that same date, the Company also filed intrastate access charge reductions of $4.0 million, to be effective January 1, 1995. This reduction is a legislative requirement of those companies electing price cap regulation.
On October 11, 1994, the ICC issued an order in a rate restructuring case to reduce the Company's rates by $1.2 million, effective November 1, 1994. The rate restructuring case combined the Company's customers and former Contel customers under a common rate structure and restructured the Company's rates to bring them closer to underlying costs. The Company also requested and was granted approval to implement a term discount plan for intrastate access charges in Illinois. This plan offers discounted access to interexchange carriers who are willing to commit to specific time periods and usage volumes. The term discount plan will result in a further decrease in revenues of $4.0 million as compared to full price access charges.
On June 10, 1993, the ICC allowed the Company to consolidate depreciation rates of the Company and the former Contel legal entity resulting in a $5 million increase in prescribed depreciation rates effective July 1, 1994. On September 3, 1993, the Indiana Utility Regulatory Commission prescribed new depreciation rates to be effective January 1, 1994 resulting in a $1.7 million decrease in depreciation expense.
INTERSTATE SERVICES
For the provision of interstate services, the Company operates under the terms of the FCC's price cap incentive plan. The "price cap" mechanism serves to limit the rates a carrier may charge, rather than just regulating the rate of return which may be achieved. Under this approach, the maximum price that the LEC may charge is increased or decreased each year by a price index based upon inflation less a predetermined productivity target. LECs may, within certain ranges, price individual services above or below the overall cap.
As a safeguard under its price cap regulatory plan, the FCC adopted a productivity sharing feature. Because of this feature, under the minimum productivity-gain option, the Company must share equally with its ratepayers any realized interstate return above 12.25% up to 16.25%, and all returns higher than 16.25%, by temporarily lowering the prospective prices. During 1995, the FCC is scheduled to review the LEC price cap plan to determine whether it should be continued or modified.
In 1992, the Company's rates were voluntarily reduced by $11.1 million effective July 1, 1992 and $19.0 million effective October 2, 1992.
SIGNIFICANT CUSTOMER
Revenues received from AT&T Corp. include amounts for access, billing and collection and interexchange leased facilities during the years 1994-1992 under various arrangements and amounted to $402.8 million, $404.3 million and $423.0 million, respectively.
13. SUPPLEMENTAL CASH FLOW DISCLOSURES
Set forth below is information with respect to changes in current assets and current liabilities, and cash paid for interest and income taxes:
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of GTE North Incorporated:
We have audited the accompanying consolidated balance sheets of GTE North Incorporated (a Wisconsin corporation and wholly-owned subsidiary of GTE Corporation) and subsidiary as of December 31, 1994 and 1993, and the related consolidated statements of income, reinvested earnings and cash flows for each of the three years in the period ended December 31, 1994. These financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of GTE North Incorporated and subsidiary as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, effective January 1, 1993, the Company changed its method of accounting for postretirement benefits other than pensions. Also as discussed in Note 1, effective January 1, 1992, the Company changed its method of accounting for income taxes.
Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The supporting schedule listed under Item 14 is presented for purposes of complying with the Securities and Exchange Commission's rules and is not a required part of the basic financial statements. This supporting schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Dallas, Texas January 25, 1995.
MANAGEMENT REPORT
To Our Shareholders:
The management of the Company is responsible for the integrity and objectivity of the financial and operating information contained in this Annual Report, including the consolidated financial statements covered by the Report of Independent Public Accountants. These statements were prepared in conformity with generally accepted accounting principles and include amounts that are based on the best estimates and judgments of management.
The Company has a system of internal accounting controls which provides management with reasonable assurance that transactions are recorded and executed in accordance with its authorizations, that assets are properly safeguarded and accounted for, and that financial records are maintained so as to permit preparation of financial statements in accordance with generally accepted accounting principles. This system includes written policies and procedures, an organizational structure that segregates duties, and a comprehensive program of periodic audits by the internal auditors. The Company has also instituted policies and guidelines which require employees to maintain the highest level of ethical standards.
JOHN C. APPEL President
GERALD K. DINSMORE Senior Vice President - Finance and Planning
Item 9.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
PART III
Item 10.



Item 10. Directors and Executive Officers of the Registrant
a. Identification of Directors The names, ages and positions of the directors of the Company as of March 24, 1995 are listed below along with their business experience during the past five years.
Directors are elected annually. The term of each director expires on the date of the next annual meeting of shareholders, which may be held on any business day in March, as specified in the notice of the meeting.
There are no family relationships between any of the directors or executive officers of the Company.
b. Identification of Executive Officers
The Company's policies are established not only by the Company's executive officers, but also by the executive officers of GTE Telephone Operations (Telops). Accordingly, the list below contains the names, ages and positions of the executive officers of both the Company and GTE Telephone Operations as of March 24, 1995.
Each of these executive officers has been an employee of the Company or an affiliated company for the last five years.
Except for duly elected officers and directors, no other employees had a significant role in decision making.
All officers are appointed for a term of one year.
NOTES:
(1) John C. Appel was elected President replacing Earl A. Goode who was appointed President, GTE Information Services.
(2) Mary Beth Bardin was elected Vice President - Public Affairs of GTE Telephone Operations replacing G. Bruce Redditt who was appointed Vice President - Public Affairs and Communications, GTE Corporation.
During 1994, the organizational structure of GTE Telephone Operations was restructured to include 11 regions, eliminating the previous Area management structure.
Item 11.

Item 11. Executive Compensation
Executive Compensation Tables
The following tables provide information about executive compensation.
SUMMARY COMPENSATION TABLE
The following table sets forth information about the compensation of each individual who served as Chief Executive Officer and each of the other four most highly compensated executive officers of the Company (the named executive officers) in 1994 for services in all capacities to the Company and its subsidiary.
(1) Annual Compensation represents the Company's pro rata share, if applicable, of salaries, bonuses and other annual compensation. Total annual cash compensation for Messrs. Goode, Keith, Foster, Zielke, Blanchard and Griswold, for whom allocated amounts are shown above, is $309,683; $316,658; $1,525,508; $217,104; $208,400 and $201,338 for 1994, respectively.
(2) 1994 Long-Term Incentive Plan (LTIP) Payouts include transition awards for the 1994 period, which were established by the Committee as a special grant to allow for the smooth transitioning from a single long-term performance measure (return on equity) to a combined measure (return on equity and operating cash flow margin).
(3) All other compensation includes Company contributions to defined contribution plans.
(4) Mr. Goode served as President until July 14, 1994 when he resigned from the Company to become President of GTE Information Services.
(5) Upon the resignation of Mr. Goode on July 14, 1994, Mr. Keith, whose official title remained as Area Vice President - Sales, assumed the additional responsibilities of acting President. Mr. Appel was elected President of the Company in February 1995.
(6) Mr. Blanchard served as Regional Vice President - General Manager - Illinois/Wisconsin until February 1995. In September 1994 he was also appointed General Manager - Customer Operations - Wisconsin Division, GTE Telephone Operations.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
The following table shows all grants of options and tandem stock appreciation rights (SARs) to each of the named executive officers of the Company in 1994, whether or not specifically allocated to the Company. The options and SARs were granted under the LTIP. Pursuant to Securities and Exchange Commission rules, the table also shows the value of the options granted at the end of the option terms (ten years) if the stock price were to appreciate annually by 5% and 10%, respectively. There is no assurance that the stock price will appreciate at the rates shown in the table. The table also indicates that if the stock price does not appreciate, there will be no increase in the potential realizable value of the options granted.
(1) Each option was granted in tandem with a SAR, which will expire upon exercise of the option. Under the LTIP, one-third of these grants vest annually commencing one year after the date of grant.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
The following table provides information as to options and SARs exercised by each of the named executive officers of the Company during 1994. The table sets forth the value of options and SARs held by such officers at year-end measured in terms of the closing price of GTE Corporation (GTE) common stock on December 30, 1994.
Long-Term Incentive Plan - Awards in Last Fiscal Year
The GTE 1991 LTIP provides for awards, currently in the form of stock options with tandem SARs and cash bonuses, to participating employees. The primary purpose of the LTIP is to offer participants an incentive to cause GTE to achieve superior financial performance, thereby helping to assure superior performance for the shareholders. The stock options and tandem SARs awarded under the LTIP to the named executive officers in 1994 are shown in the table on page 40.
The named executive officers are eligible to receive annual grants of performance bonuses which are earned during a 36-month performance cycle. The performance bonuses are paid in cash. Awards for the three-year performance cycle ending in 1994 are based on GTE's financial performance during the relevant cycle as measured by GTE's average return on equity (ROE) against pre-established target levels. In 1994, the Executive Compensation and Organizational Structure Committee of the Board of Directors of GTE (the Committee) established an additional measure of corporate performance - operating cash flow margin (OCFM). The Committee views OCFM as an excellent complement to ROE due to its capacity to accurately measure profitable revenue growth, a key determinant of financial strength, especially for high growth businesses. To transition from awards based solely on performance against ROE targets to awards based on a combination of ROE and OCFM performance, the Committee established two performance periods - a one-year period to run concurrently with the final year of the three-year ROE performance cycle ending in 1994 and a two-year period to run concurrently with the final two years of the three-year ROE performance cycle ending in 1995. The awards for the two award periods will be based on GTE's performance against ROE and OCFM performance for the one- and two-year periods. Awards for the three-year performance cycle ending in 1996 will be based on GTE's performance against the ROE and OCFM targets established for the full three-year cycle. Seventy-five percent of the award is determined based on ROE performance and 25% of the award is determined based on OCFM performance.
At the time performance targets for the current LTIP cycles are established, a Common Stock Unit account is set up for each participant in the LTIP. An initial dollar amount for each account (target award) is determined based on the competitive performance bonus grant practices of other major companies in the telecommunications industry and with practices of other major corporations not involved in the telecommunications industry that have a reputation for excellence, are comparable to GTE in terms of such quantitative measures as revenues, market value and total shareholder return and are viewed as direct competitors for executive talent in the overall labor market as well as GTE's past and projected financial performance. That amount is then divided by the average market price of GTE common stock for the calendar week preceding the day the account is established to determine the number of Common Stock Units in the account. The value of the account increases or decreases based on the market price of the GTE common stock. An amount equal to the dividends paid on an equivalent number of shares of GTE common stock is added on each dividend payment date. This amount is then converted into the number of Common Stock Units obtained by dividing the amount of the dividend by the average price of the GTE common stock on the composite tape of the New York Stock Exchange on the dividend payment date and added to the Common Stock Unit account. Messrs. Goode, Foster, Zielke and Griswold are the only individuals of the named executive officers eligible to receive a cash award under the LTIP. The number of Common Stock Units initially allocated in 1994 to the
named executive officers' accounts and estimated future payouts under the LTIP are shown in the following table:
(1) It is not possible to predict future dividends and, accordingly, estimated Common Stock Unit accruals in this table are calculated for illustrative purposes only and are based upon the dividend rate and price of GTE common stock at the close of business on December 30, 1994. The target award is the dollar amount derived by multiplying the Common Stock Unit balance at the end of the award cycle by the price of GTE common stock.
(2) The Threshold is the level of the average ROE and the average OCFM during the relevant cycle which represents the minimum acceptable performance level for both the ROE and OCFM performance measures. If the Threshold is attained with respect to both performance measures, the award will be equal to 20% of the combined target award for ROE and OCFM. Because ROE and OCFM are separate performance measures, it is possible to receive an award if the Threshold is achieved with respect to only one of the performance measures. If the actual results for one, but not both, performance measures is at the Threshold level, the portion of the award determined by the measure performing at the Threshold level will be at 20% of the target award for that performance measure, and no award will be made for the portion of the award determined by the measure performing at less than the Threshold level. However, if the actual results for both performance measures are below the minimum acceptable performance level, no award will be earned.
(3) The Target is the level of the average ROE and the average OCFM during the cycle which represents outstanding performance for both the ROE and OCFM performance measures. If the Target is attained with respect to both performance measures, the award will be equal to 100% of the target award for ROE and OCFM. If the actual results for one, but not both, performance measures is at the Target level, the portion of the award determined by the measure performing at the Target level will be at 100% of the target award for that performance measure, and the portion of the award determined by the measure performing at less than 100% will be determined accordingly.
(4) This column has intentionally been left blank because it is not possible to determine the maximum award until the award cycle has been completed. The maximum amount of the award is limited by the amount the actual ROE
and the actual OCFM exceed the targeted ROE and the targeted OCFM. If GTE's average ROE and OCFM during the cycle exceed their performance targets, additional bonuses may be earned according to the following schedule:
For example, if average ROE and OCFM performance each exceed the ROE and OCFM target by 0.5%, respectively, the performance bonus will equal 114% of the combined target award.
Executive Agreements
GTE has entered into agreements (the Agreements) with Messrs. Goode and Foster regarding benefits to be paid in the event of a change in control of GTE (a Change in Control).
A Change in Control is deemed to have occurred if a majority of the members of the Board do not consist of members of the incumbent Board (as defined in the Agreements) or if, in any 12-month period, three or more directors are elected without the approval of the incumbent Board. An individual whose initial assumption of office occurred pursuant to an agreement to avoid or settle a proxy or other election contest is not considered a member of the incumbent Board. In addition, a director who is elected pursuant to such a settlement agreement will not be deemed a director who is elected or nominated by the incumbent Board for purposes of determining whether a Change in Control has occurred. A Change in Control will not occur in the following situations: (1) certain merger transactions in which there is at least 50% GTE shareholder continuity in the surviving corporation, at least a majority of the members of the board of directors of the surviving corporation consists of members of the Board of GTE and no person owns more than 20% (or under certain circumstances, a lower percentage, not less than 10%) of the voting power of the surviving corporation following the transaction, and (2) transactions in which GTE's securities are acquired directly from GTE.
The Agreements provide for benefits to be paid in the event these individuals separate from service and have a "good reason" for leaving or are terminated without "cause" within two years after a Change in Control of GTE.
Good reason for leaving includes, but is not limited to, the following events: demotion, relocation or a reduction in total compensation or benefits, or the new entity's failure to expressly assume obligations under the Agreements. Termination for cause includes certain unlawful acts on the part of the executive or a material violation of his or her responsibilities to the Corporation resulting in material injury to the Corporation.
An executive who experiences a qualifying separation from service will be entitled to receive up to two times the sum of (i) base salary and (ii) the average of his or her other percentage awards under the EIP for the previous three years. The executive will also continue to receive medical and life insurance coverage for up to two years and will be provided with financial and outplacement counseling.
In addition, the Agreements with Messrs. Goode and Foster provide that in the event of a separation from service, they will receive service credit in the following amounts: two times years of service otherwise credited if the executive has five or fewer years of credited service; ten years if credited service is more than five and not more than ten years; and, if the executive's credited service exceeds ten years, the actual number of credited years of service. These additional years of service will apply towards vesting, retirement eligibility, benefit accrual and all other purposes under the Supplemental Executive Retirement Plan (SERP) and the Executive Retired Life Insurance Plan. In addition, each executive will be considered to have not less than 76 points and 15 years of accredited service for the purpose of determining his or her eligibility for early retirement benefits. The Agreements provide that there will be no duplication of benefits.
The Agreements remain in effect until the earlier of July 1 of each successive year or the date on which the executive reaches age 65, unless the Agreement is terminated earlier pursuant to its terms. The Agreements will be automatically renewed on each successive July 1 unless, not later than December 31 of the preceding year, one of the parties notifies the other that he does not wish to extend the Agreement. If a Change in Control occurs, the Agreements will remain in effect until the obligations of GTE (or its successor) under the Agreements have been satisfied.
Retirement Programs
Pension Plans
The estimated annual benefits payable, calculated on a single life annuity basis, under GTE's defined benefit pension plans at normal retirement at age 65, based upon final average earnings and years of employment, are illustrated in the table below:
PENSION PLAN TABLE
GTE Service Corporation, a wholly-owned subsidiary of GTE, maintains the GTE Service Corporation Plan for Employees' Pensions (the Service Corporation Plan), a noncontributory pension plan for the benefit of GTE employees based on years of service. Pension benefits to be paid from the Service Corporation Plan and contributions to this plan are related to basic salary exclusive of overtime, differentials, incentive compensation (except as otherwise described) and other similar types of payment. Under the Service Corporation Plan, pensions are computed on a two-rate formula basis of 1.15% and 1.45% for each year of service, with the 1.15% service credit being applied to that portion of the average annual salary for the five highest consecutive years that does not exceed the Social Security Integration Level (the portion of salary subject to the Federal Security Act), and the 1.45% service credit being applied to that portion of the average annual salary that exceeds said level. As of February 15, 1995, the credited years of service under the plan for Messrs. Goode, Keith, Foster, Zielke, Blanchard and Griswold are 32, 28, 24, 23, 32 and 21, respectively.
Under Federal law, an employee's benefits under a qualified pension plan such as the Service Corporation Plan are limited to certain maximum amounts. GTE maintains a SERP, which supplements, on an unfunded basis, the benefits of any participant in the Service Corporation Plan in an amount by which any participant's benefits under the Service Corporation Plan are limited by law. In addition, the SERP includes a provision permitting the payment of additional retirement benefits determined in a similar manner as under the Service Corporation Plan on remuneration accrued under management incentive plans as determined by the Committee. SERP benefits are payable in a lump sum or an annuity.
Executive Retired Life Insurance Plan
The Executive Retired Life Insurance Plan (ERLIP) provides Mr. Foster a postretirement life insurance benefit of three times final base salary, Messrs. Zielke and Griswold a postretirement life insurance benefit of two times final base salary, Mr. Keith a postretirement life insurance benefit of one and one-half times final base salary and Mr. Blanchard a postretirement life insurance benefit of one times final base salary. Upon retirement, ERLIP benefits may be paid as life insurance, or optionally, an equivalent amount equal to the present value of the life insurance amount (based on actuarial factors and the interest rate then in effect), as a lump sum payment, as an annuity or as installment payments.
Directors' Compensation
The current directors, all of whom are employees of GTE, are not paid any fees or remuneration, as such, for services on the Board.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management
(a) Security Ownership of Certain Beneficial Owners as of February 28, 1995:
(b) Security Ownership of Management as of December 31, 1994:
(1) Includes shares acquired through participation in GTE's Consolidated Employee Stock Ownership Plan and/or the GTE Savings Plan.
(2) Included in the number of shares beneficially owned by Messrs. Foster, Cahill, Dinsmore, Esstman, White, Goode, Keith, Zielke, Blanchard and Griswold and all directors and executive officers as a group are 214,539; 32,616; 39,499; 46,466; 109,299; 71,866; 13,199; 3,133; 10,533; 3,133 and 1,041,307 shares, respectively, which such persons have the right to acquire within 60 days pursuant to stock options.
(c) There were no changes in control of the Company during 1994.
The Federal securities laws require the Company's directors and executive officers, and persons who own more than 10% of a registered class of the Company's equity securities, to file with the Securities and Exchange Commission initial reports of ownership and reports of changes in ownership of any equity securities of the Company.
To the Company's knowledge, based solely on review of the copies of such reports furnished to the Company and representations that no other reports were required, all persons subject to these reporting requirements filed the required reports on a timely basis. All of the Company's common stock is owned by GTE and, to the Company's knowledge, none of such directors or executive officers currently owns, or has ever owned, any shares of the Company's registered preferred stock (which is the only registered class of the Company's equity securities).
Item 13.

Item 13. Certain Relationships and Related Transactions
The Company's executive officers or directors were not materially indebted to the Company or involved in any material transaction in which they had a direct or indirect material interest. None of the Company's directors were involved in any business relationships with the Company.
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) Financial Statements - See GTE North Incorporated's consolidated financial statements and report of independent accountants thereon in the Financial Statements section included elsewhere herein.
(2) Financial Statement Schedules - Schedules supporting the consolidated financial statements for the years ended December 31, 1994-1992 (as required):
II - Valuation and Qualifying Accounts
Note: Schedules other than that listed above are omitted as not applicable, not required, or the information is included in the consolidated financial statements or notes thereto.
(3) Exhibits - Included in this report or incorporated by reference.
3* Bylaws. Articles of Incorporation and amendments are referenced in the 1986 and 1987 Form 10-K's, respectively.
4* Indenture dated as of January 1, 1994 between GTE North Incorporated and The First National Bank of Chicago, as Trustee (Exhibit 4.1 of the Company's Registration Statements on Form S-3, File Nos. 33-50449 and 33-51911).
27 Financial Data Schedule.
(b) Reports on Form 8-K - No reports on Form 8-K were filed during the fourth quarter of 1994.
* Denotes exhibits incorporated herein by reference to previous filings with the Securities and Exchange Commission as designated.
GTE NORTH INCORPORATED AND SUBSIDIARY
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Thousands of Dollars)
------------------------------------------------- NOTES:
(1) Charges for purpose for which reserve was created.
(2) Recoveries of previously written-off amounts.
(3) See Note 2 to the Consolidated Financial Statements included elsewhere herein.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
GTE NORTH INCORPORATED ---------------------------- (Registrant)
Date March 24, 1995 By JOHN C. APPEL ------------------------ JOHN C. APPEL President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report is signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
JOHN C. APPEL President March 24, 1995 ------------------------ JOHN C. APPEL (Principal Executive Officer)
GERALD K. DINSMORE Senior Vice President - Finance March 24, 1995 ------------------------ GERALD K. DINSMORE and Planning and Director (Principal Financial Officer)
WILLIAM M. EDWARDS, III Controller March 24, 1995 ------------------------ WILLIAM M. EDWARDS, III (Principal Accounting Officer)
RICHARD M. CAHILL Director March 24, 1995 ------------------------ RICHARD M. CAHILL
MICHAEL B. ESSTMAN Director March 24, 1995 ------------------------ MICHAEL B. ESSTMAN
KENT B. FOSTER Director March 24, 1995 ------------------------ KENT B. FOSTER
THOMAS W. WHITE Director March 24, 1995 ------------------------ THOMAS W. WHITE
EXHIBIT INDEX -------------
3* Bylaws. Articles of Incorporation and amendments are referenced in the 1986 and 1987 Form 10-K's, respectively.
4* Indenture dated as of January 1, 1994 between GTE North Incorporated and The First National Bank of Chicago, as Trustee (Exhibit 4.1 of the Company's Registration Statements on Form S-3, File Nos. 33-50449 and 33-51911).
27 Financial Data Schedule.
* Denotes exhibits incorporated herein by reference to previous filings with the Securities and Exchange Commission as designated.