Item 1. Business
GTE California Incorporated (the Company) was incorporated in California in 1929. The Company is a wholly-owned subsidiary of GTE Corporation (GTE) and provides communications services in Southern and Central California.
The Company has a wholly-owned subsidiary, GTEL. GTEL comprises the majority of the Company's nonregulated operations including marketing telecommunications equipment and other deregulated products and services.
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 area 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 California 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 3,339,531 on January 1, 1990 to 3,825,768 on December 31, 1994.
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 13,074 employees. The Company has written agreements with the Communications Workers of America (CWA) covering substantially all hourly employees. The current agreement between the Company and the CWA expires in March 1996 and the agreement between GTEL and the CWA expires in April 1997.
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 California Public Utilities Commission (CPUC) 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 $445 million re-engineering plan that will redesign and streamline processes. In the initial year of the plan, $113 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. During 1995, the level of re-engineering activities and related expenditures are expected to accelerate as pilot programs are rolled out and other major initiatives are completed. 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 Communications 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. In 1994, GTE announced plans to build a new video network over the next 10 years which will pass seven million homes in 66 key GTE markets. GTE has requested FCC approval to construct facilities in the initial three markets, including Ventura County, California, and expects to begin construction in 1995.
In Cerritos, California, GTE concluded testing of the capabilities of copper wire, coaxial cable and fiber optics for both video and telephony delivery. In July, 1994, GTE moved to a business-as-usual operation of the Cerritos video network, including the continued provision of near pay-per-view (Center Screen(sm)) and interactive (mainStreet(tm)) services. In order to continue to
provide these services and video signal transport to the local cable operator, GTE challenged the constitutionality of the federal statute which barred the participation of telephone companies and their affiliates in the delivery of video programming directly to customers within their telephone service territories. As a result of that challenge, the United States District Court for the Eastern District of Virginia ruled in favor of GTE and declared the federal statute unconstitutional. 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 Los Angeles, California, 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.
During 1993, the CPUC approved a New Regulatory Framework (NRF) settlement agreement allowing GTE California to retain 100% of any earnings up to 15.5%, beginning in 1994. Under its prior agreement, GTE California was required to share 50% of any earnings over a 13% rate of return and refund 100% of any earnings over 16.5%. In September 1994, the CPUC issued a final order that authorized intraLATA toll competition (without pre-subscription) in California, effective January 1, 1995. It also provides for rate rebalancing with significant rate reductions for toll service and access charges while increasing basic local exchange rates closer to the actual cost of providing such service. Although the rate rebalancing is intended to be revenue neutral, its ultimate effect on revenue will depend, in part, on the extent to which rate reductions result in increased calling volumes. The decision does not permit rate increases to compensate for competitive losses of market share. GTE believes that the CPUC has over-estimated the calling volume that will be stimulated by reduced toll rates and has requested reconsideration of this aspect of the decision.
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 also adopted a productivity sharing feature. Because of this feature, under the minimum productivity-gain option, the Company must share equally with its ratepayers any realized interstate return above 12.25% up to 16.25%, and all returns higher than 16.25%, by temporarily lowering prospective prices.
During 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 negotiated terms and conditions. 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 (80%), company facilities (13%), customer premises equipment (1%) and other (6%). From January 1, 1990 to December 31, 1994, the Company made gross property additions of $2.6 billion and property retirements of $1.8 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 GTE California's Common Stock and 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 California Incorporated and Subsidiary
__________
(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 $445.2 million pretax charge for restructuring costs which reduced net income by $274.2 million.
Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
BUSINESS OPERATIONS
GTE California Incorporated (the Company), a wholly-owned subsidiary of GTE Corporation (GTE), provides local exchange, network access and long distance telecommunications services throughout Southern and Central California. The Company serves over 3.8 million access lines in its operating territories with a substantial number of those lines in Southern California. The Company also markets telecommunications equipment and other deregulated products and services through GTEL, a wholly-owned subsidiary.
RESULTS OF OPERATIONS
Net income in 1994 was $435 million as compared to $73 million in 1993. The results for 1993 include one-time after-tax charges totaling $315 million 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 12% or $47 million in 1994 and 7% or $27 million in 1993. The 1994 increase is primarily the result of ongoing quality and cost control programs and a decrease in interest expense. The 1993 decrease reflected lower operating revenues due to voluntary rate reductions and 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.
OPERATING REVENUES
Operating revenues were $2.88 billion and $2.87 billion in 1994 and 1993, respectively. This reflects an increase of less than 1% or $7 million in 1994 and a decrease of 2% or $46 million in 1993.
Local network service revenues are comprised mainly of fees charged to customers for providing local exchange service. These revenues for 1994 and 1993 were $965 million and $976 million, respectively. This reflects a decrease of 1% or $11 million in 1994 compared to an increase of 4% or $38 million in 1993. The 1994 decrease is primarily due to a rate reduction related to the price cap index and the new regulatory framework (NRF) review partially offset by continued customer growth, as experienced through an increase in access lines of 3%. The 1993 increase was primarily due to a rate increase related to the Company's 1993 price cap index under the NRF, continued customer growth, as experienced through a 3% increase in access lines, and increased revenue from CentraNet(R) and other enhanced features.
Network access service 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. These revenues for 1994 and 1993 were $670 million and $616 million, respectively. This reflects an increase of 9% or $54 million in 1994 compared to a decrease of 7% or $47 million in 1993. The 1994 increase is due to an 8% increase in minutes of use, driven in part by natural disasters in the first half of 1994, partially offset by lower rates while the 1993 decrease was primarily the result of lower interstate rates.
The Company's revenues for long distance services are provided under settlement arrangements with various telephone companies. These revenues were $961 million and $1.0 billion in 1994 and 1993, respectively. This reflects decreases of 4% or $43 million in 1994 and 2% or $19 million in 1993. The 1994 decrease is primarily due to rate reductions related to the price cap index and NRF review. The 1993 decrease was primarily due to a change in calling patterns.
Equipment sales and service revenues for 1994 and 1993 were $158 million and $164 million, respectively. This reflects decreases of 3% or $6 million in 1994 and 9% or $17 million in 1993. The 1994 decrease is primarily the result of a reduction in revenues related to the Cerritos project, GTE's testing facility in California for various video services, and a decline in revenues from sales and rental of single line and key telephone systems, partially offset by an increase in revenue from voice messaging services. The 1993 decrease was primarily the result of a decline in revenues related to the CALNET project, a large government contract for various video services, and a decline in revenues from sales and rental of single line and key telephone systems, partially offset by an increase in revenue from voice messaging services. Revenue from the CALNET project is recognized on the percentage of completion method.
Other operating revenues for 1994 and 1993 were $129 million and $116 million, respectively. This represents an increase of 11% or $13 million in 1994 compared to a decrease of 1% or $1 million in 1993. The 1994 increase is primarily due to the lower provisions for uncollectible accounts.
OPERATING EXPENSES
Cost of sales and services for 1994 and 1993 was $634 million and $667 million, respectively. This represents decreases of 5% or $33 million in 1994 and 2% or $12 million in 1993. These decreases are primarily the result of ongoing quality and cost control programs resulting in a reduction in workforce. The 1994 decrease also reflects lower switched access expenses and installation and maintenance costs. The 1993 decrease was partially offset by 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 $51 million.
Depreciation and amortization was $580 million and $583 million in 1994 and 1993, respectively. This reflects a decrease of 1% or $3 million in 1994 compared to an increase of 3% or $20 million in 1993. The 1994 decrease is primarily due to lower average depreciation rates partially offset by higher average plant balances. The 1993 increase was primarily due to higher average plant balances and depreciation rates.
Marketing, selling, general and administrative expenses were $842 million and $897 million in 1994 and 1993, respectively. The 1993 expenses include a one-time charge of $35 million associated with the enhanced early retirement and voluntary separation programs offered to eligible employees during the second quarter of 1993. Excluding this charge, marketing, selling, general and administrative expenses decreased 2% or $20 million and 4% or $40 million in 1994 and 1993, respectively. These decreases are primarily the result of ongoing quality and cost control programs resulting in a reduction in
workforce. The 1993 decrease was also due to lower advertising costs, partially offset by costs of $27 million associated with the adoption of SFAS No. 106.
OTHER (INCOME) DEDUCTIONS
Interest expense was $103 million and $121 million in 1994 and 1993, respectively. This represents a decrease of 15% or $18 million in 1994 and 8% or $10 million in 1993. These decreases are due to lower average long-term debt levels and lower average interest rates.
Income tax expense was $293 million and $71 million in 1994 and 1993, respectively. This reflects an increase of $222 million in 1994 compared to a decrease of $167 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 was cash from operations of $862 million in 1994 compared to $992 million in 1993. The decrease is primarily the result of an increase in receivables, partially offset by an increase in accounts payable and improved results from operations.
Capital expenditures represent the largest use of funds during 1994, reflecting the Company's continued growth in access lines and modernization of current facilities and provisioning of new products and services. The Company's capital expenditures during 1994 were $468 million compared to $504 million during 1993. The Company's construction costs for 1995 are expected to approximate those of 1994. During 1994, the Company received approximately $14 million of proceeds from the sale of 5,400 access lines in California to Citizens Utilities Company.
Cash used in financing activities was $377 million in 1994 compared to $506 million in 1993. The Company retired $36 million in long-term debt in 1994 compared to $176 million in 1993. In November 1993, the Company called $785 million of high-coupon first mortgage bonds with proceeds from commercial paper borrowings. These bonds had coupons ranging from 8.5% to 11%. The cost of calling these bonds was reflected as an extraordinary after-tax charge of $20.2 million in the Consolidated Statements of Income. In February, 1994, the Company issued $300 million of 5 5/8% Debentures, due 2001 to refinance a portion of the bonds being called. In March and April, 1994, respectively, the Company issued $250 million of 6 3/4% Debentures due 2004 and $250 million of 8.07% Debentures due 2024 to refinance commercial paper. Dividends of $370 million were paid to the shareholders in 1994 compared to $297 million in 1993.
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.
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 negotiated terms and conditions. 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
CONSOLIDATED STATEMENTS OF INCOME GTE California Incorporated and Subsidiary
(a) Includes billings to affiliates of $124,704, $136,800 and $135,043 for the years 1994 - 1992, respectively. (b) Includes billings from affiliates of $190,692, $174,743 and $178,125 for the years 1994 - 1992, respectively.
CONSOLIDATED STATEMENTS OF REINVESTED EARNINGS
See Notes to Consolidated Financial Statements.
CONSOLIDATED BALANCE SHEETS GTE California Incorporated and Subsidiary
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS GTE California Incorporated and Subsidiary
See Notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS GTE California Incorporated and Subsidiary
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of GTE California Incorporated (the Company) and its wholly-owned subsidiary, GTEL. 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 $81.9 million, $152.7 million and $126.0 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 $190.7 million, $174.7 million and $178.1 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 $124.7 million, $136.8 million and $135.0 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 California Public Utilities Commission (CPUC) and adopted by the Federal Communications Commission (FCC). The provisions for depreciation and amortization were equivalent to composite annual rates of 7.1%, 7.4% and 7.4% 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 CPUC 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. Long-term contracts are generally accounted for using the percentage-of-completion method with revenues recognized in the proportion that costs incurred bear to the estimated total costs to completion. Expected losses, if any, are charged to income currently.
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 $109 million. The estimated fair value of long-term debt as of December 31, 1993, exceeded the carrying value by approximately $9 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 $445.2 million, which reduced net income by $274.2 million, primarily for incremental costs related to implementation of the Company's three-year re-engineering plan. The re-engineering plan will redesign and streamline processes to improve customer-responsiveness and product quality, reduce the time necessary to introduce new products and services and further reduce costs. The re-engineering plan included $171.6 million to upgrade or replace existing customer service and administrative systems and enhance network software, $193.4 million for employee separation benefits associated with workforce reductions and $52.5 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 $113.4 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. The level of re-engineering activities and related expenditures are expected to accelerate in 1995.
During 1993, the Company offered various voluntary separation programs to its employees. These programs resulted in a pretax charge of $34.7 million which reduced net income by $21.2 million.
3. PROPERTY REPOSITIONING
On December 31, 1994 the Company sold 5,400 access lines in the state of California to Citizens Utilities Company for $14 million in cash. This represents less than 1% of the Company's access lines. The transaction was accounted for as a sale.
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:
* Thousands of Dollars
There were no retirements, redemptions or other activity for the years 1994-1992.
At the Company's option, these series of preferred stock are redeemable at premiums, in whole or in part, on thirty days notice.
The 4 1/2% Series (1945 issue) is entitled to one vote per share, with the right to vote cumulatively in the election of directors. Otherwise, the preferred shareholders have no voting rights.
No shares of preferred stock were reserved for officers and employees, or for options, warrants, conversions or other rights. The Company is not in arrears in its dividend payments at December 31, 1994.
5. COMMON STOCK
The authorized common stock of the Company consists of 100,000,000 shares with a par value of $20 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, $4.8 million was restricted as to the payment of cash dividends on common stock under the terms of the Articles of Incorporation.
6. LONG-TERM DEBT
Long-term debt outstanding, exclusive of current maturities, is as follows:
In November 1993, the Company called $785 million of high-coupon first mortgage bonds with proceeds from commercial paper borrowings. These bonds had coupons ranging from 8.5% to 11%. The cost of calling these bonds is reflected as an extraordinary after-tax charge of $20.2 million in the Consolidated Statements of Income. In February 1994, the Company issued $300 million of 5 5/8% Debentures, due 2001 to refinance a portion of the bonds being called. The Company issued in March and April of 1994, $250 million of 6 3/4% Debentures due 2004 and $250 million of 8.07% Debentures due 2024 also to refinance the bonds called.
The aggregate principal amounts of bonds and debentures that may be issued is subject to the restrictions and provisions of the Company's indentures. None of the securities shown above were held in sinking or other special funds of the Company or pledged by the Company.
Debt discount on the Company's outstanding long-term debt is amortized over the lives of the respective issues.
Maturities, installments and sinking fund requirements (excluding amounts to be satisfied by securities held by the Company) 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, which are generally refinanced at a later date, 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 $2.0 million. In addition, a $2.8 billion credit line is available to the Company through shared lines of credit with GTE and other affiliates. 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 taxes computed by applying the 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 net unamortized regulatory asset balance at December 31, 1994 of $57.1 million and the net unamortized regulatory asset balance at December 31, 1993 of $2.8 million are reflected as other assets 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 corporate debt securities.
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 regulatory adjustment reflects the use of the aggregate cost method as required by the CPUC and results in $310.0 million and $263.7 million at December 31, 1994 and 1993, respectively, being reflected in other deferred credits in the accompanying Consolidated Balance Sheets.
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 $888.3 million and $979.7 million and vested benefit obligations of $794.1 million and $887.5 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 $16.0 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% 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 $3.4 million and the accumulated postretirement benefit obligations at December 31, 1994 by $44.5 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 include, among others, newly established limits to the Company's annual contribution to postretirement medical costs and a revised cost sharing schedule based on a retiree's years of service. The net effect of these changes reduced the accumulated postretirement benefit obligations at December 31, 1993 by $132.7 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 $9.9 million, $10.2 million and $11.2 million in 1994-1992, respectively.
10. LEASE COMMITMENTS
The Company has noncancelable leases covering certain buildings, office space and equipment that contain varying renewal options for terms up to 26 years. Rental expense was $37.4 million, $31.3 million and $35.5 million in 1994-1992, respectively. Minimum rental commitments for noncancelable leases through 1999 do not exceed $14.0 million annually and aggregate $9.5 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 is subject to regulation by the FCC for interstate business and the CPUC for intrastate operations.
INTRASTATE SERVICES
Effective January 1, 1990 the CPUC adopted the new regulatory framework (NRF) for the Company. The new framework replaced the traditional "rate case" process with a framework that was centered around a Price Cap Index (PCI) mechanism with "sharing" of intrastate earnings (those earnings subject to the CPUC regulation) above a benchmark rate of return. This plan is designed to stimulate productivity and efficiencies with a portion of these gains flowing directly to the customer. In May 1992, the CPUC initiated a proceeding to review the NRF plan. On September 1, 1993, the CPUC ordered that modifications be made to the Company's NRF plan. Effective January 1, 1994, the Company is required to refund to customers all earnings over a 15.5% rate of return. As part of the settlement agreement approved by the CPUC, the CPUC eliminated the previous sharing mechanism where half of any earnings over the 13% rate of return benchmark would be refunded to ratepayers and the Company agreed to reduce its rates by $53 million. On December 17, 1993, the CPUC approved the Company's 1994 price cap index filing which resulted in a rate reduction of approximately $100 million. This reduction includes the $53 million rate reduction agreed to by the Company in the NRF review.
Under NRF, rates are adjusted annually by the PCI which is based on inflation minus a productivity improvement factor. Rates for partially competitive services (i.e. Centrex and custom calling features) may be priced below the price cap within a range set by the CPUC. Rates are also adjusted for exogenous events that are beyond the control of management as defined in this plan. Fully competitive services (eg., directory advertising) are not subject to pricing limits set by the CPUC.
The 1992 index adjustment resulted in a rate reduction of approximately $30 million, which the CPUC approved in an order issued December 18, 1991. The 1993 price cap index adjustment resulted in a rate increase of $11 million, which the CPUC approved in an order issued December 16, 1992. In 1992 and 1993 the Company refunded to its customers approximately $30 million and $33 million, respectively, in accordance with the "sharing mechanism" of the NRF. The refunds represented 50% of the Company's 1991 and 1992 intrastate earnings over the 13% rate of return benchmark.
In September 1994, the CPUC issued a final order that authorized intraLATA toll competition (without pre-subscription) in California, effective January 1, 1995. It also provides for rate rebalancing with significant rate reductions for toll service and access charges while increasing basic local exchange rates closer to the actual cost of providing such service. Specifically, the CPUC reduced rates for the Company's toll services by an average of 42% and its switched access rates by more than 50% while offsetting the revenue impacts by increasing other rates closer to cost. Monthly service rates for flat-rated residential customers increased from $11.21 to $17.25 while measured business customers rates increased from $10.46 to $19.22. Although the rate rebalancing is intended to be revenue neutral, its ultimate effect on revenue will depend, in part, on the extent to which rate reductions result in increased calling volumes. The decision does not permit rate
increases to compensate for competitive losses of market share. GTE believes that the CPUC has over-estimated the calling volume that will be stimulated by reduced toll rates and has requested reconsideration of this aspect of the decision.
The CPUC adopted pricing standards and contracting rules which provide the Company increased flexibility to respond to competition. Tariff prices for competitive services can be decreased on ten days notice from a pre-set ceiling and can subsequently be increased up to the ceiling on 30 days notice. Contracts can utilize a new "express contracting procedure" which allows contracts to be effective in 14 days rather than the 40 days previously required. In addition, "express contracts" do not require CPUC approval.
On October 12, 1994, the CPUC issued a decision which authorizes further proceedings to be held with regard to a previous Commission decision that adopted accrual accounting for SFAS 106. The previous CPUC decision permitted the Company recovery of its SFAS 106 costs as an exogenous factor in annual price cap filings. This decision reaffirmed the CPUC decision to adopt SFAS 106 for ratemaking purposes. However, the issue of exogenous recovery will be further reviewed and any revenues collected in rates subsequent to October 12, 1994, are subject to refund pending further investigation. The Company is currently recovering $42 million annually in rates for SFAS 106 costs. No amounts related to this matter have been reserved.
In December, 1994, the CPUC issued a decision which adopts an initial procedural plan to facilitate opening local exchange telecommunications markets to competition by January 1, 1997. This plan allows parties until March 31, 1995 to negotiate a settlement on implementation issues. If the parties are unable to resolve the issues, the CPUC will intervene. Concerns to be addressed include issuing two orders in early 1995 to resolve Open Network Architecture (ONA) technical issues on expanded interconnection and local transport restructure. The second order would adopt a methodology for developing long-run incremental cost studies. One docket will be launched addressing Universal Service Issues and another docket will be launched addressing pre-subscription issues. Interested parties will be allowed to provide recommendations on the scope and content of interim rules for local competition. The next NRF review proceeding will be initiated in May 1995, if no settlement can be reached.
On December 7, 1994, the CPUC issued Decision 94-12-003 approving and adopting, without modification, new depreciation rates for the Company effective January 1, 1995. This decision represents the Company's first uncontested approval of depreciation rates since the inception of the NRF.
In March 1991, the merger of the Company's parent, GTE, and Contel Corporation (Contel) was consummated. In a decision issued on March 13, 1991 the CPUC approved a stipulation agreement which tentatively approved the merger of GTE and Contel. The decision also established a second phase of the proceeding in which GTE was directed to show that the merger meets certain California statutory requirements. GTE was also ordered to submit a plan for the merger of the Contel and GTE regulated California subsidiaries. On September 14, 1992 the Company and Contel of California, Inc. joined with GTE and Contel in filing a comprehensive plan with the CPUC to merge Contel of California, Inc. into the Company.
On December 23, 1993, an Administrative Law Judge issued a proposed Phase II order allowing the merger of Contel of California, Inc. and the Company. The proposed order would add a third phase to the merger proceeding in which the issues of a start-up revenue requirement for Contel's pre-merger operations and rate integration of the respective company tariffs will be considered.
On April 20, 1994 the CPUC issued a decision giving final approval to the merger of Contel of California, Inc. into the Company. The decision requires the merging companies to flow through to their ratepayers all of the estimated savings that will be produced from the merger. This flow through requirement is based on the CPUC's interpretation of certain statutory requirements. The CPUC, however, provided the parties with the opportunity to supplement the evidentiary record to show why the estimated merger savings should be apportioned between ratepayers and shareholders. That filing was made on April 29, 1994. By making the filing, the effective date of the decision approving the merger has been delayed. The Company and other interested parties filed reports and comments pursuant to this proceeding.
INTERSTATE SERVICES
For the provision of interstate services, the Company operates under the terms of the FCC's price cap incentive plan. The "price cap" mechanism serves to limit the rates a carrier may charge, rather than just regulating the rate of return which may be achieved. Under this approach, the maximum price that the local exchange carrier (LEC) may charge is increased or decreased each year by a price index based upon inflation less a predetermined productivity target. LECs may, within certain ranges, price individual services above or below the overall cap.
As a safeguard under its 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 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, $6.3 million effective July 17, 1992, $17.6 million effective October 2, 1992 and $45.0 million effective December 15, 1992.
SIGNIFICANT CUSTOMER
Revenues received from AT&T Corp. include amounts for access, billing and collection and interexchange leased facilities revenues during the years 1994-1992 under various arrangements and amounted to $281.6 million, $282.4 million and $349.1 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:
14. QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized 1994 and 1993 quarterly financial data is as follows:
(a) Net income includes a $20.2 million extraordinary charge for the early retirement of debt. Income before extraordinary charge was $86.8 million. (b) Net operating income includes a $445.2 million pretax charge for restructuring costs which reduced net income by $274.2 million.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of GTE California Incorporated:
We have audited the accompanying consolidated balance sheets of GTE California Incorporated (a California 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 California 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 Accounts. 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 organization 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.
C. MICHAEL CRAWFORD 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
Reference is made to the Registrant's Proxy Statement covering the Annual Meeting of Shareholders to be held April 12, 1995, pages 3 and 4, which is incorporated herein by reference. A complete list of executive officers of the Registrant as of March 1, 1995 is provided below.
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.
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) 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.
(2) C. Michael Crawford was elected President replacing Larry J. Sparrow who was elected President - Carrier Markets of GTE Telephone Operations and Vice President - Carrier Markets of the Company.
3) Charles J. Somes was elected Secretary replacing Kenneth J. Okel who was appointed Assistant Vice President and Associate General Counsel - Regional Operations - Western, GTE Telephone Operations.
Item 11.

Item 11. Executive Compensation
Reference is made to the Registrant's Proxy Statement covering the Annual Meeting of Shareholders to be held April 12, 1995, pages 4 to 16, which is incorporated herein by reference.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management
Reference is made to the Registrant's Proxy Statement covering the Annual Meeting of Shareholders to be held April 12, 1995, page 16, which is incorporated herein by reference.
Item 13.

Item 13. Certain Relationships and Related Transactions
Reference is made to the Registrant's Proxy Statement covering the Annual Meeting of Shareholders to be held April 12, 1995, pages 3, 4 and 17, which is incorporated herein by reference.
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) Financial Statements - See GTE California 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 the one 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.
2.1* Agreement of Merger, dated September 10, 1992 between GTE California Incorporated and Contel of California, Inc. (Exhibit 2.1 of the 1993 Form 10-K. File No. 1-6417).
3* Articles of Incorporation and Bylaws (Exhibit 3 of the 1988 Form 10-K, File No. 1-6417).
4* Indenture dated as of December 1, 1993 between GTE California Incorporated and Bank of America National Trust and Savings Association, as Trustee (Exhibit 4.1 of the Company's Registration Statement on Form S-3, File No. 33-51541).
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 CALIFORNIA 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 CALIFORNIA INCORPORATED ----------------------------- (Registrant)
Date March 24, 1995 By C. MICHAEL CRAWFORD -------------- ----------------------------------- C. MICHAEL CRAWFORD 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.
EXHIBIT INDEX -------------
2.1* Agreement of Merger, dated September 10, 1992 between GTE California Incorporated and Contel of California, Inc. (Exhibit 2.1 of the 1993 Form 10-K. File No. 1-6417).
3* Articles of Incorporation and Bylaws (Exhibit 3 of the 1988 Form 10-K, File No. 1-6417).
4* Indenture dated as of December 1, 1993 between GTE California Incorporated and Bank of America National Trust and Savings Association, as Trustee (Exhibit 4.1 of the Company's Registration Statement on Form S-3, File No. 33-51541).
27 Financial Data Schedule.
* Denotes exhibits incorporated herein by reference to previous filings with the Securities and Exchange Commission as designated.


Item 1. Business
(a) General Development of Business
The Company was founded as a partnership in 1901. It was incorporated in Missouri in 1902 and reincorporated in Delaware in 1969. Its corporate headquarters are located in Kansas City, Missouri, and principal plants and offices are operated throughout the continental United States. Principal international operations are conducted through Butler Building Systems, Ltd., a wholly owned United Kingdom subsidiary acquired in 1991, and a Saudi Arabian joint venture.
The Company and its subsidiaries are primarily engaged in the design, manufacture and sale of systems and components for nonresidential structures. Products and services fall into three principal business segments: (1) Building Systems, consisting primarily of custom designed and pre-engineered steel and wood frame building systems for commercial, community, industrial and agricultural uses; (2) Construction and construction management services for purchasers of large, complex or multiple site building projects; and (3) Other Building Products for low, medium and high-rise nonresidential buildings, consisting primarily of curtain wall and storefront systems, skylights and roof vents. This group also includes the manufacture and sale of grain storage bins and the distribution of grain handling and conditioning equipment.
The Company's products are sold primarily through numerous independent dealers. Other Company products are sold through a variety of distribution arrangements.
(b) Financial Information about Industry Segments
The information required by Item 1(b) is hereby incorporated by reference to page 20 and 21 of the Company's Annual Report furnished to the Commission pursuant to Rule 14a-3(b) and attached as Exhibit 13.0 to this report (see also items 6, 7, and 8 of this report).
(c) Narrative Description of Business
Building Systems The Company's largest segment, Building Systems, includes the U.S. steel and wood frame pre-engineered building systems; Butler European operations consisting of 100% wholly owned subsidiaries in the United Kingdom, France, and Germany; and a 30% owned Saudi Arabian joint venture (Saudi Building Systems, Ltd.), all of which manufacture and market pre-engineered steel frame building systems; Butler Real Estate, Inc. a real estate developer; a 45% owned Japanese joint venture marketing pre-engineered building systems to Japanese firms to meet their U.S. and international building requirements; sales offices in Canada and Mexico; and representative offices in China.
The Company's building systems consist primarily of custom designed and pre-engineered one to five-story steel and one to two-story wood framed buildings for commercial, community, industrial and agricultural uses such as office buildings, manufacturing facilities, warehouses, schools, shopping centers and farm buildings. Principal product components of the systems are structural members and a variety of pre-engineered wall and roof components. These are fabricated according to standard or customer specifications and shipped to building sites for
assembly by independent dealers. Building components are manufactured in plants located at Galesburg and Charleston, Illinois; Laurinburg, North Carolina; Birmingham, Alabama; Visalia, California; Annville, Pennsylvania; San Marcos, Texas; Lester Prairie, Minnesota; Ottawa, Kansas; and Clear Brook, Virginia.
Butler Building Systems, Ltd. manufactures and markets the Company's pre-engineered steel frame buildings primarily for the United Kingdom and European markets from its facility in Kirkcaldy, Scotland. Saudi Building Systems, Ltd. manufactures and markets pre-engineered steel frame buildings for Middle Eastern markets at manufacturing facilities located in Jeddah, Saudi Arabia. The Company serves the Canadian market through a branch office in Burlington, Ontario.
Building Systems' products are distributed throughout the world by independent Butler dealers. The dealers provide construction services and in many cases complete design and engineering capabilities.
Nonresidential pre-engineered buildings compete with ordinary forms of building construction in the low-rise commercial, community, industrial and agricultural markets. Competition is primarily based upon cost, time of construction, appearance, thermal efficiency and other specific customer requirements.
The Company also competes with numerous pre-engineered steel frame building manufacturers doing business within the United States, Canada, and the United Kingdom. Approximately five of these manufacturers account for the majority of industry sales. The Company believes that its 1994 sales of steel frame pre-engineered buildings within the United States exceeded those of any other nonresidential steel frame pre-engineered buildings manufacturer, with its next largest competitors being Varco-Pruden Buildings, a division of United Dominion Industries Ltd., Ceco and Star Buildings Systems combined, a division of Robertson - Ceco Corporation, American Buildings Company, and NCI Building Systems, Inc. Competition among manufacturers of pre-engineered buildings is based primarily upon price, service, product design and performance, and marketing capabilities.
The Company's Lester wood frame buildings business ranks second in sales to the industry leader, Morton Buildings, Inc., a major manufacturer which sells direct to the end user.
Butler Real Estate, Inc., a wholly-owned subsidiary of the Company, provides real estate development services in cooperation with Butler dealers. On the basis of commitments to lease obtained from credit worthy customers, Butler Real Estate, Inc. acquires building sites, arranges with Butler dealers for construction of project improvements, and then sells the completed projects to investors.
BMC Real Estate, Inc., a wholly-owned subsidiary of the Company, participates solely in four land development ventures. Three of the ventures are partnerships with ownership interests ranging from 35% to 50%. The fourth venture is wholly-owned.
Construction Services The Company's Construction Services segment consists of a wholly-owned construction subsidiary, BUCON, Inc. which provides comprehensive design, planning, execution and construction management services to major purchasers of construction. Revenues of the segment are derived primarily from general contracting. In addition, the Construction
Services segment performs "furnish and erect" and "materials only" subcontracts using products from several Company divisions, predominantly the Company's Buildings Division. Competition is primarily based upon price, time necessary to complete a project, design, and product performance. Construction Services competes with national, regional, and local general contracting firms, and whenever possible, performs projects in conjunction with independent Butler dealers.
Other Building Products This segment includes the operations of the Vistawall, Walker and Grain Systems Divisions. The Walker business was sold December 6, 1993. The Vistawall business designs, manufactures and markets architecturally oriented component systems for the nonresidential construction market. The Grain Systems' business manufactures and markets grain storage bins and also distributes grain conditioning and handling equipment.
The Vistawall Division designs, manufactures and sells aluminum curtain wall systems for mid and high-rise office markets, and entry doors and other standard storefront products for low-rise retail and commercial markets. The products are distributed on a material supply basis to either curtain wall erection subcontractors or general contractors, and through distribution warehouses to glazing contractors for the storefront and entry door products. Manufacturing and distribution facilities are located in Lincoln, Rhode Island; Atlanta, Georgia; Modesto and Hayward, California; Cincinnati and Cleveland, Ohio; Terrell, Houston and Dallas, Texas; Tampa, Florida; Washington, D.C.; Chicago, Illinois; and St. Louis, Missouri. The Division operates in highly competitive markets with other national manufacturers which operate multiple plants and distribution facilities, and with regional manufacturers. Competition is primarily based on cost, delivery capabilities, appearance and other specific customer requirements.
The Vistawall Division at its Terrell, Texas location also designs, manufactures and installs Naturalite skylights of all types, from the more standard designs used in commercial and industrial buildings, to highly complex engineered solutions for monumental building projects. In addition, the Division designs and manufactures roof accessories, such as smoke and heat vents, for conventional and pre-engineered buildings. The Division markets its Naturalite products through its existing independent representative organization. There are numerous competitors in this industry with competition primarily based on price, engineering and installation capabilities, delivery, and other specific customer requirements.
The Walker Division, which was sold to The Wiremold Company in December, 1993, manufactured a full array of power, lighting, electronics and communication distribution systems for office, retail, and institutional buildings. Principal products consisted of underfloor duct and cellular floor systems.
The Grain Systems Division manufactures and markets grain storage bins from its Kansas City, Missouri plant. It also distributes grain conditioning and handling equipment. The Division's products are sold primarily to farmers and commercial grain elevators through a nationwide network of independent dealers. Products are also manufactured for export. Grain systems are sold in highly competitive markets in direct competition with national companies and smaller regional manufacturers. Competition is principally based on price,
delivery schedules, and product performance.
Manufacturing and Materials The Company's manufacturing operations include most conventional metal fabricating operations, such as punching, shearing, welding, extruding and forming of sheet and structural steel and aluminum. The Company also operates painting and anodizing lines for structural steel and aluminum components, respectively. Wood frame manufacturing operations include sawing and truss fabrication. The principal materials used in the manufacture of the Company's products include steel, aluminum, wood, and purchased parts. All materials are presently available to the Company in sufficient quantities to meet current needs.
Seasonal Business Historically, the Company's sales and net earnings have been affected by cycles in the general economy which influence nonresidential construction markets (see in particular Item 7 of this report). In addition, the Company's sales usually reach a peak during the summer when construction activity is highest. Sales for the first, second, third and fourth quarters of 1994 were $117 million, $175 million, $190 million and $210 million, respectively.
Backlog The Company's backlog of orders believed to be firm was $237 million at December 31, 1994 and $140 million at December 31, 1993. The Construction Services segment, where margins are significantly lower than those associated with product sales, accounted for $33 million of the year-end 1994 backlog and $25 million of the year-end 1993 backlog.
Employees At December 31, 1994 the Company employed 3,564 persons, 2,565 of whom were non-union employees, and 999 were hourly paid employees who were members of four unions. At December 31, 1993 the Company employed 3,064 persons. A labor agreement with the union at the Buildings Division Galesburg, Illinois plant will expire in 1995.
Item 2.

Item 2. Properties
The principal plants and physical properties of the Company consist of the manufacturing facilities described under Item 1, and the Company's executive offices in Kansas City. The 142,000 square foot Vistawall facility located in Lincoln, Rhode Island which has light manufacturing and fabrication operations is classified under "Assets held for sale". The 144,000 square foot Garland, Texas facility previously used for the operations of Naturalite was sold in January, 1995 and was recorded in "Investments and other assets". The proceeds from the sale were used to retire the existing mortgage on the property. Through a subsidiary, the Company also owns a land development venture with property located on a 108 acre site in San Marcos, Texas. The property is recorded in "Assets held for sale" and described in the "Real Estate Subsidiaries" footnote on page 19 in the Company's Annual Report. All other plants and offices described under Item 1 are utilized by the Company and are generally suitable and adequate for the business activity conducted therein. The Company's manufacturing facilities described under Item 1, along with current outsourcing agreements with various fabricators, have production capabilities sufficient to meet current and foreseeable needs.
Except for leased facilities listed below, all of the Company's principal plants and offices are owned:
(1) Leased space used for the Company's executive offices in Kansas City, Missouri (104,524 sq. ft. lease expiring in the year 2001 with an option to renew).
(2) Leased space used for the Vistawall Division plant in Terrell, Texas (145,000 sq. ft. and 121,000 sq. ft. with leases expiring in 2006 and 1995, respectively, both containing options to renew), and fabrication and distribution facilities in Dallas and Houston, Texas; St. Louis, Missouri; Chicago, Illinois; Washington, D.C.; Cincinnati and Cleveland, Ohio; Atlanta, Georgia; Tampa, Florida; and Modesto and Hayward, California (215,000 sq. ft. leased with various expiration dates).
Item 3.

Item 3. Legal Proceedings.
There are no material legal or environmental proceedings pending as of March 9, 1995. Proceedings which are pending consist of matters normally incident to the business conducted by the Company and taken together do not appear to be material.
Item 4.

Item 4. Submissions of Matters to a Vote of Security Holders.
No matters have been submitted to a vote of stockholders since the last annual meeting of shareholders on April 19, 1994.
PART II
Item 5.

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Incorporated by reference to the information under "Quarterly Financial Information (Unaudited)", "Price Range of Common Stock (Unaudited)" and "Historical Review 1994-1990" on pages 26 and 28 of the Annual Report.
In September, 1994 the Board of Directors approved the resumption of a regular cash dividend, at an indicated annual rate of 40 cents per share. The initial 10 cent quarterly payment was made in October 1994. The Company has limited restrictions on the payment of dividends based on certain debt covenants of the Note Agreement dated June 1, 1994, between the Company and four insurance companies (incorporated by reference to the Form 10-Q for the quarter ended June 30, 1994, as indicated under Item 14). As of December 31, 1994 the Company had approximately $23.4 million of retained earnings available for cash dividends.
Item 6.

Item 6. Selected Financial Data.
Incorporated by reference to the information under "Historical Review 1994-1990" on page 28 of the Annual Report.
Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Incorporated by reference to the information under "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 12 and 13 of the Annual Report.
Item 8.

Item 8. Financial Statements and Supplementary Data.
Incorporated by reference to the consolidated financial statements and related notes on pages 14 through 27 of the Annual Report.
Item 9.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Not applicable.
PART III
Item 10.

Item 10. Directors and Executive Officers of the Registrant.
Information as to Directors is incorporated herein by reference to pages 3 through 5 of the Proxy Statement. The Executive Officers, their ages, their positions and offices with the Company and their principal occupations during the past five years are shown below:
Corporate Executive Officers
Robert H. West - age 56, Chairman of the Board and Chief Executive Officer; Chairman of the Executive Committee and member of the Board Organization Committee. He joined the Company in 1968, became President in 1978 and Chairman of the Board in 1986. Mr. West is a director of Commerce Bancshares, Inc., Santa Fe Pacific Corp., Kansas City Power & Light Company, and St. Luke's Hospital. He is a trustee of the University of Missouri at Kansas City.
Donald H. Pratt - age 57, President; member of the Executive Committee. He joined Butler in 1965, became Executive Vice President in 1980, and President of the Company in 1986. Mr. Pratt is also a director of Union Bancshares, Inc., Wichita, Kansas, and is a trustee of the Kansas City Art Institute and Midwest Research Institute. He serves on the FFA Sponsors Advisory Board.
Richard O. Ballentine - age 58, Vice President, General Counsel, and Secretary since 1978. He joined Butler in 1975 as Vice President - Legal.
John T. Cole - age 44, Controller since 1990. He joined Butler in 1977 and previously was Corporate Audit Manager.
John J. Holland - age 44, Vice President - Finance since 1990. He joined Butler in 1980 and became Vice President - Controller in 1986.
John W. Huey - age 47, Vice President - Administration since 1993 and Assistant Secretary since 1987. He joined Butler in 1978 and was previously Assistant General Counsel.
Larry C. Miller - age 38, Treasurer since 1989. He joined Butler in 1980 and became Assistant Treasurer in 1985.
Division Executive Officers
Moufid (Mike) Alossi - age 52, President, Butler World Trade since 1993. He joined Butler in 1968 and previously was Vice President-International Sales and Marketing.
William D. Chapman - age 52, President, International Operations since 1992. He joined Butler in 1979 and was previously Vice President, International Operations.
Thomas J. Hall - age 49, President, Butler Real Estate, Inc. since 1991. He joined Butler in 1969, and was named Vice President and General Manager of Butler Real Estate, Inc. in 1987.
Larry D. Hayes - age 56, President, Lester Building Systems Division since 1991. He joined Butler in 1975 and previously was President, Rural Systems Division.
Richard S. Jarman - age 48, President, Buildings Division since 1986. He joined Butler in 1974.
William L. Johnsmeyer - age 47, President Butler Construction (Bucon, Inc.) since 1990. He joined Butler in 1982 and became President, Walker Division in 1984.
Robert J. Kronschnabel - age 59, President, Grain Systems Division since 1994. He joined Butler in 1979 and was previously President, Naturalite/EPI in 1988 and became Vice President and General Manager, Grain Systems Division in 1991.
Nelson R. Markel - age 48, Managing Director, Butler Europe since 1991 and was previously Marketing Manager, Buildings Division.
Ronald F. Rutledge - age 53, President Vistawall Division since 1984 when he joined Butler.
Item 11.

Item 11. Executive Compensation.
Incorporated by reference to the information under "Report on Executive Compensation", "Summary Compensation Table" and "Aggregated Option/SAR Exercises and Fiscal Year-End Option/SAR Value Table" on pages 7 through 11 of the Proxy Statement.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management.
Incorporated by reference to the information under "Beneficial Ownership Table" on pages 13 and 14 of the Proxy Statement.
Item 13.

Item 13. Certain Relationships and Related Transactions.
Incorporated by reference to the information under "Election of Class C Directors" on pages 2 through 9 and "Report on Executive Compensation" in the Proxy Statement.
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
The following documents are filed as part of this report:
(a) Financial Statements:
Consolidated Balance Sheets as of December 31, 1994 and 1993.
Consolidated Statements of Earnings and Retained Earnings - Years Ended December 31, 1994, 1993 and 1992.
Consolidated Statements of Cash Flow - Years Ended December 31, 1994, 1993 and 1992.
Notes to Consolidated Financial Statements.
The foregoing have been incorporated by reference to the Annual Report as indicated under Item 8.
(b) Financial Statement Schedules:
Auditors' Report on Financial Statement Schedule
IX - Valuation and Qualifying Accounts
All other schedules are omitted because they are not applicable or the information is contained in the consolidated financial statements or notes thereto.
(c) Exhibits:
3.1 Certificate of Incorporation (incorporated by reference to Exhibit 3.5 to Company's Form 10-K for year ended, December 31, 1986).
3.2 Bylaws of Butler Manufacturing Company (incorporated by reference to Exhibit 3.7 to Company's Form 10-K for year ended December 31, 1987).
4.1 Note Agreement between the Company and four Insurance Companies dated as of June 1, 1994 (incorporated by reference to Exhibit 4 of the Company's Form 10-Q for the quarter ended June 30, 1994).
10.1 Butler Manufacturing Company Executive Deferred Compensation Plan as amended (incorporated by reference to Exhibit 10.2 to the Company's Form 10-K for the year ended December 31, 1989).
10.2 Butler Manufacturing Company Stock Incentive Plan for 1987, as amended (incorporated by reference to Exhibit 10.1 to the Company's Form 10-K for the year ended December 31, 1990).
10.3 Butler Manufacturing Company Stock Incentive Plan of 1979, as amended (incorporated by reference to Exhibit 10.2 to the Company's Form 10-K for the year ended December 31, 1990).
10.4 Form of Change of Control Employment Agreements, as amended, between the Company and each of six executive officers (incorporated by reference to Exhibit 10.3 to the Company's Form 10-K for the year ended December 31,1990).
10.5 Copy of Butler Manufacturing Company Supplemental Benefit Plan as amended and restated.
10.6 Form of Butler Manufacturing Company Split Dollar Life Insurance Agreement (Collateral Assignment Method; Bonus Arrangement) entered into between the Company and certain executive officers.
10.7 Form of Butler Manufacturing Company Split Dollar Life Insurance Agreement (Collateral Assignment Method; Roll Out Arrangement) entered into between the Company and certain executive officers.
13.0 Butler Manufacturing Company 1994 Annual Report (only the information expressly incorporated herein by reference).
22.0 Set forth below is a list as of March 9, 1995 of subsidiaries of the Company and their respective jurisdictions of incorporation. Subsidiaries not listed, when considered in the aggregate as a single subsidiary, do not constitute a significant subsidiary.
Jurisdiction of Subsidiary Incorporation ---------- ------------- Butler Export, Inc. Barbados Butler Building Systems, Ltd. Scotland Butler Bausysteme GmbH Germany Butler Systemes de Construction SARL France BMC Real Estate, Inc. Delaware BUCON, Inc. Delaware Butler Real Estate, Inc. Delaware Butler Holdings, Inc. Delaware Lester's of Minnesota, Inc. Minnesota
24.0 Power of Attorney to sign this Report by each director.
27.0 Financial Data Schedule
No reports on Form 8-K were filed by the Company during the quarter ended December 31, 1994.
The calculation of the aggregate market value of the Common Stock of the Company held by non-affiliates as reflected on the front of the cover page is based on the assumption that non-affiliates do not include directors. Such assumption does not reflect a belief by the Company or any director that any director is an affiliate of the Company.
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 on this 8th day of March, 1995.
BUTLER MANUFACTURING COMPANY
BY /S/ Robert H. West --------------------------------- Robert H. West Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities indicated on the dates indicated.
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors Butler Manufacturing Company
We consent to the incorporation by reference in Registration Statements Nos. 33-14464, 2-63830, 2-55753 and 2-36370 on Form S-8 and the related Prospectus dated June 11, 1987, with Appendix dated March 7, 1995, of Butler Manufacturing Company of our report dated February 3, 1995 which contained an explanatory paragraph regarding the adoption of Statements of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" and No. 109, "Accounting for Income Taxes", relating to the consolidated balance sheets of Butler Manufacturing Company and subsidiaries as of December 31, 1994, and 1993, and the related consolidated statements of earnings and retained earnings and cash flows and the related schedule for each of the years in the three-year period ended December 31, 1994, which reports appear in or are incorporated by reference in the Annual Report on Form 10-K of Butler Manufacturing Company for the fiscal year ended December 31, 1994. We also consent to the reference to our firm under the heading "Experts" in the Prospectus to the Registration Statements.
/S/ KPMG PEAT MARWICK LLP ------------------------- KPMG PEAT MARWICK LLP Kansas City, Missouri March 24, 1995
BUTLER MANUFACTURING COMPANY AND SUBSIDIARIES KANSAS CITY, MISSOURI
Consolidated Financial Statement Schedules (Form 10-K)
December 31, 1994, 1993 and 1992
(With Auditors' Report Thereon)
INDEPENDENT AUDITORS' REPORT
The Board of Directors Butler Manufacturing Company:
Under date of February 3, 1995, we reported on the consolidated balance sheets of Butler Manufacturing Company and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of earnings and retained earnings and cash flows for each of the years in the three-year period ended December 31, 1994, as contained in the 1994 Annual Report. That report included an explanatory paragraph regarding the adoption of Statements of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" and No. 109, "Accounting for Income Taxes". These consolidated financial statements and our report thereon are incorporated by reference in the Annual Report on Form 10-K for the year 1994. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule as listed in item 14. This consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this consolidated financial statement schedule based on our audits.
In our opinion, such schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material aspects, the information set forth therein.
/S/ KPMG PEAT MARWICK LLP ------------------------- KPMG PEAT MARWICK LLP Kansas City, Missouri February 3, 1995
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SCHEDULE IX
BUTLER MANUFACTURING COMPANY AND SUBSIDIARIES
Valuation and Qualifying Accounts
(Thousands of Dollars)
(A) Includes acquisition and disposition of divisions and subsidiaries.
(B) "Credited to earnings" reflects adjustments to the original estimated loss provision for receivables. This adjustment is due to a reassessment of the collection status of trade receivables made during the year.
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