Item 1. BUSINESS
The Registrant ("Trust") owns in fee, mineral and non-mineral lands on the Mesabi Iron Range of Minnesota. Income is derived through royalties on iron ore minerals (principally taconite) taken from these properties by lessees. The Registrant is presently involved solely with the leasing and care of these properties. There have been no significant changes in these functions since the beginning of the fiscal year.
The raw materials essential to the business of the Registrant are the minerals contained in properties owned and leased by the Registrant. Since the Registrant leases its properties to mining interests which control the amount of ore production, the Registrant itself has no control over the tonnage mined from its properties but is solely involved with administering the leases on the properties. Since operating companies insist on freedom to move from property to property as mining requirements dictate, such changes in production cannot be reduced to financial forecasts.
Registrant owns mineral interests in 12,033 acres on the Mesabi Iron Formation, including approximately 7,443 acres which are wholly owned, 1,080 acres in which Registrant is a tenant in common with a 91% interest, 3,350 acres in tenancy in common with a 50% interest and 160 acres in tenancy in common with other fractional interests. Of said total, 7,112 acres are under lease and 4,921 acres are unleased.
Registrant cannot estimate at this time any tonnages for nonmagnetic taconite because of lack of drilling, testing and of any established commercial treatment method for Mesabi Iron Range nonmagnetic taconite. To give a better perspective on magnetic taconite, Registrant's engineers estimate that the magnetic taconite under lease as of January 1, 1997 was equivalent to 403,300,000 tons of pellets.
Present leases provide for minimum payments (advance royalties) aggregating approximately $1,688,000 for the year 1997 even if no taconite is mined. All of this amount is attributable to long-term taconite leases.
None of the Registrant's leases provide for any right of renewal by the lessees upon expiration, even though unmined minerals might remain. Any extension of any such terminating lease would have to be negotiated in the same manner as unleased properties.
All leases granted by the Registrant, except some covering remnants of natural ore, have provisions for escalation of royalty rates. Most of the taconite royalty rates are escalated on the basis of the price of pellets, the iron content, the Producers Price Index (PPI) (All Commodities), the PPI (Iron and Steel subgroup) or certain combinations of the above.
Firm data on competitive conditions in the iron ore industry are not available. Iron ore is also available from a number of other sources. The Registrant's non-taconite shipments have ceased as a source of income because the ore deposits have, for practical purposes, been exhausted. The mining of taconite by lessees is the most important part of the Registrant's business. Future development depends, to a large part, on the demand for taconite from the Registrant's properties by mining companies.
The Registrant's royalty income is dependent on the number of tons of taconite shipped from its properties by the lessees, royalty rates, advance royalties collected and liquidation of advance royalties collected. Following is a summary of shipments by lessee during 1996, 1995 and 1994:
TONS SHIPPED ------------------------------------------- 1996 1995 1994 -------------------------------------------
United States Steel Corporation (USX) 2,739,614 1,637,165 1,118,136 Hibbing Taconite Company 1,890,509 3,381,057 2,953,027 National Steel Corporation 1,349,404 979,125 115,581 LTV Steel Mining Company - - 22,807 ------------------------------------------- 5,979,527 5,997,347 4,209,551 ===========================================
At December 31, 1996, the Registrant employed 11 persons. The Registrant has been engaged in only one line of business, namely the leasing and maintenance of its mineral properties. The business of the Registrant is not seasonal, but income depends upon production by mining companies which lease its properties. The Registrant has no operations in foreign countries and has no customers or lessees in foreign countries.
As previously reported, Section 646 of the Tax Reform Act of 1986, as amended, provided a special elective provision under which the Trust was allowed to convert from taxation as a corporation to that of a grantor trust. Pursuant to an Order of the Ramsey County District Court, the Trustees filed the Section 646 election with the Internal Revenue Service on December 30, 1988. On January 1, 1989, the Trust became exempt from federal and Minnesota corporate income taxes. For years 1989 and thereafter, certificate holders are taxed on their allocable share of the Trust's income whether or not the income is distributed. For certificate holder tax purposes, the Trust's income is determined on an annual basis, one-fourth then being allocated to each quarterly record date.
The Trustees provided annual tax information in January 1997 to certificate holders of record with holdings on any of the four quarterly record dates during 1996. This information included a:
Substitute Form 1099-MISC - This form reported one's 1996 allocable share of income from the Trust, distributions declared and any taxes withheld. (Foreign certificate holders received a Form 1042S.)
Trust Supplemental Statement - This statement reported the number of units (shares) held on any of the four quarterly record dates in 1996.
Tax Return Guide - This guide instructed the certificate holder as to the preparation of their income tax returns with respect to income allocated from the Trust and various deductions allowable.
The following is a listing of the Registrant's current leases:
Item 2.

Item 2. PROPERTIES
The Registrant owns in fee, mineral and nonmineral lands on the Mesabi Iron Range of Minnesota, most of which are leased to mining companies who extract taconite. Taconite deposits are substantial.
Item 3.

Item 3. LEGAL PROCEEDINGS
In proceedings commenced in 1972, the Minnesota Supreme Court determined that while by the terms of the Trust, the Trustees are given discretionary powers to convert Trust assets to cash and to distribute the proceeds to certificate holders, they are limited in their exercise of those powers by the legal duty imposed by well established law of trusts to serve the interests of both term beneficiaries and the reversionary beneficiary with impartiality. Thus, the Trustees have no duty to exercise the powers of sale and distribution unless required to do so to serve both term and reversionary interests; and if the need arises, the Trustees may petition the District Court of Ramsey County, Minnesota, for further instructions defining what is required in a particular case to balance the interests of certificate holders and reversioner. Also, the Court, in effect, held that the Trust is a conventional trust, rather than a business trust, and must operate within the framework of well established trust law.
By a letter dated March 22, 1996, certificate holders of record as of March 6, 1996 and the reversioner were notified of a hearing on April 16, 1996 in Ramsey County Courthouse, Saint Paul, Minnesota, for the purpose of settling and allowing the Trust accounts for the year 1995. By Court Order signed and dated April 16, 1996, the said accounts were settled and allowed in all respects. By previous Orders, the Court settled and allowed the accounts of the Trustees for preceding years of the Trust.
Item 4.

Item 4. SUBMISSION OF MATTERS TO A VOTE OF CERTIFICATE HOLDERS
None.
PART II
Item 5.

Item 5. MARKET FOR THE REGISTRANT'S SHARES OF BENEFICIAL INTEREST AND RELATED SECURITY HOLDER MATTERS
Shares of Beneficial Interest, Market Prices and Distributions on pages 3 and 4 of the annual report to certificate holders for the year ended December 31, 1996 are incorporated herein by reference.
Item 6.

Item 6. SELECTED FINANCIAL DATA
Selected Financial Data on page 2 of the annual report to certificate holders for the year ended December 31, 1996 is incorporated herein by reference.
Item 7.

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of Operations on page 2 of the annual report to certificate holders for the year ended December 31, 1996 are incorporated herein by reference.
Item 8.

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements of the Registrant, included in the annual report to certificate holders for the year ended December 31, 1996, are incorporated herein by reference:
Balance Sheets--December 31, 1996 and 1995.
Statements of Income--Years ended December 31, 1996, 1995 and 1994.
Statements of Beneficiaries' Equity--Years ended December 31, 1996, 1995 and 1994.
Statements of Cash Flows--Years ended December 31, 1996, 1995 and 1994.
Notes to Financial Statements--December 31, 1996.
Quarterly Results of Operations on page 4 of the annual report to certificate holders for the year ended December 31, 1996 are incorporated herein by reference.
Item 9.

Item 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
Item 10.

Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Registrant, being a trust, has no directors as such. The management of the Trust is vested in the following trustees and officers whose terms of office are not fixed for a specified time:
YEARS OF NAME AND POSITION AGE SERVICE ----------------------------------------------------------------------
Harry L. Holtz President of the Trustees 78 25 years Joseph S. Micallef Trustee 63 20 Roger W. Staehle Trustee 63 15 Robert A. Stein Trustee 58 15 Thomas A. Janochoski Vice President and Secretary 38 5
Principal occupations of Trustees and officers during the last five years:
HARRY L. HOLTZ President and Chief Executive Officer, Great Northern Iron Ore Properties.
JOSEPH S. MICALLEF Consultant and Director, Fiduciary Counselling, Inc., St. Paul, Minnesota; Advisory Director, First Trust National Association until February 27, 1996; President and Chief Executive Officer, Fiduciary Counselling, Inc., St. Paul, Minnesota until December 31, 1995.
ROGER W. STAEHLE Adjunct Professor, Institute of Technology, University of Minnesota; Industrial Consultant.
ROBERT A. STEIN Executive Director and Chief Operating Officer, American Bar Association; Dean of the Law School, University of Minnesota until December 31, 1994.
THOMAS A. JANOCHOSKI Vice President and Secretary, Chief Financial Officer, Great Northern Iron Ore Properties.
Executive employees in addition to those listed above include Roger P. Johnson, Manager of Mines and Chief Engineer.
There are no family relationships among any of the above persons.
Item 11.

Item 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION ----------------------------- NAME AND PRINCIPAL POSITION YEAR SALARY BONUS --------------------------------------------------------------------
Harry L. Holtz, CEO and President of the Trustees 1996 $80,000 $35,000 1995 80,000 35,000 1994 80,000 25,746
The Trust Agreement (as modified by Court Orders) currently provides for annual compensation to the President of the Trustees of $80,000 and, in addition, a sum equal to one percent of the excess of the gross income of the Trust over $5,000,000 for that year until his annual compensation shall reach $115,000. No other executive's compensation exceeds $100,000. The Trustees, including the President, are not eligible to receive retirement benefits based on their services as Trustees. There are no options, SARs, long-term performance-based incentive plans or retirement benefits applicable to the CEO or the Trustees and, accordingly, disclosure tables with respect to such benefits have been omitted.
COMPENSATION OF TRUSTEES
The Trust Agreement (as modified by Court Orders) currently provides for annual compensation to each Trustee (other than the President) of $30,000, without any additional amounts payable for committee participation or special assignments. There are no other arrangements pursuant to which any Trustee was compensated for any services provided as a Trustee during the year.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Because the compensation of the Trustees and the Chief Executive Officer is established by the Trust Agreement (as modified by Court Orders), there is no compensation committee of the Trustees and there is no Trustee compensation committee report on executive compensation. The Board of Trustees, as a whole, determines the compensation of executive officers other than the President and Chief Executive Officer.
Item 12.

Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
(a) The only authorized securities of the Registrant are Trustees' Certificates of Beneficial Interest and the holders of these securities do not have voting rights. Entities holding more than 5% of the Certificates of Beneficial Interest outstanding, of record and/or beneficially, include:
NAME SECURITIES HELD % OF CLASS -------------------------------------------------------------
First Bank System, Inc. 77,816 5.19%
(b) There were no securities owned by the Trustees or officers as of December 31, 1996.
Item 13.

Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
PART IV
Item 14.

Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) and (2)--The response to this portion of Item 14 is submitted as a separate section of this report.
(3) Listing of Exhibits:
Exhibit 13--Annual Report to Certificate Holders
Exhibit 23--Consent of Independent Auditors
Exhibit 27--Financial Data Schedule (only filed electronically via EDGAR)
Exhibit 99--Tax Return Guide
(b) Report on Form 8-K--None.
(c) Exhibits--The response to this portion of Item 14 is submitted as a separate section of this report.
(d) Financial Statement Schedules--The response to this portion of Item 14 is submitted as a separate section of this report.
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.
GREAT NORTHERN IRON ORE PROPERTIES ---------------------------------- (Registrant)
/s/ Harry L. Holtz February 17, 1997 ---------------------------------------- ----------------- Harry L. Holtz, Chief Executive Officer, Date Trustee and President of the Trustees
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 and in the capacities and on the dates indicated.
/s/ Joseph S. Micallef February 17, 1997 ---------------------------------------- ----------------- Joseph S. Micallef, Trustee Date
/s/ Roger W. Staehle February 17, 1997 ---------------------------------------- ----------------- Roger W. Staehle, Trustee Date
/s/ Robert A. Stein February 17, 1997 ---------------------------------------- ----------------- Robert A. Stein, Trustee Date
/s/ Thomas A. Janochoski February 17, 1997 ---------------------------------------- ----------------- Thomas A. Janochoski, Date Vice President and Secretary, Chief Financial Officer
ANNUAL REPORT ON FORM 10-K
ITEM 14(a)(1) and (2) and ITEM 14(d)
LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
FINANCIAL STATEMENT SCHEDULES
YEAR ENDED DECEMBER 31, 1996
GREAT NORTHERN IRON ORE PROPERTIES
W-1290 First National Bank Building 332 Minnesota Street Saint Paul, Minnesota 55101-1361
FORM 10-K--Item 14(a)(1) and (2) GREAT NORTHERN IRON ORE PROPERTIES
LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
The following financial statements of Great Northern Iron Ore Properties, included in the annual report of the Registrant to its certificate holders for the year ended December 31, 1996, are incorporated by reference in Item 8:
Balance Sheets--December 31, 1996 and 1995
Statements of Beneficiaries' Equity--Years ended December 31, 1996, 1995 and 1994
Statements of Income--Years ended December 31, 1996, 1995 and 1994
Statements of Cash Flows--Years ended December 31, 1996, l995 and l994
Notes to Financial Statements--December 31, l996
All Item 14(d) schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.


Item 1. Business
GTE Hawaiian Telephone Company Incorporated (the Company) (formerly Hawaiian Telephone Company) was incorporated under the laws of the Kingdom of Hawaii in 1883. The Company is a wholly-owned subsidiary of GTE Corporation (GTE) and provides communications services in Hawaii and in the Pacific and Asia.
The Company has three wholly-owned subsidiaries: Micronesian Telecommunications Corporation (MTC), GTE Hawaiian Tel Insurance Company Incorporated and GTE Hawaiian Tel International Incorporated. MTC, which is headquartered in Saipan in the Commonwealth of the Northern Marianas, provides local and international telecommunications services on the islands of Saipan, Tinian and Rota. GTE Hawaiian Tel Insurance Company Incorporated provides auto liability, general liability and workers' compensation insurance to the Company on a direct basis. GTE Hawaiian Tel International Incorporated is an entity established in accordance with a Federal Communications Commission (FCC) order that allows the Company to be classified as a nondominant provider of International Message Telephone Service (IMTS). See Note 10 of the Company's consolidated financial statements included in Item 8 for further detail.
The Company's principal line of business is providing communications services ranging from local telephone service for the home and office to highly complex voice and data services for various industries. The Company provides local telephone service on each island in Hawaii and provides intraLATA (Local Access and Transport Area) toll service among the islands. InterLATA toll services between Hawaii and domestic points within the United States are provided by interexchange carriers (IXCs) which connect the Company's local facilities for call origination and termination. The IXCs are charged fees (access charges) for interconnection to the Company's local facilities. Business and residential customers also pay access charges to connect to the local network to obtain long distance service. The Company also provides interLATA toll service between Hawaii and international termination points in competition with interLATA common carriers. These international revenues are settled between the Company and interLATA common carriers through revenue sharing arrangements. The Company earns other revenues by providing such services as billing and collection and operator services to IXCs. At December 31, 1996, the Company served 827,561 access lines in its service territories.
At December 31, 1996, the Company had 2,886 employees.
The Company has written agreements with the International Brotherhood of Electrical Workers (IBEW) covering substantially all non-management employees. In 1994, the contracts with the IBEW expired. Negotiations continued through 1995, and in 1996, a new three-year agreement was reached.
REGULATORY AND COMPETITIVE TRENDS
The Company is subject to regulation by the Public Utilities Commission (PUC) of the State of Hawaii as to its intrastate business operations and by the FCC as to its interstate operations.
Advances in technology, together with a number of regulatory, legislative and judicial actions, continue to accelerate and expand the level of competition and opportunities available to the Company. Presently, the Company is subject to competition from numerous sources, including competitive access providers (CAPs) for network access services. In addition, competition from alternative local-exchange carriers (ALECs), IXCs, wireless carriers and cable providers, as well as more recent entry by media and computer companies, is expected to increase in the rapidly changing telecommunications marketplace.
On February 8, 1996, the Telecommunications Act of 1996 (the Telecommunications Act) became law. This comprehensive telecommunications reform legislation addresses a wide range of competitive and regulatory issues that will affect the future development of local and long distance services, cable television and information services. The new law removes regulatory and court- ordered barriers to competition between segments of the industry, enabling local-exchange, long distance, wireless and cable companies to compete in offering voice, video and information services.
The Telecommunications Act requires the FCC and state commissions to open local-exchange markets and to set new guidelines for interconnection, loosens restrictions barring local telephone companies from entering the cable television market, and preserves universal service while equalizing the responsibility for contribution among all carriers.
Following passage of the Telecommunications Act, the FCC has undertaken to issue rules governing three areas: interconnection, universal service and access charge reform. In August 1996, the FCC released its rules implementing the provision of number portability and dialing parity in accord with the Telecommunications Act. In August 1996, the FCC also adopted its rules governing interconnection, unbundling of network elements and wholesale prices and other terms for competitive entry into local-exchange service. These rules generally require local-exchange carriers (LECs) to make their services available to competitors at a wholesale discount and to make their network elements available to competitors at below-cost prices. GTE petitioned for judicial review of these rules on the grounds that they were inconsistent with the Telecommunications Act. In October 1996, the U.S. Court of Appeals for the Eighth Circuit granted GTE's request for stay of the pricing provisions of the FCC's rules pending the Court's resolution of the merits of GTE's petition. Oral arguments on the merits were held in January 1997, and the Court's ruling is expected in the spring of 1997.
GTE is continuing to negotiate with requesting carriers over the terms of interconnection, unbundled network elements and resale rates. In some cases, the parties have been unable to agree within the statutory period for negotiation and have gone to arbitration before various state regulatory commissions. Since November 1996, a number of state commission decisions determining the prices and terms of unresolved issues have been released (See Note 10 of the Company's consolidated financial statements included in Item 8). Subsequent decisions are expected to be issued over a period extending through the first half of 1997.
The Company has exercised its right under the Telecommunications Act to challenge state regulatory commission arbitration orders that govern agreements between the Company and its competitors. The Company has filed lawsuits in federal district courts in Hawaii.
In November 1996, the Federal-State Joint Board released its recommended universal service plan, and in December 1996, the FCC issued its access reform proposals. Both proposals incorporate a pricing methodology similar to the one that GTE is appealing in the interconnection case. A final order in the universal service proceeding must be adopted by early May 1997, and a decision on the access reform proceeding is expected shortly thereafter.
A key provision of the Telecommunications Act eliminated the legal restraints of the GTE Consent Decree which kept the Company from providing interLATA long distance services. This action will simplify GTE's ability to market local, intraLATA and interLATA service to its customers as a bundled service. In February 1996, GTE executed an agreement whereby WorldCom, Inc. will provide, on a non-exclusive basis, a full array of telecommunications services in support of GTE's entry into the interLATA long distance market. In March 1996, GTE, through a separate subsidiary, began offering long distance service to its customers in selected markets. GTE now offers the service, marketed under the name GTE Easy Savings Plan (sm), in all 50 states.
The Telecommunications Act forbids states from imposing any barriers to entry into local and toll competition. To date, local competition has been authorized in all 28 states where GTE currently offers local telephone service, including Hawaii. In addition, nineteen states, including Hawaii, have authorized plans that would allow customers to pre-subscribe to a specific carrier to handle their intraLATA toll calls. Pre- subscribed customers will simply dial "1" before the telephone number in order to complete intraLATA calls. GTE has proposals pending in all nine of the states which have not ordered implementation.
Federal regulatory activity has changed the traditional cost-based, rate-of- return regulatory framework for interstate telephone service. This regulatory framework provides economic incentives to telephone service providers to improve productivity and provide the foundation for implementing pricing flexibility necessary to address competitive entry into the Company's markets. The PUC remains under the traditional cost-based, rate-of-return regulatory framework for its intrastate telephone service.
For the provision of interstate and international access services, the Company operates under the terms of the FCC's price cap incentive plan. The "price cap" mechanism serves to limit the rates a carrier may charge, rather than just regulating the rate of return which may be achieved. Under this approach, the maximum prices that the LEC may charge are increased or decreased each year by a price index based upon inflation less a predetermined productivity target. LECs have limited pricing flexibility provided they do not exceed the allowed price cap.
Further information regarding the Company's activities with the various regulatory agencies and revenue arrangements with other telephone companies is discussed in Note 10 of the Company's consolidated financial statements included in Item 8.
The Company continues to support greater competition in telecommunications, provided that, overall, the actions to eliminate existing legal and regulatory barriers benefit consumers by allowing an opportunity for all service providers to participate equally in a competitive marketplace under comparable conditions.
The Company intends to continue to respond aggressively to regulatory and legal developments that allow for increased competition and opportunities in the marketplace. The Company expects its financial results to benefit from reduced costs and the introduction of new products and services that will result in increased usage of its telephone networks. However, it is likely that such improvements will be offset, in part, by continued strategic pricing reductions and the effects of increased competition.
INITIATIVES
In 1996, the Company and its parent, GTE, continued to position themselves to respond aggressively to competitive developments and benefit from new opportunities.
GTE Hawaiian Telephone Company Incorporated (the Company):
Restructuring and Cost Control
During 1996, the Company substantially completed the implementation of its three-year $78.3 million re-engineering program. Total costs of the program included $52.8 million related to improvements in customer service processes, $19 million related to improvements in administrative processes and $6.5 million related to the consolidation of facilities and operations and other related costs. These costs were primarily associated with the closure and relocation of various service centers, software enhancements and separation benefits related to employee reductions.
GTE Corporation (GTE):
Video Services
The Telecommunications Act eliminates the telephone company programming ban and allows GTE the flexibility to choose whether it will enter the wireline video distribution business through an open video platform arrangement or via a standard cable television operation (Title VI). The legislation also allows GTE to deploy video networks which are fully integrated with its telephone operations.
GTE, through a separate subsidiary, made its initial entry into the video market under Title VI. The most technologically-advanced hybrid fiber/coaxial network available is being deployed. At the end of 1996, GTE had been granted six franchises, three in California and three in Florida. Construction of the networks in those markets is underway and approximately 7,000 video subscribers were acquired in 1996, bringing GTE's total video subscribers to approximately 15,000.
Internet Access
GTE, through a separate subsidiary, was the first local-exchange carrier to introduce nationwide Internet services to residential and business customers in 1996. By year-end 1996, GTE's Internet access service, marketed as GTE Internet Solutions, was offered in over 350 cities covering 49 states, including Hawaii. An agreement with UUNET Technologies provides the Internet backbone and local dialing capabilities. Over 70,000 customers were subscribing to GTE Internet Solutions at December 31, 1996.
GTE Long Distance
One of the most significant impacts of the Telecommunications Act's passage was the removal of certain restrictions previously included in GTE's Consent Decree. Prior to February 8, 1996, GTE was restricted from jointly marketing the products and services of the Company with those of GTE's interexchange subsidiaries. With this joint marketing restriction lifted, GTE can now offer its customers many services on one monthly bill, with one point of contact. This opportunity facilitated GTE's entry into the long distance business, as discussed above. By December 31, 1996, GTE, through a separate subsidiary, was offering the service, marketed under the name GTE Easy Savings Plan (sm), in all 50 states and was serving over 825,000 customers.
ENVIRONMENTAL MATTERS
GTE maintains monitoring and compliance programs related to environmental matters. The Company's annual expenditures for environmental compliance have not been and are not expected to be material. Costs incurred include outlays required to keep existing operations in compliance with environmental regulations and an underground storage tank replacement program.
Item 2.

Item 2. Properties
The Company's property consists principally of land, structures and equipment required to provide various telecommunications services. All of these properties, located in the state of Hawaii and on the islands of Saipan, Tinian and Rota, are generally in good operating condition and adequate to satisfy the needs of the business. Substantially all of the Company's property is subject to the liens of its respective mortgages securing funded debt. From January 1, 1992 to December 31, 1996, the Company made capital expenditures of $782 million for new plant and facilities required to meet telecommunication service needs and to modernize plant and facilities. These additions were equal to 38% of gross plant of $2 billion at December 31, 1996.
In the fourth quarter of 1995, the Company discontinued the use of Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation" (FAS 71).
In general, FAS 71 required the Company to depreciate its telephone plant and equipment over lives approved by regulators which, in many cases, extended beyond the assets' economic lives. FAS 71 also required the deferral of certain costs based upon approvals received from regulators to recover such costs in the future. As a result of these requirements, the recorded net book value of certain assets and liabilities, primarily telephone plant and equipment, were in many cases higher than that which would otherwise have been recorded based on their economic lives. See Note 2 of the Company's consolidated financial statements included in Item 8.
Item 3.

Item 3. Legal Proceedings
There are no pending legal proceedings which would have a material impact on the Company's consolidated financial statements.
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 (GTE).
SHAREHOLDER SERVICES
The First National Bank of Boston, Transfer Agent and Registrar for GTE and the Company's common stock, should be contacted with any questions relating to shareholder accounts. This includes the following:
o Account information
o Dividends
o Market prices
o Transfer instructions
o Statements and reports
o Change of address
Shareholders may call toll-free at 1-800-225-5160 anytime, seven days a week. Customer Service Representatives are available Monday through Friday between the hours of 8 a.m. and 5 p.m. Eastern Time. Outside the United States call 1- 617-575-2990.
Or write to: Bank of Boston c/o Boston EquiServe, L.P. P.O. Box 9121 Boston, MA 02205-9121
For overnight delivery services, use the following address: Bank of Boston c/o Boston EquiServe, L.P. Blue Hills Office Park 150 Royall Street Canton, MA 02021
The Bank of Boston address where shareholders, banks and brokers may deliver certificates is One Exchange Place, 55 Broadway in New York City.
PARENT COMPANY ANNUAL REPORT
To obtain a copy of the 1996 annual report of our parent company or the annual Form 10-K filed with the Securities and Exchange Commission, call 1-800-225- 5160.
INFORMATION VIA THE INTERNET
Internet World Wide Web users can access information on GTE through the following universal resource: http://www.gte.com
PRODUCTS AND SERVICES HOTLINE
Shareholders may call 1-800-828-7280 to receive information concerning GTE products and services.
Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Dollars in Millions)
BUSINESS OPERATIONS
GTE Hawaiian Telephone Company Incorporated (the Company), a wholly-owned subsidiary of GTE Corporation (GTE), provides a full range of telecommunications products and services in Hawaii and in the Pacific and Asia. The Company has three wholly-owned subsidiaries. Micronesian Telecommunications Corporation (MTC) is headquartered in Saipan and provides local and international telecommunications services on the islands of Saipan, Tinian and Rota. GTE Hawaiian Tel Insurance Company Incorporated provides auto liability, general liability and workers' compensation insurance to the Company on a direct basis. GTE Hawaiian Tel International Incorporated is an entity established in accordance with a Federal Communications Commission (FCC) order that allows the Company to be classified as a nondominant provider of International Message Telephone Service (IMTS). See Note 10 of the Company's consolidated financial statements included in Item 8

Item 8. Financial Statements and Supplementary Data
GTE Hawaiian Telephone Company Incorporated and Subsidiaries CONSOLIDATED STATEMENTS OF INCOME
(a) Includes billings to affiliates of $43,469, $41,958 and $38,420 for the years 1996-1994, respectively. (b) Includes billings from affiliates of $39,376, $45,446 and $37,322 for the years 1996-1994, respectively.
See Notes to Consolidated Financial Statements.
GTE Hawaiian Telephone Company Incorporated and Subsidiaries CONSOLIDATED BALANCE SHEETS
See Notes to Consolidated Financial Statements.
GTE Hawaiian Telephone Company Incorporated and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS
See Notes to Consolidated Financial Statements.
GTE Hawaiian Telephone Company Incorporated and Subsidiaries CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY
See Notes to Consolidated Financial Statements.
GTE Hawaiian Telephone Company Incorporated and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
GTE Hawaiian Telephone Company Incorporated (the Company) provides a wide variety of communications services, in Hawaii and in the Pacific and Asia, ranging from local telephone service for the home and office to highly complex voice and data services for various industries. At December 31, 1996, the Company served 827,561 access lines in its service territories. The Company is a wholly-owned subsidiary of GTE Corporation (GTE).
BASIS OF PRESENTATION
The Company prepares its consolidated financial statements in accordance with generally accepted accounting principles which require that management make estimates and assumptions that affect reported amounts. Actual results could differ from those estimates.
The consolidated financial statements include the accounts of the Company and its three wholly-owned subsidiaries. The subsidiaries include Micronesian Telecommunications Corporation (MTC), GTE Hawaiian Tel Insurance Company Incorporated and GTE Hawaiian Tel International Incorporated, an entity established in accordance with a Federal Communications Commission (FCC) order that allows the Company to be classified as a nondominant provider of International Message Telephone Service (IMTS). All significant intercompany items have been eliminated.
The Company discontinued applying the provisions of Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation" (FAS 71), in the fourth quarter of 1995 (see Note 2).
Reclassifications of prior-year data have been made, where appropriate, to conform to the 1996 presentation.
TRANSACTIONS WITH AFFILIATES
GTE Supply (100% owned by GTE) provides construction and maintenance equipment, supplies and electronic repair services to the Company. These purchases and services amounted to $34.3 million, $27.7 million and $27.1 million for the years 1996-1994, respectively. Such purchases and services are recorded in the accounts of the Company, at cost, which includes a normal return realized by GTE Supply.
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 $39.4 million, $45.4 million and $37.3 million for the years 1996-1994, respectively. The amounts charged for these affiliated transactions are based on a proportional cost allocation method.
The Company's consolidated financial statements include allocated expenses based on the sharing of certain executive, administrative, financial, accounting, marketing, personnel, engineering, and other support services being performed at consolidated work centers among the domestic GTE Telephone Operating Companies. The amounts charged for these affiliated transactions are based on a proportional cost allocation method as filed with the FCC.
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 $43.5 million, $42 million and $38.4 million for the years 1996-1994, respectively.
DEPRECIATION AND AMORTIZATION
In 1996, the Company began providing for depreciation on a straight-line basis over the estimated economic lives of its assets (see Note 2). The Company had previously provided for depreciation on a straight-line basis over asset lives approved by regulators. Maintenance and repairs of property 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 or extraordinary retirements of property where profit or loss is recognized.
Franchises, goodwill and other intangibles are amortized on a straight-line basis over the periods to be benefited, or 40 years, whichever is less.
REVENUE RECOGNITION
Revenues are recognized when earned. This is generally based on usage of the Company's local-exchange networks or facilities. For other products and services, revenues are generally recognized when services are rendered or products are delivered to customers.
INVENTORIES AND SUPPLIES
Inventories and supplies are stated at the lower of cost, determined principally by the average cost method, or net realizable value.
EMPLOYEE BENEFIT PLANS
Pension and postretirement health care and life insurance benefits earned during the year as well as interest on accumulated benefit obligations are accrued currently. Prior service costs and credits resulting from changes in plan benefits are amortized over the average remaining service period of the employees expected to receive benefits. Material curtailment/settlement gains and losses associated with employee separations are recognized in the period in which they occur.
STOCK OPTION PLANS
In 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (FAS 123). As permitted by FAS 123, the Company continues to apply the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25). The difference between the recognition and measurement provisions of FAS 123 and APB 25 is not significant to the Company's results of operations.
INCOME TAXES
The Company's results are included in GTE's consolidated federal income tax return. The Company participates in a tax-sharing agreement with GTE and remits tax payments to GTE based on its tax liability on a separate company basis.
Deferred tax assets and liabilities are established for temporary differences between the way certain income and expense items are reported for financial reporting and tax purposes and subsequently adjusted to reflect changes in tax rates expected to be in effect when the temporary differences reverse. A valuation allowance is established for any deferred tax asset for which realization is not likely. Deferred income taxes are not provided on undistributed earnings of the Company's foreign subsidiary, approximately $38 million at December 31, 1996, as such earnings are expected to be permanently reinvested in the foreign subsidiary.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include investments in short-term, highly liquid securities, which have maturities when purchased of three months or less.
2. EXTRAORDINARY CHARGE
In response to legislation (see Note 10) and the increasingly competitive environment, the Company discontinued the use of FAS 71 in the fourth quarter of 1995.
As a result of the decision to discontinue FAS 71, the Company recorded a non- cash, after-tax extraordinary charge of $263.4 million (net of tax benefits of $167.8 million) in the fourth quarter of 1995. The charge primarily represents a reduction in the net book value of telephone plant and equipment through an increase in accumulated depreciation. In addition to the one-time charge, beginning in 1996, the Company shortened the depreciable lives of its telephone plant and equipment as follows:
3. RESTRUCTURING COSTS
During 1993, the Company recorded one-time restructuring costs of $78.3 million, which reduced net income by $48.2 million, primarily for incremental costs related to implementation of the Company's re-engineering plan to improve customer-responsiveness and product quality, reduce the time necessary to introduce new products and services and further reduce costs. The restructuring costs included $52.8 million to re-engineer customer service processes and $19 million to re-engineer administrative processes. The restructuring costs also included $6.5 million to consolidate facilities and operations and other related costs. These expenditures were primarily associated with the closure and relocation of various service centers, software enhancements and separation benefits associated with employee reductions. The re-engineering plan was substantially completed in 1996, consistent with the original cost estimates.
4. SHAREHOLDER'S EQUITY
COMMON STOCK
The authorized common stock of the Company consists of 18,000,000 shares with a par value of $25 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.
ADDITIONAL PAID-IN CAPITAL
Additional paid-in capital includes a capital contribution of $50 million received in August 1996 from GTE to improve the Company's financial position.
5. DEBT
Long-term debt as of December 31, was as follows:
In March, April and June 1996, the Company redeemed prior to stated maturity, the $35 million 8 3/4% Series T first mortgage bonds, the $35 million 8 1/2% Series V first mortgage bonds and the $75 million 9% Series AA first mortgage bonds, respectively. The Company issued $150 million of 7 3/8% Series B debentures, due 2006, in September 1996 to refinance this high-coupon debt. Net proceeds were used to finance the Company's construction program and for general corporate purposes.
In August 1995, the Company issued $150 million of 7% Series A Debentures, due 2006. The net proceeds were used toward the repayment of short-term debt incurred for the purpose of financing the Company's construction program.
The aggregate principal amount of bonds and debentures that may be issued is subject to the restrictions and provisions of the Company's indentures. None of the securities shown above were held in sinking or other special funds of the Company or pledged by the Company. Debt discounts and premiums on the Company's outstanding long-term debt are amortized over the lives of the respective issues. Substantially all of the Company's telephone plant is subject to the liens of the indentures under which the bonds listed above were issued.
Estimated payments of long-term debt during the next five years are: $18.7 million in 1997; $22 million in 1998; $2.1 million in 1999; $2.3 million in 2000 and $22.3 million in 2001.
Total short-term obligations as of December 31, were as follows:
6. FINANCIAL INSTRUMENTS
During 1996, the Company entered into forward contracts to sell $150 million of U.S. Treasury Bonds in order to hedge against future changes in market interest rates related to the debt the Company called and subsequently refinanced in September 1996. A gain of approximately $9 million occurred upon the settlement of the forward contracts and is being amortized over the life of the associated refinanced debt as an offset to interest expense.
The fair values of financial instruments, other than long-term debt, closely approximate their carrying value. As of December 31, 1996, the estimated fair value of long-term debt based on either reference to quoted market prices or an option pricing model, was lower than the carrying value by approximately $9 million. The estimated fair value of long-term debt as of December 31, 1995 exceeded the carrying value by approximately $12 million.
7. INCOME TAXES
The income tax provision (benefit) is as follows:
A reconciliation between taxes computed by applying the statutory federal income tax rate to pre-tax income and income taxes provided in the consolidated statements of income is as follows:
The tax effects of temporary differences that give rise to the current deferred income tax benefits and deferred income tax liabilities at December 31, are as follows:
8. EMPLOYEE BENEFIT PLANS
RETIREMENT PLANS
The Company sponsors noncontributory defined benefit pension plans covering substantially all employees. The benefits to be paid under these plans are generally based on years of credited service and average final earnings. The Company's funding policy, subject to the minimum funding requirements of U.S. employee benefit and tax laws, is to contribute such amounts as are determined on an actuarial basis to provide the plans with assets sufficient to meet the benefit obligations of the plans. The assets of the plans consist primarily of corporate equities, government securities and corporate debt securities.
The components of the net pension credit for 1996-1994 were as follows:
The expected long-term rate of return on plan assets was 9.0% for 1996 and 8.5% for 1995 and 1994.
The funded status of the plans and the net prepaid pension cost at December 31, were as follows:
Assumptions used to develop the projected benefit obligations at December 31, were as follows:
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 1996-1994 included the following components:
The following table sets forth the plans' funded status and the accrued postretirement benefit obligations as of December 31:
The assumed discount rates used to measure the accumulated postretirement benefit obligations were 7.5% at December 31, 1996 and December 31, 1995. The assumed health care cost trend rate was 8.75% in 1996 and averaged 9.75% in 1995 and is assumed to decrease gradually to an ultimate rate of 6.0% in the year 2004. A one percentage point increase in the assumed health care cost trend rates for each future year would have increased 1996 costs by $3.1 million and the accumulated postretirement benefit obligations as of December 31, 1996 by $37.9 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 $3.1 million in 1996 and $3 million in 1995-1994, respectively.
9. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is summarized as follows at December 31:
Depreciation expense in 1996-1994 was equivalent to a composite average percentage of 6.1%, 6.3% and 6.5%, respectively.
10. REGULATORY AND COMPETITIVE MATTERS
The Company is subject to regulation by the Public Utilities Commission (PUC) of the State of Hawaii with respect to intrastate business operations and by the FCC for its interstate and international business operations, earth station ownership and the use of authorized radio frequencies.
INTRASTATE SERVICES
Rate Matters
On May 11, 1993, the Company filed a general rate increase application with the PUC, requesting approval to increase intrastate revenues by $50.4 million. This represented a 15.9% increase over intrastate revenues for 1993 at current rates, and was the first rate increase application the Company had filed since 1985. The Company's rate restructure proposal and earnings investigation which were in progress were incorporated into the rate case docket. Hearings took place in March and April 1994. On June 14, 1994, the PUC ordered that the Company continue its rates at existing levels and denied the Consumer Advocate's recommendation for an interim revenue decrease.
On October 14, 1994, the Company filed a Notice of Intent to file another rate case with the PUC. The Company also filed a Motion for Waiver of Commission Rules and for approval of 1995 to be the test year. The waiver requested that the Company be allowed the option to file its rate case application in early 1995 without having to use a split 1995/1996 test year. On November 29, 1994, the PUC approved the Company's request for the waiver of its test year rules.
On November 29, 1994, the PUC issued an order approving the adoption of accrual accounting for Postretirement Benefits Other Than Pensions (FAS 106) for ratemaking purposes. The PUC's order directed the Company to file plans for reflecting the full impact of FAS 106 in rates to be effective January 1, 1995. The PUC approved, on January 19, 1995, the Company's plan to reflect an additional $10.7 million of Postretirement Benefits Other Than Pensions in its rates, retroactive to January 1, 1995.
On June 9, 1995, the PUC issued a decision on the Company's 1993 Rate Case. The PUC ordered that the Company's existing rate of return, rate base, and rate structure remain unchanged until the next rate case. The Company notified the PUC on July 10, 1995 that it would appeal the decision to the Hawaii Supreme Court. On March 7, 1997, the Company filed a stipulation to withdraw its appeal of the PUC's 1993 Rate Case order and focus on an appeal of selected issues in the 1995 Rate Case discussed below.
On September 29, 1995, the Company filed an application to increase its rates by $74 million in its 1995 Rate Case. The PUC approved bifurcation of the proceeding into a revenue requirement phase (Phase I) and a rate design phase (Phase II). The PUC held public hearings on Phase I in late 1995. The Department of Defense (DOD), AT&T Communications of Hawaii (AT&T) and Pacwest Telecommunications Corporation (Pacwest) filed motions to intervene in this proceeding. On January 12, 1996, the PUC granted the DOD intervention in both phases but limited AT&T and Pacwest to participating in the formulation of issues for Phase I. The PUC subsequently allowed AT&T to continue as a participant in the proceeding for limited issues but denied Pacwest's request for continued participation.
On July 26, 1996, the Company filed a stipulation with the PUC requesting approval of an agreement reached with the Division of Consumer Advocate, DOD and AT&T that resolves most of the issues presented in the Company's Rate Case. Based on the issues resolved, the parties agreed the Company is entitled to an interim revenue increase of $17.9 million. This figure is based on $10.1 million for the agreed upon issues plus an additional $7.8 million to allow the Company to recover depreciation expense at levels currently authorized by the PUC. On August 1, 1996, the PUC adopted the agreement with the interim revenue increase of $17.9 million. The four remaining issues before the PUC pending a final decision were Hurricane Iniki recovery, interisland fiber recovery, depreciation expense levels and incentive compensation recovery. The Company received a final award of $23.6 million on January 31, 1997 reflecting a final decision on Hurricane Iniki recovery with an award of $5.7. On March 3, 1997, the Company filed a notice of
Appeal with the Supreme Court of the State of Hawaii to seek review of the PUC's Phase I final order regarding interisland fiber recovery, depreciation expense levels and recovery of incentive based compensation for management employees.
Arbitration Activity
In August 1996, pursuant to the Telecommunications Act of 1996 (the Telecommunications Act), AT&T filed a petition with the PUC requesting arbitration of remaining interconnection, resale, and unbundling issues between AT&T and the Company. Hearings were held on October 14 to 17, 1996, and Decision No. 15229 was issued by the PUC on December 12, 1996. In its decision, the PUC ordered the Company, including many other things, to discount all retail services at a rate of 15% and offer unbundled network elements at a price based on the Company's total element long run incremental cost (TELRIC) increased by 10% for joint and common costs, with both parties filing an interconnection agreement within 30 days. On January 10, 1997, the Company filed a complaint for declaratory and injunctive relief in the United States District Court. However, the Company continued to negotiate with AT&T and filed, under protest, an interconnection agreement with the PUC on February 26, 1997.
Western Wireless Corporation (Western Wireless) filed a petition for arbitration with the PUC on September 6, 1996. The PUC held a hearing on November 12, 1996 and issued Decision No. 15277 on December 24, 1996, ordering both parties to file an interconnection agreement on January 23, 1997. On February 21, 1997, the PUC issued an order approving the interconnection agreement filed January 24, 1997. The Company filed a complaint for declaratory and injunctive relief in the United States District Court on February 14, 1997.
On October 16, 1996, GST Telecom Hawaii petitioned the PUC for arbitration which was ultimately withdrawn on November 8, 1996. On November 27, 1996, an interconnection agreement between the Company and GST Telecom Hawaii was filed with approval granted by the PUC in Decision and Order No. 15283. A revised interconnection agreement was filed with the PUC on January 16, 1997, with the E911 and Telecommunications Relay Service (TRS) agreements filed on January 16, and January 24, 1997, respectively.
Sprint Corporation (Sprint) petitioned the PUC for arbitration in September 1996 on many of the same issues that were submitted by AT&T. Hearings were held on December 2, and 3, 1996, and on January 17, 1997, the PUC issued Decision No. 15316 which reaffirmed decisions issued in the previous arbitration proceedings. The Company filed, under protest, an interconnection agreement with the PUC on February 24, 1997. Sprint is seeking to adopt the provision of the AT&T agreement in lieu of the negotiated agreement ordered by the PUC. The Company filed its opposition on February 27, 1997 seeking approval of the arbitrated agreement submitted in compliance with the PUC's decision.
Communications Infrastructure
On May 11, 1993, the PUC initiated a communications infrastructure proceeding which was intended to investigate such issues as: what markets should be opened to competition; who should be allowed to compete in those markets; and what rules, if any, should apply. As part of this proceeding, on May 17, 1996, the PUC formally adopted administrative rules governing telecommunications competition and establishing a universal service fund in Hawaii. Since June 3, 1996, the effective date of the new rules, the PUC has granted certificates of authority to numerous applicants to operate as resellers of telecommunications services and has others pending.
On June 12, 1996, the PUC issued its decision and order implementing its new administrative rules. Among its provisions, the order approved the Company's cost recovery tariff and denied interexchange carriers' requests for "discounted" or impaired intrastate access rates. On June 24, 1996, the Company filed a motion for reconsideration of portions of the PUC's order. In its August 30, 1996 ruling, the PUC ruled in the Company's favor on the majority of issues raised by the Company.
In compliance with certain requirements set forth in the June 12, 1996 order, the Company filed position statements in July 1996 relating to equal access cost recovery and impaired assets. On August 12, 1996, the Company filed position statements relating to revenue-neutral rate rebalancing, universal service, and the classification of services into non-competitive, partially competitive and fully competitive categories. On September 3, 1996, the Company filed a position statement on unbundling. Also on November 12, 1996, the Company filed a tariff application to implement remote call forwarding as an interim measure pending full number portability. This tariff application was suspended on December 11, 1996, pending further investigation by the Commission.
Additionally, the PUC issued draft administrative rules on August 13, 1996 concerning aggregator and operator service, pay telephone service, and shared tenant service. The parties filed comments on the draft rules on August 28, 1996. Public hearings on these rules are expected in the first quarter of 1997.
On December 12, 1996, the PUC issued a decision on the petition of AT&T for arbitration with the Company concerning interconnection of AT&T's facilities and equipment with the Company's network. Pursuant to this ruling, many of the issues contained in this AT&T arbitration proceeding will be deferred to the communications infrastructure docket. These issues include: 1) permanent wholesale rates for resale of telecommunications services by an incumbent local exchange carrier; 2) the appropriate cost basis for interconnection and unbundled network elements; 3) the appropriate pricing methodology for collocation; and 4) costing for access to poles, ducts, conduits and rights-of- way. Further activity to address these and other issues within the communications infrastructure proceeding is currently pending PUC action.
Competition
On March 1, 1996, the PUC ordered the Company to implement 1+ and 0+ equal access within the state by May 1, 1996. On March 11, 1996, the Company filed a motion for stay of proceedings and for reconsideration of the PUC's order. On April 19, 1996, the PUC denied the Company's motion for stay of the order. Effective July 10, 1996, the Company implemented 1+ and 0+ equal access.
During the first quarter of 1995, the PUC authorized AT&T and Sprint to provide interisland toll service on a 10XXX basis, effective March 1, 1995. The PUC reserves the right to modify or rescind the authority depending on the impact to the Company. On February 14, 1995, the PUC approved the Company's request to lower its toll rates and make changes to its various calling plans to keep them competitive with AT&T's rates. On February 22, 1995, the PUC granted MCI Communication Corporations' application to provide interisland toll service on a 10XXX basis.
Rural Service Plans
In September 1992, the PUC initiated an investigation of the Company's provision of telephone service in the rural areas in the state. On November 2, 1994, the PUC issued its ruling in this proceeding, requesting the Company to convert all existing rural multi-party lines to single-party over a three-year period. The ruling further allowed the Company to collect one-half of the cost of conversion from existing multi-party customers choosing to convert to single-party service. The estimated remaining costs of up to $20.2 million will be recovered from general ratepayers statewide through a three-year monthly surcharge. On February 24, 1995, the PUC approved the Company's Rural Service Plan (RSP). On September 1, 1995, the Company began assessing a three-year general ratepayer surcharge, while issuing its first offers to convert customers to single-line service in those rural areas that were upgraded pursuant to the RSP 1995 construction schedule. Construction activities under the RSP will continue through 1997.
The PUC opened a docket on December 12, 1994, and ordered the Company to show cause why the PUC should not authorize an alternate telecommunications provider for the rural areas of the state. On December 13, 1995, the PUC issued a decision allowing a telecommunications carrier other than the Company to seek authorization to provide service in the Ka'u area on the island of Hawaii. The PUC accepted bid proposals through May 15, 1996 from carriers, including the Company, who were interested in serving the first rural area for which an alternative telecommunications provider may be authorized. The PUC selected TelHawaii Incorporated (TelHawaii) as the alternative provider and
carrier of last resort (COLR) in the Ka'u area of the island of Hawaii, effective May 31, 1997. The PUC further required the Company and TelHawaii to negotiate all necessary agreements including, as required or appropriate, an agreement for the transfer to or use by TelHawaii of the Company's assets and agreements for extended area service, directory assistance and publications, interconnection, enhanced 911, and telecommunications relay services. The Company intends to continue offering a competitive alternative for Ka'u customers even after TelHawaii begins providing alternative telecommunications services as a COLR.
On July 25, 1996, the Company filed a Motion for Reconsideration/Clarification of the PUC's July 15, 1996 order selecting TelHawaii as the alternative provider of telecommunications services and as the COLR in the Ka'u area of the island of Hawaii. On August 16, 1996, the Company filed its Notice of Appeal of the PUC's orders. The Company is appealing the PUC's order on the basis that the Company opposes the effective taking of its property by forced sale of its assets in Ka'u and that the order is contrary to the Telecommunications Act. On September 5, 1996, the Company filed an Expedited Motion for Stay Pending Appeal and an Emergency Motion for Temporary Stay Pending Supreme Court Review of the Expedited Motion.
On September 16, 1996, the PUC ordered the Company to show cause why it should not pay a fine for not complying with the PUC's prior order to respond to information requests issued by TelHawaii. A hearing was held on September 30, 1996, with an order from the PUC assessing a $0.3 million fine on the Company. The Company paid the fine under protest on October 3, 1996, and filed a Motion for Reconsideration of the PUC's order on October 3, 1996 due to the legal grounds for noncompliance with the PUC's order. On November 8, 1996, the Company also filed a motion requesting the PUC consider issuing a clarification order and an order granting mitigation and abatement of fines and penalties levied. On December 23, 1996, the PUC issued Order No. 15266 denying the Company's motion for reconsideration and motion for clarification and directed the parties to continue negotiation of "sale or use" of the Ka'u facilities. On January 22, 1997, the Company filed an appeal of this order with the Hawaii Supreme Court. The PUC has opened two new dockets as a result of petitions filed by rural area communities on the island of Hawaii to assess the level of service provided by the Company.
INTERSTATE AND INTERNATIONAL SERVICES
For the provision of interstate and international 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 have limited pricing flexibility provided they do not exceed the allowed price cap.
In March 1995, the FCC adopted interim rules to be utilized by LECs, including the Company, for their 1995 Annual Price Cap Filing. The interim rules allowed LECs to select from three productivity/sharing options for each tariff entity.
Each of the three options reflected an increase to the 3.3% productivity factor elected by the Company since 1991. The Company selected the following productivity factors and sharing thresholds for use in the 1996-1997 and 1995- 1996 tariff years:
Since the Company's access fees were priced below the FCC's maximum price, the near-term impact of productivity increases were not expected to be significant. Under the interim rules, the Company filed tariffs to reduce rates by $5 million annually, effective August 1, 1995. On September 20, 1995, the FCC released its proposed rulemaking proceeding on price caps which proposes specific changes to reflect and encourage emerging competition in local and access service markets and to establish the path towards decreased regulation of LECs' services. On September 27, 1995, the FCC solicited comments on a number of specific issues regarding methods for establishing the price caps, such as productivity measurements, sharing, the common line formula and exogenous costs. The Company submitted its 1996 annual interstate access filing on April 2, 1996, utilizing the FCC interim price cap rules. In doing so, the Company changed its productivity factor from 5.3% to 4.0% for its subsidiary, MTC. On June 24, 1996, the FCC ordered all LECs subject to price cap regulation, including the Company, to update their GDP-PI inflation factors through the fourth quarter of 1995. Overall, the final 1996 interstate access filing resulted in an annual price increase of $1 million, effective July 1, 1996.
On February 8, 1996, the Telecommunications Act became law. This comprehensive telecommunications reform legislation addresses a wide range of competitive and regulatory issues that will affect the future development of local and long distance services, cable television and information services. The new law removes regulatory and court-ordered barriers to competition between segments of the industry, enabling local-exchange, long distance, wireless and cable companies to compete in offering voice, video and information services.
The Telecommunications Act requires the FCC and state commissions to open local-exchange markets and to set new guidelines for interconnection, loosens restrictions barring local telephone companies from entering the cable television market, and preserves universal service while equalizing the responsibility for contribution among all carriers.
On August 8, 1996, the FCC published its First Report and Order (the Order) containing rules implementing Section 251 of the Telecommunications Act dealing with interconnection, unbundling of network elements and wholesale prices and other terms for competitive entry into local-exchange service. On August 9, 1996, the FCC released its Second Report and Order implementing the provision of number portability and dialing parity in accord with the Telecommunications Act.
On September 16, 1996, GTE filed an appeal and motion for stay of the Order with the United States Court of Appeals for the District of Columbia. This appeal argued that the FCC had no jurisdiction to impose national pricing rules for what is essentially local service. This appeal was subsequently transferred to the Court of Appeals for the Eighth Circuit together with appeals by other LECs and state regulatory commissions. On October 15, 1996, the Eighth Circuit granted a partial stay. The stay delays implementation of the Order's pricing provisions and associated rules, as well as the rules requiring GTE and other LECs to permit requesting carriers to select terms and conditions from various agreements between them and other carriers for purposes of interconnection. On November 12, 1996, the Supreme Court denied applications to vacate the stay filed by the FCC and various companies seeking to enter the local-exchange business. Additionally, the Court held oral arguments on the merits on January 17, 1997. The Court's ruling is expected in the spring of 1997.
While GTE cannot predict the outcome of the Court's final decision, GTE intends to continue to vigorously present its position in Court.
In November 1996, the Federal-State Joint Board released its recommended universal service plan, and in December 1996, the FCC issued its access reform proposals. Both proposals incorporate a pricing methodology similar to the one that GTE is appealing in the interconnection case. A final order in the universal service proceeding must be adopted by early May 1997, and a decision on the access reform proceeding is expected shortly thereafter.
On December 20, 1996, the Company filed an application requesting approval to transfer certain property to the newly established GTE Hawaiian Tel International entity. The transfer of property will be done in accordance with an FCC Order released on October 22, 1996 which allows the Company to be reclassified as a nondominant provider of International Message Telephone Service (IMTS), subject to certain safeguards which the Company must first satisfy.
The safeguards include the establishment of a separate legal entity with separate books of account, no sharing of transmission or switching facilities with an affiliated LEC, the acquiring of services from the LEC on a tariffed basis, and the treatment as a nonregulated affiliate under the FCC's joint cost and affiliate transaction rules. As a nondominant IMTS provider, the Company will have the ability to effectively compete with other nondominant carriers in the Hawaii IMTS market. The Company is currently awaiting PUC approval of the property transfer.
SIGNIFICANT CUSTOMER
Revenues received from AT&T include amounts for access and billing and collection during the years 1996-1994 under various arrangements and amounted to $45.9 million, $47.5 million and $46 million, respectively.
11. COMMITMENTS AND CONTINGENCIES
The Company has noncancelable leases covering certain buildings, office space and equipment. Rental expense was $13.9 million, $12.8 million and $15.7 million in 1996-1994, respectively. Minimum rental commitments under noncancelable leases through 2001 do not exceed $2.9 million annually and aggregate $42.4 million thereafter.
The Company is subject to a number of proceedings arising out of the conduct of its business, including those relating to regulatory actions, commercial transactions and/or environmental, safety and health matters. Management believes that the ultimate resolution of these matters will not have a material adverse effect on the results of operations or the financial position of the Company.
Recent judicial and regulatory developments, as well as the pace of technological change, have continued to influence industry trends, including accelerating and expanding the level of competition. As a result, the Company's operations face increasing competition in virtually all aspects of its business. The Company continues to support greater competition in telecommunications, provided that, overall, the actions to eliminate existing legal and regulatory barriers benefit consumers by allowing an opportunity for all service providers to participate in a competitive marketplace under comparable conditions.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of GTE Hawaiian Telephone Company Incorporated:
We have audited the accompanying consolidated balance sheets of GTE Hawaiian Telephone Company Incorporated (a Hawaii corporation and wholly-owned subsidiary of GTE Corporation) and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, shareholder's equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements and the schedule and exhibit 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 and exhibit 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 Hawaiian Telephone Company Incorporated and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, in 1995, the Company discontinued applying the provisions of Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation".
Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The supporting schedule and exhibit listed under Item 14 are presented for purposes of complying with the Securities and Exchange Commission's rules and are not a required part of the basic financial statements. The supporting schedule and exhibit have been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly state 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 28, 1997
MANAGEMENT REPORT
To Our Shareholder:
The management of the Company is responsible for the integrity and objectivity of the financial and operating information contained in this Annual Report on Form 10-K, including the consolidated financial statements covered by the Report of Independent Public Accountants. These statements were prepared in conformity with generally accepted accounting principles and include amounts that are based on the best estimates and judgments of management.
The Company has a system of internal accounting controls which provides management with reasonable assurance that transactions are recorded and executed in accordance with its authorizations, that assets are properly safeguarded and accounted for, and that financial records are maintained so as to permit preparation of financial statements in accordance with generally accepted accounting principles. This system includes written policies and procedures, an organizational structure that segregates duties, and a comprehensive program of periodic audits by the internal auditors. The Company has also instituted policies and guidelines which require employees to maintain the highest level of ethical standards.
WARREN H. HARUKI 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 IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) Financial Statements - See GTE Hawaiian Telephone Company 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, 1996-1994 (as required):
II - Valuation and Qualifying Accounts
Note: Schedules other than the one listed above are omitted as not applicable, not required, or the information is included in the consolidated financial statements or notes thereto.
(3) Exhibits - Included in this report or incorporated by reference.
3.1* Articles of Incorporation and Bylaws (Exhibit 3.2 of the 1987 Form 10-K, File No. 2- 33059)
3.2* Amended By-laws (Exhibit 3.2 of the 1994 Form 10-K, File No. 2-33059)
4.1* Indenture dated as of February 1, 1995 between GTE Hawaiian Telephone Company Incorporated and Hawaiian Trust Company Limited, as Trustee (Exhibit 4.1 of the Company's Registration Statement of Form S-3, File No. 33-57743, filed with the Securities and Exchange Commission On February 17, 1995).
4.2* First Supplemental Indenture dated as of July 1, 1996 between GTE Hawaiian Telephone Company Incorporated and Hawaiian Trust Company Limited, as Trustee (Exhibit 4.3 of the Company's Report on Form 8-K, dated July 1, 1996).
10* Material Contracts - Agreements Between GTE and Certain Executive Officers (Exhibit 10 of the 1995 Form 10-K, File No. 2-33059)
12 Statements re: Calculation of the Consolidated Ratio of Earnings to Fixed Charges
26* Revised Form of Invitation for Bids pertaining to Registration Statement on Form S-3 (File No. 33-57743)
27 Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of 1996.
* Denotes exhibits incorporated herein by reference to previous filings with the Securities and Exchange Commission as designated.
GTE Hawaiian Telephone Company Incorporated and Subsidiaries
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS For the Years Ended December 31, 1996, 1995 and 1994
(Thousands of Dollars)
NOTES:
(1) Charges for which reserve was created. (2) Recoveries of previously written-off amounts. (3) Represents amounts necessary to satisfy commitments related to the re- engineering program that have been reclassified to Accounts Payable and Accrued Expenses. (4) See Note 3 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 HAWAIIAN TELEPHONE COMPANY INCORPORATED ------------------------------- (Registrant)
Date March 25, 1997 By Warren H. Haruki -------------- ------------------------------- Warren H. Haruki 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.
Warren H. Haruki President and Director March 25, 1997 - ------------------------- (Principal Executive Officer) Warren H. Haruki
Gerald K. Dinsmore Senior Vice President - Finance and March 25, 1997 - ------------------------- Planning and Director Gerald K. Dinsmore (Principal Financial Officer)
William M. Edwards, III Vice President - Controller March 25, 1997 - ------------------------- (Principal Accounting Officer) William M. Edwards, III
John C. Appel Director March 25, 1997 - ------------------------- John C. Appel
Richard M. Cahill Director March 25, 1997 - ------------------------- Richard M. Cahill
Michael B. Esstman Director March 25, 1997 - ------------------------- Michael B. Esstman
Thomas W. White Director March 25, 1997 - ------------------------- Thomas W. White
EXHIBIT INDEX