NEW YORK TELEPHONE CO - 10-K Annual Report

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FORM 10-K
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996

OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to ____________________

Commission file number 1-3435

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New York Telephone Company

I.R.S. Employer
A New York Corporation Identification No. 13-5275510

1095 Avenue of the Americas, New York, New York 10036
Telephone Number (212) 395-2121

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Securities registered pursuant to Section 12(b) of the Act:

Name of each exchange
Title of each class on which registered
- ---------------------------------- ----------------------------------
See attachment New York Stock Exchange, Inc.

Securities registered pursuant to Section 12(g) of the Act: None.

THE REGISTRANT, A WHOLLY-OWNED SUBSIDIARY OF NYNEX CORPORATION, MEETS THE
CONDITIONS SET FORTH IN GENERAL INSTRUCTION J(1)(a) AND (b) OF FORM 10-K AND IS
THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT PURSUANT TO GENERAL
INSTRUCTION J(2).

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No __

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]*

- ---------
* Not applicable

DOCUMENTS INCORPORATED BY REFERENCE:

None.

Attachment

Title of each class
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REFUNDING MORTGAGE BONDS:
$ 60,000,000 4 5/8% Refunding Mortgage Bonds Series L, Due October 1, 1997
$ 60,000,000 4 5/8% Refunding Mortgage Bonds Series M, Due January 1, 2002
$ 70,000,000 4 1/4% Refunding Mortgage Bonds Series N, Due January 1, 2000
$130,000,000 4 5/8% Refunding Mortgage Bonds Series O, Due January 1, 2004
$100,000,000 4 7/8% Refunding Mortgage Bonds Series P, Due January 1, 2006
$ 75,000,000 6% Refunding Mortgage Bonds Series Q, Due September 1, 2007
$150,000,000 7 1/2% Refunding Mortgage Bonds Series R, Due March 1, 2009
$200,000,000 7 3/4% Refunding Mortgage Bonds Series T, Due December 15, 2006
$200,000,000 7 3/8% Refunding Mortgage Bonds Series V, Due December 15, 2011
DEBENTURES:
$200,000,000 Principal Amount of 40 Year 7 7/8% Debentures, Due June 15, 2017
$150,000,000 Principal Amount of 21 Year 8 5/8% Debentures, Due November 15, 2010
$200,000,000 Principal Amount of 40 Year 9 3/8% Debentures, Due July 15, 2031
$100,000,000 Principal Amount of 30 Year 7 5/8% Debentures, Due February 1, 2023
$200,000,000 Principal Amount of 12 Year 6 1/2% Debentures, Due March 1, 2005
$100,000,000 Principal Amount of 20 Year 7% Debentures, Due May 1, 2013
$100,000,000 Principal Amount of 20 Year 7% Debentures, Due June 15, 2013
$250,000,000 Principal Amount of 32 Year 7% Debentures, Due August 15, 2025
$250,000,000 Principal Amount of 30 Year 6.70% Debentures, Due November 1, 2023
$200,000,000 Principal Amount of 40 Year 7% Debentures, Due December 1, 2033
$450,000,000 Principal Amount of 30 Year 7 1/4% Debentures, Due February 15, 2024
NOTES:
$100,000,000 Principal Amount of 5 Year 5 1/4% Notes, Due September 1, 1998
$200,000,000 Principal Amount of 10 Year 5 7/8% Notes, Due September 1, 2003
$150,000,000 Principal Amount of 10 Year 5 5/8% Notes, Due November 1, 2003
$150,000,000 Principal Amount of 10 Year 6 1/4% Notes, Due February 15, 2004

TABLE OF CONTENTS

PART I

Item Page
- ---- -----

1. Business (Abbreviated pursuant to General Instruction J(2)) ........................... 1
2. Properties .............................................................................. 6
3. Legal Proceedings ..................................................................... 6
4. Submission of Matters to a Vote of Security Holders
(Omitted pursuant to General Instruction J(2)) ..........................................
PART II
5. Market for Registrant's Common Equity and Related Stockholder Matters (Inapplicable) ...
6. Selected Financial Data ............................................................... 7
7. Management's Discussion and Analysis of Results of Operations (Management's Narrative
Analysis of Results of Operations is provided pursuant to General Instruction J(2)) ... 8
8. Consolidated Financial Statements and Supplementary Data:
Report of Management .................................................................. 17
Report of Independent Accountants ...................................................... 18
Statements:
Consolidated Statements of Income and Retained Earnings (Accumulated Deficit) for each
of the Three Years in the Period Ended December 31, 1996 .............................. 19
Consolidated Balance Sheets as of December 31, 1996 and 1995 ........................ 20
Consolidated Statements of Cash Flows for each of the Three Years in the Period Ended
December 31, 1996 ..................................................................... 22
Notes to Consolidated Financial Statements .......................................... 23
Supplementary Information:
Quarterly Financial Information (Unaudited) .......................................... 37
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ... 38
PART III
(Omitted pursuant to General Instruction J(2))
10. Directors and Executive Officers of the Registrant ....................................
11. Executive Compensation ..................................................................
12. Security Ownership of Certain Beneficial Owners and Management ........................
13. Certain Relationships and Related Transactions ..........................................
PART IV
14. Exhibits, Consolidated Financial Statement Schedule and Reports on Form 8-K ............ 39

PART I

Item 1. BUSINESS.

General

New York Telephone Company (the "Company"), which was incorporated in 1896 under
the laws of the State of New York, has its principal executive offices at 1095
Avenue of the Americas, New York, New York 10036 (telephone number 212 395-2121)
and provides telecommunications services in New York and a small portion of
Connecticut (Greenwich and Byram only). The Company is a wholly-owned subsidiary
of NYNEX Corporation ("NYNEX").

Empire City Subway Company (Limited) ("Empire"), a wholly-owned subsidiary of
the Company, is primarily in the business of leasing underground conduit in
Manhattan and the Bronx, primarily to companies in the telecommunications
business. Approximately 92% of Empire's 1996 revenues was generated from the
Company.

Intrastate communications services are under the jurisdiction of state public
utility commissions (see Regulatory Environment - State below), and interstate
communications services are under the jurisdiction of the Federal Communications
Commission ("FCC") (see Regulatory Environment - Federal below). In addition,
state and federal regulators review various transactions between NYNEX
affiliates.

Prior to the enactment of the Telecommunications Act of 1996 (the "Act"), the
operations of NYNEX and its subsidiaries were subject to the requirements of a
consent decree known as the "Modification of Final Judgment" ("MFJ"), which
arose out of an antitrust action brought by the United States Department of
Justice against AT&T Corp. ("AT&T"). Pursuant to the MFJ, AT&T divested its 22
wholly-owned local exchange companies ("LECs"), including the Company and New
England Telephone and Telegraph Company ("New England Telephone"), a
wholly-owned subsidiary of NYNEX (collectively, the "Telephone Companies"),
distributed them to seven regional holding companies ("RHCs"), and distributed
the stock of the RHCs to AT&T's stockholders on January 1, 1984.

The Act provides that any conduct or activity previously subject to the MFJ is
now subject instead to the restrictions and obligations imposed by the Act (see
Competition below).

Telecommunications

The Company provides primarily two types of telecommunications services,
exchange telecommunications and exchange access, in New York State and a small
portion of Connecticut.

Exchange telecommunications service is the transmission of telecommunications
among customers located within geographical areas (local access and transport
areas, or "LATAs"). These LATAs are generally centered on a city or other
identifiable community of interest and, subject to certain exceptions, each LATA
marks an area within which the LEC operating therein may provide
telecommunications services. Exchange telecommunications service may include
local and long distance service within a LATA. Examples of exchange
telecommunications services include switched local residential and business
services, private line voice and data services, Wide Area Telecommunications
Service, long distance and Centrex services.

Exchange access service refers to the link provided by LECs between a customer's
premises and the transmission facilities of other telecommunications carriers,
generally interLATA carriers. Examples of exchange access services include
switched access and special access services.

Certain billing and collection services are performed by the Company for other
telecommunications companies, primarily AT&T, and certain information providers
that elect to subscribe to these services rather than perform such services
themselves. In 1996, less than 1% of the Company's operating revenues was
derived from billing and collection services. In 1996, the Company and AT&T
signed a contract extending the Company's role as an AT&T long distance billing
and collection agent through December 31, 1997. The agreement allows AT&T the
flexibility of gradually assuming certain administrative and billing functions
now performed by the Company.

1

There are six LATAs that comprise the area served by the Company, and they are
referred to as follows: the New York City Metropolitan Area (which includes
Westchester, Rockland, Putnam, Nassau and Suffolk Counties in New York and
Greenwich and Byram in Connecticut), Poughkeepsie, Albany-Glens Falls,
Syracuse-Utica, Buffalo and Binghamton-Elmira.

The following table sets forth for the Company the approximate number of network
access lines in service at the end of each year:

(In Thousands)
-------------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- -------
Network Access Lines
in Service ......... 11,123 10,795 10,477 10,135 9,897

The territories served by the Company contain sizable areas and many localities
in which local service is provided by nonaffiliated telephone companies. On
December 31, 1996, these nonaffiliated companies had approximately 1,180,000
network access lines in service. Rochester, Jamestown, Middletown, Webster and
Henrietta, New York are the only cities with a population of more than 25,000
within the Company's general operating area that are served by such
nonaffiliated companies.

For the year ending December 31, 1996, approximately 91% of the total operating
revenues of the Company was derived from telecommunications services, of which
one customer, AT&T, accounted for approximately 10%, primarily in network access
and other revenues. The remaining approximate 9% of total operating revenues was
from other sources, primarily licensing fees for telephone directories and
inside wire related charges.

Certain Affiliated Business Operations

Telesector Resources Group, Inc.

Telesector Resources Group, Inc. ("Telesector Resources") is a wholly-owned
subsidiary of the Telephone Companies. The Company has a 66 2/3% ownership in
Telesector Resources and shares voting rights equally with the other owner, New
England Telephone.

The Telephone Companies have consolidated all or part of many regional service
and support functions into Telesector Resources as part of the business
restructuring (see Business Restructuring below). Regional service functions are
interstate access services, operator services, public communications, sales,
market area services, corporate services, information services, labor relations,
engineering/construction and business planning. Support functions are quality
and process re-engineering, marketing, accounting, finance, data processing and
related services, technology and planning, public relations, legal and human
resources. In addition, Telesector Resources provides various procurement,
procurement support and materials management services to the Telephone
Companies, on a nonexclusive basis. These services include product evaluation,
contracting, purchasing, materials management and disposition, warehousing,
transportation, and equipment repair management. Under a reciprocal services
agreement, the Company provides certain administrative and other services for
Telesector Resources.

The RHCs own equal interests in Bell Communications Research, Inc. ("Bellcore").
NYNEX's interest is held by Telesector Resources. Bellcore furnishes to the
LECs, and certain of their subsidiaries, technical and support services relating
to exchange telecommunications and exchange access services, a portion of which
is research and development. Bellcore has also served as a central point of
contact for coordinating the efforts of the other RHCs in meeting the national
security and emergency preparedness requirements of the federal government. In
November 1996, the RHCs signed definitive agreements to sell Bellcore to Science
Applications International Corporation ("SAIC"). In addition, agreements were
put in place to provide for continued services from SAIC for existing and new
systems and for RHC rights to use Bellcore-owned intellectual property. Closing
is expected to occur in the second half of 1997, pending regulatory approval in
various jurisdictions across the country.

NYNEX Information Resources Company

The Company has an agreement with NYNEX Information Resources Company
("Information Resources"), a wholly-owned subsidiary of NYNEX, pursuant to which
Information Resources pays a fee to the Company for the

2

use of the Company's name in soliciting directory advertising and in publishing
and distributing directories. Since 1986, the Company and the New York State
Public Service Commission ("NYSPSC") have been negotiating the terms of this
agreement.

Since 1991, Information Resources has made payments to the Company of all of
Information Resources' earnings related to publishing directories in New York in
excess of a regulated return. In 1992, the NYSPSC instituted a proceeding to
investigate the directory publishing operations of the Company and its NYNEX
affiliates ("1992 proceeding"). In 1993, an administrative law judge of the
NYSPSC issued a recommended decision urging the Company to assume the directory
publishing function itself and/or negotiate a modified agreement with
Information Resources. In February 1997, the NYSPSC approved a settlement
agreement resolving all pending issues in the NYSPSC's retrospective
investigation of the Company's transactions with affiliates (see Note 0), as
well as certain portions of the 1992 proceeding. Under the settlement as
approved by the NYSPSC, Information Resources will transfer its subscriber
listings database and the management of the database to a regulated subsidiary
of NYNEX which, in turn, must provide access to all directory publishers on the
same terms. Pending review of the NYSPSC's order when issued, the Company is
unable to determine the disposition or status of the 1992 proceeding.

Business Restructuring

See Business Restructuring in Part II, Item 7.

Extraordinary Item

See Extraordinary Item in Part II, Item 7.

Capital Expenditures

The Company meets the expanding needs for telecommunications services by making
capital expenditures to upgrade and extend the existing telecommunications
network, including new construction, optical fiber and modernization. Capital
expenditures exclude the equity component of allowance for funds used during
construction prior to the discontinuance of Statement of Financial Accounting
Standards No. 71, "Accounting for the Effects of Certain Types of Regulation"
(see Extraordinary Item, Part II, Item 7), and additions under capital leases.

Capital expenditures for 1992 through 1996 are set forth below:

(In Millions)
- --------------------------
1996 $1,308
1995 $1,436
1994 $1,330
1993 $1,342
1992 $1,221

Regulatory Environment

In addition to the discussion below, please see Regulatory Environment in Part
II, Item 7.

Proposed Merger

In response to regulatory filings made by NYNEX in July, state regulatory
commissions in New York and Connecticut indicated that they have authority to
approve the proposed merger between NYNEX and Bell Atlantic Corporation ("Bell
Atlantic") and initiated proceedings. In November, the commission in Connecticut
issued an order approving the Merger. Effective March 21, 1997, the New York
State Public Service Commission ("NYSPSC") issued an order approving the Merger,
subject to the acceptance of certain conditions by NYNEX and Bell Atlantic
within 10 days. NYNEX has stated that the NYSPSC's conditions will require
careful review.

In addition, NYNEX and Bell Atlantic have filed applications with the FCC
seeking approval of the transfer of control of certain FCC licenses and
authorizations held by their telephone companies.

NYNEX is unable to predict when all necessary regulatory action will be
completed.

3

Telecommunications Act of 1996

In December, the FCC commenced a proceeding on Access Reform to review its
system of interstate access charges. This proceeding, which the FCC is
implementing to ensure that the charges are compatible with interconnection and
universal service actions stemming from the Act, will likely result in a
fundamental restructuring of interstate switched access. The FCC's Notice
requests comment on all aspects of access charges and details two approaches for
adjusting access charges to better reflect their economic cost. Under the
"Market Based Approach to Access Reform," the FCC would rely on potential and
actual competition to drive prices toward economic cost. In the alternative
"Prescriptive Approach to Access Reform," the FCC would specify the nature and
timing of price changes, using strict regulatory, rather than market-based,
mechanisms. Comments were filed in January and reply comments in early February.
A decision is anticipated by May 1997.

The Federal/State Joint Board established under the Act has issued its
recommendations for implementing the universal service provisions of the Act.
The Joint Board's decision outlined the telecommunications services that would
be supported by the universal service fund and recommended that the FCC adopt a
proxy costing model, based on forward-looking costs, to develop the amount of
support to be given to carriers in high cost areas. The Joint Board also
recommended that carriers contribute to the universal service fund based on
their gross telecommunications revenues net of payments to other carriers.
Assessments in that manner would reduce the share to be paid by interexchange
carriers such as AT&T and MCI Corporation and increase the contribution by the
incumbent LECs such as the Telephone Companies. The Joint Board made no
recommendations, deferring to the FCC, on the size of the universal service fund
or on how carriers will recover payments made to the fund. With regard to
universal service for schools and libraries, including Internet access, the
Joint Board recommended a fund of no more than $2.25 billion, to be used to
provide discounts ranging from 20 to 90 percent. Under the Act, the FCC has
until early May 1997 to issue its final decision implementing the Joint Board's
recommendations.

The proceedings on interconnection, access reform and universal service, taken
together, will determine the regulatory framework for competitive local exchange
markets as required by the Act. While the outcome of these proceedings cannot be
predicted, they are likely to have a significant impact on the Telephone
Companies' future rate structures, rate levels and revenues.

In December, the FCC issued orders establishing the operational and accounting
safeguards to be applied when an RHC's affiliates conduct certain activities or
offer certain services permitted under the Act, including manufacturing,
interLATA information services and interLATA telecommunications services. The
FCC concluded that an RHC's affiliate may share non-operations related services,
such as marketing, data processing, administrative and corporate governance
services, with the RHC and its local exchange and service companies. In
addition, once the competitive checklist is met, the RHC's local exchange and
long distance affiliates may jointly market each other's services on an equal
footing with competitors. The local exchange company will continue to be
required to inform its new customers of their right to select any interLATA
carrier and to take their order for the selected carrier. With respect to
accounting safeguards, the FCC decided to rely, to a large extent, upon its
existing nonregulated cost accounting and affiliate transactions rules. The
RHC's long distance affiliate will be considered a nonregulated affiliate with
respect to its dealings with the RHC's local exchange and other affiliates.

In June, the FCC adopted rules that will contribute towards the development of
competition in the local exchange market by allowing customers to retain their
telephone numbers when switching local service providers. The FCC's rules
implement the number portability obligations imposed on local exchange carriers
by the Act. Local exchange carriers are to begin implementing number portability
in the 100 largest metropolitan areas by October 1997, with completion by the
end of 1998. Starting in 1999, number portability outside of those areas must be
provided within six months after receiving a specific request from a
telecommunications carrier. The FCC has a pending proceeding on cost recovery
for meeting these requirements.

State

New York
Incentive Plan

The Company has been regulated by the NYSPSC under the Performance Incentive
Plan (the "Plan") since 1995. The Plan is performance-based, replacing rate of
return regulation with a form of price regulation and incentives

4

to improve service, and does not restrict the Company's earnings. Prices were
capped at current rates for "basic" services such as residence and business
exchange access, residence and business local calling and LifeLine service, and
price reduction commitments were established for a number of services, including
toll and intraLATA carrier access services. Certain prices may be adjusted
annually based on certain costs associated with NYSPSC mandates and other
defined "exogenous" events. The Plan establishes service quality targets with
stringent rebate provisions if the Company is unable to meet some or all of the
targets.

Competition Proceedings
In March 1997 the NYSPSC established rates for the Company's principal unbundled
network elements (loops, local and tandem switching, interoffice transport,
signaling systems) to be made available for use by competitors. Hearings on
additional elements, including operator services, operations support systems and
service management systems, and on a variety of related charges and "cost
onsets" will be held in March 1997.

The NYSPSC has established a collaborative proceeding on universal service to
develop and recommend mechanics for funding programs such as lifeline, emergency
services, and telecommunications relay service. The merits of further access
charge reductions, as well as the appropriate discount for schools and
libraries, are also being considered in that proceeding.

The NYSPSC has determined that service quality reporting should vary by company
size, and performance history, but that all companies will be expected to
provide service consistent with performance standards. The NYSPSC intends to
initiate a review of all of its service quality standards. The NYSPSC has
instituted a formal proceeding to design the reports deemed necessary for it to
monitor competition.

Federal

Price Cap Plan

The Telephone Companies are subject to incentive regulation in the form of price
caps. Price cap limits are subject to adjustment each year to reflect inflation,
a productivity factor and certain other cost changes. The price cap formula
adjusts the limits on access price levels upward for inflation, downward for
productivity, and up or down for certain "exogenous" cost beyond the carrier's
control.

In March 1996, the U. S. Court of Appeals for the District of Columbia Circuit
denied petitions filed by the Telephone Companies and several other LECs for
review of a 1995 FCC decision that had required each LEC to (a) "reinitialize"
its price cap index to reflect a higher productivity factor, and (b) recalculate
its price cap index on a prospective basis to exclude cost increases due to
changes in the accounting treatment of other postemployment benefit expenses.

Competition

Most of the services that the Company provides in its local telecommunications
markets have been facing increasing competition for the past several years. The
Company has responded by obtaining increased pricing flexibility under incentive
regulation, introducing new services, and improving service quality. Sustained
increases over the past two years in Private Line/Special Access revenues, and
the number of Centrex win-backs from PBX vendors indicate the Company's ability
to respond effectively in its most competitive markets.

Competition for intraLATA toll revenues has intensified with the increased
marketing of dial-around programs by interexchange carriers. IntraLATA
presubscription ("ILP") began in New York in late 1995 and was completed in
February 1996. To date, the retail toll revenues the Company has lost are being
offset in part by increased revenues from wholesale access charges and increased
total intraLATA usage.

In the highly competitive interstate access market, the Company received a
waiver from the FCC in 1995, to deaverage switched access rates in the
metropolitan New York LATA and introduce a new fixed monthly charge paid
directly by interexchange carriers. This has enabled the Company to charge
prices that more accurately reflect the market conditions in its most
competitive area.

5

Employee Relations

The Company and its subsidiary had approximately 37,200 employees at December
31, 1996. Approximately 32,000 employees are represented by unions, of which
approximately 96% are represented by the Communications Workers of America
("CWA") and approximately 4% by the International Brotherhood of Electrical
Workers ("IBEW"), both of which are affiliated with the AFL-CIO.

In 1994, agreements were ratified with the CWA and the IBEW to extend the
collective bargaining agreements through August 8, 1998. The wage rates
increased 4.0%, 4.0% and 3.5% in August 1994, 1995 and 1996, respectively, and
will increase 3.0% in August 1997. In 1997, there may also be a cost-of-living
adjustment. The agreements also provide for retirement incentives, a commitment
to no layoffs or loss of wages as a result of company-initiated "process
change", an enhanced educational program, and stock grant and other incentives
to improve service quality.

Item 2. PROPERTIES.

The properties of the Company do not lend themselves to simple description by
character and location of principal units.

At December 31, 1996, the gross book value of telephone plant was $20.9 billion,
consisting principally of telephone plant and equipment (88%). Other
classifications include: land, land improvements and buildings (9%); furniture
and other equipment (1%); and plant under construction and other (2%).

Substantially all of the Company's central office equipment is located in
buildings owned by the Company and is situated on land that it owns. Many
administrative offices, garages and business offices are in rented quarters.

As part of the Company's 1993 restructuring associated with re-engineering the
way service is delivered to customers (see Business Restructuring above), the
Company consolidated work centers to build larger work teams in fewer locations.
At December 31, 1996, the majority of the planned work centers were completed.

Substantially all of the Company's assets are subject to lien under the
Company's Refunding Mortgage indenture. At December 31, 1996, the principal
amount of Refunding Mortgage bonds outstanding was $1.0 billion.

Item 3. LEGAL PROCEEDINGS.

There were no proceedings reportable under Item 3.

6

PART II

Item 6. SELECTED FINANCIAL DATA.

(In Millions) 1996 1995 1994 1993 1992
----------------------------------------------------------------

Operating revenues $ 8,022 $ 7,937 $ 7,737 $ 7,847 $ 7,746
Operating expenses $ 6,573 $ 6,932 $ 6,958 $ 7,505 $ 6,259
Interest expense $ 289 $ 307 $ 314 $ 349 $ 363
Earnings before extraordinary item and
cumulative effect of change in accounting
principle $ 774 $ 501 $ 345 $ 82 $ 856
Extraordinary item for the discontinuance of
regulatory accounting principles, net of
taxes $ - $ (2,292) $ - $ - $ -
Cumulative effect of change in accounting for
directory publishing income, net of taxes $ 56 $ - $ - $ - $ -
Cumulative effect of change in accounting for
postemployment benefits, net of taxes $ - $ - $ - $ (89) $ -
Net income (loss) $ 830 $ (1,791) $ 345 $ (8) $ 856
Telephone plant--net $ 9,346 $ 9,306 $12,023 $12,116 $12,134
Total assets $11,662 $ 11,569 $15,296 $15,435 $15,603
Long-term debt $ 3,853 $ 3,913 $ 3,972 $ 3,972 $ 3,984
Share owner's equity $ 2,728 $ 2,473 $ 4,805 $ 5,185 $ 5,916
Capital expenditures* $ 1,308 $ 1,436 $ 1,330 $ 1,342 $ 1,221
Return to equity 31.93% (50.09)% 6.81% (0.13)% 14.66%
Ratio of earnings to fixed charges 4.63 3.16 2.40 1.04 3.98
Network access lines in service (in thousands) 11,123 10,795 10,477 10,135 9,897

See Management's Discussion and Analysis of Results of Operations for the
effect of certain items on 1996 and 1995 results, and restructuring charges
on 1996, 1995, 1994 and 1993 results of operations.

* Excludes additions under capital lease obligations, and prior to the
discontinuance of regulatory accounting principles, the equity component of
allowance for funds used during construction.

7

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS.

The following Management's Narrative Analysis of Results of Operations is
provided pursuant to General Instruction J(2) to Form 10-K.

Results of Operations

Net income for New York Telephone Company (the "Company") for the year ended
December 31, 1996 was $830.0 million. Net loss for the same period of 1995 was
$(1.8) billion.

Net income for the year ended December 31, 1996 includes an after-tax gain of
$55.7 million for the cumulative effect of a change in accounting for directory
publishing income (see Note C). Net income for the year ended December 31, 1996
also includes after-tax charges of $93.6 million for accruals related to various
regulatory, and legal obligations and contingencies, and self-insurance
programs. In addition, there were after-tax charges of $57.1 million for
retirement incentives (see Business Restructuring). Net income for the same
period of 1995 includes an extraordinary, after-tax charge of $2.3 billion for
the discontinuance of regulatory accounting principles, after-tax charges of
$197.6 million for retirement incentives, and after-tax charges of $160.6
million for accruals related to various operating tax provisions, regulatory
obligations and contingencies, self-insurance programs, and revised benefit
charges.

Excluding the above items, net income for the year ended December 31, 1996 would
have been $925.0 million, an improvement of $66.3 million, or 7.7%, over
adjusted net income for the same period of 1995.

Operating Revenues

Operating revenues for the year ended December 31, 1996 were $8.0 billion, an
improvement of $85.2 million, or 1.1%, over the same period of 1995.

Included in the operating revenues for the year ended December 31, 1996 were
charges of $41.0 million related to customer claims, and a $14.0 million refund
ordered by the New York State Public Service Commission ("NYSPSC") pertaining to
intrastate gross receipts tax collected by the Company on behalf of
interexchange carriers. Included in operating revenues for the same period of
1995 was $14.0 million of intrastate revenues collected on behalf of the taxing
authority from interexchange carriers associated with the state gross receipts
tax. (The Company is no longer required to collect gross receipts tax from
interexchange carriers and remit to the taxing authority.)

Excluding the items discussed above, operating revenues for the year ended
December 31, 1996 would have improved $154.2 million, or 1.9%, over adjusted
operating revenues for the same period of 1995.

The $154.2 million improvement in adjusted operating revenues includes the
following categories:

Local service revenues are earned from the provision of local exchange, local
private line and local public network services. The $20.5 million, or 0.4%,
decrease results from the net of (i) a $97 million increase attributable to
revenues earned from Optional Calling Plans ("OCPs") which were recorded in Long
distance revenues in 1995 (see Long distance revenues), a $64 million increase
resulting primarily from increased demand, driven by growth in access lines and
sales of calling features, and (ii) a $70 million decrease in rates attributable
to an order by the NYSPSC approving a performance-based regulatory plan (the
"Plan") (see Regulatory Environment-State), a $62 million decrease due to the
reduction of revenues for service rebate obligations pursuant to the Plan, $16
million of which was refunded in 1996 (see Regulatory Environment-State) and a
$50 million decrease resulting from the reclassification of the reduction of
revenues for service rebate obligations pursuant to the service improvement plan
implemented in 1994 (see Regulatory Environment-State) from Other revenues to
Local service revenues (see Other revenues). Certain decreases, primarily due to
customer selection of competing carriers as a result of intraLATA
presubscription ("ILP"), are being partially offset by increases in Network
access revenues.

Long distance revenues are earned from the provision of services beyond the
local service area, but within the local access and transport area ("LATA"), and
include public and private network switching. The $43.5 million, or 12.5%,

8

decrease results from a $23 million decrease primarily due to decreased demand,
a $10 million decrease attributable to revenues earned from OCPs which were
recorded in Long distance revenues in 1995 and are currently recorded in Local
service revenues (see Local service revenues), and a $10 million decrease in
message toll service rates.

Network access revenues are earned from the provision of exchange access
services primarily to interexchange carriers. The $54.4 million, or 2.4%,
improvement results from the net of (i) a $104 million improvement in switched
access revenues and a $32 million improvement in special access revenues, both
primarily due to increased demand, including the previously mentioned partial
offset of decreases in Local service revenues, and (ii) a $63 million reduction
in interstate rates and a $19 million reduction in intrastate rates attributable
to an NYSPSC order (see Regulatory Environment-State).

Other revenues are earned from the provision of products and services other than
Local service, Long distance and Network access. The $163.8 million, or 31.1%,
improvement results from a $50 million increase resulting from the
reclassification of the reduction of revenues for anticipated service rebate
obligations pursuant to the service improvement plan implemented in 1994 (see
Regulatory Environment-State) from Other revenues to Local service revenues (see
Local service revenues), a net $44 million increase due to the 1995 cessation of
"setting aside" revenues and the recognition of previously "set aside" revenues
as a result of an NYSPSC order approving the Plan effective the second quarter
of 1995, the recognition of $43 million previously deferred revenues in
connection with ILP and other Plan commitments that were met in 1996, an $18
million increase in directory revenues from the directory licensing agreement
with NYNEX Information Resources Company ("Information Resources") consisting of
$9 million of retirement incentive costs recorded during 1995 and $9 million
attributable to business growth, and a $9 million increase due to the
elimination of the deferral of intrastate revenues as a result of the
discontinuance of regulatory accounting principles.

Operating Expenses

Operating expenses for the year ended December 31, 1996 were $6.6 billion, a
decrease of $359.3 million, or 5.2%, from the same period of 1995. Included in
the operating expenses for the year ended December 31, 1996 were charges of
$87.8 million for retirement incentives (see Business Restructuring), charges of
$103.0 million related to regulatory contingencies and various self-insurance
programs, and a $14.0 million intrastate gross receipts tax refund (see
Operating Revenues). Included in operating expenses for the same period of 1995
were charges of $304.1 million for retirement incentives, charges of $232.0
million related to operating tax provisions, various self-
insurance programs, regulatory contingencies, and revised benefit costs, a $15.1
million charge resulting from a court decision on overearnings complaints, and
$14.0 million of gross receipts tax collected and remitted to the taxing
authority (see Operating Revenues).

Excluding the items discussed above, operating expenses would have increased
$29.1 million, or 0.5%, over adjusted operating expenses for 1995.

The $29.1 million increase in adjusted operating expenses includes the following
categories:

Depreciation and amortization decreased $58.6 million, or 4.2%, from 1995
resulting primarily from the net of (i) a $34 million increase due to growth in
depreciable plant investment, and (ii) decreases of $72 million attributable to
revised estimates of future net salvage value and remaining useful lives, and
$15 million attributable to the discontinuance of regulatory accounting
principles in 1995.

Taxes other than income, which include gross receipts taxes, property taxes and
other non-income based taxes, decreased $32.4 million, or 4.5%, from 1995
primarily due to a $15 million decrease in gross receipts taxes principally
attributable to a 1995 tax settlement, an $8 million decrease due to lower taxes
on dividends, and a $5 million decrease in gross receipts taxes attributable to
a change in New York State legislation.

Employee related costs, which consist primarily of wages, payroll taxes, and
employee benefits, increased $57.8 million over 1995 resulting primarily from
the net of (i) a $93 million increase in wages primarily due to additional labor
costs attributable to initiatives to improve service quality, partially offset
by work force reductions attributable to the force reduction program and the
transfer of employees to Telesector Resources Group, Inc.

9

("Telesector Resources") associated with re-engineering service delivery to
customers (see Other operating expenses), and (ii) a $35 million net decrease in
benefit expenses primarily due to a $22 million decrease attributable to a
reduction in medical costs, a $12 million decrease resulting from the
amortization of deferred pension costs pursuant to an NYSPSC approved plan in
1995, and a $6 million decrease attributable to the discontinuance of regulatory
accounting principles, partially offset by a $5 million increase in pension
expense attributable to changes in actuarial assumptions.

Other operating expenses, which consist primarily of contracted and centralized
services, rent and other general and administrative costs, increased $62.2
million over 1995 resulting primarily from the net of (i) a $50 million increase
in charges from affiliated companies, primarily attributable to increases in
Telesector Resources' contracted and centralized services due to process
re-engineering costs not accrued for in the 1993 business restructuring reserves
and costs to implement the competitive checklist provisions of the
Telecommunications Act of 1996 (the "Act") (see Regulatory Environment -
Federal), and the transfer of employees from the Company to Telesector
Resources, partially offset by decreases due to Telesector Resources' force
reduction program, a $22 million increase primarily attributable to lease
buyouts, a $15 million increase in contracted and centralized services primarily
due to the outsourcing of motor vehicle fleet maintenance, and a $12 million
increase primarily due to lower capitalization of expenses as a result of the
discontinuance of regulatory accounting principles, and (ii) a $17 million
decrease in materials primarily attributable to favorable purchase pricing, a $9
million decrease in right to use fees resulting from modified deployment
schedules, a $7 million decrease in land and buildings rent expense and a $5
million decrease in fixed rate uncollectible losses from billing and collection
services performed under contract by the Company for AT&T Corp. ("AT&T").

Other income (expense) - net

Other income (expense) - net decreased $34.3 million from 1995 primarily due to
a $26 million decrease attributable to a change in the recording of capitalized
interest expense (in 1996, capitalized interest expense was recorded as a
reduction to Interest expense), and a $5 million decrease attributable to the
elimination of issues related to the discontinuance of regulatory accounting
principles (see Note B).

Interest expense

Interest expense decreased $18.3 million, or 6.0%, from 1995 resulting primarily
from the net of (i) a $7 million increase resulting primarily from the reversal
of interest charges on the revenue set aside in 1995 (see Regulatory Environment
- - State), and (ii) a $22 million decrease attributable to a change in the
recording of capitalized interest expense (see Other income (expense) - net).

Income taxes

Income taxes increased $154.7 million from 1995, attributable to an increase in
pretax income and the elimination of excess deferred tax reversals as a result
of the discontinuance of regulatory accounting principles (see Note B).

Extraordinary item

In the second quarter of 1995, the discontinuance of regulatory accounting
principles required the Company, for financial accounting purposes, to adjust
telephone plant and equipment and to eliminate non-plant regulatory assets and
liabilities from the balance sheet. This change resulted in an after-tax
extraordinary charge of $2.3 billion, consisting of $1.8 billion to adjust the
carrying amount of telephone plant and equipment and $0.5 billion to write off
non-plant regulatory assets and liabilities.

Cumulative effect of change in accounting principle

Effective January 1, 1996, Information Resources changed the recognition of its
directory publishing income from the "amortized" method to the "point of
publication" method. Under the point of publication method, revenues and
production expenses are recognized when the directories are published rather
than over the lives of the directories

10

(generally one year) as was the case under the amortized method. NYNEX
Corporation ("NYNEX") and the Company believe the change to the point of
publication method is preferable because it is the method that is generally
followed by publishing companies and reflects more precisely the operations of
the business. The Company's portion of the initial effect of the change to the
point of publication method was reported as a cumulative effect of a change in
accounting principle which resulted in a one-time, non-cash gain of $95.4
million ($55.7 million after-tax) in the first quarter of 1996. The application
of the point of publication method for the year ended 1996 did not have a
material effect on operating results, and would not have been material had it
been applied in 1995.

Effects of Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation"

The Financial Accounting Standards Board ("FASB") issued Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation"
("Statement No. 123"), effective for fiscal years beginning after December 15,
1995. NYNEX elected the disclosure-only provisions which require pro forma
amounts to be disclosed as if NYNEX had elected to recognize compensation costs
consistent with the method prescribed by Statement No. 123 (See Note F).

Anticipated Effects of Statement of Financial Accounting Standards No. 125
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities" and No. 127 "Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125"

In June 1996, the FASB issued Statement of Financial Accounting Standards No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" ("Statement No. 125"). Subsequently in December
1996, the FASB issued an amendment to Statement No. 125, Statement of Financial
Accounting Standards No. 127, "Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125" ("Statement No. 127"). NYNEX is required
to adopt Statement No. 125 for transactions occurring after December 31, 1996,
however Statement No. 127 defers certain provisions of Statement No. 125 until
after December 31, 1997. Statement No. 125 establishes the criteria to evaluate
whether a transfer of financial assets should be accounted for as a pledge of
collateral in a secured borrowing or as a sale. It also provides guidance on the
recognition and measurement of servicing assets and liabilities and on the
extinguishments of liabilities. Statement No. 127 defers the specific provisions
of Statement No. 125 which address secured borrowings and collateral as well as
the accounting for transfers of financial assets for repurchase agreements,
dollar roll, securities lending, and similar transactions.

Management is currently evaluating the financial impact of these accounting
standards; the effect of Statement No. 125 and Statement No. 127 on the
Company's results of operations and financial position has not yet been
determined.

Business Restructuring

The Company's 1993 results included pretax charges of approximately $992 million
($645 million after-tax) for business restructuring. Business restructuring
resulted from a comprehensive analysis of the Company's operations and work
processes, resulting in a strategy to redesign them to improve efficiency and
customer service, to adjust quickly to accelerating change, to implement work
force reductions, and to produce savings necessary for the Company to operate in
an increasingly competitive environment.

The 1993 pretax charges were comprised of: $557 million for severance and
postretirement medical costs to reduce the work force by 9,000 employees by the
end of 1996; $208 million for process re-engineering costs, primarily for
systems redesign and work center consolidation; and $227 million for the
Company's allocated portion of Telesector Resources business restructuring
charges.

Work Force Reductions: Additional Charges

During 1994, the Company announced retirement incentives to provide a voluntary
means of implementing substantially all of the work force reductions planned in
1993. The retirement incentives were to be offered at different times through
1996 depending on local force requirements and were expected to incur additional
charges

11

over that period of time as employees elected to leave the business through
retirement incentives rather than through the severance provisions of the 1993
force reduction plan.

During 1995, it became evident that the number of management employees leaving
under the retirement incentives would exceed the original estimate. It was also
determined that, as a result of volume of business growth, the expected
reduction in the number of associates (previously referred to as nonmanagement
employees) would be less than anticipated and would not be fully achieved until
1998. In July 1996, the Company extended the period for offering retirement
incentives to management employees to mid-1997 to better coordinate force sizing
with process re-engineering implementation and service improvement initiatives.
In late February 1997, the Company decided that the management retirement
incentive plan will end in March 1997 when all managers will have received the
offer at least once over the life of the plan.

At the present time, the Company expects the total number of employees (which
excludes Telesector Resources) who will elect to take the retirement incentives
to be in the range of 9,500 to 10,100, consisting of approximately 3,200
management and 6,300 to 6,900 associates, depending on work volumes, needs of
the business and timing of the incentive offers.

The actual number of employees who elected to leave under retirement incentives
in 1994, 1995 and 1996 are as follows:

1994 1995 1996 Total
------- ------ ------ -------
Management 1,100 740 470 2,310
Associates 2,600 1,180 430 4,210
------- ------ ------ -------
Total 3,700 1,920 900 6,520
======= ====== ====== =======

The actual additional charges for retirement incentives in 1996 and 1995 are as
follows:

1996 1995
---- ----
(In Millions) Pretax After-Tax Pretax After-Tax
-----------------------------------------------------

Pension enhancements $96.8 $ 62.9 $ 255.2 $ 165.9
Postretirement medical costs (9.0) (5.8) 48.9 31.7
----- ------- -------- -----------
Total* $87.8 $ 57.1 $ 304.1 $ 197.6
===== ======= ======== ===========

* For the year ended December 31, 1996 and 1995, $25.2 million and $64.6
million, respectively, ($16.4 million and $42.0 million, respectively,
after-tax) were allocated to the Company from Telesector Resources for its
pension enhancements and ($10.8) million and $17.9 million, respectively,
($(7.0) million and $11.6 million, respectively, after-tax) were allocated
from Telesector Resources for its associated postretirement medical benefits.

The severance reserves established in 1993 have been and will continue to be
transferred primarily to the pension liability on a per employee basis as
employees accept the retirement incentives. The postretirement medical
liability established in 1993 had been and will continue to be applied to
retired employees on a per employee basis as employees accept the retirement
incentives. Most of the cost of the retirement incentives is funded by NYNEX's
pension plans.

Work Force Reductions: Reserve Utilization

The 1993 charges for work force reductions of $557 million ($362 million
after-tax) were comprised of $287 million for employee severance payments
(including salary, payroll taxes and outplacement costs) and $270 million for
postretirement medical costs. These costs were for planned work force reductions
of 1,500 management employees and 7,500 associates.

12

The actual utilization of the 1993 severance reserves and the application of the
1993 postretirement medical liability in 1994, 1995 and 1996 are shown below:

Total
(In Millions) 1994 1995 1996 Total Remaining
-------------------------------------------------
Severance $ 135 $41 $44 $220 $67
Postretirement medical costs $ 82 $36 $61 $179 $91

The severance and postretirement medical amounts above include allocations of
$18 and $26 million, respectively, in 1996, $8 and $4 million, respectively, in
1995 and $20 and $8 million, respectively, in 1994, which were transferred to
Telesector Resources for employees who left Telesector Resources under the
retirement incentives (217,150 and 395 employees in 1994, 1995 and 1996,
respectively).

Assuming that employees will continue to leave under the retirement incentives,
it is expected that the remaining $67 million of severance reserves will be
utilized and the remaining $91 million of the postretirement medical liability
will be applied in 1997 and 1998, as associates leave under the retirement
incentives. The reserves for management employees were completely utilized
during 1996.

Process Re-engineering Costs

Approximately $208 million of the 1993 charges ($135 million after-tax) consists
of costs associated with re-engineering service delivery to customers, including
operating the Company and New England Telephone and Telegraph Company ("New
England Telephone") (collectively, the "Telephone Companies") as a single
enterprise under the "NYNEX" brand. During the period 1994 through 1996, NYNEX
has been decentralizing the provision of residence and business customer service
throughout the region, creating regional businesses to focus on unique markets,
and centralizing numerous operations and support functions. The process
re-engineering costs are incurred in connection with systems redesign, work
center consolidation, branding, relocation, training and process re-engineering
implementation. Process re-engineering costs which were not included in the 1993
charges have been expensed as incurred (see Operating Expenses).

Systems redesign is the cost of developing new systems, processes and procedures
to facilitate implementation of process re-engineering initiatives in order to
realize operational efficiencies and enable the Company to reduce work force
levels. These projects consist of radical changes in the applications and
systems supporting business functions to be redesigned as part of the
restructuring plan. All of the costs associated with these projects are
incremental to ongoing operations. Specifically, only software purchases and
external contractor expenses, which are normally expensed in accordance with
Company policy, were included in the 1993 restructuring charges. The business
processes included in systems redesign are customer contact and customer
operations.

Customer contact represents the direct interface with the customer to provide
sales, billing inquiry and repair service scheduling on the first contact.
Customer operations focuses on network monitoring and surveillance, trouble
testing, dispatch control, and proactive repair, with reliability as a critical
competitive advantage.

Work center consolidation costs are incremental costs associated with
establishing work teams in fewer locations to take advantage of lower force
levels and system efficiencies. These costs include moving costs, lease
termination costs (from the date premises are vacated), and other consolidation
costs. Branding includes the costs to develop a single "NYNEX" brand identity
associated with restructured business operations. Relocation costs are costs
incurred to move personnel to different locations resulting from work center
consolidations. These costs are computed in accordance with the Company's
relocation guidelines and the provisions of collective bargaining agreements.
Training costs are for training associates on newly-designed, cross-functional
job positions and re-engineered systems created as part of the restructuring
plan, which will permit one employee to perform tasks formerly performed by
several employees, and include tuition, out-of-pocket course development and
administrative costs, facilities charges, and related travel and lodging.
Re-engineering implementation costs are incremental costs to complete
re-engineering initiatives.

Process Re-engineering: Reserve Utilization

At December 31, 1993, the process re-engineering costs were estimated for
systems redesign, work center

13

consolidation, branding, relocation, training and re-engineering implementation.
At December 31, 1996, the actual utilization of the reserves for process
re-engineering costs are as follows:

(In Millions) 1994 1995 1996 Total
-------------------------------------
Systems redesign $ - $ 68 $ 64 $ 132
Work center consolidation 10 35 3 48
Branding 15 4 - 19
Relocation - - - -
Training - 2 3 5
Re-engineering implementation 1 - - 1
------ ------ ------ ------
Total $ 26 $ 109 $ 70 $ 205
====== ====== ====== ======

At December 31, 1996, $3 million of reserves remained and will be utilized in
1997 for systems redesign.

Systems redesign: During 1994, it was determined that systems redesign would
require a larger than anticipated upfront effort to fully integrate interfaces
between various systems and permit development of multi-tasking capabilities.
This higher degree of complexity and additional functionality required by
real-time, interactive systems caused a delay in the implementation of the
systems redesign. It was realized at this time that utilization of the process
re-engineering reserves for systems redesign would be higher than originally
estimated. During 1995, process re-engineering reserves were utilized for
increased efforts due to the complexity and extensiveness of integration testing
and quality assurance processes. During 1996, it was determined that although
certain systems redesign goals had been accomplished, other goals would not be
completed until mid-1997.

The actual utilization of the systems redesign reserves, by business process,
are as follows:

(In Millions) 1994 1995 1996 Total
------------------------------------
Customer contact $ - $ 49 $ 34 $ 83
Customer operations - 19 30 49
------ ------ ------ ------
Total $ - $ 68 $ 64 $ 132
====== ====== ====== ======

The reserve utilization for work center consolidation was lower than the
estimate due to an increase in the number of work centers from what was
originally planned based on union agreements, the majority of which were
completed in 1995. The reserve utilization for relocation of employees was lower
than the estimate due to the increase in the number of work centers and terms of
the union agreements resulting in less than anticipated employee relocations.
Training was delayed in 1994 due to the timing of the union agreements and the
higher degree of complexity of systems redesign. The utilization of reserves for
training costs were reduced due to the predominant use of in-house, on-the-job
and multi-media training. Reserve utilization for re-engineering implementation
was combined with the related projects (i.e., systems redesign) and therefore
did not require separate identification.

Costs Allocated From Telesector Resources

Approximately $227 million of restructuring charges ($148 million after-tax) was
allocated to the Company from Telesector Resources, primarily related to
Telesector Resources' work force reduction and re-engineering programs. The
actual utilization of these reserves are as follows:

(In Millions) 1994 1995 1996 Total
-------------------------------------
Severance $ 71* $ - $ - $ 71
Postretirement medical costs 31 - - 31
Systems re-engineering 45 68 5 118
Re-engineering implementation 21 14 - 35
------ ------ ------ ------
Total $ 168 $ 82 $ 5 $ 255
====== ====== ====== ======

* 1994 includes $28 million of severance amounts associated with the balance of
the 1991 restructuring reserve at December 31, 1993.

14

Cost Savings

As of December 31, 1996, approximately 6,500 employees have accepted the
retirement incentives. Without the effect of the offsets noted below, this would
equate to an average reduction in wages and benefits, on an annualized basis, of
approximately $329 million. In addition, the Company's share of the annualized
average reduction in wages and benefits attributable to the 3,500 employees of
Telesector Resources leaving under retirement incentives would be approximately
$136 million.

The wage and benefit savings described above, have been, through December 31,
1996, and will continue to be, substantially offset by increased wage and
benefit, and nonwage expenses attributable to the effects of wage and price
inflation, the hiring of employees primarily to handle significantly increased
volumes of business and to improve service, and investments in new marketing and
service delivery initiatives.

Financing

At December 31, 1996, the Company had $250 million of unissued, unsecured debt
securities registered with the Securities and Exchange Commission. In February
1997, the Company decided to redeem its $42 million 8.20% Thirty Year Private
Placement Notes, due July 1, 2008; the Notes were redeemed on March 5, 1997.

Collective Bargaining Agreements

In 1994, a series of collective bargaining agreements were reached with the
Communications Workers of America and the International Brotherhood of
Electrical Workers that extended through August 8, 1998. The wage rates
increased 4.0%, 4.0% and 3.5% in August 1994, 1995 and 1996, respectively, and
will increase 3.0% in August 1997. In 1997, there may also be a cost-of-living
adjustment. The agreements also provide for retirement incentives, a commitment
to no layoffs or loss of wages as a result of company-initiated "process
change", an enhanced educational program, and stock grant and other incentives
to improve service quality.

Regulatory Environment

Telecommunications Act of 1996

The Act granted the regional holding companies ("RHCs") immediate relief for the
provision of "out-of-region" services, that is, interLATA or international
telecommunications services originating outside of the RHC's home region. In
order to provide "in-region" services, the RHC must obtain approval from the
Federal Communications Commission ("FCC") under Section 271 of the Act, which
requires compliance with a competitive checklist and the provision of
interconnection to a facilities-based competitor for business and residential
service. If such interconnection is not requested, the RHC must have a
state-approved Statement of Terms and Conditions under which it will be
provided.

In August, the FCC issued an Order setting forth the terms and conditions for
interconnection. The Order establishes comprehensive technical rules, and sets
national cost and pricing standards. The Order also sets "default" or "proxy"
rates for interconnection and related functions, which state regulatory
commissions may use until the FCC-mandated cost studies have been completed. The
proposed default rates and resale discount result in rates that in many cases
are significantly less than the rates approved by the NYSPSC in the Competition
proceedings (see Regulatory Environment - State), the negotiated rates contained
in the Telephone Companies' various interconnection agreements pending before
the state regulatory commissions and the Telephone Companies' costs. The Order
also permits a carrier to select individual provisions from any other
interconnection agreement the local exchange company has negotiated.

In October, the U. S. Court of Appeals for the 8th Circuit issued a stay of the
Order, with respect to the pricing rules and the selective contract provision,
pending completion of appeals by state regulatory commissions, local exchange
carriers such as NYNEX, and other parties. A decision is expected by April 1997.

15

The Telephone Companies are actively engaged in the negotiation of
interconnection agreements with various competitive local exchange carriers and
wireless carriers under the Act, including those terms of the FCC's Order not
subject to stay. State-specific agreements have been reached with a number of
carriers. Arbitration proceedings were commenced where the Telephone Companies
and the affected carrier were unable to reach agreement. Under the time frame
prescribed by the Act, interconnection agreements in each of the states in which
the Telephone Companies operate were to have been arbitrated and approved by
January 1997, with AT&T and MCI Corporation ("MCI"), and by February 1997 with
Sprint Corporation. No agreements have been reached, and negotiations are
on-going.

The FCC has initiated proceedings under the Act to address universal service
obligations and a fundamental restructuring of access charges. As part of the
access reform proceeding, the FCC will address, on remand from the U. S. Court
of Appeals, the "residual interconnection charge" ("RIC") imposed on all
interexchange carriers for local transport access services beginning in 1992.
The Court directed the FCC to implement a cost-based alternative to the RIC, or
explain why a departure from cost-based pricing is necessary. The RIC accounts
for approximately $600 million of NYNEX's annual revenues.

The proceedings on interconnection, access reform and universal service, taken
together, will determine the regulatory framework for competitive local exchange
markets as required by the Act. While the outcome of these proceedings cannot be
predicted, they are likely to have a significant impact on the Telephone
Companies' future rate structures, rate levels and revenues.

In February 1997, NYNEX submitted to the NYSPSC for its approval of a proposed
Statement of Terms and Conditions for interconnection pursuant to Section 271.
NYNEX also submitted to the NYSPSC for its review a draft of NYNEX's Section 271
application to the FCC. These matters are pending before the NYSPSC. NYNEX
expects to file its Section 271 application with the FCC within the next few
months. Under Section 271, the FCC must approve or deny the application within
90 days of filing.

State

Price Regulation, Competition and Other Proceedings

The Company has been able to replace rate of return regulation with a price
regulation plan in New York. This state regulatory plan eliminates the Company's
obligation to share earnings with customers, allows the Company greater
flexibility to vary prices to meet competition and imposes service quality
performance measurements.

Incentive Plan: The performance incentive plan ("Plan") establishes service
quality targets with stringent rebate provisions if the Company is unable to
meet some or all of the targets. Based on service performance results for Plan
Year 1, which ended August 31, 1996, the Company was required to issue rebates
to customers in the aggregate amount of $72 million.

In mid-February 1997, the NYSPSC determined that the Company had not met all the
targets under a 1994 service improvement plan and directed the Company to refund
$12.6 million of previously "set aside" revenues, plus interest of $4 million,
to customers.

At the time the Plan was adopted, it was estimated that, depending on how long
the Plan remained in effect, the Company's prices would have been decreased by
an amount that, based on fixed volumes of business, would produce an aggregate
revenue reduction over the term of the plan of $1.1 billion at the end of five
years, or $1.9 billion at the end of seven years.

MCI's lawsuit seeking to overturn the Plan is pending. MCI challenges the lack
of an earnings cap and asserts that the Company's rates should be further
reduced annually by the amount of the $153 million set-aside.

Competition Proceedings: In November 1996, the NYSPSC issued an order setting a
discount of approximately 19% to 22% for the Company services offered for
resale.

16

Item 8. CONSOLIDATED FINANCIAL STATEMENTS.

Report of Management

Management of New York Telephone Company and its subsidiary (the "Company") has
the responsibility for preparing the accompanying consolidated financial
statements and for their integrity and objectivity. The consolidated financial
statements were prepared in accordance with generally accepted accounting
principles, which require Management to make estimates and assumptions that
affect reported amounts. Actual results could differ from those estimates. In
Management's opinion, the consolidated financial statements are fairly
presented. Management also prepared the other information in this report and is
responsible for its accuracy and consistency with the consolidated financial
statements.

The consolidated financial statements have been audited by Coopers & Lybrand
L.L.P. ("Coopers & Lybrand"), independent accountants, whose appointment was
approved by the Company's Board of Directors. Management has made available to
Coopers & Lybrand all of the Company's financial records and related data, as
well as the minutes of share owner's and directors' meetings. Furthermore,
Management believes that all representations made to Coopers & Lybrand during
its audits were valid and appropriate.

Management of the Company has established and maintains an internal control
structure that is designed to provide reasonable assurance as to the integrity
and reliability of the consolidated financial statements, the protection of
assets from unauthorized use or disposition, and the prevention and detection of
fraudulent financial reporting. The concept of reasonable assurance recognizes
that the cost of the internal control structure should not exceed the benefits
to be derived. The internal control structure provides for appropriate division
of responsibility and is documented by written policies and procedures that are
communicated to employees with significant roles in the financial reporting
process. Management monitors the internal control structure for compliance,
considers recommendations for improvement from both the internal auditors and
Coopers & Lybrand, and updates such policies and procedures as necessary.
Monitoring includes an internal auditing function to independently assess the
effectiveness of the internal controls and recommend possible improvements
thereto. Management believes that the internal control structure of the Company
is adequate to accomplish the objectives discussed herein.

The Audit Committee of the Board of Directors, which is comprised of directors
who are not employees, meets periodically with Management, the internal auditors
and Coopers & Lybrand to review the manner in which they are performing their
responsibilities and to discuss matters relating to auditing, internal controls
and financial reporting. Both the internal auditors and Coopers & Lybrand
periodically meet privately with the Audit Committee and have access to the
Audit Committee at any time.

Management also recognizes its responsibility for conducting Company activities
under the highest standards of personal and corporate conduct. This
responsibility is accomplished by fostering a strong ethical climate as
characterized in the NYNEX Code of Business Conduct, which is publicized
throughout the Company. The Code of Conduct addresses, among other things,
standards of personal conduct, potential conflicts of interest, compliance with
all domestic and foreign laws, accountability for Company property, and the
confidentiality of proprietary information.

Richard A. Jalkut
President and Chief Executive Officer

John Diercksen
Acting Vice President - Finance and Treasurer

17

REPORT OF INDEPENDENT ACCOUNTANTS

To the Share Owner and Board of Directors of
New York Telephone Company:

We have audited the consolidated financial statements and the consolidated
financial statement schedule of New York Telephone Company and Subsidiary (the
"Company") listed in Item 14(a)(1) and (2) of this Form 10-K. These consolidated
financial statements and consolidated financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements and consolidated financial
statement 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 consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of the
Company as of December 31, 1996 and 1995, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
In addition, in our opinion, the consolidated financial statement schedule
referred to above, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information required to be included therein.

As discussed in Note C to the consolidated financial statements, during the
first quarter of 1996, the Company changed its method of recognizing directory
publishing revenues and production expenses effective January 1, 1996.
Additionally, as discussed in Note B to the consolidated financial statements,
in the second quarter of 1995, the Company discontinued accounting for its
operations in accordance with Statement of Financial Accounting Standards No.
71, "Accounting for the Effects of Certain Types of Regulation".

Coopers & Lybrand L.L.P.
New York, New York
February 7, 1997

18

NEW YORK TELEPHONE COMPANY
CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS (ACCUMULATED DEFICIT)
(In Millions)

For the Year Ended December 31,
--------------------------------------
1996 1995 1994
--------- --------- --------

OPERATING REVENUES
Local service $ 4,746.0 $ 4,794.5 $4,743.3
Long distance 304.6 348.1 348.1
Network access 2,280.4 2,267.0 2,245.7
Other 691.3 527.5 399.5
--------- --------- --------
Total operating revenues 8,022.3 7,937.1 7,736.6
--------- --------- --------
OPERATING EXPENSES
Maintenance and support 2,575.0 2,431.2 2,448.7
Depreciation and amortization 1,335.1 1,393.7 1,486.5
Marketing and customer services 1,088.3 1,054.2 979.1
Taxes other than income 668.4 798.8 789.6
Provision for uncollectible revenues 108.0 109.2 79.9
Other 798.2 1,145.2 1,174.2
--------- --------- --------
Total operating expenses 6,573.0 6,932.3 6,958.0
--------- --------- --------
Operating income 1,449.3 1,004.8 778.6
Other income (expense) - net (4.9) 29.4 21.2
Interest expense 288.5 306.8 314.4
--------- --------- --------
Earnings before income taxes, extraordinary item and cumulative
effect of change in accounting principle 1,155.9 727.4 485.4
Income taxes 381.6 226.9 140.4
--------- --------- --------
Earnings before extraordinary item and cumulative effect of change
in accounting principle 774.3 500.5 345.0
Extraordinary item for the discontinuance of regulatory accounting
principles, net of taxes (Note B) - (2,291.6) -
Cumulative effect of change in accounting for directory publishing
income, net of taxes (Note C) 55.7 - -
--------- --------- --------
NET INCOME (LOSS) $ 830.0 $(1,791.1) $ 345.0
========= ========= ========
RETAINED EARNINGS (ACCUMULATED DEFICIT)
Beginning of year $(1,269.4) $ 702.2 $1,082.0
Net income (loss) 830.0 (1,791.1) 345.0
Dividends (Note T) - (180.5) (724.8)
--------- --------- --------
End of year $ (439.4) $(1,269.4) $ 702.2
========= ========= ========

See accompanying notes to consolidated financial statements.

19

NEW YORK TELEPHONE COMPANY
CONSOLIDATED BALANCE SHEETS
(In Millions)

December 31,
----------------------
1996 1995
-------- --------

ASSETS
Current assets:
Cash $ 22.8 $ 39.9
Receivables
Trade (net of allowance of $162.3 and $154.7, respectively) 1,535.0 1,584.9
Affiliates 124.6 45.5
Other 26.0 29.2
Deferred charges 70.6 52.5
Deferred income taxes 0.8 44.1
Inventory 110.8 62.8
Prepaid expenses and other 98.3 82.4
--------- ---------
Total current assets 1,988.9 1,941.3
--------- ---------
Telephone plant - net 9,345.8 9,305.8
Long-term investment, deferred charges and other 327.5 321.8
--------- ---------
TOTAL ASSETS $11,662.2 $11,568.9
========= =========

See accompanying notes to consolidated financial statements.

20

NEW YORK TELEPHONE COMPANY
CONSOLIDATED BALANCE SHEETS
(In Millions)

December 31,
------------------------
1996 1995
-------- ---------

LIABILITIES AND SHARE OWNER'S EQUITY
Current liabilities:
Accounts payable
AT&T $ 131.4 $ 203.6
Affiliates 657.4 840.6
Trade and other 881.7 908.1
Compensated absences 162.4 151.7
Short-term debt 629.6 367.0
Dividends payable 191.6 180.5
Taxes accrued 62.4 29.8
Deferred income taxes 83.5 -
Advance billing and customers' deposits 180.8 173.8
Interest accrued 64.3 67.2
-------- ---------
Total current liabilities 3,045.1 2,922.3
-------- ---------
Long-term debt 3,852.6 3,913.3
Deferred income taxes 17.4 102.1
Unamortized investment tax credits 106.7 130.9
Other long-term liabilities and deferred credits 1,912.4 2,027.5
-------- ---------
Total liabilities 8,934.2 9,096.1
-------- ---------
Commitments and contingencies (Notes J, K, L, O and P)
Share owner's equity:
Common stock-one share, without par value (Note T) 1.0 1.0
Additional paid-in capital (Note T) 3,166.4 3,741.2
Retained earnings/(Accumulated deficit) (439.4) (1,269.4)
-------- ---------
Total share owner's equity 2,728.0 2,472.8
-------- ---------
TOTAL LIABILITIES AND SHARE OWNER'S EQUITY $11,662.2 $11,568.9
======== =========

See accompanying notes to consolidated financial statements.

21

NEW YORK TELEPHONE COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Millions)

For the Year Ended December 31,
----------------------------------------
1996 1995 1994
--------- ---------- ---------

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 830.0 $ (1,791.1) $ 345.0
--------- ---------- ---------
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Extraordinary item, net of taxes - 2,291.6 -
Depreciation and amortization 1,335.1 1,393.7 1,486.5
Deferred income taxes-net 10.8 (174.2) (268.0)
Deferred credits-net (24.2) (29.5) (32.4)
Changes in operating assets and liabilities:
Receivables (26.0) (175.2) (56.9)
Deferred charges (18.1) (21.7) 16.5
Deferred income taxes 43.3 120.4 (5.7)
Inventory (48.0) 10.7 (1.1)
Prepaid expenses and other (15.9) (25.2) 45.7
Accounts payable (271.1) 215.6 251.7
Taxes accrued 32.6 (43.1) 24.6
Deferred income tax liability 83.5 - -
Advance billing and customers' deposits 7.0 (4.5) (8.9)
Interest accrued (2.9) (7.5) 16.5
Other-net (281.4) 223.6 219.4
--------- ---------- ---------
Total adjustments 824.7 3,774.7 1,687.9
--------- ---------- ---------
Net cash provided by operating activities 1,654.7 1,983.6 2,032.9
--------- ---------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1,308.1) (1,436.4) (1,329.9)
--------- ---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Advances from NYNEX 261.0 18.3 (550.5)
Dividends paid to NYNEX (563.7) (542.2) (724.6)
Issuance of long-term debt - - 593.5
Repayment of long-term debt and capital leases (61.0) (6.5) (5.8)
--------- ---------- ---------
Net cash used in financing activities (363.7) (530.4) (687.4)
--------- ---------- ---------
Net (decrease) increase in cash (17.1) 16.8 15.6
Cash at beginning of year 39.9 23.1 7.5
--------- ---------- ---------
Cash at end of year $ 22.8 $ 39.9 $ 23.1
========= ========== =========

See accompanying notes to consolidated financial statements.

22

New York Telephone Company
Notes To Consolidated Financial Statements

A Accounting Policies

Nature of Operations

New York Telephone Company and its wholly-owned subsidiary, Empire City Subway
Company (Limited) (jointly referred to as the "Company"), primarily provide
exchange telecommunications and exchange access services in substantially all of
New York and a small portion of Connecticut. The Company is a wholly-owned
subsidiary of NYNEX Corporation ("NYNEX"). Intrastate communications services
are regulated by state public service commissions ("state commissions"), and
interstate communications services are regulated by the Federal Communications
Commission ("FCC").

The communications and media industry continues to experience fundamental
changes at an ever-increasing pace. Telecommunications, information and
entertainment services are converging in the market, driven by technology and
released by landmark federal legislation that has removed historic regulatory
barriers and increased competition. These changes are likely to have a
significant effect on the future financial performance of many companies in the
industry. The Company cannot predict the effect of such competition on its
business.

NYNEX is implementing a major restructuring of its business, is entering into
domestic strategic alliances and is expanding globally in select international
markets in order to respond to competition. In addition, NYNEX is pursuing
reforms in telecommunications policy at both the state and federal levels. In
February 1996, the Telecommunications Act of 1996 was signed into law. This
legislation will lead to the development of competition in local and long
distance telephone service, cable television, and information and entertainment
services.

Basis of Presentation

The consolidated financial statements include the accounts of the Company and
its subsidiary. The Company has a 66 2/3% ownership interest in Telesector
Resources Group, Inc. ("Telesector Resources") and shares voting rights equally
with the other owner, New England Telephone and Telegraph Company ("New England
Telephone"), which is a wholly-owned subsidiary of NYNEX. The Company uses the
equity method of accounting for its investment in Telesector Resources.

The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles ("GAAP"). GAAP requires Management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Due to the uncertainty inherent in making
estimates, actual results could differ from those estimates. The 1995 and 1994
consolidated financial statements have been reclassified to conform to the
current year's format.

In the first quarter of 1996, NYNEX Information Resources Company ("Information
Resources"), a wholly-owned subsidiary of NYNEX, changed the recognition of its
directory publishing revenue and production expenses from the "amortized" method
to the "point of publication" method. The initial effect of the change to the
point of publication method is reported as a cumulative effect of a change in
accounting principle (see Note C).

In the second quarter of 1995, the Company discontinued using GAAP applicable to
regulated entities (see Note B).

Inventory

Inventory, consisting of materials and supplies, is carried principally at
average cost.

23

Telephone Plant

Telephone plant is stated at its original cost. When depreciable plant is
disposed of, the carrying amount is charged to accumulated depreciation.

As a result of the implementation of Statement of Financial Accounting Standards
No. 101, "Regulated Enterprises - Accounting for the Discontinuation of
Application of FASB Statement No. 71" ("Statement No. 101"), in the second
quarter of 1995, the Company began recording depreciation expense using shorter
asset lives based on expectations as to the revenue-producing lives of the
assets (see Note B), calculated on a straight-line basis using the concept of
"remaining life." Previously, depreciation rates used by the Company were
prescribed by the FCC and by the state commissions for interstate operations and
for intrastate operations, respectively.

Capitalized Interest Cost

As a result of the application of Statement No. 101, capitalized interest for
the Company is recorded as a cost of telephone plant and equipment and a
reduction of interest, in accordance with the provisions of Statement of
Financial Accounting Standards No. 34, "Capitalization of Interest Cost"
("Statement No. 34"). Previously, regulatory authorities allowed the Company to
capitalize interest, including an allowance on share owner's equity, as a cost
of constructing certain plant and as income, included in Other income (expense)
- - net. Such income was realized over the service life of the plant as the
resulting higher depreciation expense was recovered through the rate-making
process.

Computer Software Costs

The Company capitalizes initial right-to-use fees for central office switching
equipment, including initial operating system and initial application software
costs. For non-central office equipment, only the initial operating system
software is capitalized. Subsequent additions, modifications, or upgrades of
initial software programs, whether operating or application packages, are
expensed.

Refinancing Charges

As a result of the application of Statement No. 101, the Company no longer
defers call premiums and other charges associated with the redemption of
long-term debt, and previously deferred refinancing costs were eliminated (see
Note B). The intrastate portion of these costs had been deferred and amortized
over periods stipulated by the state commissions. The interstate portion had
been expensed as required by the FCC.

Income Taxes

NYNEX and its subsidiaries, including the Company, file a consolidated Federal
income tax return. The Company's provision for federal income taxes currently
payable is allocated in accordance with its contribution to the consolidated
group's taxable income and tax credits.

Deferred tax assets and liabilities are measured based on the enacted tax rates
that will be in effect in the years in which temporary differences are expected
to reverse.

For the Company, prior to the application of Statement No. 101, the treatment of
excess deferred taxes resulting from the reduction of tax rates in prior years
was subject to federal income tax and regulatory rules. Deferred income tax
provisions of the Company were based on amounts recognized for rate-making
purposes. The Company recognized a deferred tax liability and established a
corresponding regulatory asset for tax benefits previously flowed through to
ratepayers. The major temporary difference that gave rise to the net deferred
tax liability was depreciation, which for income tax purposes is determined
based on accelerated methods and shorter lives. Statement of Financial
Accounting Standards No. 71, "Accounting for the Effects of Certain Types of
Regulation" ("Statement No. 71"), required the Company to reflect the additional
deferred income taxes as regulatory assets to the extent that they would be
recovered in the rate-making process. In accordance with the normalization
provisions under federal tax law, the Company reversed excess deferred taxes
relating to depreciation of regulated assets over the regulatory

24

lives of those assets. For other excess deferred taxes, the state commissions
generally allowed amortization of excess deferred taxes over the reversal period
of the temporary difference giving rise to the deferred taxes. As a result of
the application of Statement No. 101, income tax-related regulatory assets and
liabilities were eliminated (see Note B).

The Tax Reform Act of 1986 repealed the investment tax credit ("ITC"), effective
January 1, 1986. As required by tax law, ITC for the Company was deferred and is
amortized as a reduction to tax expense over the estimated service lives of the
related assets giving rise to the credits.

Anticipated Effects of Statement of Financial Accounting Standards No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities" and No. 127, "Deferral of the Effective Date of Certain
Provisions of FASB Statement No. 125"

In June 1996, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" ("Statement
No. 125"). Subsequently, in December 1996, the FASB issued an amendment to
Statement No. 125, Statement of Financial Accounting Standards No. 127,
"Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125"
("Statement No. 127"). NYNEX is required to adopt Statement No. 125 for
transactions occurring after December 31, 1996, however Statement No. 127 defers
certain provisions of Statement No. 125 until after December 31, 1997. Statement
No. 125 establishes the criteria to evaluate whether a transfer of financial
assets should be accounted for as a pledge of collateral in a secured borrowing
or as a sale. It also provides guidance on the recognition and measurement of
servicing assets and liabilities and on the extinguishments of liabilities.
Statement No. 127 defers the specific provisions of Statement No. 125 which
address secured borrowings and collateral as well as the accounting for
transfers of financial assets for repurchase agreements, dollar roll, securities
lending, and similar transactions.

Management is currently evaluating the financial impact of these accounting
standards; the effect of Statement No. 125 and Statement No. 127 on the
Company's results of operations and financial position has not yet been
determined.

B Discontinuance of Regulatory Accounting Principles

In the second quarter of 1995, the Company discontinued accounting for its
operations in accordance with the provisions of Statement No. 71. As a result,
the Company recorded an extraordinary non-cash charge of approximately $2.3
billion, net of income taxes of $1.2 billion.

The operations of the Company no longer met the criteria for application of
Statement No. 71 due to a number of factors including: significant changes in
regulation (achievement of price regulation rather than rate-of-return
regulation in New York); an intensifying level of competition; and the
increasingly rapid pace of technological change. Under Statement No. 71, the
Company had accounted for the effects of rate actions by federal and state
regulatory commissions by establishing certain regulatory assets and
liabilities, including the depreciation of its telephone plant and equipment
using asset lives approved by regulators and the deferral of certain costs and
obligations based on approvals received from regulators. The Company had
continually assessed its position and the recoverability of its
telecommunications assets with respect to Statement No. 71. Telephone plant and
equipment was adjusted through an increase in accumulated depreciation, to
reflect the difference between recorded depreciation and the amount of
depreciation that would have been recorded had the Company not been subject to
rate regulation. Gross plant was written off where fully depreciated, and
non-plant regulatory assets and liabilities were eliminated from the balance
sheet.

The after-tax extraordinary charge recorded consists of $1.8 billion for the
adjustment to telephone plant and equipment and $0.5 billion for the write-off
of non-plant regulatory assets and liabilities.

The net decrease of $2.8 billion to telephone plant and equipment was supported
by a depreciation analysis, which identified inadequate depreciation reserve
levels which the Company believes resulted principally from the cumulative
under-depreciation of telephone plant and equipment as a result of the
regulatory process. An impairment

25

analysis was performed that did not identify any additional amounts not
recoverable from future operations. ITC amortization was accelerated as a result
of the reduction in asset lives of the associated telephone plant and equipment.

The major elements of the 1995 write-off of non-plant regulatory net assets were
as follows:

(In Millions) Pretax After-tax
---------- ----------
Compensated absences $ 120.2 $ 78.1
Deferred pension costs 264.4 171.9
Refinancing costs 184.7 120.1
Deferred taxes - 53.7
Other 119.5 77.7
-------- -------
Total $ 688.8 $ 501.5
======== =======

With the adoption of Statement No. 101, the Company now uses estimated asset
lives for certain categories of telephone plant and equipment that are shorter
than those approved by regulators. These shorter asset lives result from the
Company's expectations as to the revenue-producing lives of the assets.

A comparison of average asset lives before and after the discontinuance of
Statement No. 71 for the most significantly affected categories of telephone
plant and equipment is as follows:

Average lives (in years)
-----------------------------------
Composite
Regulator-Approved Economic
Asset Lives Asset Lives
--------------------- -------------
Digital Switching 16 12
Circuit - Other 10 8
Aerial Metallic Cable 20 17
Underground Metallic Cable 25 15
Buried Metallic Cable 25 17
Fiber 25 20

The application of Statement No. 101 does not change the Company's accounting
and reporting for regulatory purposes.

C Change in Accounting Principle

Effective January 1, 1996, Information Resources changed the recognition of its
directory publishing income from the "amortized" method to the "point of
publication" method. Under the point of publication method, revenues and
production expenses are recognized when the directories are published rather
than over the lives of the directories (generally one year) as was the case
under the amortized method. NYNEX and the Company believe the change to the
point of publication method is preferable because it is the method that is
generally followed by publishing companies and reflects more precisely the
operations of the business. Pursuant to the directory licensing agreement
between Information Resources and the Company, the Company's portion of the
initial effect of the change to the point of publication method was reported as
a cumulative effect of a change in accounting principle which resulted in a
one-time, non-cash gain of $95.4 million ($55.7 million after-tax) in the first
quarter of 1996. The application of the point of publication method for the year
ended 1996 did not have a material effect on operating results, and would not
have been material had it been applied in 1995.

26

D Income Taxes

The components of Income tax expense (benefit) are as follows:

(In Millions) 1996* 1995** 1994
- --------------------------------------------------------------
Federal:
Current $390.4 $ 426.6 $ 435.9
Deferred-net 10.1 (174.2) (268.0)
Deferred tax credits-net (24.2) (29.5) (32.4)
------ ------- -------
376.3 222.9 135.5
State and local 5.3 4.0 4.9
------ ------- -------
Total $381.6 $ 226.9 $ 140.4
====== ======= =======

* Does not include the deferred tax expense of $33.4 million associated with
the Cumulative effect of change in accounting for directory publishing income.

** Does not include the deferred tax benefit of $1.2 billion associated with the
Extraordinary item for the discontinuance of regulatory accounting principles.

A reconciliation between the federal income tax expense computed at the
statutory rate and the Company's effective tax expense is as follows:

(In Millions) 1996 1995 1994
- -------------------------------------------------------------------------------
Federal income tax expense computed at the
statutory rate $403.6 $254.6 $169.9
a. Amortization of investment tax credits (15.8) (21.5) (32.4)
b. Amortization of excess deferred federal
taxes due to change in the tax rates - (5.2) (29.9)
c. Depreciation of certain taxes and payroll-
related construction costs capitalized for
financial statement purposes, but
deducted for income tax purposes in
prior years - 2.9 13.1
d. Federal income tax return adjustment for
the difference between the accrued and
actual tax expense (5.8) .2 (0.4)
e. Allowance for funds used during
construction, which is excluded from
taxable income, net of applicable
depreciation - 8.9 6.7
f. Other items-net (0.4) (13.0) 13.4
------ ------ ------
Income tax expense $381.6 $226.9 $140.4
====== ====== ======

Not included above are gross receipts taxes the Company is subject to in lieu of
a state income tax. Temporary differences for which deferred income taxes have
not been provided by the Company are represented principally by "c" above. Upon
the discontinuance of Statement No. 71 (see Note B), items "b" and "c" above
have been eliminated.

27

The components of current and non-current deferred tax assets and liabilities at
December 31, 1996 and 1995 are as follows:

(In Millions) 1996 1995
- ----------------------------------------------------
Deferred tax assets
Employee benefits $ 707.7 $ 663.7
Restructuring charges 46.3 107.2
Unamortized ITC 35.9 44.3
Other 335.5 245.0
-------- --------
1,125.4 1,060.2
-------- --------
Deferred tax liabilities
Depreciation and amortization 971.9 966.1
Employee benefits 88.3 88.3
Other 165.3 63.8
-------- --------
1,225.5 1,118.2
-------- --------
Net deferred tax liabilities $ 100.1 $ 58.0
======== ========

During 1995, income tax-related regulatory assets and liabilities were
eliminated as a result of the discontinued application of Statement No. 71 (see
Note B).

E Employee Benefits

Pensions

Substantially all of the Company's employees are covered by one of two NYNEX
noncontributory defined benefit pension plans (the "Plans"). Benefits for
management employees are based on a modified career average pay plan while
benefits for associates (employees previously referred to as nonmanagement) are
based on a nonpay-related plan. Contributions are made, to the extent deductible
under the provisions of the Internal Revenue Code, to an irrevocable trust for
the sole benefit of pension plan participants.

Total pension benefit for 1996, 1995 and 1994 was $132.7, $152.4 and $165.8
million, respectively. Deferral of pension cost was discontinued as of January
1, 1993, and the Company had implemented a plan to recover deferred pension
costs through the rate-making process (see Postretirement Benefits Other Than
Pensions below). The pension benefit for 1996, 1995 and 1994 includes the effect
of plan amendments and changes in actuarial assumptions for the discount rate
and future compensation levels. At December 31, 1996 and 1995, the Company
recorded approximately $958.3 million and $1.0 billion, respectively, in Other
long-term liabilities and deferred credits representing the Company's pension
liability.

The assumptions used to determine the projected benefit obligation at December
31, 1996 and 1995 include a discount rate of 7.75% and 7.25%, respectively, and
an increase in future compensation levels in both years of 4.1% for management
employees, and 4.0% for associates. The expected long-term rate of return on
pension plan assets used to calculate pension expense was 8.9% in 1996, 1995 and
1994. The actuarial projections included herein anticipate plan improvements for
active employees in the future.

As a result of planned work force reductions primarily through retirement
incentives in 1996, 1995 and 1994, the Company incurred additional pension costs
of $93.6, $214.0 and $412.2 million, respectively, partially offset by the 1993
severance reserves which were transferred to the pension liability. In 1996,
this cost was comprised of a charge for special termination benefits of $144.1
million and a curtailment gain of $31.5 million, partially offset by 1993
severance reserves of $26.0 million. In 1995, this cost was comprised of a
charge for special termination benefits of $290.2 million and a curtailment gain
of $76.2 million, partially offset by 1993 severance reserves of $31.9 million.
In 1994, this cost was comprised of a charge for special termination benefits of
$551.6 million and a curtailment gain of $139.4 million, partially offset by
1993 severance reserves of $106.7 million.

28

Postretirement Benefits Other Than Pensions

The Company provides certain health care and life insurance benefits for retired
employees and their families. Substantially all of the Company's employees may
become eligible for these benefits if they reach pension eligibility while
working for the Company. The Company participates in the NYNEX benefit plans,
and the structure of the plans is such that certain disclosures required by
Statement of Financial Accounting Standards No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions" ("Statement No. 106"), cannot be
presented for the Company on an individual basis. A comparison of the actuarial
present value of the accumulated postretirement benefit obligation with the fair
value of plan assets, the components of the net postretirement benefit cost, and
the reconciliation of the funded status of the plans with the amount recorded on
the balance sheet are provided on a consolidated basis in NYNEX's Annual Report
on Form 10-K for the years ended December 31, 1996 and 1995.

The postretirement benefit cost for 1996 includes pretax credits to medical
expense of $41.1 million for plan amendments primarily intended to reduce
company costs under managed care options.

The Company recognizes the transition obligation for retired employees and the
earned portion for active employees over a 20-year period. The cost of health
care benefits and group life insurance was determined using the unit credit cost
actuarial method. The net postretirement benefit cost for 1996, 1995 and 1994
for the Company was $265.4, $295.7 and $299.1 million, respectively.

The actuarial assumptions used to determine the 1996 and 1995 obligation for
postretirement benefit plans under Statement No. 106 are as follows: discount
rate of 7.75% and 7.25%, respectively; weighted average expected long-
term rate of return on plan assets of 8.4% in both years; weighted average
salary growth rate of 4.0% in both years; medical cost trend rate of 10.6% and
11.6% in 1996 and 1995, respectively, grading down to 4.5% in 2008; and dental
cost trend rate of 3.5% and 4.0% in 1996 and 1995, respectively, grading down to
3.0% in 2002.

As a result of planned work force reductions, the Company recorded an additional
$270.5 million of postretirement benefit cost in 1993 accounted for as a
curtailment. In 1996, 1995 and 1994 under work force reduction retirement
incentives, the Company incurred additional postretirement benefit costs of
$43.5, $65.2 and $230.7 million, respectively. In 1996, this cost was comprised
of a curtailment loss of $29.9 million and a charge for special termination
benefits of $11.7 million, partially offset by $36.0 million accrued for in
1993. In 1995, this cost was comprised of a curtailment loss of $37.4 million
and a charge for special termination benefits of $27.8 million, partially offset
by $32.2 million accrued for in 1993. In 1994, this cost was comprised of a
curtailment loss of $172.9 million and a charge for special termination benefits
of $57.8 million, partially offset by $74.4 million accrued for in 1993.

NYNEX established two separate Voluntary Employees' Beneficiary Association
Trusts ("VEBA Trusts"), one for management and the other for associates, to
begin prefunding postretirement health care benefits. At December 31, 1992,
NYNEX had transferred excess pension assets, totaling $486 million, to health
care benefit accounts within the pension plans and then contributed those assets
to the VEBA Trusts. No additional contributions were made in 1996, 1995 and
1994. The assets in the VEBA Trusts consist primarily of equity and fixed income
securities. Additional contributions to the VEBA Trusts are evaluated and
determined by NYNEX management.

Regulatory Treatment

With respect to interstate treatment, in 1994 the FCC's 1993 order denying
exogenous treatment of additional costs recognized under Statement No. 106 was
overturned in the court. Tariff revisions were filed by the Company and New
England Telephone (collectively, the "Telephone Companies") with the FCC in 1994
to amend price cap indices to reflect additional exogenous costs recognized
under Statement No. 106, including $42 million of costs already accrued,
increased annual costs of $21 million and increased rates of $2.2 million.
Commencing December 30, 1994, the Telephone Companies began collecting these
revenues, subject to possible refund pending resolution of the FCC Common
Carrier Bureau's investigation. The annual update to the price cap rates,
effective August 1, 1995, included tariff revisions to recover approximately $21
million of exogenous costs resulting from the implementation of Statement No.
106. In November 1996, NYNEX filed tariff revisions to reduce its interstate
access charges by $21 million because it had completed the recovery of exogenous
costs resulting from the implementation of Statement No. 106.

With respect to intrastate treatment, the Company eliminated remaining deferred
pension costs upon the discontinuance of Statement No. 71.

29

F Stock Options

NYNEX has stock option plans for key management employees under which options to
purchase NYNEX common stock are granted at a price equal to or greater than the
market price of the stock at the date of grant. The 1990 Stock Option Plan,
which expired on December 31, 1994, permitted the grant of options through
December 1994 to purchase up to 4 million shares. In January 1995, NYNEX
established the 1995 Stock Option Plan, that permits the grant of options no
later than December 31, 1999 to purchase up to 20 million shares of common
stock. One-third of the options could be exercised one year from the grant date,
with another one-third exercisable two years from the grant date, and the
remaining one-third exercisable three years from the grant date. These options
expire ten years from the grant date.

Both the 1990 and the 1995 Stock Option Plans for key management employees allow
for the granting of stock appreciation rights ("SARs") in tandem with options
granted. Upon exercise of a SAR, the holder may receive shares of common stock
or cash equal to the excess of the market price of the common stock at the
exercise date over the option price. SARs may be exercised in lieu of the
underlying option only when those options become exercisable. There are no
outstanding SARs as of December 31, 1995 and 1996.

Effective March 31, 1992, NYNEX established stock option plans for associates
and for management employees other than those eligible to participate in the
1990 and 1995 Stock Option Plans ("Take Stock In NYNEX"). Employees were granted
options, with the number of options varying according to employee level, to
purchase a fixed number of shares of NYNEX common stock at the market price of
the stock on the grant date. Fifty percent of the options could be exercised one
year from the grant date, with the remaining fifty percent exercisable two years
from the grant date. These options expire ten years from the grant date. In
October 1994 and January 1996, employees were granted additional options under
these plans.

NYNEX has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation"
("Statement No. 123"), but applies Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations in
accounting for its plans. Pro forma results, assuming NYNEX had elected to
recognize compensation costs for the 1995 Stock Option Plan and the Take Stock
in NYNEX plans based on the fair value at the grant dates for awards under those
plans, consistent with the method prescribed by Statement No. 123 are as
follows:

Year Ended December 31,
-------------------------------------------------------
1996 1995
---------------------------- --------------------------
(In Millions) Pro forma As Reported Pro forma As Reported
- ------------------- ----------- -------------- ------------- ------------
Net Income (Loss) $816.6 $830.0 $(1,791.8) $(1,791.1)

The fair value of NYNEX stock options used to compute net income is the
estimated present value at the grant date using the Black Scholes option-pricing
model with the following weighted average assumptions for 1996 and 1995:
Dividend yield of 4.66% for 1996 and 6.50% for 1995; expected volatility of
15.3% for 1996 and 1995; a risk free interest rate of 5.42% for 1996 and 7.63%
for 1995 and an expected holding period of five years for both 1996 and 1995.

30

G Telephone Plant-Net

The components of telephone plant-net are as follows:

December 31,
-------------------------
(In Millions) 1996 1995
- ----------------------------------------------------------------
Buildings $ 1,878.0 $ 1,835.9
Telephone plant and equipment 18,252.0 17,475.1
Furniture and other equipment 151.0 137.7
Other 113.6 117.5
---------- ---------
Total depreciable telephone plant 20,394.6 19,566.2
Less: accumulated depreciation 11,515.4 10,847.8
---------- ---------
8,879.2 8,718.4
Land 70.7 71.2
Plant under construction and other 395.9 516.2
---------- ---------
Total Telephone plant-net $ 9,345.8 $ 9,305.8
========== =========

The discontinued application of Statement No. 71 resulted in a net decrease to
telephone plant and equipment of $2.8 billion in 1995, primarily through an
increase in accumulated depreciation (see Note B).

H Long-Term Debt

Interest rates and maturities on long-term debt outstanding are as follows:

December 31,
--------------------
(In Millions) Interest Rates Maturities 1996 1995
- ---------------------------------------------------------------------------------------------

Refunding Mortgage Bonds 4 1/4% - 7 3/4% 2000-2006 $ 560.0 $ 620.0
6 % - 7 1/2% 2007-2011 425.0 425.0
Debentures 6 1/2% - 8 5/8% 2005-2017 750.0 750.0
6 7/10% - 9 3/8% 2023-2033 1,450.0 1,450.0
Notes 5 1/4 % - 8 1/5% 1998-2008 642.0 642.0
Unamortized discount-net (26.4) (28.3)
------- -------
3,800.6 3,858.7
Long-term capital lease obligations 52.0 54.6
------- -------
Total Long-term debt $3,852.6 $3,913.3
======= =======

In February 1997, the Company decided to redeem its $42 million 8.20% Thirty
Year Private Placement Notes, due July 1, 2008; the Notes were redeemed on March
5, 1997.

In 1998, $100 million of the Notes will mature.

The Company's Refunding Mortgage Bonds and the Company's Forty Year 7 7/8%
Debentures due June 15, 2017 are callable upon thirty days notice, at the option
of the Company, five years after the issue date. The Company's Forty Year 9 3/8%
Debentures due July 15, 2031, Thirty Year 7 5/8% Debentures due February 1,
2023, Thirty-Two Year 7% Debentures due August 15, 2025 and Thirty Year 7 1/4%
Debentures due February 15, 2024 are callable upon thirty days notice, at the
option of the Company, ten years after the issue date. The Company's Thirty Year
6.7% Debentures due November 1, 2023 and Forty Year 7% Debentures due December
1, 2033 are callable upon thirty days notice, at the option of the Company,
twenty years after the issue date. The Company's Twelve Year 6 1/2% Debentures
due March 1, 2005, Twenty Year 7% Debentures due May 1, 2013, Twenty Year 7%
Debentures due June 15, 2013 and Twenty-One Year 8 5/8% Debentures due November
15, 2010 are not callable.

31

Substantially all of the Company's assets are subject to lien under the
Company's Refunding Mortgage Bond indenture.

At December 31, 1996, the Company had $250 million of unissued, unsecured debt
securities registered with the Securities and Exchange Commission.

I Short-Term Debt

Short-term debt and related weighted average interest rates are as follows:

Weighted Average
Interest Rates
-----------------------
December 31, December 31,
(In Millions) 1996 1995 1996 1995
- ---------------------------------- ------ ------ ------ ------

Advances from NYNEX $568.4 $307.4 5.44% 5.93%
Current portion of long-term debt 60.0 55.0
Other 1.2 4.6
------ ------
Total Short-term debt $629.6 $367.0
====== ======

$60.0 million of the Company's Refunding Mortgage Bonds, due on October 1, 1997,
has been reclassified from long-term debt at December 31, 1996.

Interest expense on advances from NYNEX was $25.2, $17.0 and $16.8 million in
1996, 1995 and 1994, respectively.

J Financial Commitments

As of December 31, 1995, the Company had deferred $188 million of revenues ($161
million under the plan approved by the NYSPSC in 1995 associated with
commitments for fair competition, universal service, service quality and
infrastructure improvements (the "Incentive Plan"), and $27 million for a 1994
service improvement plan obligation). These revenues will be recognized as
commitments are met or obligations are satisfied under the plans. If the Company
is unable to meet certain of these commitments, the NYSPSC has the authority to
require the Company to refund these revenues to customers. During 1996, $43
million of the deferred revenues were recognized in connection with intraLATA
presubscription ("ILP") and other commitments that were met in 1996, and $50
million of the deferred revenues were utilized for rebates issued to customers
for not meeting service commitments in prior periods. As of December 31, 1996,
$95 million of revenues remained deferred. In February 1997, the NYSPSC
determined that the Company had not met all of the targets established in the
1994 service improvement plan and directed the Company to refund to customers
$13 million, plus interest of approximately $4 million, of the $27 million set
aside revenues.

The Incentive Plan establishes service quality targets with stringent rebate
provisions if the Company is unable to meet some or all of the targets. In
November 1996, the NYSPSC announced its decision that, based on service
performance results for Plan Year 1, which ended August 31, 1996, the Company
would be required to issue rebates to customers in the aggregate amount of at
least $62 million. During 1996, the Company accrued $62 million of revenues. As
of December 31, 1996, $16 million in rebates have been issued and $46 million
remained accrued. In mid-February 1997, the NYSPSC denied the Company's claim of
miscalculation of certain service performance data and ordered that additional
rebates of $10 million be rebated to customers.

In December 1995, Telesector Resources entered into purchase agreements with
various suppliers to purchase, on behalf of the Telephone Companies, equipment
and software to upgrade the network. The purchase agreements have a term of five
years with a commitment of approximately $550 million, of which approximately
$450 million remains at December 31, 1996.

In October 1996, the Telephone Companies entered into contracts with a supplier
for the deployment of digital loop fiber transport equipment for approximately
one million new fiber-optic lines. The contracts are for a fifteen year

32

plan with a total price not to exceed $170 million. As of December 31, 1996, no
purchases had been made under these contracts.

K Lease Commitments

The Company leases certain facilities and equipment used in its operations.
Rental expense was $90.5, $90.6 and $94.7 million for 1996, 1995 and 1994,
respectively. At December 31, 1996, the minimum lease commitments under
noncancelable leases for the periods shown are as follows:

(In Millions) Operating Capital
- -------------------------------------------------------------------
1997 $ 24.6 $ 11.1
1998 22.6 10.8
1999 20.0 10.8
2000 15.3 10.7
2001 13.4 10.6
Thereafter 32.1 371.1
------- -------
Total minimum lease payments $128.0 425.1
=======
Less: executory costs 8.5
-------
Net minimum lease payments 416.6
Less: interest 361.9
-------
Present value of net minimum lease payments $ 54.7
=======

L Transactions With AT&T Corp.

In 1996, 1995 and 1994, AT&T Corp. ("AT&T") provided approximately 10%, 11% and
11%, respectively, of the Company's total operating revenues, primarily Network
access revenues and Other revenues from billing and collection services
performed under contract by the Company for AT&T. In connection with such
services, the Company purchases the related receivables with recourse, up to a
contractual limit.

M Transactions With Affiliates

The Company and other NYNEX subsidiaries receive corporate governance and
ownership services such as securities administration, investor relations,
certain tax, legal and accounting support, and human resources planning services
from NYNEX. The costs of these services are allocated to the Company and the
other NYNEX subsidiaries through intercompany billings. NYNEX performs a
semi-annual study to identify on whose behalf functions of corporate departments
are being performed. Directly charged costs apply exclusively to one subsidiary
and are charged only to that subsidiary. Directly attributable costs apply to
more than one subsidiary and are allocated based on usage, specific work plans,
and relative size (composite of employees and assets) of the applicable
subsidiaries. Indirectly attributable and unattributable costs for services
performed on behalf of all subsidiaries are allocated based on the relative size
of the subsidiaries. For 1996, 1995 and 1994, the Company recorded allocated
costs of $33.4, $31.6 and $17.9 million, respectively, in connection with these
services. The Company also participates in compensation plans utilizing NYNEX
stock.

Telesector Resources performs marketing, legal and accounting, finance, data
processing and related services and materials management services on a
centralized basis on behalf of the Telephone Companies. Prior to 1993, the costs
of these services were allocated to the Telephone Companies based on an annual
study which identified on whose behalf functions were being performed. Since
1993, costs are allocated based on identification of detailed work functions
that are approved and documented within Telesector Resources' planning and
budgeting process. Costs are directly assigned, directly attributed or
indirectly attributed based on the analysis of the work function. In 1996, 1995
and 1994, the Company recorded charges from Telesector Resources of $1.2
billion, $1.1 billion and $889.6 million, respectively, for data processing
services and materials-related charges, including both materials management
services (such as procurement support, warehousing and transportation costs) and
the Company's purchase of materials (including items charged to plant accounts).
The total materials-related charges to the Company in 1996, 1995 and 1994 were
approximately $314.9, $320.1 and $313.6 million, respectively. Telesector

33

Resources acts as a purchasing agent for the Company for directly shipped
materials and supplies. During 1996, 1995 and 1994, total agency purchases by
Telesector Resources amounted to $66.0, $76.2 and $155.4 million, respectively.
In addition, in 1996, 1995 and 1994, approximately $14.4, $82.5 and $57.4
million, respectively, of restructuring charges ($9.4, $53.7 and $37.3 million
after-tax) were allocated to the Company from Telesector Resources, primarily
related to its force reduction and re-engineering programs. In 1996, the
Company, New England Telephone and NYNEX transferred approximately 430, 330 and
30 employees, respectively, to Telesector Resources associated with
re-engineering the way service is delivered to customers, including operating as
a single enterprise under the "NYNEX" brand. In 1995, the Company, New England
Telephone and NYNEX transferred approximately 1,200, 930 and 170 employees,
respectively, to Telesector Resources associated with re-engineering the way
service is delivered to customers, including operating as a single enterprise
under the "NYNEX" brand.

Telesector Resources owns a one-seventh interest in Bell Communications
Research, Inc. ("Bellcore"). Bellcore furnishes technical and support services
relating to exchange telecommunications and exchange access services, a portion
of which is research and development. For 1996, 1995 and 1994, the Company
recorded charges of $40.4, $54.7 and $69.3 million, respectively, for services
provided by Bellcore.

In November 1996, NYNEX and the other regional holding companies signed
definitive agreements to sell Bellcore to Science Applications International
Corporation. Closing is expected to occur in the second half of 1997, pending
regulatory approval in various jurisdictions across the country.

The Company has an agreement with Information Resources pursuant to which
Information Resources pays a fee to the Company for the use of the Company's
name in soliciting directory advertising and in publishing and distributing
directories. For 1996, 1995 and 1994, licensing fees, included in Other
revenues, amounted to $170.9, $152.8 and $146.4 million, respectively.

Since 1991, Information Resources has made payments to the Company of all of
Information Resources' earnings related to publishing directories in New York in
excess of a regulated return. In 1992, the NYSPSC instituted a proceeding to
investigate the directory publishing operations of the Company and its NYNEX
affiliates ("1992 proceeding"). In 1993, an administrative law judge of the
NYSPSC issued a recommended decision urging the Company to assume the directory
publishing function itself and/or negotiate a modified agreement with
Information Resources. In February 1997, the NYSPSC approved a settlement
agreement resolving all pending issues in the NYSPSC's retrospective
investigation of the Company's transactions with affiliates (see Note O), as
well as certain portions of the 1992 proceeding. Under the settlement as
approved by the NYSPSC, Information Resources will transfer its subscriber
listings database and the management of the database to a regulated subsidiary
of NYNEX which, in turn, must provide access to all directory publishers on the
same terms. Pending review of the NYSPSC's order when issued, the Company is
unable to determine the disposition or status of the 1992 proceeding.

N Taxes Other Than Income

Taxes other than income consist of:

(In Millions) 1996 1995 1994
- -------------------------------------------------
Gross receipts $ 356.7 $ 472.8 $ 450.7
Property 264.1 262.9 274.9
Other 47.6 63.2 64.0
-------- -------- -------
Total $ 668.4 $ 798.8 $ 789.6
======== ======== =======

O Revenues Subject To Possible Refund

Several state and federal regulatory matters may possibly require the refund of
a portion of the revenues collected in the current and prior periods. As of
December 31, 1996, the aggregate amount of such revenues that was estimated to
be subject to possible refund was approximately $284 million, plus related
interest, of which approximately $239 million was attributable to affiliate
transaction issues in the Company's 1990 intrastate rate case. In February 1997,

34

the NYSPSC approved the settlement agreement in that case, which had been
submitted in July 1996 by the Company, the NYSPSC Staff, the Consumer Protection
Board and the Department of Law. The settlement resolves all pending issues
related to affiliate transactions. Under the settlement as approved by the
NYSPSC, the Company will refund $87 million, which includes $4 million in
interest for 1996. The Company accrued a charge for the refund in 1995 and 1996.
The outcome of each other pending matter, as well as the time frame within which
each will be resolved, is not presently determinable.

P Litigation and Other Contingencies

Various legal actions and regulatory proceedings are pending that may affect the
Company. While counsel cannot give assurance as to the outcome of any of these
matters, in the opinion of Management based upon the opinion of counsel, the
ultimate resolution of these matters in future periods is not expected to have a
material effect on the Company's financial position but could have a material
effect on operating results.

Q Supplemental Cash Flow Information

The following information is provided in accordance with Statement of Financial
Accounting Standards No. 95, "Statement of Cash Flows":

For the years ended
December 31,
(In Millions) 1996 1995 1994
- ---------------------------------------------------
Income tax payments $338.4 $481.5 $355.4
Interest payments * $299.9 $293.5 $272.3

* Amounts shown are net of capitalized interest of $22.4, $26.5 and $32.8
million in 1996, 1995 and 1994, respectively.

R Fair Value of Financial Instruments

The following table presents the carrying amounts and fair values of the
Company's financial instruments at December 31, 1996 and 1995. Statement of
Financial Accounting Standards No. 107, "Disclosures about Fair Value of
Financial Instruments," defines fair value as the amount at which the instrument
could be exchanged in a current transaction between willing parties, other than
a forced liquidation or sale.

(In Millions) December 31,
- -----------------------------------------
1996 1995
--------- --------

Long-term debt:
Carrying amount $3,800.6 $3,858.7
Fair value $3,724.8 $3,972.5

S Business Restructuring

In 1996, 1995 and 1994, $87.8, $304.1 and $523.4 million, respectively, of
pretax retirement incentive charges were recorded. These charges were included
in the Consolidated Statements of Income in Other expenses.

T Share Owner's Equity

Pursuant to the resolutions of the Board of Directors of the Company, adopted on
June 21, 1995, the Common stock of the Company was reduced by approximately $4.1
billion and such amount was reallocated to Additional paid-in capital. All
subsequent dividends have been declared from Additional paid-in capital.

35

U Proposed Merger

On April 22, 1996, NYNEX and Bell Atlantic Corporation ("Bell Atlantic")
announced a proposed merger of equals pursuant to a definitive merger agreement
(the "Merger"), dated April 21, 1996 that provided for the formation of a new
company to be named Bell Atlantic Corporation. On July 2, 1996, NYNEX and Bell
Atlantic executed an amendment to the agreement effecting a technical change in
the transaction structure of the Merger. As amended, the agreement provides that
a newly formed subsidiary of Bell Atlantic will merge with and into NYNEX,
thereby making NYNEX a wholly owned subsidiary of Bell Atlantic. There is no
change in the fundamental elements of the proposed Merger. Each NYNEX
shareholder will receive 0.768 shares of Bell Atlantic common stock in exchange
for one share of NYNEX common stock. The purpose of the amendment to the Merger
agreement is to expedite the regulatory approval process by eliminating the need
to obtain congressional approval of the Merger under a 1913 District of Columbia
"anti-merger" law. The state regulatory commissions in NYNEX's region have
approved or have not sought jurisdiction over the Merger. Effective March 21,
1997, the New York State Public Service Commission ("NYSPSC") issued an order
approving the Merger, subject to the acceptance of certain conditions by NYNEX
and Bell Atlantic within 10 days. NYNEX has stated that the NYSPSC's conditions
will require careful review. In addition, NYNEX and Bell Atlantic have filed
applications with the FCC seeking approval of the transfer of control of certain
FCC licenses and authorizations held by their telephone subsidiaries. The Merger
is expected to qualify as a pooling of interests for accounting purposes. At
special meetings held in November 1996, the shareholders of both companies voted
to approve the Merger. The completion of the Merger is subject to a number of
conditions, including certain regulatory approvals and receipt of opinions that
the Merger will be tax free, except, in the case of NYNEX shareholders, for tax
payable because of cash received for a fractional share and the payment by NYNEX
of certain transfer taxes on behalf of its shareholders. NYNEX is unable to
predict when it will be able to complete the Merger.

36

Supplementary Information

Quarterly Financial Information (Unaudited)

For the quarter ended
(In Millions) March 31, June 30, September 30, December 31,
- ------------------------------------------------------------------------------------------------

1996
- ----
Operating revenues $1,917.8 $ 2,069.4 $2,012.9 $2,022.2
Operating income $ 215.4 $ 419.5 $ 388.4 $ 426.0
Earnings before cumulative effect of
change in accounting for directory
publishing income $ 98.6 $ 230.5 $ 205.4 $ 239.8
Cumulative effect of change in
accounting for directory publishing
income, net of taxes $ 55.7 - $ - $ -
Net income $ 154.3 $ 230.5 $ 205.4 $ 239.8
1995
- ----
Operating revenues $1,929.7 $ 2,008.4 $1,968.6 $1,973.1
Operating income $ 306.5 $ 125.1 $ 309.4 $ 295.4
Net income (loss) $ 154.6 $(2,255.2) $ 163.2 $ 141.1

Results for the first, second, third and fourth quarters of 1996 include $23.4,
$31.1, $11.4 and $21.9 million, respectively, of pretax charges for retirement
incentives, which were reflected in operating expenses. The after-tax effect of
these charges was $15.2, $20.3, $7.4 and $14.2 million, respectively.

Results for the first quarter of 1996 include the effects of the change in
accounting for directory publishing income, recorded as a cumulative effect of a
change in accounting principle (see Note C), and $93.6 million of charges
related to various self-insurance programs, legal, regulatory and other
obligations and contingencies. Results for the third quarter of 1996 include a
gain of $9 million ($5.9 million after-tax) resulting from revised charges
related to customer claims as a result of favorable negotiations with
interexchange carriers. Results for the third and fourth quarters of 1996 also
include $9.7 and $31.4 million, respectively, of pretax credits to medical
expense associated with plan amendments. Results for the second, third and
fourth quarters of 1996 include $11.9, $28.1 and $31.6 million, respectively, of
pretax credits to depreciation expense associated with revised estimates of
future net salvage value.

Results for the first, second, third and fourth quarters of 1995 include $33.8,
$115.2, $14.7 and $140.4 million, respectively, of pretax charges for retirement
incentives, which were reflected in operating expenses. The after-tax effect of
these charges was $22.0, $74.9, $9.5 and $91.2 million, respectively.

Results for the second quarter of 1995 include the effects of the discontinuance
of regulatory accounting principles, recorded as an extraordinary item (see Note
B); and $162.0 million ($105.3 million after-tax) for certain items to meet
various tax, benefit and legal obligations and contingencies, which was included
in operating expenses. Results for the third quarter of 1995 include $85.1
million ($55.3 million after-tax) for certain items to meet tax and legal
obligations and contingencies, which was included in operating expenses. Results
for the fourth quarter of 1995 include a net $33.4 million of pretax credits in
operating expenses ($22.0 million after-tax) primarily due to revised estimates
associated with benefit accruals, and a $13.7 million ($8.9 million after-tax)
reduction in Interest expense on the revenue set aside as ordered by the NYSPSC,
partially offset by a $15.0 million ($9.7 million after-tax) charge in operating
expenses for a gross receipts tax settlement.

In the third quarter of 1995, there was a change in the presentation of gross
receipts taxes that were collected from customers. In the first two quarters of
1995, these taxes were included in operating revenues and expenses. In the last
two quarters, as a result of a tax law change, these taxes were no longer
required to be collected.

For further discussion of these items, see Management's Discussion and Analysis
of Results of Operations.

37

Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

There were no events reportable under Item 9.

38

PART IV

Item 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM
8-K.

(a) Documents filed as part of this Annual Report on Form 10-K.

Page(s) in this
Annual Report on
Form 10-K
------------------

(1) Consolidated Financial Statements filed as part of this report
are listed in the Table of Contents and contained in Item 8
herein.
(2) Consolidated Financial Statement Schedule. The following
consolidated financial statement schedule of the Registrant is
included herein in response to Item 14:
II - Valuation and Qualifying Accounts 41

Consolidated financial statement schedules other than that listed above have
been omitted b required information is contained in the consolidated financial
statements and notes thereto such schedules are not required or applicable.

(3) Exhibits. Exhibits on file with the Securities and Exchange Commission
("SEC"), identifi parentheses below, are incorporated herein by reference as
exhibits hereto.

Exhibit
Number
- ---------

(3) a Certificate of Incorporation of New York Telephone Company (the "Company") as
amended and restated December 2, 1987 (Exhibit No. (3)a to the Registrant's filing on
Form SE dated March 24, 1988, File No. 1-3435).

(3) b By-laws of the Company as amended April 22, 1987 (Exhibit No. (3)b to the
Registrant's filing on Form SE dated March 24, 1988, File No. 1-3435).

(4) No instrument which defines the rights of holders of long-term debt of the Company
and its subsidiary is filed herewith pursuant to Regulation S-K, Item
601(b)(4)(iii)(A).
Pursuant to this regulation, the Company hereby agrees to furnish a copy of any such
instrument to the SEC upon request. (10)(ii)B Service Agreement concerning
provision by Telesector Resources Group, Inc. to the Company of numerous services,
including (i) purchasing, materials handling, inspection, distribution, storage and
similar services and (ii) technical, regulatory, government relations, marketing
operational support and similar services, dated March 31, 1992 (Exhibit No. (19)(i)1
to the Registrant's filing on Form SE dated March 23, 1993, File No. 1-3435).

(12) Computation of Ratio of Earnings to Fixed Charges.

(23) Consent of Independent Accountants.

(24) Powers of attorney.
(b) Reports on Form 8-K.

39

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.

NEW YORK TELEPHONE COMPANY

By John W. Diercksen
---------------------------------
John W. Diercksen
Acting Vice President-Finance and
Treasurer

March 27, 1997

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 date indicated.

Principal Executive Officer:

Richard A. Jalkut*
President and Chief Executive Officer

Principal Financial Officer:

John W. Diercksen
Acting Vice President-Finance and Treasurer

Principal Accounting Officer:

John W. Diercksen*
Controller

Directors:

A Majority of Directors:

Lilyan H. Affinito* *By: John W. Diercksen
Joseph A. Califano, Jr.* ------------------------------------
A. J. Eckelman* (John W. Diercksen, as attorney-in-
Thomas F. Gilbane, Jr.* fact, and on his own behalf as
Ronald A. Homer* Principal Financial Officer and
Alice Stone Ilchman* Principal Accounting Officer)
Richard A. Jalkut*
Jane E. Newman* March 27, 1997
Donald B. Reed*
Paul L. Snyder*
Ira Stepanian*
Frank J. Tasco*

40

NEW YORK TELEPHONE COMPANY AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENT SCHEDULE
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(In Millions)

COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
- ---------------------------------------------------------------------------------------------------------------------
Additions
------------------------------
Balance at Charged to Charged to Balance at
Beginning of Costs and Other End of
Description Period Expenses Accounts Deductions Period
- ---------------------------------------------------------------------------------------------------------------------

Allowance for Uncollectibles
Year 1996 ............... $154.7 $107.8 $167.4 (a) $267.6 (b) $162.3
Year 1995 ............... $133.6 $109.2 $180.7 (a) $268.8 (b) $154.7
Year 1994 ............... $134.8 $ 79.9 $145.3 (a) $226.4 (b) $133.6
Restructuring
Year 1996 ............... $184.6 $ - $ - $114.3 $ 70.3
Year 1995 ............... $334.0 $ - $ - $149.4 $184.6
Year 1994 ............... $494.0 $ - $ - $160.0 $334.0

- -----------
(a) Includes amounts to establish a reserve for purchased accounts receivable.
(b) Amounts written-off as uncollectible. Amounts previously written-off are
credited directly to this account when recovered.

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