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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
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 1-6393
VERIZON PENNSYLVANIA INC.
A Pennsylvania Corporation I.R.S. Employer Identification No. 23-0397860
1717 Arch Street, 32nd Fl., Philadelphia, Pennsylvania 19103
Telephone Number (215) 466-9900
-------------------------
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(a) AND
(b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE
FORMAT PURSUANT TO GENERAL INSTRUCTION H(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
--- ---
Verizon Pennsylvania Inc.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED STATEMENTS OF INCOME
Three Months Ended June 30, Six Months Ended June 30,
------------------------------------------------------------
(Dollars in Millions) (Unaudited) 2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------------
OPERATING REVENUES
(including $58.3, $49.4, $126.1 and $106.3 from affiliates) $ 905.9 $ 931.3 $1,788.7 $1,865.2
------------------------------------------------------------
OPERATING EXPENSES
Operations and support (including $181.2, $190.7, $331.0 and
$342.9 to affiliates) 462.1 480.1 864.5 961.6
Depreciation and amortization 221.6 219.1 439.8 432.7
------------------------------------------------------------
683.7 699.2 1,304.3 1,394.3
------------------------------------------------------------
OPERATING INCOME 222.2 232.1 484.4 470.9
OTHER INCOME AND (EXPENSE), NET
(including $(8.5), $.1, $(32.4) and $(26.2) from affiliates) (4.3) .8 (27.7) (23.7)
INTEREST EXPENSE
(including $.9, $13.4, $1.5 and $27.7 to affiliate) 33.4 32.9 67.3 68.1
------------------------------------------------------------
INCOME BEFORE PROVISION FOR INCOME TAXES AND
EXTRAORDINARY ITEM 184.5 200.0 389.4 379.1
PROVISION FOR INCOME TAXES 80.2 83.5 175.3 169.0
------------------------------------------------------------
INCOME BEFORE EXTRAORDINARY ITEM 104.3 116.5 214.1 210.1
EXTRAORDINARY ITEM
Early extinguishment of debt, net of tax -- -- (.9) --
------------------------------------------------------------
NET INCOME $ 104.3 $ 116.5 $ 213.2 $ 210.1
============================================================
See Notes to Condensed Financial Statements.
1
Verizon Pennsylvania Inc.
CONDENSED BALANCE SHEETS
ASSETS
------
(Dollars in Millions) June 30, 2002 December 31, 2001
- ---------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
CURRENT ASSETS
Short-term investments $ 40.4 $ 114.7
Accounts receivable:
Trade and other, net of allowances for uncollectibles of $160.8 and $100.2 569.3 629.4
Affiliates 82.7 74.7
Material and supplies 21.0 24.5
Prepaid expenses 139.0 33.2
Deferred income taxes 94.7 72.2
Other 96.4 94.3
---------------------------------------------
1,043.5 1,043.0
---------------------------------------------
PLANT, PROPERTY AND EQUIPMENT 12,841.0 12,567.4
Less accumulated depreciation 8,113.7 7,746.3
---------------------------------------------
4,727.3 4,821.1
---------------------------------------------
PREPAID PENSION ASSET 554.8 387.8
---------------------------------------------
OTHER ASSETS 354.4 417.0
---------------------------------------------
TOTAL ASSETS $ 6,680.0 $ 6,668.9
=============================================
See Notes to Condensed Financial Statements.
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Verizon Pennsylvania Inc.
CONDENSED BALANCE SHEETS
LIABILITIES AND SHAREOWNER'S INVESTMENT
(Dollars in Millions, Except Per Share Amount) June 30, 2002 December 31, 2001
- ---------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
CURRENT LIABILITIES
Debt maturing within one year:
Note payable to affiliate $ 155.3 $ 52.5
Other 425.4 275.4
Accounts payable and accrued liabilities:
Affiliates 250.9 247.7
Other 541.9 580.9
Other liabilities 184.2 181.5
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1,557.7 1,338.0
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LONG-TERM DEBT 1,740.3 2,095.2
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EMPLOYEE BENEFIT OBLIGATIONS 600.2 593.0
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DEFERRED CREDITS AND OTHER LIABILITIES
Deferred income taxes 517.1 428.4
Unamortized investment tax credits 22.1 22.7
Other 252.2 273.3
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791.4 724.4
----------------------------------------------
SHAREOWNER'S INVESTMENT
Common stock - $20 par value per share 1,594.7 1,594.7
Authorized shares: 80,210,000
Outstanding shares: 79,732,681
Contributed capital 217.2 181.3
Reinvested earnings 178.5 142.3
----------------------------------------------
1,990.4 1,918.3
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TOTAL LIABILITIES AND SHAREOWNER'S INVESTMENT $ 6,680.0 $ 6,668.9
==============================================
See Notes to Condensed Financial Statements.
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Verizon Pennsylvania Inc.
CONDENSED STATEMENTS OF CASH FLOWS
Six Months Ended June 30,
---------------------------------------------
(Dollars in Millions)(Unaudited) 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 567.2 $ 500.4
--------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net change in short-term investments 74.3 43.5
Capital expenditures (331.5) (600.0)
Investment in unconsolidated business (35.8) --
Other, net (1.6) (2.3)
--------------------------------------------
Net cash used in investing activities (294.6) (558.8)
--------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Early extinguishment of debt (225.0) --
Principal repayments of borrowings and capital lease obligations (.2) (50.2)
Change in note payable to affiliate 102.8 277.1
Dividends paid (177.0) (151.0)
Capital contribution from parent 35.8 --
Net change in outstanding checks drawn
on controlled disbursement accounts (9.0) (17.5)
--------------------------------------------
Net cash (used in)/provided by financing activities (272.6) 58.4
--------------------------------------------
NET CHANGE IN CASH -- --
CASH, BEGINNING OF PERIOD -- --
--------------------------------------------
CASH, END OF PERIOD $ -- $ --
============================================
See Notes to Condensed Financial Statements.
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Verizon Pennsylvania Inc.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
Verizon Pennsylvania Inc. is a wholly owned subsidiary of Verizon
Communications Inc. (Verizon Communications). The accompanying unaudited
condensed financial statements have been prepared based upon Securities and
Exchange Commission (SEC) rules that permit reduced disclosure for interim
periods. These financial statements reflect all adjustments that are necessary
for a fair presentation of results of operations and financial position for the
interim periods shown including normal recurring accruals. The results for the
interim periods are not necessarily indicative of results for the full year. The
balance sheet at December 31, 2001 has been derived from the audited financial
statements at that date but does not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. For a more complete discussion of significant accounting
policies and certain other information, you should refer to the financial
statements included in our 2001 Annual Report on Form 10-K.
We have reclassified certain amounts from prior year's data to conform to
the 2002 presentation.
2. Adoption of New Accounting Standards
Goodwill and Other Intangible Assets
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142
no longer permits the amortization of goodwill and indefinite-lived intangible
assets. Instead, these assets must be reviewed annually (or more frequently
under prescribed conditions) for impairment in accordance with this statement.
This impairment test uses a fair value approach rather than the undiscounted
cash flows approach previously required by SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of."
The goodwill impairment test under SFAS No. 142 requires a two-step approach,
which is performed at the reporting unit level, as defined in SFAS No. 142. Step
one identifies potential impairments by comparing the fair value of the
reporting unit to its carrying amount. Step two, which is only performed if
there is a potential impairment, compares the carrying amount of the reporting
unit's goodwill to its implied value, as defined in SFAS No. 142. If the
carrying amount of the reporting unit's goodwill exceeds the implied fair value
of that goodwill, an impairment loss is recognized for an amount equal to that
excess. Intangible assets that do not have indefinite lives are amortized over
their useful lives and reviewed for impairment in accordance with SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets." The adoption
of SFAS No. 142 did not impact our results of operations or financial position
because we had no goodwill or indefinite-lived intangible assets at December 31,
2001 and 2000.
Our other intangible assets consist of non-network software as follows:
As of June 30, 2002 As of December 31, 2001
-----------------------------------------------------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
(Dollars in Millions) Amount Amortization Amount Amortization
- -------------------------------------------------------------------------------------------------------------------------------
Non-network software (3 to 7 years) $186.2 $59.7 $184.6 $44.2
Intangible assets amortization expense was $7.8 million for the three
months ended June 30, 2002 and $15.5 million for the six months ended June 30,
2002. It is estimated to be $15.5 million for the remainder of 2002, $31.0
million in 2003, $29.0 million in 2004, $20.9 million in 2005 and $15.7 million
in 2006, related to our non-network software.
Impairment or Disposal of Long-Lived Assets
Effective January 1, 2002, we adopted SFAS No. 144. This standard
supersedes SFAS No. 121 and the provisions of Accounting Principles Board (APB)
Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," with regard to reporting the effects of a
disposal of a segment of a business. SFAS No. 144 establishes a single
accounting model for assets to be disposed of by sale and addresses several SFAS
No. 121 implementation issues. The adoption of SFAS No. 144 did not have a
material effect on our results of operations or financial position.
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Verizon Pennsylvania Inc.
3. Recent Accounting Pronouncements
Asset Retirement Obligations
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 143, "Accounting for Asset Retirement Obligations." This standard provides
the accounting for the cost of legal obligations associated with the retirement
of long-lived assets. SFAS No. 143 requires that companies recognize the fair
value of a liability for asset retirement obligations in the period in which the
obligations are incurred and capitalize that amount as a part of the book value
of the long-lived asset. That cost is then depreciated over the remaining life
of the underlying long-lived asset. We are required to adopt SFAS No. 143
effective January 1, 2003. We are currently evaluating the impact this new
standard will have on our future results of operations or financial position.
Debt Extinguishment
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." SFAS No. 145, among other things, eliminates the requirement that
all gains and losses on the extinguishment of debt must be classified as
extraordinary items on the income statement, thereby permitting the
classification of such gains and losses as extraordinary items only if the
criteria of APB Opinion No. 30, "Reporting the Results of Operations-Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions," are met. We are required to
adopt this provision of SFAS No. 145 no later than January 1, 2003 and upon
adoption we will reclassify in our statements of income previously reported
extraordinary charges for the early extinguishment of debt to income from
continuing operations.
Exit or Disposal Activities
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This standard addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." EITF Issue No.
94-3 required accrual of liabilities related to exit and disposal activities at
a plan (commitment) date. SFAS No. 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when the liability is
incurred. The provisions of this standard are effective for exit or disposal
activities that are initiated after December 31, 2002.
4. Dividend
On August 1, 2002, we declared and paid a dividend from Reinvested
Earnings in the amount of $102.0 million to Verizon Communications.
5. Debt
During March 2002, we recorded extraordinary charges associated with the
early extinguishment of long-term debt, which reduced net income by $.9 million
(net of income tax benefits of $.6 million). These debt extinguishments
consisted of the following:
. $50.0 million of 4 3/8% debentures due on February 1, 2003
. $100.0 million of 6 3/4% debentures due on May 1, 2008
. $75.0 million of 7 1/8% debentures due on January 1, 2012
6. Shareowner's Investment
Common Contributed Reinvested
(Dollars in Millions) Stock Capital Earnings
- ------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 $1,594.7 $181.3 $142.3
Net income 213.2
Dividends declared to Verizon Communications (177.0)
Capital contribution from Verizon Communications 35.8
Other .1
-----------------------------------------------------------
Balance at June 30, 2002 $1,594.7 $217.2 $178.5
===========================================================
Net income and comprehensive income were the same for the six months ended
June 30, 2002 and 2001.
6
Verizon Pennsylvania Inc.
7. Commitments and Contingencies
Various legal actions and regulatory proceedings are pending to which we
are a party and claims which, if asserted, may lead to other legal actions. We
have established reserves for specific liabilities in connection with regulatory
and legal matters that we currently deem to be probable and estimable. We do not
expect that the ultimate resolution of pending regulatory and legal matters in
future periods will have a material effect on our financial condition, but it
could have a material effect on our results of operations.
Several regulatory matters may require us to refund to customers a portion
of the revenues collected in the current and prior periods. The outcome of each
pending matter, as well as the time frame within which each matter will be
resolved, is not presently determinable.
Regulatory conditions to the Bell Atlantic - GTE merger include
commitments to, among other things, promote competition and the widespread
deployment of advanced services, while helping to ensure that consumers continue
to receive high-quality, low cost telephone services. In some cases, there are
significant penalties associated with not meeting these commitments. The cost of
satisfying these commitments could have a significant impact on net income in
future periods.
8. Investment in Verizon Ventures III Inc.
In December, 2000, we transferred certain advanced data assets to an
affiliated company, Verizon Ventures III Inc. (Ventures III) in exchange for
common stock of Ventures III. This transfer was done to satisfy a condition of
the Federal Communications Commission's (FCC) approval of the Bell Atlantic -
GTE merger, which required the provision of advanced data services through a
separate affiliate. Throughout 2000 and 2001, we continued to invest in Ventures
III through the transfer of additional assets. As a result of the transfers, we
acquired an ownership interest in Ventures III, which we accounted for under the
equity method of accounting.
In September 2001, the FCC issued an order eliminating this merger
condition. Following the FCC order, we made necessary filings with our state
regulatory commission for approval of the transfer of these assets back to us.
On June 1, 2002, after required state regulatory approvals were obtained,
Ventures III transferred assets back to us with an aggregate net book value of
$63.8 million. In consideration of the transfer of these assets, we have
surrendered our common stock in Ventures III and remitted cash compensation.
In connection with this reintegration, we received a capital contribution
from our parent of $35.8 million in the second quarter of 2002. This equity was
immediately contributed to Ventures III. No gain or loss was recognized as a
result of the reintegration of the advanced data assets to us. This
reintegration did not have a material effect on our results of operations or
financial condition.
9. Employee Severance and Other Items
In connection with the Bell Atlantic - GTE merger on June 30, 2000, we
incurred charges associated with employee severance of $20.0 million. These
costs, as recorded under SFAS No. 112, "Employers' Accounting for Postemployment
Benefits," represent the benefit costs for the separation of management
employees who were entitled to benefits under pre-existing separation plans. As
of June 30, 2002, the severances in connection with the Bell Atlantic - GTE
merger are complete.
During the fourth quarter of 2001, we recorded a charge of $76.6 million
for the voluntary and involuntary separation of employees in accordance with
SFAS No. 112. During the second quarter of 2002, we recorded a charge of $30.4
million associated with employee severance and related pension enhancements. The
charge included severance benefits of $21.5 million as recorded under SFAS No.
112 and related pension enhancements of $8.9 million. As of June 30, 2002, a
total of approximately 830 employees have been separated under the 2001 and 2002
severance programs, excluding a significant number of voluntary separations that
were not processed by June 30, 2002. The remaining severance liability relating
to these programs is $75.5 million, which includes future payments to employees
separated as of June 30, 2002. We expect to complete the severance programs
within a year of when the charge was recorded.
Also, in the second quarter of 2002, we recorded a pension settlement gain
of $33.5 million as a result of pension plan distributions which surpassed the
sum of service cost and interest cost during the year. Settlements of pension
obligations and special termination benefits are recorded in accordance with
SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined
Pension Plans and for Termination Benefits."
In addition, during the second quarter of 2002, we recorded an impairment
charge of $53.6 million driven by our financial statement exposure of WorldCom
Inc.
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Verizon Pennsylvania Inc.
Item 2. Management's Discussion and Analysis of Results of Operations
(Abbreviated pursuant to General Instruction H(2).)
This discussion should be read in conjunction with the Condensed
Financial Statements and Condensed Notes to Financial Statements.
RESULTS OF OPERATIONS
- ---------------------
We reported net income of $213.2 million for the six month period ended
June 30, 2002, compared to net income of $210.1 million for the same period in
2001. Our reported results for the first half of 2002 included the following
special items:
Employee Severance and Other Items
During the second quarter of 2002, we recorded a charge of $30.4
million associated with employee severance and related pension enhancements. The
charge included severance benefits of $21.5 million as recorded under Statement
of Financial Accounting Standards (SFAS) No. 112, "Employers' Accounting for
Postemployment Benefits," and related pension enhancements of $8.9 million.
Also, in the second quarter of 2002, we recorded a pension settlement
gain of $33.5 million as a result of pension plan distributions which surpassed
the sum of service cost and interest cost during the year. Settlements of
pension obligations and special termination benefits are recorded in accordance
with SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of
Defined Pension Plans and for Termination Benefits."
In addition, during the second quarter of 2002, we recorded an
impairment charge of $53.6 million driven by our financial statement exposure of
WorldCom Inc.
Verizon Ventures III
During 2000 and 2001, pursuant to one of the Federal Communications
Commission's (FCC) requirements for the Bell Atlantic - GTE merger, we
transferred our advanced data assets to Verizon Ventures III Inc. (Ventures III)
in exchange for an ownership interest in Ventures III, which we accounted for
under the equity method of accounting. In September 2001, the FCC issued an
order eliminating this merger condition. On June 1, 2002, after required state
regulatory approvals were obtained, these assets were transferred back to us and
we surrendered our ownership in Ventures III. (See Note 8 to the Condensed
Financial Statements.)
This reintegration principally affected our comparison of Network
access services revenues, Other income and (expense), net, and the Provision for
income taxes, as described below.
OPERATING REVENUES
- ------------------
(Dollars in Millions)
Six Months Ended June 30,
-----------------------------------------
2002 2001
- ---------------------------------------------------------- --------------------
Local services $ 955.9 $1,005.1
Network access services 632.1 630.3
Long distance services 101.5 119.1
Other services 99.2 110.7
-----------------------------------------
Total $1,788.7 $1,865.2
=========================================
We recognize service revenues based upon usage of our local exchange
network and facilities and contract fees. We recognize product and other service
revenues when the products are delivered and accepted by the customers and when
services are provided in accordance with contract terms.
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Verizon Pennsylvania Inc.
LOCAL SERVICES
2002 - 2001 (Decrease)
- --------------------------------------------------------------------------------
Six Months $(49.2) (4.9)%
- --------------------------------------------------------------------------------
Local service revenues are earned from the provision of local exchange,
local private line, wire maintenance, voice messaging and value-added services.
Value-added services are a family of services that expand the utilization of the
network, including products such as Caller ID, Call Waiting and Return Call. The
provision of local exchange services not only includes retail revenues, but also
includes local wholesale revenues from unbundled network elements (UNEs),
interconnection revenues from competitive local exchange carriers (CLECs),
certain data transport revenues and wireless interconnection revenues.
Local service revenues declined in the first six months of 2002 primarily
due to the effect of lower demand and usage of some basic wireline services, as
reflected by a decline in our switched access lines in service of 5.2% from June
30, 2001. This decrease primarily reflects the impact of the economic slowdown
and competition. Technology substitution has also affected local service revenue
growth, as indicated by lower demand for residential access lines.
NETWORK ACCESS SERVICES
2002 - 2001 Increase
- --------------------------------------------------------------------------------
Six Months $1.8 .3%
- --------------------------------------------------------------------------------
Network access service revenues are earned from end-user subscribers and
from long distance and other competing carriers who use our local exchange
facilities to provide usage services to their customers. Switched access
revenues are derived from fixed and usage-based charges paid by carriers for
access to our local network. Special access revenues originate from carriers and
end-users that buy dedicated local exchange capacity to support their private
networks. End-user access revenues are earned from our customers and from
resellers who purchase dial-tone services.
Network access service revenue growth in the first six months of 2002 was
mainly attributable to higher customer demand for special access services,
particularly for high-capacity, high-speed digital services, the reintegration
of Ventures III and one-time settlements with carriers. These increases were
substantially offset by the impact of the slowing economy, as reflected by a
decline in minutes of use from carriers and CLECs and by price reductions
associated with federal price cap filings and other regulatory decisions.
LONG DISTANCE SERVICES
2002 - 2001 (Decrease)
- --------------------------------------------------------------------------------
Six Months $(17.6) (14.8)%
- --------------------------------------------------------------------------------
Long distance revenues are earned primarily from calls made to points
outside a customer's local calling area, but within our service area (intraLATA
toll). IntraLATA toll calls originate and terminate within the same LATA, but
generally cover a greater distance than a local call. These services are
regulated by the Pennsylvania Public Utility Commission (PPUC) except where they
cross state lines. Other long distance services that we provide include 800
services, Wide Area Telephone Service (WATS), and corridor services (between
LATAs in Philadelphia and southern New Jersey).
Long distance service revenues declined in the first six months of 2002
primarily due to competition and the effects of toll calling discount packages
and product bundling offers of our intraLATA toll services. Technology
substitution and the slowing economy also affected long distance service revenue
growth.
9
Verizon Pennsylvania Inc.
OTHER SERVICES
2002 - 2001 (Decrease)
- --------------------------------------------------------------------------------
Six Months $(11.5) (10.4)%
- --------------------------------------------------------------------------------
Our other services include such services as billing and collections for
long distance carriers and affiliates, facilities rentals to affiliates and
nonaffiliates, public (pay) telephone, customer premises equipment (CPE) and
sales of materials and supplies to affiliates. Other service revenues also
include fees paid by customers for nonpublication of telephone numbers and
multiple white page listings and fees paid by an affiliate for usage of our
directory listings.
Other service revenues decreased in the first six months of 2002
primarily due to the effect of a one-time reclassification in 2001 associated
with regulatory-related activities and a change in the allocation among
affiliates of per call compensation for pay phone service.
OPERATING EXPENSES
- -------------------
(Dollars in Millions)
OPERATIONS AND SUPPORT
2002 - 2001 (Decrease)
- --------------------------------------------------------------------------------
Six Months $(97.1) (10.1)%
- --------------------------------------------------------------------------------
Operations and support expenses consist of employee costs and other
operating expenses. Employee costs consist of salaries, wages and other employee
compensation, employee benefits and payroll taxes. Other operating expenses
consist of contract services including centralized services expenses allocated
from affiliates, rent, network software costs, operating taxes other than
income, the provision for uncollectible accounts receivable, reciprocal
compensation, and other costs.
The decrease in operations and support expenses was primarily
attributable to effective cost control measures and favorable pension plan
income, including the effect of pension settlement gains recorded in the second
quarter of 2002 associated with lump-sum settlements of pension obligations for
some former employees. Lower employee costs associated with declining workforce
levels, lower interconnection and related costs associated with reciprocal
compensation arrangements and a one-time reclassification in 2001 associated
with regulatory-related activities also contributed to the decrease in
operations and support expenses. An increase in the provision for uncollectible
accounts receivable, employee severance and related pension enhancement costs
recorded in the second quarter of 2002 and salary and wage increases for
employees partially offset the decline in operations and support expenses for
the six months ended June 30, 2002.
DEPRECIATION AND AMORTIZATION
2002 - 2001 Increase
- --------------------------------------------------------------------------------
Six Months $7.1 1.6%
- --------------------------------------------------------------------------------
Depreciation expense is principally based on the composite group
remaining life method and straight-line composite rates. This method provides
for the recognition of the cost of the remaining net investment in telephone
plant, less anticipated net salvage value, over the remaining asset lives. This
method requires the periodic revision of depreciation rates.
Depreciation and amortization expense increased in the first six months
of 2002 primarily due to growth in depreciable telephone plant and increased
software amortization costs. These increases were substantially offset by the
effect of lower rates of depreciation.
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Verizon Pennsylvania Inc.
OTHER RESULTS
- -------------
(Dollars in Millions)
OTHER INCOME AND (EXPENSE), NET
2002 - 2001 (Decrease)
- --------------------------------------------------------------------------------
Six Months $(4.0) (16.9)%
- --------------------------------------------------------------------------------
Other income and (expense), net includes equity income (losses),
interest income and other nonoperating income and expense items.
The decrease in other income and (expense), net, was primarily
attributable to higher equity losses from our investment in Ventures III in the
first six months of 2002, over the same period in 2001.
INTEREST EXPENSE
2002 - 2001 (Decrease)
- --------------------------------------------------------------------------------
Six Months $(0.8) (1.2)%
- --------------------------------------------------------------------------------
Interest expense includes costs associated with borrowing and capital
leases, net of capitalized interest costs. We capitalize interest associated
with the acquisition or construction of plant assets. Capitalized interest is
reported as a cost of plant and a reduction in interest expense.
Interest expense decreased in the first six months of 2002, over the
same period in 2001, primarily as a result of lower interest rates and lower
average levels of short-term debt with an affiliate. These decreases were
substantially offset by the effect of higher levels of long-term debt and lower
capitalized interest costs resulting from lower levels of average telephone
plant under construction.
EFFECTIVE INCOME TAX RATES
Six Months Ended June 30,
- --------------------------------------------------------------------------------
2002 45.0%
- --------------------------------------------------------------------------------
2001 44.6%
- --------------------------------------------------------------------------------
The effective income tax rate is the provision for income taxes as a
percentage of income before provision for income taxes and extraordinary item.
Our effective income tax rate was higher for the six months ended June 30, 2002,
compared to the same period in 2001, primarily due to the effect of higher
equity losses associated with our investment in Ventures III, for which we do
not recognize income tax benefits.
EARLY EXTINGUISHMENT OF DEBT
During March 2002, we recorded extraordinary charges associated with
the early extinguishment of long-term debt, which reduced net income by $.9
million (net of income tax benefits of $.6 million).
See Note 5 to the Condensed Financial Statements.
11
Verizon Pennsylvania Inc.
OTHER MATTERS
- -------------
In-Region Long Distance
Under the Telecommunications Act of 1996, our ability to offer
in-region long distance services (that is, services originating in the states
where we operate as a local exchange carrier) is largely dependent on satisfying
specified requirements. The requirements include a 14-point "competitive
checklist" of steps which we must take to help competitors offer local services
through resale, through purchase of UNEs, or by interconnecting their own
networks to ours. We must also demonstrate to the FCC that entry into the
in-region long distance market would be in the public interest.
On September 19, 2001, the FCC released an order approving our
application for permission to enter the in-region long distance market in
Pennsylvania. The order is currently on appeal to the U.S. Court of Appeals.
Since October 23, 2001, in-region long distance service is being offered by a
separate non-regulated subsidiary of Verizon Communications Inc. as required by
law.
Recent Accounting Pronouncements
Asset Retirement Obligations
In June 2001, the Financial Accounting Standards Board (FASB) issued
SFAS No. 143, "Accounting for Asset Retirement Obligations." This standard
provides the accounting for the cost of legal obligations associated with the
retirement of long-lived assets. SFAS No. 143 requires that companies recognize
the fair value of a liability for asset retirement obligations in the period in
which the obligations are incurred and capitalize that amount as a part of the
book value of the long-lived asset. That cost is then depreciated over the
remaining life of the underlying long-lived asset. We are required to adopt SFAS
No. 143 effective January 1, 2003. We are currently evaluating the impact this
new standard will have on our future results of operations or financial
position.
Debt Extinguishment
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." SFAS No. 145, among other things, eliminates the requirement that
all gains and losses on the extinguishment of debt must be classified as
extraordinary items on the income statement, thereby permitting the
classification of such gains and losses as extraordinary items only if the
criteria of APB Opinion No. 30, "Reporting the Results of Operations-Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions," are met. We are required to
adopt this provision of SFAS No. 145 no later than January 1, 2003 and upon
adoption we will reclassify in our statements of income previously reported
extraordinary charges for the early extinguishment of debt to income from
continuing operations.
Exit or Disposal Activities
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This standard addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." EITF Issue No.
94-3 required accrual of liabilities related to exit and disposal activities at
a plan (commitment) date. SFAS No. 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when the liability is
incurred. The provisions of this standard are effective for exit or disposal
activities that are initiated after December 31, 2002.
Compensation for Internet Traffic
We continue to incur expenditures related to reciprocal compensation
arrangements with CLECs and other carriers to terminate calls on their network.
On April 27, 2001, the FCC released an order addressing intercarrier
compensation for dial-up connections for Internet-bound traffic. The FCC found
that Internet-bound traffic is interstate and subject to the FCC's jurisdiction.
Moreover, the FCC again found that Internet-bound traffic is not subject to
reciprocal compensation under Section 251(b)(5) of the 1996 Act. Instead, the
FCC established federal rates per minute for this traffic that decline from
$0.0015 to $0.0007 over a three-year period. The FCC order also sets caps on the
total minutes of this traffic that may be subject to any intercarrier
compensation and requires that incumbent local exchange carriers must offer to
pay reciprocal compensation for local traffic at the same rate as they are
required
12
Verizon Pennsylvania Inc.
pay on Internet-bound traffic. On May 3, 2002 the U.S. Court of Appeals for the
D.C. Circuit remanded the April 27, 2001 FCC order for further proceedings. It
did not vacate the interim pricing rules established in that order and they
remain in effect.
Several parties, including Pac-West Telecomm and Focal Communications
Corp. have requested rehearing, asking the court to vacate the underlying order.
A decision on the rehearing petitions remains pending, and the FCC's underlying
order remains in effect.
13
Verizon Pennsylvania Inc.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
There were no proceedings reportable under this Item.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit
Number
-------
3b Amended Bylaws of Verizon Pennsylvania Inc.
12 Computation of Ratio of Earnings to Fixed Charges.
(b) There were no Current Reports on Form 8-K filed during the
quarter ended June 30, 2002.
14
Verizon Pennsylvania Inc.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Verizon Pennsylvania Inc.
Date: August 14, 2002 By /s/ Edwin F. Hall
-------------------------------------------
Edwin F. Hall
Controller
UNLESS OTHERWISE INDICATED, ALL INFORMATION IS AS OF AUGUST 7, 2002.
15
EXHIBIT INDEX
Exhibit
Number
-------
3b Amended Bylaws of Verizon Pennsylvania Inc.
12 Computation of Ratio of Earnings to Fixed Charges.