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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 2-36292
VERIZON SOUTH INC.
A Virginia Corporation I.R.S. Employer Identification No. 56-0656680
1095 Avenue of the Americas, Room 3868, New York, New York 10036
Telephone Number (212) 395-2121
-------------------------
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 South 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 $13.7, $21.3, $32.6 and $39.2 from affiliates) $390.7 $407.2 $785.2 $822.3
------------------------------------------------------------
OPERATING EXPENSES
Operations and support (including $55.5, $50.5, $103.2 and
$87.8 to affiliates) 180.8 187.7 339.6 347.1
Depreciation and amortization 49.6 76.9 99.4 152.3
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230.4 264.6 439.0 499.4
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OPERATING INCOME 160.3 142.6 346.2 322.9
OTHER INCOME AND (EXPENSE), NET
(including $1.3, $(1.4), $2.7, and $(2.4) from affiliates) 1.5 (1.4) 2.9 (2.4)
INTEREST EXPENSE
(including $.2, $1.5, $.3 and $2.7 to affiliates) 19.6 19.8 39.1 34.5
------------------------------------------------------------
INCOME BEFORE PROVISION FOR INCOME TAXES AND
EXTRAORDINARY ITEM 142.2 121.4 310.0 286.0
PROVISION FOR INCOME TAXES 55.9 48.9 121.9 114.2
------------------------------------------------------------
INCOME BEFORE EXTRAORDINARY ITEM 86.3 72.5 188.1 171.8
EXTRAORDINARY ITEM
Early extinguishment of debt, net of tax -- (.3) -- (.3)
------------------------------------------------------------
NET INCOME $ 86.3 $ 72.2 $188.1 $171.5
============================================================
See Notes to Condensed Financial Statements.
1
Verizon South Inc.
CONDENSED BALANCE SHEETS
ASSETS
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(Dollars in Millions) June 30, 2002 December 31, 2001
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(Unaudited)
CURRENT ASSETS
Cash $ .1 $ .1
Short-term investments 13.2 37.8
Note receivable from affiliate 254.0 274.6
Accounts receivable:
Trade and other, net of allowances for uncollectibles of $41.3 and $29.1 210.1 247.2
Affiliates 63.3 22.5
Material and supplies 11.2 9.7
Prepaid expenses 25.2 18.7
Net assets held for sale 752.6 703.8
Other 31.2 32.1
--------------------------------------------
1,360.9 1,346.5
--------------------------------------------
PLANT, PROPERTY AND EQUIPMENT 3,203.9 3,147.6
Less accumulated depreciation 1,936.5 1,883.1
--------------------------------------------
1,267.4 1,264.5
--------------------------------------------
PREPAID PENSION ASSET 408.1 389.6
--------------------------------------------
OTHER ASSETS 56.1 56.4
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TOTAL ASSETS $3,092.5 $3,057.0
============================================
See Notes to Condensed Financial Statements.
2
Verizon South 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 $ 166.5 $ 152.4
Accounts payable and accrued liabilities:
Affiliates 96.1 61.5
Other 111.8 194.2
Other liabilities 356.5 357.4
---------------------------------------------
730.9 765.5
---------------------------------------------
LONG-TERM DEBT 899.5 913.3
---------------------------------------------
EMPLOYEE BENEFIT OBLIGATIONS 200.2 202.0
---------------------------------------------
DEFERRED CREDITS AND OTHER LIABILITIES
Deferred income taxes 296.4 259.4
Unamortized investment tax credits .1 .2
Other 63.6 65.1
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360.1 324.7
---------------------------------------------
SHAREOWNER'S INVESTMENT
Common stock - $25 par value per share 525.0 525.0
Authorized shares: 25,000,000
Outstanding shares: 21,000,000
Contributed capital 74.0 71.8
Reinvested earnings 302.8 254.7
---------------------------------------------
901.8 851.5
---------------------------------------------
TOTAL LIABILITIES AND SHAREOWNER'S INVESTMENT $3,092.5 $3,057.0
=============================================
See Notes to Condensed Financial Statements.
3
Verizon South Inc.
CONDENSED STATEMENTS OF CASH FLOWS
Six Months Ended June 30,
---------------------------------------------
(Dollars in Millions) (Unaudited) 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 231.0 $ 135.0
--------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net change in short-term investments 24.6 13.1
Capital expenditures (143.4) (201.4)
Change in note receivable from affiliate 20.6 (27.7)
Investment in unconsolidated business (2.1) --
Other, net 7.2 5.7
---------------------------------------------
Net cash used in investing activities (93.1) (210.3)
---------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from borrowings -- 290.6
Principal repayments of borrowings and capital lease obligations -- (12.4)
Change in note payable to affiliate -- (87.1)
Dividends paid (140.0) (133.0)
Capital contribution from parent 2.1 --
---------------------------------------------
Net cash (used in)/provided by financing activities (137.9) 58.1
---------------------------------------------
NET CHANGE IN CASH -- (17.2)
CASH, BEGINNING OF PERIOD .1 25.6
---------------------------------------------
CASH, END OF PERIOD $ .1 $ 8.4
=============================================
See Notes to Condensed Financial Statements.
4
Verizon South Inc.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
Verizon South Inc. is a wholly owned subsidiary of GTE Corporation (GTE),
which 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 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 other intangible assets at December 31, 2001 and
2000.
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.
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.
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Verizon South Inc.
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 $41.5 million to GTE.
5. Debt
During the first half of 2001, we redeemed $12.4 million of 10.54% twenty
year first mortgage bonds due in 2008. As a result of this early extinguishment
of debt, we recorded an extraordinary charge that reduced net income by $.3
million (net of an income tax benefit of $.2 million).
6. Shareowner's Investment
Common Contributed Reinvested
(Dollars in Millions) Stock Capital Earnings
- --------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 $525.0 $71.8 $ 254.7
Net income 188.1
Dividends declared to GTE (140.0)
Capital contribution from GTE 2.1
Other .1
----------------------------------------------------------
Balance at June 30, 2002 $525.0 $74.0 $ 302.8
==========================================================
Net income and comprehensive income were the same for the six months ended
June 30, 2002 and 2001.
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.
6
Verizon South Inc.
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 commissions for approval of the transfer of these assets back to us.
During the fourth quarter of 2001, Ventures III transferred assets to us, after
required state regulatory approvals were obtained, in the jurisdictions of
Kentucky, Virginia and South Carolina. Ventures III transferred advanced data
assets back to us, after required state regulatory approvals were obtained, with
an aggregate net book value of $2.4 million in Alabama and North Carolina on
January 1, 2002. 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 $2.1 million in the first 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 $25.7 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
well as an accrual of ongoing SFAS No. 112 obligations for GTE employees. 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 $3.5 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 $3.0
million in accordance with SFAS No. 112 associated with employee severance. As
of June 30, 2002, a total of approximately 60 employees have been separated
under the 2001 and 2002 severance programs. The remaining severance liability
relating to these programs is $3.1 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.
In addition, during the second quarter of 2002, we recorded an impairment
charge of $7.6 million driven by our financial statement exposure of WorldCom
Inc.
10. Subsequent Events - Sales of Telephone Operations in Alabama and Kentucky
On July 1, 2002, Verizon South Inc. and Contel of the South, Inc. (both
wholly owned indirect subsidiaries of Verizon Communications Inc.) completed the
sale of their telephone access lines (approximately 300,000 lines) and related
local exchange operations in Alabama to CenturyTel of Alabama, L.L.C. for
approximately $1.0 billion in cash, pursuant to an agreement entered into in the
fourth quarter of 2001. Verizon South Inc. owned and operated approximately
170,000 of these access lines and received cash proceeds from the sale of
approximately $572 million. Verizon South Inc. expects to record a gain as a
result of the sale of its Alabama operations.
On July 31, 2002, Verizon South Inc. completed the sale of its telephone
access lines (approximately 600,000 lines) and related local exchange operations
in Kentucky to Kentucky ALLTEL, Inc. for approximately $1.9 billion in cash,
pursuant to an agreement entered into in the fourth quarter of 2001. Verizon
South Inc. expects to record a gain as a result of the sale of its Kentucky
operations.
The net assets pertaining to the Alabama and Kentucky operations,
principally plant, property and equipment of $752.6 million at June 30, 2002 and
$703.8 million at December 31, 2001, are classified in our balance sheets as
"Net assets held for sale." Given the decision to sell, no depreciation was
recorded for these assets during the second half of 2001 and the first half of
2002, in accordance with Statements of Financial Accounting Standards Nos. 121
and 144. Accordingly, depreciation expense was lower by $26.8 million in the
three months ended June 30, 2002 and $53.6 million in the six months ended June
30, 2002.
7
Verizon South Inc.
The Alabama and Kentucky operations represent approximately 37% of the
access lines that we had in service at June 30, 2002, and contributed
approximately 37% to operating revenues for both the six months ended June 30,
2002 and the year ended December 31, 2001.
11. Subsequent Event - Early Extinguishment of Debt
On August 1, 2002, we recorded an extraordinary charge associated with the
early extinguishment of $16.5 million of 8.88% twenty year first mortgage bonds
due on November 30, 2009, which reduced net income by $.4 million (net of an
income tax benefit of $.2 million).
8
Verizon South 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 $188.1 million for the six month period ended
June 30, 2002, compared to net income of $171.5 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 $3.0 million
in accordance with Statement of Financial Accounting Standards (SFAS) No. 112,
"Employers' Accounting for Postemployment Benefits," associated with employee
severance.
In addition, during the second quarter of 2002, we recorded an
impairment charge of $7.6 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. In the fourth quarter of 2001 and the
first quarter of 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, Operations and support expenses, 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 $385.9 $450.4
Network access services 332.0 293.6
Long distance services 12.7 15.7
Other services 54.6 62.6
-----------------------------------------
Total $785.2 $822.3
=========================================
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.
9
Verizon South Inc.
LOCAL SERVICES
2002 - 2001 (Decrease)
- --------------------------------------------------------------------------------
Six Months $(64.5) (14.3)%
- --------------------------------------------------------------------------------
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 were affected by the settlement of a state
regulatory matter in the state of Virginia. This settlement resulted in refunds
to customers from both local service revenues and network access revenues in the
first quarter of 2001. The effect of these refunds was entirely offset by the
reversal of an accrual in 2001 which was recorded in local service revenues.
Price reductions and the effects of the economic slowdown and competition, as
reflected by a decline in our switched access lines in service of 1.2% from June
30, 2001, also contributed to the decrease in local service revenues. Technology
substitution, as indicated by lower demand for residential access lines, and
lower billings to CLECs for interconnection of their network with our network,
further contributed to the decrease in local service revenues.
NETWORK ACCESS SERVICES
2002 - 2001 Increase
- --------------------------------------------------------------------------------
Six Months $38.4 13.1%
- --------------------------------------------------------------------------------
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.
The increase in network access service revenue in the first six months of
2002 was primarily due to the effect of the settlement of a regulatory matter in
the state of Virginia in the first quarter of 2001. This settlement resulted in
refunds to customers which was entirely offset by the reversal of an accrual
recorded in local service revenues in 2001, as described above. In addition,
higher customer demand for special access services, particularly for
high-capacity, high-speed digital services, and the reintegration of Ventures
III also contributed to the revenue increase, but to a lesser extent.
These increases were partially offset by the effect of mandated price
reductions on interstate and intrastate access services and other regulatory
decisions. In addition, growth in switched access service revenue declined in
the first half of 2002 due to the impact of the slowing economy, as reflected by
a decline in minutes of use from carriers and CLECs.
LONG DISTANCE SERVICES
2002 - 2001 (Decrease)
- --------------------------------------------------------------------------------
Six Months $(3.0) (19.1)%
- --------------------------------------------------------------------------------
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 state regulatory commissions except where they cross state lines.
Other long distance services that we provide include 800 services and Wide Area
Telephone Service (WATS). We also earn revenue from private line and operator
services associated with long distance calls.
Long distance service revenues declined in the first six months of 2002
primarily due to the effects of competition, technology substitution and the
slowing economy. Mandated price reductions on some long distance services also
contributed to the decline in long distance revenues, but to a lesser extent.
10
Verizon South Inc.
OTHER SERVICES
2002 - 2001 (Decrease)
- --------------------------------------------------------------------------------
Six Months $(8.0) (12.8)%
- --------------------------------------------------------------------------------
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 and customer premises equipment (CPE).
Other service revenues also include fees paid by customers for non-publication
of telephone numbers and multiple white page listing, fees paid by an affiliate
for usage of our directory listings and fees paid by an affiliate for the
provision of sales agent services.
Other service revenues decreased in the first six months of 2002 primarily
due to lower revenue from CPE sales. This decrease was partially offset by an
increase in sales and services to affiliates.
OPERATING EXPENSES
- ------------------
(Dollars in Millions)
OPERATIONS AND SUPPORT
2002 - 2001 (Decrease)
- --------------------------------------------------------------------------------
Six Months $(7.5) (2.2)%
- --------------------------------------------------------------------------------
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, as well as the effect of declining workforce
levels. These decreases were substantially offset by higher centralized services
expenses allocated to us by Verizon Services, as well as an increase in the
provision for uncollectible accounts receivable. The reintegration of Ventures
III and employee severance costs recorded in the second quarter of 2002 further
offset the decline in operations and support expenses for the six months ended
June 30, 2002.
DEPRECIATION AND AMORTIZATION
2002 - 2001 (Decrease)
- --------------------------------------------------------------------------------
Six Months $(52.9) (34.7)%
- --------------------------------------------------------------------------------
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 decreased in the first six months of
2002 primarily due to our decision to dispose of certain properties and, as a
consequence, we no longer depreciate these assets in accordance with SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of" and SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." (See Note 10 to the Condensed Financial
Statements.)
11
Verizon South Inc.
OTHER RESULTS
- -------------
(Dollars in Millions)
OTHER INCOME AND (EXPENSE), NET
2002 - 2001 Increase
- --------------------------------------------------------------------------------
Six Months $5.3 220.8%
- --------------------------------------------------------------------------------
Other income and (expense), net includes equity income (losses), interest
income and other nonoperating income and expense items. As a result of the
reintegration of Ventures III in the fourth quarter of 2001 and the first
quarter of 2002, we no longer recognize equity income (losses) from this
investment.
The increase in other income and (expense), net, was primarily
attributable to an increase in interest income on a note receivable with an
affiliate and the effect of equity losses recognized in 2001 from our investment
in Ventures III.
INTEREST EXPENSE
2002 - 2001 Increase
- --------------------------------------------------------------------------------
Six Months $4.6 13.3%
- --------------------------------------------------------------------------------
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 increased in the first six months of 2002, over the same
period in 2001, primarily due to the effect of refinancing short-term debt from
an affiliate with long-term debt at a higher interest rate and, to a lesser
extent, lower capitalized interest costs resulting from lower levels of average
telephone plant under construction.
EFFECTIVE INCOME TAX RATES
Six Months Ended June 30,
- --------------------------------------------------------------------------------
2002 39.3%
- --------------------------------------------------------------------------------
2001 39.9%
- --------------------------------------------------------------------------------
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 lower for the six months ended June 30, 2002,
compared to the same period in 2001, primarily due to the effect of equity
losses associated with our investment in Ventures III, which were recorded in
2001, for which we did not recognize income tax benefits and by a decrease in
non-recurring income tax expense.
EXTRAORDINARY ITEM
During the first half of 2001, we redeemed $12.4 million of long-term debt
prior to stated maturity and recorded an after-tax extraordinary charge of $.3
million (net of tax benefits of $.2 million).
See Note 5 to the Condensed Financial Statements.
12
Verizon South Inc.
OTHER MATTERS
- -------------
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 to 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.
Subsequent Events - Sales of Telephone Operations in Alabama and Kentucky
On July 1, 2002, Verizon South Inc. and Contel of the South, Inc. (both
wholly owned indirect subsidiaries of Verizon Communications Inc.) completed the
sale of their telephone access lines (approximately 300,000 lines) and related
local exchange operations in Alabama to CenturyTel of Alabama, L.L.C. for
approximately $1.0 billion in cash, pursuant to an agreement entered into in the
fourth quarter of 2001. Verizon South Inc. owned and operated approximately
170,000 of these access lines and received cash proceeds from the sale of
approximately $572 million. Verizon South Inc. expects to record a gain as a
result of the sale of its Alabama operations.
13
Verizon South Inc.
On July 31, 2002, Verizon South Inc. completed the sale of its telephone
access lines (approximately 600,000 lines) and related local exchange operations
in Kentucky to Kentucky ALLTEL, Inc. for approximately $1.9 billion in cash,
pursuant to an agreement entered into in the fourth quarter of 2001. Verizon
South Inc. expects to record a gain as a result of the sale of its Kentucky
operations.
The Alabama and Kentucky operations represent approximately 37% of the
access lines that we had in service at June 30, 2002, and contributed
approximately 37% to operating revenues for both the six months ended June 30,
2002 and the year ended December 31, 2001.
Subsequent Event - Early Extinguishment of Debt
On August 1, 2002, we recorded an extraordinary charge associated with the
early extinguishment of $16.5 million in First Mortgage Bonds due November 30,
2009, which reduced net income by $.4 million (net of an income tax benefit of
$.2 million).
14
Verizon South 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
------
3.1 Amended and Restated Articles of Incorporation of Verizon
South Inc.
3.2 Amended and Restated Bylaws of Verizon South 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.
15
Verizon South 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 South 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.
16
EXHIBIT INDEX
Exhibit
Number
------
3.1 Amended and Restated Articles of Incorporation of Verizon
South Inc.
3.2 Amended and Restated Bylaws of Verizon South Inc.
12 Computation of Ratio of Earnings to Fixed Charges.