TELECOMUNICACIONES DE PUERTO RICO INC - 10-Q Quarterly Report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934

For the quarterly period ended: SEPTEMBER 30, 2003

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 333-85503

TELECOMUNICACIONES DE PUERTO RICO, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

COMMONWEALTH OF PUERTO RICO 66-0566178
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)

1515 FD ROOSEVELT AVENUE
GUAYNABO, PUERTO RICO 00968

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

Registrant's telephone number, including area code: 787-792-6052

(Former name, former address and former fiscal year,
if changed since last report)

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 whether the registrant is an accelerated filer.

YES [ ] NO [X]

Telecomunicaciones de Puerto Rico, Inc. had 25 million shares of no par common
stock outstanding at November 14, 2003.

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1

TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES

INDEX

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited) 3

Condensed Consolidated Balance Sheets--September 30, 2003 and December 31, 2002 3

Condensed Consolidated Statements of Operations--Three Months Ended September 30, 2003
and 2002; Nine Months Ended September 30, 2003 and 2002 4

Condensed Consolidated Statements of Changes in Shareholders' Equity--Nine 5
Months Ended September 30, 2003 and Year Ended December 31, 2002

Condensed Consolidated Statements of Cash Flows--Nine Months Ended September 30,
2003 and 2002 6

Notes to Condensed Consolidated Financial Statements 7

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 29

Item 3. Quantitative and Qualitative Disclosures About Market Risk 43

Item 4. Controls and Procedures 44

PART II. OTHER INFORMATION

Item 1. Legal Proceedings 45

Item 2. Changes in Securities and Use of Proceeds 45

Item 3. Defaults Upon Senior Securities 45

Item 4. Submission of Matters to a Vote of Security Holders 45

Item 5. Other Information 45

Item 6. Exhibits and Reports on Form 8-K 45

SIGNATURES 46

EXHIBIT INDEX 47

2

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

The accompanying notes are an integral part of these financial statements.

3

TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands)

The accompanying notes are an integral part of these financial statements.

4

TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

(in thousands)

The accompanying notes are an integral part of these financial statements.

5

TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

The accompanying notes are an integral part of these financial statements.

6

TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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1. BUSINESS / CORPORATE STRUCTURE

Telecomunicaciones de Puerto Rico, Inc., a Puerto Rico corporation ("we" or
the "Company"), holds 100% of the common stock of Puerto Rico Telephone
Company, Inc. ("PRTC"), PRT Larga Distancia, Inc. ("PRTLD"), and Datacom
Caribe, Inc. ("Datacom"). The Company also holds a 67% interest in
Coqui.net Corporation ("Coqui.net"), in which Popular, Inc., one of the
Company's shareholders, holds the remaining 33% interest. The Company also
holds a 24% interest in Verizon Information Services, Puerto Rico, Inc. S
en C ("VISI"), in which GTE Holdings (Puerto Rico) LLC, our majority
shareholder, holds a 36% interest. The Company is the largest
telecommunications service provider in Puerto Rico. PRTC is the incumbent
local exchange carrier for the island of Puerto Rico. Wireline service is
provided by PRTC and cellular service is provided by the wireless division
of PRTC, under the brand of Verizon Wireless Puerto Rico, Inc. ("Verizon
Wireless"). The Company's off-island long distance service is provided by
PRTLD. The Company's dial-up Internet access service is provided by
Coqui.net. The Company's directory-publishing revenues are generated by
VISI.

GTE Corporation ("GTE"), through its subsidiary GTE Holdings (Puerto Rico)
LLC, acquired a 40% interest in, and management control over, the Company
on March 2, 1999 from Puerto Rico Telephone Authority ("PRTA"), an entity
of the Commonwealth of Puerto Rico (the "Acquisition"). In connection with
the Acquisition, Popular, Inc. acquired a 10% interest in the Company. GTE
and Bell Atlantic Corporation merged on June 30, 2000 to form Verizon
Communications Inc. ("Verizon"). On January 25, 2002, GTE Holdings (Puerto
Rico) LLC and Popular, Inc. acquired an additional 12% and 3% interest in
the Company, respectively, by exercising an option each had held since the
Acquisition (the "Option Exercise"). Verizon and Popular, Inc. obtained the
additional ownership interest from PRTA Holdings Corp., a subsidiary of
PRTA ("PRTA Holdings"). Verizon and Popular, Inc. paid PRTA Holdings $138
million and $34 million, respectively, for a total of $172 million in cash
for the additional 3,750,000 shares at a $45.9364 per share price
established in the Share Option Agreement, an agreement entered into at the
time of the Acquisition. As a result, Verizon now owns 52%, PRTA owns 28%,
Popular owns 13%, and the Employee Stock Ownership Plan owns 7% of the
outstanding capital stock of the Company. The Company is an affiliate of
Verizon, which consolidates the Company's financial results with its own
financial results.

PRTC/VERIZON WIRELESS MERGER

On May 1, 2002, the Company completed a tax-free reorganization whereby it
merged Verizon Wireless, a wholly-owned subsidiary of the Company, into
PRTC. Prior to the merger, the Company created a new wholly-owned
subsidiary, PRTLD, to carry the off-island long distance business
previously provided by Verizon Wireless. The objectives for the
reorganization were to (i) integrate the wireline and wireless operations
without jeopardizing the continuity of the off-island long distance
license, (ii) simplify the overall corporate structure to reduce
administrative costs, and (iii) provide better control and monitoring of
the off-island long distance business and increase its potential for growth
in Puerto Rico. As a result of this merger, the Company released a deferred
tax valuation allowance related to the Acquisition of approximately $93
million, approximately $51 million of which was recorded against goodwill
and approximately $42 million of which was recorded as a deferred tax
benefit in the Company's consolidated statement of income for the second
quarter of 2002 in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 109, "Accounting for Income Taxes."

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with accounting principles generally accepted
in the United States for interim financial information and the rules and
regulations of the Securities and Exchange Commission ("SEC"). Certain
information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally
accepted in the United States for annual financial statements have been
condensed or omitted pursuant to such rules and regulations. Management
believes the financial statements include all adjustments and recurring
accruals necessary to present fairly the results of operations and
financial condition for the interim periods shown. The Condensed
Consolidated Balance Sheet at December 31, 2002 was derived from audited
financial statements and should be read in conjunction with the notes
thereto included in the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 2002.

7

RECLASSIFICATIONS

Reclassifications of prior periods' data have been made to conform to the
current period's presentation.

3. ACCOUNTING CHANGE FOR DIRECTORY REVENUE RECOGNITION

During the second quarter of 2003, the Company changed its method of
accounting for directory-publishing revenues and related expenses from the
point-of-publication method to the amortization method, effective January
1, 2003.

Under the point-of-publication method, such revenues and related expenses
are recognized on the date that the directory is published and
substantially delivered. Under the amortization method, pre-publication
revenues and expenses are deferred and capitalized, respectively.
Subsequent to publication, revenues are recognized and expenses amortized
over the lives of the directories, which is generally one year.

While both methods fully comply with accounting principles generally
accepted in the United States, the Company adopted the amortization method
because it is becoming the industry standard.

The cumulative effect of applying this accounting change to prior years is
recognized as of January 1, 2003 as a one-time, non-cash loss of $17
million ($13 million, after tax).

The effect of applying the new method for the nine months ended September
30, 2003 is a one-time non-cash revenue increase of $10 million, which has
been included in operating income.

The following table shows the pro forma effect on operating results for the
three and nine months ended September 30, 2002 had the Company applied the
amortization method during prior periods:

8

4. SUMMARY OF RECENT ACCOUNTING PRONOUNCEMENTS

ACCOUNTING FOR GOODWILL AND OTHER INTANGIBLES

The Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets"
effective January 1, 2002, which provides guidance on the initial
recognition and measurement of goodwill and other intangible assets
acquired in a business combination.

SFAS No. 142 no longer permits the amortization of goodwill and other
indefinite-lived intangible assets. Instead, these assets must be reviewed
annually (or, under certain conditions, more frequently) for impairment in
accordance with this statement. This impairment test uses a fair value
approach rather than the undiscounted cash flow approach previously
required by SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of."

Intangible assets that do not have indefinite lives will continue to be
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 Company has evaluated its assets using the fair value approach
for each reporting unit to determine if there is an impairment exposure
(transitional impairment test) and the impact it would have on the
Company's results of operations for 2003. The evaluation of the two
reporting units revealed no impairment exposure.

ASSET RETIREMENT OBLIGATIONS

On January 1, 2003, the Company adopted SFAS No. 143, "Accounting for Asset
Retirement Obligations." This statement 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 part of the book
value of the long-lived asset. The Company has determined that PRTC does
not have a material legal obligation to remove long-lived assets as
described by this statement. However, the Company has included estimated
removal costs in the Company's group depreciation models. These costs have
increased depreciation expense and accumulated depreciation for future
removal costs for existing assets. These removal costs are recorded as a
reduction to accumulated depreciation when the assets are retired and
removal costs are incurred.

For some assets, such as telephone poles, the removal costs exceed salvage
value. Under the provisions of SFAS No. 143, the Company is required to
exclude costs of removal from the Company's depreciation rates for assets
for which the removal costs exceed salvage. Accordingly, in connection with
the initial adoption of this standard on January 1, 2003, the Company has
reversed accrued costs of removal in excess of salvage from the Company's
accumulated depreciation accounts for these assets. The adjustment was
recorded as a cumulative effect of an accounting change, resulting in the
recognition of an estimated gain of $117 million ($71 million after tax).
Effective January 1, 2003, the Company began expensing costs of removal in
excess of salvage for these assets as incurred. The impact of this change
in accounting resulted in a decrease in depreciation expense and an
increase in operational and support expenses. The Company estimates that
the net increase to operating income in 2003, excluding the cumulative
effect adjustment, will be approximately $12 million ($7 million after
tax).

ACCOUNTING FOR IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS

In August 2001, the Financial Accounting Standards Board (the "FASB")
issued 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 Company adopted SFAS No. 144
effective January 1, 2002, without any impact on its 2002 financial
statements.

9

EXTINGUISHMENTS OF DEBT AND ACCOUNTING FOR CERTAIN CAPITAL LEASE
OBLIGATIONS

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." For most companies, SFAS No. 145 requires gain and losses on
extinguishments of debt to be classified as income or loss from continuing
operations rather than as extraordinary items as previously required under
SFAS No. 4. However, extraordinary treatment is required for certain
extinguishments as provided in APB Opinion No. 30. This statement also
amends SFAS No. 13 to require that certain modifications to capital leases
be treated as sale-leaseback transactions and modifies the accounting for
sub-leases. In addition, the FASB rescinded SFAS No. 44, which addressed
the accounting for intangible assets of motor carriers and made numerous
technical corrections that are not substantive in nature to existing
pronouncements. The Company evaluated the impact of the adoption of SFAS
No. 145 and concluded that there is no material effect on its results of
operations and financial condition.

ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES

In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This statement 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
Restructuring)." EITF Issue No. 94-3 previously required that a liability
related to exit and disposal activities be recognized at the date of a
company's commitment to an exit plan. By contrast, 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 statement
are effective for exit or disposal activities that are initiated after
December 31, 2002. The Company evaluated the impact of the adoption of SFAS
No. 146 and concluded that there is no a material effect on its results of
operations and financial condition.

AMENDMENTS OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES

In April 2003, the FASB issued SFAS No. 149, "Amendments of Statement 133
on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 149 is effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. In addition, all provisions
of SFAS No. 149 should be applied prospectively. However, the provisions of
this statement that relate to SFAS 133 Implementation Issues that have been
effective for fiscal quarters beginning prior to June 15, 2003 continue to
be applied in accordance with their respective effective dates. The Company
evaluated the impact of the adoption of SFAS No. 149 and concluded that
there is no material effect on its results of operations and financial
condition.

ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH
LIABILITIES AND EQUITY

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity."
This standard clarifies the accounting for certain financial instruments
that, under previous guidance, issuers could account for as equity. SFAS
No. 150 requires that those instruments be classified as liabilities in
statements of financial position. The requirements of this statement apply
to issuers' classification and measurement of freestanding financial
instruments, including those that comprise more than one option or forward
contract. SFAS No. 150 is effective for all financial instruments entered
into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003. The
Company evaluated the impact of the adoption of SFAS No. 150 and concluded
that there is no material effect on its results of operations and financial
condition.

ACCOUNTING FOR REVENUE ARRANGEMENTS WITH MULTIPLE DELIVERABLES

In November 2002, the Emerging Issues Task Force ("EITF") of the FASB
reached a consensus on EITF No. 00-21, "Accounting for Revenue Arrangements
with Multiple Deliverables." EITF No. 00-21 addresses how to account for
arrangements that may involve multiple revenue-generating activities.
Specifically, the issue addresses how to determine whether an arrangement
involving multiple deliverables contains more than one unit of accounting.
The consensus guidance will be applicable to agreements entered into in
quarters beginning after June 15, 2003. The Company evaluated the impact of
the adoption of EITF No. 00-21 and concluded that there is no material
effect on its results of operations and financial condition.

10

5. PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consist of:

Effective July 1, 2002, the Company revised its accounting estimates
relating to depreciation, based on a detailed review of the lives
underlying the depreciation rates. The depreciation rate revisions reflect
expected useful lives resulting from the impact of technology and future
competition as well as more closely approximating the assumptions used by
other telephone companies. These revisions resulted in a decrease in
depreciation expense by approximately $6 million for the second half of
2002 and approximately $9 million for the nine months ended September 30,
2003.

6. GOODWILL

Following is a breakdown of goodwill.

11

7. INTANGIBLES

Intangibles consist of:

8. OTHER ASSETS

Other assets consist of:

12

9. VOLUNTARY SEPARATION AND RETIREMENT PROGRAMS

The Company offered a voluntary separation program to qualified management
employees during the fourth quarter of 2002 and recorded a $0.5 million
non-cash provision as a result of 8 employees accepting the program.

In January 2003, an additional 29 qualified management employees accepted
the voluntary separation program, representing an expense of $1.4 million,
which was recorded in the first quarter of 2003. During the second quarter
of 2003, the Company offered to members of one of the unions a voluntary
separation program that closed on June 20, 2003, which 44 qualified
employees accepted. Also, during the second quarter of 2003, an additional
147 employees in the craft union accepted a retirement program offered by
the Company that closed on June 30, 2003. As a result of these two
programs, an additional provision of $3.3 million was recorded.

10. DEFERRED ESOP COMPENSATION

The Employee Stock Ownership Plan ("ESOP") acquired a 3% equity interest in
the Company in 1999, which was financed by a $26 million, twenty-year note
borrowed from the Company to establish a contributory investment fund for
employees. The ESOP only invests in shares of the Company's common stock.
Shares are held by the ESOP's trustee and maintained in a suspense account
until they are released to employee participants. The yearly release of
shares to participants is based on the greater of participant contributions
plus a Company match of 30% up to 5% of wages or a minimum based on an
amortization schedule. The minimum is based on the ratio of annual debt
service to total debt service multiplied by the initial 750,000 shares.

Compensation expense is recorded based on the release of shares at market
value, which is based on an independent appraisal performed annually. The
ESOP released approximately 39,800 shares in 2002. This release resulted in
compensation expense of $3 million for the year ended December 31, 2002,
reflecting the market value of the shares. The release of shares, based
upon the per share price established at the Acquisition, amounted to $1.4
million for December 31, 2002, which is reflected as a reduction of
deferred ESOP compensation in equity.

11. OTHER CURRENT LIABILITIES

Other current liabilities consist of:

13

12. DEBT

Debt consists of:

The senior notes, commercial paper, term credit facilities, working capital
facility, and bank notes are unsecured and non-amortizing. PRTC is the
guarantor of these debt instruments.

The Company has a $400 million commercial paper program with maturities not
to exceed 365 days, which is backed by a bank note facility. The commercial
paper dealer agreement for the program was signed in November 2000. The
bank note facility is a syndicated five-year revolving facility expiring in
March 2004. Amounts outstanding under this facility bear interest at 32.5
basis points over the London Interbank Offered Rate ("LIBOR"). Effective
November 2002, the bank note facility was decreased from $500 million to
$400 million. The bank note credit agreement includes financial covenants,
the most significant of which is that the outstanding principal balance
under the bank note facility must not exceed four times adjusted Earnings
Before Interest, Taxes, Depreciation, and Amortization ("EBITDA"), as
defined in the facility agreement.

The Company also has a $40 million working capital credit facility with
Banco Popular de Puerto Rico, an affiliate of Popular, Inc., which was
renewed on June 30, 2003 with a term of one year. Amounts outstanding under
this facility bear interest at a rate of 30 basis points over LIBOR. At
September 30, 2003, the Company did not have a balance outstanding under
this facility.

On August 31, 2001, the Company entered into an interest rate swap contract
with a notional amount of $150 million. In September 2002, the Company drew
the value out of the hedge position without changing the fixed/floating
funding mix of the original swap transaction. This transaction resulted in
cash proceeds of $11 million, reflected in cash from operations as required
by SFAS No. 104, "Statement of Cash Flows - Net Reporting of Certain Cash
Payments and Classification from Hedging Transactions" and created a
deferred derivative, which will be amortized until 2006. The purpose of the
swap is to hedge against changes in the fair market value of the Company's
senior notes to achieve a targeted mix of fixed and variable rate debt. The
swap receives interest at a fixed rate of 6.65% and pays interest at a net
variable rate equal to six month LIBOR plus 170 basis points, with
semi-annual settlements and reset dates every May 15 and November 15 until
maturity of the May 15, 2006 senior notes. The swap was entered into "at
market" and, as a result, there was no exchange of premium at the initial
date of the swap. The Company designates the swap as a hedge of the changes
in fair market value of the senior notes due to changes in the designated
benchmark interest rate. PRTC is the guarantor of the interest rate swap.

14

Aggregate maturities of the senior notes and term credit facilities are as
follow:

13. OTHER NON-CURRENT LIABILITIES

Other non-current liabilities consist of:

14. SHAREHOLDERS' EQUITY

COMMON STOCK

Common stock consists of fifty million authorized shares, no par value,
twenty five million shares of which were outstanding at September 30, 2003
and December 31, 2002.

SUBSCRIPTION RECEIVABLE

The subscription receivable reflects future receipts from PRTA at its
present value, using an 8% discount rate. As part of the Acquisition
agreement, PRTA agreed to contribute a total of $200 million in cash or
stock as a capital contribution in equal installments of $40 million over
five years beginning on March 2, 2000. The Company will use the $200
million capital contribution to partially fund its underfunded pension and
other post-employment benefit obligations. The stock purchase agreement
requires that the Company contribute $66 million, which includes the $40
million received from PRTA, to the pension plan immediately upon receipt of
the proceeds each year. The Company received the fourth $40 million
installment in March 2003 and made the required pension payment of $66
million.

ACCUMULATED OTHER COMPREHENSIVE LOSS

The accumulated other comprehensive loss represents unrecognized losses,
other than unrecognized prior service costs which are reflected as an other
asset, associated with the hourly employee pension fund, since the
accumulated benefit obligation exceeds the fair value of plan assets.

The accumulated other comprehensive loss amount as of December 31, 2002 has
been adjusted in the amount of $57.6 million in order to reflect the
after-tax amount in accordance with the provisions of SFAS No. 130,
"Reporting Comprehensive Income."

15

DIVIDENDS

The Company's shareholders' agreement requires the payment of dividends
equal to at least 50% of consolidated net income, in the following quarter
to the extent funds are legally available.

Dividend payments were made in the following periods:

In March 2003, the Company declared a $17.8 million dividend for the fourth
quarter of 2002, which was paid in the second quarter of 2003. In addition,
in the second quarter of 2003, the Company paid a $50.3 million dividend
for the first quarter of 2003. The senior note indentures and credit
facility agreements do not contain any dividend restrictions.

15. FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts and estimated fair values of the Company's financial
instruments are as follows:

16

16. SEGMENT REPORTING

The Company has two reportable segments: Wireline and Wireless.

The Wireline segment consists of:

o Local services, including basic voice, telephone and
telecommunications equipment rentals, value-added services, high-speed
private line services, Internet access and public phone service;

o Access services to long distance carriers, competitive local exchange
carriers, and cellular and paging operators to originate and terminate
calls on the Company's network;

o Long distance services including direct dial on-island and off-island,
operator assisted calls, prepaid calling card and high-speed private
line services;

o Directory publishing rights services; and

o Telecommunication equipment sales and billing and collection services
to competing long distance operators in Puerto Rico.

The Wireless segment consists of:

o Cellular service; and

o Wireless equipment sales.

The accounting policies of the segments are the same as those followed by
the Company (see Note 2). The Company accounts for intersegment revenues at
market prices.

17

Segment results for the Company are as follow:

18

17. CONDENSED CONSOLIDATING INFORMATION

The following summarizes the unaudited condensed consolidating financial
information as of September 30, 2003 and December 31, 2002 and for the
quarters then ended presents the financial position, results of operations
and cash flows of (i) the Company as if it had accounted for its
subsidiaries using the equity method, (ii) the Guarantor Subsidiary (as
defined below); and (iii) the Non-Guarantor Subsidiaries (as defined below)
on a combined basis. The consolidation entries eliminate investments in
subsidiaries and intercompany balances and transactions.

The Notes are guaranteed by PRTC (the "Guarantor Subsidiary"), a
wholly-owned subsidiary of the Company, but not guaranteed by the Company's
other subsidiaries, Coqui.net, PRTLD and Datacom (the "Non-Guarantor
Subsidiaries"). The guarantee by the Guarantor Subsidiary is full and
unconditional.

19

CONDENSED CONSOLIDATING BALANCE SHEETS
September 30, 2003
(in thousands)

20

CONDENSED CONSOLIDATING BALANCE SHEETS
December 31, 2002
(in thousands)

21

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
For the three months ended September 30, 2003
(in thousands)

22

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
For the three months ended September 30, 2002
(in thousands)

23

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
For the nine months ended September 30, 2003
(in thousands)

24

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
For the nine months ended September 30, 2002
(in thousands)

25

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
For the nine months ended September 30, 2003
(in thousands)

26

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
For the nine months ended September 30, 2002
(in thousands)

27

18. CONTINGENCIES AND REGULATORY AND OTHER MATTERS

The Company is a defendant in various legal matters arising in the ordinary
course of business. Management, after consultation with legal counsel,
believes at this time that the resolution of these matters will not have a
material adverse effect on the Company's financial condition and results of
operations. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Regulatory and Other Matters" for more
information regarding legal and regulatory matters, including a regulatory
dispute regarding intra-island access fees charged to long distance
carriers.

In connection with the privatization of the Company, PRTA agreed to
indemnify, defend and hold the Company harmless from specified litigation in
excess of $50 million in the aggregate, including one environmental matter.

The Company is regulated by the United States Federal Communications
Commission (the "FCC") for inter-state wireline services and by the Puerto
Rico Telecommunications Board ("TRB") for intra-island wireline services.

The Company has an agreement with a provider for the implementation of a
traffic polling and billing software system for its wireline operations.
While the traffic polling portion has been implemented, management has
determined that it is in the Company's best interests to abandon the billing
portion of the software system. The amount of capitalized costs for software
and labor related to the billing portion of $32.3 million was written off
and included in operating expenses during the second quarter of 2003.
Management is currently in discussions with the provider of the system and
seeking a satisfactory resolution of this matter.

In September 2003, the Company established a pre-tax reserve of $73 million,
including interest, for the end-user and AT&T refund referred to in the TRB
Resolution and Order of February 28, 2002. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Regulatory and
Other Matters - Intra-Island Long Distance Access Rate Dispute" for more
information regarding the TRB Resolution and Order of February 28, 2002.

28

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

In this report, the Company has made forward-looking statements. These
statements are based on the Company's estimates and assumptions and are subject
to certain risks and uncertainties. Forward-looking statements include
information concerning possible or assumed future results of operations, as well
as those statements preceded or followed by the words "anticipates," "believes,"
"estimates," "expects," "hopes," "targets" or similar expressions.

Future results could be affected by subsequent events and could differ
materially from those expressed in the forward-looking statements. If future
events and actual performance differ from the Company's assumptions, the actual
results could vary significantly from the performance projected in the
forward-looking statements.

The following important factors could affect future results and could
cause those results to differ materially from those expressed in the
forward-looking statements: (1) materially adverse changes in economic
conditions in Puerto Rico; (2) material changes in available technology; (3) the
final resolution of regulatory initiatives and proceedings, including
arbitration proceedings pertaining to, among other matters, the terms of
interconnection, access charges, universal service, unbundled network elements
and resale rates; (4) changes in the Company's accounting assumptions that may
be required by regulatory agencies, including the SEC, or that result from
changes in the accounting rules or their application, which could result in an
impact on earnings; and (5) the extent, timing, success and overall effects of
competition from others in the Puerto Rico telecommunications service industry.

CRITICAL ACCOUNTING POLICIES

GENERAL

The Company's discussion and analysis of its financial condition and
results of operations are based upon the Company's unaudited condensed
consolidated financial statements, which have been prepared in accordance with
the accounting principles generally accepted in the United States for interim
financial information and the rules and regulations of the SEC. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States for annual financial statements have been condensed or omitted
pursuant to such rules and regulations.

The preparation of these financial statements requires the Company to
make estimates and judgments that affect the reported interim amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an ongoing basis, the Company evaluates its estimates,
including those related to bad debts, intangible assets, income taxes, financing
operations, contingencies and litigation. The Company bases its estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.

The Company believes the following critical accounting policies affect
its more significant judgments and estimates used in the preparation of its
condensed consolidated financial statements.

ALLOWANCE FOR DOUBTFUL ACCOUNTS

The Company maintains allowances for doubtful accounts for estimated
losses resulting from the inability of its customers to make required payments.
If the financial condition of the Company's customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required. Because of uncertainties inherent in the estimation
process, the Company's estimate of losses and the related allowance may change.
The Company does not depend on any single customer for its business.

29

DEFERRED TAXES

The Company uses an asset and liability approach in accounting for
income taxes in accordance with the provisions of SFAS No. 109, "Accounting for
Income Taxes." Deferred tax assets and liabilities are recognized for temporary
differences between the way certain income and expense items are reported for
financial reporting and tax purposes.

The Company records a valuation allowance to reduce its deferred tax
assets to the amount that is more likely than not to be realized. While the
Company has considered future taxable income and ongoing prudent and feasible
tax planning strategies in assessing the need for the valuation allowance, in
the event the Company were to determine that it would be able to realize its
deferred tax assets in the future in excess of its net recorded amount, an
adjustment to the deferred tax asset would increase income in the period such
determination was made. Likewise, should the Company determine that it would not
be able to realize all or part of its net deferred tax asset in the future, an
adjustment to the deferred tax asset would be charged to income in the period
such determination was made.

As discussed in Note 1 to the condensed consolidated financial
statements, on May 1, 2002, the Company completed a tax-free reorganization
whereby it merged Verizon Wireless into PRTC. As a result of this merger, the
Company released a deferred tax valuation allowance related to the Acquisition
of approximately $93 million, approximately $51 million of which was recorded
against goodwill and approximately $42 million of which was recorded as a
deferred tax benefit in the Company's consolidated statement of income during
the second quarter of 2002 in accordance with SFAS No. 109. Management believes
that sufficient book and tax income will be generated by the merged company to
realize the benefits of these tax assets.

PROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION

Property, plant and equipment is stated at original cost, including
interest on funds borrowed to finance the acquisition of capital additions.
Repairs and maintenance are expensed as incurred. Depreciable property disposed
of in the ordinary course of business, less any salvage value, is charged to
accumulated depreciation with no gain or loss recognized. Gains or losses from
the sale of land are recorded in results of operations.

The Company's depreciation expense is 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 over the remaining asset lives. This method also requires a periodic
evaluation of the average remaining useful lives related to the expected
recoverability of the carrying value of assets based on changes in technology,
environmental factors, the federal and local regulatory environment, and other
competitive forces. Effective July 1, 2002, the Company revised its accounting
estimates relating to depreciation based on a detailed review of the lives
underlying the depreciation rates. The depreciation rate revisions reflect
expected useful lives resulting from the impact of technology and future
competition as well as more closely approximating the assumptions used by other
telephone companies. These revisions resulted in a decrease in depreciation
expense by approximately $9 million for the nine months ended September 30, 2002
and approximately $9 million for the nine months ended September 30, 2003. See
Note 5 to the condensed consolidated financial statements for further details.

30

RESULTS OF OPERATIONS

The Company has two reportable segments, Wireline and Wireless. See
Note 16 to the condensed consolidated financial statements for additional
information on the Company's segments. Reclassifications of prior years' data
have been made to conform to the 2003 presentation.

The Wireline segment consists of:

o Local services, including basic voice, telephone and
telecommunications equipment rentals, value-added services,
high-speed private line services, Internet access and public
phone service;

o Long distance services including direct dial on-island and
off-island, operator assisted calls, prepaid calling card and
high-speed private line services;

o Access services to long distance carriers, competitive local
exchange carriers, and cellular and paging operators to
originate and terminate calls on the Company's network;

o Directory publishing rights revenues; and

o Telecommunication equipment sales and billing and collection
services to competing long distance operators in Puerto Rico.

The Wireless segment consists of:

o Cellular services; and

o Wireless equipment sales.

31

REVENUES

EXPENSES AND CHARGES

OPERATING DATA

32

QUARTER ENDED SEPTEMBER 30, 2003 COMPARED WITH QUARTER ENDED SEPTEMBER 30, 2002

REVENUES. Revenues for the quarter ended September 30, 2003 decreased $9
million, or 3%, to $309 million from $318 million for the same 2002 period.

WIRELINE:

Wireline revenues include revenues from local service, long distance,
network access, directory and other services. Wireline revenues for the quarter
ended September 30, 2003 decreased $14 million, or 6%, to $259 million from $273
million for the same 2002 period.

Local service revenues include revenues from basic voice, telephone and
telecommunications equipment rental, value-added services, high-speed private
line services, Internet access, and public phone service. Local service revenues
for the quarter ended September 30, 2003 decreased $3 million, or 2%, to $142
million from $145 million for the same 2002 period. The decrease is due to
decreased revenues from local voice services. The decrease in revenues from
local voice services was driven by a decrease in revenues from measured services
of $3 million.

Long distance revenues include direct dial on-island and off-island,
operator-assisted calls, prepaid calling cards and on-island private line
revenues. Long distance revenues decreased $1 million, or 3%, to $36 million for
the quarter from $37 million for the same 2002 period. The decrease was due to a
decrease in intra-island long distance revenues of $1 million. Intra-island long
distance revenues have decreased mainly due to customer traffic migration to the
cellular network and general economic conditions.

Network access revenues include revenues from services provided to long
distance carriers, competitive local exchange carriers, and cellular and paging
operators to originate and terminate calls on the Company's network. These
revenues for the quarter decreased $16 million, or 20%, to $64 million compared
to $80 million for the same 2002 period. The decrease was driven by lower
intra-island access revenues of $4 million, a decrease in off-island switching
revenues of $7 million and lower carrier common line access revenues of $6
million that were partially offset by higher subscriber line charges of $1
million resulting from a rate increase in July 2002.

Directory and other revenues include revenues from directory publishing
rights, telecommunications equipment rental and billing and collection services
to competitor long distance operators. Directory and other revenues for the
quarter ended September 30, 2003 increased $6 million, or 55%, to $17 million,
from $11 million for the quarter ended September 30, 2002. The increase was due
to an increase in revenues from directory publishing rights of $5 million
resulting from the change in the Company's method of accounting for revenues
from directory publishing rights from the point-of-publication method to the
amortization method and an increase of $1 million in wireline equipment sales.

WIRELESS:

Revenues from cellular and paging services and related equipment sales
for the quarter ended September 30, 2003 increased $5 million, or 12%, to $50
million from $45 million for the comparable 2002 period. Cellular service
revenues for the quarter ended September 30, 2003 increased $3 million, or 7%,
to $46 million from $43 million for the same 2002 period. The increase was
primarily the result of an increase of 15,000 cellular customers compared to the
quarter ended September 30, 2002 due to attractive price plans and the
implementation of a marketing strategy to align the Company's product and
service offerings with those of Verizon Wireless in the U.S.

Paging revenues declined $1 million for the quarter ended September 30,
2003. The decrease was related to a complete reduction of paging customers. The
Company entered into an agreement to sell its paging division and received
approval from the FCC of the negotiated agreement in July 2003. The Company
closed the paging operations on August 2003.

Wireless equipment sales increased $3 million to $4 million for the
quarter ended September 30, 2003 from $1 million for the comparable 2002 period.
This increase is a result of the increase in customers who subscribed for
wireless services in 2003.

33

OPERATING COSTS AND EXPENSES. Operating costs and expenses for the
quarter ended September 30, 2003 increased $81 million, or 42%, to $276 million
from $195 million reported for the same period in 2002.

WIRELINE:

Wireline expenses for the quarter ended September 30, 2003 increased
$76 million, or 47%, to $239 million from the $163 million reported for the same
period in 2002.

Labor and benefit expenses for the quarter ended September 30, 2003
increased $10 million, or 12%, to $93 million from $83 million reported for the
same period in 2002, due to increases in pension and other post-employment
benefits ("OPEBs") expense recognition of $7 million, which resulted from a
decrease in the rate of return on plan assets in addition to a decrease in the
discount rate, which reflects a softening economy. There was also an increase in
contractors expense of $3 million.

Other operating expenses of $146 million for the quarter ended
September 30, 2003, increased $66 million, or 83%, compared to the same 2002
period. The increase is due to the pre-tax reserve of $66 million (including
interest) established in September 2003 for the end-user and AT&T refund
referred to in the TRB Resolution and Order of February 2002. See "Regulatory
and Other Matters - Intra-Island Long Distance Access Rate Dispute" for more
information regarding the TRB Resolution and Order of February 28, 2002.

WIRELESS:

Wireless expenses for the quarter ended September 30, 2003 increased $5
million, or 16%, to $37 million from the $32 million reported for the same
period in 2002.

Labor and benefit expenses remained constant at $8 million for the
quarters ended September 30, 2003 and 2002.

Other operating expenses for the quarter ended September 30, 2003
increased $5 million, or 21%, to $29 million from the $24 million reported for
the comparable 2002 period. The increase was due to a higher subsidy on
equipment sales of $4 million and higher network management fees of $1 million.

DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization of
$64 million remained constant for the quarters ended September 30, 2003 and
2002.

INTEREST EXPENSE. Interest expense of $19 million for the quarter ended
September 30, 2003 was $8 million higher than for the comparable 2002 period,
mainly due to the additional $7 million in interest from the pre-tax reserve of
$66 million established in September 2003 as a result of the TRB Resolution and
Order of February 2002.

EQUITY INCOME FROM JOINT VENTURE. Equity income from joint venture
remained constant for the quarters ended September 30, 2003 and 2002. The equity
income was generated from the Company's approximate 24% interest in VISI, the
largest yellow page publishing company in Puerto Rico.

INCOME TAXES. A $19 million tax benefit for the quarter ended September
30, 2003 was recognized. The decrease of $36 million when compared to the $17
million provision reported for the quarter ended September 30, 2002 was
primarily due to the pre-tax reserve of $73 million (including interest)
established for the end-user and AT&T refund referred to in the TRB Resolution
and Order of February 2002.

34

NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 2002

REVENUES. Revenues for the nine months ended September 30, 2003 decreased
$11 million, or 2%, to $961 million from $972 million for the same 2002 period.

WIRELINE:

Wireline revenues include revenues from local service, long distance,
network access, directory and other services. Wireline revenues for the nine
months ended September 30, 2003 decreased $25 million, or 3%, to $810 million
from $835 million for the same 2002 period.

Local service revenues include revenues from basic voice, telephone and
telecommunications equipment rental, value-added services, high-speed private
line services, Internet access, and public phone service. Local service revenues
for the nine months ended September 30, 2003 increased $3 million to $435
million from $432 million for the same 2002 period. The increase is due to
increased local data services offset by decreased local voice services. The
increase in local data services was mainly driven by an increase in Internet
access revenues of $4 million and an increase in revenues from high- speed
private line services of $1 million. The decrease in revenues from local voice
services was mainly driven by a decrease in revenues from measured services of
$4 million and telephone rent of $2 million, offset by an increase in deferred
activation and installation revenues of $4 million.

Long distance revenues include direct dial on-island and off-island,
operator-assisted calls, prepaid calling cards and on-island private line
revenues. Long distance revenues decreased $10 million, or 9%, to $102 million
for the nine months ended September 30, 2003 from $112 million for the same 2002
period. The decrease was due to a decrease in intra-island long distance
revenues of $8 million and a decrease in on-island private line revenues of $4
million, partially offset by an increase of $2 million in off-island long
distance revenues. Intra-island long distance revenues have decreased mainly due
to customer traffic migration to the cellular network and general economic
conditions.

Network access revenues include revenues from services provided to long
distance carriers, competitive local exchange carriers, and cellular and paging
operators to originate and terminate calls on the Company's network. These
revenues for the nine months ended September 30, 2003 decreased $21 million, or
9%, to $223 million compared to $244 million for the same 2002 period. The
decrease was driven by lower intra-island access revenues of $11 million coupled
with lower carrier common line access revenues of $7 million and lower
off-island switching revenues of $6 million that were partially offset by higher
subscriber line charges of $5 million (which resulted from a rate increase in
July 2002).

Directory and other revenues include revenues from directory publishing
rights, telecommunications equipment rental and billing and collection services
to competitor long distance operators. Directory and other revenues for the nine
months ended September 30, 2003 increased $3 million, or 7%, to $50 million,
from $47 million for the nine moths ended September 30, 2002. The increase was
due to an increase in revenues from directory publishing rights of $3 million
resulting from the change in the Company's method of accounting for revenues
from directory publishing rights from the point-of-publication method to the
amortization method.

WIRELESS:

Revenues from cellular and paging services and related equipment sales
for the nine months ended September 30, 2003 increased $14 million, or 11%, to
$151 million from $137 million for the comparable 2002 period. Cellular service
revenues for the nine months ended September 30, 2003 increased $13 million, or
11%, to $141 million from $128 million for the same 2002 period. The increase
was primarily the result of an increase of 15,000 cellular customers compared to
the nine months ended September 30, 2002 due to attractive price plans and the
implementation of a marketing strategy to align the Company's product and
service offerings with those of Verizon Wireless in the U.S.

Paging revenues declined $3 million for the nine months ended September
30, 2003. The decrease was related to a complete reduction of paging customers.
The Company entered into an agreement to sell its paging division and received
approval from the FCC of the negotiated agreement in July 2003. The Company
closed the paging operations on August 2003.

Wireless equipment sales increased $4 million, or 80%, to $9 million
for the nine months ended September 30, 2003 from $5 million for the comparable
2002 period. This increase is a result of the increase in customers who
subscribed for wireless services in 2003.

35

OPERATING COSTS AND EXPENSES. Operating costs and expenses for the nine
moths ended September 30, 2003 increased $117 million, or 20%, to $711 million
from $594 million reported for the same period in 2002.

WIRELINE:

Wireline expenses for the nine months ended September 30, 2003
increased $104 million, or 21%, to $600 million from the $496 million reported
for the same period in 2002.

Labor and benefit expenses for the nine months ended September 30, 2003
increased $24 million, or 10%, to $280 million from $256 million reported for
the same period in 2002, due to increases in OPEBs expense recognition of $27
million, which resulted from a decrease in the rate of return on plan assets in
addition to a decrease in the discount rate, which reflects a softening economy.
These increases were partially offset by a decrease in contractor and
temporaries expense of $2 million and overtime expenses of $1 million as part of
cost-constraint measures taken.

Other operating expenses of $320 million for the nine months ended
September 30, 2003, increased $80 million, or 34%, compared to the same 2002
period. The increase is due to cancelled capital projects of $29 million, which
is mainly due to the write-off for the billing software system abandoned by the
Company (an additional $3 million write-off is included as interest) and the
pre-tax reserve of $66 million (an additional $7 million is included as
interest) established in September 2003 for the end-user and AT&T refund
referred to in the TRB Resolution and Order of February 2002. This increase was
partially offset by a decrease in interconnection charges of $14 million that
resulted from an interconnection settlement agreement and a decrease in rates.

WIRELESS:

Wireless expenses for the nine months ended September 30, 2003
increased $13 million, or 14%, to $111 million from the $98 million reported for
the same period in 2002.

Labor and benefit expenses remained constant at $24 million for the
nine months ended September 30, 2003 and 2002.

Other operating expenses for the nine months ended September 30, 2003
increased $13 million, or 18%, to $87 million from the $74 million reported for
the comparable 2002 period. The increase was due to a higher subsidy on
equipment sales of $7 million, the absence of a gain on the sale of land of $3
million recognized during the nine months ended September 30, 2002, higher
commission and rent expenses of $2 million and $1 million, respectively.

VOLUNTARY SEPARATION AND RETIREMENT PROVISIONS. In January 2003, an
additional 29 qualified management employees accepted the voluntary separation
program offered by the Company in December 2002, which resulted in a provision
of $1.4 million. During the second quarter of 2003, 191 union employees accepted
a combined voluntary separation program and retirement program offered by the
Company that closed on June 20, 2003 and June 30, 2003, respectively, which
resulted in an additional provision of $3.3 million.

DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization
expense of $187 million for the nine months ended September 30, 2003 was $10
million lower than for the comparable 2002 period. The decrease in depreciation
and amortization expense is mainly due to a revision in wireline depreciation
rates, which became effective July 1, 2002, reducing depreciation expense by $9
million for the nine months ended September 30, 2003, and the adoption of SFAS
No. 143, effective January 1, 2003, which required the exclusion of the costs of
removal from the Company's depreciation rates for assets for which the removal
costs exceed salvage value. The decrease was partially offset by higher gross
plant balances.

INTEREST EXPENSE. Interest expense of $43 million for the nine months
ended September 30, 2003 was $7 million higher than for the same 2002 period,
due to the additional $7 million in interest of the pre-tax reserve of $66
million established in September 2003 as a result of the TRB Resolution and
Order of February 2002.

EQUITY INCOME FROM JOINT VENTURE. Equity income from joint venture
remained constant at $2 million for the nine months ended September 30, 2003 and
2002. This equity income was generated from the Company's approximate 24%
interest in VISI, the largest yellow page publishing company in Puerto Rico.

36

MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY. A $1 million minority
interest included in the Company's results of operations for the nine months
ended September 30, 2003 represents Popular, Inc.'s 33% minority interest in
Coqui.net.

INCOME TAXES. A $5 million tax provision for the nine months ended
September 30, 2003 reflects a 30% effective tax rate. The difference between the
effective and the statutory tax rate of 39% equates to $5 million, primarily
reflecting permanent differences related to interest accretion on the PRTA
subscription receivable and equity income in subsidiary. The decrease of $5
million when compared to the $10 million provision reported for the nine months
ended September 30, 2002 was due to lower earnings in 2003 and the recognition
of a $42 million deferred tax benefit that resulted from the merger of Verizon
Wireless into PRTC on May 1, 2002. (see Note 1)

CUMULATIVE EFFECT OF ACCOUNTING CHANGE. Under the provisions of SFAS
No. 143, the Company is required to exclude costs of removal from the Company's
depreciation rates for assets for which the removal costs exceed salvage.
Accordingly, in connection with the initial adoption of this standard on January
1, 2003, the Company has reversed accrued costs of removal in excess of salvage
value from the Company's accumulated depreciation accounts for these assets. The
adjustment was recorded as a cumulative effect of an accounting change,
resulting in the recognition of a non-cash gain of $117 million ($71 million
after tax). Effective January 1, 2003, the Company began expensing costs of
removal in excess of salvage value for these assets as incurred.

Effective January 1, 2003, the Company changed its method of accounting
for revenues from directory publishing rights and related expenses from the
point-of-publication method to the amortization method. Although both methods
fully comply with accounting principles generally accepted in the United States,
the change was made because the amortization method is becoming the industry
standard. The cumulative effect of applying this accounting change to prior
years is recognized as of January 1, 2003 as a one-time, non-cash loss of $17
million ($13 million, after tax).

37

LIQUIDITY AND CAPITAL RESOURCES

CONSOLIDATED FINANCIAL CONDITION

NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 2002

OVERALL LIQUIDITY ASSESSMENT

The Company believes that cash from operations is sufficient to meet
working capital needs. Current assets exceeded current liabilities at September
30, 2003 by $133 million. We believe our sources of funds, from operations and
from readily available external financing arrangements, are sufficient to meet
ongoing operating, financing and investing requirements. We expect that
presently foreseeable capital requirements will continue to be financed through
internally generated funds.

We have an undrawn $400 million bank note facility maturing in March
2004, as well as a $40 million working capital credit facility maturing in June
2004. The bank note facility is a syndicated five-year revolving credit
facility. At September 30, 2003, the Company had no outstanding balance under
the working capital credit facility. An aggregate principal amount of $300
million of the Company's senior notes matured on May 15, 2002. During the year
ended December 31, 2002, we refinanced these notes and the related interest
payment through the issuance of new term loans in an aggregate principal amount
of $225 million.

OPERATIONS

Cash from operations continued to be our primary source of funds. The
$14 million increase in cash from operations for the nine months ended September
30, 2003 as compared to the same period in 2002 was primarily due to lower
voluntary separation payments of $10 million, lower management fee and royalties
disbursements of $7 million, partially offset by higher operating income tax and
property tax payments of $5 million.

A total provision of $16.4 million has been recorded related to early
retirement and voluntary separation programs for the nine months ended September
30, 2001 involving 113 employees. During the fourth quarter of 2002, the Company
offered a voluntary separation program to qualified management employees. Eight
qualified management employees accepted the program, and the Company recorded a
$0.5 million non-cash provision.

In January 2003, an additional 29 qualified management employees
accepted the voluntary separation program representing an additional expense of
$1.4 million recorded in the first quarter of 2003. During the second quarter of
2003, 191 union employees accepted a combined voluntary separation program and
retirement program offered by the Company that closed on June 20, 2003 and June
30, 2003, respectively, which resulted in an additional provision of $3.3
million.

INVESTING

Net cash used in investing activities for the nine months ended
September 30, 2003 was $104 million compared to $134 million for the same period
in 2002. The $30 million decrease in cash used in investing activities is mainly
due to a decrease in capital expenditures and costs of removal. Effective
January 1, 2003, under SFAS No. 143, costs of removal are expensed when
incurred.

The capital expenditure program for 2002 amounted to $205 million,
which was financed from internally generated funds. The decrease in capital
expenditures during 2003 is partially due to decreased spending on specific
software projects, as well as a general decrease in spending as the Company
aligned its capital spending with softening demand for new wireline service.

38

We have invested approximately $1.01 billion from the date of the
Acquisition through September 30, 2003 to expand and enhance our networks. In
2003, we expect to make up to approximately $185 million in capital
expenditures.

FINANCING

Debt outstanding, excluding capital leases, decreased $142 million for
the nine months ended September 30, 2003 and increased $186 million for the nine
months ended September 30, 2002. Borrowings under bank loans, working capital
facilities and the commercial paper program decreased from $323 million at
December 31, 2002 to $181 million at September 30, 2003 and increased from $194
million at December 31, 2001 to $380 million at September 30, 2002.

During 2002, the Company refinanced $300 million of senior notes, which
matured on May 15, 2002, with new term credit agreements with four banks. The
aggregate principal amount of the term loans is $225 million, with maturities
ranging from two to three years, bearing interest at 60 to 100 basis points over
LIBOR. During the third quarter of 2003, we issued advances to principal of term
loans by $44 million reducing the term loans balance to $181 million at
September 30, 2003.

In the Acquisition, PRTA agreed to contribute cash or stock worth a
total of $200 million as a capital contribution in five equal $40 million
installments over five years beginning on March 2, 2000 to partially fund its
underfunded pension and other post-employment benefit obligations. In March
2003, $40 million was received in cash from PRTA for the fourth installment. See
Note 14 to the condensed consolidated financial statements.

The shareholders' agreement requires the payment of dividends equal to
at least 50% of net income, payable quarterly to the extent funds are legally
available. For the nine months ended September 30, 2002, the Company paid
dividends of $53 million corresponding to the first and second quarter of 2002
and the fourth quarter of 2001. For the nine months ended September 30, 2003,
the Company paid dividends amounting to $68 million corresponding to the first
quarter of 2003 and the fourth quarter of 2002. The senior note indentures and
credit facility agreements do not contain restrictions on the payment of
dividends.

CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS

(1) Pension obligations represent contributions based on ERISA minimum
rules.

39

REGULATORY AND OTHER MATTERS

REGULATORY AND COMPETITIVE TRENDS

Regulatory activity at the federal and local levels was primarily
directed at meeting challenges in maintaining existing access rates and
retaining subsidies to support the costs of Universal Service and other
services. We are also addressing local number portability requirements.

We continued to meet the wholesale requirements of new competitors and
have signed agreements with wireless and wireline carriers. These agreements
permit them to purchase unbundled network elements, to resell retail services,
and to interconnect their networks with ours.

INTRA-ISLAND LONG DISTANCE ACCESS RATE DISPUTE

On February 28, 2002, the TRB issued a Resolution and Order (the
"February 2002 Order") with respect to the reconsideration requested by the
Company of the TRB's October 10, 2001 order to reduce the access rates the
Company charges to long distance carriers to originate and terminate
intra-island long distance calls through the Company's network.

The February 2002 Order requires new rates for intra-island access to
be implemented through phased-rate reductions over four years. The prospective
access rate reductions (on a two-way basis) were ordered to take place on April
1st of each year as follows:

April 2002: From 9.3 cents per minute to 7.9 cents per minute
April 2003: From 7.9 cents per minute to 6.5 cents per minute
April 2004: From 6.5 cents per minute to 5.0 cents per minute
April 2005: From 5.0 cents per minute to 2.1 cents per minute

The February 2002 Order also requires PRTC to pay a $68 million refund
to end-user customers. The TRB calculated this amount based on the difference
between the 9.3 cents and 7.9 cents rate for TRB-estimated traffic from the
period beginning on April 1, 2000 through March 31, 2002. The refund can be made
in 12 equal quarterly installments beginning on April 1, 2002. The Company filed
with the Puerto Rico Circuit Court of Appeals (the "Court") an appeal of the
February 2002 Order in which the Company alleges that the TRB made errors of law
and procedure in its determination of access charges and its order requiring the
Company to make the cash refund. On March 27, 2002, the Court stayed the refund
and the rate reduction until the hearing of the appeal.

On April 2, 2002, AT&T, Sprint and LTD (the "Carriers") filed a
petition with the Court for review of the February 2002 Order, requesting the
Court to order the rate reduction without a phase-in period, remand the case
back to the TRB, direct the TRB to calculate the refund from the period
beginning on April 1997 instead of April 2000, and require that the refund be
paid to the Carriers instead of end-user customers.

The hearing involving oral presentations by the parties was held on
February 19, 2003. On April 22, 2003, the parties filed their corresponding
post-hearing final briefs therefore finally submitting the case for
adjudication. On August 19, 2003, the Court issued its final decision on the
proceeding confirming the TRB Order on Reconsideration of February 28, 2002 in
all respects and rejecting the claims of PRTC and the Carriers. On September 4,
2003, PRT requested reconsideration of the Court's determination on the grounds
that although the Court correctly described the applicable legal standards the
Court erred in applying those standards to the facts of the case. On October 2,
2003, the Court denied PRTC's reconsideration. As a result of the Court's
decision, the Company established a pre-tax reserve of $73 million, including
interest, in September 2003 for the end-user and AT&T refund referred to in the
February 2002 Order. This reserve is in addition to the reserve established in
connection with the stay of the TRB Order on Reconsideration issued by the
Court.

On October 30, 2003, the Company filed a petition for a writ for
certiorari before PR Supreme Court challenging the $68 million refund portion of
the Order. The phased down portion of the Order was settled with the major
carriers. The Company believes that the Carriers' petition for review is without
merit.

In November 2003, the Company proposed, and two members of the TRB
indicated their support for, a plan to revise the Board's end-user refund order
and end the dispute over this issue. Under the terms of this plan, instead of
making the refunds as ordered by the TRB, PRTC will eliminate the touchtone
charge, implement expanded local calling areas and provide certain credits to
the residential basic rent. The estimated 2003 cash flow impact is a reduction
of $15 million.

40

CARRIER ACCESS BILLING

During the first and second quarter of 2003, some carriers established
a series of billing claims with the company regarding tariff interpretation,
traffic routing at the network level and misclassification of access traffic for
determination of applicable access elements.

The company entered into negotiations with the major carriers and
settled the billing claims and phased-rate reductions required by the February
2002 Order. Management deems there are no other material impacts to the
company's financial results.

PUBLIC TELEPHONE SERVICE PROVIDER - ANTI COMPETITIVE ACTIONS

On November 8, 2001, Telefonos Publicos de Puerto Rico, Inc. ("TPPR"),
the largest competitive provider of public pay phones in Puerto Rico filed a
suit in the United States District Court of Puerto Rico, claiming predatory,
exclusionary and anticompetitive acts and seeking $75 million in damages. We
filed a motion to dismiss the case and are awaiting a decision from the court.

Pan American Telephone, Inc., Intouch Telecommunications, Inc., and
Choicetel Communications, Inc., three additional competitive providers also
filed a similar suit in the United States District Court of Puerto Rico on
September 4, 2002 on the same grounds. On November 8, 2002, after having
evaluated and determined that this suit is similar to TPPR's suit, we filed a
motion to dismiss the case. We are currently awaiting a decision from the court.

On August 16, 2002, PSA, the parent company for Phoenix of Puerto Rico
filed a suit in the United States bankruptcy court in the District of Delaware,
claiming anti competitive acts. The claims have since been transferred to the
United States District Court of Delaware and the disputes between the two
parties include PRTC's amended administrative claim against PSA, and PSA's
complaint for over $9 million against PRTC. PRTC has filed a motion to dismiss
and change of venue which is pending before the United States District Court of
Delaware.

The Company's management believes all of these claims are without
merit.

P.R. DEPARTMENT OF EDUCATION (THE "PRDOE") DEBT

On June 30, 2003, PRTC filed a complaint against the PRDOE with the
Superior Court, seeking collection of monies for $31 million due for services
rendered under the Reeducate Program, which is based on the Federal E-Rate
Program, from 1999 to June 30, 2003. The Reeducate Program funds Internet
connections for schools throughout Puerto Rico and PRTC has provided services
under contract to the PRDOE. The outstanding amount that PRDOE currently owes to
PRTC is $34 million. PRTC intends to amend the complaint to reflect the proper
amount owed. From the amount claimed, 89% would be paid by the Federal
Communications Commission's School & Libraries Division ("SLD"), who
administered the Federal E-Rate Program, if the funding for the fourth and fifth
years under the program is released.

PRTC is currently evaluating the outstanding amounts owed by PRDOE for
the third year under the program, which is approximately $1.2 million, after SLD
paid its corresponding percentage (87%) under the program.

CTI ASSET TRANSFER

Prior to the Acquisition, PRTC transferred its net wireless assets on
September 1, 1998 to CTI (which became Verizon Wireless, a division of PRTC, on
May 1, 2002). Our predecessors later filed a waiver request in 1998 with the FCC
to record this transfer at book value instead of fair value. Since our
predecessors had not included the costs of wireless operations in the regulated
rate setting process, we believe that ratepayers did not bear the cost of our
predecessor's wireless investment.

The FCC denied the Company's petition in April 2001, but recognized
that while there were questions concerning certain costs and expenses, the
cellular and paging assets had been removed from the interstate rate base.

41

The TRB stated in its February 2002 Order that for any prospective rate
increase that the Company may pursue to compensate for revenue deficiencies it
must first be applied against the gain in the wireless asset transfer, equating
to $56 million applicable to intrastate. We will contest this position based on
the fact that the wireless entity was set up after the last regulated intrastate
rate increase in 1982 and therefore these costs were not included in setting
such rates.

Neither the FCC nor the TRB has commenced any further proceedings to
address this issue. While we believe that the resolution of this matter and any
related proceedings will not have a material effect on the Company's financial
condition and results of operations, we cannot provide assurance that any
further regulatory actions will be favorable to the Company.

PRICE CAP REGULATION

The FCC requires that companies that set interstate access rates based
on a price cap formula must use the price cap formula for all of their
affiliates. The price cap formula is based on a plan called Coalition of
Affordable Local and Long Distance Service that used rate-of-return as a basis
for setting rates. The Company was originally required to implement price caps
by March 2, 2000.

However, the FCC delayed conversion to price cap regulation until June
30, 2002, and the Company has requested a further extension until June 30, 2003.
Under an order released by the FCC on April 18, 2002, the Company is no longer
required to file a waiver request until the FCC completes its review of the
"all-or-nothing" rule.

INTERSTATE HIGH COST SUBSIDY

On October 21, 1999, the FCC adopted a new high cost support mechanism,
which has resulted in the phase out of the Company's high cost subsidy revenues.
These revenues were $49 million in 2000, $33 million in 2001 and $4 million for
2002. On February 28, 2003, PRTC sent a letter to the FCC, requesting the FCC to
take action to restore the high-cost universal service support that the Company
lost due to FCC policies adopted for non-rural companies based on the cost
characteristics of mainland companies. PRTC requested that the FCC address the
loss of its universal service support by adopting rules for insular areas that
are similar to those applied to rural carriers. In an order dated October 16,
2003 and released October 27, 2003, the FCC rejected PRTC's request for
reconsideration of its non-rural high cost support mechanism, but did not deal
with its February 28, 2003 request.

MESSAGE PROCESSING AND BILLING SYSTEM

The Company has an agreement with a provider for the implementation of
a traffic polling and billing software system for its wireline operations. While
the traffic polling portion has been implemented, management has determined that
it is in the Company's best interests to abandon the billing portion of the
software system. The amount of capitalized costs for software and labor related
to the billing portion of $32.3 million was written off and included in
operating expenses during the second quarter of 2003. Management is currently in
discussions with the provider of the system and seeking a satisfactory
resolution of this matter.

BROTHERHOOD OF INDEPENDENT TELEPHONE WORKERS ("HIETEL") UNION CONTRACT

In October 2003, one of our union contracts, a collective bargaining
agreement with the HIETEL expired. The Company is currently in negotiations for
a new agreement with the HIETEL.

RECENT ACCOUNTING PRONOUNCEMENTS

See Note 4 to the condensed consolidated financial statements contained in Part
1, Item 1 of this report for disclosure on recent accounting pronouncements.

42

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

INTEREST RATE SENSITIVITY

We are exposed to market risk in the normal course of business,
resulting primarily from interest rate changes on our senior notes and interest
rate swap agreements.

The following table summarizes the fair value of our senior notes and
interest rate swaps at September 30, 2003 and December 31, 2002 and provides a
sensitivity analysis of the fair values of these instruments assuming a 100
basis point increase or decrease in the yield curve. The sensitivity analysis
does not include the fair values of our floating-rate debt since it is not
significantly affected by changes in market interest rates.

43

ITEM 4. CONTROLS AND PROCEDURES

The Company maintains disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as
amended) that are designed to ensure that information required to be disclosed
in the Company's reports is recorded, processed, summarized and reported, within
the time periods specified in the SEC's rules and forms. In designing and
evaluating the Company's disclosure controls and procedures, the Company's chief
executive officer and chief financial officer recognized that any controls and
procedures, no matter how well-designed and operated, can provide only
reasonable assurance of achieving the desired control objectives. The Company's
chief executive officer and chief financial officer have evaluated the
effectiveness of the Company's disclosure controls and procedures, as of the end
of the period covered by this report (the "Evaluation Date"). They have
concluded that as of the Evaluation Date, the Company's disclosure controls and
procedures were effective at the reasonable assurance level.

There has been no change in the Company's internal control over
financial reporting during the Company's most recent fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.

44

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company is a defendant in various legal matters arising in the
ordinary course of business. Management, after consultation with legal counsel,
believes that the resolution of these matters will not have a material adverse
effect on the Company's financial position and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Regulatory and Other Matters" for more information regarding legal
and regulatory matters, including a regulatory dispute regarding intra-island
access fees charged to long distance carriers.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

a) See Exhibits Index on page following signatures.

b) No reports on Form 8-K were filed during the quarter for which
this report is filed.

45

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.

TELECOMUNICACIONES DE PUERTO RICO, INC.

By: /s/ JON E. SLATER
-------------------------------------
Name: Jon E. Slater
Title: Chief Executive Officer
Date: November 14, 2003

By: /s/ WALTER C. FORWOOD
--------------------------------------
Name: Walter C. Forwood
Title: Chief Financial Officer
Date: November 14, 2003

By: /s/ ADAIL ORTIZ
-----------------------------------------
Name: Adail Ortiz
Title: Chief Accounting Officer
Date: November 14, 2003

46

EXHIBIT INDEX