UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

For the fiscal year ended: December 31, 2003

or

For the transition period from         to         

Commission File Number 333-85503

Telecomunicaciones de Puerto Rico, Inc.

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

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

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

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 [  ]

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

Indicate by check mark whether the registrant is an accelerated filer.

YES [  ] NO [X]

At June 30, 2003, the aggregate market value of the common stock held by non-affiliates of the registrant was approximately $47 million. This amount represents the value of the vested shares under the Employee Stock Ownership Plan (“ESOP”) at a stated price of $51.81. The stated price was established under a share option agreement, dated as of March 2, 1999, which was entered into as part of the acquisition by GTE Corporation of a 40% interest in the registrant. For a description of the acquisition and share ownership of the registrant, see Part I, Item 1, “Business” and Part III, Item 12, “Security Ownership of Certain Beneficial Owners and Management.”

At March 30, 2004, 25 million shares of no par common stock of the registrant were outstanding.

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INDEX

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ITEM 1. BUSINESS

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

     In this Annual Report on 10-K, 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 such words as “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 our accounting policies that may be required by regulatory agencies, including the Securities and Exchange Commission (“SEC”) or that result from changes in the accounting policies 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.

OVERVIEW

     We are the largest telecommunications service provider in Puerto Rico and the seventh largest local exchange carrier in the United States as measured by access lines in service. Wireline service, which has been provided since 1914, is marketed under the PRT brand. At December 31, 2003, we had approximately 1.2 million access lines in service, including 940,000 residential and 290,000 business lines. Since November 2001, we have been marketing our cellular service under the Verizon Wireless brand as part of a strategy to align our product and service offerings with those of Verizon Wireless in the U.S.

     We have invested approximately $1.1 billion from the date of the Acquisition (as defined below) through December 31, 2003 to expand and enhance our network. In 2004, we expect to invest an additional $160 million in capital expenditures. Our digital switching wireline network encompasses over 83,000 fiber miles with speeds of up to OC-192 and supplies direct fiber optic connections to more office buildings than any other service provider on the island. Our cellular network utilizes the code division multiple access (“CDMA”) standard and the time division multiple access (“TDMA”) standard. During 2003, the Company decided to switch all TDMA clients to the CDMA network. We have invested approximately $81 million since 2001 in a new network overlay using the CDMA standard. We commenced selling CDMA service in December 2001.

STRATEGY

     We expect to maintain our wireline market leadership position by improving customer service, providing value, and meeting increasing customer bandwidth requirements. We are focused on reducing service and repair provisioning, repair intervals and improving the responsiveness of our customer care personnel. Customer value will be delivered through bundled plans, including offerings of long distance, Internet, Digital Subscriber Line (“DSL”), wireless access, and value-added local services, such as caller ID, call forwarding and call waiting. Our network deployment plans are designed to meet business and government expectations for dedicated high-speed bandwidth access, as well as residential consumer demand for DSL service to enhance Internet access speed.

     Our wireless strategy seeks to retain our significant base of postpaid cellular customers as well as targeting our competitors high-value customers focus on the reliability of our network and the coverage of our network together with innovative products and pricing offerings.

BUSINESS OVERVIEW AND CORPORATE RESTRUCTURING

     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 holds a 67% interest in Coqui.net Corporation (“Coqui.net”), in which Popular, Inc., one of our shareholders, holds the

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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. PRTC is the incumbent local exchange carrier for the island of Puerto Rico. Wireline service is provided by PRTC and wireless services are provided by Verizon Wireless, a division of PRTC. The Company’s off-island long distance service is provided by PRTLD and its dial-up Internet access service is provided by Coqui.net. 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. acquired the additional ownership interest from PRTA Holdings Corp., a subsidiary of the 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 a share option agreement entered into at the time of the Acquisition. As a result, Verizon owns 52%, Popular owns 13%, PRTA owns 28% and the Employee Stock Ownership Plan (“ESOP”) 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 Puerto Rico, Inc. (“Verizon Wireless”) 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 of 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.

BUSINESS SEGMENTS

     We have two reportable segments: Wireline and Wireless. For additional information on our reportable segments, see Note 18 to our consolidated financial statements included under Part II, Item 8, “Financial Statements and Supplementary Data.”

     The Wireline segment consists of:

•

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

•

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

•

Access services to long distance carriers, competitive local exchange carriers, and cellular and paging operators to originate and terminate calls on our network;

•

Directory publishing rights revenues; and

•

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

     The Wireless segment consists of:

•

Cellular service; and

•

Wireless equipment sales.

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REVENUES

     Reclassifications of prior years’ data have been made to conform to the 2003 presentation. For further information, refer to Note 2 to our consolidated financial statements included under Part II, Item 8, Financial Statements and Supplementary Data.”

WIRELINE

LOCAL SERVICES

     OVERVIEW

     Local services include basic voice services, value-added services, special services, Internet and data access, and deferred activation and installation services. The following table reflects the breakdown of residential and business access lines in service, excluding public phones, direct inward dialed business lines, wide area telecommunications services lines, private branch exchange trunks, and cellular and paging customers:

ACCESS LINES IN SERVICE

     BASIC VOICE SERVICE

     Basic voice service is the largest component of local service revenues, generating $356 million, or 28%, of total revenues for the year ended December 31, 2003. Basic voice is a regulated service and rate structures have not changed since 1982. Rates are categorized as either residential or business/government and are further divided into four zones based on town boundaries. Residential customers have a choice of selecting an unlimited local calling plan or a measured service plan at a fixed price of 13 cents per message unit within a local calling area. As of December 31, 2003 there were 68 local calling areas. Business customers must be on a measured service plan.

     As part of the Company’s value added services, the Company will reduce in 2004 from 68 to 10 larger local calling areas as part of a four phased reduction plan resulting from a study of the customers calling patterns and the commercial zones movement.

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     Business/government customers pay basic local rate ranging from $36.65 to $38.25 per month and $68.00 average revenue per user (“ARPU”) when measured service is included. The unlimited local service plan for residential customers varies significantly by zone. San Juan and Ponce residential customers, who are in zone 1, pay $18.80 per month while customers in the rural area, who are in zone 4, pay $8.45 per month. Residential basic ARPU approximates $22.00 excluding a Federal Communications Commission (“FCC”) imposed subscriber line charge of $6.50 per month to primary residential customers. For single-line business customers the subscriber line charge is also equal to $6.50, while $9.20 per month is charged to multi-line business customers. These subscriber line revenues are classified as access revenues. These rates also exclude other enhance services as directory assistance and white-page directory listings.

     TELEPHONE RENTAL

     Approximately 56% of single-line business customers and 31% of residential customers rent telephones. We generated $16 million in revenues from telephone rentals for the year ended December 31, 2003, representing a decrease of $3 million, or 16%, as compared to the same period in 2002 mainly due to customer tendency to purchase equipment. Rental levels are still high compared to those of U.S. mainland operators, as we own the inside wire on many of our customer’s premises and must maintain the inside wire and phone.

     VALUE - - ADDED SERVICES

     Value-added services include over 15 voice features, such as caller ID, call waiting, and voice mail. Charges for these features range from $1.50 to $6.25 per month. Some of these features are also sold in discounted bundled packages. Approximately 42% of our residential customers purchase at least one of these features. Our revenues from value-added services were $47 million for the year ended December 31, 2003, representing an increase of $2 million, or 5%, as compared to the same period in 2002.

     SPECIAL SERVICES

     Special services include private high-speed dedicated lines marketed to businesses for data transport. Our revenues from special services remained constant at $54 million for the year ended December 31, 2003, as compared to the same period in 2002.

     INTERNET ACCESS

     We market unlimited dial-up Internet access through Coqui.net, one of our subsidiaries, under two brands (PRT.net and Coqui.net) which averaged $16 per month for 2003. We generated $29 million of revenue in 2003 from 164,000 dial-up Internet access customers at December 31, 2003, an increase of $4 million and 29,000 customers over prior year, or 16% in revenues and 22% in customers, respectively.

     PUBLIC PHONES

     Public telephone revenues in 2003 were $9 million, an increase of $1 million, or 13%, from the prior year. This increase is mainly due to an FCC mandated dial around compensation refund of $2 million that we received from one of our carriers, partially offset by a decrease in revenues of $1 million due to 2,000 fewer phones as compared to prior year. The Company continues to focus on rationalizing margin locations and the impact of customers’ traffic migration to the cellular network. We hold less than 50% of the public phone market at December 31, 2003.

NETWORK ACCESS

     Network access services are provided to long distance carriers, resellers, other local exchange carriers, cellular and paging companies for the origination and termination of calls on our network. These entities pay access charges based on specific agreements, which some have durations of one to three years. We also collect network access fees directly from our customers from FCC-mandated line charges.

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     Network access revenues for the years ended December 2003, 2002 and 2001 were $295 million, $325 million and $355 million, respectively, and included the following amounts:

     Long-term and High Cost federal subsidies are received through pooling arrangements administered by the National Exchange Carriers Association (“NECA”). Subscriber line charge increased in 2003 due to an increase from $6.00 per month to $6.50 per month for primary residential and single line business customers, while multi-line business customers monthly charge remained constant at $9.20. This increase was offset by a decrease in off-island switched and common carrier line charges directly associated with the increase in subscriber line charges and in on-island switched charges. 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.

LONG DISTANCE

     Long distance revenues include direct dial on-island and off-island, operator-assisted calls, prepaid calling cards and on-island private line revenues. The following chart shows our minutes of use (MOU) in the on-island and off-island long distance market for the years ended December 31, 2003, 2002 and 2001, respectively:

     Long distance revenues of $138 million in 2003 reflected a decrease of $8 million as compared with 2002 due mainly to the introduction of value-added plans and lower traffic as customers calling migrated to other networks, primarily cellular.

DIRECTORY SERVICES

     We received $20 million in publishing revenue in 2003 under a revenue sharing arrangement with VNU World Directories, Inc. (“VNU”). VNU is the publisher of white and yellow page directories distributed in Puerto Rico and there is no other significant competitive product. We entered into a 95-year agreement in 1999 with Verizon Information Services, Inc. a joint venture among VNU, Verizon, and ourselves which provides us a publishing right of 35% of yellow page advertising revenues, plus billing and collection fees.

BILLING AND COLLECTION SERVICES

     We generated revenues of $11 million in 2003 from billing and collection services primarily from AT&T and TLD, the two largest competitive off-island long distance carriers. This is a decrease of $2 million from the prior year due to lower retail long distance traffic as customer traffic migrates to cellular technology. Both carriers represented approximately 89% of our total billing and connection fees for 2003. Our contract with TLD expired in October 2003, and we are currently negotiating a new contract with TLD. Our contract with AT&T expires in June 2004.

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WIRELESS

     The following table shows the breakdown of our cellular and paging customers:

CELLULAR AND PAGING CUSTOMERS

CELLULAR SERVICE

     Cellular demand has grown rapidly in recent years due to increased competition, attractive price plans, prepaid calling cards, and wide market acceptance. We offer digital cellular service under the Verizon Wireless brand in the B block 800-megahertz frequency using both TDMA and CDMA. We have invested $81 million since 2001 in a CDMA overlay network and commenced selling this service in December 2001.

     At December 31, 2003, there were six facility-based cellular operators providing service with varying coverage in Puerto Rico. Competition in the market has resulted in the emergence of a variety of plans with large bundles of free night and weekend minutes as well as free incoming calls.

     We have 19 stores and kiosks throughout the island, which generate approximately half of our postpaid and prepaid gross additions. The balance is sold through various dealers and agent outlets. Roaming agreements have been signed with AT&T, Verizon Wireless, and BellSouth to increase coverage for our customers on the U.S. mainland. We are also offering roaming in other countries, including the Dominican Republic, through Verizon Dominicana (formerly Codetel), a Verizon affiliate, and in the U.S. Virgin Islands.

     Postpaid customer growth of 5% is below prior year growth. We also experienced a decrease in prepaid customers of 8%. In late 2001, we began marketing our cellular service under the Verizon Wireless brand as part of a strategy to align our product and service offerings with those of Verizon Wireless in the U.S.

     ARPU was $40 in 2003, a $1 decrease from the prior year. Postpaid ARPU was $51 in 2003, a $1 decrease from the prior year and prepaid ARPU was $19 in 2003, a $1 decrease from prior year.

     Postpaid customer churn was 3.2% per month in 2003, an increase of approximately 0.3% from the prior year. We believe churn is relatively high compared to U.S. mainland standards mainly due to the intensity of competition with six facilities-based competitors and higher disconnections as a result of non-payment.

NETWORK INFRASTRUCTURE

     We have invested approximately $1.1 billion from the Acquisition date through 2003 including $176 million in 2003 to expand and enhance our networks.

WIRELINE NETWORK

     Our network has evolved into a multi-protocol network, handling SONET, ATM and IP with the following characteristics:

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	•		Our 100% digital switching network includes 29 local host central offices and two access tandems to ensure redundancy and network reliability. Also, we have a long distance switch to provide access to national and international long distance calls.
	•		Approximately 90% of our transmission circuits use fiber optic systems consisting of 83,000 miles of fiber optic cable in fiber-ring and point-to-point configurations.
	•		The entire fiber optic backbone transport network consists of self-healing SONET rings operating at bandwidths up to OC-192, with new equipment installed capable of evolving to DWDM. Fiber optic cable facilities have been provided to over 200 office buildings for business and residential customers.
	•		Approximately 39% of the outside cable serving the local loop is underground and buried.
	•		Our network is monitored by a network monitoring center, which operates 24 hours per day, with the capabilities to monitor customers’ IP based networks.
	•		Our Remote Access Server (“RAS”) network includes 28 nodes located throughout the island connecting Internet customers of various ISP providers through more than 40,000 modems.
	•		DSL service has been extended to 287 sites equipped with an aggregate of 37,160 ports. As of December 31, 2003, we had approximately 21,000 DSL customers, representing an increase of 7,000 customers as compared to last year.
	•		Our ATM network provides ATM and Frame Relay services and also serves as the transport medium for DSL and RAS networks. This network also provides PRTC with IP capability.

WIRELESS NETWORK

     We operate a CDMA and TDMA digital network through 320 wireless cell sites covering the entire island. We have invested $81 million since 2001 in a CDMA overlay network as part of our business strategic plan to fully migrate our customers to CDMA network. See item 8 Financial Statements and Supplementary Data. We commenced selling CDMA service in December 2001.

EMPLOYEES

     The workforce totaled 5,381 full-time employees at December 31, 2003 of which 76 % are represented by two unions, the Union of Independent Telephone Workers, known as UIET, and the Brotherhood of Independent Telephone Workers, known as HIETEL.

     A new 3-year contract was signed effective January 17, 2003, with the UIET union, involving approximately 2,800 members. The UIET contract contains wage increases of 4.4% in 2003, 4.2% in 2004, and 4.0% in 2005. If the union workforce remains unchanged, these increases, together with benefit improvements, payroll taxes and offsetting concessions, will result in increases of labor costs of $1.5 million for 2003, $5.9 million for 2004 and $9.9 million for 2005. The HIETEL contract, involving approximately 1,300 members, expired in October 2003 and we are currently negotiating a new contract. At this time, we can not determine when and upon what terms the negotiations will be completed.

     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 UIET 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.

     In December 2003, the Company offered an early retirement program to qualified management employees. A non-cash provision of $12.6 million was recorded relating to 147 employees who had accepted as of December 31, 2003.

     As a result of the voluntary separation and retirement program mentioned above, the reduction in workforce totaled 367 in 2003, or 6%.

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CONCESSION AND LICENSES

     We hold concessions, licenses and permits adequate for the conduct of our business in the markets which we serve. Advances in technology, together with a number of regulatory, legislative and judicial actions, continue to accelerate and increase competition in those markets we serve.

ENVIRONMENTAL REGULATIONS

     Our operations are subject to federal and local laws and regulations governing the use, storage, disposal of, and exposure to, hazardous materials, the release of pollutants into the environment and the remediation of contamination. As an owner or operator of facilities in which hazardous materials are used, we could be subject to environmental laws that impose liability for the entire cost of cleanup at contaminated sites, regardless of fault or the lawfulness of the activity that resulted in the contamination. We believe, however, that our operations are in substantial compliance with applicable environmental laws and regulations.

     Many of our properties contain underground and aboveground storage tanks used for the storage of fuel. Some of these tanks may have leaked or otherwise caused contamination. We have remediated known contamination at a number of properties. We cannot be certain, however, that we have discovered all contamination or that the regulatory authorities will not request additional remediation at sites that have previously undergone remediation.

     Our cellular operations are also subject to regulations and guidelines that impose a variety of operational requirements relating to radio frequency emissions. The potential connection between radio frequency emissions and certain negative health effects, including some forms of cancer, has been the subject of substantial study by the scientific community in recent years. To date, the results of these studies have been inconclusive. Although we have not been named in any lawsuits alleging damages from radio frequency emissions, it is possible that we could be sued in the future, particularly if scientific studies conclusively determine that radio frequency emissions are harmful.

REGULATORY ENVIRONMENT IN PUERTO RICO

     We are regulated by the FCC and the Telecommunications Regulatory Board of Puerto Rico (“TRB”), and are subject to the Federal Telecommunications Act of 1996 (“the Act”) and the Puerto Rico Telecommunications Act. The Act opened our local exchange market to competition. There is one facility-based competitive local exchange carrier and two resellers of wireline local service on the island. The blended discount rate to resellers was approximately 24% based on negotiated agreements. Dialing parity, which opened up the on-island long distance market to competition, was introduced in February 1999. Our intra-island access charges are based on rate-of-return methodology.

     Basic local rates have remained unchanged since 1982 at $18.80 per month for residential unlimited service in the metro area. Additionally customers are billed a subscriber line charge of $6.50 per month and off-island long distance rates are similar to interstate rates in the US mainland at $.07 per minute. Our local tariff structure has historically had 68 local calling area zones. At the end of 2003 we agreed to expand our local calling zones to respond to customer demand, and in February instituted a four phase program to reduce the number of local calling areas to 10 by the end of 2004. See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters – Intra-Island Long Distance Access rate Dispute.”

     The TRB has adopted a forward looking economic model to set intra-island access charges and reductions in those rates are being implemented in phases which will be completed in April 2005 in accordance with commitments made to the major carriers and the TRB. In addition to ordering significant reductions in intra-island access charges, the TRB has ordered a $68 million refund to end-user customers relating to this dispute for which the Company has established a pre-tax reserve of $73 million, including interest. For more information, see Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters – Intra-Island Long Distance Access rate Dispute.”

     On January 1, 2002, the TRB adopted a local universal service fund for qualified low-income customers. This lifeline program is funded by all intra-island telecommunications providers through contributions to the TRB based on intra-island retail revenues. Qualified lifeline customers receive a local $3.50 per month credit along with an additional federal $1.75 per month credit from the Company. These credits together with existing federal credits of $8.25 per month result in total credits for a lifeline customer of $13.50 per month. Contributions made by the Company to the TRB are recovered through an end-user charge that commenced on March 1, 2002. The Company is reimbursed from the TRB for credits given to Lifeline customers.

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     The wireless business is not subject to price regulation.

     INFORMATION ON OUR INTERNET WEBSITE

     Our website address is www.telefonicapr.com and contains links to our SEC filings. We have adopted a written Code of Ethics applicable to all directors, officers and employees and is also available on our website.

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ITEM 2. PROPERTIES

PROPERTY, PLANT AND EQUIPMENT

     Gross investment in property, plant and equipment is $4.0 billion at December 31, 2003 and 2002, as follows:

     “Outside plant” consists primarily of aerial cable, underground cable, conduit and wiring, and telephone poles. “Central office and transmission equipment” mainly consists of switching equipment, transmission equipment and related facilities. “Other equipment” includes public telephones, motor vehicles, special purpose vehicles, furniture, and capital leases. “Land and buildings” consists of land, buildings and leasehold improvements.

PROPERTIES

     We have facilities in all the major population centers of San Juan, Mayagüez, Ponce, Fajardo, Humacao, Arecibo, Aguadilla, and Guayama and in some other smaller towns. Facilities as of December 31, 2003 include the following:

     We believe that all of these properties are generally in good operating condition and are adequate to satisfy the needs of the business.

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ITEM 3. 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 at this time that the resolution of these matters will not have a material adverse effect on the Company’s financial position and results of operations. See Part II, Item 7, “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.

     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. 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. As a result, the 2003 cash flow impact was a reduction of $16 million to the pre-tax reserve.

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

     Not applicable.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET FOR COMMON STOCK

     While there is no established trading market for the Company’s common stock, the shares are valued annually by the ESOP trustee’s financial advisors. The appraisal is used to value cash distributions to ESOP participants and measure the Company’s share performance for employees who participate in the ESOP Plan.

HOLDERS

     There were 25 million outstanding shares of common stock and four shareholders of record at March 31, 2004. See Part II, Item 12 “Security Ownership of Certain Beneficial Owners and Management” for shareholder information.

DIVIDENDS

     Our shareholders agreement requires the payment of dividends equal to at least 50% of consolidated net income, to be paid in the following quarter to the extent funds are legally available. During 2003, the Company paid dividends of $68 million, or $2.725 per share, applicable to the first quarter of 2003 and the fourth quarter of 2002. During 2002, the Company paid dividends of $69 million, or $2.753 per share, applicable to the first three quarters of 2002 and the fourth quarter of 2001.

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ITEM 6. SELECTED FINANCIAL DATA

SELECTED CONSOLIDATED FINANCIAL AND OPERATIONAL DATA

     The following table was derived from our audited consolidated financial statements and the audited financial statements of PRTC and Verizon Wireless (“Predecessors”) for the designated periods. You should read the following data together with (a) our Predecessor’s historical financial statements and the notes thereto for the period from January 1, 1999 to March 1, 1999; and (b) our historical consolidated financial statements and the notes thereto as of and for the year ended December 31, 2000 and for the period from March 2, 1999 to December 31, 1999, all of which have been audited by Deloitte & Touche LLP, except for the consolidated financial statements and notes thereto as of and for the years ended December 31, 2003, 2002 and 2001, which have been audited by Ernst & Young LLP, independent auditors, and appear elsewhere in this report. Our current results of operations and financial condition differ materially from those prior to the Acquisition due primarily to:

•

The incurrence of $1.6 billion of debt and related interest expense in connection with and at the time of Acquisition;

•

The Company becoming a tax paying entity;

•

Voluntary early retirement and separation programs introduced since 1999;

•

The management fees and royalties paid to Verizon;

•

The introduction of dialing parity in the on-island long distance market and our entrance into the off-island long distance market;

•

Revaluation of assets and liabilities to reflect purchase accounting relating to the Acquisition;

•

The discontinuation of regulatory accounting principles, as described in Statement of Financial Accounting Standards (“SFAS”) No. 71, accounting for the Effects of Certain Types of Regulation”; and

•

The impact of various regulatory initiatives, related to the reduction of the Federal High Cost Funding.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CRITICAL ACCOUNTING POLICIES

General

The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.

The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to bad debts, intangible assets, income taxes, financing operations, pensions and other post-retirement benefits, and contingencies and litigation. The Company’s management 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 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.

Deferred Taxes

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

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 consolidated financial statements, the Company executed a reorganization plan, which became effective May 1, 2002, whereby Verizon Wireless merged into PRTC. As a result of this merger, the Company released a deferred tax valuation allowance, related to the Acquisition, of $93 million, of which $51 million was recorded against goodwill and $42 million 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, “Accounting for Income Taxes.” Management believes that sufficient book and taxable 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 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.

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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, less anticipated net salvage value, 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 changed its accounting estimates relating to depreciation resulting from a detailed review of the lives underlying the depreciation rates. The rate changes 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 charges resulted in decreasing depreciation expense by approximately $6 million for the second half of 2002 and approximately $12 million for the year ended December 31, 2003. Refer to Note 4 to the consolidated financial statements for further details.

Pensions

The Company accounts for its defined benefit pension plans in accordance with SFAS No. 87, “Employers’ Accounting for Pensions” which requires that amounts recognized in financial statements be determined on an actuarial basis. SFAS No. 87 and the policies used by the Company, notably the use of a calculated value of plan assets (which is further described below), generally reduced the volatility of pension income (expense) from changes in pension liability discount rates and the performance of the pension plan’s assets.

The most significant element in determining the Company’s pension income (expense) in accordance with SFAS No. 87 is the expected return on plan assets. At December 31, 2003, the Company assumed that the expected long-term rate of return on plan assets is 8.5%, which remained constant in comparison with prior year. Historically, the Company’s pension plan assets have earned in excess of 8.5%; therefore, the Company believes that its assumption of future returns of 8.5% is reasonable.

At the end of each year, the Company determines the rate used to discount plan liabilities. The discount rate reflects the current rate at which the pension liabilities could be effectively settled at the end of the year. In estimating this rate, the Company looks to rates of return on high quality, fixed-income investments that receive one of the two highest ratings given by a recognized ratings agency. At December 31, 2003, the Company determined this rate to be 6.25%, which is 0.5% lower than the prior year. The increase in the pension liability resulting from the change has been deferred in accordance with the amortization provisions of SFAS No. 87.

Other Post Employment Benefits

We provide retiree health benefits for employees that retire under our Pension Plan. We use various actuarial assumptions including the discount rate and the expected trend in health care costs to estimate the costs and benefit obligations for our retiree health plan.

At December 31, 2003, we assumed a discount rate of 6.25%, which is 0.5% lower than the prior year and increased our retiree health benefit liability. A large portion of this loss has been deferred in accordance with the amortization provisions of SFAS No. 106.

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RESULTS OF OPERATIONS

		The Company has two reportable segments, Wireline and Wireless.
		The Wireline segment consists of:
•		Local services, including basic voice, telephone and telecommunications equipment rentals, value-added services, high-speed private line services, Internet access and public phone service;
•		Access services to long distance carriers, competitive local exchange carriers, and cellular and paging operators to originate and terminate calls on our network;
•		Long distance services including direct dial on-island and off-island, operator assisted calls, prepaid calling card and high-speed private line services;
•		Directory publishing rights revenues; and
•		Telecommunication equipment sales and billing and collection services to competing long distance operators in Puerto Rico.
		The Wireless segment consists of:
•		Cellular service; and
•		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.

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REVENUES

EXPENSES AND CHARGES

OPERATING DATA

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YEAR ENDED DECEMBER 31, 2003 COMPARED WITH YEAR ENDED DECEMBER 31, 2002

     REVENUES. Revenues for the year ended December 31, 2003 decreased $20 million, or 2%, to $1,281 million from $1,301 million in 2002.

     WIRELINE:

          Wireline revenues include local service, long distance, network access, directory revenues and other services. Wireline revenues for the year ended December 31, 2003 decreased $36 million, or 3%, to $1,080 million from $1,116 million in 2002.

          Local service revenues include 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 year ended December 31, 2003 increased $1 million, to $579 million from $578 million in 2002. The increase is due to increased revenues from local data services of $3 million offset by decreased revenues from local voice services of $2 million. The increase in revenues from local data services was driven by an increase in revenues from Internet access of $3 million. The decrease in revenues from local voice services was driven by a decrease in revenues from basic voice of $14 million offset by an increase in deferred activation revenues of $12 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 $8 million, or 6%, to $138 million for the year ended December 31, 2003 from $146 million for the 2002. The decrease was due to a decrease in intra-island long distance revenues of $8 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 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 year ended December 31, 2003 decreased $30 million, or 9%, to $295 million compared to $325 million for 2002. The decrease was driven by lower intra-island access revenues of $13 million, a decrease in off-island switching and special access revenues of $11 million and lower carrier common line access revenues of $12 million that were partially offset by higher subscriber line charges of $6 million resulting from a rate increase in July 2003.

          Directory and other revenues include directory publishing rights, telecommunication equipment sales and billing and collection services to competitor long distance operators. Directory and other revenues for the year ended December 31, 2003 increased $1 million, or 2%, to $68 million from $67 million for the year ended December 31, 2002, mainly due to an increase in wireline equipment sales of $2 million partially offset by a decrease in customer premises equipment (“CPE”) maintenance revenues of $1 million.

     WIRELESS:

          Revenues from cellular and paging services and related equipment sales for the year ended December 31, 2003 increased $16 million, or 9%, to $201 million from $185 million for 2002. Cellular service revenues increased $14 million, or 8%, to $187 million from $173 million in 2002. The increase was primarily the result of an increase of 12,000 post paid cellular customers compared to the year ended December 31, 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 $4 million for the year ended December 31, 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 its paging operations in August 2003.

          Wireless equipment sales increased $6 million, or 86%, to $13 million for year ended December 31, 2003 from $7 million for 2002. This increase is a result of the increase in customers who subscribed for wireless services in 2003 and to post paid contract renewals.

     OPERATING COSTS AND EXPENSES. Operating costs and expenses for the year ended December 31, 2003 increased $127 million, or 16%, to $921 million from $794 million reported for the year 2002.

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     WIRELINE:

          Wireline expenses for the year ended December 31, 2003 increased $103 million, or 16%, to $766 from the $663 million reported in 2002.

          Labor and benefit expenses increased $36 million, or 11%, to $370 million from $334 million reported for the year ended December 31, 2002, due to increases in Pension and OPEBs expense recognition of $34 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.

          Other operating expenses of $396 million for the year ended December 31, 2003, increased $67 million, or 20%, compared to 2002. 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), a pre-tax reserve of $66 million (an additional $7 million is included as interest) for the end-user and AT&T refund referred to in the TRB Resolution and Order of February 2002 and the net cost of removal of $4 million due to the adoption of SFAS No. 143, “Accounting for Asset Retirement Obligations” on January 1, 2003. Under the provisions of SFAS No. 143, we are required to exclude costs of removal from our depreciation rates for assets for which the removal costs exceed salvage. Effective January 1, 2003, we began expensing costs of removal in excess of salvage for these assets as incurred. This increase was partially offset by a decrease in interconnection charges of $16 million that resulted from an interconnection settlement agreement coupled with a decrease in rates and a decrease in management fees of $15 million.

     WIRELESS:

          Wireless expenses for the year ended December 31, 2003, increased $24 million, or 18%, to $155 million from $131 million reported for the year ended December 31, 2002.

          Labor and benefit expenses increased $1 million, or 3%, to $32 million from the $31 million reported for the year ended 2002. The increase in labor and benefits expenses is mainly due to higher contractor expenses.

          Other operating expenses increased $23 million, or 23%, to $123 million from the $100 million reported for the comparable 2002 period. The increase was due to a higher subsidy on equipment sales of $11 million, the absence of a gain on the sale of land of $3 million recognized during year ended December 31, 2002, higher network management fees of $3 million, higher commission expenses of $2 million, higher inventory obsolescence expense of $2 million, higher rent expense of $1 million and higher outsource billing expense of $1 million.

          EARLY RETIREMENT AND VOLUNTARY SEPARATION 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. In December 2003, the Company offered an early retirement program to qualified management employees. A non-cash provision of $12.6 million was recorded relating to 147 employees who had accepted as of December 31, 2003.

          DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization expense of $252 million for the year ended December 31, 2003 was $10 million lower than for 2002, a decrease of 4%. 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 $12 million for the year ended December 31, 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 $53 million for the year ended December 31, 2003 was $6 million higher than 2002 due to 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, partially offset by a $1 million reduction related to a decrease in short term borrowings.

          EQUITY INCOME FROM JOINT VENTURE. Equity income from joint venture of $2 million for the year ended December 31, 2003 decreased $1 million as compared with the same period in 2002. This equity income was generated from the Company’s

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approximate 24% interest in VISI, the largest yellow page publishing company in Puerto Rico.

          MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY. A $2 million minority interest included in the Company’s results of operations for the year ended December 31, 2003 represents the minority share of the income or loss of Popular, Inc.’s 33% investment in Coqui.net.

          ASSET IMPAIRMENT CHARGE. Management decided to migrate in 2004 all TDMA clients to the CDMA network and dispose of the TDMA network. The Company determined that an indicator of impairment existed because the expected undiscounted cash flows from TDMA network were lower that its carrying amount. Since the estimated fair value of $26 million is lower than the $37.8 million carrying amount of the TDMA network as of December 31, 2003, the Company recorded an impairment loss of $11.8 million.

          INCOME TAXES. A $8 million tax provision for the year ended December 31, 2003 reflects a 32% effective tax rate. The difference between the effective and the statutory tax rate of 39% equates to $2 million, primarily reflecting permanent differences related to interest accretion on the PRTA subscription receivable and equity income in subsidiary. The decrease of $8 million when compared to the $29 million provision reported for the year ended December 31, 2002 was due to lower earnings in 2003.

          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 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).

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YEAR ENDED DECEMBER 31, 2002 COMPARED WITH YEAR ENDED DECEMBER 31, 2001

     REVENUES. Revenues for the year ended December 31, 2002 decreased $96 million, or 7%, to $1,301 million from $1,397 million in 2001.

     WIRELINE:

          Wireline revenues include local service, long distance, network access, directory revenues and other services. Wireline revenues for the year ended December 31, 2002 decreased $75 million, or 6%, to $1,116 million from $1,191 million in 2001.

          Local service revenues include 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 year ended December 31, 2002 increased $12 million, or 2%, to $578 million from $566 million 2001. The increase is due to higher local data services while local voice services remained constant. The increase in local data services was mainly driven by an increase in Internet access revenues of $3 million, an increase in DSL revenues of $2 million, and an increase in frame relay 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 $40 million, or 22%, to $146 million for the year ended December 31, 2002 from $186 million for the 2001. The decrease was mainly due to a decrease in intra-island long distance revenues of $28 million, a decrease in operator service revenues of $6 million and a decrease in off-island long distance revenues of $6 million. Long distance revenues have decreased mainly due to customer traffic migration to the cellular network.

          Network access revenues include services provided to long distance carriers, competitive local exchange carriers, and cellular and paging operators to originate and terminate calls on other network. These revenues for the year ended December 31, 2002 decreased $30 million, or 8%, to $325 million compared to $355 million for 2001. The decrease was primarily caused by a decrease in interstate high cost fund subsidies of $33 million, reflecting a phasing out of this subsidy (see “Regulatory Matters-Interstate High Cost Subsidy”). The decrease was partially offset by an increase in local USF charges of $4 million.

          Directory and other revenues include directory publishing rights, telecommunication equipment sales and billing and collection services to competitor long distance operators. Directory and other revenues for the year ended December 31, 2002 decreased $17 million, or 20%, to $67 million from $84 million for the year ended December 31, 2001, mainly due to a decrease in equipment sales of $13 million and a decrease in billing and collection service revenues of $4 million, reflecting lower long distance traffic from competitors.

     WIRELESS:

          Revenues from cellular and paging services and related equipment sales for the year ended December 31, 2002 decreased $21 million, or 10%, to $185 million from $206 million for 2001. Cellular service revenues decreased $4 million, or 2%, to $173 million from $177 million in 2001. This was primarily the result of combined cellular ARPU declining from $44 to $41 as new price plans with larger bundles of minutes were introduced into the market, which was partially offset by customer growth.

          Paging revenues declined $10 million, or 67%, to $5 million for the year ended December 31, 2002 from $15 million for 2001. The decrease was related to a reduction of 33,000 customers.

          Wireless equipment sales decreased $7 million, or 50%, to $7 million for year ended December 31, 2002 from $14 million for 2001. This decrease is mainly due to lower prepaid gross additions associated with lower promotional activities during the year ended December 31, 2002.

     OPERATING COSTS AND EXPENSES. Operating costs and expenses for the year ended December 31, 2002 decreased $33 million, or 4%, to $793 million from $826 million reported for the year 2001.

     WIRELINE:

          Wireline expenses for the year ended December 31, 2002 increased $2 million to $663 from the $661 million reported in

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2001.

          Labor and benefit expenses decreased $16 million, or 5%, to $334 million from $350 million reported for the year ended December 31, 2001. This decrease in labor and benefit expense primarily reflects headcount reductions including the effect of early retirements and voluntary separation programs, as well as a reduction in overtime, contractor and expatriate expenses.

          Other operating expenses of $329 million for the year ended December 31, 2002, increased $18 million, or 6%, compared to 2001. The increase is primarily due to higher property and municipal tax provisions of $16 million and higher bad debt provisions of $10 million, offset in part by lower consulting and advertising expenses of $6 million and $5 million, respectively.

     WIRELESS:

          Wireless expenses for the year ended December 31, 2002, decreased $34 million, or 21%, to $131 million from the $165 million reported for the year ended December 31, 2001.

          Labor and benefit expenses decreased $3 million, or 9%, to $31 million from the $34 million reported for the year ended 2001. The decrease in labor and benefits expenses is mainly due to lower overtime, expatriate and temporary employee expenses.

          Other operating expenses decreased $31 million, or 24%, to $100 million from the $131 million reported for the comparable 2001 period. The decrease was due to lower costs from equipment sold of $21 million and lower bad debt provisions of $10 million and a $3 million gain on the sale of land. These decreases were offset by an increase in facilities expenses of $3 million associated with the new CDMA network.

          EARLY RETIREMENT AND VOLUNTARY SEPARATION PROVISIONS. In December 2002, the Company offered a voluntary separation program to qualified management employees. A non-cash provision of $0.5 million was recorded relating to 8 employee acceptances.

          A total of $52 million was recorded for early retirement and voluntary separation programs during 2001 associated with four separate offerings to a total of 567 employees.

          DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization expense of $262 million for the year ended December 31, 2002 was $9 million lower than for 2001, a decrease of 3%. The decrease in depreciation and amortization expense is mainly due to a change in wireline depreciation rates, which became effective July 1, 2002, reducing depreciation expense by $6 million and the discontinued amortization of goodwill and other indefinite life intangibles, as a result of the adoption of SFAS No. 142, “Goodwill and Other Intangible Assets” which reduced amortization expense by $16 million for the year ended December 31, 2002. This decrease of $22 million was offset in part by higher gross plant balances, which produced approximately $13 million in depreciation expense.

          INTEREST EXPENSE. Interest expense of $47 million for the year ended December 31, 2002 was $15 million lower than 2001 due to lower interest rates and lower debt balances.

          EQUITY INCOME FROM JOINT VENTURE. Earnings of $3 million were generated for the year ended December 31, 2002 from our approximate 25% interest in VISI.

          MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY. A $1 million minority interest included in the Company’s results of operations for the year ended December 31, 2002 represents the minority share of the income or loss of Popular, Inc.’s 33% investment in Coqui.net.

          INCOME TAXES. A $29 million tax provision for the year ended December 31, 2002 reflects the tax effect of the merger of Verizon Wireless into PRTC. See Note 1 to our consolidated financial statements included under Part II, Item 8, “Financial Statements and Supplementary Data.” As a result of this merger, the Company released a deferred tax valuation allowance of $93 million, of which $51 million was recorded against goodwill and $42 million of which was recorded as a deferred tax benefit during the second quarter of 2002. The difference between the statutory tax and the effective rate of 15%, or $48 million, primarily reflects permanent differences related to the $42 million release of the valuation allowance and other permanent differences such as the internal accretion on the government subscription receivable and joint venture equity income.

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LIQUIDITY AND CAPITAL RESOURCES

CONSOLIDATED FINANCIAL CONDITION

YEAR ENDED DECEMBER 31, 2003 COMPARED WITH YEAR ENDED DECEMBER 31, 2002

OVERALL LIQUIDITY ASSESSMENT

          The Company believes that cash from operations is sufficient to meet working capital needs. Current assets exceeded current liabilities at December 31, 2003 by $119 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, an undrawn $40 million working capital capital credit facility maturing in June 2004. 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 term loans in an aggregate principal amount of $225 million.

OPERATIONS

          Cash from operations continued to be our primary source of funds. The $48 million decrease in cash from operations for the year ended December 31, 2003 as compared to the prior year was primarily due to higher pension and OPEBs contributions of $46 million. Pension plan payments increased by $46 million due to a management strategy to fully fund the pension plans.

INVESTING

          Net cash used in investing activities for the year ended December 31, 2003 was $170 million compared to $206 million for the same period in 2002. The decrease in cash used in investing activities of $36 million is mainly due to a decrease in capital expenditures and costs of removal as a result of 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. Also, effective January 1, 2003, under SFAS No. 143, costs of removal are expensed when incurred.

          We have invested approximately $1.1 billion from the date of the Acquisition through December 31, 2003 to expand and enhance our networks. In 2004, we expect to make up to approximately $160 million in capital expenditures, which will be financed from internally generated funds.

FINANCING

          Debt outstanding, excluding capital leases, decreased $173 million for the year ended December 31, 2003 and decreased $161 million for the year ended December 31, 2002. During 2002, the Company refinanced $300 million of senior notes, which matured on May 15, 2002, with new term credit agreements. The aggregate principal amount of the term loans was $225 million, with maturities ranging from two to three years, bearing interest at 60 to 100 basis points over the London Interbank Offered Rate (“LIBOR”) at December 31, 2002. During year 2003, the Company prepaid principal of term loans by $102 million reducing the outstanding balance to $123 million at December 31, 2003 and reduced interest rate to 70 basis point over LIBOR.

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          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 2004, $40 million was received in cash from PRTA for the fifth and final installment. See Note 14 to the condensed consolidated financial statements.

           The shareholders’ agreement requires the payment of dividends equal to at least 50% of consolidated net income, payable quarterly to the extent funds are legally available. For the year ended December 31, 2003, the Company paid dividends amounting to $68 million corresponding to the first quarter of 2003 and the fourth quarter of 2002. For the year ended December 31, 2002, the Company paid dividends of $69 million corresponding to the first three quarters of 2002 first and the fourth quarter of 2001. The senior note indentures and credit facility agreements do not contain restrictions on the payment of dividends.

OFF-BALANCE SHEET ARRANGEMENTS

CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS

The following table provides a summary of our contractual obligations and commercial commitment at December 31, 2003. Additional detail about these items is included in the notes to the consolidated financial statements.

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REGULATORY AND OTHER MATTERS

REGULATORY AND COMPETITIVE TRENDS

          Regulatory activity at the federal and local levels was primarily directed at meeting challenges in maintaining support for local exchange rates and Universal Service while affecting the rate rebalancing and regulatory restructuring required by an increasingly competitive environment. Among the issues generating regulatory activity are: local number portability requirements, interconnection agreements, the FCC’s triennial review and reverse toll billing elimination.

          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, PRTC 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 and implementing tariffs filed with the TRB as noted in the next paragraph.

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          In November 2003, the Company proposed, and two members of the TRB indicated their support for, a plan to revise the Boards’s end-user refund order and end the dispute over this issue. First, PRTC has filed tariffs implementing the reduction in intra-island access charges ordered by the TRB in its Order on Reconsideration of February 27, 2002. The composite per minute access rate was reduced from 9.3 cents to 6.5 cents on January 1, 2004 and will decrease according to the TRB phase reduction schedule which will end on April 1, 2005. See above. Second, PRTC agreed to implement a phased reduction in the number of local exchange calling areas from 68 to 10, the first phase of which became effective on February 2004, coupled with the deferred implementation of a flat charge designed to offset the resulting revenue losses. Third, the plan included a number of other elements benefiting consumers; elimination of touchtone charges; one time credits for single line residential customers equal to their basic monthly service rate in December 2003 and June 2005; and a commitment not to raise residential rates through December 2006, without providing certain information to the TRB in advance. While the TRB has accepted and approved these commitments, it has not issued a final resolution and order to terminate the refund provisions in the Order and there has been litigation relating to aspects of the plan at the TRB and Puerto Rico Supreme Court. The 2003 cash flow impact was a reduction of $16 million to the pre-tax reserve.

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. The cash flow effect of the settlement will be approximately $27 million. 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, Teléfonos Públicos 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 motion to change of venue was granted by the U.S. District Court of Delaware and now the motion to dismiss is pending before the United States District Court of Puerto Rico.

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

PUERTO RICO 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.

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TOUCHTONE CHARGES

          On November 17, 2003, six residential subscribers and eight business service subscribers filed a class action suit with the Superior Court of Puerto Rico (the “Superior Court”) under the Puerto Rico Telecommunications Act of 1996 (“Act”) and the Puerto ico Class Action Act of 1971. The plaintiffs claim that the Company’s charges for touchtone service are not based on cost, and are therefore in violation of the Act. They have requested that the Court (i) issue an Order certifying the case as a class action, (ii) designate the plaintiffs as representative of the class, (iii) find that the charges are illegal, and (iv) order the Company to reimburse every subscriber for excess payments made since September 1996. On December 30, 2003, PRTC filed its corresponding answer to the complaint and requested the dismissal of the same based on the grounds that the claim is not a legitimate class action suit. On February 17, 2004, the plaintiffs filed their first set of interrogatories and request for admissions as to initiate a discovery proceeding. PRTC will ask the Court that the threshold issue to decide first must be the class certification.

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.

          The TRB stated in the 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 uses rate-of-return as a basis for setting rates. The Company was previously 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 issued 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 that the FCC 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. On January 14, 2004, PRTC filed a petition for clarification and/or reconsideration of several portions of the FCC Order of October 27, 2003 based on the grounds that the FCC has not acted upon the specific mandate of Section 254 to provide support for insular areas.

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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.

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.

TRB AUDIT

          As provided by law, the TRB is currently conducting an ordinary audit of our affiliate transactions and regulatory accounting. We do not expect to have a material impact in the Company’s financial conditions and results.

RECENT ACCOUNTING PRONOUNCEMENTS

For disclosure of recent accounting pronouncements, see Note 4 to our consolidated financial statements included under Part II, Item 8, “Financial Statements and Supplementary Data.”

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ITEM 7A. 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 swap at December 31, 2003 and 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.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES

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INDEPENDENT AUDITORS’ REPORT

The Board of Directors and Shareholders of Telecomunicaciones de Puerto Rico, Inc.:

We have audited the accompanying consolidated balance sheet of Telecomunicaciones de Puerto Rico, Inc. and subsidiaries (the “Company”) as of December 31, 2003 and 2002, and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for the years then ended. Our audit also included the financial statement schedule listed in the Index at Item 14 for the years ended December 31, 2003 and 2002. These financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audit.

We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Telecomunicaciones de Puerto Rico, Inc. and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

As discussed in Note 3 and 4 to the consolidated financial statements, the Company changed its methods of accounting for directory revenues and expenses, and asset retirement obligations effective January 1, 2003; as discussed in Note 4 to the consolidated financial statements, the Company changed its method of accounting for goodwill and other intangible assets effective January 1, 2002.

Ernst & Young LLP
San Juan, Puerto Rico

February 28, 2004

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Telecomunicaciones de Puerto Rico, Inc. and Subsidiaries

Consolidated Balance Sheets

(In thousands)

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

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Telecomunicaciones de Puerto Rico, Inc. and Subsidiaries

Consolidated Statements of Operations

(In thousands)

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

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Telecomunicaciones de Puerto Rico, Inc. and Subsidiaries

Consolidated Statements of Changes in Shareholders’ Equity

(In thousands)