UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

þ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended: December 31, 2004

or

o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from _______ to _______

Commission File Number 333-85503

Telecomunicaciones de Puerto Rico, Inc.

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 þ   NO o

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. þ

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

YES o NO þ

At June 30, 2004, the aggregate market value of the common stock held by non-affiliates of the registrant was approximately $56 million. This amount represents the value of the vested shares under the Employee Stock Ownership Plan (“ESOP”) at a stated price of $57.77. 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 31, 2005, 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 and industry conditions in Puerto Rico, and labor matters, including workforce levels and labor negotiations, and any resulting financial and/or operational impact, in the markets served by us; (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.

     Although the Company believes the expectations reflected in its forward-looking statements are reasonable, the Company cannot guarantee its future performance or results of operations. All forward-looking statements in this filing are based on information available to the Company on the date of this filing; however, the Company is not obligated to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The risks described above and elsewhere in this report, including in Item 7, “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” should be considered when reading any forward-looking statements in this filing. Given these uncertainties and risks, the reader should not place undue reliance on these forward-looking statements.

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, 2004, we had approximately 1.2 million access lines in service, including 887,000 residential and 281,000 business lines. We market our cellular service under the Verizon Wireless brand.

     We have invested approximately $1.2 billion from the date of the Acquisition (as defined below) through December 31, 2004 to expand and enhance our network. In 2005, we expect to invest an additional $155 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 migrate all TDMA clients to the CDMA network. We have invested approximately $113 million since 2001 in a network overlay using the CDMA standard.

STRATEGY

     During 2004, the Company was reorganized, consolidating previously separate wireline and wireless operations. The reorganization will enable the Company to better focus on delivering integrated customer solutions, while fully leveraging our assets and human resources across the organization. Management will continue to monitor our wireline and wireless reportable segments.

     We expect to maintain our wireline market leadership position by improving customer service, providing value, and meeting increasing customer bandwidth requirements. Customer value will continue to 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

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ID, call forwarding and call waiting. Our network deployment plans are designed to meet business and government requirements for dedicated high-speed bandwidth access, as well as residential consumer demand for DSL service.

     Our wireless strategy is to provide the best customer value in wireless services with the highest quality of network. We plan to invest $40 million in 2005 to add the capacity needed to meet our growing customer base and to extend our high speed EV-DO service beyond the Metro Area. We believe we will continue to improve the customer experience by providing the latest wireless entertainment and productivity service.

     Also during 2004, the company reduced the number of local calling areas in Puerto Rico from 68 to 10. The calling areas were extended based on customer calling patterns and commercial zones and will enable the company to better compete in the market, while benefiting the subscriber base.

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 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. Wireline service is provided by PRTC, the incumbent local exchange carrier for the island of Puerto Rico, and wireless services are provided by Verizon Wireless Puerto Rico, Inc. (“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 through 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 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 enable the Company to integrate its wireline and wireless operations without jeopardizing the continuity of its off-island long distance license; to simplify the Company’s overall corporate structure to reduce administrative costs; and to provide better control and monitoring of the Company’s off-island long distance business and increase its potential for growth in Puerto Rico.

PUBLIC TELEPHONES OPERATIONS

     In December 2004, the Company entered into an agreement to sell the public telephone assets, subject to certain terms and conditions, to a local public telephone service provider. The transaction is currently being reviewed by the Department of Justice to ensure compliance with applicable antitrust regulations. The disposition of the public telephone assets will enable management to focus on higher growth areas, such as wireless and broadband.

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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 data services, Internet access and public phone service;
•	Long distance services including direct dial on-island and off-island, operator assisted calls, and prepaid calling card;
•	Access services to long distance carriers, competitive local exchange carriers, and wireless operators for originating and terminating 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:
•	Postpaid and prepaid cellular service; and
•	Wireless equipment sales.

        CONSOLIDATED

     Reclassifications of prior years’ data have been made to conform to the 2004 consolidated presentation. For further information, refer to Note 2 to our consolidated financial statements included under Part II, Item 8, Financial Statements and Supplementary Data.”

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WIRELINE

LOCAL SERVICES

     OVERVIEW

     Local services include basic voice services, value-added services, high speed data services, Internet, 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, and private branch exchange trunks:

        ACCESS LINES IN SERVICE

     BASIC VOICE SERVICE

     Basic voice service is the largest component of local service revenues, generating $330 million, or 27%, of total revenues for the year ended December 31, 2004, representing a decrease of $14 million, or 4%, as compared to the same period in 2003. The decrease is mainly attributed to line substitution due to customer migration to the wireless network. 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, 2004 there were 10 local calling areas. Business customers must be on a measured service plan.

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

     Business and Government customers pay basic local rate by principal line ranging from $35.00 to $38.25 per month. In 2004, Business and Government average revenue per user (“ARPU”) was $54.64, excluding Internet and long distance services. 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, excluding applicable Expanded Area Service (“EAS”) surcharges. The EAS surcharge of $2.50 per line is being gradually phased in, with complete implementation by December 2006. In 2004, residential basic ARPU was approximately $23.33, excluding Internet and long distance services and 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 enhanced services such as directory assistance and white-page directory listings.

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     TELEPHONE RENTAL

     Approximately 14% of single-line business customers and 43% of residential customers rent telephones. We generated $14 million in revenues from telephone rentals for the year ended December 31, 2004, representing a decrease of $2 million, or 13%, as compared to the same period in 2003 as customers increasingly prefer to purchase the equipment, versus renting. Rental levels are 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, call forward, anonymous call reject and voice mail. Charges for these features range from $1.50 to $7.50 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 $46 million for the year ended December 31, 2004, representing a decrease of $1 million, or 2%, as compared to the same period in 2003, attributed primarily to our decrease in access lines.

     SPECIAL SERVICES

     Special services include private high-speed dedicated lines marketed to businesses, wireless carriers and other service providers for data transport and network connectivity. Our revenues from special services were $90 million for the year ended December 31, 2004, representing an increase of $10 million, or 13%, as compared to the same period in 2003. The increase in revenue is reflected of the increase in demand, primarily from expanded network coverage by wireless carriers.

     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 2004. We generated $33 million of revenue in 2004 from approximately 168,000 Internet access customers at December 31, 2004, an increase of $4 million and approximately 4,000 customers over prior year, or 14% in revenues and 2% in customers, respectively. The increase in year 2004 is mainly due to the increase in customers as we continue to penetrate the Internet dial-up market and take customers looking for faster services at a lower rate.

     PUBLIC PHONES

     Public telephone revenues in 2004 were $5 million, a decrease of $4 million, or 44%, from the prior year. This decrease is mainly due to 1,000 fewer phones as compared to the prior year, while the market share is at 53% of the public phone market at December 31, 2004. The Company is expected to conclude negotiations and regulatory reviews to sell its public telephone assets during 2005.

     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.

     Network access revenues for the years ended December 2004, 2003 and 2002 were $269 million, $295 million and $325 million, respectively, and included the following amounts:

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     Long-term and High Cost federal subsidies are received through pooling arrangements administered by the National Exchange Carriers Association (“NECA”). 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. Revenue from the 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. For 2004, the subscriber line charge rates remained constant. The decrease of $26 million in year 2004 was mainly due to a decrease in on-island switched revenue due to 531 million lower minutes of use and a $.03 reduction in the access rates.

LONG DISTANCE

     Long distance revenues include direct dial on-island and off-island calls, operator-assisted calls, and prepaid calling cards. 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, 2004, 2003 and 2002, respectively:

     Long distance revenues of $69 million in 2004 reflected a decrease of $42 million, or 38%, as compared with 2003 due mainly to the introduction of lower calling rates associated with bundled plans, the reduction in the number of local calling areas from 68 to 10 during 2004, and lower traffic as customers migrate traffic to other networks, primarily cellular. The reduction in revenues in 2004 also incorporates an adjustment of receivable balances reflecting billed activity for current and prior periods. The prior periods amounts do not have a material impact in the financial statements.

DIRECTORY SERVICES

     We received $20 million in publishing revenue in 2004 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, for which 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 with a right of 35% of yellow page advertising revenues, plus billing and collection fees.

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BILLING AND COLLECTION SERVICES

     We generated revenues of $7 million in 2004 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 $4 million from the prior year due to lower retail long distance messages processed for these carriers. Our contracts with TLD and AT&T expire in May 1, 2006 and June 30, 2007, respectively. Both carriers represented approximately 93% of our total billing and collection fees for 2004.

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 $113 million since 2001 in a CDMA overlay network and commenced selling this service in December 2001, which $31 million corresponds to current year 2004.

     At December 31, 2004, there were six facility-based cellular providers offering 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 and nation-wide long distance.

     We have 25 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 various cellular carriers, including 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 grew by 21% over the prior year. Also, we experienced a decrease in Prepaid customers of 14%. The decrease in Prepaid customers reflects our focus on quality, long-term Postpaid customers, while still maintaining a substantial Prepaid subscriber base. In late 2001, we began marketing our cellular service under the Verizon Wireless brand as part of our strategy to align our product and service offerings with those of Verizon Wireless in the U.S.

     ARPU for all cellular customers was $43 in 2004, unchanged from the prior year. Postpaid ARPU was $54 in 2004, a $1 decrease from the prior year and prepaid ARPU was $15 in 2004, a $4 decrease from the prior year.

     Postpaid customer churn was 2.4% per month in 2004, a decrease of approximately 0.8% 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 involuntary disconnections as a result of non-payment.

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LONG DISTANCE

          On April 2004, PRTC and PRTLD entered into a reseller agreement regarding long distance revenues generated by cellular customers, resulting in revenue of $5 million during year 2004.

NETWORK INFRASTRUCTURE

     We have invested approximately $1.2 billion from the Acquisition date through 2004 to expand and enhance our networks, including $168 million in 2004.

WIRELINE NETWORK

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

	o	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.
	o	Approximately 90% of our transmission circuits use fiber optic systems consisting of 90,000 miles of fiber optic cable in fiber-ring and point-to-point configurations.
	o	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 250 office buildings for business and residential customers. Also, a MAN (Metro Area Network) installed in the Metropolitan Area to provide Ethernet services.
	o	Approximately 39% of the outside cable serving the local loop is underground and buried.
	o	Our network is monitored by a network monitoring center, which operates 24 hours per day, with the capabilities to monitor customers’ IP based networks.
	o	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.
	o	DSL service has been extended to 220 sites equipped with an aggregate of 63,800 ports. As of December 31, 2004, we had approximately 40,000 DSL customers, representing an increase of 19,000 customers as compared to last year.
	o	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 278 wireless cell sites covering the entire island. We have invested $113 million since 2001 in a CDMA overlay network as part of our business strategic plan to fully migrate our customers to CDMA network by end 2004. See item 8 Financial Statements and Supplementary Data. We commenced selling CDMA service in December 2001.

EMPLOYEES

     The Company’s workforce totaled 5,100 full-time employees at December 31, 2004 of which 77 % are represented by two unions, the Union of Independent Telephone Workers, known as UIET, and the Brotherhood of Independent Telephone Workers, known as HIETEL.

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     A new 3-year contract was signed with the UIET union effective January 17, 2003, which covers approximately 1,500 member-employees. The UIET contract contains wage increases of 4.4% in 2003, 4.2% in 2004, and 4.0% in 2005. If the union workforce remained unchanged, these increases, together with benefit improvements, payroll taxes and offsetting concessions, would have resulted in increases of labor costs of $1.5 million for 2003, $5.9 million for 2004, and $9.9 million for 2005. With the HIETEL union, a new 4-year contract was signed effective January 1, 2004, involving approximately 2,400 member-employees.

     A total of $2.8 million and $17.3 million were recorded for early retirement and voluntary separation programs offered during 2004 and 2003, respectively summarized below:

     As a result of the voluntary separation and retirement program mentioned above, the reduction in workforce totaled 43 in 2004 and 367 in 2003, or 1% and 6% of the 2004 and 2003 workforce, respectively.

     In February 2005, the Company offered a voluntary separation program to eligible management employees. Those employees have until March 25^th to decide on this offer.

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.

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     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 average discount offered to resellers was approximately 24% from retail rates 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 ordered a $68 million refund to end-user customers relating to this dispute for which, in September 2003, the Company has established a pre-tax reserve of $73 million, including interest. As a result of the TRB’s support of the revision to the end-user refund order through agreed rate reductions and consolidation of calling areas, the final settlement of carrier access rate disputes and the PR Supreme Court issued resolution rendering the litigation moot; during year 2004, the Company revised the pre-established contingency at $14 million, associated with the expected June 2005 single line credit. 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.

     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. Information contained on our website is not incorporated by reference in, and should not be considered a part of, this Annual Report on Form 10-K. We have adopted a written Code of Ethics applicable to all directors, officers and employees which is also available on our website. The Company intends to disclose any amendments to or waivers of the code of ethics on behalf of the Company’s Chief Executive Officer, Chief Financial Officer, Controller, and persons performing similar functions, on the Company’s website at the Internet website address set forth above.

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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, 2004 and 2003, 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, 2004 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.

     The Company has been a party to proceedings regarding the access rates the Company charges to long distance carriers to originate and terminate intra-island long distance calls through the Company’s network. In October 2001, the TRB issued an order to reduce these access rates, and the Company subsequently requested a reconsideration of the order. On February 28, 2002, the TRB issued an order (the “February 2002 Order”) denying the Company’s request and requiring that PRTC pay a $68 million refund to end-user customers. The Company has filed tariffs implementing the reduction in intra-island access charges as required by the February 2002 Order. On October 30, 2003, the Company filed a petition for a writ of certiorari before the Puerto Rico Supreme Court, challenging the refund portion of the February 2002 Order. In November 2003, the Company proposed a plan to revise the refund portion of the February 2002 Order. Although the TRB has yet to issue an order revising the refund portion of the February 2002 Order, the Company revised the pre-established contingency at $14 million, associated with the expected June 2005 single line credit based on subsequent events. For a more detailed description of this dispute, 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 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. The claim is for $75 million in damages. The Company filed a motion to dismiss the lawsuit which was largely denied by the Court on August 2004. The lawsuit is currently in the discovery stage and trial began on November 22, 2004. The Company’s management believes that TPPR’s claim is without merit.

     On September 4, 2002, Pan American Telephone, Inc., Intouch Telecommunications, Inc., and Choicetel Communications, Inc., three other competitive providers of public pay phones in Puerto Rico, filed a similar suit in the United States District Court of Puerto Rico. On January 13, 2005, the Court dismissed the case with prejudice for lack of prosecution.

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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

     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

     Under the Company’s shareholders agreement, to the extent funds are legally available; the Company is required to pay quarterly dividends on its common stock equal to at least 50% of consolidated net income. During 2004, the Company paid dividends of approximately $62 million, or $2.631 per share, which were declared in the second, third and fourth quarters of 2004. During 2003, the Company paid dividends of $68 million, or $2.725 per share, which were declared in the first quarter of 2003 and the fourth quarter of 2002.

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ITEM 6. SELECTED FINANCIAL DATA

SELECTED CONSOLIDATED FINANCIAL AND OPERATIONAL DATA

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

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. We have two reportable segments: Wireline and Wireless. Wireline service, which has been provided since 1914, is marketed under the PRT brand. At December 31, 2004, we had approximately 1.2 million access lines in service, including 887,000 residential and 281,000 business lines. We market our cellular service under the Verizon Wireless brand. 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.

     We have invested approximately $1.2 billion from the date of the Acquisition through December 31, 2004 to expand and enhance our network. In 2005, we expect to invest an additional $155 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 migrate all TDMA clients to the CDMA network. We have invested approximately $113 million since 2001 in a network overlay using the CDMA standard.

     The sections that follow provide information aspects of our operations and investments, both at the consolidated and segment levels, and include discussions of our results of operations, financial position and sources and uses of cash, as well as significant future commitments. In addition, we have highlighted key trends and uncertainties to the extent practicable. The content and organization of the financial and non-financial data presented in these sections are consistent with information used by our chief operating decision makers for, among other purposes, evaluating performance and allocating resources. We also monitor several key economic indicators as well as the state of the economy in general, primarily in Puerto Rico, in evaluating our operating results and analyzing and understanding business trends. While most key economic indicators impact our operations to some degree, including gross domestic product, we have noted correlations to housing starts, personal consumption expenditures and capital spending, as well as more macroeconomic indicators such as inflation and unemployment rates.

     Our results of operations, financial position and sources and uses of cash in the current and future periods reflect the management’s focus on the following four key areas:

	•	Revenue Growth – Our emphasis is on revenue transformation, devoting more resources to higher growth markets such as wireless as well as expanded services to enterprise markets. In the year ended December 31, 2004, revenues from the growth of wireless areas, in particular post-paid cellular services increased by 11% compared to the year ended December 31, 2003 and wireless represented 15% of the total revenues, up from 14% of total revenues in the year ended December 31, 2003. The Company added approximately 50,000 post-paid wireless customers during the year ended December 31, 2004.
	•	Operational Efficiency – While focusing resources on growth markets, we are continually challenging our management team to lower expenses in all segments through technology-assisted productivity improvements. The effect of these and other efforts, such as labor agreements and early retirement and voluntary separation plans, has significantly changed the Company’s cost structure. The Company has significantly lower workforce levels, in comparison with prior year 2003, which will provide ongoing expense benefits. Labor and benefits expenses declined by approximately $15 million in the year ended December 31, 2004 compared to the same period in 2003, largely as a result of year 2004’s early retirement and voluntary separation plans.
	•	Capital Allocation – Capital spending has been, and will continue to be directed toward growth markets. Also, the Capital spending is focused on High-speed wireless data, replacement of the TDMA network as well as voice over the Internet and expanded services offered to large business customers.
	•	Cash Flow Generation – The financial statements reflect the emphasis of management on using cash provided by our operating and investing activities to significantly reduce debt and to fund our pension plans.

     Supporting these key focus areas are continuing initiatives to more effectively package and add value to our products and services. Innovative product bundles include local wireline services, long distance, wireless and DSL for consumer and general business retail customers.

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CONSOLIDATED RESULTS OF OPERATIONS

     In this section, we discuss our overall results of operations and highlight special and non-recurring items. In the following section, we review the performance of our two segments. We believe that this presentation will assist readers in better understanding our results of operations and trends from period to period.

CONSOLIDATED REVENUES

     Consolidated revenues for the year 2004 decreased $67 million, or 5%, to $1,214 million from $1,281 million for the same period in 2003. For the year ended December 31, 2003, consolidated revenues decreased $20 million, or 2%, to $1,281 million from $1,301 million for the same period in 2002. These decreases were primarily the result of lower revenues in network access revenues and in long distance revenues, partially offset by higher cellular revenues.

     Network access revenues for the year ended December 31, 2004 decreased $26 million, or 9%, to $269 million compared to $295 million for the same period in 2003. For the year ended December 31, 2003 network access revenues decreased $30 million, or 9%, to $295 million compared to $325 million for the same period in 2002. These decreases were mainly driven by a decrease in intra-island access revenues due to the implementation of phase rate reduction required by the TRB in its Resolution and Order issued on February 28, 2002 (the “February 2002 Order”). See “Regulatory and Other Matters – Intra-Island Long Distance Access Rate Dispute”.

     Long distance revenues for the year ended December 31, 2004 decreased $43 million, or 38%, to $69 million compared to $112 million for the same period in 2003. For the year ended December 31, 2003 long distance revenues decreased $5 million, or 4%, to $112 million compared to $117 million for the same period in 2002. These decreases were mainly the result of the impact of the Extended Area Service (EAS) implementation. See “Regulatory and Other Matters – Intra-Island Long Distance Access Rate Dispute”. The reduction in revenues in 2004 also incorporates an adjustment of receivable balances reflecting billed activity. The prior periods amounts do not have a material impact in the financial statements.

     Cellular revenues for the year ended December 31, 2004 increased $9 million, or 5%, to $196 million from $187 million for the same period in 2003. For the year ended December 31, 2003 cellular revenues increased $14 million, or 8%, to $187 million compared to $173 million for the same period in 2002. These increases were mainly the result of an increase in the number of cellular customers due to attractive price plans and the implementation of marketing strategies to align the Company’s product and service offerings with those of Verizon Wireless in the United States.

CONSOLIDATED OPERATING EXPENSES

     Consolidated operating expenses for the year ended December 31, 2004 decreased $191 million, or 21%, to $730 million from $921 million for the same period in 2003. For the year ended December 31, 2003 consolidated operating expenses increased $129 million, or 16%, to $921 million from $792 million for the same period in 2002.

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     Labor and benefit expenses for the year ended December 31, 2004 decreased $15 million, or 4%, to $387 million from $402 million for the same period in 2003. This increase was mainly due to lower salary expense and expatriate expense as a result of the reduction in workforce and to a decrease in pension and OPEBs expenses mainly associated with the Company’s recognition of the impact of the federal subsidy under Medicare Drug Act of 2003 on the Company’s accumulated post-retirement benefit obligations and net post-retirement benefit costs in the third quarter of 2004. See note 9 to the audited consolidated financial statements. This decrease was partially offset by higher post-employment benefits.

     Labor and benefit expenses for the year ended December 31, 2003 increased $37 million, or 10%, to $402 million from $365 million for the same period in 2002, due to increases in pension and OPEBs expense recognition which resulted from a decrease in the rate of return on plan assets and in the discount rate applied. See note 9 to the audited consolidated financial statements.

     Other operating expenses for the year ended December 31, 2004 decreased $176 million, or 34%, to $343 million from $519 million for the same period in 2003, primarily due to the absence of the pre-tax reserve for the end-user and AT&T refund referred to in the February 2002 Order recognized during the quarter ended September 30, 2003 and the reversal of the reserve during year 2004. See “-Regulatory and Other Matters – Intra-Island Long Distance Access Rate Dispute.” Other factors contributing to the reduction were a decrease in bad debt expense due to the agreement with the PRDOE to settle the amounts owed out of court, and the absence of a cancelled project that required the write-off of the billing software system abandoned by the Company.

     For the year ended December 31, 2003, other operating expenses increased $92 million, or 22%, to $519 million from $427 for the same period in 2002. The increase was due to cancelled capital projects during 2003, which required the write-off of the billing software system abandoned by the Company and the establishment of the pre-tax reserve for the end-user and AT&T refund referred to in the TRB Resolution and Order of February 2002.

OTHER CONSOLIDATED RESULTS

Retirement and voluntary separation provisions

     In January 2004, 19 eligible management employees accepted the early retirement program offered by the Company in December 2003, which resulted in a provision of $1.6 million. During the fourth quarter of 2004, 24 eligible management employees accepted the voluntary separation program offered by the Company in October 2004, which resulted in a provision of $1.2 million.

     In January 2003, 29 eligible 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 eligible management employees, for which, a non-cash provision of $12.6 million was recorded relating to 147 employees who had accepted as of December 31, 2003.

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Depreciation and amortization expense

     Depreciation and amortization expense of $261 million for the year ended December 31, 2004 was $9 million, or 4%, higher than for the comparable 2003 period due to accelerated depreciation of the TDMA network resulting from management’s decision during 2003 to migrate all TDMA customers to the CDMA platform in 2004 and an increase in software amortization expense due to the implementation of various operational support systems.

     Depreciation and amortization expense of $252 million for the year ended December 31, 2003 was $10 million, or 4% lower, than for the comparable 2002 period. The decrease in depreciation and amortization expense was mainly due to a revision in wireline asset retirements and depreciation useful lives, which became effective July 1, 2002, reducing depreciation expense by $12 million for the year ended December 31, 2003, and to 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, net

     Interest expense of $43 million for the year ended December 31, 2004 was $10 million, or 19%, lower for the comparable 2003 period. The decrease was primarily due to the absence of $7 million of interest associated with the pre-tax reserve recognized during the same period in 2003 for the end-user and AT&T refund referred to in the February 2002 Order and the absence of $3 million of interest associated with the write-off for the billing software system abandoned by the Company during year ended December 31, 2003.

     Interest expense of $53 million for the year ended December 31, 2003 was $5 million higher than for the comparable 2002 period due to an additional $7 million in interest on the pre-tax reserve of $66 million established in September 2003 as a result of the TRB Resolution and Order of February 2002, an additional $3 million of interest associated with the write-off for the billing software system abandoned by the Company during year ended December 31, 2003, and a decrease of $3 million in the accretion of discount on subscription receivable, partially offset by a $10 million reduction in interests of bonds and banks debt related to a decrease in short term borrowings.

Equity income from joint venture

     The $2 million, $2 million, and $3 million equity income from joint venture for the year ended December 31, 2004, 2003, and 2002, respectively, were generated from our 24% interest in VISI, the largest yellow page publishing company in Puerto Rico.

Minority interest in consolidated subsidiary

     The $3 million, $2 million, and $1 million minority interest included in the Company’s results of operations for the year ended December 31, 2004, 2003, and 2002, respectively, reflects the 33% interest in Coqui.net, held by Popular, Inc., one of our shareholders.

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 than its carrying amount. Since the estimated fair value of $26 million is less 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

     The effective income tax rate is the provision for income taxes as a percentage of income before tax from continuing operations. A $67.8 million tax provision for the year ended December 31, 2004 reflects a 37.9% effective tax rate. The difference of $2 million between the effective and the statutory tax rate of 39%, primarily represents permanent differences related to recognition of equity income from the joint venture and amortization of tax deductible goodwill.

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     An $8 million tax provision for the year ended December 31, 2003 reflects a 32% effective tax rate. The difference between the effective tax rate 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 $21 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, we are required to exclude costs of removal from our depreciation rates for assets for which the removal costs exceed salvage value. Accordingly, in connection with the initial adoption of this standard on January 1, 2003, we have reversed accrued costs of removal in excess of salvage value from our accumulated depreciation accounts for these assets. The adjustment was recorded as a cumulative effect of an accounting change, resulting in the recognition of an estimated gain of $117 million ($71 million after tax). Effective January 1, 2003, we began expensing costs of removal in excess of salvage value for these assets in the period in which they are incurred.

     Effective January 1, 2003, the Company changed its method of accounting for revenues derived 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 was recognized as of January 1, 2003 as a one-time, non-cash loss of $17 million ($13 million, after tax).

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SEGMENT RESULTS OF OPERATIONS

     The Company has two reportable segments, Wireline and Wireless. See Note 17 to the unaudited condensed consolidated financial statements for additional information on the Company’s segments. Reclassifications of prior period’s data have been made to conform to the current period’s presentation.

     The Wireline segment consists of:

	•	Local services, including basic voice, telephone and telecommunications equipment rentals, value-added services, high-speed data services, Internet access and public phone service;
	•	Long distance services including direct dial on-island and off-island, operator assisted calls, and prepaid calling card;
	•	Access services to long distance carriers, competitive local exchange carriers, and wireless operators for originating and terminating calls on the Company’s network;
	•	Directory publishing rights services; and
	•	Telecommunication equipment sales and billing and collection services to competing long distance operators in Puerto Rico.
	The Wireless segment consists of:
	•	Postpaid and Prepaid services; and
	•	Wireless equipment sales.

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RESULTS OF OPERATIONS REVENUE WIRELINE

     OPERATING DATA

     Wireline revenues include local service, network access, long distance, directory and other revenues. For the year ended December 31, 2004, wireline revenues decreased $85 million, or 8%, to $1,004 million from $1,089 million for the same period in 2003. For the year ended December 31, 2003 decreased $39 million, or 3%, to $1,089 million from $1,128 million in 2002.

Local Services

     Local service revenues include revenues from basic voice, telephone and telecommunications equipment rental, value-added services, high-speed private line services, Internet access, and public phone service. Local service revenues for the year ended December 31, 2004 decreased $16 million, or 3%, to $596 million from $612 million for the comparable 2003 period. The decrease is due to decreased revenues from local voice services of $31 million partially offset by increased revenues from local data services of $15 million. The decrease in revenues from local voice services was driven mainly by fewer access lines, absence of touch tone charges, and decrease in business measured services. The increase in local data services was primarily driven by an increase in the number of customers requesting our high-speed special services and internet services, which resulted in a $21 million increase in both high-speed special services and internet service revenue, partially offset by absence of Edunet billing of $7 million.

     Local service revenues for the year ended December 31, 2003 decreased $1 million, or less than 1%, to $612 million from $613 million in 2002. The decrease is mainly due to decreased revenues from local voice services of $2 million driven by a decrease in revenues from basic voice of $4 million offset by an increase in deferred activation charges of $5 million.

Network Access

     Network access revenues include revenues from services provided to long distance carriers, competitive local exchange carriers, and cellular and paging operators to originate and terminate calls on our network. These revenues for the year ended December 31, 2004 decreased $25 million, or 8%, to $271 million compared to $296 million for the same 2003 period. The decrease was driven by a decrease in intra-island access revenues of $22 million due to the implementation of the phase rate reduction required by the TRB in the February 2002 Order, previously defined and included in the integrated plan.

     These revenues for the year ended December 31, 2003 decreased $35 million, or 11%, to $296 million compared to $331 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.

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Long Distance

     Long distance revenues include direct dial on-island and off-island, operator-assisted calls and prepaid calling cards revenues. Long distance revenues for the year ended December 31, 2004 decreased $48 million, or 42%, to $66 million from $114 million for the comparable 2003 period due to a decrease in intra-island long distance revenues as a result of the impact of the Extended Area Service (EAS) implementation and a decrease in long distance call volumes. The reduction in revenues in 2004 also incorporates an adjustment of receivable balances reflecting billed activity. The prior periods amounts do not have a material impact in the financial statements.

     Long distance revenues decreased $4 million, or 3%, to $114 million for the year ended December 31, 2003 from $118 million for the comparable 2002 period. The decrease was due to a decrease in intra-island long distance revenues of $8 million, which decrease was partially offset by an increase in prepaid long distance card revenues of $2 million. Intra-island long distance revenues have decreased mainly due to customer traffic migration to the cellular network and general economic conditions.

Directory and Other

     Directory and other revenues include revenues from directory publishing rights, telecommunication equipment sales and billing and collection services provided to competing long distance operators in Puerto Rico. Directory and other revenues for the year ended December 31, 2004 increased $4 million, or 6%, to $71 million from $67 million for the same period in 2003 due to an increase in late payment fees of $7 million, which was partially offset by a decrease in billing and collections revenues of $3 million.

     Directory and other revenues for the year ended December 31, 2003 increased $1 million, or 2%, to $67 million from $66 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.

RESULTS OF OPERATIONS EXPENSE WIRELINE

     Wireline expenses for the year ended December 31, 2004 decreased $203 million, or 26%, to $564 million from $767 million for the same period in 2003. Wireline expenses for the year ended December 31, 2003 increased $106 million, or 16%, to $767 from the $661 million reported for the same period in 2002.

Labor and benefits

     Labor and benefit expenses for the year ended December 31, 2004 decreased $15 million, or 4%, to $355 million from $370 million for the same period in 2003, due to a decrease in pension and OPEB expenses of $13 million and a headcount reduction which resulted in a decrease in salary expenses of $8 million and a decrease in expatriate expenses of $4 million. This decrease was partially offset by higher post-retirement benefits of $9 million.

     Labor and benefit expenses for the year ended December 31, 2003 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.

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Other operating expenses

     Other operating expenses for the year ended December 31, 2004 decreased $188 million, or 47%, to $209 million from $397 for the same period in 2003. The decrease was due to the fact that the 2003 results included $29 million associated with the write-off of the billing software system, which was abandoned by the Company and recognized for the year ended December 31, 2003, and to a $66 million pretax reserve for the end user and AT&T refund previously referred to. Of the latter reserve, $43 million was reversed during the year ended December 30, 2004. See “-Regulatory and Other Matters – Intra-Island Long Distance Access Rate Dispute.” Two other changes contributed to the reduction in expenses: a decrease in management fees of $12 million as the Verizon Management and Technology License Agreements expired on March 2, 2004 and were replaced by a new Service Agreement and a decrease in bad debt expense of $38 million due to a settlement with the PRDOE regarding amounts owed. See “-Regulatory and Other Matters – Puerto Rico Department of Education (The “PRDOE”) Debt.”

     Other operating expenses of $397 million for the year ended December 31, 2003, increased $70 million, or 21%, compared to the same period in 2002. The increase is due to cancelled capital projects of $29 million, which required the write-off of 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 February 2002 Order 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 value. Effective January 1, 2003, we began expensing costs of removal in excess of salvage value for these assets in the period in which they are 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.

RESULTS OF OPERATIONS REVENUE WIRELESS

     OPERATING DATA

     Revenues from cellular services and related equipment sales for the year ended December 31, 2004 increased $24 million, or 12%, to $226 million from $202 million for the comparable 2003 period. Revenues from cellular services and related equipment sales for the year ended December 31, 2003, increased $15 million, or 8%, to $202 million from $187 million reported for the year ended December 31, 2002.

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Cellular Services

     Cellular service revenues for the year ended December 31, 2004 increased $11 million, or 6%, to $199 million from $188 million for the same period in 2003. This increase was primarily the result of an increase of 50,000 post paid cellular customers for 2004 compared to the same period in 2003 due to attractive price plans and the implementation of marketing strategies to align the Company’s product and service offerings with those of Verizon Wireless in the United States.

     Revenues from cellular services for the year ended December 31, 2003 increased $13 million, or 7%, to $188 million from $175 million for 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 United States.

Long Distance

     On April 2004, PRTC and PRTLD entered into a reseller agreement regarding long distance revenues generated by cellular customers, resulting in revenue of $5 million during year 2004.

Paging Revenues

     Paging revenues declined $1 million and $4 million for the year ended December 31, 2004 and 2003, respectively. 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

     Revenues from wireless equipment sales increased $9 million, or 64%, to $22 million for the year ended December 31, 2004 from $13 million for the comparable 2003 period. These increases are the result of postpaid contract renewals.

     Wireless equipment sales increased $6 million, or 91%, 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.

RESULTS OF OPERATIONS EXPENSE WIRELESS

     Wireless expenses for the year ended December 31, 2004 increased $18 million, or 11%, to $182 million from $164 million for the same period in 2003. Wireless expenses for the year ended December 31, 2003, increased $18 million, or 12%, to $164 million from $146 million reported for the year ended December 31, 2002.

Labor and benefits

     Labor and benefit expenses for the year ended December 31, 2004 and 2003 were constant at $32 million.

     Labor and benefit expenses for the year ended December 31,2003 increased $1 million, or 3%, to $32 million from the $31 million reported for the year ended December 31, 2002. The increase in labor and benefits expenses is mainly due to higher contractor expenses.

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Other operating expenses

     Other operating expenses for the year ended December 31, 2004 increased $18 million, or 14%, to $150 million from $132 million for the comparable 2003 period. The increase was due to a higher subsidy on equipment sales of $12 million, higher bad debt expense of $3 million, and higher network management fees of $2 million.

     Other operating expenses increased $17 million, or 15%, to $132 million from the $115 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 and higher inventory obsolescence expense of $2 million.

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LIQUIDITY AND CAPITAL RESOURCES

CONSOLIDATED FINANCIAL CONDITION

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, 2004 by $108 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.

     On March 1, 2005, the Company entered into a new unsecured, undrawn $400 million 364-day revolving credit facility, which matures in March 2006 and replaced the prior undrawn facility which matured on March 2, 2005. The Company also has an undrawn $40 million working capital credit facility, which matures on June 29, 2005 and replaced the prior facility which matured in June 2004. See Note 11 to the unaudited condensed consolidated financial statements for more detailed information. During the year ended December 31, 2002, we refinanced our 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. For year ended December 31, 2004, net cash provided by operating activities was $289 million compared to $357 million for the same period in 2003. The $68 million decrease was primarily due to higher pension contributions of $55 million, which are part of management’s strategy to fully fund the pension plans by 2007 and higher OPEBs disbursements of $4 million associated with the Company’s recognition of the effects of the Medicare Drug Act of 2003.

     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 management’s strategy to fully fund the pension plans by 2007.

INVESTING

     Net cash used in investing activities for the year ended December 31, 2004 was $166 million compared to $170 million for the same period in 2003. The $4 million decrease in net cash used in investing activities was due to a $3 million 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, offset by $1 million decrease in proceeds from the sale of buildings in 2003.

     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 in the period in which they are incurred.

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     We have invested approximately $1.2 billion from the date of the Acquisition through December 31, 2004 to expand and enhance our networks. Our planned capital expenditures for 2005 are approximately $155 million, which we expect to finance with internally generated funds.

FINANCING

     Net cash used in financing activities for the year ended December 31, 2004 and 2003 was $81 million and $198 million, respectively. We reduced outstanding debt, including capital leases by $60 million for the year ended December 30, 2004 and by $170 million for the year ended December 31, 2003. Borrowings under term credit facilities, working capital facilities and commercial paper decreased from $153 million at December 31, 2003 to $93 million at December 31, 2004 and from $324 million at December 31, 2002 to $153 million at December 30, 2003. 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 the year ended December 31, 2004, the Company prepaid $30 million of principal of term loans, reducing the outstanding balance to $93 million at December 31, 2004. During the year ended December 31, 2003, the Company prepaid $102 million of principal of term loans, reducing the outstanding balance to $123 million at December 31, 2003 and reduced the interest rate thereon to 70 basis points over LIBOR.

     In connection with 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 under funded pension and other post-employment benefit obligations. In March 2004, the Company received the fifth and final $40 million installment in cash from PRTA. See Note 15 to the unaudited condensed consolidated financial statements for more information.

     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, 2004, the Company paid dividends amounting to $62 million corresponding to the first, second, and third quarters of 2004. 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. The senior note indentures and credit facility agreements do not contain restrictions on the payment of dividends.

OFF-BALANCE SHEET ARRANGEMENTS

The Company currently does not have any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS

The following table provides a summary of our contractual obligations and commercial commitments at December 31, 2004. 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 has been primarily directed at meeting challenges in maintaining support for local exchange rates and Universal Service while effecting the rate rebalancing and restructuring required by an increasingly competitive environment. Among the issues generating regulatory activity are the expansion of local calling areas, local number portability requirements, interconnection agreements, the FCC’s triennial review and the elimination of reverse toll billing.

     We have continued to meet the wholesale requirements of new competitors and have signed agreements with wireless and wireline carriers. These agreements permit carriers to purchase unbundled network elements, resell retail services, and 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 on the Company’s network.

     The February 2002 Order required 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 go into effect on April 1^st 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 for the period April 1, 2000 through March 31, 2002. The refund can be made in 12 quarterly, equal installments starting 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 to make the cash refund.

     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 that the Court to order the rate reduction without a phase-in period, remand the case back to the TRB and direct the TRB to calculate the refund from and after April 1997 instead of April 2000, with the Carriers receiving the refund instead of the 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 submitting the case for final adjudication. On August 19, 2003, the Court issued its final decision on the proceeding confirming the February 2002 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 request. As a result of the Court’s decision, the Company established a pre-tax reserve of $73 million, including interest, in September 2003 (3rd quarter) 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 of certiorari before the Puerto Rico Supreme Court (“the Supreme Court”) challenging the $68 million refund portion of the February 2002 Order. The phased-rate reduction portion of the February 2002 Order was settled with the major carriers. See “Carrier Access Billing”.

     In November 2003, the Company proposed, and two members of the TRB indicated their support for, a plan to revise the TRB’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

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was reduced from 9.3 cents to 6.5 cents on January 1, 2004 and will continue to decrease in accordance with the TRB phase reduction schedule, which will end on April 1, 2005. In addition, 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 in February 2004, coupled with the deferred implementation of a flat charge designed to offset the resulting revenue losses. The plan included a number of other elements benefiting consumers, including the 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 of approximately $14 million, and a commitment not to raise residential rates through December 2006 without providing certain information to the TRB in advance. The 2003 cash flow impact was a reduction of $16 million to the pre-tax reserve associated with one of the two one-time single line credits.

     On February 4, 2004, Centennial filed with the Supreme Court an opposition to PRTC’s request that the Court hold the case in abeyance until the TRB issued a Resolution and Order confirming the commitments negotiated in November 2003. On April 6, 2004, Centennial filed a motion requesting dismissal of the case, arguing that the settlement between the TRB and PRTC rendered the case moot. In the alternative, Centennial also argued that the TRB lacked jurisdiction to modify the end-user refund order, pending the petition for certiorari before the Supreme Court. Centennial claimed that the commitment negotiated in November 2003 with respect to the $68 million refund was null and void. On April 15, 2004, PRTC responded to and opposed Centennial’s filing.

     On April 23, 2004, PRTC and Centennial entered into a settlement agreement and on April 29, 2004, jointly filed a motion with the Supreme Court informing the Supreme Court of the settlement. Centennial withdrew its opposition to PRTC’s petition and on April 30, 2004, the Puerto Rico Supreme Court issued a Resolution denying PRTC’s petition for certiorari on the grounds of that the issue was moot.

     As a result of the TRB’s support of the revision to the end-user refund order through agreed rate reductions and consolidation of calling areas, the final settlement of carrier access rate disputes and the Supreme Court resolution rendering the litigation moot; the Company revised the pre-established contingency at $14 million, associated with the expected June 2005 single line credit.

EXTENDED AREA SERVICE (EAS) LOCAL CALLING ZONE DISPUTE

     In December 2003, AT&T and Sprint, (later followed by TLD) challenged PRTC’s actions in implementing the reduction of calling areas before the TRB, and sought an injunction to further reductions in the number of calling areas. PRTC has opposed the request for the injunction and intends to fulfill its commitments to the TRB. The TRB considered the matter in hearings held on April 28 and 30 and on May 3, 2004 and determined that the carriers’ request for injunctive relief should not proceed. The TRB allowed PRTC to implement its EAS Phase IV as scheduled on May 4, 2004 and ordered PRTC to sustain from further EAS implementation until an expedited investigation process had been completed.

     On May 6, 2004, PRTC submitted to the TRB and to the carriers a proposed expedited schedule in an effort to resolve the investigation prior to the next phase of the EAS implementation, which was scheduled for June 7, 2004 and covered Puerto Rico’s metro area. A hearing on the investigation was held on June 2, 2004.

     After the hearing, the TRB terminated the stay it had issued and allowed PRTC to continue to the next phase of the EAS implementation, subject to the satisfaction of certain customer information and data collection requirements relating to the impact of the EAS implementation on measured service customers. On June 7, 2004, the TRB allowed the Company to continue with the implementation of the metro area zone, which is the largest zone.

     As a result of the TRB’s determination subsequent to the hearing of June 2, 2004, the Company reduced the reserve originally established in September 2003 to $14 million.

     On July 8, 2004, the TRB issued a Resolution and Order initiating the investigation process regarding the EAS implementation impact on measured service customers. The TRB ordered PRTC to submit monthly reports that would reflect the impact on measured service customers. PRTC complied with the filing of the first two reports on September 7 and October 7, 2004. PRTC is also required to file a report on its customer information program with respect to EAS on that date.

     On September 20 and September 22, 2004, AT&T and Sprint filed a motion requesting authorization to amend the complaint and to obtain discovery from PRTC. On October 4, 2004, PRTC filed a motion opposing both motions. A resolution on both motions is pending.

     As of October 4, 2004, PRTC had completed all phases of its EAS implementation program.

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     However, on October 21, 2004, AT&T and Sprint, made a joint filing before the TRB requesting the initiation of a rulemaking proceeding for PRT’s new local calling zones. This request for rule-making aims to obstruct any future local zone reductions by PRTC. On December 1, 2004, PRT submitted its opposition to the petition.

CARRIER ACCESS BILLING

     During the first and second quarters of 2003, certain carriers made a series of billing claims against 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 Company does not believe that the impact of these settlements will have a material effect on the Company’s results of operations.

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 lawsuit against us in the United States District Court of Puerto Rico, claiming predatory, exclusionary and anticompetitive acts and seeking $75 million in damages. The Company filed a motion to dismiss the lawsuit which was largely denied by the Court on August 2004. The lawsuit is currently in the discovery stage and trial is scheduled to begin November 22, 2004. The Company’s management believes that TPPR’s claim is without merit.

     Pan American Telephone, Inc., Intouch Telecommunications, Inc., and Choicetel Communications, Inc., three other competitive providers of public pay phones in Puerto Rico, also filed a similar lawsuit against us in the United States District Court of Puerto Rico on September 4, 2002 on the same grounds. On November 8, 2002, we filed a motion to dismiss the lawsuit and/or in the alternative to consolidate the lawsuit with TPPR’s lawsuit. The Court denied the motion to dismiss without prejudice. On September 7, 2004, the parties filed a joint motion for dismissal with prejudice after reaching a settlement agreement, which put an end to all claims and controversies between them in the proceeding. On January 13, 2005, the Court dismissed the case with prejudice for lack of prosecution.

     On August 16, 2002, PSA, the parent company of Phoenix of Puerto Rico, filed a lawsuit against PRTC in the United States Bankruptcy Court for 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 claim for over $9 million from PRTC. PRTC’s motion to change venue to Puerto Rico was granted by the United States District Court of Delaware and the motion to dismiss is currently pending before the United States District Court of Puerto Rico. On September 24, 2004, the Court issued an Opinion and Order granting PRTC’s motion to dismiss.

PUERTO RICO DEPARTMENT OF EDUCATION (THE “PRDOE”) DEBT

     On June 30, 2003, PRTC filed a complaint against the PRDOE with the Puerto Rico Superior Court, seeking collection of fees due for services rendered under the PRDOE’s 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 contracted services to the PRDOE. Based on PRTC’s review of its services rendered under the Reeducate Program, the outstanding amount that PRDOE currently owes to PRTC is $34 million. Under the E-Rate program, 89% of this amount is to be paid by the FCC’s School & Libraries Division (“SLD”), which administers 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 we believe is approximately $1.2 million, after SLD paid its corresponding percentage (87%) under the program.

     On March 4, 2004, PRTC filed a motion to dismiss the complaint based on an agreement with the PRDOE to attempt to settle the amounts owed out of court. On March 24, 2004, the court dismissed the case without prejudice.

     In November 2003, the FCC directed SLD to audit the PRDOE’s compliance with the E-Rate program rules as well as billings for the Reeducate Program for years one through three of the program before the funds will be released. The audit of the PRDOE began on May 15, 2004. The auditor has contacted PRTC and PRTC is cooperating with the audit. There is no scheduled timetable for the completion of the audit process. Upon completion of that audit, SLD will determine if there is a need to recover any, or all, of the funds that were distributed during those years to the PRDOE and its vendors, including PRTC.

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     On June 17, 2004, the United States House Energy and Commerce Committee Subcommittee on Oversight and Investigations held a hearing entitled “Problems with the E-Rate Program: Waste, Fraud, and Abuse Concerns in the Wiring of Our Nation’s School’s to the Internet”. Representatives from PRTC, as well as representatives from the PRDOE testified at the hearing. This hearing was one of a series of ongoing hearings focused on the E-Rate program.

     At the beginning of July, 2004, the Universal Service Administrative Company (USAC), the E-Rate program’s administrator commenced the audit directed by the FCC. The audit was divided into two time periods: Years 1 to 3 (1999 to June 2001) and Years 4 and 5 (July 2001 to June 2003). PRTC has been providing information with respect to contracts, billing, payments and the network designed and installed by PRTC, and service levels provided in response to requests from the auditors.

     On July 30, 2004, the FCC released its Fourth Report and Order addressing the manner in which funds would be recovered under the E-Rate program. On August 13, 2004, the FCC released its Fifth Report and Order (Order) in the same proceeding adopting measures to address issues raised in the audit conducted as part of ongoing oversight of the schools and libraries support mechanisms and program concerns noted by its Office of Inspector General. Based on the standards established by the FCC, PRTC does not believe that amounts it has received from the E-Rate program are subject to recovery. PRTC is implementing procedures to ensure compliance with the requirements established by the Order.

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 Rico Class Action Act of 1971. The plaintiffs have claimed that the Company’s charges for touchtone service are not based on cost, and therefore violate of the Act. The plaintiffs have requested that the Superior 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 answer to the complaint and requested dismissal 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 to initiate discovery.

     A status conference was held on April 30, 2004 and the Superior Court ruled that at this stage of the proceedings the discovery process would be addressed, but not limited to the determination of the class.

     On June 28, 2004, a second hearing was held. During this hearing PRTC was ordered to submit responses to the plaintiffs’ request for admissions and to their first and second sets of interrogatories. PRTC submitted its responses to the plaintiffs’ request for admissions and to their first and second sets of interrogatories on July 6 and July 16, 2004, respectively. However, these responses were limited to the issue of class certifications, and the interrogatories and requests for admissions relating to the merits of the case were objected and a protective order was requested. The Superior Court denied PRTC’s requests and ordered full responses. On July 16, 2004, PRTC filed a writ of certiorari with the Puerto Rico Court of Appeals seeking reversal of the Superior Court’s order allowing discovery concerning the merits of the case before the class certification issue is resolved. On October 13, 2004, plaintiffs filed a motion opposing PRTC’s writ of certiorari. A determination is pending before the Court of Appeals.

     On October 8, 2004, plaintiffs filed with the Superior Court a motion requesting the dismissal and substitution of one of the plaintiffs.

     The PR Court of Appeals denied PRTC’s writ of certiorari requesting the reversal of a Superior Court order allowing unlimited discovery. PRTC had intended to limit discovery to the class certification issue.

     On November 15, 2004, the Superior Court held an evidentiary hearing in order to determine if this case will be certified as a class action. Even though the Court has not yet reached a determination, at the hearing, the Judge ordered PRTC to comply with the plaintiffs’ merits discovery requests and PRTC has now done so.

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

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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.

     In the February 2002 Order, the TRB provided that any prospective rate increase must first be applied against the gain from the wireless asset transfer, equating to $56 million applicable to intrastate. We plan to contest this position on the grounds 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.

     Currently, the TRB is performing an agreed upon procedures audit, which includes an audit of the CTI asset transfer. The audit is in the field work stage. While we believe that the resolution of this matter and any related proceedings will not have a material impact on the Company’s financial condition and results of operations, we cannot predict the effect of any further regulatory actions.

PRICE CAP REGULATION

     Under the FCC’s “all or nothing” rule, telecommunications carriers that set interstate access rates based on a price cap formula are required to use the price cap formula for all of their affiliates. The price cap formula is based on a plan adopted by the FCC called the Coalition of Affordable Local and Long Distance Service (“CALLS”), which uses rate-of-return as a basis for setting rates. The Company would have been required to implement price caps by March 2, 2000 under the FCC’s rules. Prior to March 2, 2000, the Company had set its interstate access rates based on rate-of-return principles.

     The FCC delayed conversion to price cap regulation until June 30, 2002, and the Company requested an 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. In addition, upon the issuance of an Order and Second Further Notice of Proposed Rulemaking (the “Order”) by the FCC on February 28, 2004, the FCC deferred further action on the all-or-nothing rule until it reviews the record compiled in response to the further notice included in the Order. Additionally, in the Order the FCC stated that all outstanding interim waivers of the all-or-nothing rule that depend on the FCC’s decision shall continue to be effective until the FCC issues a final order on this matter. As a result, the Company currently continues to set its interstate access rates based on rate-of-return principles.

     On May 10, 2004, PRTC filed comments in response to the Order, requesting that the FCC eliminate the “all or nothing rule” or, in the alternative, if the rule is not eliminated, that the FCC grant PRTC’s 1999 waiver request to permit PRTC to remain a carrier that sets its interstate access rates based on rate-of-return principles. The basis of PRTC’s request is that if PRTC were no longer eligible to receive Interstate Common Line Support (“ICLS”), PRTC would require $139 million in additional universal service support to offset lost ICLS revenues and that the CALLS plan cannot accommodate PRTC since there is a $650 million cap on the equivalent support in the CALLS plan, which was based on the anticipated universal service needs of price cap carriers that were participating in the plan at the time of its adoption. There has been no announcement regarding the expected timing for the completion of this proceeding.

INTERSTATE HIGH COST SUBSIDY

     On October 21, 1999, the FCC adopted a new high cost loop support mechanism for non-rural companies, which has resulted in the phase out of the Company’s high cost loop subsidy revenues. The Company is classified as a non-rural telephone company under the United States Telecommunications Act of 1996. The Company’s high cost loop revenues were $49 million in 2000, $33 million in 2001 and $4 million in 2002. On February 28, 2003, PRTC sent a letter to the FCC, requesting that the FCC take action to restore the high-cost loop universal service support that the Company lost due to FCC policies adopted for non-rural telephone companies and arguing that the non-rural telephone company mechanism is based on cost characteristics of mainland telephone companies. PRTC requested that the FCC address the loss of its high cost loop universal service support by adopting rules for insular areas that are similar to those applied to rural carriers. If rural carrier rules were applied to PRTC it would continue to receive high cost loop support as it had prior to the adoption of the FCC’s 1999 rules for non-rural telephone companies. On October 27, 2003, the FCC issued an order rejecting PRTC’s request for reconsideration of its classification as a non-rural carrier. However, the order did not address PRTC’s request to restore the high-cost universal service support based on the establishment of a new high cost loop support mechanism for insular carriers. On January 14, 2004, PRTC filed a petition for clarification and/or reconsideration of several

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portions of the FCC Order of October 27, 2003 on the grounds that the FCC has not acted upon the specific mandate of Section 254 to provide support for insular areas. No announcement has been made regarding the expected timing for addressing this issue.

     On November 29, 2004, the FCC released an Order on Reconsideration denying PRT’s petition. The Order, specifically mentioned that the FCC did not address PRTC’s petition of the Qwest Remand Order (filed on January 2004), or its ex-parte request on February 2003 seeking the adoption of a non-rural insular mechanism.

WORLDNET ARBITRATION PROCEEDING

     Recently, an arbitrator resolved a dispute related to an interconnection contract between PRTC and WorldNet and rendered a decision which, among other things, requires PRTC to agree to contract terms establishing numerous service quality metrics, liquidated damages provisions, reduced prices for certain network elements, continuation of wholesale discounts, certain Operational Support System parity standards, and certain requirements with respect to bundled services. PRTC is examining the impact of this decision. In accordance with the applicable arbitration rules, the parties have executed and filed the arbitrated contract with the TRB.

     On June 7, 2004, PRTC filed a request for reconsideration of the TRB’s Resolution and Order adopting the arbitrator’s decision and a request for a stay of the new interconnection agreement until the reconsideration was finally resolved. WorldNet also filed a request for reconsideration. On June 17, 2004, the TRB issued a Resolution and Order accepting both motions for reconsideration and notified the parties that a final decision on both motions would be issued within ninety days from the date of the filing, (i.e., by September 7, 2004). On June 25, 2004, PRTC’s motion for a stay was granted.

     On September 7, 2004, the TRB issued an Order on Reconsideration requiring PRTC and WorldNet to submit a revised interconnection agreement by October 22, 2004, which was subsequently extended to October 29, 2004. The new agreement must be implemented within a period of six (6) months following the date on which it is filed with the TRB.

     PRTC believes that some of the TRB’s determinations in the Order on Reconsideration are contrary to law, and on October 7, 2004, filed before the Federal District Court for the District of Puerto Rico an appeal of the TRB’s Order on Reconsideration of September 7, 2004. In addition, we filed an emergency motion for a partial stay of the Order with the TRB. Worldnet has also appealed the TRB’s Order of September 7, 2004 to the Federal District Court for the District of Puerto Rico.

     On November 12, 2004, PRTC and WorldNet completed the negotiations for a conforming interconnection and commercial agreement. The conforming interconnection agreement was submitted to the TRB for approval on November 12, 2004. On November 23, 2004, the TRB approved the agreement.

     Both petitions were consolidated by the Court on October 21, 2004. The TRB requested a remand on the bundling issue. A remand hearing was held on November 12, 2004. The parties notified the Court of the agreement reached and the Court approved the agreement. The agreement consisted of a remand order of the bundling controversy to the TRB. All the other issues will be considered by the Court through the filing of summary judgment by the parties which were due on January 14, 2005.

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 and industry conditions in Puerto Rico, and labor matters, including workforce levels and labor negotiations, and any resulting financial and/or operational impact, in the markets served by us;; (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

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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.

     Although the Company believes the expectations reflected in its forward-looking statements are reasonable, the Company cannot guarantee its future performance or results of operations. All forward-looking statements in this filing are based on information available to the Company on the date of this filing; however, the Company is not obligated to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The risks described above and elsewhere in this report, including in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” should be considered when reading any forward-looking statements in this filing. Given these uncertainties and risks, the reader should not place undue reliance on these forward-looking statements.

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, 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 provided by law, the Puerto Rico Treasury Department is currently conducting an ordinary audit of our corporate income tax returns. We do not expect the results of this audit to have a material impact on the Company’s financial condition and result of operations.

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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.

The Company’s depreciation expense is based on the composite group remaining life method using straight-line composite rates. This method provides for the recognition of the cost of the remaining net investment in telephone plant over the remaining asset lives. This method also requires a periodic evaluation of the average remaining useful lives related to the expected recoverability of the carrying value of assets based on changes in technology, environmental factors, the federal and local regulatory environment, industry and other competitive forces. Effective July 1, 2002, the Company revised its accounting estimates relating to depreciation based on a detailed review of the lives underlying the depreciation rates. The depreciation rate revisions reflect expected useful lives resulting from the impact of technology and future competition and more closely approximate the assumptions used by other telephone companies. These revisions resulted in a decrease in depreciation expense of approximately $12 million for the year ended December 31, 2003. Effective July 2004, the Company revised its plant useful lives estimates based on a detailed review of the lives underlying the depreciation rates. The revision resulted in a decrease in depreciation expense by approximately $3.3 million for the year 2004. Refer to Note 4 to the consolidated financial statements for further details.

The Company revised the method to calculate the composite useful lives to be consistent with the current depreciation study.

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, 2004, 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, 2004, the Company determined this rate to be 5.75%, 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, 2004, we assumed a discount rate of 5.75%, 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.

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 changes in the interest rates on our senior notes and interest rate swap agreements.

     The following table summarizes the fair value of our senior notes and interest rate swap agreements at December 31, 2004 and December 31, 2003 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 they are 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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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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, 2004 and 2003, 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 15 for the years ended December 31, 2004 and 2003. 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 the standards of the Public Company Accounting Oversight Board (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. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Telecomunicaciones de Puerto Rico, Inc. and subsidiaries as of December 31, 2004 and 2003, 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

March 11, 2005

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Telecomunicaciones de Puerto Rico, Inc. and Subsidiaries