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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

(Mark one)
        x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
     OF THE SECURITIES EXCHANGE ACT OF 1934
     For the quarterly period ended June 30, 2004

 

OR

 

        ¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
     OF THE SECURITIES EXCHANGE ACT OF 1934
     For the transition period from              to

 

Commission file number 1-8606

 

Verizon Communications Inc.

(Exact name of registrant as specified in its charter)

 

Delaware   23-2259884
(State of Incorporation)   (I.R.S. Employer Identification No.)
     
1095 Avenue of the Americas   10036
New York, New York   (Zip Code)
(Address of principal executive offices)    

 

Registrant’s telephone number (212) 395-2121

 

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   ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes  þ  No   ¨

 

At June 30, 2004, 2,768,468,033 shares of the registrant’s Common Stock were outstanding, after deducting 6,397,348 shares held in treasury.

 


 


Table of Contents

Table of Contents

 

          Page
Part I.    Financial Information     
Item 1.    Financial Statements (Unaudited)     
      
    

Condensed Consolidated Statements of Income

For the three and six months ended June 30, 2004 and 2003

   1
    

Condensed Consolidated Balance Sheets

June 30, 2004 and December 31, 2003

   2
      
    

Condensed Consolidated Statements of Cash Flows

For the six months ended June 30, 2004 and 2003

   3
    

Notes to Condensed Consolidated Financial Statements

   4
      
Item 2.    Management’s Discussion and Analysis of Results of Operations
and Financial Condition
   20
Item 3.    Quantitative and Qualitative Disclosures About Market Risk    40
      
Item 4.    Controls and Procedures    40
Part II.    Other Information     
      
Item 2.    Changes in Securities and Use of Proceeds    41
Item 4.    Submission of Matters to a Vote of Security Holders    42
      
Item 6.    Exhibits and Reports on Form 8-K    43
           
Signature    44
      
Certifications     


Table of Contents

Part I – Financial Information

 

Item 1. Financial Statements


 

Condensed Consolidated Statements of Income

Verizon Communications Inc. and Subsidiaries

 

     Three Months Ended June 30,        Six Months Ended June 30,  
(Dollars in Millions, Except Per Share Amounts) (Unaudited)    2004     2003        2004     2003  


Operating Revenues

   $ 17,838     $ 16,829        $ 34,974     $ 33,319  

Operating Expenses

                                   

Cost of services and sales (exclusive of items shown below)

     5,641       5,042          11,151       10,166  

Selling, general and administrative expense

     5,029       5,673          10,732       9,965  

Depreciation and amortization expense

     3,440       3,384          6,868       6,751  
    


Total Operating Expenses

     14,110       14,099          28,751       26,882  
                                     

Operating Income

     3,728       2,730          6,223       6,437  

Equity in earnings of unconsolidated businesses

     212       167          411       315  

Income from other unconsolidated businesses

           60          72       79  

Other income and (expense), net

     (2 )     (46 )        (36 )     11  

Interest expense

     (594 )     (692 )        (1,232 )     (1,447 )

Minority interest

     (676 )     (380 )        (1,153 )     (722 )
    


Income Before Provision For Income Taxes, Discontinued Operations and Cumulative Effect of Accounting Change

     2,668       1,839          4,285       4,673  

Provision for income taxes

     (871 )     (573 )        (1,289 )     (1,497 )
    


Income Before Discontinued Operations and Cumulative Effect of Accounting Change

     1,797       1,266          2,996       3,176  

Discontinued Operations

                                   

Loss from operations of Iusacell

           (952 )              (957 )

Income tax benefit

           24                22  
    


Loss on discontinued operations, net of tax

           (928 )              (935 )

Cumulative Effect of Accounting Change, Net of Tax

                          503  
    


Net Income

   $ 1,797     $ 338        $ 2,996     $ 2,744  
    


Basic Earnings Per Common Share(1)

                                   

Income before discontinued operations and cumulative effect of
accounting change

   $ .65     $ .46        $ 1.08     $ 1.15  

Loss on discontinued operations, net of tax

           (.34 )              (.34 )

Cumulative effect of accounting change, net of tax

                          .18  
    


Net Income

   $ .65     $ .12        $ 1.08     $ 1.00  
    


Weighted-average shares outstanding (in millions)

     2,770       2,754          2,770       2,751  
    


Diluted Earnings Per Common Share(1)

                                   

Income before discontinued operations and cumulative effect of
accounting change

   $ .64     $ .46        $ 1.07     $ 1.14  

Loss on discontinued operations, net of tax

           (.33 )              (.34 )

Cumulative effect of accounting change, net of tax

                          .18  
    


Net Income

   $ .64     $ .12        $ 1.07     $ .99  
    


Weighted-average shares outstanding (in millions)

     2,804       2,786          2,804       2,783  
    


Dividends declared per common share

   $ .385     $ .385        $ .77     $ .77  
    


 

(1) Total per share amounts may not add due to rounding.

 

See Notes to Condensed Consolidated Financial Statements

 

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Condensed Consolidated Balance Sheets

Verizon Communications Inc. and Subsidiaries

 

     At June 30,     At December 31,  
(Dollars in Millions, Except Per Share Amounts) (Unaudited)    2004     2003  


Assets

            

Current assets

            

Cash and cash equivalents

   $         608     $         699  

Short-term investments

   1,390     2,172  

Accounts receivable, net of allowances of $2,006 and $2,387

   9,618     9,905  

Inventories

   1,362     1,283  

Assets held for sale

   935      

Prepaid expenses and other

   3,482     4,234  
    

Total current assets

   17,395     18,293  
    

Plant, property and equipment

   181,437     180,975  

Less accumulated depreciation

   107,896     105,659  
    

     73,541     75,316  
    

Investments in unconsolidated businesses

   5,679     5,789  

Wireless licenses

   41,075     40,907  

Goodwill

   1,364     1,389  

Other intangible assets, net

   4,478     4,733  

Other assets

   18,906     19,541  
    

Total assets

   $  162,438     $  165,968  
    

Liabilities and Shareowners’ Investment

            

Current liabilities

            

Debt maturing within one year

   $      4,439     $      5,967  

Accounts payable and accrued liabilities

   12,491     14,699  

Liabilities related to assets held for sale

   502      

Other

   5,941     5,904  
    

Total current liabilities

   23,373     26,570  
    

Long-term debt

   37,449     39,413  

Employee benefit obligations

   17,255     16,759  

Deferred income taxes

   21,876     21,708  

Other liabilities

   3,565     3,704  

Minority interest

   24,821     24,348  

Shareowners’ investment

            

Series preferred stock ($.10 par value; none issued)

        

Common stock ($.10 par value; 2,774,865,381 shares and 2,772,313,619 shares issued)

   277     277  

Contributed capital

   25,461     25,363  

Reinvested earnings

   10,275     9,409  

Accumulated other comprehensive loss

   (1,669 )   (1,250 )
    

     34,344     33,799  

Less common stock in treasury, at cost

   180     115  

Less deferred compensation – employee stock ownership plans and other

   65     218  
    

Total shareowners’ investment

   34,099     33,466  
    

Total liabilities and shareowners’ investment

   $  162,438     $  165,968  
    

 

See Notes to Condensed Consolidated Financial Statements

 

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Condensed Consolidated Statements of Cash Flows

Verizon Communications Inc. and Subsidiaries

 

     Six Months Ended June 30,  
(Dollars in Millions) (Unaudited)    2004     2003  


Cash Flows from Operating Activities

                

Income before discontinued operations and cumulative effect of accounting change

   $ 2,996     $ 3,176  

Adjustments to reconcile income before discontinued operations and cumulative effect of accounting change to net cash provided by operating activities:

                

Depreciation and amortization

     6,868       6,751  

Employee retirement benefits

     1,412       170  

Deferred income taxes

     473       752  

Provision for uncollectible accounts

     512       904  

Income from unconsolidated businesses

     (483 )     (394 )

Changes in current assets and liabilities, net of effects from acquisition/disposition of businesses

     (2,325 )     (134 )

Other, net

     438       (256 )
    


Net cash provided by operating activities

     9,891       10,969  
    


                  

Cash Flows from Investing Activities

                

Capital expenditures (including capitalized software)

     (5,827 )     (5,294 )

Acquisitions, net of cash acquired, and investments

     (55 )     (1,033 )

Proceeds from disposition of businesses

     117        

Net change in short-term investments

     759       1,145  

Other, net

     247       98  
    


Net cash used in investing activities

     (4,759 )     (5,084 )
    


                  

Cash Flows from Financing Activities

                

Proceeds from long-term borrowings

     500       2,815  

Repayments of long-term borrowings and capital lease obligations

     (4,765 )     (8,573 )

Increase in short-term obligations, excluding current maturities

     1,254       1,109  

Dividends paid

     (2,131 )     (2,115 )

Proceeds from sale of common stock

     91       471  

Other, net

     (172 )     (194 )
    


Net cash used in financing activities

     (5,223 )     (6,487 )
    


Decrease in cash and cash equivalents

     (91 )     (602 )

Cash and cash equivalents, beginning of period

     699       1,422  
    


Cash and cash equivalents, end of period

   $ 608     $ 820  
    


 

See Notes to Condensed Consolidated Financial Statements

 

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Notes to Condensed Consolidated Financial Statements

Verizon Communications Inc. and Subsidiaries

(Unaudited)

 

1.    Basis of Presentation


 

The accompanying unaudited condensed consolidated financial statements have been prepared based upon Securities and Exchange Commission (SEC) rules that permit reduced disclosure for interim periods. These financial statements reflect all adjustments that are necessary for a fair presentation of results of operations and financial condition for the interim periods shown including normal recurring accruals and other items. The results for the interim periods are not necessarily indicative of results for the full year. For a more complete discussion of significant accounting policies and certain other information, you should refer to the financial statements included in the Verizon Communications Inc. (Verizon) Annual Report on Form 10-K for the year ended December 31, 2003.

 

2.    Accounting Changes


 

Directory Accounting Change

 

During 2003, we changed our method for recognizing revenues and expenses in our directory business from the publication-date method to the amortization method. The publication-date method recognizes revenues and direct expenses when directories are published. Under the amortization method, revenues and direct expenses, primarily printing and distribution costs, are recognized over the life of the directory, which is usually 12 months. This accounting change affected the timing of the recognition of revenues and expenses. As required by generally accepted accounting principles (GAAP), the directory accounting change was recorded effective January 1, 2003. The cumulative effect of the accounting change was a one-time charge of $2,697 million ($1,647 million after-tax).

 

Stock-Based Compensation

 

Effective January 1, 2003, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation,” using the prospective method (as permitted under SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure”) to all new awards granted, modified or settled after January 1, 2003. The following table illustrates the effect on net income and earnings per share if the fair value method had been applied to all outstanding and unvested options in each period.

 

     Three Months Ended June 30,      Six Months Ended June 30,  
(Dollars in Millions, Except Per Share Amounts)    2004     2003      2004     2003  


Net Income, As Reported

   $ 1,797     $  338      $ 2,996     $ 2,744  

Add: Stock option-related employee compensation expense included in reported net income, net of related tax effects

     13     8        26       16  

Deduct: Total stock option-related employee compensation expense determined under fair value based method for all awards, net of related tax effects

     (31 )   (51 )      (62 )     (102 )
    


Pro Forma Net Income

   $ 1,779     $  295      $ 2,960     $ 2,658  
    


                                 

Earnings Per Share

                               

Basic – as reported

   $ .65     $   .12      $ 1.08     $ 1.00  

Basic – pro forma

     .64     .11        1.07       .97  

Diluted – as reported

   $ .64     $   .12      $ 1.07     $ .99  

Diluted – pro forma

     .64     .11        1.06       .96  

 

After-tax compensation expense for other stock-based compensation included in net income as reported for the three and six months ended June 30, 2004 was $44 million and $95 million, respectively. For the three and six months ended June 30, 2003, after-tax compensation expense for other stock-based compensation included in net income as reported was $15 million and $32 million, respectively.

 

Asset Retirement Obligations

 

We adopted the provisions of SFAS No. 143, “Accounting for Asset Retirement Obligations” on January 1, 2003. SFAS No. 143 requires that companies recognize the fair value of a liability for asset retirement obligations in the period in which the obligations are incurred and capitalize that amount as part of the book value of the long-lived asset. We determined that Verizon does not have a material legal obligation to remove long-lived assets as described

 

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by this statement. However, prior to the adoption of SFAS No. 143, we included estimated removal costs in our group depreciation models. Consequently, in connection with the initial adoption of SFAS No. 143 we reversed accrued costs of removal in excess of salvage 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 a gain of $3,499 million ($2,150 million after-tax).

 

3.    Strategic Actions


 

Severance, Pension and Benefit Charges

 

During the second quarter of 2004, we recorded pretax pension settlement losses of $31 million ($19 million after-tax). In addition, during the first quarter of 2004, we recorded pretax pension settlement losses of $728 million ($446 million after-tax). These settlement losses related to employees that received lump-sum distributions during the quarter in connection with the previously announced voluntary separation plan under which more than 21,000 employees accepted the separation offer in the fourth quarter of 2003. These charges were recorded in accordance with SFAS No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits” which requires that settlement losses be recorded once prescribed payment thresholds have been reached.

 

During the second quarter of 2003 we recorded a special charge of $463 million ($286 million after-tax) in connection with enhanced pension benefits granted to employees retiring in the first half of 2003, estimated costs associated with the July 10, 2003 Verizon-New York arbitration ruling and pension settlement losses related to lump-sum pay-outs in 2003. On July 10, 2003, an arbitrator ruled that Verizon-New York’s termination of 2,300 employees in 2002 was not permitted under a union contract; similar cases were pending impacting an additional 1,100 employees. Verizon offered to reinstate all 3,400 impacted employees, and accordingly, recorded a charge in the second quarter of 2003 representing estimated payments to employees and other related company-paid costs.

 

In addition, in the second quarter of 2003 we recorded a special charge of $235 million ($150 million after-tax) primarily associated with employee severance costs and severance-related activities in connection with the voluntary separation of approximately 4,000 employees.

 

Other Special Items

 

In the second quarter of 2004, we recorded an expense credit of $204 million ($123 million after-tax) resulting from the favorable resolution of pre-bankruptcy amounts due from MCI. Previously reached settlement agreements became fully effective when MCI emerged from bankruptcy proceedings in the second quarter of 2004.

 

Also during the second quarter of 2004, we recorded a charge of $113 million ($87 million after-tax) related to operating asset losses pertaining to our international long distance and data network. In addition, we recorded pretax charges of $12 million ($7 million after-tax) during the current quarter in connection with the early retirement of debt. During the first quarter of 2004, we also recorded pretax charges of $43 million ($27 million after-tax) resulting from the early retirement of debt.

 

During the second quarter of 2003, we recorded other pretax charges of $258 million ($204 million after-tax) primarily related to a pretax impairment charge of $125 million ($125 million after-tax) pertaining to our leasing operations for airplanes leased to airlines that were experiencing financial difficulties and for power generating facilities. These second quarter 2003 charges also included pretax charges of $61 million ($38 million after-tax) pertaining to the early retirement of debt and other pretax charges of $72 million ($41 million after-tax).

 

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4.    Discontinued Operations


 

Discontinued operations represent the results of operations of Grupo Iusacell, S.A. de C.V. (Iusacell) prior to the sale of Iusacell in July 2003. In connection with the decision to sell our interest in Iusacell and a comparison of expected sale proceeds, less cost to sell, to the net book value of our investment in Iusacell (including the foreign currency translation balance), we recorded a pretax loss of $957 million ($931 million after-tax) in the second quarter of 2003. This loss included $317 million of goodwill. Summarized results of operations for Iusacell, which was part of our International segment, follows:

 

(Dollars in Millions)   Three Months Ended June 30,
2003
         Six Months Ended June 30,
2003
 


Income from operations of Iusacell before income taxes

  $ 5          $  

Investment loss

    (957 )          (957 )

Income tax benefit

    24            22  
   


Loss on discontinued operations, net of tax

  $ (928 )        $ (935 )
   


 

Included in income from operations of Iusacell before income taxes in the preceding table are operating revenues of $72 million and $181 million for the three and six months ended June 30, 2003, respectively.

 

5.    Marketable Securities and Other Investments


 

We have investments in marketable securities, primarily bonds and mutual funds, which are considered “available-for-sale” under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” These investments are included in our unaudited condensed consolidated balance sheets in Investments in Unconsolidated Businesses and Other Assets. Under SFAS No. 115, available-for-sale securities are required to be carried at their fair value, with unrealized gains and losses (net of income taxes) that are considered temporary in nature recorded in Accumulated Other Comprehensive Loss. The fair values of our investments in marketable securities are determined based on market quotations.

 

We continually evaluate our investments in marketable securities for impairment due to declines in market value considered to be other than temporary. That evaluation includes, in addition to persistent, declining stock prices, general economic and company-specific evaluations. In the event of a determination that a decline in market value is other than temporary, a charge to earnings is recorded in Income From Other Unconsolidated Businesses in the unaudited condensed consolidated statements of income for all or a portion of the unrealized loss, and a new cost basis in the investment is established. As of June 30, 2004, no impairments were determined to exist.

 

During the first quarter of 2004, we sold all of our investment in Iowa Telecom preferred stock, which resulted in a pretax gain of $43 million ($43 million after-tax) included in Income From Other Unconsolidated Businesses in the unaudited condensed consolidated statements of income. The preferred stock was received in 2000 in connection with the sale of access lines in Iowa.

 

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6.    Assets Held for Sale


 

During the second quarter of 2004, we announced an agreement with The Carlyle Group to sell our wireline-related businesses in Hawaii, including Verizon Hawaii Inc. which operates 707,000 switched access lines, as well as the services and assets of Verizon Long Distance, Verizon Online and Verizon Information Services in Hawaii, for $1,650 million in cash, less debt. The closing of the transaction, expected in 2005, is contingent on approvals from the Hawaii Public Utilities Commission, the Federal Communications Commission and the U.S. Department of Justice. As a result of this transaction, we have separately classified the assets held for sale and related liabilities in the unaudited condensed consolidated balance sheet at June 30, 2004. Additional detail of the assets held for sale, and related liabilities, follows:

 

(Dollars in Millions)    At June 30, 2004

Current assets

   $ 132

Plant, property and equipment, net

     783

Other non-current assets

     20
    

Total assets

   $ 935
    

Debt maturing within one year

   $ 125

Other current liabilities

     52

Long-term debt

     302

Other non-current liabilities

     23
    

Total liabilities

   $ 502
    

 

7.    Goodwill and Other Intangible Assets


 

Goodwill

 

Changes in the carrying amount of goodwill for the six months ended June 30, 2004 are as follows:

 

(Dollars in Millions)    Domestic
Telecom
   Domestic
Wireless
   Information
Services
    International     Corporate &
Other
   Total  


Balance at December 31, 2003

   $ 314    $    $ 631     $ 444     $    $ 1,389  

Goodwill reclassifications and other

               (24 )     (1 )          (25 )
    


Balance at June 30, 2004

   $ 314    $    $ 607     $ 443     $    $ 1,364  
    


 

Other Intangible Assets

 

The major components and average useful lives of our other intangible assets follows:

 

    

At June 30, 2004


   At December 31, 2003

(Dollars in Millions)    Gross Carrying
Amount
   Accumulated
Amortization
   Gross Carrying
Amount
   Accumulated
Amortization

Amortized intangible assets:

                         

Customer lists (4 to 7 years)

   $        3,441    $ 2,598    $ 3,441    $ 2,362

Non-network internal-use software (3 to 7 years)

   6,182      2,608      5,799      2,208

Other (2 to 30 years)

   89      28      86      23
    

Total

   $        9,712    $ 5,234    $ 9,326    $ 4,593
    

Unamortized intangible assets:

                         

Wireless licenses

   $      41,075           $ 40,907       
    
         

      

 

Intangible asset amortization expense was $348 million and $693 million for the three and six months ended June 30, 2004, respectively. For the three and six months ended June 30, 2003, intangible asset amortization expense was $350 million and $692 million, respectively. It is estimated to be $698 million for the remainder of 2004, $1,231 million in 2005, $815 million in 2006, $520 million in 2007 and $386 million in 2008, primarily related to customer lists and non-network internal-use software.

 

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8.    Debt


 

Debt Issuances/Redemptions

 

In March 2004, Verizon Global Funding Corp. (Verizon Global Funding) issued $500 million of 13-month floating rate exchangeable notes at par value. The notes may be exchanged periodically into similar notes until 2011.

 

On May 4, 2004, we redeemed Verizon California Inc. $250 million 8.07% debentures due April 15, 2024. During the first quarter of 2004, we redeemed several debt issuances: Verizon Virginia Inc. $125 million 7% debentures due July 15, 2025; Verizon New York Inc. $250 million 7% debentures due August 15, 2025; Verizon New York Inc. $450 million 7.25% debentures due February 15, 2024; and Verizon Florida Inc. $200 million 7.41% Series B debentures due December 15, 2023.

 

Support Agreements and Guarantees

 

All of Verizon Global Funding’s debt has the benefit of Support Agreements between us and Verizon Global Funding, which give holders of Verizon Global Funding debt the right to proceed directly against us for payment of interest, premium (if any) and principal outstanding should Verizon Global Funding fail to pay. The holders of Verizon Global Funding debt do not have recourse to the stock or assets of most of our telephone operations; however, they do have recourse to dividends paid to us by any of our consolidated subsidiaries as well as assets not covered by the exclusion. Verizon Global Funding’s long-term debt, including current portion, aggregated $13,821 million at June 30, 2004. The carrying value of the available assets reflected in our unaudited condensed consolidated balance sheets was approximately $56.8 billion at June 30, 2004.

 

Verizon and NYNEX Corporation are the joint and several co-obligors of the 20-Year 9.55% Debentures due 2010 previously issued by NYNEX on March 26, 1990. As of June 30, 2004, $145 million principal amount of this obligation remained outstanding. In addition, Verizon Global Funding has guaranteed the debt obligations of GTE Corporation (but not the debt of its subsidiary or affiliate companies) that were issued and outstanding prior to July 1, 2003. As of June 30, 2004, $3,594 million principal amount of these obligations remained outstanding. NYNEX and GTE no longer issue public debt or file SEC reports. See Note 13 for information on guarantees of subsidiary debt listed on the New York Stock Exchange.

 

Exchangeable Notes

 

Previously, Verizon Global Funding issued two series of notes: $2,455 million of 5.75% senior exchangeable notes due on April 1, 2003 that were exchangeable into shares of Telecom Corporation of New Zealand Limited (the 5.75% Notes) and $3,180 million of 4.25% senior exchangeable notes due on September 15, 2005 that, in connection with a restructuring of Cable & Wireless Communications plc in 2000 and the bankruptcy of NTL Incorporated (NTL) in 2002, were exchangeable into shares of Cable & Wireless plc and a combination of shares and warrants in the reorganized NTL entities (the 4.25% Notes).

 

On April 1, 2003, all of the outstanding $2,455 million principal amount of the 5.75% Notes were redeemed at maturity. On March 15, 2003, Verizon Global Funding redeemed all of the outstanding 4.25% Notes. The cash redemption price for the 4.25% Notes was $1,048.29 for each $1,000 principal amount of the notes. The principal amount of the 4.25% Notes outstanding, before unamortized discount, at the time of redemption, was $2,839 million.

 

Zero-Coupon Convertible Notes

 

Previously, Verizon Global Funding issued approximately $5.4 billion in principal amount at maturity of zero-coupon convertible notes due 2021 which are redeemable at the option of the holders on May 15th in each of the years 2004, 2006, 2011 and 2016. On May 15, 2004, $3,292 million of principal amount of the notes ($1,984 million after unamortized discount) were redeemed by Verizon Global Funding. As of June 30, 2004, the remaining zero-coupon convertible notes were classified as long-term since holders at their option will not be able to have Verizon Global Funding redeem them again until May 15, 2006.

 

Debt Covenants

 

Verizon and its consolidated subsidiaries are in compliance with all of their debt covenants.

 

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9.    Comprehensive Income


 

Comprehensive income consists of net income and other gains and losses affecting shareowners’ investment that, under GAAP, are excluded from net income.

 

Changes in the components of other comprehensive income (loss) are as follows:

 

     Three Months Ended June 30,    Six Months Ended June 30,  
(Dollars in Millions)    2004     2003    2004     2003  


Net Income

   $ 1,797     $ 338    $  2,996     $ 2,744  
    


Other Comprehensive Income (Loss), Net of Taxes

                             

Foreign currency translation adjustments

     (138 )     352    (389 )     380  

Unrealized gains (losses) on marketable securities

     (18 )     15    (6 )     10  

Unrealized derivative gains (losses) on cash flow hedges

     4       5    (17 )     (28 )

Minimum pension liability adjustment

     11       11    (7 )     (9 )
    


       (141 )     383    (419 )     353  
    


Total Comprehensive Income

   $ 1,656     $ 721    $  2,577     $ 3,097  
    


 

The unrealized foreign currency translation loss in 2004 is primarily driven by the devaluation of the functional currencies at our investments in Verizon Dominicana, C. por A. (Verizon Dominicana), Vodafone Omnitel N.V. (Vodafone Omnitel) and Compañia Anónima Nacional Teléfonos de Venezuela (CANTV). The foreign currency translation gain in 2003 is primarily driven by a reclassification of the foreign currency translation loss of Iusacell of $577 million in connection with the sale of Iusacell (see Note 4) and the favorable impact of the euro on our investment in Vodafone Omnitel, partially offset by unrealized foreign currency translation losses at Verizon Dominicana and CANTV.

 

The components of Accumulated Other Comprehensive Loss are as follows:

 

(Dollars in Millions)    At June 30, 2004     At December 31, 2003  


Foreign currency translation adjustments

   $ (1,049 )   $ (660 )

Unrealized gains on marketable securities

     18       24  

Unrealized derivative losses on cash flow hedges

     (71 )     (54 )

Minimum pension liability adjustment

     (567 )     (560 )
    


Accumulated other comprehensive loss

   $ (1,669 )   $ (1,250 )
    


 

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10.    Earnings Per Share


 

The following table is a reconciliation of the share amounts used in computing earnings per share.

 

     Three Months Ended June 30,        Six Months Ended June 30,  
(Dollars and Shares in Millions, Except Per Share Amounts)    2004    2003        2004    2003  


Net Income Used For Basic Earnings Per Common Share

                                 

Income before discontinued operations and cumulative effect of
accounting change

   $ 1,797    $ 1,266        $ 2,996    $ 3,176  

Loss on discontinued operations, net of tax

          (928 )             (935 )

Cumulative effect of accounting change, net of tax

                        503  
    


Net income

   $ 1,797    $ 338        $ 2,996    $ 2,744  
    


Net Income Used For Diluted Earnings Per Common Share

                                 

Income before discontinued operations and cumulative effect of
accounting change

   $ 1,797    $ 1,266        $ 2,996    $ 3,176  

After-tax minority interest expense related to exchangeable equity interest

     7      4          13      9  
    


Income before discontinued operations and cumulative effect of
accounting change – after assumed conversion of dilutive securities

     1,804      1,270          3,009      3,185  

Loss on discontinued operations, net of tax

          (928 )             (935 )

Cumulative effect of accounting change, net of tax

                        503  
    


Net income after assumed conversion of dilutive securities

   $ 1,804    $ 342        $ 3,009    $ 2,753  
    


Basic Earnings Per Common Share(1)

                                 

Weighted-average shares outstanding – basic

     2,770      2,754          2,770      2,751  
    


Income before discontinued operations and cumulative effect of
accounting change

   $ .65    $ .46        $ 1.08    $ 1.15  

Loss on discontinued operations, net of tax

          (.34 )             (.34 )

Cumulative effect of accounting change, net of tax

                        .18  
    


Net income

   $ .65    $ .12        $ 1.08    $ 1.00  
    


Diluted Earnings Per Common Share(1)

                                 

Weighted-average shares outstanding – basic

     2,770      2,754          2,770      2,751  

Effect of dilutive securities:

                                 

Stock options

     5      4          5      4  

Exchangeable equity interest

     29      28          29      28  
    


Weighted-average shares outstanding – diluted

     2,804      2,786          2,804      2,783  
    


Income before discontinued operations and cumulative effect of
accounting change

   $ .64    $ .46        $ 1.07    $ 1.14  

Loss on discontinued operations, net of tax

          (.33 )             (.34 )

Cumulative effect of accounting change, net of tax

                        .18  
    


Net income

   $ .64    $ .12        $ 1.07    $ .99  
    


 

(1)

Total per share amounts may not add due to rounding.

 

Stock options for 255 million shares for the three and six months ended June 30, 2004 were not included in the computation of diluted earnings per share because the exercise price of stock options was greater than the average market price of the common stock. For the three and six months ended June 30, 2003, the number of shares not included in the computation of diluted earnings per share was 246 million.

 

11.     Segment Information


 

We have four reportable segments, which we operate and manage as strategic business units and organize by products and services. Our segments include a Domestic Telecom group which provides domestic wireline communications services; a Domestic Wireless group which provides domestic wireless communications services; an Information Services group which is responsible for our domestic and international publishing businesses and electronic commerce services; and an International group which includes our foreign wireline and wireless communications investments.

 

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We measure and evaluate our reportable segments based on segment income. This segment income excludes unallocated corporate expenses and other adjustments arising during each period. The other adjustments include transactions that the chief operating decision makers exclude in assessing business unit performance due primarily to their non-recurring and/or non-operational nature. Although such transactions are excluded from the business segment results, they are included in reported consolidated earnings. Gains and losses that are not individually significant are included in all segment results, since these items are included in the chief operating decision makers’ assessment of unit performance. These gains and losses are primarily contained in Information Services and International since they actively manage investment portfolios.

 

The following table provides operating financial information for our four reportable segments and a reconciliation of segment results to consolidated results:

 

     Three Months Ended June 30,        Six Months Ended June 30,  
(Dollars in Millions)      2004       2003          2004       2003  


External Operating Revenues

                                   

Domestic Telecom

   $ 9,429     $ 9,694        $ 18,852     $ 19,458  

Domestic Wireless

     6,827       5,463          12,976       10,537  

Information Services

     986       1,049          1,985       2,070  

International

     499       503          961       1,014  
    


Total segments

     17,741       16,709          34,774       33,079  

Reconciling items

     97       120          200       240  
    


Total consolidated – reported

   $ 17,838     $ 16,829        $ 34,974     $ 33,319  
    


Intersegment Revenues

                                   

Domestic Telecom

   $ 193     $ 211        $ 384     $ 388  

Domestic Wireless

     20       14          33       26  

Information Services

                           

International

     7       6          13       12  
    


Total segments

     220       231          430       426  

Reconciling items

     (220 )     (231 )        (430 )     (426 )
    


Total consolidated – reported

   $     $        $     $  
    


Total Operating Revenues

                                   

Domestic Telecom

   $ 9,622     $ 9,905        $ 19,236     $ 19,846  

Domestic Wireless

     6,847       5,477          13,009       10,563  

Information Services

     986       1,049          1,985       2,070  

International

     506       509          974       1,026  
    


Total segments

     17,961       16,940          35,204       33,505  

Reconciling items

     (123 )     (111 )        (230 )     (186 )
    


Total consolidated – reported

   $ 17,838     $ 16,829        $ 34,974     $ 33,319  
    


Operating Income

                                   

Domestic Telecom

   $ 1,428     $ 1,939        $ 2,918     $ 4,026  

Domestic Wireless

     1,615       981          2,817       1,855  

Information Services

     431       505          903       1,007  

International

     183       89          299       225  
    


Total segments

     3,657       3,514          6,937       7,113  

Reconciling items

     71       (784 )        (714 )     (676 )
    


Total consolidated – reported

   $ 3,728     $ 2,730        $ 6,223     $ 6,437  
    


Segment Income

                                   

Domestic Telecom

   $ 683     $ 915        $ 1,380     $ 1,922  

Domestic Wireless

     453       257          771       475  

Information Services

     258       299          545       599  

International

     287       314          568       580  
    


Total segment income

     1,681       1,785          3,264       3,576  

Reconciling items

     116       (1,447 )        (268 )     (832 )
    


Total consolidated net income – reported

   $ 1,797     $ 338        $ 2,996     $ 2,744  
    


 

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(Dollars in Millions)    At June 30, 2004    At December 31, 2003

Assets

           

Domestic Telecom

   $      78,226    $ 82,087

Domestic Wireless

   66,027      65,166

Information Services

   2,427      2,431

International

   11,616      11,872
    

Total segments

   158,296      161,556

Reconciling items

   4,142      4,412
    

Total consolidated

   $    162,438    $ 165,968
    

 

Major reconciling items between the segments and the consolidated results are as follows:

 

    Three Months Ended June 30,        Six Months Ended June 30,  
(Dollars in Millions)     2004        2003          2004       2003  


Total Operating Revenues

                                   

Corporate, eliminations and other

  $ (123 )    $ (111 )      $ (230 )   $ (186 )
   


    $ (123 )    $ (111 )      $ (230 )   $ (186 )
   


Operating Income

                                   

Severance, pension and benefit charges (see Note 3)

  $ (31 )    $ (697 )      $ (759 )   $ (697 )

Lease impairment and other special items (see Note 3)

    91        (197 )        91       (197 )

Corporate and other

    11        110          (46 )     218  
   


    $ 71      $ (784 )      $ (714 )   $ (676 )
   


Net Income

                                   

Severance, pension and benefit charges (see Note 3)

  $ (19 )    $ (436 )      $ (465 )   $ (436 )

Sales of investments, net (see Note 5)

                    43        

Lease impairment and other special items (see Note 3)

    29        (204 )        2       (204 )

Iusacell charge (see Note 4)

           (931 )              (931 )

Income (loss) on discontinued operations – Iusacell (see Note 4)

           4                (3 )

Cumulative effect of accounting change (see Note 2)

                          503  

Corporate and other

    106        120          152       239  
   


    $ 116      $ (1,447 )      $ (268 )   $ (832 )
   


 

Financial information for International excludes the effects of Iusacell (see Note 4).

 

Corporate, eliminations and other includes unallocated corporate expenses, intersegment eliminations recorded in consolidation, the results of other businesses such as lease financing, and asset impairments and expenses that are not allocated in assessing segment performance due to their non-recurring nature.

 

We generally account for intersegment sales of products and services and asset transfers at current market prices. We are not dependent on any single customer.

 

12.    Employee Benefits


 

We maintain noncontributory defined benefit pension plans for substantially all employees. In addition, we maintain postretirement health care and life insurance plans for our retirees and their dependents, which are both contributory and non-contributory and include a limit on the company’s share of cost for certain recent and future retirees.

 

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Net Periodic Cost

 

The following tables summarize the benefit costs related to our pension and postretirement health care and life insurance plans:

 

     (Dollars in Millions)  
     Pension

    Health Care and Life

 
Three Months Ended June 30,    2004     2003     2004     2003  


Service cost

   $ 166     $ 191     $     70     $     39  

Interest cost

     529       600     375     269  

Expected return on plan assets

     (853 )     (1,020 )   (100 )   (96 )

Amortization of transition asset

     (1 )     (10 )       1  

Amortization of prior service cost

     14       6     59     (4 )

Actuarial loss (gain), net

     14       (102 )   50     31  
    


Net periodic benefit (income) cost

     (131 )     (335 )   454     240  
    


Termination benefits

     2       319     2     3  

Settlement loss

     31       21          
    


Total cost

   $ (98 )   $ 5     $  456     $   243  
    


 

     (Dollars in Millions)  
     Pension

       Health Care and Life

 
Six Months Ended June 30,    2004      2003        2004     2003  


Service cost

   $   339      $   383        $   140     $     78  

Interest cost

   1,071      1,199        753     537  

Expected return on plan assets

   (1,728 )    (2,043 )      (201 )   (192 )

Amortization of transition asset

   (2 )    (20 )      1     2  

Amortization of prior service cost

   28      11        119     (8 )

Actuarial loss (gain), net

   27      (182 )      100     62  
    

Net periodic benefit (income) cost

   (265 )    (652 )      912     479  
    

Termination benefits

   4      319        2     3  

Settlement loss

   759      21             
    

Total cost

   $   498      $  (312 )      $  914     $   482  
    

 

Employer Contributions

 

In 2004, we expect to contribute $273 million to our qualified pension trusts, including $145 million for Telecomunicaciones de Puerto Rico, Inc. (TELPRI), $150 million to our other nonqualified pension plans and $1,149 million to our other postretirement benefit plans. During the three months ended June 30, 2004, we contributed $28 million to our TELPRI plans and $17 million to our other qualified pension trusts, $20 million to our nonqualified pension plans and $241 million to our other postretirement benefit plans. During the six months ended June 30, 2004, we contributed $93 million to our TELPRI plans and $17 million to our other qualified pension trusts, $65 million to our nonqualified pension plans and $560 million to our other postretirement benefit plans. Federal legislation on pension funding relief was enacted on April 10, 2004. The legislation provides temporary funding relief for the 2004 and 2005 plan years, principally replacing the 30-year treasury rate with a higher corporate bond rate for determining current liability. The anticipated required qualified pension trust contributions disclosed in Verizon’s Annual Report on Form 10-K for the year ended December 31, 2003 continue to be accurate.

 

Medicare Drug Act

 

On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (Medicare Drug Act) was signed into law. The Medicare Drug Act introduces a prescription drug benefit under Medicare (Medicare Part D) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. We sponsor several postretirement health care plans that provide prescription drug benefits that are deemed actuarially equivalent to the Medicare Part D and elected to recognize the impact of the federal subsidy on our accumulated postretirement benefit obligation and net postretirement benefit costs in the fourth quarter of 2003. We anticipate the recognition of the Medicare Drug Act to decrease our accumulated postretirement benefit obligation by $1,256 million and we anticipate our net postretirement benefit cost will be reduced by approximately $144 million ($144 million after-tax) in 2004. During the three and six months ended June 30, 2004, the Medicare Drug Act has reduced our net postretirement benefit cost by $36 million and $72 million, respectively.

 

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Severance Benefits

 

During the three and six months ended June 30, 2004, we paid severance benefits of $87 million and $1,296 million, respectively. At June 30, 2004, we had a remaining severance liability of $980 million, which includes future contractual payments to employees separated as of June 30, 2004.

 

13. Guarantees of Operating Subsidiary Debt

 


 

Verizon has guaranteed the following two obligations of indirect wholly owned operating subsidiaries: $480 million 7% debentures series B, due 2042 issued by Verizon New England Inc. and $300 million 7% debentures series F issued by Verizon South Inc. due 2041. These guarantees are full and unconditional and would require Verizon to make scheduled payments immediately if either of the two subsidiaries failed to do so. Both of these securities were issued in denominations of $25 and were sold primarily to retail investors and are listed on the New York Stock Exchange. SEC rules permit us to include condensed consolidating financial information for these two subsidiaries in our periodic SEC reports rather than filing separate subsidiary periodic SEC reports.

 

Below is the condensed consolidating financial information. Verizon New England and Verizon South are presented in separate columns. The column labeled Parent represents Verizon’s investments in all of its subsidiaries under the equity method and the Other column represents all other subsidiaries of Verizon on a combined basis. The Adjustments column reflects intercompany eliminations.

 

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Condensed Consolidating Statements of Income

Three Months Ended June 30, 2004

 

(Dollars in Millions)    Parent     Verizon New
England
    Verizon
South
    Other     Adjustments     Total  


Operating revenues

   $     $ 982     $ 231     $ 16,706     $ (81 )   $ 17,838  

Operating expenses

     31       901       164       13,095       (81 )     14,110  
    


Operating income (loss)

     (31 )     81       67       3,611             3,728  

Equity in earnings of unconsolidated businesses

     1,741       18             181       (1,728 )     212  

Income from other unconsolidated businesses

                                    

Other income and (expense), net

     15       1       1       (4 )     (15 )     (2 )

Interest expense

     (5 )     (41 )     (16 )     (534 )     2       (594 )

Minority interest

                       (676 )           (676 )
    


Income before provision for income taxes, discontinued operations and cumulative effect of accounting change

     1,720       59       52       2,578       (1,741 )     2,668  

Income tax benefit (provision)

     77       (15 )     (20 )     (913 )           (871 )
    


Net income

   $ 1,797     $ 44     $ 32     $ 1,665     $ (1,741 )   $ 1,797  
    


 

Condensed Consolidating Statements of Income

Six Months Ended June 30, 2004

 

(Dollars in Millions)    Parent     Verizon New
England
    Verizon
South
    Other     Adjustments     Total  


Operating revenues

   $     $ 1,974     $ 465     $ 32,698     $ (163 )   $ 34,974  

Operating expenses

     140       1,887       356       26,531       (163 )     28,751  
    


Operating income (loss)

     (140 )     87       109       6,167             6,223  

Equity in earnings of unconsolidated businesses

     2,954       37             350       (2,930 )     411  

Income from other unconsolidated businesses

                       72             72  

Other income and (expense), net

     29       8       2       (47 )     (28 )     (36 )

Interest expense

     (10 )     (82 )     (32 )     (1,112 )     4       (1,232 )

Minority interest

                       (1,153 )           (1,153 )
    


Income before provision for income taxes, discontinued operations and cumulative effect of accounting change

     2,833       50       79       4,277       (2,954 )     4,285  

Income tax benefit (provision)

     163       2       (30 )     (1,424 )           (1,289 )
    


Net income

   $ 2,996     $ 52     $ 49     $ 2,853     $ (2,954 )   $ 2,996  
    


 

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Table of Contents

Condensed Consolidating Statements of Income

Three Months Ended June 30, 2003

 

(Dollars in Millions)    Parent     Verizon New
England
    Verizon
South
    Other     Adjustments     Total  


Operating revenues

   $     $ 1,044     $ 236     $ 15,619     $ (70 )   $ 16,829  

Operating expenses

     16       960       210       12,983       (70 )     14,099  
    


Operating income (loss)

     (16 )     84       26       2,636             2,730  

Equity in earnings of unconsolidated businesses

     252       6             162       (253 )     167  

Income from other unconsolidated businesses

                       60             60  

Other income and (expense), net

     11       (4 )           (45 )     (8 )     (46 )

Interest expense

     (11 )     (40 )     (15 )     (635 )     9       (692 )

Minority interest

                       (380 )           (380 )
    


Income before provision for income taxes, discontinued operations and cumulative effect of accounting change

     236       46       11       1,798       (252 )     1,839  

Income tax benefit (provision)

     102       (16 )     (4 )     (655 )           (573 )
    


Income before discontinued operations and cumulative effect of accounting change

     338       30       7       1,143       (252 )     1,266  

Loss on discontinued operations, net of tax

                       (928 )           (928 )

Cumulative effect of accounting change, net of tax

                                    
    


Net income

   $ 338     $ 30     $ 7     $ 215     $ (252 )   $ 338  
    


 

Condensed Consolidating Statements of Income

Six Months Ended June 30, 2003

 

(Dollars in Millions)    Parent     Verizon New
England
    Verizon
South
    Other     Adjustments    Total  


Operating revenues

   $     $ 2,079     $  474     $30,905     $  (139)    $ 33,319  

Operating expenses

     (15 )     1,816     375     24,845     (139)      26,882  
    


Operating income

     15       263     99     6,060          6,437  

Equity in earnings of unconsolidated businesses

     2,561       (40 )       351     (2,557)      315  

Income from other unconsolidated businesses

     (10 )             89          79  

Other income and (expense), net

     49       (3 )   3     (23 )   (15)      11  

Interest expense

     (22 )     (83 )   (35 )   (1,318 )   11      (1,447 )

Minority interest

                   (722 )        (722 )
    


Income before provision for income taxes, discontinued operations and cumulative effect of accounting change

     2,593       137     67     4,437     (2,561)      4,673  

Income tax benefit (provision)

     151       (70 )   (26 )   (1,552 )        (1,497 )
    


Income before discontinued operations and cumulative effect of accounting change

     2,744       67     41     2,885     (2,561)      3,176  

Loss on discontinued operations, net of tax

                   (935 )        (935 )

Cumulative effect of accounting change, net of tax

           369     47     87          503  
    


Net income

   $ 2,744     $ 436     $    88     $  2,037     $(2,561)    $ 2,744  
    


 

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Condensed Consolidating Balance Sheets

At June 30, 2004

 

(Dollars in Millions)    Parent    Verizon New
England
   Verizon
South
   Other    Adjustments     Total

Cash

   $         –    $    $    $ 608    $     $ 608

Short-term investments

        100      20      1,270            1,390

Accounts receivable, net

        922      174      9,436      (914 )     9,618

Other current assets

   5,723      238      146      5,529      (5,857 )     5,779
    

Total current assets

   5,723      1,260      340      16,843      (6,771 )     17,395

Plant, property and equipment, net

   1      6,517      1,238      65,785            73,541

Investments in unconsolidated businesses

   30,787      116           7,086      (32,310 )     5,679

Other assets

   195      547      370      64,941      (230 )     65,823
    

Total assets

   $36,706    $ 8,440    $ 1,948    $ 154,655    $ (39,311 )   $ 162,438
    

Debt maturing within one year

   $       31    $ 148    $    $ 10,127    $ (5,867 )   $ 4,439

Other current liabilities

   2,407      1,243      210      15,978      (904 )     18,934
    

Total current liabilities

   2,438      1,391      210      26,105      (6,771 )     23,373

Long-term debt

   113      2,954      900      33,712      (230 )     37,449

Employee benefit obligations

   54      1,820      228      15,153            17,255

Deferred income taxes

        591      230      21,055            21,876

Other liabilities

   2      237      38      3,288            3,565

Minority interest

                  24,821            24,821

Total shareowners’ investment

   34,099      1,447      342      30,521      (32,310 )     34,099
    

Total liabilities and shareowners’ investment

   $36,706    $ 8,440    $ 1,948    $ 154,655    $ (39,311 )   $ 162,438
    

 

Condensed Consolidating Balance Sheets

At December 31, 2003

 

(Dollars in Millions)    Parent    Verizon New
England
   Verizon
South
   Other    Adjustments     Total

Cash

   $         –    $    $    $ 699    $     $ 699

Short-term investments

        200      40      1,932            2,172

Accounts receivable, net

   3      1,117      162      10,424      (1,801 )     9,905

Other current assets

   5,201      380      192      5,073      (5,329 )     5,517
    

Total current assets

   5,204      1,697      394      18,128      (7,130 )     18,293

Plant, property and equipment, net

   1      6,751      1,280      67,284            75,316

Investments in unconsolidated businesses

   30,869      117           6,354      (31,551 )     5,789

Other assets

   152      610      385      65,433      (10 )     66,570
    

Total assets

   $36,226    $ 9,175    $ 2,059    $ 157,199    $ (38,691 )   $ 165,968
    

Debt maturing within one year

   $       30    $ 513    $    $ 11,125    $ (5,701 )   $ 5,967

Other current liabilities

   2,484      1,739      301      17,508      (1,429 )     20,603
    

Total current liabilities

   2,514      2,252      301      28,633      (7,130 )     26,570

Long-term debt

   145      2,749      900      35,629      (10 )     39,413

Employee benefit obligations

   99      1,787      216      14,657            16,759

Deferred income taxes

        602      238      20,868            21,708

Other liabilities

   2      235      39      3,428            3,704

Minority interest

                  24,348            24,348

Total shareowners’ investment

   33,466      1,550      365      29,636      (31,551 )     33,466
    

Total liabilities and shareowners’ investment

   $36,226    $ 9,175    $ 2,059    $ 157,199    $ (38,691 )   $ 165,968
    

 

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Condensed Consolidating Statements of Cash Flows

Six Months Ended June 30, 2004

(Dollars in Millions)    Parent     Verizon New
England
    Verizon
South
    Other     Adjustments     Total  


Net cash from operating activities

   $ 2,708     $ 488     $ 94     $ 9,218     $ (2,617 )   $ 9,891  

Net cash from investing activities

           (186 )     (22 )     (4,530 )     (21 )     (4,759 )

Net cash from financing activities

     (2,708 )     (302 )     (72 )     (4,779 )     2,638       (5,223 )
    


Net decrease in cash

   $     $     $     $ (91 )   $     $ (91 )
    


 

Condensed Consolidating Statements of Cash Flows

Six Months Ended June 30, 2003

 

(Dollars in Millions)    Parent     Verizon New
England
    Verizon
South
    Other     Adjustments     Total  


Net cash from operating activities

   $ 3,899     $ 665     $ 113     $ 9,816     $ (3,524 )   $ 10,969  

Net cash from investing activities

           (200 )     (85 )     (4,907 )     108       (5,084 )

Net cash from financing activities

     (3,899 )     (465 )     (28 )     (5,511 )     3,416       (6,487 )
    


Net decrease in cash

   $     $     $     $ (602 )   $     $ (602 )
    


 

14.    Commitments and Contingencies


 

Several state and federal regulatory proceedings may require our telephone operations to pay penalties or to refund to customers a portion of the revenues collected in the current and prior periods. There are also various legal actions pending to which we are a party and claims which, if asserted, may lead to other legal actions. We have established reserves for specific liabilities in connection with regulatory and legal actions, including environmental matters, that we currently deem to be probable and estimable. We do not expect that the ultimate resolution of pending regulatory and legal matters in future periods, including the Hicksville matters described below, will have a material effect on our financial condition, but it could have a material effect on our results of operations.

 

During 2003, under a government-approved plan, remediation of the site of a former facility in Hicksville, New York that processed nuclear fuel rods in the 1950s and 1960s commenced. Remediation beyond original expectations proved to be necessary and a reassessment of the anticipated remediation costs was conducted. In addition, a reassessment of costs related to remediation efforts at several other former facilities was undertaken. As a result, an additional environmental remediation expense of $240 million was recorded in the fourth quarter of 2003. We expect overall remediation efforts, including soil and ground water remediation and property costs, to take place over the next several years, and our cost estimates may be revised as remediation continues.

 

There are also litigation matters associated with the Hicksville site primarily involving personal injury claims in connection with alleged emissions arising from operations in the 1950s and 1960s at the Hicksville site. These matters are in various stages, and no trial date has been set.

 

Under the terms of an investment agreement, Vodafone Group Plc (Vodafone) may require Verizon Wireless to purchase up to an aggregate of $20 billion worth of Vodafone’s interest in Verizon Wireless at designated times between 2003 and 2007 at its then fair market value. In the event Vodafone exercises its put rights, we have the right, exercisable at our sole discretion, to purchase up to $12.5 billion of Vodafone’s interest instead of Verizon Wireless for cash or Verizon stock at our option. Vodafone may require the purchase of up to $10 billion during a 61-day period opening on June 10 and closing on August 9 in 2004, and the remainder, which may not exceed $10 billion in any one year, during a 61-day period opening on June 10 and closing on August 9 in 2005 through 2007. Vodafone also may require that Verizon Wireless pay for up to $7.5 billion of the required repurchase through the assumption or incurrence of debt.

 

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15.    Subsequent Events


 

We announced on July 8, 2004 that we had won an auction for a spectrum license covering the New York metropolitan area held by NextWave Telecom Inc. Under the terms of the purchase agreement, we will pay $930 million for the license which covers the New York metropolitan area. The transaction is subject to several federal reviews and is expected to close by the end of 2004. In addition, on July 1, 2004 we announced an agreement to purchase Qwest Wireless’s spectrum licenses and wireless network assets for $418 million covering several existing and new markets. The transaction is subject to federal reviews and is expected to close by the fourth quarter of 2004 or early 2005.

 

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


 

Overview

 

Verizon Communications Inc. is one of the world’s leading providers of communications services. Verizon companies are the largest providers of wireline and wireless communications in the United States, with 142 million access line equivalents and 40.4 million wireless customers. Verizon is also the largest directory publisher in the world, as measured by directory titles and circulation. Verizon’s international presence extends primarily to the Americas, as well as investments in Europe. Stressing diversity and commitment to the communities in which we operate, Verizon has a highly diverse workforce of approximately 208,000 employees.

 

We are comprised of four strategic business units: Domestic Telecom, Domestic Wireless, Information Services and International. Domestic Telecom includes local, long distance and other communications services. Domestic Wireless products and services include wireless voice and data services and equipment sales. Information Services consists of our domestic and international directory publishing businesses and electronic commerce services. International operations include wireline and wireless communications operations and investments primarily in the Americas and Europe.

 

The sections that follow provide information about the important 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. 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 the United States where the majority of our operations are located, in evaluating our operating results and analyzing and understanding business trends. While most key economic indicators, including gross domestic product, impact our operations to some degree, we have noted higher correlations to housing starts, non-farm employment, personal consumption expenditures and capital spending, as well as more general economic 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 Verizon management’s focus on the following four key areas:

 

Revenue Growth – Our emphasis is on revenue transformation, devoting more resources from traditional services, where we have been experiencing access line losses, to the higher growth markets such as wireless, digital subscriber lines (DSL), long distance and other data services as well as expanded services to enterprise markets. In the second quarter of 2004, revenues from these growth areas increased by 21% compared to the second quarter of 2003 and represent more than 52% of our total revenues, up from 46% of total revenues in the second quarter of 2003. Verizon reported consolidated revenue growth of 6.0% in the second quarter of 2004 compared to the second quarter of 2003, led by 25.0% higher revenue at Domestic Wireless. Verizon added 1.5 million wireless customers, 280,000 DSL lines, 632,000 long distance lines and 650 Enterprise Advance sales in the second quarter of 2004.

 

Operational Efficiency – While focusing resources on growth markets, we are continually challenging our management team to lower expenses through technology-assisted productivity improvements. The effect of these and other efforts, such as 2003’s labor agreements and voluntary separation plans, has been to significantly change the company’s cost structure. Verizon now has significantly lower workforce levels, which will provide ongoing expense benefits. Domestic Telecom’s salary and wage expenses declined by more than $200 million in the current quarter compared to the second quarter of 2003 largely as a result of last year’s voluntary separation plans.

 

Capital Allocation – Capital spending has been, and will continue to be directed toward growth markets. High-speed wireless data (EV-DO), replacement of copper lines with fiber optics to the home, as well as voice over the Internet (VoIP) and expanded services to enterprise markets are examples of areas of capital spending in support of these growth markets.

 

Cash Flow Generation – The financial statements reflect the emphasis of management on not only directing resources to growth markets, but also using cash provided by our operating and investing activities for repayments of debt in addition to providing a stable dividend to our shareowners.

 

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Supporting these key focus areas are continuing initiatives to more effectively package and add more value to our products and services. At Domestic Telecom, we recently announced the introduction of VoiceWingsm, Verizon’s nationwide VoIP service that allows customers with DSL or cable-modem broadband service to make telephone calls and utilize advanced service features through an Internet connection rather than the traditional telephone network. In addition, Verizon announced its fiber optics to the home product name, Verizon Fiossm, pricing and two additional locations in which it will be offered: Huntington Beach, California and Tampa, Florida. In 2004, we have also begun expanding our bundles to include video in the retail bundle through an agreement with DIRECTV and plan to add iobism call management services later in the year. Innovative product bundles include local wireline services, long distance, wireless and DSL for consumer and general business retail customers. In our enterprise markets, we are expanding our presence having completed the build-out of our nationwide network and by expanding our portfolio of advanced data services. These efforts will also help counter the effects of competition and technology substitution that have resulted in access line losses that have contributed to declining Domestic Telecom revenues over the past several years.

 

At Domestic Wireless, we will continue to execute on the fundamentals of our network superiority and value proposition to deliver growth for the business. In addition, we have expanded the markets we are offering EV-DO to include Las Vegas, Nevada.

 

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 four reportable segments. We exclude the effects of the special and non-recurring items from the segments’ results of operations since management does not consider them in assessing segment performance, due primarily to their non-recurring and/or non-operational nature. We believe that this presentation will assist readers in better understanding our results of operations and trends from period to period. This section on consolidated results of operations carries forward the segment results, which exclude the special and non-recurring items, and highlights and describes those items separately to ensure consistency of presentation in this section and the “Segment Results of Operations” section.

 

Consolidated Revenues

 

     Three Months Ended June 30,                Six Months Ended June 30,        
(Dollars in Millions)    2004     2003     % Change          2004     2003     % Change  


Domestic Telecom

   $ 9,622     $ 9,905     (2.9 )%        $ 19,236     $ 19,846     (3.1 )%

Domestic Wireless

     6,847       5,477     25.0            13,009       10,563     23.2  

Information Services

     986       1,049     (6.0 )          1,985       2,070     (4.1 )

International

     506       509     (.6 )          974       1,026     (5.1 )

Corporate & Other

     (123 )     (111 )   10.8            (230 )     (186 )   23.7  
    


            


     

Consolidated Revenues

   $ 17,838     $ 16,829     6.0          $ 34,974     $ 33,319     5.0  
    


            


     

 

Consolidated revenues in the second quarter of 2004 were higher by $1,009 million, or 6.0% and $1,655 million, or 5.0% for the six months ended June 30, 2004, compared to the similar periods of 2003. These increases were primarily the result of significantly higher revenues at Domestic Wireless, partially offset by lower revenues at Domestic Telecom and Information Services.

 

Domestic Wireless’s revenues increased by $1,370 million, or 25.0% for the second quarter of 2004 and $2,446 million, or 23.2% for the six months ended June 30, 2004 compared to the similar periods in 2003. These increases were primarily due to a 16.8% increase in customers as of June 30, 2004 compared to June 30, 2003 as well as an increase in average service revenue per customer per month (ARPU). ARPU increased 3.2% to $50.80 for the second quarter of 2004 and by 2.5% to $49.44 for the six months ended June 30, 2004 compared to the similar periods in 2003, primarily due to higher access price plan offerings as well as an increase in data revenues per customer, partially offset by decreased roaming revenue as a result of rate reductions with third-party carriers and decreased long distance revenue due to bundled pricing.

 

Revenues at Domestic Telecom declined during the second quarter of 2004 by $283 million, or 2.9% and $610 million, or 3.1% for the six months ended June 30, 2004, compared to the similar periods of the prior year primarily due to lower revenues from local and network access services, partially offset by higher long distance revenues. The decline in local service revenues of $248 million in the second quarter of 2004 and $467 million for the six months

 

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ended June 30, 2004 was mainly due to lower demand and usage of our basic local exchange and accompanying services, as reflected by a 4.2% decline in switched access lines in service from a year ago, driven by the effects of competition, regulatory pricing rules for unbundled network elements (UNEs) and technology substitution. Network access services revenues declined by $183 million in the second quarter of 2004 and by $408 million for the six months ended June 30, 2004 principally due to decreasing switched minutes of use (MOUs) and access lines, as well as mandated price reductions associated with federal and state price cap filings and other regulatory decisions. Switched MOUs declined 5.6% in the second quarter of 2004 and 4.8% for the six months ended June 30, 2004, from a year ago, reflecting the impact of access line loss and wireless substitution. These factors were partially offset by higher customer demand for high capacity and digital data services. Long distance service revenues increased $132 million in the second quarter of 2004 and $249 million for the six months ended June 30, 2004, principally as a result of customer growth from our interLATA long distance services, partially offset by the introduction of new, lower price plans. We added 632,000 long distance lines in the second quarter of 2004 and 1,470,000 long distance lines in the six months ended June 30, 2004, for a total of 16.8 million long distance lines nationwide, representing a 21.4% increase in long distance lines from a year ago.

 

Information Services’ operating revenues decreased $63 million, or 6.0% in the second quarter of 2004 and $85 million, or 4.1% for the six months ended June 30, 2004. The decrease was due primarily to reduced domestic print advertising revenue and the elimination of revenue as a result of the sale of European operations in 2003.

 

Consolidated Operating Expenses

 

     Three Months Ended June 30,               Six Months Ended June 30,       
(Dollars in Millions)    2004    2003    % Change          2004    2003    % Change  


Cost of services and sales

   $  5,641    $  5,042    11.9 %        $11,151    $10,166    9.7 %

Selling, general and administrative expense

   5,029    5,673    (11.4 )        10,732    9,965    7.7  

Depreciation and amortization expense

   3,440    3,384    1.7          6,868    6,751    1.7  
    
             
      

Total Operating Expenses

   $14,110    $14,099    .1          $28,751    $26,882    7.0  
    
             
      

 

Cost of Services and Sales

 

Consolidated cost of services and sales in the second quarter of 2004 were higher by $599 million, or 11.9% and $985 million, or 9.7% for the six months ended June 30, 2004, compared to the similar periods of 2003. These increases were driven by increases in pension and other postretirement benefit costs and higher costs associated with our growth businesses, including wireless, long distance and DSL.

 

As of December 31, 2003, we changed key employee benefit plan assumptions in response to conditions in the securities markets. In addition, as a result of extending and increasing limits (caps) on company payments toward retiree health care costs in connection with the union contracts ratified in the fourth quarter of 2003, we began recording health care costs as if there were no caps in the fourth quarter of 2003 relative to these union contracts. The impact of these assumption changes and lower than expected actual asset returns resulted in net pension and other postretirement benefit expense (primarily in cost of services and sales) of $268 million in the second quarter of 2004 and $543 million for the six months ended June 30, 2004, compared to pension income, net of other postretirement benefit expense of $72 million and $151 million in the second quarter and six months ended June 30, 2003, respectively.

 

Higher costs were also driven by our growth businesses including wireless, long distance and DSL. Increases in wireless customers and higher usage per customer increased MOUs on the wireless network and resulted in higher wireless network costs in the current year periods. Cost of wireless handsets and other equipment sales increased by 27.3% in the second quarter of 2004 and 22.0% for the six months ended June 30, 2004 compared to the similar periods in 2003, primarily due to higher gross activations and an increase in equipment upgrades. In addition, both the quarter and year-to-date comparisons were affected by the prior year reduction in operating expenses of $98 million in the second quarter of 2003 and $111 million year-to-date 2003 for insurance recoveries related to the terrorist attacks on September 11, 2001.

 

These expense increases were partially offset in both periods by the effect of work force reductions of approximately 13,300 employees, or 6.0%, over the past year, principally in connection with a voluntary separation plan announced in the fourth quarter of 2003 and lower wireless roaming rates.

 

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Table of Contents

Selling, General and Administrative Expense

 

Consolidated selling, general and administrative expense in the second quarter of 2004 was $644 million, or 11.4% lower and $767 million, or 7.7% higher for the six months ended June 30, 2004, compared to the similar periods of 2003. During the second quarter of 2004, special charges declined by $954 million, partially offset by higher costs at Domestic Wireless and Domestic Telecom compared to the second quarter of 2003. For the six months ended June 30, 2004, higher costs at Domestic Wireless and Domestic Telecom were partially offset by a $226 million decline in special charges compared to the similar period in 2003.

 

Higher selling, general and administrative expense at Domestic Wireless, Domestic Telecom and corporate in the quarter and six months ended June 30, 2004 was driven by increases in salary and benefits expense as a result of an increase in the number of customer care and sales employees and higher sales commissions related to the increase in gross customer additions and customer renewals in the current year periods at Domestic Wireless and increases in pension and benefits expenses. Also contributing to the increases were higher advertising and promotion expenses and higher rental, professional and general costs.

 

Special charges recorded in selling, general and administrative expense were $954 million and $226 million lower in the second quarter of 2004 and the six months ended June 30, 2004, respectively, compared to the similar periods in 2003. Special charges recorded during the second quarter of 2004 and six months ended June 30, 2004 included $31 million and $759 million, respectively, related to pension settlement losses incurred in connection with the voluntary separation of approximately 21,000 employees in the fourth quarter of 2003 who received lump-sum distributions during the current year periods. During the second quarter of 2003 and six months ended June 30, 2003 we recorded special charges of $697 million in connection with enhanced pension benefits granted to employees retiring in the first half of 2003, estimated costs associated with the July 10, 2003 Verizon-New York arbitration ruling, pension settlement losses related to lump-sum pay-outs in 2003 and employee severance costs and severance-related activities in connection with the voluntary separation of approximately 4,000 employees.

 

Special charges in the second quarter of 2004 also included an expense credit of $204 million resulting from the favorable resolution of pre-bankruptcy amounts due from MCI, partially offset by a charge of $113 million related to operating asset losses. During the second quarter of 2003, we recorded other pretax charges of $197 million related to our leasing operations and other charges.

 

Depreciation and Amortization Expense

 

Consolidated depreciation and amortization expense in the second quarter of 2004 was higher by $56 million, or 1.7% and $117 million, or 1.7% for the six months ended June 30, 2004, compared to the similar periods of 2003. These increases were primarily due to increased depreciation expense related to the increase in depreciable assets, partially offset by lower Domestic Telecom depreciation rates.

 

Other Consolidated Results

 

Equity in Earnings of Unconsolidated Businesses

 

Equity in earnings of unconsolidated businesses increased by $45 million, or 26.9% in the second quarter of 2004 and by $96 million, or 30.5% for the six months ended June 30, 2004, compared to the similar periods in 2003. These increases were primarily the result of continued operational growth of Verizon’s equity investment in Vodafone Omnitel N.V. (Vodafone Omnitel) and favorable foreign currency exchange rates of the euro, Vodafone Omnitel’s functional currency.

 

Income From Other Unconsolidated Businesses

 

Income from other unconsolidated businesses decreased by $60 million in the second quarter of 2004 and by $7 million in the six months ended June 30, 2004, compared to the similar periods in 2003. The decrease in the second quarter of 2004 compared to the similar period of 2003 was primarily due to the sale of shares of our investment in Taiwan Cellular Corporation (TCC) in the 2003 period. The decrease for the first six months of 2004 includes a pretax gain of $43 million recorded in connection with the sale of our investment in Iowa Telecom preferred stock in the first quarter of 2004.

 

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Other Income and (Expense), Net

 

     Three Months Ended June 30,           Six Months Ended June 30,        
(Dollars in Millions)    2004     2003     % Change     2004     2003     % Change  


Interest income

   $ 16     $ 9     77.8 %   $ 68     $ 67     1.5 %

Foreign exchange losses, net

     (13 )     (10 )   30.0       (37 )     (9 )   nm  

Other, net

     (5 )     (45 )   (88.9 )     (67 )     (47 )   42.6  
    


       


     

Total

   $ (2 )   $ (46 )   (95.7 )   $ (36 )   $ 11     nm  
    


       


     

nm – Not meaningful

 

The changes in other income and expense, net were partially due to unfavorable changes in foreign exchange rates and other expenses. Higher foreign exchange losses were recorded in the second quarter of 2004 and in the six months ended June 30, 2004, compared to the similar periods in 2003 by Verizon Dominicana, C. por A. (Verizon Dominicana), which uses the Dominican Republic peso as its functional currency. Lower other, net expenses in the second quarter of 2004 were driven by $49 million lower costs related to the early retirement of debt compared to the second quarter of 2003. Higher other, net expenses in the first six months of 2004 were driven by costs of $43 million recorded in the first quarter of 2004 in connection with the early retirement of debt.

 

Interest Expense

 

     Three Months Ended June 30,                Six Months Ended June 30,        
(Dollars in Millions)    2004     2003     % Change          2004     2003     % Change  


Interest expense

   $ 594     $ 692     (14.2 )%        $ 1,232     $ 1,447     (14.9 )%

Capitalized interest costs

     40       33     21.2            75       68     10.3  
    


            


     

Total interest costs on debt balances

   $ 634     $ 725     (12.6 )        $ 1,307     $ 1,515     (13.7 )
    


            


     

Average debt outstanding

   $ 43,415     $ 50,545     (14.1 )        $ 44,425     $ 51,809     (14.3 )

Effective interest rate

     5.8 %     5.7 %                5.9 %     5.9 %      

 

The decreases in interest costs for the second quarter of 2004 and the six months ended June 30, 2004 were primarily due to decreases in average debt levels of $7,130 million and $7,384 million, respectively, compared to the similar periods in 2003.

 

Minority Interest

 

     Three Months Ended June 30,               Six Months Ended June 30,       
(Dollars in Millions)    2004    2003    % Change          2004    2003    % Change  


Minority interest

   $ 676    $ 380    77.9 %        $ 1,153    $ 722    59.7 %

 

The increases in minority interest expense for the second quarter of 2004 and the six months ended June 30, 2004, compared to the similar periods in 2003, were primarily due to the higher earnings at Domestic Wireless, which has a significant minority interest attributable to Vodafone Group Plc (Vodafone) and higher earnings at Telecomunicaciones de Puerto Rico, Inc. (TELPRI).

 

Provision for Income Taxes

 

     Three Months Ended June 30,                Six Months Ended June 30,        
(Dollars in Millions)    2004     2003     % Change          2004     2003     % Change  


Provision for income taxes

   $  871     $  573     52.0 %        $ 1,289     $ 1,497     (13.9 )%

Effective income tax rate

   32.6 %   31.2 %                30.1 %     32.0 %      

 

The effective income tax rate is the provision for income taxes as a percentage of income from continuing operations before the provision for income taxes. Our effective income tax rates for the second quarter of 2004 and six months ended June 30, 2004 were favorably impacted by tax benefits related to deferred tax balance adjustments and expense credits that are not taxable. In addition, we recorded a tax benefit resulting from an Internal Revenue Service audit settlement in the six months ended June 30, 2004. Our effective income tax rate for the three months ended June 30, 2003 was favorably impacted by tax benefits resulting from the reversal of a valuation allowance relating to investments.

 

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Discontinued Operations

 

Discontinued operations represent the results of operations of Grupo Iusacell, S.A. de C.V. (Iusacell) prior to the sale of Iusacell in July 2003. In connection with our decision to sell our interest in Iusacell and a comparison of expected net sale proceeds to the net book value of our investment in Iusacell, we recorded a pretax loss of $957 million ($931 million after-tax, or $.33 per diluted share) in the second quarter of 2003.

 

Cumulative Effect of Accounting Change

 

Directory Accounting Change

 

During 2003, we changed our method for recognizing revenues and expenses in our directory business from the publication-date method to the amortization method. The publication-date method recognizes revenues and direct expenses when directories are published. Under the amortization method, revenues and direct expenses, primarily printing and distribution costs, are recognized over the life of the directory, which is usually 12 months. This accounting change affected the timing of the recognition of revenues and expenses. As required by generally accepted accounting principles, the directory accounting change was recorded effective January 1, 2003. The cumulative effect of the accounting change was a one-time charge of $2,697 million ($1,647 million after-tax, or $.59 per diluted share).

 

Impact of SFAS No. 143

 

We adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 143, “Accounting for Asset Retirement Obligations” on January 1, 2003. SFAS No. 143 requires that companies recognize the fair value of a liability for asset retirement obligations in the period in which the obligations are incurred and capitalize that amount as part of the book value of the long-lived asset. We determined that Verizon does not have a material legal obligation to remove long-lived assets as described by this statement. However, prior to the adoption of SFAS No. 143, we included estimated removal costs in our group depreciation models. Consequently, in connection with the initial adoption of SFAS No. 143 we reversed accrued costs of removal in excess of salvage 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 a gain of $3,499 million ($2,150 million after-tax, or $.77 per diluted share).

 

Segment Results of Operations

 

We have four reportable segments, which we operate and manage as strategic business units and organize by products and services. Our segments are Domestic Telecom, Domestic Wireless, Information Services and International. Additional information about our segments can be found in Note 11 to the unaudited condensed consolidated financial statements.

 

We measure and evaluate our reportable segments based on segment income. This segment income excludes unallocated corporate expenses and other adjustments arising during each period. The other adjustments include transactions that the chief operating decision makers exclude in assessing business unit performance due primarily to their non-recurring and/or non-operational nature. Although such transactions are excluded from business segment results, they are included in reported consolidated earnings. We previously highlighted the more significant of these transactions in the “Consolidated Results of Operations” section. Gains and losses that are not individually significant are included in all segment results, since these items are included in the chief operating decision makers’ assessment of unit performance. These gains and losses are primarily contained in Information Services and International since they actively manage investment portfolios.

 

Domestic Telecom

 

Domestic Telecom provides local telephone services, including voice and data transport, enhanced and custom calling features, network access, directory assistance, private lines and public telephones in 29 states and the District of Columbia. This segment also provides long distance services, customer premises equipment distribution, data solutions and systems integration, billing and collections, Internet access services and inventory management services.

 

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Operating Revenues

 

     Three Months Ended June 30,          Six Months Ended June 30,       
(Dollars in Millions)    2004    2003    % Change     2004    2003    % Change  


Local services

   $4,655    $4,903    (5.1 )%   $  9,336    $  9,803    (4.8 )%

Network access services

   3,046    3,229    (5.7 )   6,145    6,553    (6.2 )

Long distance services

   1,033    901    14.7     2,031    1,782    14.0  

Other services

   888    872    1.8     1,724    1,708    .9  
    
        
      
     $9,622    $9,905    (2.9 )   $19,236    $19,846    (3.1 )
    
        
      

 

Local Services

 

Local service revenues are earned by our telephone operations from the provision of local exchange, local private line, wire maintenance, voice messaging and value-added services. Value-added services are a family of services that expand the utilization of the network, including products such as Caller ID, Call Waiting and Return Call. The provision of local exchange services not only includes retail revenues but also includes local wholesale revenues from UNEs, interconnection revenues from competitive local exchange carriers (CLECs) and wireless carriers, and some data transport revenues.

 

The decline in local service revenues of $248 million, or 5.1% in the second quarter of 2004 and $467 million, or 4.8% for the six months ended June 30, 2004 was mainly due to lower demand and usage of our basic local exchange and accompanying services, as reflected by a 4.2% decline in switched access lines in service from a year ago. This revenue decline was mainly driven by the effects of competition, regulatory pricing rules for UNEs and technology substitution. Regulatory pricing rules for UNEs, which mandate lower prices for other carriers that use our facilities to provide local exchange services, are putting downward pressure on our revenues by shifting the mix of access lines from retail to wholesale. We added 425,000 UNE platform lines in the second quarter of 2004 and 933,000 in the six months ended June 30, 2004, bringing total UNE platform provisioned lines to 6.0 million at June 30, 2004, compared to 4.1 million a year ago. Technology substitution also affected local service revenue growth in both periods, as indicated by declining demand for residential access lines of 4.4% at June 30, 2004, compared to a year ago, as more customers substituted wireless services for traditional landline services. At the same time, basic business access lines have declined 3.8% at June 30, 2004, compared to the similar period last year, primarily reflecting competition and a shift to high-speed, high-volume special access lines.

 

We continue to seek opportunities to retain and win-back customers. Our Freedom service plans offer local services with various combinations of long distance, wireless and Internet access services in a discounted bundle available on one bill. Since January 2003, we have introduced our Freedom service plans in 20 key markets, which cover approximately 91% of consumer access lines. For small businesses, we have also rolled out Verizon Freedom for Business in nine markets, covering approximately 77% of business access lines. As of June 30, 2004, approximately 50% of Verizon’s residential customers have purchased local services in combination with either Verizon long distance or Verizon DSL, or both.

 

Network Access Services

 

Network access services revenues are earned from end-user customers and long distance and other competing carriers who use our local exchange facilities to provide usage services to their customers. Switched access revenues are derived from fixed and usage-based charges paid by carriers for access to our local network. Special access revenues originate from carriers and end-users that buy dedicated local exchange capacity to support their private networks. End-user access revenues are earned from our customers and from resellers who purchase dial-tone services. Further, network access revenues include our DSL services.

 

Network access services revenues declined by $183 million, or 5.7% in the second quarter of 2004 and by $408 million, or 6.2% for the six months ended June 30, 2004. These declines were principally due to decreasing switched MOUs and access lines, as well as mandated price reductions associated with federal and state price cap filings and other regulatory decisions. Switched MOUs declined 5.6% in the second quarter of 2004 and 4.8% for the six months ended June 30, 2004, from a year ago, reflecting the impact of access line loss and wireless substitution.

 

These factors were partially offset by higher customer demand for high capacity and digital data services that grew 5.7% in the second quarter of 2004 and 4.3% for the six months ended June 30, 2004, compared to a year ago. Special access revenue growth reflects continuing demand in the business market for high-capacity, high-speed digital services, partially offset by lessening demand for older, low-speed data products and services. Voice-grade equivalents (switched access lines and data circuits) grew 3.2% in the six months ended June 30, 2004, compared to

 

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the similar period in 2003, as customers chose more high-capacity digital services. We added 625,000 new DSL lines in the six months ended June 30, 2004, including 280,000 in the second quarter, for a total of 2.9 million lines at June 30, 2004, representing a 52.5% increase from a year ago.

 

The Federal Communications Commission (FCC) regulates the rates that we charge long distance carriers and end-user customers for interstate access services. See “Other Factors That May Affect Future Results – FCC Regulation and Interstate Rates” for additional information on FCC rulemakings concerning federal access rates, universal service and unbundling of network elements and broadband services.

 

Long Distance Services

 

Long distance service revenues include both intraLATA toll services and interLATA long distance voice services.

 

Long distance service revenues increased $132 million, or 14.7% in the second quarter of 2004 and $249 million, or 14.0% for the six months ended June 30, 2004, principally as a result of customer growth from our interLATA long distance services, partially offset by the introduction of new, lower price plans. We added 632,000 long distance lines in the second quarter of 2004 and 1,470,000 long distance lines in the six months ended June 30, 2004, for a total of 16.8 million long distance lines nationwide, representing a 21.4% increase in long distance lines from a year ago. Our long distance lines include adjustments of 1,487,000 lines in the second quarter of 2004 related to first quarter of 2004 reported long distance lines and 782,000 lines in the second quarter of 2003. These adjustments pertain to an overstatement of long distance lines discovered through an internal review in the second quarter of 2004, which was the result of an internal system database issue. The introduction of our Freedom service plans continues to stimulate growth in long distance services. In 2003, we received final FCC approval to offer long distance services in our remaining three jurisdictions and began offering long distance services throughout the United States, capping a seven-year effort. As of June 30, 2004, approximately 44% of our local wireline residential customers have chosen Verizon as their long distance carrier.

 

Other Services

 

Our other services include such services as billing and collections for long distance carriers, public (coin) telephone and customer premises equipment and supply sales. Other services revenues also include services provided by our non-regulated subsidiaries such as data solutions and systems integration businesses.

 

Revenues from other services in the second quarter and year-to-date 2004 periods remained substantially unchanged from a year ago. Revenue increases resulting from higher sales of voice and data customer premises equipment services were substantially offset by declines in business volumes related to billing and collection services, public telephone services, and the sale of a non-strategic business.

 

Operating Expenses

 

     Three Months Ended June 30,          Six Months Ended June 30,       
(Dollars in Millions)    2004    2003    % Change     2004    2003    % Change  


Cost of services and sales

   $3,642    $3,413    6.7 %   $  7,360    $  6,936    6.1 %

Selling, general and administrative expense

   2,343    2,253    4.0     4,492    4,253    5.6  

Depreciation and amortization expense

   2,209    2,300    (4.0 )   4,466    4,631    (3.6 )
    
        
      
     $8,194    $7,966    2.9     $16,318    $15,820    3.1  
    
        
      

 

Cost of Services and Sales

 

Cost of services and sales includes the following costs directly attributable to a service or product: salaries and wages, benefits, materials and supplies, contracted services, network access and transport costs, customer provisioning costs, computer systems support and cost of products sold. Aggregate customer care costs, which include billing and service provisioning, are allocated between cost of services and sales and selling, general and administrative expense.

 

The increase in cost of services and sales of $229 million, or 6.7% in the second quarter of 2004 and $424 million, or 6.1% for the six months ended June 30, 2004 was largely driven by increased pension and other postretirement benefit costs. As of December 31, 2003, Verizon evaluated key employee benefit plan assumptions in response to current conditions in the securities markets. The expected rate of return on pension plan assets has been maintained at 8.50%. However, the discount rate assumption has been lowered from 6.75% in 2003 to 6.25% in 2004, consistent with interest rate levels at the end of 2003. Further, as a result of extending and increasing limits (caps) on company

 

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payments toward retiree health care costs in connection with the union contracts ratified in the fourth quarter of 2003, we began recording health care costs as if there were no caps in the fourth quarter of 2003 relative to these union contracts. The overall impact of these assumption changes, combined with the impact of lower than expected actual asset returns over the past three years, resulted in net pension and other postretirement benefit expense (primarily in cost of services and sales) of $220 million in the second quarter of 2004 and $434 million for the six months ended June 30, 2004, compared to pension income, net of other postretirement benefit expense of $111 million and $219 million in the second quarter and six months ended June 30, 2003, respectively. Higher costs associated with our growth businesses such as long distance and DSL and wage increases for management employees also contributed to the increase in cost of services and sales in both periods. Further, both the quarter and year-to-date comparisons were affected by the prior year reduction to operating expenses of approximately $98 million in the second quarter of 2003 and $111 million year-to-date 2003 for insurance recoveries related to the terrorist attacks on September 11, 2001. The year-to-date increase in costs also includes the effect of a favorable adjustment of approximately $80 million recorded in the first quarter of 2003 in connection with our ongoing review of local interconnection expense charged by CLECs.

 

These expense increases were partially offset in both periods by the effect of work force reductions of approximately 14,200 employees, or 9.2%, over the past year, principally in connection with a voluntary separation plan announced in the fourth quarter of 2003, and by a favorable adjustment to our interconnection expense in connection with the MCI settlement.

 

Selling, General and Administrative Expense

 

Selling, general and administrative expense includes salaries and wages and benefits not directly attributable to a service or product, bad debt charges, taxes other than income, advertising and sales commission costs, customer billing, call center and information technology costs, professional service fees and rent for administrative space.

 

Selling, general and administrative expense increased by $90 million, or 4.0% in the second quarter of 2004 and $239 million, or 5.6% for the six months ended June 30, 2004. In both periods, these increases include higher net pension and benefit costs as described above and higher rental, professional and general costs. The year-to-date cost increase also includes higher non-income taxes principally related to gross receipts and property and increased advertising costs associated with the launch of bundles and packages. These cost increases were partially offset in both periods by the effect of work force reductions and in the year-to-date period by a gain on the sale of a small business unit.

 

Depreciation and Amortization Expense

 

The decrease in depreciation and amortization expense of $91 million, or 4.0% in the second quarter of 2004 and $165 million, or 3.6% for the six months ended June 30, 2004, compared to the similar periods last year, was mainly driven by lower rates of depreciation.

 

Segment Income

 

     Three Months Ended June 30,               Six Months Ended June 30,       
(Dollars in Millions)    2004    2003    % Change          2004    2003    % Change  


Segment Income

   $ 683    $ 915    (25.4 )%        $ 1,380    $ 1,922    (28.2 )%

 

Segment income decreased by $232 million, or 25.4% in the second quarter of 2004 and by $542 million for the six months ended June 30, 2004 compared to the similar periods in 2003, primarily as a result of the after-tax impact of operating revenues and operating expenses described above and favorable deferred tax balance adjustments in the current year periods.

 

Special and non-recurring items not included in Domestic Telecom’s segment income totaled $(10) million and $482 million for the three months ended June 30, 2004 and 2003, respectively. Special and non-recurring charges included in the second quarter of 2004 related to an expense credit resulting from the favorable resolution of pre-bankruptcy amounts due from MCI largely offset by operating asset losses pertaining to our international long distance and data network, pension settlement losses for employees that received lump-sum distributions during the quarter under the prior year voluntary separation plan and costs associated with the early retirement of debt. The special and non-recurring items in the similar period of 2003 primarily related to severance and other benefit charges. Special and non-recurring items totaling $408 million for the six months ended June 30, 2004 also included additional pension settlement losses and early retirement of debt costs as well as a gain on the sale of an investment. Special and non-recurring items totaling $(1,570) million for the six months ended June 30, 2003 also included a net gain recorded in connection with the adoption of SFAS No. 143 and the directory accounting change.

 

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Domestic Wireless

 

Our Domestic Wireless segment provides wireless voice and data services and equipment sales across the United States. This segment primarily represents the operations of the Verizon Wireless joint venture.

 

Operating Revenues

 

     Three Months Ended June 30,               Six Months Ended June 30,       
(Dollars in Millions)    2004    2003    % Change          2004    2003    % Change  


Wireless sales and services

   $ 6,847    $ 5,477    25.0 %        $ 13,009    $ 10,563    23.2 %

 

Revenues earned from our consolidated wireless segment grew by $1,370 million, or 25.0% in the second quarter of 2004 and $2,446 million, or 23.2% for the six months ended June 30, 2004 compared to the similar periods in 2003. Service revenue of $6,043 million for the second quarter of 2004 was $1,032 million, or 20.6% higher than the similar period in 2003, and service revenue of $11,544 million for the six months ended June 30, 2004 was $1,873 million, or 19.4% higher than the similar period in 2003. These increases were primarily due to a 16.8% increase in customers as of June 30, 2004 compared to June 30, 2003 as well as an increase in ARPU.

 

We ended the second quarter of 2004 with more than 40.4 million customers, compared to 34.6 million customers at the end of the second quarter of 2003. More than 1.5 million net customers were added during the second quarter of 2004 compared to 1.3 million during the second quarter of 2003. We added over 2.9 million net customers during the six months ended June 30, 2004 compared to more than 2.1 million during the similar period in 2003. Retail net additions accounted for approximately 95% of the total net adds. The overall composition of our customer base as of June 30, 2004 was 92% retail postpaid, 4% retail prepaid and 4% resellers. As of June 30, 2004, approximately 38.4 million, or 95% of our customers subscribe to digital service, compared to 91% at June 30, 2003. In addition, our average monthly churn rate, the rate at which customers disconnect service, decreased to 1.4% in the second quarter of 2004 and decreased to 1.5% for the six months ended June 30, 2004, compared to 1.7% in the second quarter of 2003 and 1.9% for the six months ended June 30, 2003. Retail postpaid churn decreased to 1.2% in the second quarter of 2004 and decreased to 1.3% for the six months ended June 30, 2004, compared to 1.4% in the second quarter of 2003 and 1.5% for the six months ended June 30, 2003.

 

ARPU increased 3.2% to $50.80 for the second quarter of 2004 and by 2.5% to $49.44 for the six months ended June 30, 2004 compared to similar periods in 2003, primarily due to higher access price plan offerings as well as an increase in data revenues per customer. Data revenues increased by $168 million, or 193%, in the second quarter of 2004 and $296 million, or 186% for the six months ended June 30, 2004, compared to similar periods in 2003, as a result of higher use of our messaging and other data services. For the second quarter of 2004, data revenue accounted for 4.2% of service revenue, compared to 1.7% during the second quarter of 2003. These increases were partially offset by decreased roaming revenue as a result of rate reductions with third-party carriers and decreased long distance revenue due to bundled pricing.

 

Operating Expenses

 

     Three Months Ended June 30,               Six Months Ended June 30,       
(Dollars in Millions)    2004    2003    % Change          2004    2003    % Change  


Cost of services and sales

   $1,854    $1,567    18.3 %        $  3,512    $3,006    16.8 %

Selling, general and administrative expense

   2,275    1,973    15.3          4,522    3,839    17.8  

Depreciation and amortization expense

   1,103    956    15.4          2,158    1,863    15.8  
    
             
      
     $5,232    $4,496    16.4          $10,192    $8,708    17.0  
    
             
      

 

Cost of Services and Sales

 

Cost of services and sales, which are costs to operate the wireless network as well as the cost of roaming, long distance and equipment sales, grew by $287 million, or 18.3% for the second quarter of 2004 and $506 million, or 16.8% for the six months ended June 30, 2004 compared to the similar periods in 2003. These increases were primarily due to higher wireless network costs in the current year periods caused by increased MOUs on the wireless network, partially offset by lower roaming, local interconnection and long distance rates. Cost of equipment sales grew by 27.3% in the second quarter of 2004 and 22.0% for the six months ended June 30, 2004 compared to similar periods in 2003. These increases were primarily due to an increase in handsets sold, due to higher gross activations and an increase in equipment upgrades for the second quarter and the six months ended June 30, 2004 compared to the similar periods in 2003.

 

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Selling, General and Administrative Expense

 

Selling, general and administrative expenses grew by $302 million, or 15.3% in the second quarter of 2004 and $683 million, or 17.8% for the six months ended June 30, 2004 compared to the similar periods in 2003. These increases were primarily due to an increase in salary and benefits expense of $172 million for the second quarter of 2004 and $373 million for the six months ended June 30, 2004 compared to similar periods in 2003. The salary and benefits expense increases were primarily the result of higher benefits costs and an increase in the number of customer care and sales employees. Also contributing to the increases was a $21 million aggregate increase in sales commissions in our direct and indirect channels for the second quarter of 2004 and a $82 million increase for the six months ended June 30, 2004, compared to similar periods in 2003, primarily related to the increase in gross customer additions and customer renewals in the current year periods. Advertising and promotion expenses increased by $43 million in the second quarter of 2004 and $68 million for the six months ended June 30, 2004, compared to similar periods in 2003.

 

Depreciation and Amortization Expense

 

Depreciation and amortization increased by $147 million, or 15.4% in the second quarter of 2004 and $295 million, or 15.8% for the six months ended June 30, 2004 compared to similar periods in 2003. These increases were primarily due to increased depreciation expense related to the increase in depreciable assets.

 

Segment Income

 

     Three Months Ended June 30,               Six Months Ended June 30,       
(Dollars in Millions)    2004    2003    % Change          2004    2003    % Change  


Segment Income

   $ 453    $ 257    76.3 %        $ 771    $ 475    62.3 %

 

Segment income increased by $196 million, or 76.3% in the second quarter of 2004 and by $296 million, or 62.3% for the six months ended June 30, 2004 compared to the similar periods in 2003 primarily as a result of the after-tax impact of operating revenues and operating expenses described above, partially offset by an increase in minority interest. Increases in minority interest were principally due to the increased earnings of the Domestic Wireless segment, which has a significant minority interest attributable to Vodafone.

 

Information Services

 

Information Services’ multi-platform business is comprised of our yellow pages directories, online directory and search services through SuperPages.com, and directory and information services on wireless telephones through SuperPages On the Go. This segment’s operations are principally in the United States, Canada and Latin America.

 

Operating Revenues

 

     Three Months Ended June 30,               Six Months Ended June 30,       
(Dollars in Millions)    2004    2003    % Change          2004    2003    % Change  


Operating Revenues

   $ 986    $ 1,049    (6.0 )%        $ 1,985    $ 2,070    (4.1 )%

 

Information Services’ operating revenues decreased $63 million, or 6.0% in the second quarter of 2004 and $85 million, or 4.1% for the six months ended June 30, 2004. The decrease was due primarily to reduced domestic print advertising revenue and the elimination of revenue as a result of the sale of European operations, which was completed in July 2003. SuperPages.com continues to achieve strong growth, as demonstrated by a 14.5% increase in revenue and a 44.0% increase in searches in the second quarter of 2004 compared to the second quarter of 2003 and a 16.9% increase in revenue and a 55.8% increase in searches in the six months ended June 30, 2004 compared to the similar period in 2003.

 

Operating Expenses

 

     Three Months Ended June 30,          Six Months Ended June 30,       
(Dollars in Millions)    2004    2003    % Change     2004    2003    % Change  


Cost of services and sales

   $157    $160    (1.9 )%   $   312    $   314    (.6 )%

Selling, general and administrative expense

   374    361    3.6     722    705    2.4  

Depreciation and amortization expense

   24    23    4.3     48    44    9.1  
    
        
      
     $555    $544    2.0     $1,082    $1,063    1.8  
    
        
      

 

Total operating expenses remained relatively flat during the second quarter of 2004 and six months ended June 30, 2004 compared to the similar periods in 2003. Selling, general and administrative expenses increased $13 million, or

 

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3.6% in the second quarter of 2004 and $17 million, or 2.4% for the six months ended June 30, 2004 compared to the similar periods in the prior year. The increases were due primarily to increased bad debt expenses and higher pension and benefit costs, partially offset by reduced expenses related to the July 2003 sale of European operations. Depreciation and amortization expense increased slightly due primarily to software amortization of new systems placed into service in 2003.

 

Segment Income

 

     Three Months Ended June 30,               Six Months Ended June 30,       
(Dollars in Millions)    2004    2003    % Change          2004    2003    % Change  


Segment Income

   $ 258    $ 299    (13.7 )%        $ 545    $ 599    (9.0 )%

 

Segment income decreased $41 million, or 13.7% in the second quarter of 2004, and $54 million, or 9.0% for the six months ended June 30, 2004 compared to the similar periods in 2003. These decreases were due primarily as a result of the after-tax impact of the operating revenues and expense issues described above. Special and non-recurring items not included in Information Services’ segment income were $5 million for the quarter ended June 30, 2003, primarily related to severance charges. For the six months ended June 30, 2004 and 2003, special items totaled $8 million and $1,584 million, respectively. The special items included in the current year period were primarily related to pension settlement losses for employees who received lump-sum distributions under the prior year voluntary separation plan. The special items in the first six months of 2003 also included a loss recorded in connection with the directory accounting change and severance charges.

 

International

 

Our International segment includes international wireline and wireless telecommunication operations and investments primarily in the Americas and Europe. Our consolidated international investments as of June 30, 2004 included Verizon Dominicana in the Dominican Republic, TELPRI in Puerto Rico and Micronesian Telecommunications Corporation in the Northern Mariana Islands. Either the cost or the equity method is applied to those investments in which we have less than a controlling interest.

 

On June 13, 2003, we announced our decision to sell our 39.4% consolidated interest in Iusacell. In the second quarter of 2003, we reclassified our investment and results of operations of Iusacell as discontinued operations. Discontinued operations are excluded from International’s segment income.

 

Operating Revenues

 

     Three Months Ended June 30,               Six Months Ended June 30,       
(Dollars in Millions)    2004    2003    % Change          2004    2003    % Change  


Operating Revenues

   $ 506    $ 509    (.6 )%        $ 974    $ 1,026    (5.1 )%

 

Revenues generated by our international businesses decreased $3 million, or .6% in the second quarter of 2004 and $52 million, or 5.1% for the six months ended June 30, 2004 compared to the similar periods in 2003. These decreases are primarily due to declining foreign exchange rates in the Dominican Republic offset by operational growth at Verizon Dominicana and a favorable adjustment to carrier access revenues at TELPRI.

 

Operating Expenses

 

     Three Months Ended June 30,          Six Months Ended June 30,       
(Dollars in Millions)    2004    2003    % Change     2004    2003    % Change  


Cost of services and sales

   $156    $140    11.4 %   $303    $278    9.0 %

Selling, general and administrative expense

   87    195    (55.4 )   215    351    (38.7 )

Depreciation and amortization expense

   80    85    (5.9 )   157    172    (8.7 )
    
        
      
     $323    $420    (23.1 )   $675    $801    (15.7 )
    
        
      

 

Cost of Services and Sales

 

Cost of services and sales increased $16 million, or 11.4% in the second quarter of 2004 and $25 million, or 9.0% for the six months ended June 30, 2004 compared to the similar periods in 2003. These increases primarily reflect higher variable costs at Verizon Dominicana partially offset by the decline of the Dominican Republic’s foreign exchange rates.

 

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Selling, General and Administrative Expense

 

Selling, general and administrative expenses decreased $108 million, or 55.4% in the second quarter of 2004 and decreased $136 million, or 38.7% for the six months ended June 30, 2004 compared to the similar periods in 2003. These decreases are primarily the result of a favorable resolution of the third quarter of 2003 TELPRI charge recorded as a result of an adverse Puerto Rico Circuit Court of Appeals ruling on intra-island long distance access rates, an asset write-off recorded in the second quarter of 2003 and declining foreign exchange rates in the Dominican Republic.

 

Depreciation and Amortization Expense

 

Depreciation and amortization expense decreased $5 million, or 5.9% in the second quarter of 2004 and $15 million, or 8.7% for the six months ended June 30, 2004 compared to the similar periods in 2003. These decreases are primarily due to declining foreign exchange rates in the Dominican Republic.

 

Segment Income

 

     Three Months Ended June 30,               Six Months Ended June 30,       
(Dollars in Millions)    2004    2003    % Change          2004    2003    % Change  


Segment Income

   $ 287    $ 314    (8.6 )%        $ 568    $ 580    (2.1 )%

 

Segment income decreased by $27 million, or 8.6% in the second quarter of 2004 and $12 million, or 2.1% for the six months ended June 30, 2004 compared to the similar periods in 2003. The 2004 decreases in segment income were primarily the result of decreases in income from other unconsolidated businesses and higher taxes, partially offset by increases in equity in earnings of unconsolidated businesses and Verizon’s share (after minority interest) of the after-tax impact of operating revenues and operating expenses described above.

 

Income from other unconsolidated businesses decreased by $59 million in the second quarter of 2004 and decreased $60 million in the six months ended June 30, 2004 compared to similar periods in 2003. These decreases primarily relate to 2003 sales of our interest in TCC.

 

Equity in earnings of unconsolidated businesses increased by $43 million in the second quarter of 2004 and increased $96 million in the six months ended June 30, 2004 compared to the similar periods in 2003. These increases primarily reflect the continued operational growth at Vodafone Omnitel and favorable foreign currency impacts from the euro on that investment.

 

The special and non-recurring item not included in International’s segment income of $1 million for the six months ended June 30, 2004 related to pension settlement losses for employees that received lump-sum distributions during the first quarter of 2004 under the prior year voluntary separation plan. Special and non-recurring items not included in International’s segment income of $931 million for the second quarter of 2003 and $900 million for the six months ended June 30, 2003 primarily related to a loss on our investment in Iusacell.

 

Special Items

 

Severance, Pension and Benefit Charges

 

During the second quarter of 2004, we recorded pretax pension settlement losses of $31 million ($19 million after-tax, or $.01 per diluted share). In addition, during the first quarter of 2004, we recorded pretax pension settlement losses of $728 million ($446 million after-tax, or $.16 per diluted share). These settlement losses related to employees that received lump-sum distributions during the quarter in connection with the previously announced voluntary separation plan under which more than 21,000 employees accepted the separation offer in the fourth quarter of 2003. These charges were recorded in accordance with SFAS No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits” which requires that settlement losses be recorded once prescribed payment thresholds have been reached. Verizon had previously estimated settlements related to the voluntary separation plan to total $700 million to $900 million, after taxes, mostly in the first quarter of 2004 although continuing throughout the year. Due to favorable offsets such as an improved return on pension plan assets and lower than expected lump-sum payouts, we now expect total after-tax charges associated with the voluntary separation plan may be less than the lower end of this range.

 

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During the second quarter of 2003 we recorded a special charge of $463 million ($286 million after-tax, or $.10 per diluted share) in connection with enhanced pension benefits granted to employees retiring in the first half of 2003, estimated costs associated with the July 10, 2003 Verizon-New York arbitration ruling and pension settlement losses related to lump-sum pay-outs in 2003. On July 10, 2003, an arbitrator ruled that Verizon-New York’s termination of 2,300 employees in 2002 was not permitted under a union contract; similar cases were pending impacting an additional 1,100 employees. Verizon offered to reinstate all 3,400 impacted employees, and accordingly, recorded a charge in the second quarter of 2003 representing estimated payments to employees and other related company-paid costs.

 

In addition, in the second quarter of 2003 we recorded a special charge of $235 million ($150 million after-tax, or $.05 per diluted share) primarily associated with employee severance costs and severance-related activities in connection with the voluntary separation of approximately 4,000 employees.

 

Sale of Investment

 

During the first quarter of 2004, we sold all of our investment in Iowa Telecom preferred stock, which resulted in a pretax gain of $43 million ($43 million after-tax, or $.02 per diluted share) included in Income From Other Unconsolidated Businesses in the unaudited condensed consolidated statements of income. The preferred stock was received in 2000 in connection with the sale of access lines in Iowa.

 

Discontinued Operations

 

During the second quarter of 2003, we announced our decision to sell our 39.4% consolidated interest in Iusacell into the tender offer launched by Movil Access, a Mexican company. Verizon tendered its shares shortly after the tender offer commenced, and the tender offer closed on July 29, 2003. In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, we have classified the results of operations of Iusacell as discontinued operations. In connection with the decision to sell our interest in Iusacell and a comparison of expected net sale proceeds to the net book value of our investment in Iusacell (including the foreign currency translation balance), we recorded a pretax loss of $957 million ($931 million after-tax, or $.33 per diluted share).

 

Other Special Items

 

In the second quarter of 2004, we recorded an expense credit of $204 million ($123 million after-tax, or $.04 per diluted share) resulting from the favorable resolution of pre-bankruptcy amounts due from MCI. Previously reached settlement agreements became fully effective when MCI emerged from bankruptcy proceedings in the second quarter of 2004.

 

Also during the second quarter of 2004, we recorded a charge of $113 million ($87 million after-tax, or $.03 per diluted share) related to operating asset losses pertaining to our international long distance and data network. In addition, we recorded pretax charges of $12 million ($7 million after-tax, or less than $.01 per diluted share) during the current quarter in connection with the early retirement of debt. During the first quarter of 2004, we also recorded pretax charges of $43 million ($27 million after-tax, or $.01 per diluted share) resulting from the early retirement of debt.

 

During the second quarter of 2003, we recorded other pretax charges of $258 million ($204 million after-tax, or $.07 per diluted share) primarily related to a pretax impairment charge of $125 million ($125 million after-tax, or $.04 per diluted share) pertaining to our leasing operations for airplanes leased to airlines that were experiencing financial difficulties and for power generating facilities. These second quarter 2003 charges also included pretax charges of $61 million ($38 million after-tax, or $.01 per diluted share) pertaining to the early retirement of debt and other pretax charges of $72 million ($41 million after-tax, or $.01 per diluted share).

 

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Consolidated Financial Condition

 

     Six Months Ended June 30,             
(Dollars in Millions)    2004     2003          $ Change  


Cash Flows Provided By (Used In)

                             

Operating activities

   $ 9,891     $ 10,969          $ (1,078 )

Investing activities

     (4,759 )     (5,084 )          325  

Financing activities

     (5,223 )     (6,487 )          1,264  
    


Increase (Decrease) in Cash and Cash Equivalents

   $ (91 )   $ (602 )        $ 511  
    


 

We use the net cash generated from our operations to fund network expansion and modernization, repay external financing, pay dividends and invest in new businesses. Additional external financing is utilized when necessary. While our current liabilities typically exceed current assets, our sources of funds, primarily from operations and, to the extent necessary, from readily available external financing arrangements, are sufficient to meet ongoing operating and investing requirements. We expect that capital spending requirements will continue to be financed primarily through internally generated funds. Additional debt or equity financing may be needed to fund additional development activities or to maintain our capital structure to ensure our financial flexibility.

 

Cash Flows Provided By Operating Activities

 

Our primary source of funds continues to be cash generated from operations. The decrease in cash from operating activities for the six months ended June 30, 2004 compared to the similar period of 2003 was primarily due to a higher decrease in current liabilities (use of cash) in the first six months of 2004 and a higher decrease in receivables (source of cash) in the first six months of the prior year. Higher severance payments were recorded in the first six months of 2004 and higher tax refunds were recorded in the first six months of 2003. In addition, the higher decrease in receivables in the first six months of 2003 was driven by a greater reduction of days sales outstanding in that period compared to the first six months of 2004.

 

Cash Flows Used In Investing Activities

 

Capital expenditures continue to be our primary use of capital resources and facilitate the introduction of new products and services, enhance responsiveness to competitive challenges and increase the operating efficiency and productivity of our networks. Including capitalized software, we invested $2,942 million in our Domestic Telecom segment in the first six months of 2004, compared to $3,019 million in the first six months of 2003. We also invested $2,747 million in our Domestic Wireless segment in the first six months of 2004, compared to $2,096 million in the first six months of 2003. The steady capital investment in Domestic Telecom and the increase in capital spending in Domestic Wireless represent our continuing effort to invest in high growth areas including wireless, long distance, DSL and Enterprise Advance.

 

Capital spending, including capitalized software, is expected to be approximately $12 billion to $13 billion in 2004. The range includes $6.5 billion to $7.0 billion for Domestic Telecom, $5.0 billion to $5.5 billion for Domestic Wireless (expected to be the high end of the range) and a total of $.5 billion for Information Services, International and corporate and other businesses.

 

We invested $55 million in acquisitions and investments in businesses during the first six months of 2004 primarily related to Verizon’s limited partnership investments in entities that invest in affordable housing projects. In the first six months of 2003, we invested $1,033 million in acquisitions and investments in businesses including $762 million to acquire 50 Personal Communications Services licenses and related network assets from Northcoast Communications LLC and $146 million for other wireless properties. In the first six months of 2004, we received cash proceeds of $117 million from the sale of a small business unit.

 

Other, net investing activities for the first six months of 2004 includes net cash proceeds received in connection with the sale of investments, including Iowa Telecom preferred stock.

 

Under the terms of an investment agreement relating to our wireless joint venture, Vodafone may require Verizon Wireless to purchase up to an aggregate of $20 billion worth of Vodafone’s interest in Verizon Wireless at designated times between 2003 and 2007 at its then fair market value. In the event Vodafone exercises its put rights, we have the right, exercisable at our sole discretion, to purchase up to $12.5 billion of Vodafone’s interest instead of Verizon Wireless for cash or Verizon stock at our option. Vodafone may require the purchase of up to $10 billion during a 61-day period opening on June 10 and closing on August 9 in 2004, and the remainder, which may not exceed $10

 

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billion in any one year, during a 61-day period opening on June 10 and closing on August 9 in 2005 through 2007. Vodafone also may require that Verizon Wireless pay for up to $7.5 billion of the required repurchase through the assumption or incurrence of debt.

 

Cash Flows Used In Financing Activities

 

Cash of $3,011 million was used to reduce our total debt during the first six months of 2004. We repaid $2,259 million and $2,459 million of Domestic Telecom and corporate long-term debt, respectively. The Domestic Telecom debt repayment includes the early retirement of $1,275 million of long-term debt. The corporate debt repayment includes $1,984 million of zero-coupon convertible notes redeemed by Verizon Global Funding Corp. Also during the six months ended June 30, 2004 we increased our short-term borrowings by $1,254 million and Verizon Global Funding issued $500 million of long-term debt.

 

Cash of $4,649 million was used to reduce our total debt during the first half of 2003. We repaid $5,646 million of Verizon Global Funding, $1,800 million of Domestic Telecom and $1,095 million of other corporate long-term debt with the issuance of short and long-term debt. We increased our short-term borrowings by $1,109 million while Verizon Global Funding and Domestic Telecom issued long-term debt with principal amounts of $1,500 million and $1,350 million, respectively, resulting in total cash proceeds of $2,766 million, net of discounts, costs and a payment related to a hedge on the interest rate for an anticipated financing.

 

Our ratio of debt to debt combined with shareowners’ equity was 55.1% at June 30, 2004, compared to 58.8% at June 30, 2003.

 

As of June 30, 2004, we had $130 million in bank borrowings outstanding. In addition, we had approximately $5.7 billion of unused bank lines of credit and our financing subsidiary had shelf registrations for the issuance of up to $10.5 billion of unsecured debt securities. The debt securities of our telephone and financing subsidiaries continue to be accorded high ratings by primary rating agencies. In March 2004, Standard & Poor’s announced that it put Verizon’s debt on review with negative implications, citing general industry issues. We have adopted a debt portfolio strategy that continues our overall debt reduction efforts through the remainder of the year.

 

Verizon and its consolidated subsidiaries are in compliance with all of their debt covenants.

 

As in prior quarters, dividend payments were a significant use of capital resources. We determine the appropriateness of the level of our dividend payments on a periodic basis by considering such factors as long-term growth opportunities, internal cash requirements, and the expectations of our shareowners. In the first and second quarters of 2004 and 2003, we announced quarterly cash dividends of $.385 per share.

 

Decrease in Cash and Cash Equivalents

 

Our cash and cash equivalents at June 30, 2004 totaled $608 million, a $91 million decrease from cash and cash equivalents at December 31, 2003 of $699 million.

 

Market Risk

 

We are exposed to various types of market risk in the normal course of our business, including the impact of interest rate changes, foreign currency exchange rate fluctuations, changes in equity investment prices and changes in corporate tax rates. We employ risk management strategies using a variety of derivatives, including interest rate swap agreements, interest rate locks, foreign currency forwards, equity options and basis swap agreements. We do not hold derivatives for trading purposes.

 

It is our general policy to enter into interest rate, foreign currency and other derivative transactions only to the extent necessary to achieve our desired objectives in limiting our exposures to the various market risks. Our objectives include maintaining a mix of fixed and variable rate debt to lower borrowing costs within reasonable risk parameters and to protect against earnings and cash flow volatility resulting from changes in market conditions. We do not hedge our market risk exposure in a manner that would completely eliminate the effect of changes in interest rates, equity prices and foreign exchange rates on our earnings. We do not expect that our net income, liquidity and cash flows will be materially affected by these risk management strategies.

 

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Exchangeable Notes

 

In 1998, Verizon Global Funding issued notes exchangeable into shares of Telecom Corporation of New Zealand Limited (TCNZ) and into shares of Cable & Wireless Communications plc (subsequently Cable & Wireless plc and NTL Incorporated) as described in Note 8 to the unaudited condensed consolidated financial statements. These financial instruments exposed us to market risk, including (i) equity price risk, because the notes were exchangeable into shares that are traded on the open market and routinely fluctuate in value, (ii) foreign exchange rate risk, because the notes were exchangeable into shares that are denominated in a foreign currency, and (iii) interest rate risk, because the notes carried fixed interest rates.

 

On April 1, 2003, all of the outstanding $2,455 million principal amount of the 5.75% notes that were exchangeable into shares of TCNZ were redeemed at maturity. On March 15, 2003, Verizon Global Funding redeemed all of the outstanding 4.25% notes. The cash redemption price for the 4.25% notes was $1,048.29 for each $1,000 principal amount of the notes. The principal amount of the 4.25% notes outstanding, before unamortized discount, at the time of redemption, was $2,839 million.

 

Foreign Currency Translation

 

The functional currency for nearly all of our foreign operations is the local currency. The translation of income statement and balance sheet amounts of these entities into U.S. dollars are recorded as cumulative translation adjustments, which are included in Accumulated Other Comprehensive Loss in our unaudited condensed consolidated balance sheets. At June 30, 2004, our primary translation exposure was to the Venezuelan bolivar, Dominican Republic peso, Canadian dollar and the euro. We have not hedged our accounting translation exposure to foreign currency fluctuations relative to the carrying value of these investments.

 

Our earnings were affected by foreign currency gains or losses associated with the U. S. dollar denominated assets and liabilities at Verizon Dominicana and at Iusacell prior to selling Iusacell in July 2003 (see “Consolidated Results of Operations – Other Consolidated Results – Discontinued Operations”).

 

Other Factors That May Affect Future Results

 

Recent Developments

 

Spectrum Purchases

 

We announced on July 8, 2004 that we had won an auction for a spectrum license covering the New York metropolitan area held by NextWave Telecom Inc. Under the terms of the purchase agreement, we will pay $930 million for the license which covers the New York metropolitan area. The transaction is subject to several federal reviews and is expected to close by the end of 2004. In addition, on July 1, 2004 we announced an agreement to purchase Qwest Wireless’s spectrum licenses and wireless network assets for $418 million covering several existing and new markets. The transaction is subject to federal reviews and is expected to close by the fourth quarter of 2004 or early 2005.

 

MCI Bankruptcy Matters

 

Verizon has several significant business relationships with MCI, both as a customer for our services and a supplier of services. On April 20, 2004, MCI emerged from bankruptcy proceedings. Settlement agreements reached with MCI in June and December of 2003 that addressed all pre-bankruptcy receivables and payables as well as certain other pre- and post-bankruptcy disputes between the companies became fully effective. In the second quarter of 2004, we recorded an expense credit of $204 million resulting from the favorable resolution of pre-bankruptcy amounts due from MCI.

 

Telephone Access Lines

 

During the second quarter of 2004, we entered into an agreement to sell our wireline-related businesses in Hawaii, which operates 707,000 switched access lines, for $1,650 million in cash, less debt. The closing of the transaction, expected in 2005, is contingent on state and federal approvals.

 

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As we have stated in the past, Verizon periodically evaluates its assets and properties for strategic fit and financial performance. As we have previously disclosed, we have had discussions regarding the possible sale of telephone access lines in upstate New York.

 

Environmental Matters

 

During 2003, under a government-approved plan, remediation of the site of a former facility in Hicksville, New York that processed nuclear fuel rods in the 1950s and 1960s commenced. Remediation beyond original expectations proved to be necessary and a reassessment of the anticipated remediation costs was conducted. In addition, a reassessment of costs related to remediation efforts at several other former facilities was undertaken. As a result, an additional environmental remediation expense of $240 million was recorded in the fourth quarter of 2003.

 

New York Recovery Funding

 

In August 2002, President Bush signed the Supplemental Appropriations bill which included $5.5 billion in New York recovery funding. Of that amount, approximately $750 million has been allocated to cover utility restoration and infrastructure rebuilding as a result of the September 11th terrorist attacks. These funds will be distributed through the Lower Manhattan Development Corporation following an application and audit process. As of June 30, 2004, we have applied for reimbursement of approximately $266 million. We received an advance of $11 million in December 2003 and an additional advance of $77 million in June 2004. We are awaiting the results of an audit relating to the total amount that we have applied for reimbursement, including funds already received.

 

Telecommunications Act of 1996

 

We face increasing competition in all areas of our business. The Telecommunications Act of 1996 (1996 Act), regulatory and judicial actions and the development of new technologies, products and services have created opportunities for alternative telecommunication service providers, many of which are subject to fewer regulatory constraints. We are unable to predict definitively the impact that the ongoing changes in the telecommunications industry will ultimately have on our business, results of operations or financial condition. The financial impact will depend on several factors, including the timing, extent and success of competition in our markets, the timing and outcome of various regulatory proceedings and any appeals, and the timing, extent and success of our pursuit of new opportunities resulting from the 1996 Act and technological advances.

 

In-Region Long Distance

 

Under the 1996 Act, our ability to offer in-region long distance services in the regions where the former Bell Atlantic telephone subsidiaries operate as local exchange carriers was largely dependent on satisfying specified requirements. These requirements included a 14-point “competitive checklist” of steps which we must take to help competitors offer local services through resale, through purchase of UNEs, or by interconnecting their own networks to ours. We were required to demonstrate to the FCC that our entry into the in-region long distance market would be in the public interest. We now have authority from the FCC to offer in-region long distance service in all 14 of the former Bell Atlantic jurisdictions.

 

FCC Regulation and Interstate Rates

 

Our telephone operations are subject to the jurisdiction of the FCC with respect to interstate services and related matters.

 

Access Charges and Universal Service

 

On May 31, 2000, the FCC adopted the Coalition for Affordable Local and Long Distance Services (CALLS) plan as a comprehensive five-year plan for regulation of interstate access charges. The CALLS plan has three main components. First, it establishes a portable interstate access universal service support of $650 million for the industry. This explicit support replaces implicit support embedded in interstate access charges. Second, the plan simplifies the patchwork of common line charges into one subscriber line charge (SLC) and provides for de-averaging of the SLC by zones and class of customers in a manner that will not undermine comparable and affordable universal service. Third, the plan sets into place a mechanism to transition to a set target of $.0055 per minute for switched access services. Once that target rate is reached, local exchange carriers are no longer required to make further annual price cap reductions to their switched access prices. The annual reductions leading to the target rate, as well as annual reductions for the subset of special access services that remain subject to price cap regulation was set at 6.5% per year.

 

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As a result of tariff adjustments which became effective in July 2003, virtually all of our switched access lines reached the $.0055 benchmark. On June 29, 2004, the U.S. Court of Appeals for the D.C. Circuit upheld the FCC’s prior approval of an increase in the SLC cap. The current cap is $6.50.

 

The FCC previously initiated investigations of the interstate access rates charged by Verizon’s local telephone companies during the 1993 to 1996 tariff years under the price cap rules that were in place prior to the adoption of the CALLS plan. On July 30, 2004, the FCC released an order resolving one of the issues in those pending investigations, and concluded that some of Verizon’s local telephone companies had incorrectly calculated the impact of their obligation to “share” a portion of their earnings above certain prescribed levels with their access customers. The amount of any refund as a result of that finding will be determined in a further phase of the proceeding. Other issues remain under investigation.

 

The FCC has adopted rules for special access services that provide for pricing flexibility and ultimately the removal of services from price regulation when prescribed competitive thresholds are met. Approximately 55% of special access revenues are now removed from price regulation.

 

In November 1999, the FCC adopted a new mechanism for providing universal service support to high-cost areas served by large local telephone companies. This funding mechanism provides additional support for local telephone services in several states served by our telephone operations. This system has been supplemented by the new FCC access charge plan described above. On October 16, 2003, in response to a previous court decision, the FCC announced a decision providing additional justification for its non-rural high-cost universal support mechanism and modifying it in part. That decision also has been appealed. The FCC also has proceedings underway to evaluate possible changes to its current rules for assessing contributions to the universal service fund. Any change in the current assessment mechanism could result in a change in the contribution that local telephone companies must make and that would have to be collected from customers.

 

Unbundling of Network Elements

 

On February 20, 2003, the FCC announced a decision adopting new rules defining the obligations of incumbent local exchange carriers to provide competing carriers with access to UNEs. The decision was the culmination of an FCC rulemaking referred to as its triennial review of its UNE rules, and also was in response to a decision by the U.S. Court of Appeals for the D.C. Circuit. The U.S. Court of Appeals for the D.C. Circuit had overturned the FCC’s previous unbundling rules on the grounds that the FCC did not adequately consider the limitations of the “necessary and impair” standards of the 1996 Act when it chose national rules for unbundling and that it failed to consider the relevance of competition from other types of service providers, including cable and satellite.

 

The text of the order and accompanying rules was released on August 21, 2003. With respect to broadband facilities, such as mass market fiber to the premises loops and packet switching, that order generally removed unbundling obligations under Section 251 of the 1996 Act. With respect to narrowband services, the order generally left unbundling obligations in place, with certain limited exceptions, and delegated to state regulatory proceedings a further review. The order also provided a new set of criteria relating to when carriers may purchase a combination of unbundled loops and transport elements known as enhanced extended loops (EELs).

 

The FCC’s order significantly increases arbitrage opportunities by making it easier for carriers to use EELs for non-local service at regulated prices set using the pricing formula that applies to UNEs rather than competitive special access prices. In addition, the FCC’s order eliminates important safeguards that protected against this kind of arbitrage, including the FCC’s previous rule against co-mingling unbundled elements and other services. As a result, we estimate the impact on earnings related to this portion of the FCC’s order to be potentially 4 cents to 6 cents per diluted share in 2004.

 

Multiple parties, including Verizon, appealed various aspects of the decision. Multiple parties also have asked the FCC to clarify or reconsider various aspects of its order, and Verizon has petitioned the FCC to make clear that any broadband facilities that do not have to be unbundled under Section 251 of the 1996 Act also do not have to be unbundled under another provision of the 1996 Act. On March 2, 2004, the U.S. Court of Appeals for the D.C. Circuit issued an order upholding the FCC in part, and overturning its order in part. The court upheld the FCC with respect to broadband facilities. On the narrowband unbundling requirements the court reversed key aspects of the FCC decision. The court’s reversal of the FCC went into effect on June 16, 2004 after both the U.S. Court of Appeals for the D.C. Circuit and the U.S. Supreme Court denied motions to further stay the decision. Petitions by state regulators and other carriers seeking U.S. Supreme Court review of the U.S. Court of Appeals for the D.C. Circuit decision are pending.

 

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Intercarrier Compensation

 

On April 27, 2001, the FCC released an order addressing intercarrier compensation for dial-up connections for Internet-bound traffic. The FCC found that Internet-bound traffic is interstate and subject to the FCC’s jurisdiction. Moreover, the FCC again found that Internet-bound traffic is not subject to reciprocal compensation under Section 251(b)(5) of the 1996 Act. Instead, the FCC established federal rates per minute for this traffic that decline from $.0015 to $.0007 over a three-year period. The FCC order also sets caps on the total minutes of this traffic that may be subject to any intercarrier compensation and requires that incumbent local exchange carriers must offer to both bill and pay reciprocal compensation for local traffic at the same rate as they are required to pay on Internet-bound traffic. On May 3, 2002, the U.S. Court of Appeals for the D.C. Circuit rejected part of the FCC’s rationale for its April 27, 2001 order, but declined to vacate the order while it is on remand. As a result, pending further action by the FCC, the FCC’s underlying order remains in effect.

 

More generally, the FCC has an ongoing rulemaking that could fundamentally restructure the regulatory regime for intercarrier compensation, including, but not limited to, access charges, compensation for Internet traffic, and reciprocal compensation for local traffic. As noted above, the FCC also has pending before it the issues relating to intercarrier compensation for dial-up Internet-bound traffic that were remanded by the U.S. Court of Appeals for the D.C. Circuit, including whether to affirm, reverse or modify its previous determinations that this traffic is not subject to reciprocal compensation under Section 251(b)(5) of the 1996 Act. Disputes also remain pending in a number of forums relating to the appropriate compensation for Internet-bound traffic during previous periods under the terms of our interconnection agreements with other carriers.

 

The FCC also is considering multiple petitions asking it to declare whether, and under what circumstances, services that employ Internet protocol are subject to access charges under current law, or asking it to forbear from any requirement to pay access charges on some such services. On March 10, 2004, the FCC initiated a rulemaking proceeding to address the regulation of services that use Internet protocol, including voice services. The FCC also concluded in response to one such petition that one provider’s peer-to-peer Internet protocol service that does not use the public switched network is an interstate information service and is not subject to access charges. In addition, during April 2004, the FCC issued an order in connection with another such petition that stated that the petitioning company’s service that utilizes Internet protocol for only one intermediate part of a call’s transmission is subject to access charges.

 

Broadband Services

 

The FCC has several ongoing rulemakings considering the regulatory treatment of broadband services. Among the questions at issue are whether to require local telephone companies like Verizon to offer such services as a common carrier or whether such services may be offered under a potentially less regulated private carriage arrangement, and whether to declare broadband services offered by local telephone companies as non-dominant and what the effect should be of any such classification.

 

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Cautionary Statement Concerning Forward-Looking Statements

 

In this Management’s Discussion and Analysis of Results of Operations and Financial Condition, and elsewhere in this Quarterly Report, we have made forward-looking statements. These statements are based on our estimates and assumptions and are subject to risks and uncertainties. Forward-looking statements include the information concerning our possible or assumed future results of operations. Forward-looking statements also include those preceded or followed by the words “anticipates,” “believes,” “estimates,” “hopes” or similar expressions. For those statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

 

The following important factors, along with those discussed elsewhere in this Quarterly Report, could affect future results and could cause those results to differ materially from those expressed in the forward-looking statements:

 

materially adverse changes in economic and industry conditions and labor matters, including workforce levels and labor negotiations, and any resulting financial and/or operational impact, in the markets served by us or by companies in which we have substantial investments;

 

material changes in available technology;

 

technology substitution;

 

an adverse change in the ratings afforded our debt securities by nationally accredited ratings organizations;

 

the final results of federal and state regulatory proceedings concerning our provision of retail and wholesale services and judicial review of those results;

 

the effects of competition in our markets;

 

our ability to satisfy regulatory merger conditions;

 

the ability of Verizon Wireless to continue to obtain sufficient spectrum resources; and

 

changes in our accounting assumptions that regulatory agencies, including the SEC, may require or that result from changes in the accounting rules or their application, which could result in an impact on earnings.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk


 

Information relating to market risk is included in Item 2, Management’s Discussion and Analysis of Results of Operations and Financial Condition in the section under the caption “Market Risk.”

 

Item 4. Controls and Procedures


 

Our chief executive officer and chief financial officer have evaluated the effectiveness of the registrant’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934), as of the end of the period covered by this quarterly report, that ensure that information relating to the registrant which is required to be disclosed in this report is recorded, processed, summarized and reported, within required time periods. Based on this evaluation, which disclosed no significant deficiencies or material weaknesses, they have concluded that the registrant’s disclosure controls and procedures were adequate and effective to ensure that material information relating to the registrant and its consolidated subsidiaries would be made known to them by others within those entities, particularly during the period in which this quarterly report was being prepared. There were no changes in the registrant’s internal control over financial reporting during the period covered by this quarterly report that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

 

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Part II – Other Information

 

Item 2. Changes in Securities and Use of Proceeds


 

Period   (a) Total Number of
Shares Purchased
  (b) Average Price Paid
per Share
  (c) Total Number of
Shares Purchased as Part
of Publicly Announced
Plans or Programs (1)
  (d) Maximum Number of
Shares that May Yet Be
Purchased Under the
Plans or Programs (2)
         
April 2004   250,000     $37.39     250,000     79,750,000
         
May 2004   225,000     $36.52     225,000     79,525,000
         
June 2004   1,936,800     $35.17     1,936,800     77,588,200
         
Total   2,411,800     $36.36     2,411,800     77,588,200

 

(1)

On January 22, 2004, Verizon’s Board of Directors authorized a common stock repurchase program.

 

(2)

The program authorizes total repurchases of up to 80 million common shares and expires no later than the close of business on February 28, 2006. Under the plan, Verizon has the option to repurchase shares for the corporation over time, with the amount and timing of repurchases depending on market conditions and corporate needs.

 

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


 

Our 2004 Annual Meeting of Shareholders was held on April 28, 2004. At the meeting, the following items were submitted to a vote of shareholders.

 

The number of common shares present at the Annual Meeting of Shareholders of Verizon Communications Inc. voting and withholding authority to vote in the election of Directors (the “Total Vote”) was 2,297,003,757 or 82.92% of the common shares outstanding on March 1, 2004, the record date for said meeting.

 

(a)

The following nominees were elected to serve on the Board of Directors:

 

Name of Nominee   Votes Cast For   Votes Withheld

James R. Barker   2,174,243,971   122,759,786
Richard L. Carrión   2,164,744,213   132,259,544
Robert W. Lane   2,205,654,803   91,348,954
Sandra O. Moose   2,089,991,083   207,012,674
Joseph Neubauer   2,164,981,567   132,022,190
Thomas H. O’Brien   2,191,050,600   105,953,157
Hugh B. Price   2,155,104,931   141,898,826
Ivan G. Seidenberg   2,148,894,998   148,108,759
Walter V. Shipley   2,188,828,118   108,175,639
John R. Stafford   2,174,476,408   122,527,349
Robert D. Storey   2,142,962,767   154,040,990

 

(b)

The appointment of Ernst & Young LLP as independent auditor for 2004 was ratified with 2,206,064,092 votes for, 66,266,887 votes against, and 24,672,778 abstentions.

 

(c)

A shareholder proposal regarding Cumulative Voting was defeated with 609,365,978 votes for, 1,116,675,838 votes against, 172,782,009 abstentions and 398,179,932 broker non-votes.

 

(d)

A shareholder proposal regarding composition of the Board of Directors was defeated with 375,545,097 votes for, 1,484,053,711 votes against, 39,225,017 abstentions and 398,179,932 broker non-votes.

 

(e)

A shareholder proposal regarding Separate Chairman and CEO was defeated with 680,102,742 votes for, 1,180,442,987 votes against, 38,278,096 abstentions and 398,179,932 broker non-votes.

 

(f)

A shareholder proposal regarding Any Future Poison Pill was defeated with 687,683,365 votes for, 1,159,718,500 votes against, 51,421,960 abstentions and 398,179,932 broker non-votes.

 

(g)

A shareholder proposal regarding Supplemental Executive Retirement Plans was defeated with 691,698,985 votes for, 1,169,948,290 votes against, 37,176,550 abstentions and 398,179,932 broker non-votes.

 

(h)

A shareholder proposal regarding Options or Stock Grants Based on Tracking Stock was defeated with 287,099,148 votes for, 1,564,698,844 votes against, 47,025,833 abstentions and 398,179,932 broker non-votes.

 

(i)

A shareholder proposal regarding Diversity Report on Option Grants to Employees was defeated with 180,869,826 votes for, 1,555,754,991 votes against, 162,199,008 abstentions and 398,179,932 broker non-votes.

 

(j)

A shareholder proposal regarding Report on Political Contributions was defeated with 275,910,646 votes for, 1,468,835,437 votes against, 154,077,742 abstentions and 398,179,932 broker non-votes.

 

(k)

A shareholder proposal regarding Collection of Universal Service Fees and Number Portability Fees was defeated with 103,651,044 votes for, 1,625,469,229 votes against, 169,703,552 abstentions and 398,179,932 broker non-votes.

 

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Item 6. Exhibits and Reports on Form 8-K


 

(a)

Exhibits:

 

Exhibit
Number


    

    10a

   Employment Agreement between Verizon and Marc C. Reed.

    10b

   Employment Agreement between Verizon and Thomas J. Tauke.

    12

   Computation of Ratio of Earnings to Fixed Charges.

    31.1

   Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

    31.2

   Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

    32.1

   Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

    32.2

   Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(b)

Reports on Form 8-K filed or furnished during the quarter ended June 30, 2004:

 

A Current Report on Form 8-K, furnished on April 27, 2004 announcing Verizon’s earnings for the first quarter ended March 31, 2004.

 

A Current Report on Form 8-K, filed on May 21, 2004, containing a press release announcing an agreement to sell wireline-related businesses in Hawaii.

 

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Signature


 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

       

VERIZON COMMUNICATIONS INC.

Date: August 6, 2004       By  

/s/ David H. Benson


               

     David H. Benson

     Senior Vice President and Controller

     (Principal Accounting Officer)

 

UNLESS OTHERWISE INDICATED, ALL INFORMATION IS AS OF AUGUST 2, 2004.

 

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