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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2004

or

For the transition period from              to             

Commission File Number 001-10415

MCI, Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (703) 886-5600

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

None

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

Common Stock, $.01 Par Value

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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

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

The aggregate market value of common equity as of June 30, 2004, based on the average bid and asked prices of MCI common stock on such date of $14.43 per share was approximately $4.6 billion.

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to distribution of securities confirmed by a court.    Yes  x    No  ¨

As of February 28, 2005, there were 324,755,920 shares outstanding of MCI, Inc. common stock.

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the Registrant’s Proxy Statement in connection with the 2005 Annual Meeting (Part III)

TABLE OF CONTENTS

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

The following statements in this Annual Report (and in other statements oral or written made by us) are or may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995:

(i) any statements regarding possible or assumed future results of operations of our business, pricing trends, the markets for our services and products, anticipated capital expenditures, our cost reduction and operational restructuring initiatives, regulatory developments, or competition;

(ii) any statements preceded by, followed by, or that include the words “intends,” “estimates,” “believes,” “expects,” “anticipates,” “plans,” “projects,” “should,” “could” or similar expressions; and

(iii) other statements regarding matters that are not historical facts.

You are cautioned not to place undue reliance on these statements, which speak only as of the date this document is filed. These statements are based on management’s current expectations and are subject to uncertainty and changes in circumstances. Actual results may differ materially from these expectations due to matters arising out of pending class action and other lawsuits and the ongoing internal and government investigations related to the previously announced restatements of WorldCom, Inc.’s financial results. Other factors that may cause actual results to differ materially from management’s expectations include, but are not limited to:

The cautionary statements contained or referred to in this section also should be considered in connection with any subsequent written or oral forward-looking statements that may be issued by us or persons acting on our behalf. We undertake no duty to update these forward-looking statements, even though our situation may change in the future.

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PART I

ITEM 1. BUSINESS

Overview

We are one of the world’s leading global communication companies, providing a broad range of services in over 200 countries on six continents. Each day, we provide Internet, data and voice communication services for thousands of businesses and government entities throughout the world and millions of consumer customers in the United States. We own and operate one of the most extensive communications networks in the world, comprising approximately 100,000 route miles of network connections linking metropolitan centers and various regions across North America, Europe, Asia, Latin America, the Middle East, Africa and Australia. In addition to transporting customer traffic over our network, we provide value-added services that make communications more secure, reliable and efficient and we provide managed network services for customers that outsource all or portions of their communications and information processing operations.

We conduct our business primarily using the brand name MCI. References herein to “MCI,” “we,” “us,” “our” or the “Company” refer to MCI, Inc., a Delaware corporation, and, unless the context otherwise requires or is otherwise expressly stated, its subsidiaries and its predecessor. Our website address is www.mci.com, and we make available free of charge through our website our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports filed or furnished under Sections 13(a) or 15(d) of the Securities Act of 1934 as soon as reasonably practicable after we file the material with the Securities and Exchange Commission (“SEC”). Our principal executive offices are located at 22001 Loudoun County Parkway, Ashburn, Virginia 20147 (telephone number 703-886-5600).

Company Background

MCI’s predecessor was WorldCom, Inc., a Georgia corporation formed in 1983 (“WorldCom” or “Predecessor”). From its inception, WorldCom grew significantly as a result of numerous acquisitions. On December 31, 1996, WorldCom acquired MFS Communications, which owned UUNET, one of the world’s most extensive Internet backbone networks. On September 14, 1998, WorldCom acquired MCI Communications Corporation, one of the world’s largest providers of telecommunications services. On October 1, 1999, WorldCom acquired SkyTel Communications, Inc. (“SkyTel”), a leading provider of messaging services in the United States. On July 1, 2001, WorldCom acquired Intermedia Communications Inc. (“Intermedia”), a provider of voice and data services, and, as a result, a controlling interest in Digex, Incorporated (“Digex”), a provider of managed web and application hosting services.

These acquisitions, along with large capital expenditure programs, greatly expanded WorldCom’s network operations, its customer base, the range of services it provided and the capabilities of its sales, service and technical personnel. However, these acquisitions and capital expenditure programs contributed to a sharp increase in WorldCom’s outstanding debt, which was over $30 billion as of June 30, 2002.

On June 25, 2002, WorldCom announced that, as a result of an internal audit of its capital expenditure accounting, it was determined that its previously issued financial statements had not been prepared in accordance with accounting principles generally accepted in the United States. Following a comprehensive review, WorldCom restated its consolidated financial statements for the fiscal years ended December 31, 2000 and 2001 and for the first quarter of 2002. The restated 2000 and 2001 financial statements were audited by KPMG LLP (“KPMG”), which replaced Arthur Andersen LLP (“Andersen”) as WorldCom’s external auditors in May 2002.

On July 21, 2002, WorldCom and substantially all of its U.S. subsidiaries filed voluntary petitions for relief in the U.S. Bankruptcy Court for the Southern District of New York under Chapter 11 of Title 11 of the U.S. Bankruptcy Code. On April 20, 2004 (the “Emergence Date”), WorldCom’s plan of reorganization was

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consummated and WorldCom emerged from bankruptcy. On the emergence date, WorldCom merged with and into MCI whereby the separate existence of WorldCom ceased and MCI became the surviving company.

In addition to restating our consolidated financial statements and completing our plan of reorganization, we have made extensive changes in the composition of our senior management and our Board of Directors. Also, we have implemented numerous changes in our business processes, internal controls and corporate governance policies and procedures.

Merger with Verizon Communications

On February 14, 2005, Verizon Communications Inc. (“Verizon”), MCI and a wholly-owned subsidiary of Verizon (“Merger Sub”) entered into an Agreement and Plan of Merger (the “Merger Agreement”). The Merger Agreement provides that, upon the terms and subject to the conditions set forth in the Merger Agreement, MCI will merge with and into the Verizon subsidiary (the “Merger”), with the Verizon subsidiary continuing as the surviving person (or, in certain situations, as provided in the Merger Agreement, a wholly-owned corporate subsidiary of Verizon will merge with and into MCI, with MCI as the surviving person.)

At the effective time and as a result of the Merger, MCI will become a wholly-owned subsidiary of Verizon and each share of MCI common stock will be converted into the right to receive (x) 0.4062 shares of Verizon common stock and (y) cash in the amount of $1.50 per share, which amount of cash and number of shares may be reduced pursuant to a purchase price adjustment based on MCI’s bankruptcy claims and for certain tax liabilities, on the terms specified in the Merger Agreement. The Merger Agreement also provides for payment of a special cash dividend in the amount of $4.10 per share (less the per share amount of any dividend declared by MCI during the period beginning on February 14, 2005 and ending on the closing date of the merger) of MCI common stock after the Merger Agreement is approved by the shareholders. All outstanding MCI stock-based awards at the effective time will be replaced by a grant of Verizon stock-based awards.

Consummation of the Merger is subject to customary conditions, including (i) approval by the shareholders of MCI, (ii) expiration or termination of the applicable Hart-Scott-Rodino waiting period and receipt of certain other federal, state or international regulatory approvals, (iii) absence of any law or order prohibiting the closing, and (iv) subject to certain exceptions, the accuracy of representations and warranties and the absence of any Material Adverse Effect (as defined in the Merger Agreement) with respect to each party’s business. In addition, Verizon’s obligation to close is subject to other conditions, including (i) absence of any pending U.S. governmental litigation with a reasonable likelihood of success seeking to prohibit the closing or to impose certain limitations, (ii) receipt of a bankruptcy order issued by the Unites States Bankruptcy Court for the Southern District allowing for the substitution of shares of Verizon common stock for shares of MCI common stock to satisfy certain bankruptcy-related claims, and (iii) receipt of an order issued by the United States District Court for the Southern District of New York relating to MCI’s Corporate Monitor and certain affirmative obligations imposed by prior order of the United States District Court for the Southern District of New York. The Merger Agreement contains certain termination rights for both MCI and Verizon, and further provides that, upon termination of the Merger Agreement under specified circumstances, MCI may be required to pay Verizon a termination fee of $200 million.

Consummation of the Merger will constitute a “Change of Control” under MCI’s outstanding Senior Notes due 2007, Senior Notes due 2009 and Senior Notes due 2014 (collectively, the “Senior Notes”), which will obligate the surviving person to make an offer to purchase the Senior Notes within 30 days after the effective time at a purchase price equal to 101% of principal amount plus accrued interest.

Our merger with Verizon, as well as other recently announced mergers and acquisitions, is occurring within a communications industry that has undergone significant changes in recent years. These changes include severe price competition resulting in part from excess network capacity due to overbuilding and the substitution of email, instant messaging and wireless telephone service for traditional wireline voice communications. Other important changes in our industry are the entry of new competitors, such as Verizon and the other regional Bell operating companies (“RBOCs”) into the long distance market, and cable television and other companies into the consumer telephony business. Also, there have been regulatory changes making it more difficult for competitive

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local exchange carriers like us to provide traditional telephone service, particularly to consumer customers, in competition with the RBOCs and other incumbent local exchange carriers. At the same time, technology changes are enabling the development of advanced networking services primarily based on Internet protocol (“IP”) communications and customer demand is increasing for such value-added services, including network management, application hosting and comprehensive security solutions.

We believe that consummation of our merger with Verizon will strengthen the services both companies provide and help the combined company better face the changing conditions within the communications industry. In addition, we believe that the combined company will have significant financial strength to maintain and improve MCI’s network as well as have enhanced capabilities to develop new value-added services, including sophisticated IP-based services. Furthermore, we believe that business, government and consumer customers will benefit from having improved access to a broad range of services, including wireless communication services and Internet, data and voice services provided through the combined global networks of MCI and Verizon. See “Risk Factors—The merger with Verizon may not occur or, if it does, may not provide all the anticipated benefits.”

On February 24, 2005, we received a revised proposal from Qwest Communications International, Inc. (“Qwest”) to acquire us. Our board of directors announced that it would conduct a thorough review of the Qwest proposal. On March 2, 2005, we announced our intention to engage with Qwest to review its February 24, 2005 proposal. This decision was made with the concurrence of Verizon. Subsequently, MCI and Qwest have been in ongoing discussions regarding Qwest’s proposal. These discussions are continuing as of the date of filing of this Annual Report on Form 10-K.

Strategy

We have developed the following four-part strategy based on our current competitive position, significant telecommunications and computing technological developments and the increasing demand for sophisticated services:

We have a strategically important position within the communications market due to the following:

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To capitalize on our current strategic position and to prepare for the progressively more sophisticated and expansive future IP needs of our customers, we are taking actions with the goal of achieving undisputed leadership in providing and enabling communications over the Internet. These actions include accelerating the convergence of all of our Internet, data and voice traffic onto a common IP backbone that will integrate our IP network with our existing frame relay, asynchronous transfer mode (“ATM”) and voice networks and will operate under a unified standard IP protocol. Around the perimeter of this common core IP network, we are adding multi-service edge devices to consolidate IP, data and voice traffic onto this network and also adding converged packet access to allow such traffic to use common access circuits. By converting to this converged IP architecture, we will have a common set of network systems for all forms of traffic that should produce cost savings for our customers and us, as well as further improve our flexibility and reliability in delivering services and enable rapid introduction of new services on a global basis.

In addition, we are modifying our network operating systems and information technology systems to enable greater ease, efficiency and effectiveness in customer use of our converged network. This involves our adopting unified systems to allow common network management, provisioning and billing. Also, we are modifying our data center architecture to share computing resources on a grid basis as well as developing processes for distributing applications to users on demand which will reduce costs and increase network security. Furthermore, we are enhancing the portal access to our information systems and building greater web services capability into these systems to enable our software applications and those of our customers to communicate and work together across our IP network.

We believe that new technology developments and changing customer preferences will drive the convergence of network communications and computing. In this environment, we expect that there will be opportunities to provide advanced services, such as grid computing in which computing, storage and software applications will be offered to customers as network utilities and made available on an as-needed basis.

In anticipation of this environment, we are developing next generation services and placing increased emphasis on the value-added services we currently provide to customers. For example, we have established centers of excellence for the enhancement and delivery of four types of services: managed network services; security services; contact center solutions; and web and application hosting. In addition, we are expanding and strengthening the range of service offerings for our customers by upgrading our own capabilities. Adding to our service capabilities is also likely to involve the formation of strategic partnerships with other firms having highly regarded expertise in specific areas or the acquisition of firms with special expertise, such as our recently completed acquisition of Network Security Technologies, Inc. (“NetSec”), a leading provider of managed security services. Consistent with the strategic emphasis we place on the Internet, we are also creating IP-based systems for the customer usage of these services. Furthermore, we are adding more field representatives with training and experience in network technology and engineering to improve the effectiveness of our sales programs and the delivery of value-added services.

Our objective is to be the leading communications company in enabling customers to do more with their computing and networking infrastructure and making them more effective in serving the needs of their customers. Consequently, we should earn stronger relationships with our customers on a strategic level and will be a more integral part of their communication and information systems. This will better position us to be the preferred supplier of both currently available and next generation value-added services.

Simplifying how we do business has three objectives: enhancing sales effectiveness, improving customer satisfaction and increasing operating efficiency. We plan to achieve these objectives by strengthening the technical and sales skills of our customer-facing field representatives, empowering our

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branch sales offices to take more direct responsibility for developing and maintaining customer relationships, better aligning our corporate administrative and technical specialist personnel to support our business operations, establishing clear accountability for achieving business objectives, accurately measuring our success in achieving our objectives, and appropriately compensating our employees for the success that they achieve. In addition, we are changing our business processes, such as channeling the delivery of certain value-added services through centers of excellence and unifying and streamlining systems for sales, order entry, provisioning, billing, accounts receivable management and other similar functions.

Success in simplifying how we do business should result in better competitive positioning for us in the traditional telecommunications market and the emerging market for value-added services. It should also result in a lower cost structure and higher profit margins.

Improvements in our financial structure include reductions in our operating costs, with an emphasis on decreasing access costs, the expenses we incur for transmissions over other carriers’ networks. We are lowering our costs so that we are better positioned not only to offer our customers superior value in the network facilities and associated services they obtain from us, but also to earn a sufficient return on our investments. We believe our ongoing cost reduction efforts are appropriate because we anticipate continued pressure on market pricing.

Enhancements to our systems for measuring and reporting internal operating and financial results are also part of the improvements we are making in our financial structure. The focus of these enhancements is on our approach to fully allocating our costs among our individual business units so that comprehensive income statements are available to business unit managers and our executive management. With these fully allocated statements, we are better able to establish prices for the services we provide our customers, better align expense levels with revenue opportunities, identify cost cutting and profit improvement opportunities and improve the information used to make investment decisions. In addition, we are better able to establish accountability for business unit operating and financial results and more closely align internal goals and external financial measurements. With these enhanced internal reporting tools, our business should be more efficient and effective in serving the needs of our customers and generating returns for our investors. In addition, the business segment financial data included in the notes to our consolidated financial statements have been derived from these fully cost-allocated internal reports and will provide the external financial community with greater visibility and a clearer understanding of our performance.

Business Segments

We operate through three business segments, each of which focuses on specific customer groups:

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We began operating under these three business segments in the second quarter of 2004. However, we determined that it was impracticable to restate our 2002 results into the new business segment structure and as such, those results are not presented. The tables below display revenues, operating (loss) income, and assets of our business segments for 2004 and 2003 (in millions):

All of our business segments offer Internet, data and voice services, as described below. The specific mix of the services offered by each of the three business segments reflects the communication needs of the customers served by the segment. For example, our services related to more complex and higher value-added Internet and data communications account for a more significant portion of the revenues from the accounts within the Enterprise Markets business segment and the larger commercial accounts within the U.S. Sales & Service segment than they do for our other customers. Similarly, revenues from the consumer accounts within the U.S. Sales & Service segment are derived almost entirely from voice services.

For the International & Wholesale Markets business segment, basic transport services account for a substantial portion of revenues. We have organized our international and wholesale account groups within this segment since the revenues and operating income, along with the associated management decisions, from one account group often impact the other account group. This is largely due to existence of arbitrage activity in the cross-border markets between tariffs and wholesale pricing for transport services.

For further information on the results of these business segments and information on the results of the business segments by which we previously aligned our business, see Note 22 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K and see “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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Internet Services

We offer not only a comprehensive range of alternatives for customers to access the Internet but also sophisticated value-added services that make Internet communications more economical, efficient, reliable and secure as well as easier, faster and more effective in conveying data, information and entertainment.

Access services are built around our global network providing connectivity in more than 2,700 cities in over 200 countries. We enable customers to access the Internet through dedicated broadband lines with speeds ranging from 768 kilobits per second to Gigabit Ethernet (equal to one billion bits per second) and up to OC-48 (2.5 billion bits per second). For customers using dial-up access, we have over two million modems located throughout the world. Once connected, the customer’s traffic is routed over our networks to the desired location, whether on our network or elsewhere on the Internet.

We also provide Internet-based virtual private networks (“VPN”) to customers desiring a high level of security when connecting their operating facilities, data centers, remote sites or mobile users over the public Internet. VPN services include encryption, bandwidth prioritization and centralized continuous monitoring and management. Customers utilizing these services are attracted to the combination of the low-cost public Internet network and the reliability and security we provide.

For high-volume customers that desire a more significant level of security and reliability for their VPN networks, we provide private Internet protocol (“PIP”) networks using multi-protocol label switching (“MPLS”) to deliver voice, data and video traffic. Our use of MPLS also enables customers to continue utilizing their existing non-IP data and voice networks as they transition over time to operating on standard IP.

In addition, we provide web hosting services that enable customers to outsource portions of their Internet operations so that they can more rapidly and cost-effectively provide online information and business transaction capabilities to their own customers and to employees, suppliers, investors and other interested parties. These services are provided through approximately 200 data centers, including over 40 special data centers that operate 24 hours a day with enhanced service levels. Our web hosting services include technical support and performance management for hardware, operating systems and applications. Other web hosting services include database management, server collocation, storage services, customized web site activity reporting, stress testing, firewall management, virus detection and elimination, and other enhanced security services.

To assist customers operating contact centers that receive Internet communications by email and web site contacts, we provide services for managing such contacts. These services include routing to balance the use of multiple contact centers or to direct contacts to agents with relevant knowledge and skills. Through using these services, our customers can increase the efficiency and effectiveness of their contact centers.

Data Services

We use our frame relay, ATM and IP networks to provide high bandwidth data transmission services over both public and private networks.

Frame relay services allow cost-effective and secure high-speed interconnection of data centers, local area networks, remote facilities, branch offices, point of sale terminals and other sites that send or receive data. Frame relay is a high-speed communications technology that divides the information into frames or packets. Through our frame relay switches strategically located in 47 countries and our correspondent relationships, we offer frame relay services in over 90 countries. In addition, our network access relationships with other communication companies enable customers to access frame relay locations in most countries in the world.

ATM services enable the integration of data, voice, video and multimedia communications over a single network. This consolidation of applications onto one network reduces network, equipment and operational costs. Through our ATM switches in 21 countries and interconnects with other data networks, we can extend ATM connectivity throughout most of the world.

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For customers with high-volume data transmission requirements or the need for heightened levels of security or availability, we provide private line services in which a customer contracts for the use of a specific circuit on a dedicated basis. The private line connects directly to our network, thereby reducing originating access costs compared to using “switched” access that is shared among many network users. We offer dedicated circuits as Metro Private Lines between two points in a single metropolitan area, as well as Domestic Private Lines linking points within the United States and International Private Lines connecting points around the world.

For customers interested in creating, expanding, modifying or upgrading their networks, we provide network planning, design, implementation and optimization services. This may involve the configuration and installation of the customer’s equipment, the design of custom or dedicated network operating centers and security services, including firewalls, virus detection and elimination and the encryption of traffic over the customer’s network for added security. While the revenues from these activities are included in the data category within our business segment information in Note 22 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, these services also are provided for Internet and voice communication networks.

For customers that outsource all or portions of their communications operations, we provide a variety of managed network services. These services extend from the operation and maintenance of individual network devices to the complete management of sophisticated global networks. Activities conducted on behalf of our clients include network monitoring and trouble-shooting, on-site repair services and the management of applications such as e-mail and other business programs that are used across a business enterprise or government agency. As of December 2004, we managed over 2,900 customer networks, including approximately 200,000 individual devices located in over 120 countries. While the revenues from these activities are included in the data category within our business segment information, we also provide managed network services for Internet and voice communication networks.

Voice Services

Through our local, long distance and international voice communication services, our customers can call to anywhere in the United States and to virtually any telephone number around the world. High-volume customers are connected to our global voice network through dedicated access lines, while lower volume customers are connected through switched access provided either by us or by an incumbent local exchange carrier.

Besides traditional telephone service, we also offer a range of enhanced voice communication services. For customers operating contact centers, these services include routing for work load balancing among multiple contact centers and among individual agents, as well as routing to match inbound calls with appropriately skilled agents. Other services include voice recognition and speech automation to facilitate contacts or to enable automated telephone access to databases and other electronic information services. During 2004, over 1.4 billion minutes per month of enhanced voice calls were handled through these services provided by MCI Services.

Another of our enhanced voice communication services is conferencing. We provide audio and video teleconferencing on both an automated basis and a moderator-assisted basis. In addition, we provide web-based audio and video conferencing hosted over the Internet and operate conferencing centers in the United States, the United Kingdom and Hong Kong.

Other voice communication services that we offer include calling cards, prepaid phone cards, toll-free services, voice messaging, speed dialing, caller identification, call waiting, call forwarding, three-way calling and information service access.

Sales and Marketing

We have organized our sales and marketing personnel by the customer segments that they serve. Approximately 7,600 sales and service representatives serve the mid and large-size corporate and government

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customers of our Enterprise Markets and U.S. Sales & Service business segments. These representatives include highly trained and experienced network engineering, technology and operations experts, as well as specialists in specific services and applications. Some of these representatives have long-standing relationships with specific customers and their understanding of customer communication needs is a key aspect of our market strategy.

The majority of our sales and service representatives are located in our commercial branch organization, which consists of 85 sales offices organized under 46 branches and overseeing over 60,000 customers. For our larger customers, we have dedicated teams that serve their needs on a full-time basis. For small businesses, we sell primarily through telemarketing and sales agents and presently have approximately one million small business customers.

For our corporate and government customers with sophisticated communication systems and complex service requirements, we have established MCI Services. Within MCI Services, we have organized centers of excellence that are responsible for the development and delivery of the following services: managed network services, security services, contact center solutions and web and application hosting. These specialized groups provide comprehensive telecommunications industry expertise and broad understanding of network technology to solve customer problems and facilitate successful execution of their business operations. In addressing a customer’s specific needs, MCI Services integrates specialized knowledge inside of our company with highly regarded firms outside of our company that have leading positions in relevant technical areas. We aim to deliver value-added solutions, strengthen our relationships with customers and integrate our problem-solving capabilities into the customer’s internal business process.

For our consumer customers, we utilize a variety of sales channels according to the types of services being offered. Our consumer subscription services consist of local, long distance and international calling, operator assisted calling, inbound toll-free services, calling card services, collect calling and Internet access. At present, we have over seven million consumer customers for our long distance subscription service, and over three million of these customers also subscribe to our local telephone service. The primary sales channel for subscription services has been telemarketing by our own employees as well as third party telemarketing firms. Due in part to the implementation of do-not-call lists limiting the telephone numbers accessible by telemarketing and regulatory actions that have decreased the profitability of these services, we have decreased our telemarketing activities and expect further decreases during 2005.

In selling subscription services, we also use our customer service centers, some of which our employees operate and some of which are outsourced to third party firms. To increase effectiveness in assisting consumers and selling additional subscription services, our customer service operates 24 hours a day and provides customer support in ten languages. The other sales channel that we use to sell subscription services to consumers is direct response marketing, which includes direct mail, on-line marketing and use of marketing partners to offer customers unique awards and benefits.

For the marketing to consumers of pre-paid calling cards that are sold on a transaction basis rather than as subscription services, we distribute through retailers, often using co-branded or retailer branded cards. Our other transaction services are dial-around telephone services like 1-800-COLLECT, and we utilize direct response marketing.

Outside the United States, we offer our services solely to businesses, government entities and telecommunications carriers. For these international customers, we have approximately 2,500 sales and service representatives located in regional offices in 76 countries.

For our wholesale customers in the United States, which consist of Internet access providers, other telecommunication carriers and communication service resellers, we employ approximately 225 sales and service representatives. For our wholesale customers outside the United States, we utilize sales and service representatives located in our international regional offices.

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Network

We own and operate one of the world’s largest and most sophisticated networks for Internet, data and voice communications. On a typical day, our network processes billions of messages, including one petabyte (equal to one quadrillion bytes) of data and approximately one billion minutes of voice communications. The network described within this section is utilized by each of our three business segments.

Our long-haul network consists of approximately 100,000 route miles of fiber-optic cable that is capable of transporting traffic at speeds of 10 gigabits (10 billion bits) per second and connects with other networks around the world. Our IP network is one of the world’s largest and fastest, with connectivity to more than 2,700 cities in more than 200 countries across six continents. We also operate global frame relay and ATM data networks.

In addition to our Internet and data networks, we operate a voice communications network handling telephone calls within the United States and around the world. Our global voice network is comprised of over 300 switches, and calls are automatically completed through more than 100 possible routes. Reliability of the voice network is maximized using a process called Dynamically Controlled Routing (“DCR”) and by employing synchronous optical network (“SONET”) rings. DCR monitors each trunk in the network for any path degradation such as congestion or fiber cuts and, as necessary, dynamically reroutes calls to alternative non-degraded paths. SONET rings allow restoration of service within 50 milliseconds following a network failure.

As part of our overall network, we have an extensive metropolitan network of over 13,000 route miles serving customers in all major United States and key international cities. We have local-to-global-to-local connectivity to over 100,000 buildings (with over 8,000 buildings directly connected to our network and approximately 92,000 indirectly connected). Deployed in business centers throughout the United States, Western Europe, the United Kingdom, Japan, Australia and Singapore, our local networks are constructed using closed-loop self-healing fiber rings.

In addition to land-based network facilities, we own or lease fiber optic capacity on most major intercontinental undersea cable systems in the Atlantic and Pacific Ocean regions. We also own and operate 27 gateway satellite earth stations that enhance our ability to offer Internet, data and voice communications to and from locations throughout the world.

In view of the substantial capacity of our networks and the slowdown in telecommunications spending by customers in recent years, we have focused our network planning and engineering efforts on further improving reliability and efficiency rather than expanding network capacity. Through these efforts, we believe that we have achieved service levels that lead the telecommunications industry.

With regard to efficiency, we continue to deploy Dense Wavelength Division Multiplexing (“DWDM”) technology that allows an optical fiber to carry multiple wavelength signals. Originally, this technology allowed eight different wavelength signals to be transmitted. We have been a leader in further developing DWDM technology, enabling the deployment of systems capable of carrying 64, 80 and 160 separate wavelength signals per fiber. Consequently, we are able to handle additional network traffic at low incremental capital costs and with up to 160 channels within an optical fiber operating at 10 gigabits per second.

As part of our strategy of achieving undisputed IP leadership, we are further upgrading our backbone network. First, we are planning to convert 32,000 route miles to an Ultra-Long Haul (“ULH”) network, with 5,000 route miles converted by the end of 2005. Converting to ULH will reduce network elements by approximately 70%, increase reliability, lower transport costs and can enable wavelength services such as grid computing and data center mirroring. Second, as part of converging all of our network traffic onto a common IP backbone, we are adding multi-service edge devices that consolidate IP, data and voice traffic onto our high-speed IP network. Third, we are implementing converged packet access (“CPA”), with the initial deployment expected in 2005. CPA enables the delivery of IP, data and voice traffic via common access circuits and will reduce our access costs, improve operating efficiency and enable us to provide our customers with scaleable

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bandwidth on demand. Fourth, as part of our IP convergence, we are beginning to modify our traditional voice switches to advanced call processing Soft Switches that can simultaneously handle both circuit-based voice traffic as well as voice-over-IP (“VoIP”) traffic. VoIP divides voice communications into digital packets and, instead of using a dedicated circuit, the individual packets seek the most efficient route over multiple transmission lines within IP networks before being reassembled at the destination point. The packet basis of VoIP and the IP focus of our network enhancements are allowing us to develop additional services, including electronic numbering (“ENUM”) services that enable traditional telephone calls and VoIP communications to interwork seamlessly and session initiated protocol (“SIP”) services that enable customers to communicate regardless of the communication device they use or where they are located.

Patents, Trademarks and Service Marks

We own or have licenses to various patents, trademarks, service marks, copyrights and other intellectual property used in our business. We do not believe that the expiration of any of our intellectual property rights, or the non-renewal of those rights, would materially affect our results of operations.

Competition

The telecommunications industry is highly competitive. Factors contributing to the industry’s increasingly competitive market include regulatory changes, product substitution, technological advances, excess network capacity and the entrance of new competitors. In this environment, competition is based on price and pricing plans, the types of individual services offered, the combination of services into bundled offerings, customer service, the quality and reliability of services provided and the development of new products and services.

Our competitors include the following:

Internationally, we compete primarily with incumbent telephone companies, some of which have special regulatory status and exclusive rights to provide certain services and have historically dominated their local markets. We also compete with other international service providers, some of which are affiliated with incumbent telephone companies in other countries.

While there has been a long history of mergers and acquisitions within the communications industry, several proposed combinations have been announced recently. These include the December 15, 2004 announcement of a merger between Sprint and Nextel, the January 10, 2005 announcement of ALLTEL’s agreement to purchase Western Wireless and the January 31, 2005 announcement by SBC Communications of its proposed purchase of AT&T. We are also planning to participate in the industry consolidation that is occurring and, on February 14, 2005, we announced our agreement to merge with Verizon. See “Merger with Verizon Communications.”

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Employees

As of December 31, 2004, we employed approximately 40,000 full and part-time employees. Compared to other companies in the telecommunications industry, we have few employees who are represented by labor unions. As of December 31, 2004, we had 292 union employees, which is equal to less than 1% of our total employees.

As of December 31, 2004, our Enterprise Markets unit employed approximately 8% of our total employees, U.S. Sales & Service employed 33%, International & Wholesale employed 17% and approximately 42% were employed in our network operations, systems engineering and corporate functions. Approximately 82% of our total employees are located in the United States and 18% are located outside of the United States.

Regulation

We are subject to varying degrees of federal, state, local, and international regulation. In the United States, our telecommunications subsidiaries are most heavily regulated by the states, especially for the provision of local exchange services. Generally, our telecommunications subsidiaries must be licensed separately by the public utility commission (“PUC”) in each state to offer local exchange and intrastate long distance services. No PUC, however, subjects us to rate of return regulation. Nor are we currently required to obtain authorization from the Federal Communications Commission (“FCC”) for installation or operation of our network facilities used for domestic services, other than licenses for specific multi-channel multipoint distribution services (“MMDS”), wireless communications services, terrestrial microwave, and satellite earth station facilities that utilize radio frequency spectrum. FCC approval is required, however, for the installation and operation of our international facilities and services. We are subject to varying degrees of regulation in the foreign jurisdictions in which we conduct business, including authorization for the installation and operation of network facilities. No assurance can be given that changes in current or future regulations adopted by the FCC, state, or foreign regulators or legislative initiatives in the United States or abroad would not have a material adverse effect on us.

The FCC’s Local Competition Rules. In August 1996, the FCC established nationwide rules pursuant to the Telecom Act, designed to encourage new entrants to compete in local service markets through interconnection with the incumbent local exchange companies (“incumbent LECs” or “ILEC”), resale of incumbent LECs’ retail services, and use of individual and combinations of unbundled network elements (“UNEs”) owned by the incumbent LECs. “Network elements” are defined in the Telecom Act as any “facility or equipment used in the provision of a telecommunications service,” as well as “features, functions, and capabilities that are provided by means of such facility or equipment.” UNEs are network elements provided on an unbundled, or separately priced, basis. The FCC makes certain network elements available on an unbundled basis after considering at a minimum whether the failure to provide those network elements would impair the ability of the telecommunications carrier seeking access to provide the services that it seeks to offer. One combination of UNEs, known as the unbundled network element platform (“UNE-P”), encompasses all the elements necessary to provide local telephone service. As a competitive local exchange carrier (“competitive LEC” or “CLEC”), MCI relies upon the UNE-P combination to provide local services to mass market customers. Small and medium-sized business and enterprise customers, on the other hand, can be served via UNEs such as unbundled loops and unbundled transport, although our service platforms for such companies occasionally include a UNE-P component. Substantial reduction in incumbent LEC unbundling requirements, including increased pricing for existing UNE-P arrangements and prohibitions on new UNE-P arrangements, as well as restrictions on the availability of unbundled loops and transport, limits our future range of options in provisioning local services to customers.

The FCC’s 1996 Local Competition Rules were reviewed by the appellate courts, as were two subsequent decisions establishing incumbent LEC unbundling obligations. Most recently, on March 2, 2004, the U.S. Court of Appeals for the District of Columbia Circuit (“D.C. Circuit”) issued a decision that vacated and remanded key aspects of the FCC’s February 2003 Triennial Review Order, which had generally preserved the availability of unbundled switching, which is a required component of UNE-P, and the availability of loop and transport

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facilities at certain capacity levels. The court’s decision also affirmed the portions of the Triennial Review Order that had not required incumbents to lease unbundled elements for the provision of broadband services. The Supreme Court declined to grant the petition for certiorari filed by the competitive industry, thereby assuring that the D.C. Circuit’s decision will remain intact.

On remand from the D.C. Circuit, the FCC released on February 4, 2005, its Triennial Review Remand Order, which establishes new rules effective March 11, 2005, concerning the incumbent LECs’ unbundling obligations. In this decision, the FCC prohibited new UNE-P arrangements and established a twelve-month transition period for existing UNE-P arrangements. The FCC also curtailed the availability of some cost-based UNE access to DS-1 and DS-3 loops and transport. The transition periods will allow MCI to continue to serve our embedded base of UNE-P customers with rate increases; however, it might mean that no new UNE-P customers can be added at cost-based rates. The FCC directs parties to implement the new rules in their interconnection agreements and to complete change of law proceedings within twelve months of the transition date. The FCC’s rules do not purport to nullify existing agreements. To the limited extent that the final rules do preserve the unbundling of loops and dedicated transport at the DS-1 and DS-3 capacity levels, ILECs have filed challenges to those rules in the D.C. Circuit, including asking the court to deny CLECs the ability to convert special access circuits to UNEs, which would further drive up CLEC costs. CLECs have likewise filed appeals of the final rules, and these appeals might challenge the elimination of UNE-P among other possible challenges. The FCC also set aside the “qualifying service” interpretations of the Triennial Review Order, but prohibited the use of UNEs for the exclusive provision of telecommunications services in the mobile wireless and long distance markets. The FCC also determined that in the context of the local exchange markets, a general rule prohibiting access to UNEs whenever a requesting carrier is able to compete using an ILEC’s tariffed offering was inappropriate. As a result of such rules, we have been forced to raise residential phone service prices in some markets and may be forced to pull out of others, and have reduced our sales efforts pending clarity of our future pricing structure.

“Do Not Call” Registries. The Telephone Consumer Protection Act of 1991 authorized the FCC to create a national database of residential telephone numbers to which, with limited exceptions, companies would be prohibited from placing telemarketing calls. In 1992, the FCC declined to establish such a database, instead requiring carriers to create their own “Do Not Call” lists. In September 2002, the FCC initiated a rulemaking proceeding to revisit its previous decision. In December 2002, the Federal Trade Commission (the “FTC”) issued rules establishing a national Do Not Call registry. On July 3, 2003, the FCC also issued rules establishing a national Do Not Call registry. As of December 2004, over 60 million telephone numbers had been registered with the Do Not Call registry. Numerous states have enacted similar legislation requiring their state agencies to create such registries on a state-wide level. Because telemarketing has been our primary consumer sales acquisition tool, to the extent that the FCC’s adoption of such a registry affects the number of households to which we can place telemarketing calls, our sales will be affected.

Inmate Telephone Services. A group of alternative inmate service providers has filed two petitions with the FCC requesting that the FCC examine the telephone services provided to prison inmates. We provide a significant amount of interexchange collect call operator services to inmates and, if the petitions are granted, these proceedings could negatively impact our revenues.

Access Charges. Certain incumbent LECs have challenged the method we use to calculate the amount of switched access charges owed by us for Percentage of Interstate Use. If the incumbent LECs’ challenges are upheld, these proceedings could negatively impact our costs.

Voice over IP. The FCC has opened a proceeding on the regulatory framework that will apply to various VoIP services and will address the extent to which switched access charges will apply to VoIP traffic. The outcome that the FCC reaches on these issues could have a material impact on MCI’s business.

Suspension by the State of New Jersey. Effective February 9, 2004, the State of New Jersey (the “State”) suspended us from entering new State contracts. As a result of this action by the State, our name was removed from the State’s automated bidders list and was listed in the State Disqualification Report. The suspension was lifted on May 10, 2004.

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International Regulation. We are subject, through our international operations, to regulations by foreign countries. These regulations are often as demanding as the requirements imposed on incumbent telephone companies, which frequently enjoy special regulatory status. We have played an active role in regulatory proceedings throughout Europe, at both the national and European Union levels, in an attempt to persuade regulators to impose measures that would reduce leased line costs and ensure timely delivery. Although many of the foreign countries where we operate are liberalizing their telecommunications markets, either as a result of domestic legislation or by virtue of international commitments, we are not certain as to the timing or continuation of these initiatives or as to whether we will benefit from such liberalization.

Overseas Fixed-to-Mobile Termination Rates. An increasing percentage of our U.S.-originated international voice calls terminate to mobile phones overseas. In addition, our overseas affiliates in a number of countries in Europe and in Asia originate voice calls, and a large proportion of these calls also terminate to mobile phones overseas. In both cases, we ultimately rely on a mobile operator, to whom we directly or indirectly pay mobile termination fees, to connect the call to the mobile operator’s customer.

In general, the rates that we and other U.S. telecommunications carriers pay to our international correspondents for terminating U.S.-originated international voice calls to mobile phones overseas are much higher than corresponding international termination rates for wireline phones. Likewise, for overseas-originated calls, we pay significantly higher termination rates for calls made to overseas mobile phones than for calls made to overseas wireline phones.

We are actively encouraging the FCC and overseas governments to take appropriate action to reduce the rates required to be paid to terminate voice calls to mobile phones overseas. We cannot predict, however, whether the FCC and overseas regulators will eventually take action that will result in lower mobile termination rates.

Environmental Regulation. We are subject to various environmental, health and safety laws and regulations governing, among other things, the generation, storage, use and disposal of hazardous materials, the discharge of hazardous materials into the ground, air or water, and the health and safety of our employees. We have been required to pay fines in the past in connection with alleged violations of environmental laws, but these alleged violations have been resolved in all material respects. We have also been required, and may continue to be required, to remediate hazardous substance contamination at certain of our locations. Environmental laws are complex, change frequently and have tended to become stringent over time. We may incur additional capital or operating costs to comply with any such changes.

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RISK FACTORS

You should carefully consider the risks described below before investing in our securities. The risks described below are not the only ones facing us. Additional risks not currently known to us or that we currently believe are immaterial may also impair our results of operations, cash flows, and financial condition.

We face substantial competition that has resulted in pricing pressures and reduced revenues

There is substantial competition in the telecommunications industry, which has caused pricing pressure and reduced revenues. Rapid technological advances, product substitution and deregulation have all contributed to the increasingly competitive atmosphere. We expect competition to intensify due to the efforts of competitors to address difficult market conditions through reduced pricing, bundled offerings or otherwise, as well as a result of the entrance of new competitors and the development of new technologies, products and services.

We have a variety of competitors, including:

These factors could also have a material adverse effect on our business, financial condition, results of operations or cash flows.

In recent months, there has been an increased trend towards consolidation in the telecommunications industry, as reflected in announced mergers involving two of our principal competitors, the mergers of Sprint with Nextel and AT&T with SBC Communications, and our pending merger with Verizon. While we expect our pending merger, once consummated, to strengthen our ability to compete, this consolidation trend will also strengthen the resources available to these other competitors, allowing them to offer larger bundles of services and reducing their cost structure.

Outside the United States, we compete with the incumbent telephone companies, some of which still have special regulatory status and exclusive rights to provide services, and virtually all of which historically dominated their local, long distance and international services business. These companies have numerous advantages, including existing facilities, customer loyalty and substantial financial resources. We may be dependent upon obtaining facilities from these incumbent telephone companies. For example, we require interconnection with the incumbent operator’s network in order to provide ubiquitous service for our customers. Without interconnection, our customers would not be able to contact customers of the incumbent operator. We

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also compete with other service providers, many of which are affiliated with incumbent telephone companies in other countries. Typically, we must devote extensive resources to obtain regulatory approvals necessary to operate overseas and then to obtain access and interconnection with the incumbent’s network on a non-discriminatory basis.

Our ability to improve our operating results depends, in large part, upon our ability to successfully introduce new services at favorable prices while controlling our costs

To counter the impact of any continuing price declines in our industry, our strategy is to take advantage of technological developments, particularly utilization of Internet Protocol, to expand network traffic, offer new bundles of managed products and services at favorable prices, simplify our network and associated costs and enable traditional transport on a more favorable basis. Adoption of our strategy will require incremental capital expenditures and continued efforts to reduce our access and other costs to secure the benefits of our efforts. There are substantial risks that we will not be able to successfully implement these strategies or do so on favorable terms or on favorable terms that we can sustain. Among other things, our competitors may pursue the same strategies and may compete in terms of pricing that is itself subject to decline. Even if our strategy is successful, we cannot assure you that it will be sufficient to counter continuing price declines in our other revenues.

Our business will suffer if our technology and business methods become obsolete

The market for Internet, data and voice communication products and services is characterized by rapidly changing technology, evolving industry standards, emerging competition and frequent new product and service introductions. We may not be successful in identifying new product and service opportunities and developing and bringing new products and services to market in a timely manner. We are also at risk from fundamental changes in the way Internet, data and voice communication products and services are marketed, sold and delivered. Our pursuit of technological advances and new business methods may require substantial time and expense, and we may not succeed in adapting our business to the technologies, devices, protocols, regulations and marketing and sales methods that are anticipated and, in some cases, are currently being developed in the communications industry.

To access certain of our customers, we rely upon the cooperation of established local telephone companies

As a participant in the competitive local telecommunications services industry in the United States, we rely on the networks of established telephone companies or those of competitive local exchange carriers for some aspects of transmission. Federal law requires most of the established telephone companies to lease or “unbundle” elements of their networks and permit us to purchase the call origination and call termination services we need, thereby decreasing our operating expenses. However, as a result of recent litigation concerning portions of the FCC’s Triennial Review Order that required the unbundling of switching, which is a critical component of UNE-P, the FCC has determined that beginning in 2006, certain discounts provided to us by the established telephone companies will cease. We are continuing to evaluate how the anticipated rise in UNE-P access costs will impact our ability to profitably provide Mass Markets subscription services, and the cost increase may force us to withdraw from certain markets. As a result, new local service account installations and revenue may decrease from current levels in future periods. These regulatory changes will also increase costs for our other business segments as well and could adversely affect our competitive position in these segments.

In most of our international operations, we are competing with incumbent telecommunications operators from whom we require services and support. For example, we require interconnection with the incumbent operator’s network in order to provide ubiquitous service for our customers. Without interconnection, our customers would not be able to contact customers of the incumbent operator. There can be no assurance, however, that interconnection (or other services) will be provided by the incumbent operator in a timely manner or that the terms and conditions of any proposed interconnection, particularly the cost, will not have an adverse effect on our local operations.

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Government regulation of our businesses significantly impacts our business

We are subject to varying degrees of federal, state, local and international regulation. In the United States, our subsidiaries are most heavily regulated by the states, especially for the provision of local exchange services. We are also subject to varying degrees of regulation in foreign jurisdictions in which we conduct business, including authorization for the installation and operation of network facilities. We consider regulatory developments impacting our “last mile” access to customers (such as access to various network elements for both our business and mass market customers permitting call origination and termination services), intercarrier compensation arrangements and the manner in which we are permitted to offer advanced IP-based services as being the most critical to our success. Changes in current or future regulations adopted by the FCC, state or foreign regulators or legislative initiatives in the United States or abroad could have a material adverse effect on us by restricting our ability to price or offer our products and services and/or otherwise placing us at a competitive disadvantage. For additional information, see “Item 1—Regulation.”

In addition to the regulation of our business by the FCC, the FTC has introduced “Do Not Call” registries that permit consumers to request that they not be contacted by telemarketers. In addition, numerous states have enacted similar legislation requiring their state agencies to create such registries on a state-wide level. Such registries are the subject of litigation but could have a material adverse effect on telemarketing, which is one of our principal sales and marketing initiatives.

Telecommunications industry trends have materially and adversely impacted our revenues and cash flows

In 2001, the business environment for the telecommunications industry deteriorated significantly and rapidly. This environment has remained weak through 2004, primarily due to:

As a result of these trends, our revenues have declined from $28.5 billion in 2002 to $20.7 billion in 2004. We have a history of losses and may be unable to achieve and maintain profitability. We expect these trends to continue, including reduced business from financially troubled customers and downward pressure on prices. These trends could continue to have a material adverse impact on our business, financial condition, results of operations and cash flows.

Our prospects will depend in part on our ability to control our costs while maintaining and improving our service levels

In light of our declining revenues, we continue to seek ways of reducing access costs, reducing expenses and limiting our capital expenditures to maintenance and success-based projects as much as practicable while we pursue enhanced revenue opportunities. Our recent cost reductions were attributable to our efforts, aided by the nature of bankruptcy proceedings. However, our capital requirements relating to maintaining and routinely upgrading our network will continue to be significant in the coming years and we are undertaking new projects in furtherance of our IP-based strategies. Our prospects will depend in part on our ability to continue to control costs and operate efficiently, while maintaining and improving our existing service levels. The most substantial cost we must control is our access cost, which is the cost we must pay to other telecommunications providers to initiate or terminate traffic on their networks. Although we are able to attempt to influence these costs through, for example, influencing regulatory measures, these costs are not fully within our control. Regardless of the state of the economy, everyday business costs and the cost of access will continually be a concern for our business. If

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we cannot continue to control our costs, there could be a material adverse effect on our business, operations, cash flows and financial condition.

We are subject to distinct risks relating to our international operations

For the year ended December 31, 2004, 19% of our revenues were derived from our international operations. Accordingly, our business is subject to risks inherent to international operations, including:

Our international operations are conducted through a variety of different methods, including wholly-owned subsidiaries, joint ventures and operating agreements with local telecommunications companies. Each of these methods presents risks. For example, certain countries have foreign ownership limitations with respect to companies that provide telecommunications services within their borders. These restrictions obligate us to partner with one or more local companies if we want to participate in the market. As a result, our ability to control or direct the operations of the local entity is limited, either contractually or statutorily, by our obligations to our local partners.

In the event of any dispute arising from our international operations, we may be subject to the exclusive jurisdiction of foreign courts and may not be successful in subjecting foreign persons or entities to the jurisdiction of the courts of the United States. We may also be hindered or prevented from enforcing our rights with respect to foreign governments because of the doctrine of sovereign immunity. In addition, there can be no assurance that the laws, regulations or administrative practices of foreign countries relating to our ability to do business in that country will not change.

Although most of the foreign countries where we operate are liberalizing their telecommunications market, whether as a result of domestic legislation or by virtue of international commitments, there are no guarantees as to the continuation, timing or effectiveness of such liberalization. For example, certain countries have bound themselves to undertake liberalizing measures in their telecommunications market pursuant to treaty commitments under the World Trade Organization. There can be no assurance, however, that such liberalizing measures will be implemented in a timely manner or at all. In addition, if there is a failure to implement those liberalizing measures, there may not be adequate or effective recourse against the foreign government for such failure.

While we have a growing dependence on Internet-related services, the rate of development and adoption of the Internet has been slower outside the United States. Laws in the U.S. and foreign countries regarding the Internet and related data privacy issues are largely unsettled, but are becoming an increasing focus for lawmakers. Changes in these laws could require us to expend significant resources to comply or could limit our business. In addition, the application of multiple sets of laws and regulations may subject us to regulation,

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taxation, enforcement or other liability in unexpected ways, which could make it more expensive to conduct our business or limit our ability to conduct business. Regulation of the Internet may also harm our customers’ businesses, which could lead to reduced demand for our services.

The rates that we charge our customers for international services may decrease in the future due to the entry of new carriers with substantial resources and aggressiveness on the part of new or existing carriers. In addition, the consummation of mergers, joint ventures and alliances among large international carriers that facilitate targeted pricing and cost reductions, and the availability of international circuit capacity on new undersea fiber optic cables and new high capacity satellite systems, may have a negative impact on our pricing ability.

Customers of our international operations may be invoiced in United States dollars or in foreign currencies. Customers invoiced in United States dollars whose revenues are derived in other currencies may be subject to unpredictable and indeterminate increases in the event those currencies devalue relative to the United States dollar. Furthermore, those customers may become subject to exchange control regulations restricting the conversion of their revenue currencies into United States dollars. In that event, the affected customers may not be able to pay us in United States dollars. In addition, where we invoice for our services in currencies other than United States dollars, our results of operations may suffer due to currency translations in the event that those currencies devalue relative to the United States dollar and we do not elect to enter into currency hedging arrangements in respect of those payment obligations.

Our future growth may include additional acquisitions that may not be successfully integrated and may not achieve expected benefits.

Acquisitions to fill out our product offerings are a component of our growth strategy. Consistent with this strategy, we continue to engage in discussions with, and evaluate, potential acquisition targets, some of which may be material and require significant cash outlays, although we currently have no binding definitive agreements for any significant acquisitions. In the future, we may acquire other businesses. As a result of these acquisitions, we may need to utilize our available cash or seek additional financing (which could adversely affect our financial condition) and integrate product lines, dispersed operations and distinct corporate cultures. These integration efforts may not succeed or may distract our management from operating our existing business. Our failure to successfully manage future acquisitions could harm our operating results.

We depend in large part on the efforts and integrity of our key personnel. Retaining key personnel is vital for our business, and there is no guarantee we can keep such personnel

Our future success largely depends on the continued employment of certain of our key personnel, any of whom could terminate their employment at any time. In addition, in response to the conduct of the former WorldCom management and WorldCom’s accounting fraud and practices, we have undertaken to conduct our businesses at the highest ethical levels and in accordance with stringent practices embodied in our charter and our by-laws. Ultimately, for us to succeed, we will need to continue to employ and retain personnel of integrity and skill. We can offer no assurance that we will not lose key personnel and this could have a material adverse effect on our business and operations.

Historical financial information for our predecessor is not comparable to our own after emergence from bankruptcy

We adopted fresh-start reporting under the provisions of the American Institute of Certified Public Accountants Statement of Position (“SOP”) 90-7, “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code,” (“SOP 90-7”) as of December 31, 2003. Upon adoption, our reorganization value was $14.5 billion and was allocated to our assets and liabilities. Our assets were stated at fair value in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations,” (“SFAS No. 141”) and liabilities were recorded at the present value of amounts estimated to be paid. In addition, our accumulated

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deficit was eliminated, and our new debt and equity were recorded in accordance with distributions pursuant to the plan of reorganization. The adoption of fresh-start reporting had a material effect on our consolidated financial statements. As a result, our consolidated balance sheets as of December 31, 2004 and 2003 included elsewhere in this Annual Report on Form 10-K and our consolidated financial statements published for periods following December 31, 2003 are not fully comparable with those related to prior periods. This situation may make it difficult to properly evaluate an investment in our company.

The practices of our predecessor and former management continue to be scrutinized, and the results of this scrutiny may have a material and adverse effect on us

As a result of the financial fraud committed by, and the operating practices of, some of WorldCom’s former officers and employees and its bankruptcy reorganization, we have been the subject of various civil and criminal investigations by the SEC, the FCC, the U.S. Attorney’s Office, various state attorney generals and other governmental entities into our accounting and related controls, call routing practices, payment of state income taxes and other matters. As a result, our senior management team and Board of Directors have been required to devote substantial time to the resolution process for these investigations and related matters. We continue to engage in dialog with these government agencies in order to reach reasonable conclusions to these investigations, but we cannot predict what the specific resolution for each of these investigations may be. In addition to penalties that have been announced to date, it is possible that we will be required to pay other material fines, consent to additional injunctions on future conduct, conduct business with government agencies under restrictive terms, or lose our ability to conduct such business or suffer other penalties, each of which could have a material adverse effect on our business, financial condition and liquidity. In addition, we continue to be the subject of continuing scrutiny and negative publicity focused on these subjects, and this scrutiny and negative publicity may impact the terms under which, and whether, customers and suppliers continue to do business with us and may affect the tone of our dealings with regulators and others.

We have been actively working to improve our internal controls and procedures, but there can be no assurance that new material weaknesses in our internal controls will not be identified

Through reports and letters generated by our auditors, examiners and court-appointed monitors and a special committee of WorldCom’s Board as part of WorldCom’s bankruptcy, a substantial number of material weaknesses and problems were identified in our internal controls and procedures and corporate governance. We have made significant efforts to establish a framework to improve our internal controls over financial reporting. While our internal controls over financial reporting are significantly improved, management has identified a material weakness in internal control over accounting for income tax and has also identified certain other areas that it believes should be further enhanced. See “Item 9A—Controls and Procedures.” Any failure by us to have appropriate controls or to comply with the other high standards for corporate governance that we have established for ourselves could materially and adversely affect our company.

We continue to be subject to significant pending litigation, which if adversely determined could have a material and adverse effect on our operating licenses, liquidity and financial condition

We are party to significant litigation, which is described in more detail in “Item 3—Legal Proceedings.” If any of these proceedings is decided against us, we could be subject to substantial damages or other penalties. These penalties and other effects of litigation could have a material adverse effect on our operating licenses, liquidity and financial condition.

We have a significant amount of debt and other payment obligations, which could adversely affect our financial health and prevent us from fulfilling our obligations under the notes.

As of December 31, 2004, we had total indebtedness of approximately $5.9 billion. In addition to our indebtedness, we are required to make substantial additional payments in settlement of bankruptcy claims. As of

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December 31, 2004, our estimated remaining cash payments to settle pre-petition creditor claims were approximately $0.8 billion. However, that estimate is based on various assumptions and reflects our judgment based upon our prior pre-petition claims settlement history and the terms of our plan of reorganization and, if these assumptions prove incorrect, actual payments could differ from the estimated amounts.

The level of our indebtedness and other liabilities could have important consequences, including:

Covenants in our debt instruments prohibit us from engaging in certain activities, which we might otherwise wish to pursue

The indentures relating to our Senior Notes impose restrictions on our operations and financial transactions that we may wish to pursue. These restrictions will affect, and in many respects limit or prohibit, among other things, our and our subsidiaries’ ability to incur additional indebtedness; make investments; sell assets; declare or pay dividends or other distributions to shareholders; and repurchase equity interests. The restrictions contained in the terms of each of these debt instruments, as well as the terms of other indebtedness we may incur from time to time, could limit our ability to plan for or react to market conditions or meet capital needs, or otherwise restrict our activities or business plans. These restrictions could also adversely affect our ability to finance our operations or other capital needs, or to engage in other business activities that would be in our interest.

The merger with Verizon may not occur or, if it does, may not provide all the anticipated benefits

We must obtain shareholder approval and certain approvals and consents in a timely manner from federal, state and foreign agencies prior to the completion of the merger with Verizon. If we do not receive these approvals, or do not receive them on terms that satisfy the conditions set forth in the Merger Agreement, then we or Verizon will not be obligated to complete the merger. The governmental agencies from which we will seek these approvals have broad discretion in administering the governing regulations. As a condition to approval of the merger, agencies may impose requirements, limitations or costs that could negatively affect the way the combined company conducts business. These requirements, limitations or costs could jeopardize or delay the completion of the merger. If we and Verizon agree to any requirements, limitations or costs in order to obtain any approvals required to complete the merger, these requirements, limitations or additional costs could adversely affect the two companies’ ability to integrate their operations or reduce the anticipated benefits of the merger.

If we are able to consummate the merger, we expect to achieve various integration benefits. Achieving the anticipated benefits of the merger will depend in part upon whether our two companies integrate our businesses in an efficient and effective manner. We may not be able to accomplish this integration process smoothly or successfully. The integration of certain operations following the merger will require the dedication of significant management resources, which may temporarily distract management’s attention from the day-to-day business of the combined company. Employee uncertainty and lack of focus during the integration process may also disrupt the business of the combined company. Any inability of management to integrate successfully the operations of our two companies could have a material adverse effect on the combined company.

If we are unable to consummate the merger, we would continue to be exposed to the general competitive pressures and risks in the industry described above, which could be increased if certain of the other recently announced mergers in the communications industry are consummated, strengthening the competitive position of some of our competitors.

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ITEM 2. PROPERTIES

Our owned properties consist primarily of equipment and buildings used to provide Internet, data and voice communication services in North America, Latin America, Europe, the Middle East, Africa, Australia and Asia. We also lease certain switching equipment and several general office facilities. In addition, we have been granted easements, rights-of-way and rights-of-occupancy, mainly by railroads and other private land owners, for our fiber-optic network.

As of December 31, 2004, properties used by us that are significant to our operations are as follows:

We also own or lease other office facilities for sales, maintenance and administrative operations in the markets in which we operate. We had approximately 20 owned and 240 leased facilities as of December 31, 2004, including approximately 85 leased properties in international markets. The leases generally have terms ranging from one to five years, not including extensions related to the exercise of renewal options.

In addition, we own or lease other facilities which primarily support our telecommunications equipment. We have approximately 300 owned and 4,900 leased facilities as of December 31, 2004, including approximately 20 owned and 1,400 leased properties in international markets. The majority of these leases have terms generally ranging from month-to-month to 25 years. These property leases tend to have renewal options ranging from one to five years.

During 2004, we disposed of some significant facilities which were in excess of 100,000 square feet. These disposals include the sale of an owned property totaling approximately 106,000 square feet and the early termination of a leased facility totaling approximately 122,000 square feet. These facilities are not included in the table above.

See Notes 7 and 18 of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for the carrying value of our property, plant and equipment and the future minimum payments under our operating and capital leases.

ITEM 3. LEGAL PROCEEDINGS

Bankruptcy Filings

On July 21, 2002, (the “Petition Date”), WorldCom and substantially all of its direct and indirect domestic subsidiaries (the “Initial Filers”) filed voluntary petitions for relief in the United States Bankruptcy Court for the

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Southern District of New York (the “Bankruptcy Court”) under chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”). On November 8, 2002, WorldCom filed additional chapter 11 petitions for 43 of its subsidiaries (collectively with the Initial Filers, the “Debtors”), most of which were effectively inactive and none of which had significant debt. Throughout the bankruptcy proceedings, the Debtors continued to operate their businesses and manage their properties as debtors-in-possession pursuant to sections 1107(a) and 1108 of the Bankruptcy Code. By orders dated July 22, 2002 and November 12, 2002, the Debtors’ chapter 11 cases were declared to be jointly administered. In addition, pursuant to section 362 of the Bankruptcy Code, most of the litigation against the Debtors was stayed.

By order dated October 31, 2003, after due notice and a hearing, the Bankruptcy Court confirmed the Debtors’ Modified Second Amended Joint Plan of Reorganization dated October 21, 2003 (the “Plan”). The confirmation order determined that the Plan complied with the applicable requirements of the Bankruptcy Code. On April 20, 2004, WorldCom emerged from bankruptcy.

On the Emergence Date, pursuant to the Plan and as part of its emergence from bankruptcy protection, WorldCom merged with and into MCI whereby the separate existence of WorldCom ceased and MCI became the surviving company. On April 29, 2004, we filed our Annual Report on Form 10-K for the period ended December 31, 2003.

Restatements of Previously Issued Financial Statements

On June 25, 2002, WorldCom announced that as a result of an internal audit of its capital expenditure accounting, it was determined that certain transfers from line cost expenses (now referred to as access cost expenses) to capital accounts in the amount of $3.9 billion during 2001 and the first quarter of 2002 were not made in accordance with accounting principles generally accepted in the United States of America (“GAAP”). This announcement followed WorldCom’s prior notification to Andersen, which had audited its consolidated financial statements for 2001 and reviewed such interim condensed consolidated financial statements for first quarter 2002, of these improperly reported amounts. On June 24, 2002, Andersen had advised us that in light of the inappropriate transfers of line costs, Andersen’s audit report on our consolidated financial statements for 2001 and Andersen’s review of its interim condensed consolidated financial statements for the first quarter of 2002 could not be relied upon. WorldCom subsequently engaged KPMG to audit our consolidated financial statements for the years ended December 31, 2001 and 2000.

On August 8, 2002, WorldCom announced that its ongoing internal review of its consolidated financial statements discovered an additional $3.9 billion in improperly reported pre-tax earnings for 1999, 2000, 2001, and the first quarter of 2002. On November 5, 2002, WorldCom announced that it expected a further restatement of earnings in addition to amounts previously announced and that the overall amount of the restatements could total in excess of $9 billion. On March 13, 2003, WorldCom announced that it had completed a preliminary review of its goodwill and other intangible assets and property, plant and equipment accounts. This review resulted in the write-off of all existing goodwill and a substantial write-down of the carrying value of property, plant and equipment and other intangible assets, which was subsequently adjusted during WorldCom’s restatement process.

A Special Committee of WorldCom’s Board of Directors conducted an independent investigation of these matters. As a result of this investigation, we have made a number of changes to our financial and corporate governance practices. Also, Richard C. Breeden, former Chairman of the SEC, was appointed as Corporate Monitor. In his role, Mr. Breeden has closely overseen the overall process under which WorldCom reviewed its prior accounting practices, the carrying value of its assets and the quality of its internal controls. Mr. Breeden has made reports on such issues to both the SEC and the District Court from July 2002 through the present time. Certain other investigations involving the Corporation’s corporate governance and accounting practices have now been concluded. The Company’s past accounting practices remain the subject of an open investigation by the U.S. Attorney’s Office.

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As a result of the process of reviewing and restating its financial statements, WorldCom was unable to timely file periodic reports with the SEC. On March 12, 2004, WorldCom filed its Annual Report on Form 10-K for the period ended December 31, 2002. Such Annual Report contains audited financial statements for the years ended December 31, 2000, 2001 and 2002 and reflect each of the restatements and adjustments discussed above.

Regulation

We are subject to varying degrees of federal, state, local and international regulation. For more information, see “Item 1—Business—Regulation.”

Litigation

WorldCom and various current or former directors, officers, and advisors were named as defendants in a number of lawsuits alleging violations of federal and state securities laws and related claims. The filing of the Chapter 11 cases automatically stayed proceedings in private lawsuits relating to pre-petition claims as to the Debtors. Pre-petition litigation claims against the Company were discharged on the Emergence Date. Claims arising after the filing date generally were not discharged.

Merger Related Securities Litigation. On February 15, 2005, the Company received notice that an individual shareholder filed a putative class action on behalf of himself and all shareholders of the Company against the Company and all of the individual members of the Board of Directors in Chancery Court in the State of Delaware. Subsequently, Plaintiff filed an amended complaint that added among other things Verizon as a defendant in the case. Plaintiff alleges that the Company and the Board of Directors breached their fiduciary duties to shareholders in entering into the Merger Agreement with Verizon rather than accepting the merger proposal propounded by Qwest. As a remedy, Plaintiff requests that the Chancery Court issue an injunction prohibiting consummation of the Merger Agreement. Additionally, the Company has received notice that three additional putative class actions containing similar allegations were filed on February 18, 2005 against the Company and the Board of Directors in the Chancery Court in the State of Delaware. The Company will aggressively defend itself in these cases.

SEC Lawsuit and Related Proceedings. The Predecessor Company and various current or former directors, officers and advisors were named as defendants in a number of lawsuits alleging violations of federal and state securities laws and related claims.

On June 26, 2002, the SEC filed suit against the Predecessor Company and certain members of former management for violations of sections 10(b) and 13(a) of the Exchange Act and SEC Rules 10b-5, 12b-20, 13a-1 and 13a-13, alleging that from at least the first quarter of 2001 through the first quarter of 2002, WorldCom defrauded investors by disguising its true operating performance via improper accounting methods that materially overstated its income by approximately $3.9 billion. On November 5, 2002, the SEC filed an amended complaint that broadened the scope of the claims, including a claim under section 17(a) of the Securities Act, to reflect among other things the Predecessor Company’s disclosure that the overall restatements could total in excess of $9 billion. On May 19, 2003, the SEC filed a second amended complaint that added a claim for disgorgement of unlawful gains obtained as a result of the alleged misstatements.

The Company has resolved all claims brought by the SEC in this suit. The Company remains subject to the ongoing obligations imposed by the permanent injunction entered by the Court on November 26, 2002, as modified, including the oversight of Corporate Monitor Richard Breeden.

Insurance Coverage Litigation. On June 17, 2004, SR International Business Insurance Company, Ltd., one of the insurance carriers that had issued excess directors and officers (“D&O”) liability insurance coverage to WorldCom, Inc. for the period December 31, 2001 to December 31, 2002, filed an action in the United States District Court for the Southern District of New York against MCI and certain of its former directors and officers,

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seeking, among other things, rescission of its policy or, alternatively, a declaration of non-coverage under it (“SRI Action”). On May 28, 2004, one of WorldCom’s former directors, Bert C. Roberts, Jr., had filed a complaint for declaratory adjudication of rights and ancillary and supplemental relief against WorldCom’s excess D&O liability insurance carriers (“D&O Carriers”) in the United States District Court for the Southern District of New York (“Roberts Action”). By his action, Mr. Roberts sought a declaration of coverage against the D&O Carriers with respect to various underlying securities claims pending against him. Shortly thereafter, in or about August 2004, certain of the defendant D&O Carriers filed answers and counterclaims in the Roberts Action (“Carrier Counterclaims”). In their respective counterclaims, the D&O Carriers have named MCI and certain of WorldCom’s former directors and officers as counterclaim defendants and sought, among other things, to rescind the respective D&O policies issued by them or, alternatively, a declaration of no coverage under those policies. The SRI Action and the Roberts Action have been consolidated before Judge Cote and have functionally been stayed, while settlement discussions by and between the directors and officers, D&O Carriers, and underlying securities plaintiffs have been progressing. However, on February 3, 2005, Judge Cote issued a preliminary injunction requiring the insurers to pay Roberts’ defense costs as they are incurred. MCI has not yet appeared in either action and, if forced to do so, will aggressively defend itself by seeking dismissal of the SRI Action and the Carrier Counterclaims on the ground, among others, of non-justiciability.

Call Routing Investigation. On July 23, 2003, WorldCom received a subpoena from the United States Attorney’s Office for the Southern District of New York asking for information and documents concerning its projects relating to the routing of interstate or intrastate voice or data transmission that originate or terminate on the network of local exchange companies. The U.S. Attorney’s Office is investigating the Company’s practices relating to call routing that allegedly have the purpose of avoiding or reducing our payment of access charges to local exchange companies. We are cooperating fully with the U.S. Attorney’s Office, and have conducted an internal review of practices identified by the subpoena. Based on an internal review, we believe that our current practices in originating and terminating calls comply with all legal and regulatory requirements.

Investigation of the FCC Into Allegations of Improper Routing of Network Traffic. The Enforcement Bureau of the FCC has also initiated a review of the Company’s call routing practices, and has requested information from the Company regarding any conduct that might involve withholding, substituting, or modifying automatic number identification (“ANI”) or calling party number (“CPN”) information associated with interstate interexchange traffic. We are fully cooperating with the FCC in this matter and are providing the information requested. Based upon an internal review, we believe that our current practices comply with FCC regulations.

Right-of-Way Litigation. Prior to the Petition Date, the Predecessor Company was named as a defendant in five putative nationwide and twenty-five putative state class actions involving fiber optic cable on railroad, pipeline and utility rights-of-way. The complaints allege that the railroad, utility and/or pipeline companies from which the Predecessor Company obtained consent to install its fiber optic cable held only an easement in the right-of-way, and that the consent of the adjoining landowners holding the fee interest in the right-of-way did not authorize installation. The complaints allege that because such consent was not obtained, the fiber optic network owned and operated by the Predecessor Company trespasses on the property of putative class members. The complaints allege causes of action for trespass, unjust enrichment and slander of title, and seek injunctive relief, compensatory damages, punitive damages and declaratory relief. By the Petition Date, twenty-two putative class actions remained pending. In the remaining eight cases, class certification had been denied and/or the action had been dismissed. These cases were stayed as a result of the Predecessor Company’s bankruptcy filing, initially as a result of the automatic stay provisions of the Bankruptcy Code, and presently by operation of the discharge injunction incorporated into the modified Second Amended Joint Plan of Reorganization. To date, the Bankruptcy Court has denied all motions to lift the automatic stay or the discharge injunction.

Certain of the right-of-way plaintiffs filed individual and/or putative class proofs of claim in the bankruptcy proceedings. To date, the Bankruptcy Court has denied all pending motions to certify classes with respect to these proofs of claim, and has declined to extend the bar date to allow the late-filing of claims by unnamed class members. As a result of these rulings, the Company’s exposure in these matters has been substantially reduced.

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The Company also is litigating in the Bankruptcy Court, and in several federal appellate courts, the question of whether the discharge injunction contained in the Modified Second Amended Joint Plan of Reorganization bars the initiation or continuation of actions outside of the Bankruptcy Court based on the continued presence of the fiber optic cable after the Company’s discharge from bankruptcy. To date, one federal appellate court has agreed with the Company’s position, and the Bankruptcy Court recently issued decisions in two right-of-way cases finding that any further prosecution after the bankruptcy violates the discharge injunction.

The Predecessor Company executed a settlement agreement in February 2002 regarding all right-of-way litigation in Louisiana, and in June 2002 regarding all other railroad right-of-way litigation nationwide. However, following the Petition Date, the Predecessor Company opted out of the nationwide settlement agreement because the Oregon court did not approve it, and the Predecessor Company did not elect to proceed to seek approval in Illinois. During the bankruptcy proceedings, the Predecessor Company rejected the Louisiana right-of-way settlement agreement, but has since entered into an agreement in principle to implement the Louisiana agreement as a pre-petition claim against the Predecessor Company. The Company accrued for its estimate to settle the pre-petition litigation as of December 31, 2004 and 2003.

State Tax. In conjunction with the Predecessor Company’s bankruptcy claims resolution proceeding, certain states have filed claims concerning the Predecessor Company’s state income tax filings and its approach to related-party charges. To date, various states have filed proofs of claims in the aggregate amount of approximately $750 million. In addition, the State of Mississippi has filed a claim in the aggregate amount of approximately $2 billion. The Company is in discussions with the appropriate state taxing officials on these and other similar issues related to state income taxes owed by the Company and its subsidiaries.

On March 17, 2004, the Commonwealth of Massachusetts on behalf of itself and thirteen other states filed a motion to disqualify KPMG from serving as the Company’s accountant, auditor and tax advisor on the grounds that KPMG is not disinterested as required by Section 327(a) of the Bankruptcy Code. The Company believes that the filing of this motion was merely a litigation tactic and that the motion has no merit. The bankruptcy court held hearings on the motion, at the conclusion of which the bankruptcy court took the matter under advisement. On June 30, 2004, the bankruptcy court denied this motion and the states have appealed to the Southern District of New York the order denying the motion. That appeal has been stayed pending discussions with the Commonwealth concerning its tax-related proofs of claim against the Company.

Other Investigations. In addition, following WorldCom’s June 25, 2002, restatement announcement, various investigations have been initiated by, among others, the U.S. Attorney’s Office, and a state agency. These investigations are ongoing and we are cooperating fully in those inquiries.

In the normal course of our business, we are subject to proceedings, lawsuits and other claims, including proceedings under government laws and regulations related to environmental and other matters. Such matters are subject to many uncertainties and outcomes are not predictable with assurance. Consequently, we are unable to ascertain the ultimate aggregate amount of monetary liability or financial impact with respect to these matters at December 31, 2004. While these matters could affect our operating results when resolved in future periods, based on the information available to us today, we do not believe any monetary liability or financial impact would be material.

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

No matters were submitted to a vote of security holders during the year ended December 31, 2004, other than matters voted on by holders of our debt securities in the ordinary course of our bankruptcy proceedings.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Prior to WorldCom’s bankruptcy proceedings and continuing through July 29, 2002, shares of WorldCom group common stock and MCI group common stock traded on the NASDAQ National Market under the symbols “WCOM” and “MCIT,” respectively. On July 29, 2002, WorldCom issued a press release announcing NASDAQ’s decision to delist the shares of the WorldCom group common stock and MCI Group common stock due to WorldCom’s July 21, 2002, bankruptcy filing and the pending restatement of WorldCom’s financial statements. On July 30, 2002, the shares of WorldCom group common stock and MCI group common stock commenced trading on the over-the counter (“OTC”) market under the symbols “WCOEQ” and “MCWEQ.” Pursuant to the Plan, all shares of WorldCom group common stock and MCI group common stock were cancelled and rendered null and void on the Emergence Date.

On July 14, 2004, the new MCI common stock began trading on the NASDAQ National Market under the symbol “MCIP”. Prior to the listing date, the MCI common stock was trading on a “when issued” basis through April 19, 2004 and after issuance, from April 20, 2004 to July 13, 2004 in the OTC market under the symbols “MCIAV” and “MCIA”.

The following table sets forth the high and low bid quotations per share of WorldCom group common stock and MCI group common stock as reported on the OTC market from January 1, 2003 through April 19, 2004 and the MCI common stock from November 3, 2003 through December 31, 2004 as reported on the OTC market and the NASDAQ. The stock price information is based on published financial sources. OTC market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions, and may not necessarily represent actual transactions.

As of December 31, 2004, there were 319,557,905 shares of MCI common stock issued and outstanding held by approximately 500 registered holders.

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Description of MCI Common Stock

MCI is authorized to issue 3,000,000,000 shares of common stock having a par value of $0.01 (“Common Stock”). Pursuant to the Plan, approximately 296 million shares of Common Stock were issued to settle claims of debt holders, 10 million shares were issued to settle the SEC civil penalty claim and 5.7 million shares were issued to settle the claims of general unsecured creditors. We expect to issue an additional 5.4 million shares of Common Stock to settle the remaining claims of the general unsecured creditors. In addition, approximately 11 million shares of Common Stock were reserved for issuance under the new MCI, Inc. 2003 Management Restricted Stock Plan (of which approximately 8.6 million were issued on the Emergence Date). In addition, the MCI, Inc. 2003 Employee Stock Purchase Plan provides that we may issue approximately 2.2 million shares. These shares may be issued through open market purchases, from treasury shares or from authorized but unissued shares.

Dividends

Pursuant to Section 5.07 of our Plan, on August 5, 2004, the Board of Directors declared the amount of excess cash to be $2.2 billion. On the same date, the Board of Directors declared a cash dividend of $0.40 per share as a return of this shareholder capital. On September 15, 2004, the Company paid $127 million to shareholders of record on September 1, 2004. On October 15, 2004, the Board of Directors authorized another return of shareholder capital distribution in the form of a cash dividend of $0.40 per share. The Company paid the dividend of $127 million on December 15, 2004 to shareholders of record on December 1, 2004. On February 11, 2005, the Board of Directors approved a $0.40 per share dividend payment on March 15, 2005 to shareholders of record as of March 1, 2005.

Pursuant to the terms of the Company’s Merger Agreement with Verizon, shareholders will receive a special cash dividend in the amount of $4.10 per share (less the per share amount of any dividend declared by us during the period beginning on February 14, 2005 and ending on the closing date of the merger) after the Merger Agreement is approved by the shareholders.

Securities Authorized For Issuance under Equity Compensation Plans

Pursuant to our Certificate of Incorporation, we are prohibited from issuing stock options for a period of five years from the Emergence Date. As of December 31, 2004, we had 3,358,222 shares common stock available for issuance as restricted stock awards pursuant to the MCI, Inc. 2003 Management Restricted Stock Plan. The MCI, Inc. 2003 Management Restricted Stock Plan was approved pursuant to the plan of reorganization and as such, did not require the approval of the security holders. On February 28, 2005, we granted 3,333,767 shares of restricted stock awards pursuant to the MCI, Inc. 2003 Management Restricted Stock Plan.

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ITEM 6. SELECTED FINANCIAL DATA

We derived the selected historical consolidated financial data presented below as of and for each of the five years in the period ended December 31, 2004 from our audited consolidated financial statements and related notes thereto included elsewhere in this Annual Report on Form 10-K except for (i) Other Data: “Number of Employees” and year-end stock price, and (ii) the summarized statements of operations for the years ended December 31, 2001 and 2000 and balance sheet data as of December 31, 2002, 2001 and 2000, which were derived from our audited consolidated financial statements not included herein, as adjusted for discontinued operations. You should refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of this Annual Report on Form 10-K and the notes to our consolidated financial statements for additional information regarding the financial data presented below, including matters that might cause this data not to be indicative of our future financial condition or results of operations. In addition, readers should note the following information regarding the selected historical consolidated financial data presented below.

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We adopted fresh-start reporting under the provisions of SOP 90-7 as of December 31, 2003. Upon adoption, our reorganization value was $14.5 billion and was allocated to our assets and liabilities. Our assets were stated at fair value in accordance with SFAS No. 141 and liabilities were recorded at the present value of amounts estimated to be paid. In addition, our accumulated deficit was eliminated, and our new debt and equity were recorded in accordance with distributions pursuant to the Plan. The adoption of fresh-start reporting had a material effect on our consolidated financial statements. As a result, our consolidated balance sheet as of December 31, 2003 and 2004 included in this Annual Report on Form 10-K and our consolidated financial statements published for periods following December 31, 2003 will not be comparable with those published before such date.

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

The information in this Management’s Discussion and Analysis and elsewhere in this document contains certain forward-looking statements, which reflect our current view with respect to future events and financial performance. Wherever used, the words “believes,” “estimates,” “expects,” “plans,” “anticipates” and similar expressions identify forward-looking statements. Any such forward-looking statements are subject to risks and uncertainties that could cause our actual results of operations to differ materially from historical results or current expectations. See “Cautionary Statement Regarding Forward-Looking Statements” on page 1 and “Item 1—Business—Risk Factors.”

Business Overview

We are one of the world’s leading global communication companies, providing a broad range of services in over 200 countries on six continents. Each day, we provide Internet, data and voice communication services for thousands of businesses and government entities throughout the world and millions of consumer customers in the United States. We operate one of the most extensive communications networks in the world, comprising approximately 100,000 route miles of network connections linking metropolitan centers and various regions across North America, Europe, Asia, Latin America, the Middle East, Africa and Australia. In addition to transporting customer traffic over our network, we provide value-added services that make communications more secure, reliable and efficient, and we provide managed network services for customers that outsource all or portions of their communications and information processing operations.

Since April 2003, we have conducted our business primarily using the brand name “MCI.” As part of our financial reorganization, our predecessor company, WorldCom, was merged with and into MCI in April 2004. References herein to MCI, we, our and us are to MCI, Inc. and its subsidiaries and the Predecessor Company unless the context otherwise requires.

In March 2004, we realigned our operations into three new business segments and began operating under these segments in the second quarter of 2004. Effective with the realignment, our business segments are as follows:

On February 14, 2005, Verizon, MCI and a wholly-owned subsidiary of Verizon entered into an Agreement and Plan of Merger. The Merger Agreement provides that, upon the terms and subject to the conditions set forth in the Merger Agreement, MCI will merge with and into the Verizon subsidiary, with Merger Sub continuing as the surviving person (or, in certain situations, as provided in the Merger Agreement, a wholly-owned corporate subsidiary of Verizon will merge with and into MCI, with MCI as the surviving person.)

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At the effective time and as a result of the Merger, MCI will become a wholly-owned subsidiary of Verizon and each share of MCI common stock will be converted into the right to receive (x) 0.4062 shares of Verizon common stock and (y) cash in the amount of $1.50 per share, which amount of cash and number of shares may be reduced pursuant to a purchase price adjustment based on MCI’s bankruptcy claims and for certain tax liabilities, on the terms specified in the Merger Agreement. The Merger Agreement also provides for payment of a special cash dividend in the amount of $4.10 per share (less the per share amount of any dividend declared by the Company during the period beginning February 14, 2005 and ending on the closing date of the merger) of MCI common stock after the Merger Agreement is approved by the shareholders. All outstanding MCI stock-based awards at the effective time will be replaced by a grant of Verizon stock-based awards.

Consummation of the Merger is subject to customary conditions, including (i) approval of the shareholders of MCI, (ii) expiration or termination of the applicable Hart-Scott-Rodino waiting period and receipt of certain other federal, state or international regulatory approvals, (iii) absence of any law or order prohibiting the closing, (iv) subject to certain exceptions, the accuracy of representations and warranties and the absence of any Material Adverse Effect (as defined in the Merger Agreement) with respect to each party’s business. In addition, Verizon’s obligation to close is subject to other conditions, including (i) absence of any pending U.S. governmental litigation with a reasonable likelihood of success seeking to prohibit the closing or to impose certain limitations, (ii) receipt of a bankruptcy order issued by the Unites States Bankruptcy Court for the Southern District allowing for the substitution of shares of Verizon common stock for shares of MCI common stock to satisfy certain bankruptcy-related claims, and (iii) receipt of an order issued by the United States District Court for the Southern District of New York relating to MCI’s Corporate Monitor and certain affirmative obligations imposed by prior order of the United States District Court for the Southern District of New York. The Merger Agreement contains certain termination rights for both MCI and Verizon, and further provides that, upon termination of the Merger Agreement under specified circumstances, MCI may be required to pay Verizon a termination fee of $200 million.

Consummation of the Merger will constitute a “Change of Control” under MCI’s outstanding Senior Notes, which will obligate the surviving person to make an offer to purchase such Notes within 30 days after the effective time at a purchase price equal to 101% of principal amount plus accrued interest.

The communications industry has undergone significant changes in recent years, including severe price competition resulting in part from excess network capacity due to overbuilding and the substitution of email, instant messaging and wireless telephone service for traditional wireline voice communications. Other important changes in our industry are the entry of new competitors, such as Verizon and the other RBOCs into the long distance market, and cable television and other companies into the consumer telephony business. Also, there have been regulatory changes making it more difficult for competitive local exchange carriers like us to provide traditional telephone service, particularly to consumer customers, in competition with the RBOCs and other incumbent local exchange carriers. At the same time, technology changes are enabling the development of advanced networking services primarily based on IP communications and customer demand is increasing for such value-added services, including network monitoring, traffic analysis and management and comprehensive security solutions. MCI believes that consummation of the merger transaction will add new strength to the telecommunications services both companies provide and help the combined company better face these changing conditions. The merger will ensure that consumers and businesses will have a supplier with the financial strength to maintain and improve MCI’s Internet backbone network and will mean better service for enterprise customers by enhancing the combined company’s ability to compete for and serve large-business and government customers with a complete range of services, including wireless and the most sophisticated IP based services. See “Item 1—Risk Factors—The merger with Verizon may not occur or, if it does, may not provide all the anticipated benefits.”

On February 24, 2005, we received a revised proposal from Qwest Communications International, Inc. to acquire us. Our board of directors announced that it would conduct a thorough review of the Qwest proposal. On March 2, 2005, we announced our intention to engage with Qwest to review its February 24, 2005 proposal. This decision was made with the concurrence of Verizon. Subsequently, MCI and Qwest have been in ongoing discussions regarding Qwest’s proposal. These discussions are continuing as of the date of filing of this Annual Report on Form 10-K.

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Voluntary Reorganization under Chapter 11, Restatements, Reclassifications and Adjustments to Previously Issued Consolidated Financial Statements

On the Petition Date, WorldCom, Inc. and substantially all of its direct and indirect domestic subsidiaries filed voluntary petitions for relief in Bankruptcy Court under Chapter 11. On November 8, 2002, WorldCom filed bankruptcy petitions for an additional 43 of its domestic subsidiaries, most of which were effectively inactive and none of which had significant debt. Between the Petition Date and the Emergence Date, the Debtors continued to operate their businesses and manage their properties as debtors-in-possession. In addition, most litigation against the Debtors was stayed. We emerged from bankruptcy on April 20, 2004.

In June 2002, we announced that, as a result of an internal audit of our capital expenditure accounting, it was determined that certain transfers from line cost expenses (also referred to as access cost expenses) to capital accounts during 2001 and the first quarter of 2002 were not made in accordance with GAAP. We promptly notified Andersen, which had been our external auditor until May 2002, had audited our consolidated financial statements for 2001 and 2000, and had reviewed our interim condensed financial statements for the first quarter of 2002. On June 24, 2002, Andersen advised us that, in light of the inappropriate capitalization of access costs, Andersen’s audit report on our consolidated financial statements for 2001 and its review of our interim condensed consolidated financial statements for the first quarter of 2002 could not be relied upon. We also promptly notified KPMG, who had been retained in May 2002 as our external auditor, and engaged them to audit the consolidated financial statements for the years ended December 31, 2001 and 2000.

In conjunction with our restatement and through December 31, 2002 a number of balances or entries recorded in the historical accounting records could not be supported or their propriety otherwise determined. Because there was no documentary support related to these items we were unable to determine the appropriate statement of operations line item to which such amounts should be applied. As a result, these amounts have been included within operating expense and noted as “Unclassified, net” in the consolidated statement of operations for the year ended December 31, 2002.

During 2004, we determined that we had recorded in error a restatement entry which had the effect of reducing accounts receivable by $301 million through a charge to expense in the year ended December 31, 2000. The reported 2000 net loss of $48.9 billion should have been $48.6 billion, or 0.5% lower, and our assets of $44.2 billion should have been $44.5 billion, or 0.6% higher. In 2001, $35 million of the amount reversed and left a remaining $266 million understatement of accounts receivable as of December 31, 2001. This situation remained unchanged until, as a result of the application of fresh-start reporting as of December 31, 2003, the previously expensed $266 million was reversed in our statement of operations as a component of the $22.3 billion reorganization gain. Without this expense reversal, our 2003 net income of $22.2 billion would have been $21.9 billion, or 1.2% lower. As a result of the reversal of the expense in 2003, the cumulative impact to our December 31, 2003 consolidated retained earnings was zero. We assessed the impact on the 2000, 2001 and 2003 statements of operations as well as the consolidated balance sheets as of December 31, 2000, 2001, 2002 and 2003, and determined that the impact was not material to any period.

The impact of this reduction of accounts receivable in the consolidated balance sheet as of December 31, 2003 resulted in a misclassification of $266 million between accounts receivable and long-lived assets in our allocation of reorganization value under fresh-start reporting. To properly reflect the allocation of reorganization value as of December 31, 2003, we have reflected a reclassification entry in our consolidated balance sheet as of December 31, 2003, as presented herein, to reflect an increase of $266 million to our accounts receivable balance and reductions in our property, plant and equipment and intangible assets.

The adjustment of this item also resulted in a decrease to our long-term deferred tax liability by $6 million which has been reflected in the consolidated balance sheet as of December 31, 2003.

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Impairment Charges

We assess recoverability of our indefinite-lived and long-lived assets to be held and used whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. Impairment analyses of long-lived and indefinite-lived assets are performed in accordance with SFAS No. 144, and SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”). Impairment evaluations are performed at the lowest asset or asset group level for which identifiable cash flows are largely independent of the cash flows of other assets or asset groups. We generate most of our cash flows from products and services that are principally delivered to customers over our integrated telecommunications network and related intangible assets. Therefore, evaluations are performed at the entity level, excluding discontinued operations and assets held for sale, as a single group.

The industry is in a state of transition where traditional business lines are facing significant overcapacity in the marketplace, pricing pressures, changes in product mix, and customers’ continued efforts to reconfigure and consolidate their networks in order to achieve lower overall costs and improved efficiencies. Concurrently, the industry is migrating to more advanced network technologies and primarily focused around IP based platforms, and customers are requiring more advanced network services including network monitoring, traffic analysis, and comprehensive security solutions. The industry has also seen a general migration of customers from dial-up services to broadband and various wireless services. Additionally, our regulatory climate deteriorated due to a decision by the D.C. Circuit that invalidated the FCC’s February 2003 Triennial Review Order local competition rules, which set prices that incumbent providers could charge competitive providers such as the Company for UNE-P, an essential component of our Mass Market local phone service. Although several petitions were filed at the Supreme Court seeking review of the D.C. Circuit’s decision, the Solicitor General and the FCC declined to seek such review, and the Supreme Court subsequently denied the petitions. As of the date of our impairment test, the FCC had adopted interim unbundling rules (effective September 13, 2004) to maintain certain ILEC unbundling obligations under interconnection agreements as they existed prior to the D.C Circuit’s mandate. As a result, our costs for providing this service were expected to increase significantly in 2005. Some of our competitors announced their intentions to exit from this market, and the cost increases may force us to reduce efforts to acquire new customers and withdraw from certain markets. We therefore anticipated that revenues from that segment would continue to decline.

Given the market, business and regulatory conditions, we reevaluated our financial forecasts and strategy in the third quarter of 2004 when it became apparent that these trends would continue into the future. Updated cash flow and profitability projections and forecasts were developed taking into account both the 2004 changes in the competitive landscape and the regulatory issues facing us. Our executives reviewed these projections with the Audit Committee of the Board of Directors during the third quarter.

Based on the revised projections, we determined that an impairment analysis of our indefinite-lived and long-lived assets was required during the third quarter of 2004. In connection with this analysis, we evaluated our property, plant and equipment and definite and indefinite-lived intangible assets, including customer lists. We developed estimates of future undiscounted cash flows to test the recoverability of our long-lived and indefinite-lived assets. These estimates were compared to the carrying values of the assets, which resulted in the conclusion that we could not recover our carrying values through projected future operations. With the assistance of an independent third party valuation specialist, we further calculated the fair value of our long-lived and indefinite-lived assets based on the discounted cash flow analyses that utilized the revised management projections of revenues and profitability from September 1, 2004 through 2009. These projections were used in various scenarios utilizing a weighted average cost of capital between 10%-14%, a 2% terminal growth rate, certain working capital assumptions and total entity value assumptions.

We concluded that the carrying values of our definite-lived assets exceeded their estimated fair values by approximately $3.3 billion ($2.8 billion related to property, plant and equipment and $478 million related to definite-lived intangible assets) and the carrying value of an indefinite-lived asset exceeded its estimated fair

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value by approximately $260 million. These amounts represented the difference between the calculated fair values of the assets and their associated carrying values, and were recorded as a separate component of operating expenses in 2004. Our management reviewed the results of the impairment analysis with the Board of Directors, and the Board of Directors approved the impairment charges on October 15, 2004.

As a result of the impairment charge of approximately $260 million to an indefinite-lived intangible asset, we recognized a $99 million tax benefit which reduced our long-term deferred tax liability as the impairment reduced the difference between the book and tax basis. The impairment charges, after taxes, contributed approximately $3.4 billion to our 2004 net loss (loss per share of $(10.64)).

Discussion of Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in conformity with GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We evaluate our assumptions and estimates on an ongoing basis and may employ outside experts to assist in our evaluations. We believe that the estimates we use are reasonable; however, actual results could differ from those estimates. Our significant accounting policies are described in Note 2 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The following describes our most critical accounting policies:

Accounting and Reporting During Reorganization

We operated as debtors-in-possession from July 21, 2002 to the Emergence Date and adopted the provisions of SOP 90-7 upon commencement of our Bankruptcy Court proceedings. Our consolidated financial statements for the periods from July 21, 2002 through December 31, 2002 and from January 1, 2003 through December 31, 2003 have been prepared in accordance with the provisions of SOP 90-7. Interest was not accrued on debt subject to compromise subsequent to the Petition Date. Reorganization items include the expenses, realized gains and losses, and provisions for losses resulting from the reorganization under the Bankruptcy Code, and they are reported separately as reorganization items in our consolidated statements of operations.

We adopted fresh-start reporting under the provisions of SOP 90-7 as of December 31, 2003 and, accordingly, our reorganization value was allocated to our assets. Our assets were stated at fair value in accordance with SFAS No. 141 and liabilities were recorded at the present value of amounts estimated to be paid. Included in the allocation were estimates based on various assumptions and reflects our judgment based upon our prior pre-petition claims settlement history and the terms of our plan of reorganization and, if these assumptions prove incorrect, actual payments could differ from the estimated amounts. Changes in estimates and preconfirmation contingencies are reflected in the statements of operations as they are determined, whereas changes in the allocation of fair values resulted in adjustments to the assets and liabilities. In addition, our accumulated deficit was eliminated, and our new debt and equity were recorded in accordance with distributions pursuant to the Plan. The adoption of fresh-start reporting has had a material effect on our consolidated financial statements. See Notes 4 and 5 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for further discussion of the provisions of SOP 90-7.

Revenue and Associated Allowances for Revenue Adjustments and Doubtful Accounts

We recognize revenue when a sales arrangement exists, delivery has occurred or services have been rendered, the sale price is fixed and determinable, and collectibility is reasonably assured. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amount of revenues and expenses for the periods presented. Specifically, management makes estimates of future customer credits through the analysis of historical trends and known events. Significant management judgments and estimates must be made and used in connection with establishing the revenue allowances associated with discounts earned on certain customer agreements, billing allowances for pricing changes and customer disputes.

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The provisions for revenue adjustments are recorded as a reduction of revenue when incurred or ratably over a contract period. Since the revenue allowances are recorded as an offset to revenue, any future increases or decreases in the allowances will positively or negatively impact revenue by the same amount.

Similarly, our management must make estimates regarding the collectibility of our accounts receivable. Management specifically analyzes accounts receivable, including historical bad debts, customer concentrations, customer creditworthiness and current economic trends, when evaluating the adequacy of the allowance for doubtful accounts. Increases or decreases in our allowance for doubtful accounts will impact our selling, general and administrative expenses.

Access Costs

Access costs are costs incurred for transmission of voice and data over other carriers’ networks. These costs consist of both fixed payments and variable amounts based on actual usage and negotiated or regulated contract rates. We expense access costs as incurred. Accordingly, at each balance sheet date, we record our best estimate of the access costs incurred but not yet billed based on internal usage reports. Once we receive an invoice from a carrier, a process of reconciling that carrier’s invoice to our internal usage reports begins. In certain cases, this reconciliation process can take several months to complete. Once the reconciliation is complete, we agree with the carrier on the final amount due. In most cases, this process does not result in significant adjustments to our estimates. Accordingly, at each balance sheet date, we accrue access costs for estimated expenses that have not yet been billed by other carriers and for amounts for which the reconciliation of the carriers’ invoices to our internal usage reports has not been completed. Due to the complexity of the systems that capture usage information and the number of different negotiated and regulated rates, accounting for access costs requires a significant amount of estimation.

Valuation and Recoverability of Long-lived Assets

As of December 31, 2004, property, plant and equipment represented $6.3 billion and intangible assets represented $1.0 billion of our $17.1 billion in total assets. Accounting for our long-lived assets requires certain significant estimates regarding their expected useful lives and recoverability.

We record at cost our purchases of property, plant and equipment and other long-lived assets and those improvements that extend the useful life or functionality of the underlying assets. We depreciate those assets on a straight-line basis over their estimated useful lives. The estimated useful lives for transmission equipment is four to 30 years, five to nine years for telecommunications equipment, four to 39 years for furniture, fixtures, buildings and other property, plant and equipment, and three to six years for software. These useful lives are determined based on historical usage with consideration given to technological changes and trends that could impact our network architecture and asset utilization. Accordingly, in making these assessments, we consider the views of internal and outside experts regarding the impact of technological advances and trends on the value and useful lives of our network assets. We periodically reassess the remaining useful lives of our assets and make adjustments as necessary. When such an adjustment is required, we depreciate the remaining book value over the updated remaining useful life. Any increases or decreases in the remaining useful lives of our assets could have a significant effect on our consolidated results of operations in the future.

We review our indefinite-lived intangibles for impairment annually or whenever events or circumstances indicate that the carrying amount may not be recoverable. Property, plant and equipment and other definite-lived intangibles are evaluated for recovery under the provisions of SFAS No. 144. We operate an integrated telecommunications network. All assets comprising this network, related intangible assets, and the related cash flows are aggregated for the purpose of the impairment review because this aggregated level is the lowest level at which identifiable cash flows are largely independent of the cash flows of other groups of assets. This review requires us to make significant assumptions and estimates about the extent and timing of future cash flows, remaining useful lives, discount rates and growth rates. The cash flows are estimated over a significant future

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period of time, which makes those estimates and assumptions subject to a high degree of uncertainty. We also utilize market valuation models and other financial ratios which require us to make certain assumptions and estimates regarding the applicability of those models to our assets and businesses. In addition, we engage independent third party valuation specialists to assist us in our determination of estimated fair values of our assets.

Accounting for Income Taxes

We recognize deferred income tax assets and liabilities for the expected future tax consequences of transactions and events. Under this method, deferred income tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. If necessary, deferred income tax assets are reduced by a valuation allowance to an amount that is determined to be more likely than not recoverable. We must make significant estimates and assumptions about future taxable income and future tax consequences when determining the amount of the valuation allowance. In addition, tax reserves are based on significant estimates and assumptions as to the relative filing positions and potential audit and litigation exposures related thereto.

Consolidated Results of Operations

Our industry continues to go through a state of rapid transition with excess capacity and technological change placing pricing pressures on traditional business lines. At the same time, advanced networking capabilities primarily focused on IP platforms are creating new services around network design, monitoring and comprehensive security solutions. Prior to 2002, our business was significantly expanded through numerous acquisitions and large capital expenditure programs which contributed to a sharp increase in our outstanding debt. In 2002, we filed for reorganization under the U.S. bankruptcy laws. As a result, we undertook various initiatives to lower our operating costs, including the reduction of headcount of approximately 47,000 from the end of 2001 to the end of 2004, the elimination of excess facilities, investment in automation, and billing platform integrations. In addition, we undertook various initiatives with the near-term objective of minimizing further decreases in our revenues, including focusing on the acquisition and retention of enterprise customers and continuing to invest in new products and services. We believe that the cumulative effects of our cost reduction efforts and the successful execution of our business strategy should enable us to improve our consolidated operating results.

As a result of the FCC’s new unbundling rules on remand from the D.C. Circuit in the Triennial Review Order proceedings, we have been forced to raise residential phone services prices in some markets and may be forced to pull out of others, and have reduced our sales efforts pending clarity on our future pricing structure. We may take more significant action once state proceedings, and appeals on the matter have been completed.

We expect revenues to continue to decline in 2005. The most significant portion of the decline will be in our Mass Markets business within our U.S. Sales & Service segment, which still faces intense regulatory and competitive pressures. We may also experience declines in our wholesale business within our International & Wholesale Markets segment as we continue to strive to achieve higher margins in this business.

Through July, 2004, we also owned approximately a 19% economic interest and a 52% voting interest in Embratel, which is a Brazilian voice and data communications company that is operated by its own management and employees. During 2004, we sold our interest in Embratel and received $0.4 billion. We also sold Proceda, our information technology outsourcing company in Brazil, during 2004. In July 2004, we began to market OzEmail, an Internet service provider providing dial-up, broadband and wireless products to Australian consumers and small business enterprises, for sale. On February 28, 2005, we completed the divestiture of OzEmail for approximately $86 million. For 2004, 2003, and 2002, all of the results of operations of Embratel and associated Latin American operations, Proceda, and OzEmail that were previously included in our consolidated results from continuing operations were reclassified to discontinued operations.

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Our 2003 and 2002 consolidated financial statements have been prepared in accordance with SOP 90-7, which requires an entity’s statement of operations to portray the results of operations of the reporting entity during Chapter 11 proceedings. As a result, any revenues, expenses, realized gains and losses, and provisions resulting from our reorganization are reported separately as reorganization items, except those required to be reported as discontinued operations in conformity with SFAS No. 144.

The following table sets forth, for the periods indicated, our consolidated statements of operations (in millions):

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The following is a discussion of our consolidated results of operations for 2004, 2003 and 2002.

Revenues. Revenues are comprised of long distance voice, local voice, data and Internet services, as well as network technology solutions. We provide local, long distance and international voice communication services to our business customers. High-volume customers are connected to our global voice network through dedicated access lines, while lower volume customers are connected through switched access provided either by us or an ILEC. We also provide calling cards, voice messaging, speed dialing, and information service access to our business customers, as well as other value-added voice communication services such as VoIP. To our residential customers, we offer not only long distance, local, and high-speed Internet access services, but also bundled packages such as “the Neighborhood”, and various transaction services such as 1-800-COLLECT. Revenues derived from long distance and local voice services are recognized at the time of customer usage, and are based upon minutes of traffic carried and upon tariff or contracted fee schedules.

Data services include utilization of our frame relay, asynchronous transfer mode and IP networks to provide high bandwidth data transmission services over both public and private networks. Revenues from data services are recorded at the time service is provided based on monthly service fees. Internet services include access services built around our global Internet backbone, Internet-based virtual private networks (“IP VPN”), PIP networks, and web hosting services. Revenue derived from Internet services is recognized at the time the service is provided.

We also derive a portion of our revenues from the sale and installation of telecommunications equipment, including central office based remote access equipment.

During 2004, revenues decreased by $3.6 billion as compared to 2003. Voice services decreased $2.0 billion in 2004 as compared to 2003. Long distance voice revenues declined $2.1 billion, primarily driven by lower rates and volumes which impacted revenues by $1.1 billion and $1.0 billion, respectively. Long distance revenues continue to be impacted by segment mix. While overall long distance volumes declined by approximately 5%, segment mix was negatively impacted by a 23% decline in Mass Markets, driven by our decision to close selected call centers. Local voice revenues increased $0.1 billion, primarily due to growth in our Mass Markets customer base during the first half of 2004. Due to recent regulatory decisions impacting our consumer business, we will be forced to raise residential local phone service prices in some markets in 2005 and may be forced to pull out of others. Data services revenues decreased $1.1 billion, mainly due to continued rate pressure and technology substitution to IP services. Internet services decreased $0.5 billion, mainly due to the general migration of customers from dial-up services to broadband services. Included in our revenue declines were increases of $0.3 billion and $0.1 billion ($66 million in the fourth quarter) attributable to changes in foreign currency exchange rates and changes in estimates and other items, respectively.

During 2003, revenues decreased by $4.2 billion as compared to 2002. Voice services declined $1.4 billion reflecting lower retail and wholesale price levels from our business customers, which primarily resulted from the entrance of RBOCs into the long distance market, and lower rates in our consumer markets, which were due to product substitution to wireless phones, e-mail and prepaid cards, increased competition, and customer migration to lower-priced calling plans. We also experienced lower volumes in our subscription services, offset by higher wholesale volumes, and higher local volumes in our consumer market. The local volumes increased as we added customers while expanding the area in which we offer local services through using unbundled network elements in an increasing number of states. Data services revenues declined $1.4 billion primarily due to price decreases resulting from excess capacity in the marketplace and lower volumes due to weak market demand. Internet revenues decreased $1.4 billion mainly due to the general migration of customers from dial-up to broadband services, industry competition and pricing pressures negatively impacting both our wholesale and retail Internet services revenue.

Operating Expenses

Access costs. Access costs include costs incurred for the transmission of voice and data traffic over domestic and international networks that we do not own. Access costs also include contributions to the Universal

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Service Fund (“USF”) which are paid to a government-established agency, passed on to our customers and included in our revenues. Access costs as a percentage of revenues were 52% for 2004 as compared to 49% for 2003 and 47% for 2002. Access costs as a percentage of revenues increased in 2004 as compared to 2003, as declines in revenue driven by competitive rate pressure exceeded access cost reductions. In an effort to mitigate negative pricing trends, we continue to focus on an array of access cost reduction programs including circuit optimization and converting more traffic to our own network.

The decrease in access costs of $1.3 billion during 2004 as compared to 2003 was driven in part by an 11% decline in domestic long distance volumes offset by increased outbound international volumes of 12% as well as increased international traffic outside of the U.S. of 7%. We have experienced a positive trend in data and Internet circuit installs for the latter half of 2004, although associated access costs have declined by $0.5 billion as compared to 2003. Access cost reductions in 2004 were achieved by reducing special access circuit mileage costs, converting switched and dedicated traffic to our own network facilities, and by optimizing our international network. These 2004 cost savings initiatives were integral in reducing the average transmission costs per circuit from 2003 levels. Access costs were also reduced due to our restructuring efforts and contract rejections during our bankruptcy by $0.2 billion during the year. USF contributions decreased by $0.3 billion during 2004 as compared to 2003, which included the recognition in 2004 of a $68 million benefit regarding prior year contributions to the USF fund.

The decrease in access costs of $1.3 billion during 2003 as compared to 2002 was partially due to our contract renegotiations as a result of our restructuring efforts and contract rejections during our bankruptcy that reduced access costs by $0.6 billion. Access costs were further impacted by an approximately $0.7 billion decrease in access charges associated with our data, Internet and long distance voice business in the U.S., partially offset by a $0.3 billion increase in access charges associated with our local voice services. Other access cost changes included a $0.2 billion decrease in connection charges for international voice and data traffic originating in the U.S. and lower USF contributions of $0.1 billion. These access cost decreases were partially offset by changes in foreign currency exchange rates.

We expect our access costs will continue to decline due to our continued cost containment initiatives. These reductions will be partially offset by increased access costs for our local voice service, as the decision of the D.C. Circuit on the Triennial Review Order and the FCC’s rules on remand from that decision, combined with recent PUC mandated rate increases, will impact access costs in future quarters.

Costs of services and products. Costs of services and products (“COSP”) include the expenses associated with operating and maintaining our telecommunications networks, expenditures to support our outsourcing contracts, technical facilities expenses and other service related costs. COSP as a percentage of total revenue was 12% for the year ended December 31, 2004 as compared to 11% for 2003 and 12% for 2002.

The decrease in COSP of $0.3 billion in 2004 as compared to 2003 was primarily attributable to our continued focus on reducing our costs in line with our revenues. As a result, we experienced a decrease in outside services, repair and maintenance, and facility expenses totaling $0.1 billion, and a decrease of $0.1 billion in salary expense due to force reductions, net of severance expense. In addition, our expenses declined by approximately $0.1 billion due to various other cost-cutting efforts.

The decrease in COSP of $0.7 billion in 2003 as compared to 2002 was primarily attributable to initiatives to improve efficiency and better align our costs with our revenue levels. These initiatives resulted in decreased facility expenses of $0.1 billion, lower payments to marketing partners for customer awards and benefits of $0.1 billion as a result of lower total revenues, and a $0.3 billion reduction in personnel related costs and other general operating costs. COSP also decreased $0.2 billion due to reduced equipment sales.

Selling, general and administrative expenses. Selling, general and administrative (“SG&A”) expenses include sales, customer service and marketing expenses, information services costs, bad debt expense, and corporate administrative costs, such as finance, legal and human resources.

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We continued to incur reorganization items during 2004 and will incur reorganization items in 2005 for professional fees and other bankruptcy costs, although at lower levels than in 2003. As we adopted the provisions of fresh-start reporting on December 31, 2003, for accounting purposes, reorganization expenses and changes in estimates of reorganization items previously accrued have been included in our 2004 SG&A expense. These expenses totaled $36 million for 2004 and were primarily related to professional services related to our bankruptcy proceedings.

The reduction in expense of $1.3 billion in 2004 as compared to 2003 was primarily related to changes in our business strategy, as well as continued cost-cutting and process improvement initiatives. During 2004, we reduced our advertising costs by $0.4 billion due to changes in our marketing strategy. We improved our collections of receivables from historical levels which resulted in a reduction in the estimate for bad debt expense. In addition, lower revenues and rate declines contributed to the lower bad debt expense of $0.3 billion during 2004. Compensation expense declined $0.3 billion during 2004, reflecting our force reductions and lower commission expenses. We experienced a decrease of $0.1 billion in outside services mainly due to the significant accounting fees that were incurred during 2003 to assist with our restatement efforts. During 2004, we recognized a $38 million benefit from international tax settlements, and in the fourth quarter, we recognized a $91 million gain on bankruptcy settlements and the adjustment of related reserves and realized benefits of $42 million for value added tax settlements. These decreases in expense were partially offset by increased severance expenses during 2004 of $0.1 billion related to our force reductions.

The reduction in expense of $1.6 billion in 2003 as compared to 2002 was primarily due to lower personnel related costs of $0.6 billion reflecting a 3,700 decrease in the number of our employees engaged in sales support and other administrative activities, as well as improvement in bad debt expense of $0.7 billion. The improvement in bad debt expense resulted from improved credit management efforts during 2003 and a charge in 2002 to bad debt expense related to the loan to our former chief executive officer Bernard Ebbers. SG&A expenses were also reduced as a result of our restructuring efforts that led to an improvement of $0.1 billion in facility costs, our lower revenue volumes that resulted in a reduction of $0.1 billion in billing expenses, and other operational improvements. These reductions in SG&A expenses were partially offset by increased advertising of $0.1 billion to support our Mass Markets business and increased professional services fees of $0.3 billion related to the engagement of several professional services firms to assist in our financial restatement efforts.

Depreciation and amortization. Depreciation and amortization expense is primarily affected by the carrying value of our assets, which is directly impacted by our capital expenditure program and impairment charges.

Depreciation and amortization expense decreased by $0.4 billion during 2004 as compared to 2003. The decrease in expense was primarily due to a reduction in our asset carrying values related to pre-tax impairment charges of $3.5 billion recorded in 2004. The impact of our impairment charges on depreciation and amortization expense was a reduction of approximately $0.3 billion, primarily realized during the fourth quarter of 2004. Additionally, lives of certain assets were shortened during 2003 for their expected early disposal which increased the expense associated with these assets in 2003 and resulted in a reduction of depreciation expense in 2004 by $0.1 billion as compared to 2003. As a result of the implementation of fresh-start reporting as of December 31, 2003, fair values of our definite-lived intangibles such as customer lists increased, and the carrying values of our long-lived assets decreased, resulting in an increase in amortization expense of $0.1 billion in 2004 as compared to 2003, directly offset by a decrease in depreciation expense of $0.1 billion in 2004 as compared to 2003.

The decrease in depreciation and amortization expense of $0.6 billion during 2003 was principally due to the recognition of long-lived asset impairment charges of $5.0 billion in 2002, which reduced the asset carrying values.

Depreciation expenses are also affected by the level of our capital expenditures, which were $1.0 billion, $0.8 billion, and $1.0 billion for 2004, 2003 and 2002, respectively. Our reduced capital expenditures during these periods reflect reduced requirements for capacity and operating constraints resulting from bankruptcy. We

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expect 2005 capital expenditures to be consistent with 2004 levels even as we accelerate our investment in new products and services and continue to improve the efficiency, functionality and reliability of our network as well as make other operational improvements.

Impairment charges. During 2004, we recorded impairment charges of approximately $3.5 billion to adjust the carrying values of our long-lived assets and indefinite-lived intangible assets. Refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Impairment Charges” for additional details of the impairment charges. During 2002, we recorded impairment charges of $5.0 billion to adjust the carrying values of our long-lived assets and indefinite-lived intangible assets, consisting of $4.6 billion related to property, plant and equipment and $0.4 billion related to goodwill and intangibles. The decline in value for 2002 was driven by our pending bankruptcy filing, our disclosure of accounting and reporting irregularities and the resignation of senior officers. These events precipitated a lack of access to the capital markets and, therefore, a decrease in future projected cash flows.

Operating (loss) income. For 2004, our operating loss was $3.2 billion on revenues of $20.7 billion, a decrease of $3.9 billion from operating income of $0.7 billion on revenues of $24.3 billion in 2003. The principal factors underlying this decrease of $3.9 billion were impairment charges of $3.5 billion and lower operating income of $0.4 billion as the reduction in revenue of $3.6 billion was greater than the $3.2 billion reduction in our operational expenses.

For 2003, our operating income was $0.7 billion on revenues of $24.3 billion, an improvement of $5.0 billion from an operating loss of $4.3 billion on revenues of $28.5 billion in 2002. The principal factors underlying this improvement include a decrease in impairment charges of $5.0 billion, a decrease of $1.6 billion in SG&A expenses, a decrease in access cost expenses of $1.3 billion, a decrease of $0.7 billion in COSP expenses and a decrease in depreciation and amortization expenses of $0.6 billion, partially offset by a decrease in revenue of $4.2 billion.

Interest expense. Interest expense increased $0.3 billion to $0.4 billion in 2004 from $0.1 billion in 2003, and decreased $1.3 billion to $0.1 billion in 2003 from $1.4 billion in 2002.

This increase in 2004 as compared to 2003 relates to the recognition of interest expense on our Senior Notes that were issued on the Emergence Date as well as the $114 million in non-cash interest expense related to the accretion of the discount on these Senior Notes recognized from January 1, 2004 through the Emergence Date. No interest expense was paid or recognized in 2003 on our outstanding long-term debt during our bankruptcy. However, we continued to pay interest on our capital leases during 2003.

The decrease in 2003 as compared to 2002 reflects approximately $2.2 billion that was not paid or accrued on our $30.7 billion of outstanding debt that was subject to compromise as a result of our bankruptcy filing on July 21, 2002.

Miscellaneous income, net. Miscellaneous income includes: interest income, results of our equity investments, and foreign currency translation gains and losses. In 2004 and 2003, miscellaneous income was $0.1 billion and was an expense of $2.2 billion in 2002. In 2004, interest income and foreign currency gains were offset by losses from our equity investments, while 2003 included income from our equity interests and foreign currency translation gains. In 2002, we recognized $2.3 billion for an SEC civil penalty claim which was settled upon our emergence from bankruptcy for a cash consideration of $500 million and the issuance of common stock with an assigned value of $250 million.

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Reorganization items. From the Petition Date to our adoption of fresh-start reporting as of December 31, 2003, we classified certain expenses as reorganization items in accordance with SOP 90-7. Reorganization items do not include any revenues or expenses that must be reported as related to discontinued operations. In the years ended December 31, 2003 and 2002, we recorded reorganization items which totaled $22.1 billion of income and $0.8 billion of expenses, respectively. The following table sets forth the components of these items (in millions):

Contract rejection and lease termination expenses resulted from the rejection of executory contracts and leases as part of our financial reorganization under the bankruptcy laws. Employee retention and severance costs were incurred in connection with either retaining certain employees in order to complete our financial reorganization or reducing personnel levels as part of the restructuring of our business operations. These expenses were partially offset by interest income earned on our accumulated cash balances.

The costs included in reorganization items reflect the cash and non-cash expenses recognized by us in connection with our reorganization and are separately reported on the face of our consolidated statements of operations as required by SOP 90-7. The cash expenditures for reorganization items in 2003 and 2002 totaled $204 million and $114 million, respectively.

In our 2003 consolidated statement of operations, we recognized a gain of approximately $22.3 billion resulting from the difference between the amounts distributed to creditors pursuant to our Plan and our carrying value. See “Discussion of Critical Accounting Policies—Accounting and Reporting During Reorganization” above and Notes 4 and 5 to our 2004 consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The gain from the effects of the Plan and the application of fresh-start reporting was calculated as follows (in millions):

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Income tax expense. Income tax expense was $0.5 billion in 2004, and $0.3 billion in 2003 and 2002. During 2004, we recognized $0.6 billion in income tax expense primarily comprised of a $0.3 billion change in estimate related to our income tax contingencies as well as state income taxes, foreign income taxes, interest, and changes to foreign tax reserves from the effects of foreign currency exchange rates. Our 2004 federal income tax expense of $0.1 billion, generated as a result of impairment charges that are not currently deductible and certain limitations on our ability to use our net operating loss carryforwards, was entirely offset by a benefit from changes in our deferred tax balances. Offsetting our income tax expense was a benefit of $0.1 billion which resulted from our impairment charge to reduce the carrying value of our indefinite-lived intangible assets recorded in the third quarter. In addition, due to certain attribute reduction rules, we have reduced the tax basis of certain current assets by $1.5 billion, which will increase our current income tax expense as such assets are disposed.

The provisions for income taxes in 2003 and 2002 were primarily attributable to taxes on the income of our international subsidiaries and the establishment of reserves for tax contingencies which resulted in a current period tax expense. Additionally, certain expenses in our consolidated statements of operations are not deductible for income tax purposes. In 2003, the recognition of the gain on reorganization resulted in a reduction of our valuation allowance from limitations of certain tax attributes resulting in the establishment of a long-term deferred income tax liability, and did not impact income tax expense for 2003.

Income (loss) from discontinued operations. Discontinued operations reflected the operating results of our Wireless, MMDS, Embratel, and Proceda businesses which were all sold prior to December 31, 2004, as well as OzEmail, which we sold on February 28, 2005. In 2004, income from discontinued operations primarily reflected the income from our OzEmail operations and the gain on sale of Embratel. In 2003 and 2002, the loss from discontinued operations resulted primarily from our investment in Embratel.

Cumulative effects of changes in accounting principles. In 2003, we recorded a charge of $0.2 billion upon the adoption of SFAS No. 143, “Accounting for Asset Retirement Obligations (“SFAS No. 143”). In 2002, we recorded a charge related to the impairment of SkyTel’s channel rights upon the adoption of SFAS No. 142.

Net (loss) income. For 2004, our net loss was $4.0 billion, a decrease of $26.2 billion from net income of $22.2 billion in 2003. This decrease primarily resulted from the $3.9 billion decrease in operating loss discussed above, a $22.1 billion gain from reorganization items related to our application of fresh-start reporting in 2003, a $0.3 billion increase in interest expense, and a $0.2 billion increase in income tax expense offset by income in 2004 from discontinued operations as compared to a loss in 2003 and the $0.2 billion cumulative effect of a change in accounting principle recorded in 2003.

For 2003, our net income was $22.2 billion, a $31.4 billion change from a net loss of $9.2 billion in 2002. This change primarily resulted from a $22.9 billion change in reorganization items, a $5.0 billion improvement in operating income (loss), a $2.4 billion change in miscellaneous income (expense) and a decrease in interest expense of $1.3 billion.

Segment Results of Operations

In March 2004, we changed our segment reporting by realigning our previous business segments into three new business segments: Enterprise Markets, U.S. Sales & Service, and International & Wholesale Markets. Enterprise Markets serves the following customers which had been served by Business Markets in the past: global accounts, government accounts, MCI Solutions and Conferencing. U.S. Sales & Service serves the previous Mass Markets accounts and certain commercial accounts. International & Wholesale Markets serves customers internationally, as well as our wholesale accounts that were previously included in Business Markets. We began operating under these new segments during the second quarter of 2004.

In addition, we developed methodologies to fully allocate indirect costs that were previously reported in Corporate and Other to the new business segments. These costs include expenses associated with the operation of our network, access costs and cost of services and products, indirect selling, general and administrative expenses, depreciation and amortization, impairment charges, and corporate functions. The allocation methodologies are based on statistical and operational data that is generated from our continuing operations. These amounts can fluctuate based upon the performance of the individual segments.

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We have changed the way we manage our business to utilize operating income (loss) information to evaluate the performance of our business segments and to allocate resources to them. Accordingly, we have restated our results of segment operations data for 2003 into the new business segments for comparability with the current presentation. However, we determined that it was impracticable to restate our 2002 results into the new business segment structure. As such, we have only included discussion on segment data for 2004 and 2003 under the new segment structure.

All revenues are generated through external customers from three main product and service categories: Voice, Data, and Internet.

Our impairment charges recorded in 2004 were allocated to each of our business segments based on the same methodology used to allocate depreciation and amortization expense. Refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Impairment Charges” for additional details of the impairment charges.

Financial information for each of our reportable business segments and revenue product lines is as follows:

Enterprise Markets

This segment includes Global Accounts, Government Markets, and System Integrators. Global Accounts provides communications and network solutions to large multinational corporations requiring complex international network services. Government Accounts provides similar services to various government agencies. System Integrators serves customers through partnerships with third-party network solutions providers. In all cases, these services include local-to-global business data, Internet, voice services and managed network services.

For 2004 and 2003, the operating (loss) income of our Enterprise Markets segment was as follows (in millions):

Revenues. For 2004, Enterprise Markets revenues were 23% of our consolidated revenues as compared to 22% in 2003. Voice services revenues decreased due to rate declines across our entire voice business. Voice services revenues declined $63 million or 3% during 2004 as compared to 2003, driven primarily by market pricing pressures and customer contract rate changes in our long distance business which were centered in the Global and System Integrator channels. These declines were partially offset by growth in revenue from our local services. Global and System Integrators voice revenues declined by $36 million and $29 million, respectively, during 2004 as compared to 2003, while Government voice revenues were stable. In 2004, voice pricing trends in the Global market showed signs of greater stability, a trend we expect to continue in 2005.

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Data services revenues declined $0.3 billion or 10% during 2004 as compared to 2003. The decrease was driven by price erosion and product migration from traditional data to more efficient IP based technology. During 2004, revenue for traditional data services, which includes frame relay and point-to-point private line, declined by $0.2 billion or 12% as compared to 2003. In 2004, data pricing in the Global market showed signs of increasing stability, a trend we expect to continue in 2005.

Internet services revenue declined $0.2 billion or 23% during 2004 as compared to 2003, primarily due to declines in the Global business, reflecting the general migration of customers from dial-up to broadband services. Internet revenue from dial-access technologies declined by $0.1 billion while revenue from PIP services and IP VPN increased by $34 million as compared to 2003.

The Enterprise Market segment continues to focus on providing customer solutions with emphasis on local and wide area network management, integrating contact centers, hosting and comprehensive security services supporting our overall movement to IP-based platforms. Revenues in this portfolio increased by $39 million in 2004 as compared to 2003. These revenues are spread across the voice, data and Internet categories identified above.

Costs of sales and services. Costs of sales and services were 61% and 60% of segment revenues for 2004 and 2003, respectively. The increase in costs as a percentage of revenue is driven by rate declines in our system integrators business. Actual expenses decreased by $0.3 billion during 2004 as compared to 2003, primarily due to force reductions and lower volumes.

Selling, general and administrative expenses. SG&A expenses decreased by $0.1 billion during 2004 as compared to 2003, primarily due to force reductions.

Operating (loss) income. For the year ended December 31, 2004, Enterprise Markets had an operating loss of $0.5 billion as compared to an operating income of $0.3 billion for 2003. The operating loss was primarily attributable to $0.9 billion of impairment charges recorded during 2004, while decreased revenue was partially offset by lower costs.

U.S. Sales & Service

This segment serves our Mass Markets business, which includes subscription-based residential and certain small business accounts, and transactional products including 10-10-987, 10-10-220, 1-800-COLLECT, MCI Prepaid card, and our Commercial Accounts business, which serves small to medium-size business accounts. Commercial Accounts also includes our SkyTel business, which provides wireless email, interactive two-way messaging, wireless telemetry services and traditional text and numeric paging to customers throughout the United States.

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For 2004 and 2003, the operating (loss) income of our U.S. Sales & Service segment was as follows (in millions):