10-Q 1 d10q.txt VERIZON PENNSYLVANIA 1ST QUARTER FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 _____________________ FORM 10-Q _____________________ (Mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number 1-6393 VERIZON PENNSYLVANIA INC. A Pennsylvania Corporation I.R.S. Employer Identification No. 23-0397860 1717 Arch Street, 32nd Fl., Philadelphia, Pennsylvania 19103 Telephone Number (215) 466-9900 _________________________ THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT PURSUANT TO GENERAL INSTRUCTION H(2). 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 ---- ---- Verizon Pennsylvania Inc. PART I - FINANCIAL INFORMATION Item 1. Financial Statements CONDENSED STATEMENTS OF INCOME

See Notes to Condensed Financial Statements. 1 Verizon Pennsylvania Inc. CONDENSED BALANCE SHEETS ASSETS ------

See Notes to Condensed Financial Statements. 2 Verizon Pennsylvania Inc. CONDENSED BALANCE SHEETS LIABILITIES AND SHAREOWNER'S INVESTMENT ---------------------------------------

See Notes to Condensed Financial Statements. 3 Verizon Pennsylvania Inc. CONDENSED STATEMENTS OF CASH FLOWS

See Notes to Condensed Financial Statements. 4 Verizon Pennsylvania Inc. NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation Verizon Pennsylvania Inc. is a wholly owned subsidiary of Verizon Communications Inc. (Verizon Communications). The accompanying unaudited condensed financial statements have been prepared based upon Securities and Exchange Commission (SEC) rules that permit reduced disclosure for interim periods. These financial statements reflect all adjustments that are necessary for a fair presentation of results of operations and financial position for the interim periods shown including normal recurring accruals. The results for the interim periods are not necessarily indicative of results for the full year. For a more complete discussion of significant accounting policies and certain other information, you should refer to the financial statements included in our 2000 Annual Report on Form 10-K. We have reclassified certain amounts from prior year's data to conform to the 2001 presentation. 2. Revenue Recognition We recognize revenue when services are rendered based on usage of our local exchange network and facilities. For other products and services, revenues are generally recognized when services are rendered or products are delivered to customers. We defer nonrecurring service activation revenues and costs and amortize them over the expected term of the customer relationship. The deferred costs are equal to the activation fee revenue and any excess cost is expensed immediately. The deferred costs represent incremental direct costs associated with certain nonrecurring fees, such as service activation and installation fees. 3. Long-Lived Assets We assess the impairment of long-lived assets under Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" whenever events or changes in circumstances indicate that the carrying value may not be recoverable. A determination of impairment (if any) is made based on estimates of future cash flows. 4. Dividend On May 1, 2001, we declared and paid a dividend in the amount of $79.0 million to Verizon Communications. 5. Derivatives and Hedging Activities Effective January 1, 2001, we adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities." SFAS No. 133 requires that all derivatives, including derivatives embedded in other financial instruments, be measured at fair value and recognized as either assets or liabilities on our balance sheet. Changes in the fair values of derivative instruments not qualifying as hedges under SFAS No. 133 or any ineffective portion of hedges are recognized in earnings in the current period. Changes in the fair values of derivative instruments used effectively as hedges are recognized in earnings, along with changes in the fair value of the hedged item. Changes in the fair value of the effective portions of cash flow hedges are reported in other comprehensive income (loss), and recognized in earnings when the hedged item is recognized in earnings. The impact of the adoption of SFAS No. 133 on our financial statements was not material. 6. Shareowner's Investment

Net income and comprehensive income were the same for the three months ended March 31, 2001 and 2000. 5 Verizon Pennsylvania Inc. 7. Commitments and Contingencies Various legal actions and regulatory proceedings are pending to which we are a party. We have established reserves for specific liabilities in connection with regulatory and legal matters that we currently deem to be probable and estimable. We do not expect that the ultimate resolution of pending regulatory and legal matters in future periods will have a material effect on our financial condition, but it could have a material effect on our results of operations. Several federal regulatory matters may require us to refund a portion of the revenues collected in the current and prior periods. The outcome of each pending matter, as well as the time frame within which each will be resolved, is not presently determinable. Federal and state regulatory conditions to the Bell Atlantic-GTE merger include certain commitments to, among other things, promote competition and the widespread deployment of advanced services, while helping to ensure that consumers continue to receive high-quality, low cost telephone services. In some cases, there are significant penalties associated with not meeting these commitments. The cost of satisfying these commitments could have a significant impact on net income in future periods. 6 Verizon Pennsylvania Inc. Item 2. Management's Discussion and Analysis of Results of Operations (Abbreviated pursuant to General Instruction H(2).) This discussion should be read in conjunction with the Financial Statements and Notes to Financial Statements. RESULTS OF OPERATIONS --------------------- We reported net income of $93.6 million for the three month period ended March 31, 2001, compared to net income of $156.8 million for the same period in 2000. Our results were affected by merger-related costs recorded in the first quarter of 2001, as described below. Merger-related Costs In connection with the Bell Atlantic-GTE merger, which was completed in June 2000, we recorded pre-tax transition costs of $6.1 million in the first quarter of 2001 (including $4.6 million allocated from Verizon Services Corp.). These costs were recorded in Operations and Support Expense. Verizon Services Corp. is a wholly owned subsidiary of Verizon Communications Inc. (Verizon Communications) that provides various centralized services on behalf of Verizon Communications' subsidiaries. Transition costs consisted of costs to integrate systems, consolidate real estate, relocate employees and meet certain regulatory conditions of the merger. They also included costs for advertising and other costs to establish the Verizon brand. Transition costs were expensed as incurred. OPERATING REVENUE STATISTICS ----------------------------

*2000 reflects a restatement of access lines in service OPERATING REVENUES ------------------ (Dollars in Millions)

7 Verizon Pennsylvania Inc. LOCAL SERVICES 2001 - 2000 Increase -------------------------------------------------------------------------------- First Quarter $19.5 4.0% -------------------------------------------------------------------------------- Local service revenues are earned from the provision of local exchange, local private line, wire-maintenance, voice messaging and value-added services. Value-added services are a family of services that expand the utilization of the network, including products such as Caller ID, Call Waiting and Return Call. The provision of local exchange services not only includes retail revenues, but also includes local wholesale revenues from unbundled network elements (UNEs), interconnection revenues from local exchange carriers, certain data transport revenues and wireless interconnection revenues. Local service revenues increased in the first quarter of 2001 primarily as a result of higher payments received from competitive local exchange carriers for the purchase of unbundled network elements and for interconnection of their networks with our network. This increase was partially offset by a reduction in revenues resulting from a decline in access lines in service. NETWORK ACCESS SERVICES 2001 - 2000 Increase -------------------------------------------------------------------------------- First Quarter $16.9 5.7% -------------------------------------------------------------------------------- Network access revenues are earned from end-user subscribers and from long distance and other competing carriers who use our local exchange facilities to provide usage services to their customers. Switched access revenues are derived from fixed and usage-based charges paid by carriers for access to our local network. Special access revenues originate from carriers and end-users that buy dedicated local exchange capacity to support their private networks. End-user access revenues are earned from our customers and from resellers who purchase dial-tone services. Network access revenue growth in the first quarter of 2001 was mainly attributable to increased demand for special access services, reflecting a continuing expansion of the business market, particularly for high-capacity, high-speed digital services. This increase was partially offset by price reductions associated with federal and state price cap filings and other regulatory decisions. The Pennsylvania Public Utility Commission (PPUC) regulates us with respect to certain intrastate rates and services and certain other matters. The Federal Communications Commission (FCC) regulates rates that we charge long distance carriers and end-user subscribers for interstate access services. We are required to file new access rates with the FCC each year. In July 2000, we implemented the Coalition for Affordable Local and Long Distance Service (CALLS) plan. Rates included in the July 2000 CALLS plan will be in effect through June 2001. LONG DISTANCE SERVICES 2001 - 2000 (Decrease) -------------------------------------------------------------------------------- First Quarter $(8.3) (11.6)% -------------------------------------------------------------------------------- Long distance revenues are earned primarily from calls made to points outside a customer's local calling area, but within our service area (intraLATA toll). IntraLATA toll calls originate and terminate within the same LATA, but generally cover a greater distance than a local call. These services are regulated by the PPUC except where they cross state lines. Other long distance services that we provide include 800 services, Wide Area Telephone Service (WATS), and corridor services (between LATAs in Philadelphia and southern New Jersey). Long distance service revenues declined in the first quarter of 2001 primarily due to competition and the effects of toll calling discount packages and product bundling offers of our intraLATA toll services. 8 Verizon Pennsylvania Inc. OTHER SERVICES 2001 - 2000 (Decrease) -------------------------------------------------------------------------------- First Quarter $(4.0) (7.2)% -------------------------------------------------------------------------------- Our other services include such services as billing and collections for long distance carriers and affiliates, facilities rentals to affiliates and nonaffiliates, public (coin) telephone, customer premises equipment (CPE) and sales of materials and supplies to affiliates. Other service revenues also include fees paid by customers for nonpublication of telephone numbers and multiple white page listings and fees paid by an affiliate for usage of our directory listings. Other service revenues decreased in the first quarter of 2001 primarily due to lower revenues from our pay phone services as a result of the increasing popularity of wireless communications. OPERATING EXPENSES ------------------ (Dollars in Millions) OPERATIONS AND SUPPORT 2001 - 2000 Increase -------------------------------------------------------------------------------- First Quarter $52.9 12.3% -------------------------------------------------------------------------------- Operations and support expenses consist of employee costs and other operating expenses. Employee costs consist of salaries, wages and other employee compensation, employee benefits and payroll taxes. Other operating expenses consist of contract services including centralized services expenses allocated from Verizon Services, rent, network software costs, operating taxes other than income, the provision for uncollectible accounts receivable, reciprocal compensation, and other costs. The increase in operations and support expenses was primarily attributable to higher centralized services expenses allocated from Verizon Services Corp. and other affiliates. Operations and support expenses were further increased by higher interconnection and related costs associated with reciprocal compensation arrangements with competitive local exchange and other carriers to terminate calls on their network and annual salary and wage increases for management and non-management employees. In the first quarter of 2001, operations and support expenses also included the recognition of transition costs related to the Bell Atlantic - GTE merger. These increases were partially offset by lower rent expense. We continue to incur expenditures related to reciprocal compensation arrangements with competitive local exchange carriers and other carriers to terminate calls on their network. In March 2000, the United States Court of Appeals for the District of Columbia Circuit reversed and remanded the FCC's February 1999 order that concluded that calls to the Internet through Internet service providers (ISP) do not terminate at the ISP but are single interstate calls. The FCC had concluded that calls to the Internet are not therefore subject to reciprocal compensation under section 251(b)(5) of the Telecommunications Act, but left it to state regulatory commissions to determine whether local interconnection agreements entered into with competing carriers required the payment of compensation on such calls. On April 27, 2001, the FCC released an order responding to the court's remand. The FCC found that Internet-bound traffic is interstate and subject to the FCC's jurisdiction. Moreover, the FCC again found that Internet-bound traffic is not subject to reciprocal compensation under section 251(b)(5) of the Telecommunications Act. Instead, the FCC established federal rates that decline from $0.0015 to $0.0007 over a three year period. The FCC order also sets caps on the total minutes that may be subject to any intercarrier compensation and requires that incumbent local exchange carriers must offer to pay reciprocal compensation for local traffic at the same rate as they are required to pay on Internet-bound traffic. DEPRECIATION AND AMORTIZATION 2001 - 2000 Increase -------------------------------------------------------------------------------- First Quarter $23.2 12.2% -------------------------------------------------------------------------------- Depreciation and amortization expense increased in the first quarter of 2001 principally due to growth in depreciable telephone plant as a result of increased capital expenditures for higher growth services and increased software amortization costs. Higher rates of depreciation and amortization also contributed to the increase, but to a lesser extent. OTHER INCOME AND (EXPENSE), NET 2001 - 2000 (Decrease) -------------------------------------------------------------------------------- First Quarter $(32.0) ---% -------------------------------------------------------------------------------- The change in other income and (expense), net, was primarily attributable to equity losses recognized from our investment in Verizon Advanced Data Inc. (VADI). VADI is a wholly owned subsidiary of Verizon Communications that provides new exchange access services. At March 31, 2001, our ownership interest in VADI was 26.67%. Additional interest income associated with the settlement of a tax-related matter in the first quarter of 2000 also contributed to the change in other income and (expense), net, but to a lesser extent. 9 Verizon Pennsylvania Inc. INTEREST EXPENSE 2001 - 2000 Increase -------------------------------------------------------------------------------- First Quarter $4.8 15.8% -------------------------------------------------------------------------------- Interest expense includes costs associated with borrowings and capital leases, net of interest capitalized as a cost of acquiring or constructing plant assets. Interest expense increased in the first quarter of 2001, over the same period in 2000, primarily as a result of higher levels of average short-term debt with an affiliate. This increase was partially offset by higher capitalized interest costs resulting from higher levels of average telephone plant under construction. EFFECTIVE INCOME TAX RATES Three Months Ended March 31, -------------------------------------------------------------------------------- 2001 47.7% -------------------------------------------------------------------------------- 2000 41.5% -------------------------------------------------------------------------------- The effective income tax rate is the provision for income taxes as a percentage of income before the provision for income taxes. Our effective income tax rate was higher in the first quarter of 2001, principally due to equity losses associated with our investment in VADI, for which we do not recognize income tax benefits. OTHER MATTERS ------------- State Regulation On March 22, 2001, the PPUC rejected the recommended decision of an administrative law judge and declined to order a retail/wholesale structural separation of Verizon Pennsylvania. Rather, the PPUC gave us the option of instituting a functional separation between our retail and wholesale businesses with a code of conduct. The PPUC also proposed that we maintain in Pennsylvania, the separate data affiliate it established when the FCC approved the merger of Bell Atlantic and GTE, decrease UNE loop rates in rural areas, and increase penalty payments under the Performance Assurance Plan. On April 20, 2001, we accepted the proposed order with the conditions described in that order. In addition, we withdrew most of the pending appeals. 10 Verizon Pennsylvania Inc. PART II - OTHER INFORMATION Item 1. Legal Proceedings There were no proceedings reportable under this Item. Item 6. Exhibits and Reports on Form 8-K (b) There were no Current Reports on Form 8-K filed during the quarter ended March 31, 2001. 11 Verizon Pennsylvania Inc. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Verizon Pennsylvania Inc. Date: May 15, 2001 By /s/ Edwin F. Hall ------------------------------- Edwin F. Hall Chief Financial Officer and Controller UNLESS OTHERWISE INDICATED, ALL INFORMATION IS AS OF MAY 7, 2001. 12

VERIZON PENNSYLVANIA INC 10-Q