================================================================================
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 September 30, 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 1-8606
VERIZON COMMUNICATIONS INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 23-2259884
(STATE OF INCORPORATION) (I.R.S. EMPLOYER
IDENTIFICATION NO.)
1095 AVENUE OF THE AMERICAS 10036
NEW YORK, NEW YORK (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER (212) 395-2121
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ----
At September 30, 2001, 2,714,453,805 shares of the registrant's Common Stock
were outstanding, after deducting 37,196,679 shares held in treasury.
================================================================================
TABLE OF CONTENTS
ITEM NO.
PART I. FINANCIAL INFORMATION PAGE
-------------------------------------------------------------------------------------------
1. FINANCIAL STATEMENTS (UNAUDITED)
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three and nine months ended September 30, 2001 and 2000 1
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, 2001 and December 31, 2000 2
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended September 30, 2001 and 2000 3
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 4
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS 15
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 35
PART II. OTHER INFORMATION
-------------------------------------------------------------------------------------------
6. EXHIBITS AND REPORTS ON FORM 8-K 36
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Verizon Communications Inc. and Subsidiaries
(Dollars in Millions, Except Per Share Amounts) (Unaudited) THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2001 2000 2001 2000
------------- ------------- ------------- -------------
OPERATING REVENUES $ 17,004 $ 16,533 $ 50,179 $ 47,834
Operations and support expense 9,925 9,605 28,937 29,205
Depreciation and amortization 3,402 3,213 10,162 9,030
Gains on sales of assets, net -- (1,227) (5) (3,780)
------------- ------------- ------------- -------------
OPERATING INCOME 3,677 4,942 11,085 13,379
Equity in income (loss) from unconsolidated businesses 142 271 (3,306) 3,784
Other income and (expense), net 84 128 268 218
Interest expense (797) (914) (2,627) (2,603)
Minority interest (226) (142) (533) (177)
Mark-to-market adjustment - financial instruments (13) 377 (166) 664
------------- ------------- ------------- -------------
Income before provision for income taxes, extraordinary
items and cumulative effect of change in accounting
principle 2,867 4,662 4,721 15,265
Provision for income taxes 984 2,022 2,105 6,157
------------- ------------- ------------- -------------
INCOME BEFORE EXTRAORDINARY ITEMS AND CUMULATIVE
EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 1,883 2,640 2,616 9,108
Extraordinary items, net of tax (8) 826 (8) 817
Cumulative effect of change in accounting principle, net
of tax -- -- (182) (40)
------------- ------------- ------------- -------------
NET INCOME 1,875 3,466 2,426 9,885
Redemption of subsidiary preferred stock -- -- -- (8)
------------- ------------- ------------- -------------
NET INCOME AVAILABLE TO COMMON SHAREOWNERS $ 1,875 $ 3,466 $ 2,426 $ 9,877
============= ============= ============= =============
BASIC EARNINGS (LOSS) PER COMMON SHARE:
Income before extraordinary items and cumulative effect
of change in accounting principle $ .69 $ .97 $ .97 $ 3.35
Extraordinary items, net of tax -- .31 -- .30
Cumulative effect of change in accounting principle,
net of tax -- -- (.07) (.01)
------------- ------------- ------------- -------------
NET INCOME $ .69 $ 1.28 $ .90 $ 3.64
============= ============= ============= =============
Weighted-average shares outstanding (in millions) 2,712 2,708 2,708 2,717
============= ============= ============= =============
DILUTED EARNINGS (LOSS) PER COMMON SHARE:
Income before extraordinary items and cumulative
effect of change in accounting principle $ .69 $ .97 $ .96 $ 3.31
Extraordinary items, net of tax -- .30 -- .30
Cumulative effect of change in accounting principle,
net of tax -- -- (.07) (.01)
------------- ------------- ------------- -------------
NET INCOME $ .69 $ 1.27 $ .89 $ 3.60
============= ============= ============= =============
Weighted-average shares outstanding - diluted
(in millions) 2,735 2,722 2,729 2,742
============= ============= ============= =============
Dividends declared per common share $ .385 $ .385 $ 1.155 $ 1.155
============= ============= ============= =============
See Notes to Condensed Consolidated Financial Statements
1
CONDENSED CONSOLIDATED BALANCE SHEETS
Verizon Communications Inc. and Subsidiaries
(Dollars in Millions, Except Per Share Amounts) (Unaudited) SEPTEMBER 30, DECEMBER 31,
2001 2000
------------- -------------
ASSETS
Current assets
Cash and cash equivalents $ 1,365 $ 757
Short-term investments 248 1,613
Accounts receivable, net of allowances
of $2,011 and $1,562 13,726 14,010
Inventories 2,259 1,910
Net assets held for sale 1,487 518
Prepaid expenses and other 2,747 3,313
------------- -------------
Total current assets 21,832 22,121
------------- -------------
Plant, property and equipment 166,312 158,957
Less accumulated depreciation 93,415 89,453
------------- -------------
72,897 69,504
------------- -------------
Investments in unconsolidated businesses 11,284 13,115
Intangible assets 44,080 41,990
Other assets 19,410 18,005
------------- -------------
Total assets $ 169,503 $ 164,735
============= =============
LIABILITIES AND SHAREOWNERS' INVESTMENT
Current liabilities
Debt maturing within one year $ 18,847 $ 14,838
Accounts payable and accrued liabilities 11,945 13,965
Other 5,450 5,433
------------- -------------
Total current liabilities 36,242 34,236
------------- -------------
Long-term debt 45,043 42,491
Employee benefit obligations 11,648 12,543
Deferred income taxes 16,129 15,260
Other liabilities 3,706 3,797
Minority interest 21,899 21,830
Shareowners' investment
Series preferred stock ($.10 par value; none issued) -- --
Common stock ($.10 par value; 2,751,650,484
shares issued in both periods) 275 275
Contributed capital 24,505 24,555
Reinvested earnings 13,968 14,667
Accumulated other comprehensive loss (1,832) (2,176)
------------- -------------
36,916 37,321
Less common stock in treasury, at cost 1,277 1,861
Less deferred compensation - employee stock
ownership plans and other 803 882
------------- -------------
Total shareowners' investment 34,836 34,578
------------- -------------
Total liabilities and shareowners' investment $ 169,503 $ 164,735
============= =============
See Notes to Condensed Consolidated Financial Statements
2
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Verizon Communications Inc. and Subsidiaries
(Dollars in Millions) (Unaudited) NINE MONTHS ENDED SEPTEMBER 30,
2001 2000
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Income before extraordinary items and cumulative effect of
change in accounting principle $ 2,616 $ 9,108
Adjustments to reconcile income before extraordinary items
and cumulative effect of change in accounting principle
to net cash provided by operating activities:
Depreciation and amortization 10,162 9,030
Gains on sales of assets, net (5) (3,780)
Mark-to-market adjustment - financial instruments 166 (664)
Employee retirement benefits (1,610) (2,585)
Deferred income taxes 552 2,878
Provision for uncollectible accounts 1,374 945
Equity in income (loss) from unconsolidated businesses 3,306 (3,784)
Changes in current assets and liabilities,
net of effects from acquisition/disposition of businesses (3,469) 283
Other, net 4 614
------------- -------------
Net cash provided by operating activities 13,096 12,045
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (12,477) (11,880)
Acquisitions, net of cash acquired, and investments (3,005) (1,590)
Proceeds from disposition of businesses and assets 200 6,004
Investments in notes receivable -- (989)
Net change in short-term investments 1,338 922
Other, net (1,213) (596)
------------- -------------
Net cash used in investing activities (15,157) (8,129)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term borrowings 9,204 2,630
Repayments of long-term borrowings and capital lease obligations (2,003) (4,865)
Increase (decrease) in short-term obligations, excluding current maturities (1,436) 2,450
Dividends paid (3,119) (3,389)
Proceeds from sale of common stock 436 415
Purchase of common stock for treasury (18) (2,263)
Other, net (395) (99)
------------- -------------
Net cash provided by (used in) financing activities 2,669 (5,121)
------------- -------------
Increase (decrease) in cash and cash equivalents 608 (1,205)
Cash and cash equivalents, beginning of period 757 2,033
------------- -------------
Cash and cash equivalents, end of period $ 1,365 $ 828
============= =============
See Notes to Condensed Consolidated Financial Statements
3
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Verizon Communications Inc. and Subsidiaries
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared based upon Securities and Exchange Commission (SEC) rules that permit
reduced disclosure for interim periods. The condensed consolidated financial
statements for the nine months ended September 30, 2000 give retroactive effect
to the merger of Bell Atlantic Corporation (Bell Atlantic) and GTE Corporation
(GTE) on June 30, 2000, as required for business combinations using
pooling-of-interests accounting.
These financial statements reflect all adjustments that are necessary for a fair
presentation of results of operations and financial condition for the interim
periods shown including normal recurring accruals and other items. The results
for the interim periods are not necessarily indicative of results for the full
year. For a more complete discussion of significant accounting policies and
certain other information, you should refer to the financial statements included
in the Verizon Communications Inc. (Verizon) Annual Report on Form 10-K for the
year ended December 31, 2000.
We have reclassified certain amounts from prior year's data to conform to the
2001 presentation.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued Statements
of Financial Accounting Standards (SFAS) No. 141, "Business Combinations," and
No. 142, "Goodwill and Other Intangible Assets."
SFAS No. 141, which applies to business combinations occurring after June 30,
2001, requires that the purchase method of accounting be used and includes
guidance on the initial recognition and measurement of goodwill and other
intangible assets acquired in the combination.
SFAS No. 142 no longer permits the amortization of goodwill and indefinite-lived
intangible assets. Instead, these assets must be reviewed annually (or more
frequently under certain conditions) for impairment in accordance with this
statement. This impairment test uses a fair value approach rather than the
undiscounted cash flows approach previously required by SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." The amortization of goodwill included in our investments in
equity investees will also no longer be recorded upon adoption of the new rules.
Intangible assets that do not have indefinite lives will continue to be
amortized over their useful lives and reviewed for impairment in accordance with
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
We are required to adopt SFAS No. 142 effective January 1, 2002. We are
currently evaluating our intangible assets to determine the impact, if any, the
adoption of SFAS No. 142 will have on our results of operations or financial
position.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." This standard provides the accounting for the cost of legal
obligations associated with the retirement of long-lived assets. SFAS No. 143
requires that companies recognize the fair value of a liability for asset
retirement obligations in the period in which the obligations are incurred and
capitalize that amount as a part of the book value of the long-lived asset. That
cost is then depreciated over the remaining life of the underlying long-lived
asset. We are required to adopt SFAS No. 143 effective January 1, 2003. We are
currently evaluating the impact this new standard will have on our future
results of operations or financial position.
In August 2001, the FASB issued SFAS No. 144. This standard supersedes SFAS No.
121 and the provisions of Accounting Principles Board (APB) Opinion No. 30,
"Reporting the Results of Operations-Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" with regard to reporting the effects of a disposal of a
segment of a business. SFAS No. 144 establishes a single accounting model for
assets to be disposed of by sale and addresses several SFAS No. 121
implementation issues. We are required to adopt SFAS No. 144 effective January
1, 2002. We do not expect the impact of the adoption of SFAS No. 144 to have a
material effect on our results of operations or financial position.
4
3. ACCOUNTING FOR THE IMPACT OF THE SEPTEMBER 11, 2001 TERRORIST ATTACKS
The terrorist attacks on September 11th resulted in considerable loss of life
and property, as well as to exacerbate weakening economic conditions. Verizon
was not spared any of these effects, given our significant operations in New
York and Washington, D.C.
The primary financial statement impact of the September 11th terrorist attacks
pertains to Verizon's plant, equipment and administrative office space located
either in, or adjacent to the World Trade Center complex, and the associated
service restoration efforts. Given the magnitude of the destruction in the area
of the World Trade Center complex, a more refined estimate of total losses will
not be available until a more comprehensive physical inspection of the plant and
equipment, which is not yet fully accessible, can be completed. However, based
on the limited information available as of the end of the current quarter, an
estimate of equipment losses and costs incurred during the quarter associated
with service disruption and restoration of $290 million was recorded.
Verizon's insurance policies are limited to losses of $1 billion for each
occurrence and include a deductible of $1 million. As a result, we accrued an
insurance recovery of $150 million pertaining to the $290 million of losses
described in the preceding paragraph, or $140 million net costs in operations
and support expense in the condensed consolidated statements of income, and also
reported by our Domestic Telecom segment. The costs and insurance recovery were
recorded in accordance with Emerging Issues Task Force Issue No. 01-10,
"Accounting for the Impact of the Terrorist Attacks of September 11, 2001."
4. NET ASSETS HELD FOR SALE
During the third quarter of 2001, the company announced that it was exploring
the sale of approximately 1.2 million access lines in Alabama, Kentucky and
Missouri, and during the quarter committed to sell those access lines.
Consequently, as of September 30, 2001 the net assets pertaining to those access
lines, principally plant, property and equipment, were classified in the
condensed consolidated balance sheets as net assets held for sale. See Note 16
for additional information on agreements to sell these access lines.
5. MERGER CHARGES
Results for the nine months ended September 30, 2000 include charges associated
with employee severance of $584 million ($371 million after-tax, or $.14 per
diluted share) recorded in connection with the merger of Bell Atlantic and GTE
during the second quarter of 2000. These costs, as recorded under SFAS No. 112,
"Employers' Accounting for Postemployment Benefits," represent the benefit costs
for the separation of approximately 5,500 management employees who were entitled
to benefits under pre-existing separation plans, as well as an accrual of
ongoing SFAS No. 112 obligations for GTE employees. The remaining severance
liability as of September 30, 2001 is $288 million. Our results for the nine
months ended September 30, 2000 also include a pretax charge of $472 million
($378 million after-tax, or $.14 per diluted share), recorded in the second
quarter of 2000, for direct, incremental merger-related costs, including
compensation, professional services and other direct costs. In addition, our
results for the nine months ended September 30, 2000 include $385 million ($236
million after-tax, or $.09 per diluted share) for other actions in relation to
the merger or other strategic decisions, recorded in the second quarter of 2000.
We expect to incur a total of approximately $2 billion of transition costs
related to the merger and the formation of the wireless joint venture. These
costs will be incurred to integrate systems, consolidate real estate and
relocate employees. They also include approximately $500 million for advertising
and other costs to establish the Verizon brand. Transition costs incurred
through the third quarter of 2001 total $1,390 million. During the third quarter
and for the first nine months of 2001, we incurred transition costs of $254
million and $696 million ($144 million and $394 million after taxes and minority
interest, or $.05 and $.14 per diluted share), respectively. During the third
quarter and for the first nine months of 2000, we incurred transition costs of
$163 million and $335 million ($65 million and $112 million after taxes and
minority interest, or $.02 and $.04 per diluted share), respectively.
5
6. GAINS ON SALES OF ASSETS, NET
During 2001 and 2000, we recognized net gains in operations related to sales of
assets, impairments of assets held for sale and other charges, as follows:
(Dollars in Millions) THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2001 2000 2001 2000
PRETAX AFTER-TAX PRETAX AFTER-TAX PRETAX AFTER-TAX PRETAX AFTER-TAX
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Wireline properties $ -- $ -- $ 1,781 $ 1,085 $ -- $ -- $ 2,859 $ 1,740
Wireless properties -- -- -- -- 5 3 1,922 1,156
Other, net -- -- (554) (609) -- -- (1,001) (910)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
$ -- $ -- $ 1,227 $ 476 $ 5 $ 3 $ 3,780 $ 1,986
========== ========== ========== ========== ========== ========== ========== ==========
See Note 7 for a discussion of gains on sales of wireless overlap properties
subsequent to the merger.
Wireline Property Sales
During the third quarter of 2000, we sold approximately 1,049,000 access lines
of former GTE properties located in Alaska, Arkansas, Minnesota, Missouri, New
Mexico, Texas and Wisconsin for cash proceeds of $3,207 million. The pretax gain
on the sales was $1,781 million ($1,085 million after-tax, or $.40 per diluted
share).
The year-to-date net gains for asset sales include the sale of approximately
471,000 access lines of former GTE properties during June 2000 located in Iowa,
Nebraska and Oklahoma for combined cash proceeds of $1,433 million and $125
million in convertible preferred stock. The pretax gain on the sales was $1,078
million ($655 million after-tax or $.24 per diluted share).
Wireless Overlap
A U.S. Department of Justice (DOJ) consent decree issued on December 6, 1999
required GTE Wireless, Bell Atlantic Mobile, Vodafone Group plc and PrimeCo
Personal Communications L.P. (PrimeCo) to resolve a number of wireless market
overlaps in order to complete the wireless joint venture and the Bell
Atlantic-GTE merger. As a result, during April 2000 we completed a transaction
with ALLTEL Corporation (ALLTEL) that provided for the exchange of several
former Bell Atlantic Mobile markets in Texas, New Mexico and Arizona for several
of ALLTEL's wireless markets in Nevada and Iowa and cash. In a separate
transaction entered into by GTE, in June 2000, we exchanged several former GTE
markets in Florida, Alabama and Ohio, as well as an equity interest in South
Carolina, for several ALLTEL interests in Pennsylvania, New York, Indiana and
Illinois. These exchanges were accounted for as purchase business combinations
and resulted in combined pretax gains of $1,922 million ($1,156 million
after-tax, or $.42 per diluted share).
As of September 30, 2001, we completed the sales of all overlap properties with
the exception of the Chicago market. The sale of the Cincinnati market was
completed during the second quarter of 2001. The pretax gain was $80 million
($48 million after-tax, or $.02 per diluted share). In addition, during the
second quarter an agreement to sell the Chicago market at a price lower than the
net book value of the Chicago assets was executed. Consequently, we recorded an
impairment charge of $75 million ($45 million after-tax, or $.02 per diluted
share) related to the expected sale. The sale of the Chicago market is expected
to close in the fourth quarter of 2001.
Other Transactions
During the third quarter of 2000, we recorded charges related to the write-down
of certain impaired assets, determined based on expected future cash flows, and
other charges of $554 million pretax ($609 million after-tax, or $.23 per
diluted share).
(Dollars in Millions) THREE MONTHS ENDED SEPTEMBER 30, 2000
PRETAX AFTER-TAX
------------ ------------
CLEC impairment $ 334 $ 218
Real estate consolidation and other merger-related charges 220 142
Deferred taxes on contribution to the wireless joint venture -- 249
------------ ------------
$ 554 $ 609
============ ============
6
The competitive local exchange carrier (CLEC) impairment primarily relates to
the revaluation of assets and the accrual of costs pertaining to certain
long-term contracts due to strategic changes in Verizon's approach to offering
bundled services both in and out of its franchise areas.
The real estate consolidation and other merger-related charges include the
revaluation of assets and the accrual of costs to exit leased facilities that
were in excess of our needs as the result of post-merger integration activities.
The deferred tax charge is non-cash and was recorded as the result of the
contribution in July 2000 of the GTE wireless assets to Verizon Wireless based
on the differences between the book and tax bases of assets contributed.
In connection with our decisions to exit the video business and GTE Airfone, we
recorded an impairment charge during the second quarter of 2000 of $566 million
($362 million after-tax, or $.13 per diluted share) to reduce the carrying value
of these investments to their estimated net realizable value. In addition, other
sales during the quarter resulted in a net pretax gain of approximately $22
million ($6 million after-tax, or less than $.01 per diluted share). During the
first quarter of 2000, we recorded a pretax gain of $97 million ($55 million
after-tax, or $.02 per diluted share), primarily comprised of the gain on the
sale of our CyberTrust line of business.
7. EXTRAORDINARY ITEMS
During the third quarter of 2001, we retired two debt issues totaling $228
million prior to the stated maturity dates, resulting in pretax extraordinary
charges totaling $12 million ($8 million after-tax, or less than $.01 per
diluted share).
During the third quarter of 2000, we completed the sales of certain service area
conflicts prohibited by Federal Communications Commission (FCC) regulations
which resulted in pretax gains totaling $1,374 million ($826 million after-tax,
or $.30 per diluted share). Since the sales were required pursuant to the
consent decree which enabled both the formation of Verizon Wireless and the
closing of the merger, and occurred after the merger, the gains were recorded
net of taxes as Extraordinary Items in the condensed consolidated statements of
income. Results for the nine months ended September 30, 2000 also include the
retirement in the first quarter of 2000 of $128 million of debt prior to the
stated maturity date, resulting in a pretax extraordinary charge of $15 million
($9 million after-tax, or less than $.01 per diluted share).
8. WIRELESS JOINT VENTURE
On April 3, 2000, Verizon and Vodafone Group plc consummated the previously
announced agreement to combine U.S. wireless assets, including cellular,
Personal Communications Services (PCS) and paging operations. We accounted for
this transaction as a purchase business combination, and accordingly, began
reporting the combined wireless operations prospectively in the second quarter
of 2000.
9. INVESTMENTS
Marketable Securities
We have investments in marketable securities, primarily common stocks, which are
considered "available-for-sale" under SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." These investments have been included
in our condensed consolidated balance sheets in Investments in Unconsolidated
Businesses and Other Assets.
Under SFAS No. 115, available-for-sale securities are required to be carried at
their fair value, with unrealized gains and losses (net of income taxes) that
are considered temporary in nature recorded in Accumulated Other Comprehensive
Loss. The fair values of our investments in marketable securities are determined
based on market quotations.
7
The following table shows certain summarized information related to our
investments in marketable securities:
GROSS GROSS
UNREALIZED UNREALIZED
(Dollars in Millions) COST GAINS LOSSES FAIR VALUE
--------------------- ------------- ------------- ------------- -------------
AT SEPTEMBER 30, 2001
Investments in unconsolidated businesses $ 1,926 $ 380 $ (679) $ 1,627
Other assets 302 33 -- 335
------------- ------------- ------------- -------------
$ 2,228 $ 413 $ (679) $ 1,962
============= ============= ============= =============
AT DECEMBER 31, 2000
Investments in unconsolidated businesses $ 4,529 $ 559 $ (1,542) $ 3,546
Other assets 1,326 29 (241) 1,114
------------- ------------- ------------- -------------
$ 5,855 $ 588 $ (1,783) $ 4,660
============= ============= ============= =============
We continually evaluate our investments in marketable securities for impairment
due to declines in market value considered to be other than temporary. That
evaluation includes, in addition to persistent, declining stock prices, general
economic and company-specific evaluations. In the event of a determination that
a decline in market value is other than temporary, a charge to earnings is
recorded for all or a portion of the unrealized loss, and a new cost basis in
the investment is established.
Prior to the second quarter of 2001, we considered the declines in the market
values of our marketable securities investments to be temporary, due principally
to the overall weakness in the securities markets as well as telecommunications
sector share prices. However, in June 2001, we recognized a pretax loss of
$3,913 million ($2,926 million after-tax, or $1.07 diluted loss per share) in
Equity in Income (Loss) From Unconsolidated Businesses in the condensed
consolidated statements of income primarily relating to our investments in Cable
& Wireless plc (C&W), NTL Incorporated (NTL) and Metromedia Fiber Network, Inc.
(MFN). We determined, through the evaluations described above, that market value
declines in these investments at June 30, 2001 were considered other than
temporary.
During the second quarter of 2000, we recognized a pretax gain of $3,088 million
($1,941 million after-tax, or $.71 per diluted share) related to the
restructuring of our equity investment in Cable & Wireless Communications plc
(CWC). In exchange for our equity investment in CWC, we received shares of C&W
and NTL.
At September 30, 2001, the unrealized gains on marketable securities relate
primarily to our investment in Telecom Corporation of New Zealand Limited (TCNZ)
and the unrealized losses relate primarily to our investments in NTL, C&W and
MFN.
Other Securities
Prior to the merger of Bell Atlantic and GTE, we owned and consolidated Genuity
Inc. (Genuity). In June 2000, as a condition of the merger, 90.5% of the voting
equity of Genuity was issued in an initial public offering (IPO). We currently
own 8.2% of the voting equity of Genuity, which contains a contingent conversion
feature. The conversion rights are dependent on the percentage of certain of
Verizon's access lines that are compliant with Section 271 of the
Telecommunications Act of 1996. Verizon cannot currently exercise this
conversion feature.
Genuity's revenues for the second quarter and first half of 2000 were $275
million and $529 million, respectively; its net losses were $153 million and
$281 million, respectively. These periods preceded the IPO when Genuity was
wholly owned by Verizon. Consequently, these revenues and losses were included
in Verizon's consolidated results. Although no longer included in Verizon's
consolidated results of operations as a result of the IPO, Genuity's revenues
for the third quarter and first nine months of 2001 were $302 million and $905
million, respectively, its net losses were $300 million and $946 million,
respectively. Revenues and net losses for the third quarter of 2000 were $308
million and $229 million, respectively.
10. ACCOUNTING CHANGE - DERIVATIVE FINANCIAL INSTRUMENTS
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
8
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 fair
value 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 initial impact of
adoption on our consolidated financial statements was recorded as a cumulative
effect of an accounting change resulting in a charge of $182 million to current
earnings and income of $110 million to other comprehensive income (loss). The
recognition of assets and liabilities was immaterial to our financial position.
The ongoing effect of SFAS No. 133 on our consolidated financial statements will
be determined each quarter by several factors, including the specific hedging
instruments in place and their relationships to hedged items, as well as market
conditions at the end of each period. For the three months ended September 30,
2001, we recorded a charge to current earnings of $13 million and a loss of $14
million to other comprehensive income (loss). For the nine months ended
September 30, 2001, we recorded a charge to current earnings of $166 million and
a loss of $28 million to other comprehensive income (loss).
The charges to current earnings are primarily due to changes in the fair value
of the conversion option on our investment in MFN debt securities which allows
us to convert our debt securities into MFN common stock. The conversion option
has, as its underlying risk, changes in the MFN stock price. This risk is not
clearly and closely related to the change in interest rate risk underlying the
debt securities and therefore the conversion option does not qualify as a hedge
under SFAS No. 133. The fair value of the conversion option is recognized as an
asset in our balance sheet and we record the mark-to-market adjustment in
current earnings.
A net charge of $186 million related to the MFN conversion option was included
as part of the cumulative effect of the accounting change recorded on January 1,
2001. A net charge of $13 million was recorded to mark-to-market adjustment for
the three months ended September 30, 2001. A net charge of $162 million was
recorded to mark-to-market adjustment for the nine months ended September 30,
2001.
11. DEBT
Exchangeable Notes
Previously, Verizon Global Funding issued two series of notes that are
exchangeable for shares of TCNZ and for C&W and NTL shares.
The exchangeable notes are indexed to the fair market value of the common stock
into which they are exchangeable. If the price of the shares exceeds the
exchange price established at the offering date, a mark-to-market adjustment is
recorded, recognizing an increase in the carrying value of the debt obligation
and a charge to income. If the price of the shares subsequently declines, the
debt obligation is reduced (but not to less than the amortized carrying value of
the notes).
At September 30, 2001, the exchange price of the notes exchangeable into C&W and
NTL shares exceeded the combined value of the share prices. Consequently, the
notes were recorded at their amortized carrying value with no mark-to-market
adjustments recorded in the third quarter or in the first nine months of 2001.
At September 30, 2000, the decrease in the debt obligation since December 31,
1999 of $664 million ($431 million after-tax, or $.16 per diluted share) was
recorded as an increase to income in the first nine months of 2000 and an
increase to income of $377 million ($245 million after-tax, or $.09 per diluted
share) in the third quarter of 2000. As of September 30, 2001, we have recorded
no mark-to-market adjustments for the TCNZ exchangeable notes.
Support Agreements
All of Verizon Global Funding's debt (including the TCNZ and the C&W and NTL
exchangeable notes) have the benefit of Support Agreements between us and
Verizon Global Funding, which guarantee payment of interest, premium (if any)
and principal outstanding should Verizon Global Funding fail to pay. The holders
of Verizon Global Funding debt do not have recourse to the stock or assets of
most of our telephone operations or TCNZ; however, they do have recourse to
dividends paid to us by any of our consolidated subsidiaries as well as assets
not covered by the exclusion. Verizon Global Funding's long-term debt, including
current portion, aggregated $19,810
9
million at September 30, 2001. The carrying value of the available assets
reflected in our condensed consolidated financial statements was approximately
$67.1 billion at September 30, 2001.
Debt Issuances
In January 2001, Verizon Global Funding entered into a $1 billion five-year
bank loan.
In February 2001, Verizon Global Funding issued $1 billion of 7.75% notes due
2030 at a premium, resulting in gross proceeds of approximately $1,070 million.
In April 2001, Verizon South Inc., an indirect wholly owned subsidiary of
Verizon Communications, issued $300 million of 7% Series F debentures due 2041
at a discount, resulting in gross proceeds of approximately $291 million.
In May 2001, Verizon Global Funding issued $2 billion of floating rate notes due
2002. Interest on the notes is reset quarterly at three-month LIBOR plus .05%.
In May 2001, Verizon Global Funding issued approximately $5.4 billion in
principal amount at maturity of zero-coupon convertible notes due 2021,
resulting in gross proceeds of approximately $3 billion. The notes are
convertible into shares of our common stock at an initial price of $69.50 per
share if the closing price of Verizon common stock on the New York Stock
Exchange exceeds specified levels or in other specified circumstances. The
conversion price increases by at least 3% a year. The initial conversion price
represents a 25% premium over the May 8, 2001 closing price of $55.60 per share.
There are no scheduled cash interest payments associated with the notes.
In August 2001, Verizon New England Inc., an indirect wholly owned subsidiary of
Verizon Communications, issued $1 billion of 6 1/2% Series A debentures due 2011
at a discount, resulting in gross proceeds of approximately $993 million.
Reclassification of Long-Term Debt
During the second quarter of 2001, approximately $5.1 billion of revolving loans
was reclassified to short-term debt in connection with the expiration of the
current credit facility agreement in the second quarter of 2002.
12. COMPREHENSIVE INCOME
Comprehensive income consists of net income and other gains and losses affecting
shareowners' investment that, under generally accepted accounting principles,
are excluded from net income.
Changes in the components of other comprehensive income (loss) are as follows:
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
(Dollars in Millions) 2001 2000 2001 2000
--------------- -------------- ------------- ---------------
NET INCOME $ 1,875 $ 3,466 $ 2,426 $ 9,885
---------- ---------- ---------- ----------
OTHER COMPREHENSIVE INCOME (LOSS), net of taxes
Foreign currency translation adjustments (413) (28) (65) (191)
Unrealized gains (losses) on marketable securities (713) (1,266) 439 (1,064)
Unrealized derivative losses on cash flow hedges (14) -- (30) --
Minimum pension liability adjustment -- -- -- (22)
---------- ---------- ---------- ----------
(1,140) (1,294) 344 (1,277)
---------- ---------- ---------- ----------
TOTAL COMPREHENSIVE INCOME $ 735 $ 2,172 $ 2,770 $ 8,608
========== ========== ========== ==========
The change in unrealized gains (losses) on marketable securities in 2001
primarily relates to the reclassification of after-tax realized losses of $2,926
million recorded due to the other than temporary decline in market value of
certain of our marketable securities (see Note 9). The net unrealized gains
(losses) on marketable securities in 2000 primarily related to our investments
in MFN, TCNZ, C&W and NTL.
The components of accumulated other comprehensive loss are as follows:
(Dollars in Millions) AT SEPTEMBER 30, 2001 AT DECEMBER 31, 2000
--------------------- --------------------- --------------------
Foreign currency translation adjustments $ (1,473) $ (1,408)
Unrealized gains (losses) on marketable securities (295) (734)
Unrealized derivative losses on cash flow hedges (30) --
Minimum pension liability adjustment (34) (34)
------------ ------------
Accumulated other comprehensive loss $ (1,832) $ (2,176)
============ ============
10
13. EARNINGS PER SHARE
The following table is a reconciliation of the share amounts used in computing
earnings per share.
(Dollars and Shares in Millions, Except Per Share Amounts) THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------------------- 2001 2000 2001 2000
------------- ------------ ------------ ------------
NET INCOME AVAILABLE TO COMMON SHAREOWNERS
Income before extraordinary items and cumulative effect of change $ 1,883 $ 2,640 $ 2,616 $ 9,108
in accounting principle
Redemption of subsidiary preferred stock -- -- -- (8)
------------ ------------ ------------ ------------
Income available to common shareowners* 1,883 2,640 2,616 9,100
Extraordinary items, net of tax (8) 826 (8) 817
Cumulative effect of change in accounting principle, net of tax -- -- (182) (40)
------------ ------------ ------------ ------------
Net income available to common shareowners* $ 1,875 $ 3,466 $ 2,426 $ 9,877
============ ============ ============ ============
BASIC EARNINGS (LOSS) PER COMMON SHARE
Weighted-average shares outstanding 2,712 2,708 2,708 2,717
------------ ------------ ------------ ------------
Income available to common shareowners before
extraordinary items and cumulative effect of
change in accounting principle $ .69 $ .97 $ .97 $ 3.35
Extraordinary items, net of tax -- .31 -- .30
Cumulative effect of change in accounting principle, net of tax -- -- (.07) (.01)
------------ ------------ ------------ ------------
Net income available to common shareowners $ .69 $ 1.28 $ .90 $ 3.64
============ ============ ============ ============
DILUTED EARNINGS (LOSS) PER COMMON SHARE
Weighted-average shares outstanding 2,712 2,708 2,708 2,717
Effect of dilutive securities 23 14 21 25
------------ ------------ ------------ ------------
Weighted-average shares outstanding - diluted 2,735 2,722 2,729 2,742
------------ ------------ ------------ ------------
Income available to common shareowners before
extraordinary items and cumulative effect of
change in accounting principle $ .69 $ .97 $ .96 $ 3.31
Extraordinary items, net of tax -- .30 -- .30
Cumulative effect of change in accounting principle,
net of tax -- -- (.07) (.01)
------------ ------------ ------------ ------------
Net income available to common shareowners $ .69 $ 1.27 $ .89 $ 3.60
============ ============ ============ =============
*Income and Net income available to common shareowners are the same for purposes
of calculating basic and diluted earnings per share.
Stock options for 101 million shares for the three months ended September 30,
2001 and 115 million shares for the nine months ended September 30, 2001 were
not included in the computation of diluted earnings per share because the
exercise price of stock options was greater than the average market price of the
common stock. For the three and nine months ended September 30, 2000, the
numbers of shares not included in the computation of diluted earnings per share
were 107 million and 68 million, respectively. No other contingently issuable
shares were included in the diluted earnings per share calculation since
conversion conditions were not met.
14. SEGMENT INFORMATION
We have four reportable segments, which we operate and manage as strategic
business units and organize by products and services. Our segments include a
Domestic Telecom group which provides domestic wireline communications services;
a Domestic Wireless group which provides domestic wireless communications
services; an International group which includes our foreign wireline and
wireless communications investments; and an Information Services group which is
responsible for our domestic and international publishing businesses and
electronic commerce services.
We measure and evaluate our reportable segments based on adjusted net income,
which excludes unallocated corporate expenses and other adjustments arising
during each period. The other adjustments include transactions that management
excludes in assessing business unit performance due primarily to their
nonrecurring and/or non-operational nature. Although such transactions are
excluded from the business segment results, they are included in reported
consolidated earnings.
11
REPORTABLE SEGMENTS
The following table provides adjusted operating financial information for our
four reportable segments and a reconciliation of adjusted segment results to
consolidated results:
(Dollars in Millions) THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
--------------------- 2001 2000 2001 2000
---------------- ---------------- ---------------- ----------------
EXTERNAL OPERATING REVENUES
Domestic Telecom $ 10,557 $ 10,696 $ 32,158 $ 31,818
Domestic Wireless 4,510 4,026 12,921 10,124
International 570 508 1,681 1,436
Information Services 1,099 943 2,853 2,724
---------------- ---------------- ---------------- ----------------
Total segments - adjusted 16,736 16,173 49,613 46,102
Reconciling items 268 360 566 1,732
---------------- ---------------- ---------------- ----------------
Total consolidated - reported $ 17,004 $ 16,533 $ 50,179 $ 47,834
================ ================ ================ ================
INTERSEGMENT REVENUES
Domestic Telecom $ 109 $ 181 $ 381 $ 591
Domestic Wireless 11 10 29 28
International 27 -- 41 --
Information Services 13 27 32 81
---------------- ---------------- ---------------- ----------------
Total segments - reported 160 218 483 700
Reconciling items (160) (218) (483) (700)
---------------- ---------------- ---------------- ----------------
Total consolidated - reported $ -- $ -- $ -- $ --
================ ================ ================ ================
TOTAL OPERATING REVENUES
Domestic Telecom $ 10,666 $ 10,877 $ 32,539 $ 32,409
Domestic Wireless 4,521 4,036 12,950 10,152
International 597 508 1,722 1,436
Information Services 1,112 970 2,885 2,805
---------------- ---------------- ---------------- ----------------
Total segments - adjusted 16,896 16,391 50,096 46,802
Reconciling items 108 142 83 1,032
---------------- ---------------- ---------------- ----------------
Total consolidated - reported $ 17,004 $ 16,533 $ 50,179 $ 47,834
================ ================ ================ ================
NET INCOME
Domestic Telecom $ 1,152 $ 1,327 $ 3,863 $ 3,967
Domestic Wireless 182 143 431 363
International 238 194 691 520
Information Services 363 292 873 819
---------------- ---------------- ---------------- ----------------
Total segments - adjusted 1,935 1,956 5,858 5,669
Reconciling items (60) 1,510 (3,432) 4,216
---------------- ---------------- ---------------- ----------------
Total consolidated - reported $ 1,875 $ 3,466 $ 2,426 $ 9,885
================ ================ ================ ================
(Dollars in Millions) SEPTEMBER 30, 2001 DECEMBER 31, 2000
--------------------- ------------------ -----------------
ASSETS
Domestic Telecom $ 80,537 $ 78,112
Domestic Wireless 59,705 56,029
International 14,554 14,466
Information Services 3,990 3,148
-------------- --------------
Total segments 158,786 151,755
Reconciling items 10,717 12,980
-------------- --------------
Total consolidated $ 169,503 $ 164,735
============== ==============
12
Major reconciling items between the segments and the consolidated results are as
follows:
(Dollars in Millions) THREE MONTHS ENDED NINE MONTHS ENDED
--------------------- SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
------------ ------------ ------------ ------------
TOTAL REVENUES
Genuity (see Note 9) $ -- $ -- $ -- $ 529
Significant operations sold in 2000 (see Note 6) -- 142 -- 851
Regulatory settlements -- -- -- (69)
Corporate, eliminations and other 108 -- 83 (279)
------------ ------------ ------------ ------------
$ 108 $ 142 $ 83 $ 1,032
============ ============ ============ ============
NET INCOME
Genuity (see Note 9) $ -- $ -- $ -- $ (281)
(Loss)/gain on marketable securities (see Note 9) -- -- (2,926) 1,941
Mark-to-market adjustment - exchangeable notes (see Note 11) -- 245 -- 431
Mark-to-market adjustment - other financial instruments (see Note 10) (13) -- (164) --
Other charges and special items (see Note 5) -- -- -- (526)
Merger-related costs (see Note 5) -- -- -- (749)
Transition costs (see Note 5) (144) (65) (394) (112)
Gains on sales of assets, net (see Note 6) -- 476 3 1,986
Cumulative effect of accounting change (see Note 10) -- -- (182) (40)
Pension settlements -- -- -- 564
Extraordinary items (see Note 7) (8) 826 (8) 817
Corporate, eliminations and other 105 28 239 185
------------ ------------ ------------ ------------
$ (60) $ 1,510 $ (3,432) $ 4,216
============ ============ ============ ============
Pension settlement gains before tax of $911 million ($564 million after-tax)
were recognized for the nine-month period ended September 30, 2000. These gains
were recorded in accordance with SFAS No. 88, "Employers' Accounting for
Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits." They relate to certain settlements of pension obligations
for former GTE employees through direct payment, the purchase of annuities or
otherwise. There were no similar pension settlement gains recorded during 2001.
Corporate, eliminations and other includes unallocated corporate expenses,
intersegment eliminations recorded in consolidation, the results of other
businesses such as lease financing, and asset impairments and expenses that are
not allocated in assessing segment performance due to their nonrecurring nature.
We generally account for intersegment sales of products and services and asset
transfers at current market prices. We are not dependent on any single customer.
15. COMMITMENTS AND CONTINGENCIES
Several state and federal regulatory proceedings may require our telephone
operations to refund a portion of the revenues collected in the current and
prior periods. There are also various legal actions pending to which we are a
party and claims which, if asserted, may lead to other legal actions. We have
established reserves for specific liabilities in connection with regulatory and
legal 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.
Verizon Wireless was the winning bidder for 113 licenses in the FCC's auction of
1.9 GHz spectrum, which concluded in January 2001. These licenses would add
capacity for growth and advanced services in markets including New York, Boston,
Los Angeles, Chicago, Philadelphia, Seattle and San Francisco. The total price
of these licenses was approximately $8.8 billion, $1.8 billion of which has
already been paid and the balance of which will be paid when the FCC requires
payment.
There were no legal challenges to Verizon Wireless's qualifications to acquire
these licenses. However, most of the licenses that were auctioned are the
subject of pending litigation by the original licensees, NextWave Personal
Communications Inc. and NextWave Power Partners Inc. (collectively NextWave),
which have appealed to the federal courts the FCC's action canceling NextWave's
licenses and reclaiming the spectrum. In a decision on June 22, 2001, the U.S.
Court of Appeals for the D.C. Circuit ruled that the FCC was not allowed to
repossess the
13
NextWave licenses. The FCC subsequently reinstated NextWave's licenses, but on
October 19, 2001, the FCC filed a petition to the United States Supreme Court to
reverse the U.S. Court of Appeals for the D.C. Circuit's decision. If the
licenses must be returned, the FCC has stated that it will refund to winning
bidders any amounts that they may have paid, without interest. Nearly all of
Verizon Wireless's $8.8 billion license cost relates to licenses subject to
NextWave's appeal. Settlement discussions between NextWave, the FCC and the
winning bidders are ongoing.
During the fourth quarter of 2000, Verizon Wireless agreed to acquire the
wireless business of Price Communications for $1.5 billion in Verizon Wireless
stock and the repayment by Verizon Wireless of $550 million in net debt. The
transaction was conditioned upon completion of a Verizon Wireless initial public
offering by September 30, 2001. Since the IPO did not occur by September 30,
2001, we are in discussions with Price Communications to explore alternative
forms of consideration and other terms for an acquisition of the wireless
business of Price Communications.
In 2001, we agreed to provide up to $2.0 billion in interim financing to Genuity
with a maturity in 2005. As of September 30, 2001, $1,150 million of that
commitment had been loaned to Genuity, and is reported in Other Assets in the
condensed consolidated balance sheets.
16. SUBSEQUENT EVENTS
Potential Sale of Access Lines
In July 2001, we announced that we were exploring the sale of 1.2 million access
lines in Alabama, Kentucky and Missouri.
In October 2001, we agreed to sell all 675,000 of our switched access telephone
lines in Alabama and Missouri to CenturyTel Inc. for $2.2 billion. The sale must
be approved by the Alabama and Missouri public service commissions, the FCC and
the DOJ. We expect to close the sale and transfer our operations to CenturyTel
during the second half of 2002.
Also in October 2001, we agreed to sell approximately 600,000 local telephone
lines in Kentucky to ALLTEL for $1.9 billion. The sale must be approved by the
Kentucky public service commission, the FCC and the DOJ. We expect to close the
sale and transfer our operations to ALLTEL during the second half of 2002.
Verizon Wireless
In November 2001, we announced that Verizon Wireless signed definitive
agreements to acquire certain Dobson Communications Corporation wireless
operations in California, Georgia, Ohio and Tennessee. The purchases are
expected to close in the first quarter of 2002. Total population served by the
Dobson properties being acquired is approximately 950,000.
CANTV Dividend
In October 2001, shareholders of CANTV approved an extraordinary dividend of
approximately $550 million, to be paid in two installments in December 2001 and
March 2002, and a share repurchase program of up to 15% of CANTV's shares.
Verizon owns 28.5% of CANTV.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Verizon Communications Inc. was formed in June 2000 by the merger of Bell
Atlantic Corporation and GTE Corporation. Financial information for the nine
months ended September 30, 2000 gives retroactive effect to the merger, as
required for business combinations using pooling-of-interests accounting. The
formation of the wireless joint venture occurred in April 2000. Financial
information for the nine months ended September 30, 2000 does not give
retroactive effect to the formation of the wireless joint venture, as required
for purchase business combinations.
CONSOLIDATED RESULTS OF OPERATIONS
In this section, we discuss our overall reported results and highlight special
and nonrecurring items. In the following section, we review the performance of
our segments on an adjusted basis. We adjust the segments' reported results for
the effects of these items, which management does not consider in assessing
segment performance due primarily to their nonrecurring and/or non-operational
nature. We believe that this presentation will assist readers in better
understanding trends from period to period.
Reported consolidated revenues were $17,004 million for the quarter ended
September 30, 2001, compared to $16,533 million for the similar period of the
prior year. Consolidated revenues reported during the first nine months of 2001
were $50,179 million, compared to $47,834 million for the first nine months of
2000. Reported revenues were not adjusted for prior year sales of wireline
operations and the deconsolidation of Genuity Inc. In addition, prior year
revenues include the formation of the Verizon Wireless joint venture beginning
in April 2000 and include overlapping wireless properties through June 30, 2000.
Adjusted for the items in the preceding paragraph, nine-month 2001 consolidated
adjusted revenues were $50,179 million, or 5.2% higher than the first nine
months of 2000 adjusted revenues of $47,700 million.
We reported net income available to common shareowners of $1,875 million, or
$.69 diluted earnings per share for the quarter ended September 30, 2001,
compared to net income available to common shareowners of $3,466 million, or
$1.27 diluted earnings per share for the quarter ended September 30, 2000.
Reported net income available to common shareowners for the first nine months of
2001 was $2,426 million, or $.89 diluted earnings per share, compared to $9,877
million, or $3.60 diluted earnings per share, for the same period in 2000.
Included in our reported net income available to common shareowners for the
third quarter of 2001 is $84 million, or $.03 per diluted share related to
losses and service disruption and restoration costs associated with the
September 11, 2001 terrorist attacks (also see "Segment Results of Operations -
Domestic Telecom"). We also believe there will be a similar net income impact of
approximately $.03 per diluted share in the fourth quarter of 2001 for
additional losses and continuing restoration efforts. The Company previously
estimated that the total financial impact for the September 11th terrorist
attacks would be $1.7 billion to $1.9 billion. Given the magnitude of the
destruction in the area of the World Trade Center complex, a more refined
estimate of total losses will not be available until a more comprehensive
physical inspection of the plant and equipment, which is not yet fully
accessible, can be completed. The cost estimates were based on the limited
information available as of the end of the current quarter. The net income
impacts include a reduction for a preliminary assessment of insurance recovery.
Verizon's insurance policies are limited to losses of $1 billion for each
occurrence and include a deductible of $1 million. The costs and insurance
recovery were recorded in accordance with Emerging Issues Task Force Issue No.
01-10, "Accounting for the Impact of the Terrorist Attacks of September 11,
2001." Additionally, governmental reimbursement mechanisms are under
consideration but have not been specified at this time.
Our reported results were affected by special items. After adjusting for such
items, net income would have been $2,040 million, or $.75 diluted earnings per
share in the third quarter of 2001 and $1,984 million, or $.73 diluted earnings
per share in the third quarter of 2000. For the nine months ended September 30,
2001, net income would have been $6,097 million, or $2.23 diluted earnings per
share compared to $5,854 million, or $2.13 diluted earnings per share for the
nine months ended September 30, 2000.
15
The table below summarizes reported and adjusted results of operations for each
period.
(Dollars in Millions, Except Per Share Amounts) THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------------------- 2001 2000 2001 2000
--------------- -------------- -------------- --------------
Reported operating revenues $ 17,004 $ 16,533 $ 50,179 $ 47,834
Reported operating expenses 13,327 11,591 39,094 34,455
-------------- -------------- -------------- --------------
Reported operating income 3,677 4,942 11,085 13,379
REPORTED NET INCOME AVAILABLE TO
COMMON SHAREOWNERS 1,875 3,466 2,426 9,877
-------------- -------------- -------------- --------------
Merger-related costs -- -- -- 749
Transition costs 144 65 394 112
Gains on sales of assets, net -- (476) (3) (1,986)
Pension settlements -- -- -- (564)
Loss/(gain) on marketable securities -- -- 2,926 (1,941)
Mark-to-market adjustment - financial instruments 13 (245) 164 (431)
Genuity loss -- -- -- 281
Other charges and special items -- -- -- 526
Extraordinary items 8 (826) 8 (817)
Cumulative effect of accounting change -- -- 182 40
Redemption of subsidiary preferred stock -- -- -- 8
-------------- -------------- -------------- --------------
ADJUSTED NET INCOME $ 2,040 $ 1,984 $ 6,097 $ 5,854
============== ============== ============== ==============
DILUTED EARNINGS PER SHARE - REPORTED $ .69 $ 1.27 $ .89 $ 3.60
DILUTED EARNINGS PER SHARE - ADJUSTED $ .75 $ .73 $ 2.23 $ 2.13
MERGER-RELATED COSTS
Results for the nine months ended September 30, 2000 include charges associated
with employee severance of $584 million ($371 million after-tax, or $.14 per
diluted share) recorded during the second quarter of 2000. Employee severance
costs, as recorded under Statement of Financial Accounting Standards (SFAS) No.
112, "Employers' Accounting for Postemployment Benefits," represent the benefit
costs for the separation of approximately 5,500 management employees who are
entitled to benefits under pre-existing separation plans, as well as an accrual
of ongoing SFAS No. 112 obligations for GTE employees. The remaining severance
liability as of September 30, 2001 is $288 million.
In addition, results for the nine months ended September 30, 2000 include a
pretax charge of $472 million ($378 million after-tax, or $.14 per diluted
share), recorded in the second quarter of 2000, for direct, incremental
merger-related costs, including compensation, professional services and other
direct costs.
TRANSITION COSTS
We expect to incur a total of approximately $2 billion of transition costs
related to the merger and the formation of the wireless joint venture. These
costs will be incurred to integrate systems, consolidate real estate and
relocate employees. They also include approximately $500 million for advertising
and other costs to establish the Verizon brand. Transition costs incurred
through the third quarter of 2001 total $1,390 million. During the third quarter
and for the first nine months of 2001, we incurred transition costs of $254
million and $696 million ($144 million and $394 million after taxes and minority
interest, or $.05 and $.14 per diluted share), respectively. During the third
quarter and for the first nine months of 2000, we incurred transition costs of
$163 million and $335 million ($65 million and $112 million after taxes and
minority interest, or $.02 and $.04 per diluted share), respectively.
GAINS ON SALES OF ASSETS, NET
Results for the nine months ended September 30, 2001 include a pretax gain of
$80 million ($48 million after-tax, or $.02 per diluted share) recorded on the
sale of the Cincinnati market during the second quarter of 2001. During the
second quarter of 2001, an agreement to sell the Chicago market at a price lower
than the net book value of the
16
Chicago assets was executed. Consequently, results for the nine months ended
September 30, 2001 also include an impairment charge of $75 million ($45 million
after-tax, or $.02 per diluted share) related to the expected sale. The sale of
the Chicago market is expected to close in the fourth quarter of 2001. As of
September 30, 2001, we completed the sales of all overlap wireless properties
with the exception of the Chicago market.
During the third quarter of 2000, we recognized net gains of $1,227 million
($476 million after-tax, or $.17 per diluted share) related to sales of assets,
impairments of assets held for sale and other charges. These net gains resulted
primarily from a pretax gain on the sale of access lines of $1,781 million
($1,085 million after-tax, or $.40 per diluted share); impairment charges in
connection with real estate consolidation and revaluation of competitive local
exchange carrier (CLEC)-related assets and contracts totaling $554 million ($360
million after-tax, or $.14 per diluted share); and a non-cash deferred tax
charge recorded as the result of the contribution in July 2000 of the GTE
Wireless assets to Verizon Wireless ($249 million after-tax, or $.09 per diluted
share).
In addition, results for the nine months ended September 30, 2000 include net
gains of $2,456 million ($1,455 million after-tax, or $.53 per diluted share)
recorded in the second quarter of 2000 related to sales of assets and
impairments of assets held for sale. These net gains resulted primarily from a
pretax gain on the sale of access lines of $1,078 million ($655 million
after-tax, or $.24 per diluted share); pretax gains on exchanges of wireless
overlap properties of $1,922 million ($1,156 million after-tax, or $.42 per
diluted share); and an impairment charge in connection with our exit from the
video business and GTE Airfone of $566 million ($362 million after-tax, or $.13
per diluted share). Results for the nine months ended September 30, 2000 also
include a pretax gain recorded in the first quarter of 2000 of $97 million ($55
million after-tax, or $.02 per diluted share), primarily comprised of the gain
on the sale of our CyberTrust line of business.
PENSION SETTLEMENTS
Results for the nine months ended September 30, 2000 include pension settlement
gains of $911 million ($564 million after-tax, or $.21 per diluted share)
recognized in the first half of 2000. These gains were recorded in accordance
with SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of
Defined Benefit Pension Plans and for Termination Benefits." They relate to some
settlements of pension obligations for former GTE employees through direct
payment, the purchase of annuities or otherwise. There were no similar pension
settlement gains recorded during 2001.
LOSS/(GAIN) ON MARKETABLE SECURITIES
We continually evaluate our investments in marketable securities for impairment
due to declines in market value considered to be other than temporary. That
evaluation includes, in addition to persistent, declining stock prices, general
economic and company-specific evaluations. In the event of a determination that
a decline in market value is other than temporary, a charge to earnings is
recorded for all or a portion of the unrealized loss, and a new cost basis in
the investment is established.
Prior to the second quarter of 2001, we considered the declines in the market
values of our marketable securities investments to be temporary, due principally
to the overall weakness in the securities markets as well as telecommunications
sector share prices. However, included in our results for the nine months ended
September 30, 2001 is the recognition of a pretax loss recorded in June 2001 of
$3,913 million ($2,926 million after-tax, or $1.07 diluted loss per share)
primarily relating to our investments in Cable & Wireless plc (C&W), NTL
Incorporated (NTL) and Metromedia Fiber Network, Inc. (MFN). We determined,
through the evaluations described above, that market value declines in these
investments were considered other than temporary.
Our results for the nine months ended September 30, 2000 include the recognition
of a non-cash pretax gain of $3,088 million ($1,941 million after-tax, or $.71
per diluted share) relating to the completion in May 2000 of the restructuring
of Cable & Wireless Communications plc (CWC) by CWC, C&W and NTL. In connection
with the restructuring, we, as a shareholder in CWC, received shares in the two
acquiring companies, representing approximately 9.1% of the NTL shares
outstanding at the time and approximately 4.6% of the C&W shares outstanding at
the time. Based on this level of ownership, our investments in NTL and C&W are
accounted for under the cost method. Our previous interest in CWC was accounted
for using the equity method. Our exchange of CWC shares for C&W and NTL shares
resulted in the recognition of the non-cash gain and a corresponding increase in
the cost basis of the shares received.
17
MARK-TO-MARKET ADJUSTMENT - FINANCIAL INSTRUMENTS
During 2001, we began recording mark-to-market adjustments in earnings relating
to some of our financial instruments in accordance with newly effective
accounting rules on derivative financial instruments. Mark-to-market losses of
$13 million ($13 million after taxes and minority interest, or less than $.01
per diluted share) and $166 million ($164 million after taxes and minority
interest, or $.06 per diluted share) were recorded during the three- and
nine-month periods ended September 30, 2001, respectively, due primarily to the
change in the fair value of the MFN debt conversion option.
During the three- and nine-month periods ended September 30, 2000, we recorded
mark-to-market gains of $377 million ($245 million after-tax, or $.09 per
diluted share) and $664 million ($431 million after-tax, or $.16 per diluted
share), respectively, related to our $3,180 million notes which are exchangeable
into shares of C&W and NTL. These mark-to-market adjustments were required
because the carrying value of the exchangeable notes is indexed to the fair
market value of the underlying common stock. As the combined fair value of the
C&W and NTL common stock declines, our debt obligation is reduced (but not to
less than its amortized carrying value) and income is increased. If the combined
fair value of the C&W and NTL common stock increases, our debt obligation
increases and income is decreased.
GENUITY LOSS
In accordance with the provisions of a Federal Communications Commission (FCC)
order in June 2000, Genuity, formerly a wholly owned subsidiary of GTE, sold in
a public offering 174 million of its Class A common shares, representing 100% of
the issued and outstanding Class A common stock and 90.5% of the overall voting
equity in Genuity. GTE retained 100% of Genuity's Class B common stock, which
currently represents 8.2% of the voting equity in Genuity and contains a
contingent conversion feature. The sale transferred ownership and control of
Genuity to the Class A common stockholders and, accordingly, we deconsolidated
our investment in Genuity on June 30, 2000 and are accounting for our investment
in Genuity using the cost method. The impact of this change is that Genuity's
revenues and expenses, as well as changes in balance sheet accounts and cash
flows subsequent to June 30, 2000 are no longer included in our consolidated
financial results. As a result, for comparability, we have adjusted the reported
results for the first and second quarters of 2000 to exclude the results of
Genuity. Results for the nine months ended September 30, 2000 include Genuity's
after-tax losses recorded through the first half of 2000 of $281 million (or
$.10 per diluted share), of which $128 million (or $.05 per diluted share) and
$153 million (or $.05 per diluted share) were recognized in the first and second
quarters of 2000, respectively.
OTHER CHARGES AND SPECIAL ITEMS
Results for the nine months ended September 30, 2000 include the recognition of
other charges and special items of $801 million ($526 million after-tax, or $.19
per diluted share). Other charges and special items include the cost of
disposing or abandoning redundant assets, discontinued system development
projects in connection with the merger, regulatory settlements and other asset
write-downs.
EXTRAORDINARY ITEMS
During the third quarter of 2001, we retired two debt issues totaling $228
million prior to the stated maturity dates, resulting in pretax extraordinary
charges totaling $12 million ($8 million after-tax, or less than $.01 per
diluted share).
During the third quarter of 2000, we completed the sales of some of our service
area conflicts prohibited by FCC regulations, which resulted in pretax gains
totaling $1,374 million ($826 million after-tax, or $.30 per diluted share).
Since the sales were required pursuant to the consent decree which enabled both
the formation of Verizon Wireless and the closing of the merger, and occurred
after the merger, the gains were recorded net of taxes as Extraordinary
18
Items in the condensed consolidated statements of income. In addition, results
for the nine months ended September 30, 2000 include the retirement in the first
quarter of 2000 of $128 million of debt prior to the stated maturity date,
resulting in a pretax extraordinary charge of $15 million ($9 million after-tax,
or less than $.01 per diluted share).
CUMULATIVE EFFECT OF ACCOUNTING CHANGE
Impact of SAB No. 101
We adopted the provisions of the Securities and Exchange Commission (SEC) Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements"
in the fourth quarter of 2000, retroactive to January 1, 2000, as required by
the SEC. The impact to Verizon pertains to the deferral of some non-recurring
fees, such as service activation and installation fees, and associated
incremental direct costs, and the recognition of those revenues and costs over
the expected term of the customer relationship. Results for the nine months
ended September 30, 2000 include the initial impact of adoption recorded as a
cumulative effect of an accounting change of $40 million after-tax (or $.01 per
diluted share) in the first quarter of 2000.
Impact of SFAS No. 133
We adopted the provisions of SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," and the related SFAS No. 138, "Accounting
for Certain Derivative Instruments and Certain Hedging Activities" on January 1,
2001. The impact to Verizon pertains to the recognition of changes in the fair
value of derivative instruments. Results for the nine months ended September 30,
2001 include the initial impact of adoption recorded as a cumulative effect of
an accounting change of $182 million (or $.07 per diluted share) in the first
quarter of 2001. This cumulative effect charge primarily relates to the change
in the fair value of the MFN debt conversion option prior to January 1, 2001.
SEGMENT RESULTS OF OPERATIONS
We have four reportable segments, which we operate and manage as strategic
business units and organize by products and services. Our segments are Domestic
Telecom, Domestic Wireless, International and Information Services. You can find
additional information about our segments in Note 14 to the condensed
consolidated financial statements.
We measure and evaluate our reportable segments based on adjusted net income,
which excludes unallocated corporate expenses and other adjustments arising
during each period. Other adjustments include transactions that management has
excluded in assessing business unit performance, due primarily to their
nonrecurring and/or non-operational nature, but has included in reported
consolidated earnings. We previously described these items in the "Consolidated
Results of Operations" section.
19
Special items affected our segments as follows:
(Dollars in Millions) THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
--------------------- 2001 2000 2001 2000
---------------- ---------------- ---------------- ----------------
DOMESTIC TELECOM
Reported net income $ 1,040 $ 2,150 $ 3,525 $ 4,989
Special items 112 (823) 338 (1,022)
---------------- ---------------- ---------------- ----------------
Adjusted net income $ 1,152 $ 1,327 $ 3,863 $ 3,967
================ ================ ================ ================
DOMESTIC WIRELESS
Reported net income $ 167 $ 131 $ 383 $ 809
Special items 15 12 48 (446)
---------------- ---------------- ---------------- ----------------
Adjusted net income $ 182 $ 143 $ 431 $ 363
================ ================ ================ ================
INTERNATIONAL
Reported net income $ 238 $ 193 $ (1,058) $ 2,388
Special items -- 1 1,749 (1,868)
---------------- ---------------- ---------------- ----------------
Adjusted net income $ 238 $ 194 $ 691 $ 520
================ ================ ================ ================
INFORMATION SERVICES
Reported net income $ 345 $ 292 $ 847 $ 711
Special items 18 -- 26 108
---------------- ---------------- ---------------- ----------------
Adjusted net income $ 363 $ 292 $ 873 $ 819
================ ================ ================ ================
CORPORATE AND OTHER
Reported net income $ 85 $ 700 $ (1,271) $ 988
Special items 20 (672) 1,510 (803)
---------------- ---------------- ---------------- ----------------
Adjusted net income $ 105 $ 28 $ 239 $ 185
================ ================ ================ ================
Corporate and Other includes intersegment eliminations.
DOMESTIC TELECOM
Our Domestic Telecom segment consists primarily of our telephone operations that
provide local telephone services in over 30 states. These services include voice
and data transport, enhanced and custom calling features, network access,
directory assistance, private lines and public telephones. This segment also
provides customer premises equipment distribution, data solutions and systems
integration, billing and collections, Internet access services, research and
development, inventory management and long distance services.
(Dollars in Millions) THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
--------------------- 2001 2000 % CHANGE 2001 2000 % CHANGE
---------------- ---------------- -------- ---------------- ---------------- --------
RESULTS OF OPERATIONS -
ADJUSTED BASIS
OPERATING REVENUES
Local services $ 5,358 $ 5,494 (2.5)% $ 16,523 $ 16,461 0.4%
Network access services 3,378 3,301 2.3 10,069 9,828 2.5
Long distance services 793 802 (1.1) 2,313 2,385 (3.0)
Other services 1,137 1,280 (11.2) 3,634 3,735 (2.7)
---------------- ---------------- ---------------- ----------------
10,666 10,877 (1.9) 32,539 32,409 0.4
---------------- ---------------- ---------------- ----------------
OPERATING EXPENSES
Operations and support 6,059 6,108 (0.8) 17,920 18,237 (1.7)
Depreciation and
amortization 2,333 2,218 5.2 6,960 6,474 7.5
---------------- ---------------- ---------------- ----------------
8,392 8,326 0.8 24,880 24,711 0.7
---------------- ---------------- ---------------- ----------------
OPERATING INCOME $ 2,274 $ 2,551 (10.9) $ 7,659 $ 7,698 (0.5)
================ ================ ================ ================
ADJUSTED NET INCOME $ 1,152 $ 1,327 (13.2) $ 3,863 $ 3,967 (2.6)
20
DOMESTIC TELECOM - CONTINUED
HIGHLIGHTS
Domestic Telecom's adjusted operating income declined 10.9% for the third
quarter of 2001 and 0.5% for the first nine months of 2001. Adjusted results for
the third quarter of 2001 reflect a revenue decline of 1.9% and an increase in
operating costs of 0.8%, while year-to-date results include a revenue growth of
0.4% and an increase in operating costs of 0.7%.
Revenue growth rates were pressured by several factors including the weakened
U.S. economy, which has dampened demand for basic wireline and other services,
and mandated rate reductions. In addition, Domestic Telecom continues to be
affected by technology substitution, as more customers are choosing wireless and
Internet services in place of some basic wireline services. We expect these
factors to impact the revenue growth of our Domestic Telecom business for the
remainder of 2001.
Quarterly and year-to-date operating revenues reflect strong demand for our data
transport and long distance services. Data transport revenues, which include our
high-bandwidth, packet-switched and special access services, as well as Digital
Subscriber Line (DSL) services, grew more than 18% over the third quarter of
2000 and 24% year-to-date. We ended the third quarter of 2001 with data circuits
in service equivalent to 67 million voice-grade access lines, up 52% from the
same period in 2000. Data circuits now account for more than half of Verizon's
128.5 million access line equivalents. Operating revenues were also fueled by
strong growth in our interLATA long distance business. We ended the third
quarter of 2001 with 6.9 million long distance customers nationwide, an increase
of more than 50% over the third quarter of 2000. We now offer long-distance
service to more than two-thirds of all Verizon access lines nationwide,
including the introduction of long-distance services in Pennsylvania in late
October 2001. Our revenues were negatively affected by federal and state
regulatory price reductions of approximately $100 million in the third quarter
of 2001 and approximately $580 million in the first nine months of 2001,
primarily affecting our network access revenues.
Operating expenses for the three- and nine-month periods ended September 30,
2001 increased less than one percent, as compared to the same periods in 2000.
As a result of lower volumes, effective cost-control measures, merger-related
savings and other cost reductions, we were able to maintain relatively flat
expense growth, despite the added third-quarter costs related to the events of
September 11th and increased costs associated with our growth businesses such as
long distance and data services.
These and other items affecting Domestic Telecom's adjusted results of
operations for the three and nine months ended September 30, 2001 and 2000 are
discussed in the following section.
OPERATING REVENUES
Local Services
Local service revenues are earned by our telephone operations from the provision
of local exchange, local private line, wire maintenance, voice messaging and
value-added services. Value-added services are a family of services that expand
the utilization of the network, including products such as Caller ID, Call
Waiting and Return Call. The provision of local exchange services not only
includes retail revenue but also includes local wholesale revenues from
unbundled network elements (UNEs), interconnection revenues from competitive
local exchange carriers, some data transport revenues and wireless
interconnection revenues.
Our local service revenues declined $136 million, or 2.5% in the third quarter
and increased $62 million, or 0.4% in the first nine months of 2001. The effects
of lower demand and usage of our basic local wireline services and mandated
intrastate price reductions impacted both periods of 2001. Our switched access
lines in service declined 1.4% from September 30, 2000, primarily reflecting the
impact of an economic slowdown and competition for some local services.
Technology substitution also affected local service revenue growth, as indicated
by lower demand for additional residential access lines.
21
DOMESTIC TELECOM - CONTINUED
These factors were partially offset in the third quarter and more than offset in
the nine month period by higher payments received from CLECs for interconnection
of their networks with our network and by solid demand for our value-added
services as a result of new packaging of services.
Network Access Services
Network access services revenues are earned from end-user subscribers and long
distance and other competing carriers who use our local exchange facilities to
provide usage services to their customers. Switched access revenues are derived
from fixed and usage-based charges paid by carriers for access to our local
network. Special access revenues originate from carriers and end-users that buy
dedicated local exchange capacity to support their private networks. End-user
access revenues are earned from our customers and from resellers who purchase
dial-tone services.
Our network access revenues grew $77 million, or 2.3%, and $241 million, or
2.5%, in the third quarter and first nine months of 2001, respectively, compared
to the same periods in 2000. This growth was mainly attributable to higher
customer demand, primarily for special access services (including DSL) that grew
approximately 26% over the third quarter of 2000 and 28% year-to-date. Special
access revenue growth reflects strong demand in the business market for
high-capacity, high-speed digital services.
Volume-related growth was largely offset by mandated price reductions of
approximately $56 million and $415 million for the three and nine months ended
September 30, 2001, respectively. These price reductions are associated with
federal and state price cap filings and other regulatory decisions. State public
utility commissions regulate our telephone operations with respect to some
intrastate rates and services and other matters. The FCC regulates the 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. Under the plan, direct end-user access charges
are increased while access charges to long distance carriers are reduced. While
the plan continues the 6.5% (less inflation) annual reductions for most
interstate access charges, it provides for a price freeze when switched access
service prices reach $0.0055 per-minute. As a result of tariff adjustments,
which became effective in August 2000, our telephone operations in 19 states and
the District of Columbia reached the $0.0055 benchmark. Rates included in the
July 2000 CALLS plan were in effect through June 2001. Effective July 3, 2001,
we implemented further rate reductions in accordance with the plan.
The impact of the slowing economy also affected network access revenues in both
periods of 2001, as reflected by a 2.2% decline in minutes of use from carriers
and CLECs and a 1.4% reduction in switched access lines in service, as compared
to the same periods last year.
Long Distance Services
Long distance service revenues include both intraLATA toll services and
interLATA long distance voice and data services.
Long distance service revenues declined $9 million, or 1.1% in the third quarter
of 2001 and $72 million, or 3.0% in the first nine months of 2001, primarily due
to competition and the effects of toll calling discount packages and product
bundling offers of our intraLATA toll services. These reductions were
substantially offset by revenue growth from our interLATA long distance services
offered throughout the region, including significant customer win-backs
resulting from the introduction of interLATA long distance services in New York
in January 2000 and in Massachusetts in late April 2001.
Other Services
Our other services include such services as billing and collections for long
distance carriers, public (pay) telephone and customer premises equipment
services. Other services revenues also include services provided by most of our
non-regulated subsidiaries such as inventory management and purchasing, Internet
access and data solutions and systems integration businesses.
22
DOMESTIC TELECOM - CONTINUED
Revenues from other services declined $143 million, or 11.2% in the third
quarter of 2001 and $101 million, or 2.7% in the first nine months of 2001,
compared to the same periods last year. Both the three- and nine-month periods
reflect a decline in public telephone revenues as more customers substituted
wireless communications for pay phone services, and lower billing and collection
revenues reflecting the take-back of these services by interexchange carriers.
Lower data solutions and systems integration revenues due to the slowing economy
and the effect of closing our CLEC operation further contributed to the revenue
decline in 2001. These revenue reductions were partially offset in both periods
of 2001 by higher revenues from other non-regulated services.
OPERATING EXPENSES
Operations and Support
Operations and support, which consists of employee costs and other operating
expenses, decreased by $49 million, or 0.8% in the third quarter of 2001 and
$317 million, or 1.7% year-to-date, principally due to lower costs at our
telephone operations. These reductions were largely attributable to lower
employee costs, primarily due to reduced employee overtime for repair and
maintenance activity principally as a result of reduced volumes at our dispatch
and call centers. Operating costs have also decreased due to business
integration activities and achievement of merger synergies. Other effective cost
containment measures, including lower spending by non-strategic businesses,
closing our CLEC operation, and declining workforce levels and associated
employee costs, also contributed to cost reductions in both periods.
These cost reductions were substantially offset by additional charges in the
third quarter of 2001 related to the terrorist attacks on September 11th of
approximately $140 million (pretax), net of insurance recovery (see
"Consolidated Results of Operations" section) and by higher costs associated
with our growth businesses such as long distance and data services.
Depreciation and Amortization
Depreciation and amortization expense increased by $115 million, or 5.2%, in the
third quarter of 2001 and $486 million, or 7.5%, in the first nine months of
2001, compared to the same periods in 2000. These expense increases were
principally due to growth in depreciable telephone plant and increased software
amortization costs. These factors were partially offset by the effect of lower
rates of depreciation.
23
DOMESTIC WIRELESS
Our Domestic Wireless segment provides cellular, personal communications
services (PCS) and paging services and equipment sales. This segment primarily
represents the operations of Verizon Wireless, a joint venture combining our
merged wireless properties with the U.S. properties and paging assets of
Vodafone Group plc (Vodafone), including the consolidation of PrimeCo
Communications (PrimeCo). The formation of Verizon Wireless occurred in April
2000. Verizon owns a 55% interest in the joint venture and Vodafone owns the
remaining 45%. The 2001 financial results included in the table below reflect
the combined results of Verizon Wireless. The period prior to the formation of
Verizon Wireless is reported on a historical basis, and therefore, does not
reflect the contribution of the Vodafone properties and the consolidation of
PrimeCo. In addition, the financial results of several overlap properties were
included in Domestic Wireless's results through June 30, 2000.
THREE MONTHS ENDED NINE MONTHS ENDED
(Dollars in Millions) SEPTEMBER 30, SEPTEMBER 30,
--------------------- 2001 2000 % CHANGE 2001 2000 % CHANGE
-------------- ---------------- -------- ---------------- ---------------- --------
RESULTS OF OPERATIONS -
ADJUSTED BASIS
OPERATING REVENUES
Wireless services $ 4,521 $ 4,036 12.0% $ 12,950 $ 10,152 27.6%
-------------- ---------------- ---------------- ----------------
OPERATING EXPENSES
Operations and support 2,890 2,583 11.9 8,344 6,700 24.5
Depreciation and
amortization 943 879 7.3 2,749 2,078 32.3
-------------- ---------------- ---------------- ----------------
3,833 3,462 10.7 11,093 8,778 26.4
-------------- ---------------- ---------------- ----------------
OPERATING INCOME $ 688 $ 574 19.9 $ 1,857 $ 1,374 35.2
============== ================ ================ ================
MINORITY INTEREST $ (262) $ (229) 14.4 $ (649) $ (380) 70.8
ADJUSTED NET INCOME $ 182 $ 143 27.3 $ 431 $ 363 18.7
OPERATING REVENUES
Revenues earned from our consolidated wireless businesses grew by $485 million,
or 12.0%, in the third quarter of 2001 and $2.8 billion, or 27.6% in the first
nine months of 2001 compared to the similar periods in 2000. By including the
revenues of the properties of the wireless joint venture and excluding the
impact of wireless overlap properties on a basis comparable with the first nine
months of 2001, revenues were $1.7 billion, or 14.8%, higher than the similar
period of 2000. On this comparable basis, revenue growth was largely
attributable to customer additions and higher revenue per customer per month.
Our domestic wireless customer base grew to 28.7 million customers in the third
quarter of 2001, compared to 25.6 million customers in the third quarter of
2000, an increase of 12.2%. In the first quarter of 2001, we removed
approximately 900,000 non-revenue producing customers as a result of a customer
base assessment performed as part of the merger integration process. Prior
period subscribers reflect the impact from the subscriber base adjustment
allocable to the prior period. The company's strong subscriber growth and
financial performance for the first nine months of 2001 resulted from a number
of recent initiatives including the company's launch of its store-within-a-store
at 4,400 RadioShack locations. As of September 30, 2001, approximately 20
million customers were using digital service, representing 69% of total
subscribers. In addition, average usage per subscriber has increased to 274
minutes per month, which is a 36% increase compared to the third quarter of
2000.
OPERATING EXPENSES
Operations and Support
Operations and support expenses, which represent employee costs and other
operating expenses, increased by $307 million, or 11.9%, in the third quarter of
2001 and $1.6 billion, or 24.5%, in the first nine months of 2001. By including
the expenses of the properties of the wireless joint venture and excluding the
impact of wireless overlap properties on a basis comparable with the first nine
months of 2001, operations and support expenses was $1,014 million, or 13.8%
higher than the similar period of 2000. On this comparable basis, higher costs
were also attributable to the significant growth in the subscriber base
described above, as well as the continuing migration of analog customers to
digital.
24
DOMESTIC WIRELESS - CONTINUED
Depreciation and Amortization
Depreciation and amortization expense increased by $64 million, or 7.3%, in the
third quarter of 2001 and $671 million or 32.3% in the first nine months of 2001
as compared to the same periods in 2000. The year-to-date increase was mainly
attributable to the formation of the wireless joint venture in the second
quarter of 2000. Adjusting for the wireless joint venture in a manner similar to
operations and support expenses above, depreciation and amortization increased
$192 million, or 7.5%, in the first nine months of 2001 compared to the similar
period of 2000. On this comparable basis, capital expenditures for our cellular
network have increased in 2001 to support increased demand in all markets,
partially offset by lower amortization expense in the third quarter of 2001.
MINORITY INTEREST
The increase in minority interest in the third quarter of 2001 is primarily
driven by higher earnings. The significant increases in minority interest for
the first nine months of 2001 were principally due to the formation of the
wireless joint venture at the beginning of the second quarter of 2000 and the
significant minority interest attributable to Vodafone.
INTERNATIONAL
Our International segment includes international wireline and wireless
telecommunication operations, investments and management contracts in the
Americas, Europe, Asia and the Pacific. Our consolidated international
investments include Grupo Iusacell (Iusacell) (Mexico), CODETEL (Dominican
Republic), CTI Holdings, S.A. (CTI) (Argentina) and Micronesian
Telecommunications Corporation (Northern Mariana Islands). Our international
investments in which we have a less than controlling interest are accounted for
on either the cost or equity method.
THREE MONTHS ENDED NINE MONTHS ENDED
(Dollars in Millions) SEPTEMBER 30, SEPTEMBER 30,
--------------------- 2001 2000 % CHANGE 2001 2000 % CHANGE
-------------- -------------- -------- -------------- -------------- --------
RESULTS OF OPERATIONS -
ADJUSTED BASIS
OPERATING REVENUES
Wireless $ 340 $ 320 6.3% $ 1,013 $ 893 13.4%
Wireline and other 257 188 36.7 709 543 30.6
-------------- -------------- -------------- --------------
597 508 17.5 1,722 1,436 19.9
-------------- -------------- -------------- --------------
OPERATING EXPENSES
Operations and support 387 390 (0.8) 1,203 1,006 19.6
Depreciation and
amortization 85 89 (4.5) 304 253 20.2
-------------- -------------- -------------- --------------
472 479 (1.5) 1,507 1,259 19.7
-------------- -------------- -------------- --------------
OPERATING INCOME $ 125 $ 29 331.0 $ 215 $ 177 21.5
============== ============== ============== ==============
EQUITY IN INCOME FROM UNCONSOLIDATED
BUSINESSES $ 202 $ 203 (0.5) $ 685 $ 503 36.2
ADJUSTED NET INCOME $ 238 $ 194 22.7 $ 691 $ 520 32.9
The revenues and operating expenses for the International segment exclude
QuebecTel, which was deconsolidated in the second quarter of 2000. QuebecTel's
net results for all periods are included in Equity in Income from Unconsolidated
Businesses.
OPERATING REVENUES
Revenues earned from our international businesses grew by $89 million, or 17.5%,
in the third quarter of 2001 and $286 million, or 19.9% in the first nine months
of 2001 as compared to the same periods in 2000. The increase in revenues was
primarily due to an increase in wireless subscribers and wireline access lines
of the consolidated subsidiaries and the increased results of CTI's Buenos Aires
PCS operations, which commenced commercial operations in the second quarter of
2000. In addition, revenues for the three and nine months ended September 30,
2001 included revenues generated by the Verizon Global Solutions Inc. (GSI)
network which began its switching operations in the first quarter of 2001 and
continued its expansion into the third quarter of 2001.
25
INTERNATIONAL - CONTINUED
OPERATING EXPENSES
Operations and Support
Operations and support expenses, which represent employee costs and other
operating expenses, decreased $3 million, or 0.8%, in the third quarter of 2001
and increased $197 million, or 19.6%, in the first nine months of 2001 as
compared to the same periods in 2000. The decrease in third quarter was
primarily due to lower employee costs offset by the variable costs associated
with the increased revenues. The year-to-date increase was primarily generated
by GSI start-up that began its switching operations in the first quarter of 2001
and continued its expansion through the first nine months of 2001 as well as a
full nine months of CTI's Buenos Aires PCS operations, which commenced
commercial operations in the second quarter of 2000.
Depreciation and Amortization
Depreciation and amortization expense decreased $4 million, or 4.5%, for the
third quarter of 2001 and increased $51 million, or 20.2%, for the first nine
months of 2001 as compared to the same periods in 2000. This decrease in the
third quarter is primarily attributable to changes in the depreciable lives of
Iusacell's plant and equipment based on recently completed market and useful
life studies, partially offset by increased plant in service. The year-to-date
increase was attributable to higher asset base for CTI and driven by additional
capital expenditures to support increases in cellular subscribers and access
lines for CODETEL.
EQUITY IN INCOME FROM UNCONSOLIDATED BUSINESSES
Equity in income from unconsolidated businesses decreased $1 million, or 0.5%,
in the third quarter of 2001 and increased $182 million, or 36.2%, in the first
nine months of 2001 compared to the similar periods in 2000. The decrease in the
third quarter was primarily due to improved results reported by Omnitel and
CANTV, more than offset by the inclusion of TELUS Corporation's investment in
Clearnet Communications in 2001, which lowered TELUS's net income, and lower
results reported by Asian investments. The year-to-date increase was generated
by improved operational growth at Omnitel and CANTV, partially offset by
Clearnet Communications in the current year.
INFORMATION SERVICES
Our Information Services segment consists of our domestic and international
publishing businesses, including print and electronic directories and
Internet-based shopping guides, as well as website creation and other electronic
commerce services. This segment has operations principally in North America,
Europe, Asia and Latin America.
THREE MONTHS ENDED NINE MONTHS ENDED
(Dollars in Millions) SEPTEMBER 30, SEPTEMBER 30,
--------------------- 2001 2000 % CHANGE 2001 2000 % CHANGE
------------ ------------ ------------ ------------ ------------ ------------
RESULTS OF OPERATIONS -
ADJUSTED BASIS
OPERATING REVENUES
Information services $ 1,112 $ 970 14.6% $ 2,885 $ 2,805 2.9%
------------ ------------ ------------ ------------
OPERATING EXPENSES
Operations and support 485 473 2.5 1,354 1,382 (2.0)
Depreciation and
amortization 21 17 23.5 62 56 10.7
------------ ------------ ------------ ------------
506 490 3.3 1,416 1,438 (1.5)
------------ ------------ ------------ ------------
OPERATING INCOME $ 606 $ 480 26.3 $ 1,469 $ 1,367 7.5
============ ============ ============ ============
ADJUSTED NET INCOME $ 363 $ 292 24.3 $ 873 $ 819 6.6
OPERATING REVENUES
Operating revenues from our Information Services segment increased by $142
million, or 14.6%, in the third quarter of 2001 and $80 million, or 2.9%, in the
first nine months as compared to the same periods in 2000. The third quarter
increase was primarily generated by operational revenue growth and timing of
publications, partially offset
26
by lower affiliate transactions. The increase for the first nine months is
primarily due to operational revenue growth and extension revenue, partially
offset by lower affiliate transactions.
OPERATING EXPENSES
Total operating expenses for the third quarter of 2001 increased $16 million, or
3.3%, and decreased $22 million, or 1.5%, in the first nine months as compared
to the same periods in 2000. The quarter increase was primarily generated by the
cost associated with the favorable revenue, partially offset by operational
expense decreases from ongoing cost containment initiatives. The reduction in
total operating expense for the first nine months is attributable to a reduction
in operational and support expense from ongoing cost containment initiatives.
NONOPERATING ITEMS
THREE MONTHS ENDED NINE MONTHS ENDED
(Dollars in Millions) SEPTEMBER 30, SEPTEMBER 30,
--------------------- 2001 2000 % CHANGE 2001 2000 % CHANGE
-------------- -------------- -------- -------------- -------------- --------
OTHER INCOME AND (EXPENSE), NET
Interest Income $ 115 $ 74 55.4% $ 230 $ 200 15.0%
Foreign exchange gains (losses), net (36) 30 (220.0) 4 9 (55.6)
Other, net 5 24 (79.2) 34 9 277.8
-------------- -------------- -------------- --------------
Total $ 84 $ 128 (34.4) $ 268 $ 218 22.9
============== ============== ============== ==============
The changes in other income and expense in the three and nine months ended
September 30, 2001, compared to the same periods in 2000, were primarily due to
changes in interest income and foreign exchange gains and losses. We recorded
additional interest income in the three months ended September 30, 2001
primarily as a result of interest on notes receivable, higher average cash
balances and the settlement of a tax-related matter. Foreign exchange gains were
affected primarily by our Iusacell subsidiary, which uses the Mexican peso as
its functional currency. We expect that our earnings will continue to be
affected by foreign currency gains or losses associated with the U.S. dollar
denominated debt issued by Iusacell.
THREE MONTHS ENDED NINE MONTHS ENDED
(Dollars in Millions) SEPTEMBER 30, SEPTEMBER 30,
--------------------- 2001 2000 % CHANGE 2001 2000 % CHANGE
------------ ------------ -------- ------------ ------------ --------
INTEREST EXPENSE
Interest expense $ 797 $ 914 (12.8)% $ 2,627 $ 2,603 0.9%
Capitalized interest costs 137 60 128.3 314 157 100.0
------------ ------------ ------------ ------------
Total interest costs on debt balances $ 934 $ 974 (4.1) $ 2,941 $ 2,760 6.6
============ ============ ============ ============
Average debt outstanding $ 63,648 $ 52,542 21.1 $ 62,107 $ 51,402 20.8
Effective interest rate 5.9% 7.4% 6.3% 7.2%
The decrease in interest costs for the three months ended September 30, 2001 as
compared to the same period in 2000 is primarily due to lower interest rates,
partially offset by higher average debt levels. The increase in interest costs
for the nine months ended September 30, 2001, compared to the same period in
2000, is principally attributable to higher average debt levels, partially
offset by lower interest rates. The increase in debt levels was mainly the
result of the debt assumed by Verizon Wireless in connection with the formation
of Verizon Wireless, anticipated payments for FCC licenses (see "Other Factors
That May Affect Future Results") and higher capital expenditures primarily in
our Domestic Telecom and Domestic Wireless segments.
(Dollars in Millions) THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
--------------------- 2001 2000 % CHANGE 2001 2000 % CHANGE
---------------- ---------------- -------- ---------------- ---------------- --------
MINORITY INTEREST $ 226 $ 142 59.2% $ 533 $ 177 201.1%
The increase in minority interest during the third quarter of 2001 compared to
the prior year period is due to higher earnings at Verizon Wireless. The
year-to-date variance is also driven by the formation of Verizon Wireless at the
beginning of the second quarter of 2000.
27
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2001 2000 2001 2000
------------- -------------- -------------- ------------
EFFECTIVE INCOME TAX RATES 34.3% 43.4% 44.6% 40.3%
The effective income tax rate is the provision for income taxes as a percentage
of income before the provision for income taxes. The third quarter and
year-to-date 2000 effective tax rate was higher due to deferred taxes recorded
in connection with the contribution of GTE Wireless assets to Verizon Wireless
in July 2000. Our effective income tax rate for the nine months ended September
30, 2001 is not consistent with the same period last year primarily because tax
benefits were not available on some of the losses resulting from the other than
temporary decline in market value of several of our marketable securities
recorded in June 2001.
CONSOLIDATED FINANCIAL CONDITION
(Dollars in Millions) NINE MONTHS ENDED SEPTEMBER 30,
--------------------- 2001 2000 $ CHANGE
---------------- ---------------- --------
CASH FLOWS PROVIDED BY (USED IN)
Operating activities $ 13,096 $ 12,045 $ 1,051
Investing activities (15,157) (8,129) (7,028)
Financing activities 2,669 (5,121) 7,790
---------------- ---------------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $ 608 $ (1,205) $ 1,813
================ ================ ========
We use the net cash generated from our operations and from external financing to
fund capital expenditures for network expansion and modernization, pay dividends
and invest in new businesses. While current liabilities exceeded current assets
at September 30, 2001, our sources of funds, primarily from operations and, to
the extent necessary, from readily available external financing arrangements,
are sufficient to meet ongoing operating and investing requirements. We expect
that capital spending requirements will continue to be financed primarily
through internally generated funds. Additional debt or equity financing may be
needed to fund additional development activities (including the purchase of
wireless licenses obtained in the recent FCC auction, see "Other Factors That
May Affect Future Results") or to maintain our capital structure to ensure our
financial flexibility.
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES
Cash generated from operations continued to be one of our primary sources of
funds. The increase in cash from operations compared to the first nine months of
2000 primarily reflects improved results of operations before gains and losses
on asset sales and the mark-to-market adjustments of financial instruments,
which are adjusted in cash from operating activities, partially offset by an
increase in working capital requirements.
CASH FLOWS USED IN INVESTING ACTIVITIES
Capital expenditures continued to be our primary use of capital resources. We
invested $8,470 million in our Domestic Telecom business in the first nine
months of 2001, compared to $8,580 million in the first nine months of 2000 to
facilitate the introduction of new products and services, enhance responsiveness
to competitive challenges and increase the operating efficiency and productivity
of the network. We also invested approximately $3,342 million in our Domestic
Wireless businesses in the first nine months of 2001, compared to $2,378 million
during the same period last year. The increase in 2001 is primarily due to the
inclusion of both Vodafone and PrimeCo properties in Verizon Wireless in April
2000, as well as increased capital spending in existing Bell Atlantic and GTE
wireless properties. We expect total capital expenditures in 2001 to be
approximately $17.0 billion to $17.2 billion.
We invested $3,005 million in acquisitions and investments in businesses during
the first nine months of 2001, including $1,691 million for wireless licenses
obtained in the recent FCC auction, $410 million for additional wireless
spectrum purchased from another telecommunications carrier and $178 million in
wireless properties. In addition, we invested $497 million to acquire the
directory business of TELUS. In the first nine months of 2000, we invested
$1,590 million in acquisitions and investments in businesses, including
approximately $715 million in the equity of MFN, $389 million in wireless
properties and $150 million in NorthPoint.
28
During the first nine months of 2000, we also invested $975 million in
subordinated convertible notes of MFN, in connection with our overall debt and
equity investment in MFN.
In the first nine months of 2001, we received cash proceeds of $200 million in
connection with the sale of our Cincinnati wireless overlap property. In the
first nine months of 2000, we received cash proceeds of $6,004 million,
including $4,629 million from the sale of non-strategic access lines, $964
million from overlap wireless properties and $144 million from the sale of
CyberTrust.
The net change in short-term investments in 2001 includes the maturity of a $375
million short-term investment and other, net investing activities include loans
to Genuity of $1,150 million. Capitalized non-network software of $823 million
is included in other, net investing activities in 2001, compared to $644 million
during the comparable period of 2000.
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES
The net cash proceeds from increases in our total debt from December 31, 2000 of
$5,765 million was primarily due to the issuance of $7.0 billion of long-term
debt by Verizon Global Funding, partially offset by net repayments of $783
million of commercial paper and other short-term borrowings by Verizon Global
Funding and by $638 million of maturities of other corporate long-term debt. In
addition, Verizon Wireless issued $580 million of long-term debt, while Domestic
Telecom incurred $1.3 billion of long-term debt, repaid $613 million of net
short-term debt and retired $910 million of long-term debt.
The $215 million increase in our total debt during the first nine months of 2000
was primarily due to the issuance of $893 million of medium term notes, $653
million of financing transactions of cellular assets, $386 million of long-term
bank debt at Verizon Wireless and an increase in other short-term borrowings,
partially offset by repayments of long-term debt.
Our debt to equity ratio was 64.7% as of September 30, 2001, compared to 60.0%
as of September 30, 2000.
As of September 30, 2001, we had in excess of $7.9 billion of unused bank lines
of credit and $5.1 billion in bank borrowings outstanding. As of September 30,
2001, our telephone and financing subsidiaries had shelf registrations for the
issuance of up to $5.9 billion of unsecured debt securities. The debt securities
of our telephone and financing subsidiaries continue to be accorded high ratings
by primary rating agencies. However, in April 2001, Moody's Investors Service
(Moody's) revised our credit rating outlook from stable to negative. Moody's
cited concern about our ability to complete an initial public offering (IPO) of
Verizon Wireless in a timely fashion in order to pay for the anticipated FCC
spectrum auction purchases of $8.8 billion. A delay in the IPO would require us
to issue debt to cover these purchases. See "Other Factors That May Affect
Future Results." A change in an outlook does not necessarily signal a rating
downgrade but rather highlights an issue whose final resolution may result in
placing a company on review for possible downgrade.
We also have a $2.0 billion Euro Medium Term Note Program, under which we may
issue notes that are not registered with the SEC. The notes may be issued from
time to time by Verizon Global Funding, and will have the benefit of a support
agreement between Verizon Global Funding and us. There have been no notes issued
under this program.
As in prior quarters, dividend payments were a significant use of capital
resources. We determine the appropriateness of the level of our dividend
payments on a periodic basis by considering such factors as long-term growth
opportunities, internal cash requirements, and the expectations of our
shareowners. In the first, second and third quarters of 2001, we announced a
quarterly cash dividend of $.385 per share. In the first and third quarters of
2000, we announced a quarterly cash dividend of $.385 per share; and in the
second quarter of 2000, we announced two separate prorata dividends to ensure
that the respective shareowners of Bell Atlantic and GTE received dividends at
an appropriate rate.
29
INCREASE IN CASH AND CASH EQUIVALENTS
Our cash and cash equivalents at September 30, 2001 totaled $1,365 million, an
increase of $608 million compared to December 31, 2000. This increase in cash is
primarily related to the anticipated payments for FCC licenses (see "Other
Factors That May Affect Future Results").
MARKET RISK
We are exposed to various types of market risk in the normal course of our
business, including the impact of interest rate changes, foreign currency
exchange rate fluctuations, changes in equity investment prices and changes in
corporate tax rates. We employ risk management strategies using a variety of
derivatives, including interest rate swap agreements, interest rate caps and
floors, foreign currency forwards and options, equity options and basis swap
agreements. We do not hold derivatives for trading purposes.
It is our general policy to enter into interest rate, foreign currency and other
derivative transactions only to the extent necessary to achieve our desired
objectives in limiting our exposures to the various market risks. Our objectives
include maintaining a mix of fixed and variable rate debt to lower borrowing
costs within reasonable risk parameters and protecting against earnings and cash
flow volatility resulting from changes in market conditions. We do not hedge our
market risk exposure in a manner that would completely eliminate the effect of
changes in interest rates, equity prices and foreign exchange rates on our
earnings. While we do not expect that our liquidity and cash flows will be
materially affected by these risk management strategies, our net income may be
materially affected by market risks associated with the exchangeable notes
discussed below.
EXCHANGEABLE NOTES
In 1998, we issued exchangeable notes as described in Note 11 to the condensed
consolidated financial statements and discussed earlier under "Mark-to-Market
Adjustment - Financial Instruments." These financial instruments expose us to
market risk, including:
o Equity price risk, because the notes are exchangeable into shares that are
traded on the open market and routinely fluctuate in value.
o Foreign exchange rate risk, because the notes are exchangeable into shares
that are denominated in a foreign currency.
o Interest rate risk, because the notes carry fixed interest rates.
Periodically, equity price or foreign exchange rate movements may require us to
mark-to-market the exchangeable note liability to reflect the increase or
decrease in the current share price compared to the established exchange price,
resulting in a charge or credit to income. The following sensitivity analysis
measures the effect on earnings and financial condition due to changes in the
underlying share prices of the Telecom Corporation of New Zealand Limited
(TCNZ), C&W and NTL stock.
o At September 30, 2001, the exchange price for the TCNZ shares (expressed as
American Depositary Receipts) was $44.93. The C&W and NTL notes of $3,180
million are exchangeable into 128.4 million shares of C&W stock and 24.5
million shares of NTL stock.
o For each $1 increase in the value of the TCNZ shares above the exchange
price, our pretax earnings would be reduced by approximately $55 million.
Assuming the aggregate value of the C&W and NTL stocks exceeds the value of
the debt liability, each $1 increase in the value of the C&W shares
(expressed as American Depositary Receipts) or NTL shares would reduce our
pretax earnings by approximately $43 million or $24 million, respectively.
A subsequent decrease in the value of these shares would correspondingly
increase earnings, but not to exceed the amount of any previous reduction
in earnings.
o Our cash flows would not be affected by mark-to-market activity relating to
the exchangeable notes.
30
o If we decide to deliver shares in exchange for the notes, the exchangeable
note liability (including any mark-to-market adjustments) will be
eliminated and the investment will be reduced by the fair market value of
the related number of shares delivered. Upon settlement, the excess of the
liability over the book value of the related shares delivered will be
recorded as a gain. We also have the option to settle these liabilities
with cash upon exchange.
EQUITY RISK
We also have equity price risk associated with our cost investments, primarily
in common stocks, and equity price sensitive derivatives and derivatives
embedded in other financial instruments that are carried at fair value. The
value of these cost investments and derivatives is subject to changes in the
market prices of the underlying securities. Our cost investments and equity
price sensitive derivatives recorded at fair value totaled $2,014 million at
September 30, 2001.
A sensitivity analysis of our cost investments and equity price sensitive
derivatives recorded at fair value indicated that a 10% increase or decrease in
the fair value of the underlying common stock equity prices would result in a
$161 million increase or decrease in the fair value of our cost investments and
equity price sensitive derivatives. Of this amount, a change in the fair value
of our cost investments of $150 million would be recognized in Accumulated Other
Comprehensive Loss in our condensed consolidated balance sheets under SFAS No.
115. Our equity price sensitive derivatives and embedded derivatives (primarily
a MFN conversion option and several long-term call options on our common stock)
(see Note 10 - Accounting Change - Derivative Financial Instruments) do not
qualify for hedge accounting under SFAS No. 133. As such, a change of
approximately $11 million in the fair value of our equity price sensitive
derivatives and embedded derivatives would be recognized in our condensed
consolidated balance sheets and in current earnings in mark-to-market
adjustment.
We continually evaluate our investments in marketable securities for impairment
due to declines in market value considered to be other than temporary. That
evaluation includes, in addition to persistent, declining stock prices, general
economic and company-specific evaluations. In the event of a determination that
a decline in market value is other than temporary, a charge to earnings is
recorded for all or a portion of the unrealized loss, and a new cost basis in
the investment is established.
Prior to the second quarter of 2001, we considered the declines in the market
values of our marketable securities investments to be temporary, due principally
to the overall weakness in the securities markets as well as telecommunications
sector share prices. However, included in our results for the nine months ended
September 30, 2001 is the recognition of a pretax loss recorded in June 2001 of
$3,913 million ($2,926 million after-tax, or $1.07 diluted loss per share)
primarily relating to our investments in C&W, NTL and MFN. We determined,
through the evaluations described above, that market value declines in these
investments were considered other than temporary.
OTHER FACTORS THAT MAY AFFECT FUTURE RESULTS
On October 30, 2001, we filed a Current Report on Form 8-K announcing our third
quarter financial results, revised 2001 guidance information and other
information pertaining to current estimates for the September 11, 2001
restoration costs and entry into long distance markets in 2002.
BELL ATLANTIC-GTE MERGER
Federal and state regulatory conditions to the merger included some 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. The pretax cost to begin compliance with these conditions was
approximately $200 million in 2000. We expect a similar impact in 2001 and 2002.
31
RECENT DEVELOPMENTS
VERIZON WIRELESS
FCC Auctions
Verizon Wireless was the winning bidder for 113 licenses in the FCC's auction of
1.9 GHz spectrum, which concluded in January 2001. These licenses would add
capacity for growth and advanced services in markets including New York, Boston,
Los Angeles, Chicago, Philadelphia, Seattle and San Francisco. The total price
of these licenses was approximately $8.8 billion, $1.8 billion of which has
already been paid and the balance of which will be paid when the FCC requires
payment.
There were no legal challenges to Verizon Wireless's qualifications to acquire
these licenses. However, most of the licenses that were auctioned are the
subject of pending litigation by the original licensees, NextWave Personal
Communications Inc. and NextWave Power Partners Inc., which have appealed to the
federal courts the FCC's action canceling NextWave's licenses and reclaiming the
spectrum. In a decision on June 22, 2001, the U.S. Court of Appeals for the D.C.
Circuit ruled that the FCC was not allowed to repossess the NextWave licenses.
The FCC subsequently reinstated NextWave's licenses, but on October 19, 2001,
the FCC filed a petition to the United States Supreme Court to reverse the U.S.
Court of Appeals for the D.C. Circuit's decision. If the licenses must be
returned, the FCC has stated that it will refund to winning bidders any amounts
that they may have paid, without interest. Nearly all of Verizon Wireless's $8.8
billion license cost relates to licenses subject to NextWave's appeal.
Settlement discussions between NextWave, the FCC and the winning bidders are
ongoing.
Timing of Initial Public Offering
In August 2000, we filed a registration statement with the SEC for a planned IPO
of Verizon Wireless common stock. Since then we have periodically reiterated
that the IPO will occur when market conditions are favorable.
Price Communications Wireless
During the fourth quarter of 2000, Verizon Wireless agreed to acquire the
wireless business of Price Communications for $1.5 billion in Verizon Wireless
stock and the repayment by Verizon Wireless of $550 million in net debt. The
transaction was conditioned upon completion of a Verizon Wireless IPO by
September 30, 2001. Since the IPO did not occur by September 30, 2001, we are in
discussions with Price Communications to explore alternative forms of
consideration and other terms for an acquisition of the wireless business of
Price Communications.
Acquisition of Some of Dobson Communications' Wireless Operations
In November 2001, we announced that Verizon Wireless signed definitive
agreements to acquire some of Dobson Communications Corporation's wireless
operations in California, Georgia, Ohio and Tennessee. The purchases are
expected to close in the first quarter of 2002. Total population (POPS) served
by the four Dobson properties is approximately 950,000.
POTENTIAL SALE OF ACCESS LINES
In July 2001, we announced that we were exploring the sale of 1.2 million access
lines in Alabama, Kentucky and Missouri.
In October 2001, we agreed to sell all 675,000 of our switched access telephone
lines in Alabama and Missouri to CenturyTel Inc. for $2.2 billion. The sale must
be approved by the Alabama and Missouri public service commissions, the FCC and
the U.S. Department of Justice (DOJ). We expect to close the sale and transfer
our operations to CenturyTel during the second half of 2002.
Also in October 2001, we agreed to sell approximately 600,000 local telephone
lines in Kentucky to ALLTEL for $1.9 billion. The sale must be approved by the
Kentucky public service commission, the FCC and the DOJ. We expect to close the
sale and transfer our operations to ALLTEL during the second half of 2002.
32
TELECOMMUNICATIONS ACT OF 1996
In-Region Long Distance
We offer long distance service nationwide, except in those states served by the
former Bell Atlantic telephone operations where we have not yet received
authority to offer long distance service under the Telecommunications Act of
1996. We now have authority to offer in-region long distance service in four
states in the former Bell Atlantic territory, accounting for more than half of
the lines served by the former Bell Atlantic. In addition to the New York order
released in December 1999, on April 16, 2001, July 23, 2001, and September 19,
2001, the FCC released orders approving our applications for permission to enter
the in-region long distance market in Massachusetts, Connecticut and
Pennsylvania, respectively. Both the Massachusetts and Pennsylvania orders are
currently on appeal to the U.S. Court of Appeals.
We have now filed state applications for support of our anticipated applications
with the FCC for permission to enter the in-region long distance market in Rhode
Island, New Hampshire, Vermont, Maine and New Jersey.
FCC REGULATION AND INTERSTATE RATES
Access Charges and Universal Service
On May 31, 2000, the FCC adopted a plan advanced by members of the industry (The
Coalition for Affordable Local and Long Distance Service, or "CALLS") as a
comprehensive five-year plan for regulation of interstate access charges. The
CALLS plan has three main components. First, it establishes a portable
interstate access universal service support of $650 million for the industry.
This explicit support replaces implicit support embedded in interstate access
charges. Second, the plan simplifies the patchwork of common line charges into
one subscriber line charge (SLC) and provides for de-averaging of the SLC by
zones and class of customers in a manner that will not undermine comparable and
affordable universal service. Third, the plan sets into place a mechanism to
transition to a set target of $.0055 per minute for switched access services.
Once that target rate is reached, local exchange carriers are no longer required
to make further annual price cap reductions to their switched access prices. The
annual reductions leading to the target rate, as well as annual reductions for
special access services was set at 6.5 percent per year.
On September 10, 2001, the U.S. Court of Appeals for the Fifth Circuit ruled on
an appeal of the FCC order adopting the plan. The court upheld the FCC on
several challenges to the order, but remanded two aspects of the decision back
to the FCC on the grounds that they lacked sufficient justification. The court
remanded back to the FCC for further consideration its decision setting the
annual reduction factor at 6.5% and the size of the new universal service fund
at $650 million. The entire plan (including these elements) will continue in
effect pending the FCC's further consideration of its justification of these
components.
Compensation for Internet Traffic
On April 27, 2001, the FCC released an order addressing intercarrier
compensation for dial-up connections of Internet-bound traffic. The FCC found
that Internet-bound traffic is interstate and subject to the FCC's jurisdiction.
Moreover, the FCC again found that Internet-bound traffic is not subject to
reciprocal compensation under section 251(b)(5) of the Telecommunications Act.
Instead, the FCC established federal rates for this traffic that decline from
$0.0015 to $0.0007 over a three year period. The FCC order also sets caps on the
total minutes of this traffic that may be subject to any intercarrier
compensation and requires that incumbent local exchange carriers must offer to
pay reciprocal compensation for local traffic at the same rate as they are
required to pay on Internet-bound traffic. Several competing carriers and state
regulators appealed this order to the U.S. Court of Appeals for the D.C.
Circuit. The court denied a motion to stay the FCC order, and the order went
into effect. The appeal remains pending.
33
OTHER MATTERS
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards (SFAS) No. 141, "Business Combinations," and No.
142, "Goodwill and Other Intangible Assets."
SFAS No. 141, which applies to business combinations occurring after June 30,
2001, requires that the purchase method of accounting be used and includes
guidance on the initial recognition and measurement of goodwill and other
intangible assets acquired in the combination.
SFAS No. 142 no longer permits the amortization of goodwill and indefinite-lived
intangible assets. Instead, these assets must be reviewed annually (or more
frequently under some conditions) for impairment in accordance with this
statement. This impairment test uses a fair value approach rather than the
undiscounted cash flows approach previously required by SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." The amortization of goodwill included in our investments in
equity investees will also no longer be recorded upon adoption of the new rules.
Intangible assets that do not have indefinite lives will continue to be
amortized over their useful lives and reviewed for impairment in accordance with
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
We are required to adopt SFAS No. 142 effective January 1, 2002. We are
currently evaluating our intangible assets to determine the impact, if any, the
adoption of SFAS No. 142 will have on our results of operations or financial
position.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." This standard provides the accounting for the cost of legal
obligations associated with the retirement of long-lived assets. SFAS No. 143
requires that companies recognize the fair value of a liability for asset
retirement obligations in the period in which the obligations are incurred and
capitalize that amount as a part of the book value of the long-lived asset. That
cost is then depreciated over the remaining life of the underlying long-lived
asset. We are required to adopt SFAS No. 143 effective January 1, 2003. We are
currently evaluating the impact this new standard will have on our future
results of operations or financial position.
In August 2001, the FASB issued SFAS No. 144. This standard supersedes SFAS No.
121 and the provisions of Accounting Principles Board (APB) Opinion No. 30,
"Reporting the Results of Operations-Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" with regard to reporting the effects of a disposal of a
segment of a business. SFAS No. 144 establishes a single accounting model for
assets to be disposed of by sale and addresses several SFAS No. 121
implementation issues. We are required to adopt SFAS No. 144 effective January
1, 2002. We do not expect the impact of the adoption of SFAS No. 144 to have a
material effect on our results of operations or financial position.
34
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
In this Management's Discussion and Analysis, and elsewhere in this Quarterly
Report, we have made forward-looking statements. These statements are based on
our estimates and assumptions and are subject to risks and uncertainties.
Forward-looking statements include the information concerning our possible or
assumed future results of operations. Forward-looking statements also include
those preceded or followed by the words "anticipates," "believes," "estimates,"
"hopes" or similar expressions. For those statements, we claim the protection of
the safe harbor for forward-looking statements contained in the Private
Securities Litigation Reform Act of 1995.
The following important factors, along with those discussed elsewhere in this
Quarterly Report, could affect future results and could cause those results to
differ materially from those expressed in the forward-looking statements:
o the duration and extent of the current economic downturn;
o materially adverse changes in economic conditions in the markets served by
us or by companies in which we have substantial investments;
o material changes in available technology;
o an adverse change in the ratings afforded our debt securities by nationally
accredited ratings organizations;
o the final outcome of federal, state and local regulatory initiatives and
proceedings, including arbitration proceedings, and judicial review of
those initiatives and proceedings, pertaining to, among other matters, the
terms of interconnection, access charges, and unbundled network element and
resale rates;
o the extent, timing, success and overall effects of competition from others
in the local telephone and toll service markets;
o the timing and profitability of our entry and expansion in the national
long distance market;
o our ability to combine former Bell Atlantic and GTE operations, satisfy
regulatory conditions and obtain revenue enhancements and cost savings;
o the profitability of our broadband operations;
o the ability of Verizon Wireless to achieve revenue enhancements and cost
savings, and obtain sufficient spectrum resources;
o the continuing financial needs of Genuity, our ability to convert our
ownership interest in Genuity into a controlling interest consistent with
regulatory conditions, and Genuity's ensuing profitability;
o our ability to recover insurance proceeds relating to equipment losses and
other adverse financial impacts resulting from the terrorist attacks on
September 11, 2001; and
o changes in our accounting assumptions that regulatory agencies, including
the SEC, may require or that result from changes in the accounting rules or
their application, which could result in an impact on earnings.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information relating to market risk is included in Item 2, Management's
Discussion and Analysis of Financial Condition and Results of Operations, in the
Consolidated Financial Condition section under the caption "Market Risk."
35
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit
Number
-------
12 Computation of Ratio of Earnings to Fixed Charges.
(b) Reports on Form 8-K filed during the quarter ended September 30, 2001:
A Current Report on Form 8-K, dated July 31, 2001, was filed containing a
press release announcing our second quarter 2001 financial results and
supplemental information about our revised 2001 earnings guidance. It also
included a current ratio of earnings to fixed charges.
A Current Report on Form 8-K, dated August 2, 2001, was filed containing
adjusted base information about our revised 2001 earnings guidance.
36
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 COMMUNICATIONS INC.
Date: November 14, 2001 By /s/ Lawrence R. Whitman
------------------------------------
Lawrence R. Whitman
Senior Vice President and Controller
(Principal Accounting Officer)
UNLESS OTHERWISE INDICATED, ALL INFORMATION IS AS OF NOVEMBER 7, 2001.
37
EXHIBIT INDEX
Exhibit
Number
-------
12 Computation of Ratio of Earnings to Fixed Charges.