ITEM 1. BUSINESS
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
In this Form 10-K, the Company has made forward-looking statements. These statements are based on Company estimates and assumptions and are subject to certain risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of operations, as well as those statements preceded or followed by the words "anticipates," "believes," "estimates," "expects," "hopes," "targets" or similar expressions.
Future results could be affected by subsequent events and could differ materially from those expressed in the forward-looking statements. If future events and actual performance differ from the Company's assumptions, the actual results could vary significantly from the performance projected in the forward-looking statements.
The following important factors could affect future results and could cause those results to differ materially from those expressed in the forward-looking statements: (1) materially adverse changes in economic conditions in Puerto Rico; (2) material changes in available technology; (3) the final resolution of regulatory initiatives and proceedings, including arbitration proceedings pertaining to, among other matters, the terms of interconnection, access charges, universal service, unbundled network elements and resale rates; (4) changes in our accounting policies that may be required by regulatory agencies, including the Securities and Exchange Commission ("SEC") or that result from changes in the accounting policies or their application, which could result in an impact on earnings; and (5) the extent, timing, success and overall effects of competition from others in the Puerto Rico telecommunications service industry.
OVERVIEW
We are the largest telecommunications service provider in Puerto Rico and the seventh largest local exchange carrier in the United States as measured by access lines in service. Wireline service, which has been provided since 1914, is marketed under the PRT brand. At December 31, 2002, we had approximately 1.3 million access lines in service, including 957,000 residential and 303,000 business lines. Since November 2001 we have been marketing our cellular brand as Verizon Wireless as part of a strategy to align our service offering with Verizon Wireless in the U.S.
We have invested approximately $900 million from the date of the Acquisition (as defined below) through year-end 2002 to expand and enhance our networks. In 2003, we expect to invest up to $190 million in capital expenditures. Our digital switching wireline network encompasses over 83,000 fiber miles with speeds of up to OC-192 and supplies direct fiber optic connections to more office buildings than any other service provider on the island. Our cellular network utilizes the time division multiple access ("TDMA") standard. We have invested approximately $60 million since 2001 in a new network overlay using the code division multiple access ("CDMA") standard. We commenced selling CDMA service in December 2001.
STRATEGY
We expect to maintain our wireline market leadership position by improving customer service, providing value, and meeting increasing customer bandwidth requirements. We are focused on reducing service and repair provisioning, repair intervals and improving the responsiveness of our customer care personnel. Customer value will be delivered through bundled plans, including choices of long distance, Internet, DSL, wireless access, and value-added local services, such as caller ID, call forwarding and call waiting. Our network deployment plans are designed to meet business and government expectation for dedicated high-speed bandwidth access, as well as residential consumer demand for Digital Subscriber Line ("DSL") service to enhance Internet access speed.
Our wireless strategy is addressed at retaining our significant base of postpaid cellular customers as well as targeting our competitors high-value customers and people who do not yet use cellular service.
BUSINESS OVERVIEW AND CORPORATE RESTRUCTURING
Telecomunicaciones de Puerto Rico, Inc., a Puerto Rico corporation (the "Company"), holds 100% of the common stock of Puerto Rico Telephone Company, Inc. ("PRTC"), PRT Larga Distancia, Inc. ("PRTLD"), and Datacom Caribe, Inc. ("Datacom"). The Company holds a 67% interest in Coqui.net Corporation ("Coqui.net"), in which Popular, Inc., one of our shareholders, holds the remaining 33% interest, and the Company also holds a 25% interest in Verizon Information Services Puerto Rico, Inc. S en C. ("VISI"),
in which GTE Holdings (Puerto Rico) LLC, our majority shareholder, holds a 36% interest. The Company is the largest telecommunications service provider in Puerto Rico. PRTC is the incumbent local exchange carrier for the island of Puerto Rico. Wireline service is provided by PRTC and wireless services are provided by Verizon Wireless, a division of PRTC. The Company's off-island long distance service is provided by PRTLD. The Company's dial-up Internet access service is provided by Coqui.net. The Company's directory publishing revenues are generated by VISI.
GTE Corporation ("GTE"), through its subsidiary GTE Holdings (Puerto Rico) LLC, acquired a 40% interest in and management control over the Company on March 2, 1999 from Puerto Rico Telephone Authority ("PRTA"), an entity of the Commonwealth of Puerto Rico (the "Acquisition"). In the Acquisition, Popular, Inc. acquired a 10% interest in the Company. GTE and Bell Atlantic Corporation merged on June 30, 2000 to form Verizon Communications Inc. ("Verizon"). On January 25, 2002, GTE Holdings (Puerto Rico) LLC and Popular, Inc. acquired an additional 12% and 3% interest in the Company, respectively, by exercising an option each held since the Acquisition (the "Option Exercise"). Verizon and Popular, Inc. obtained the additional ownership interest from PRTA Holdings Corp., a subsidiary of the PRTA ("PRTA Holdings"). Verizon and Popular, Inc. paid PRTA Holdings $138 million and $34 million, respectively, for a total of $172 million in cash for the additional 3,750,000 shares at a $45.9364 per share price established in a share option agreement, an agreement entered into at the time of the Acquisition. As a result, Verizon owns 52%, Popular owns 13%, PRTA owns 28% and the Employee Stock Ownership Plan ("ESOP") owns 7% of the outstanding capital stock of the Company. The Company is an affiliate of Verizon, which consolidates the Company's financial results with its own financial results.
PRTC/VERIZON WIRELESS MERGER
On May 1, 2002, the Company completed a tax-free reorganization whereby it merged Verizon Wireless Puerto Rico, Inc. ("Verizon Wireless") into PRTC. Prior to the merger, the Company created a new wholly owned subsidiary, PRTLD, to carry the off-island long distance business previously provided by Verizon Wireless. The objectives of the reorganization were to (i) integrate the wireline and wireless operations without jeopardizing the continuity of the off-island long distance license, (ii) simplify the overall corporate structure to reduce administrative costs, and (iii) provide better control and monitoring of the off-island long distance business and increase its potential for growth in Puerto Rico.
BUSINESS SEGMENTS
We have two reportable segments, Wireline and Wireless. See Note 18 to the consolidated financial statements for additional information on our segments.
The Wireline segment consists of:
- - Local services, including basic voice, telephone and telecommunications equipment rentals, value-added services, high-speed private line services, Internet access and public phone service;
- - Long distance services including direct dial on-island and off-island, operator assisted calls, prepaid calling card and high-speed private line services;
- - Access services to long distance carriers, competitive local exchange carriers, and cellular and paging operators to originate and terminate calls on our network;
- - Directory publishing rights revenues; and
- - Telecommunication equipment sales and billing and collection services to competing long distance operators in Puerto Rico.
The Wireless segment consists of:
- - Cellular service; and
- - Wireless equipment sales.
Reclassifications of prior years' data have been made to conform to the 2002 presentation. For further information refer to Note 2 to the consolidated financial statements.
WIRELINE
LOCAL SERVICES
OVERVIEW
Local services include basic voice services, value-added services, special services, Internet and data access, and deferred activation and installation services. The following table shows the breakdown of residential and business access lines in service, excluding public phones, direct inward dialed business lines, wide area telecommunications services lines, private branch exchange trunks, and cellular and paging customers:
ACCESS LINES IN SERVICE
BASIC VOICE SERVICE
Basic voice service is the largest component of local service revenues, generating $370 million or 28% of total revenues in 2002. Basic voice is a regulated service and rate structures have not changed since 1982. Rates are categorized as either residential or business/government and are further divided into four zones based on town boundaries. Residential customers have a choice of selecting an unlimited local calling plan or a measured service plan at a fixed price of 13 cents per unit within a local calling area. There are currently 68 local calling areas. Business customers must select a measured service plan.
The rate distribution for business/government customers varies slightly ranging from $36.65 to $38.25 per month and $69.00 average revenue per user ("ARPU") when measured service is included. The unlimited local service plan for residential customers varies significantly. San Juan and Ponce residential customers in zone 1 pay $18.80 per month while customers on the rural area in
zone 4 pay $8.45 per month. Residential basic ARPU approximates $13.60 excluding a Federal Communications Commission ("FCC") imposed subscriber line charge of $6.00 per month to primary residential customers. For single-line business customers the subscriber lines charge is also equal to $6.00 while $9.20 per month is charged to multi-line business customers, as these revenues are classified as access revenues. These rates also exclude other miscellaneous fees for white-page directory listings and touch calling of approximately $1.50 per month each.
TELEPHONE RENTAL
Approximately 55% of single-line businesses and 36% of residential customers rent telephones, which generated $19 million in revenues in 2002. Rental levels are high compared to U.S. mainland operators as we own the inside wire in many customer's premises and must maintain the inside wire and phone.
VALUE - ADDED SERVICES
Value-added services include over 15 voice features, such as caller ID, call waiting, and voice mail. Charges for these features range from $1.50 to $6.25 per month and some of these features are also sold in discounted bundled packages. Approximately 42% of our residential customers purchase at least one service. Value-added revenues were $45 million in 2002, an increase of $1 million, or 2%, as compared to last year.
SPECIAL SERVICES
Special services include private high-speed dedicated lines marketed to businesses for data transport. Revenues of $54 million in 2002 represented an increase of $8 million, or 17%, over the prior year. The increase was mainly driven by business demand for greater bandwidth.
INTERNET ACCESS
We market unlimited dial-up Internet access through the Coqui.net Corporation under two brands (PRT.net and Coqui.net) which averaged $15 per month for 2002. We generated $25 million of revenue in 2002 from 135,000 dial-up Internet access customers at December 31, 2002, an increase of $2 million or 6,000 customers, or 9% in revenues and 5% in customers, over the prior year.
PUBLIC PHONES
Public telephone revenues in 2002 were $8 million, a decrease of $3 million, or 27%, from the prior year. This decrease is due to 2,000 fewer phones as compared to last year as the Company continues to focus on higher margin locations and to the customers traffic migration to the cellular network. We believe we held less than 50% of the public phone market at December 31, 2002, as measured by fourth quarter 2002 revenues.
NETWORK ACCESS
Network access services are provided to long distance carriers, resellers, other local exchange carriers, cellular and paging companies for the origination and termination of calls to and from large local business customers. These entities pay access charges based on specific agreements (which have durations of one to three years). We also collect network access fees directly from our customers from FCC-mandated line charges.
Network access revenues for the years ended December 2002, 2001 and 2000 totaled $325 million, $355 million and $389 million, respectively, and included the following amounts (in millions):
Long-term and High Cost federal subsidies are received through pooling arrangements administered by the National Exchange Carriers Association ("NECA"). Subscriber line charge increased in 2002 due to an increase from $3.50 per month to $6.00 per month for primary residential and single line business customers, while multi-line business customers monthly charge increased from $6.00 to $9.20. This increase was offset by a decrease in off-island switched and common carrier line charges. On October 21, 1999, the FCC adopted a new high cost support mechanism, which has resulted in the phase out of the Company's High Cost Subsidy revenues. These revenues have decreased since 1999. We recorded revenues of $4 million in 2002, $33 million in 2001 and $49 million in 2000.
LONG DISTANCE
Long distance revenues include direct dial on-island and off-island, operator-assisted calls, prepaid calling cards and on-island private line revenues. The following chart shows our minutes of use in the on-island and off-island long distance market for the years ended December 31, 2002, 2001 and 2000, respectively:
Long distance revenues of $146 million in 2002 reflected a decrease of $40 million as compared with 2001. Due mainly to lower traffic as customers calling migrate to cellular networks.
DIRECTORY SERVICES
We received $20 million in publishing revenue in 2002 under a revenue sharing arrangement with VNU World Directories, Inc. ("VNU"). VNU is the publisher of white and yellow page directories distributed under the PRT brand and there is no other significant competitive product in Puerto Rico. We entered into a 95-year agreement in 1999 with Verizon Information Services, Inc. a joint venture among VNU, Verizon, and ourselves which provides us a publishing right of 35% of yellow page advertising revenues, plus billing and collection fees.
BILLING AND COLLECTION SERVICES
We generated revenues of $13 million in 2002 from billing and collection services primarily from AT&T and TLD, the two largest competitive off-island long distance carriers. This is a decrease of $3 million from the prior year due to lower retail long distance traffic as customer traffic migrates to cellular technology. Both carriers generate roughly equal billing and collection volumes and represented approximately 91% of total fees for 2002. The TLD and AT&T contracts will expire in October 2003 and June 2004, respectively.
WIRELESS
CELLULAR AND PAGING CUSTOMERS
CELLULAR SERVICE
Cellular demand has grown rapidly in recent years due to increased competition, attractive price plans, prepaid calling cards, and wide market acceptance. We offer digital cellular service under the Verizon Wireless brand in the B block 800-megahertz frequency using both TDMA and CDMA. We have invested $60 million since 2001 in a CDMA overlay network and commenced selling this service in December 2001.
There were six facility-based cellular operators providing service with varying coverage at the end of 2002. Competition in the market has resulted in the emergence of a variety of plans with large bundles of free night and weekend minutes as well as free incoming calls.
We have 24 stores and kiosks throughout the island, which generate approximately half of our postpaid and prepaid gross additions. The balance is sold through various dealers and agent outlets. Roaming agreements have been signed with AT&T, Verizon Wireless, and Bell South to increase coverage for our customers on the U.S. mainland. We are also offering roaming in other countries, including the Dominican Republic, through Codetel, a Verizon affiliate, and in the U.S. Virgin Islands.
Postpaid customer growth of 14% is above prior years growth. We also experienced an increase in prepaid customers of 21%. In late 2001 we began marketing our cellular brand as Verizon Wireless as part of a strategy to align our product and service offerings with those of Verizon Wireless in the U.S.
ARPU was $41 in 2002, a $3 decrease from the prior year. Postpaid ARPU was $52 in 2002, a $8 decrease from the prior year and prepaid ARPU was $20 in 2002.
Postpaid customer churn was 2.9% per month in 2002, an increase of approximately 1.8% from the prior year. We believe churn is high compared to U.S. mainland standards because of the intensity of competition with six facilities-based competitors and higher disconnections as a result of non-payment.
NETWORK INFRASTRUCTURE
We have invested approximately $900 million from the Acquisition in 1999 through 2002 including $205 million in 2002 to expand and enhance our networks.
WIRELINE NETWORK
Our network has evolved into a multi-protocol network, handling SONET, ATM and IP. Our network has the following characteristics:
- 100% digital switching network includes 29 local host central offices and two access tandems to ensure redundancy and network reliability.
- Approximately 90% of our transmission circuits use fiber optic systems; consisting of 83,000 miles of fiber optic cable in fiber-ring and point-to-point configurations.
- The entire fiber optic backbone transport network consists of self-healing SONET rings operating at bandwidths up to OC-192, with the new equipment that has been installed capable of evolving to DWDM. Fiber optic cable facilities have been provided to over 200 office buildings for business and residential customers.
- Approximately 39% of outside cable serving the local loop is underground and buried.
- Our network is monitored by a Network Monitoring Center, which operates 24 hours per day. We have upgraded the capabilities of this center to monitor customer's IP based networks.
- Our Remote Access Server ("RAS") network includes 26 nodes located throughout the island connecting Internet customers of various ISP providers through more than 29,000 modems.
- DSL service has been extended to 55 sites equipped with 14,000 ports. As of December 31, 2002, we had approximately 7,000 DSL customers, an increase of 4,500 customers as compared to last year.
- Our ATM network provides ATM and Frame Relay services and also serves as the transport medium for DSL and RAS networks. This network also provides PRT with IP capability.
WIRELESS NETWORK
We operate a TDMA digital network using the IS-136 standard. Our network contains 13,600 voice channels, representing 90% digital and 10% analog. We have invested $60 million since 2001 in a CDMA overlay network. We commenced selling CDMA service in December 2001. We have 312 wireless cell sites covering the entire island.
EMPLOYEES
The workforce totaled 5,750 full-time employees at December 31, 2002 of which 78 % are represented by two unions, the Union of Independent Telephone Workers, known as UIET, and the Brotherhood of Independent Telephone Workers, known as HIETEL.
A new 3-year contract was signed effective January 17, 2003, with the UIET union, involving 2,800 members. The UIET contract contains wage increases of 4.4% in 2003, 4.2% in 2004, and 4.0% in 2005. If the union workforce remains unchanged, these increases, together with benefit improvements, payroll taxes and offsetting concessions, will result in increases of labor costs of $1.5 million for 2003, $5.9 million for 2004 and $9.9 million for 2005. The HIETEL contract, involving approximately 1,700 members, expires in October 2003.
In December 2002, the Company offered a voluntary separation program to qualified management employees. A non-cash provision of $0.5 million was recorded relating to 8 employees who had accepted as of December 31, 2002. In January 2003, an additional 29 qualified management employees accepted the voluntary separation program representing an additional expense of $1.4 million recorded in 2003. A total of $52 million was recorded for early retirement and voluntary separation programs during 2001 associated with four separate offerings accepted by a total of 567 employees.
CONCESSION AND LICENSES
We hold concessions, licenses and permits adequate for the conduct of our business in the markets which we serve. Advances in technology, together with a number of regulatory, legislative and judicial actions, continue to accelerate and increase competition in the markets we serve.
ENVIRONMENTAL REGULATIONS
Our operations are subject to federal and local laws and regulations governing the use, storage, disposal of, and exposure to, hazardous materials, the release of pollutants into the environment and the remediation of contamination. As an owner or operator of facilities where hazardous materials are used, we could be subject to environmental laws that impose liability for the entire cost of cleanup at contaminated sites, regardless of fault or the lawfulness of the activity that resulted in the contamination. We believe, however, that our operations are in substantial compliance with applicable environmental laws and regulations.
Many of our properties contain underground and aboveground storage tanks used for the storage of fuel. Some of these tanks may have leaked or otherwise caused contamination. We have remediated known contamination at a number of properties. We cannot be sure, however, that we have discovered all contamination or that the regulatory authorities will not request additional remediation at sites that have previously undergone remediation.
Our cellular operations are also subject to regulations and guidelines that impose a variety of operational requirements relating to radio frequency emissions. The potential connection between radio frequency emissions and certain negative health effects, including some forms of cancer, has been the subject of substantial study by the scientific community in recent years. To date, the results of these studies have been inconclusive. Although we have not been named in any lawsuits alleging damages from radio frequency emissions, it is possible we could be sued in the future, particularly if scientific studies conclusively determine that radio frequency emissions are harmful.
REGULATORY ENVIRONMENT IN PUERTO RICO
We are regulated by the FCC and the Telecommunications Regulatory Board of Puerto Rico ("TRB") and are subject to the Federal Telecommunications Act of 1996 ("the Act") and the Puerto Rico Telecommunications Act. The Act opened our local exchange market to competition. There is one facility-based competitive local exchange carrier and two resellers of wireline local service on the island. The blended discount rate to resellers was approximately 24% based on negotiated agreements. Dialing parity, which opened up the on-island long distance market to competition, was introduced in February 1999. Our intra-island access charges are based on rate-of-return methodology.
Basic local rates have remained unchanged since 1982 at $18.80 per month for residential unlimited service in the metro area. Additionally customers are billed a subscriber line charge of $6 per month and off-island long distance rates are similar to interstate rates in the US mainland at $.07 per minute. Our tariff structure is unique with 68 local calling area zones outside of San Juan.
The TRB has adopted a forward looking economic model to set intra-island access charges and the Company has contested the preliminary results of the economic model and the impact that adoption will have on its rate of return and its local rates. In addition to ordering significant reductions in intra-island access charges, the TRB has ordered a $68 million refund relating to this dispute for which the Company has made no provision, as it believes such a refund at this stage in the appeals process is not merited. For more information, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters."
The TRB adopted a local universal service fund for qualified low-income customers, on January 1, 2002. This program is funded by all intra-island telecommunications providers through contributions to the TRB based on intra-island retail revenues. Qualified lifeline customers receive a local $3.50 per month credit along with an additional federal $1.75 per month credit from the Company. These credits together with existing federal credits of $7.75 per month result in total credits for a lifeline customer of $13.00 per month. Contributions made by the Company to the TRB are recovered through an end-user charge that commenced on March 1, 2002. The Company is reimbursed from the TRB for credits given to Lifeline customers.
The wireless business is not subject to price regulation.
ITEM 2.
ITEM 2. PROPERTIES
PROPERTY, PLANT AND EQUIPMENT
Gross investment in property, plant and equipment are $4.0 billion at December 31, 2002 and 2001, as follows:
"Outside plant" consists primarily of aerial cable, underground cable, conduit and wiring, cellular plant, and telephone poles. "Central office and transmission equipment" mainly consists of switching equipment, transmission equipment and related facilities. "Other equipment" includes public telephones, motor vehicles, special purpose vehicles, furniture, and capital leases. "Land and buildings" consists of land, buildings and leasehold improvements.
PROPERTIES
We have facilities in all the major population centers of San Juan, Mayaguez, Ponce, Fajardo, Humacao, Arecibo, Aguadilla, and Guayama and in some smaller towns. Facilities as of December 31, 2002 include the following:
There were five fewer administrative offices and commercial and customer service stores at December 31, 2002 versus the prior year as the Company has implemented a cost reduction program reducing the number of facilities. All of these properties are generally in good operating condition and are adequate to satisfy the needs of the business.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is a defendant in various legal matters arising in the ordinary course of business. Management, after consultation with legal counsel, believes at this time that the resolution of these matters will not have a material adverse effect on the Company's financial position and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters" for more information regarding legal and regulatory matters, including a regulatory dispute regarding intra-island access fees charged to long distance carriers.
In connection with the privatization of the Company, the PRTA agreed to indemnify, defend and hold the Company harmless from specified litigation in excess of $50 million in the aggregate, including one environmental matter. The Company is regulated by the FCC for inter-state wireline services and by the Puerto Rico Telecommunications Board ("TRB") for intra-state wireline services.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(A) MARKET FOR COMMON STOCK
While there is no established trading market for the Company's common stock, the shares are valued annually by the ESOP trustee's financial advisors. The appraisal is used to value cash distributions to ESOP participants and measure the Company's share performance for employees who participate in the ESOP Plan.
(B) HOLDERS
There were 25 million outstanding shares of common stock and four shareholders of record at December 31, 2002. See Item 12 "Security Ownership of Certain Beneficial Owners and Management" for shareholder information.
(C) DIVIDENDS
Our shareholders agreement requires the payment of dividends equal to at least 50% of consolidated net income, to be paid in the following quarter to the extent funds are legally available. During 2002, the Company paid dividends of $69 million, or $2.753 per share, applicable to the first three quarters of the year and the fourth quarter of 2001. Fourth quarter dividends were declared and paid in March 2003. During 2001, the Company paid dividends of $58 million, or $2.315 per share, applicable to the first three quarters of the year.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL AND OPERATIONAL DATA
The following table was derived from our audited consolidated financial statements and the audited financial statements of PRTC and Verizon Wireless ("Predecessors") for the designated periods. You should read the following data together with (a) our Predecessor's historical financial statements and the notes thereto for the period from January 1, 1999 to March 1, 1999; and (b) our historical consolidated financial statements and the notes thereto as of and for the year ended December 31, 2000 and for the period from March 2, 1999 to December 31, 1999, all of which have been audited by Deloitte & Touche LLP, except for the consolidated financial statements and notes thereto as of and for the years ended December 31, 2002 and 2001, which have been audited by Ernst & Young LLP, independent auditors, and appear elsewhere in this report. Our current results of operations and financial condition differ materially from those prior to the Acquisition due primarily to:
- - The incurrence of $1.6 billion of debt and related interest expense in connection with and at the time of Acquisition;
- - The Company becoming a tax paying entity;
- - Voluntary early retirement and separation programs introduced since 1999;
- - The management fees and royalties paid to Verizon;
- - The introduction of dialing parity in the on-island long distance market and our entrance into the off-island long distance market;
- - Revaluation of assets and liabilities to reflect purchase accounting relating to the Acquisition; and
- - The discontinuation of regulatory accounting principles, as described in FAS 71.
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(1) Reclassifications of prior years' data have been made to conform to current year presentation.
(2) EBITDA represents operating income plus depreciation and amortization expense. EBITDA is used by some investors and analysts to analyze and compare companies on the basis of liquidity. EBITDA is not recognized under generally accepted accounting principles and should therefore not be construed as an alternative for net income, which is an indicator of a company's performance, or cash flow from operations, which is a liquidity measure. It is included because we believe it provides additional information with respect to our anticipated ability to meet future debt service, capital expenditures, and working capital requirements. The calculation of EBITDA may be different from the calculation used by other companies and therefore comparability may be affected.
(3) Determined by dividing EBITDA by revenues and sales.
(4) The ratio of earnings to fixed charges of the Predecessors has not been presented, as the fixed charges were nominal prior to the Acquisition since there was no significant indebtedness.
(5) The Company paid dividends during 2002 and 2001 of $69 million, or $2.753 per share, and of $58 million or $2.315 per share, respectively. Dividends were paid for the first time during 2001. There were 25 million outstanding shares of common stock and four shareholders of record both at December 31, 2002 and 2001.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
GENERAL
The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to bad debts, intangible assets, income taxes, financing operations, pensions and other post-retirement benefits, and contingencies and litigation. The Company's management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of the Company's customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Because of uncertainties inherent in the estimation process, management's estimate of losses and the related allowance may change. The Company is not dependent on any single customer.
DEFERRED TAXES
The Company uses an asset and liability approach in accounting for income taxes following the provisions of SFAS No. 109, "Accounting for Income Taxes." Deferred tax assets and liabilities are established for temporary differences between the way certain income and expense items are reported for financial reporting and tax purposes.
The Company records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. While the Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event the Company were to determine that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should the Company determine that it would not be able to realize all or part of its net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made.
As discussed in Note 1 to the consolidated financial statements, the Company executed a reorganization plan, which became effective May 1, 2002, whereby Verizon Wireless merged into PRTC. As a result of this merger, the Company released a deferred tax valuation allowance, related to the Acquisition, of $93 million, of which $51 million was recorded against goodwill and $42 million was recorded as a deferred tax benefit in the Company's consolidated statement of income during the second quarter of 2002 in accordance with SFAS No. 109. Management believes that sufficient book and taxable income will be generated by the merged company to realize the benefits of these tax assets.
PROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION
Property, plant and equipment is stated at original cost, including interest on funds borrowed to finance the acquisition of capital additions. Repairs and maintenance are expensed as incurred. Depreciable property disposed of in the ordinary course of business, together with the cost of removal, less salvage value, is charged to accumulated depreciation with no gain or loss recognized. Gains or losses from the sale of land are recorded in results of operations.
The Company's depreciation expense is based on the composite group remaining life method and straight-line composite rates. This method provides for the recognition of the cost of the remaining net investment in telephone plant, less anticipated net salvage value, over the remaining asset lives. This method also requires a periodic evaluation of the average remaining useful lives related to the expected recoverability of the carrying value of assets based on changes in technology, environmental factors, the federal and local regulatory environment, and other competitive forces. Effective July 1, 2002, the Company changed its accounting estimates relating to depreciation resulting from a detailed review of the lives underlying the depreciation rates. The rate changes reflect expected useful lives resulting from the impact of technology and future competition as well as more closely approximating the assumptions used by other telephone companies. These charges resulted in decreasing depreciation expense by approximately $6 million for the second half of 2002. Refer to Note 4 to the consolidated financial statements for further details.
PENSIONS
The Company accounts for its defined benefit pension plans in accordance with SFAS No. 87, "Employers' Accounting for Pensions" which requires that amounts recognized in financial statements be determined on an actuarial basis. SFAS No. 87 and the policies used by the Company, notably the use of a calculated value of plan assets (which is further described below), generally reduced the volatility of pension income (expense) from changes in pension liability discount rates and the performance of the pension plan's assets.
The most significant element in determining the Company's pension income (expense) in accordance with SFAS No. 87 is the expected return on plan assets. At December 31, 2002, the Company assumed that the expected long-term rate of return on plan assets would be 8.5%, which is 0.75% lower than the prior year. Historically, the Company's pension plan assets have earned in excess of 8.5%; therefore, the Company believes that its assumption of future returns of 8.5% is reasonable.
At the end of each year, the Company determines the rate used to discount plan liabilities. The discount rate reflects the current rate at which the pension liabilities could be effectively settled at the end of the year. In estimating this rate, the Company looks to rates of return on high quality, fixed-income investments that receive one of the two highest ratings given by a recognized ratings agency. At December 31, 2002, the company determined this rate to be 6.75%, which is 0.5% lower than the prior year. The increase in the pension liability resulting from the change has been deferred in accordance with the amortization provisions of SFAS No. 87.
OTHER POST EMPLOYMENT BENEFITS
We provide retiree health benefits for employees that retire under our Pension Plan. We use various actuarial assumptions including the discount rate and the expected trend in health care costs to estimate the costs and benefit obligations for our retiree health plan.
At December 31, 2002, we assumed a discount rate of 6.75%, which is 0.5% lower than the prior year and increased our retiree health benefit liability. A large portion of this loss has been deferred in accordance with the amortization provisions of SFAS No. 106.
RESULTS OF OPERATIONS
We have two reportable segments, Wireline and Wireless. See Note 18 to the consolidated financial statements for additional information on our segments. Reclassifications of prior years' data have been made to conform to the 2002 presentation.
The Wireline segment consists of:
- - Local services, including basic voice, telephone and telecommunications equipment rentals, value-added services, high-speed private line services, Internet access and public phone service;
- - Access services to long distance carriers, competitive local exchange carriers, and cellular and paging operators to originate and terminate calls on our network;
- - Long distance services including direct dial on-island and off-island, operator assisted calls, prepaid calling card and high-speed private line services;
- - Directory publishing rights revenues; and
- - Telecommunication equipment sales and billing and collection services to competing long distance operators in Puerto Rico.
The Wireless segment consists of:
- - Cellular service; and
- - Wireless equipment sales.
REVENUES
EXPENSES AND CHARGES
OPERATING DATA
YEAR ENDED DECEMBER 31, 2002 COMPARED WITH YEAR ENDED DECEMBER 31, 2001
REVENUES. Revenues for the year ended December 31, 2002 decreased $96 million, or 7%, to $1,301 million from $1,397 million in 2001.
WIRELINE:
Wireline revenues include local service, long distance, network access, directory revenues and other services. Wireline revenues for the year ended December 31, 2002 decreased $75 million, or 6%, to $1,116 million from $1,191 million in 2001.
Local service revenues include basic voice, telephone and telecommunications equipment rental, value-added services, high-speed private line services, Internet access, and public phone service. Local service revenues for the year ended December 31, 2002 increased $12 million, or 2%, to $578 million from $566 million 2001. The increase is due to higher local data services while local voice services remained constant. The increase in local data services was mainly driven by an increase in Internet access revenues of $3 million, an increase in DSL revenues of $2 million, and an increase in frame relay revenues of $4 million.
Long distance revenues include direct dial on-island and off-island, operator-assisted calls, prepaid calling cards and on-island private line revenues. Long distance revenues decreased $40 million, or 22%, to $146 million for the year ended December 31, 2002 from $186 million for the 2001. The decrease was mainly due to a decrease in intra-island long distance revenues of $28 million, a decrease in operator service revenues of $6 million and a decrease in off-island long distance revenues of $6 million. Long distance revenues have decreased mainly due to customer traffic migration to the cellular network.
Network access revenues include services provided to long distance carriers, competitive local exchange carriers, and cellular and paging operators to originate and terminate calls on other network. These revenues for the year ended December 31, 2002 decreased $30 million, or 8%, to $325 million compared to $355 million for 2001. The decrease was primarily caused by a decrease in interstate high cost fund subsidies of $33 million, reflecting a phasing out of this subsidy (see "Regulatory Matters-Interstate High Cost Subsidy"). The decrease was partially offset by an increase in local USF charges of $4 million.
Directory and other revenues include directory publishing rights, telecommunication equipment sales and billing and collection services to competitor long distance operators. Directory and other revenues for the year ended December 31, 2002 decreased $17 million, or 20%, to $67 million from $84 million for the year ended December 31, 2001, mainly due to a decrease in equipment sales of $13 million and a decrease in billing and collection service revenues of $4 million, reflecting lower long distance traffic from competitors.
WIRELESS:
Revenues from cellular and paging services and related equipment sales for the year ended December 31, 2002 decreased $21 million, or 10%, to $185 million from $206 million for 2001. Cellular service revenues decreased $4 million, or 2%, to $173 million from $177 million in 2001. This was primarily the result of combined cellular ARPU declining from $44 to $41 as new price plans with larger bundles of minutes were introduced into the market, which was partially offset by customer growth.
Paging revenues declined $10 million, or 67%, to $5 million for the year ended December 31, 2002 from $15 million for 2001. The decrease was related to a reduction of 33,000 customers.
Wireless equipment sales decreased $7 million, or 50%, to $7 million for year ended December 31, 2002 from $14 million for 2001. This decrease is mainly due to lower prepaid gross additions associated with lower promotional activities during the year ended December 31, 2002.
OPERATING COSTS AND EXPENSES. Operating costs and expenses for the year ended December 31, 2002 decreased $33 million, or 4%, to $793 million from $826 million reported for the year 2001.
WIRELINE:
Wireline expenses for the year ended December 31, 2002 increased $2 million to $663 from the $661 million reported in 2001.
Labor and benefit expenses decreased $16 million, or 5%, to $334 million from $350 million reported for the year ended December 31, 2001. This decrease in labor and benefit expense primarily reflects headcount reductions including the effect of early retirements and voluntary separation programs, as well as a reduction in overtime, contractors and expatriate expenses.
Other operating expenses of $329 million for the year ended December 31, 2002, increased $18 million, or 6%, compared to 2001. The increase is primarily due to higher property and municipal tax provisions of $16 million and higher bad debt provisions of $10 million, offset in part by lower consulting and advertising expenses of $6 million and $5 million, respectively.
WIRELESS:
Wireless expenses for the year ended December 31, 2002, decreased $34 million, or 21%, to $131 million from the $165 million reported for the year ended December 31, 2001.
Labor and benefit expenses decreased $3 million, or 9%, to $31 million from the $34 million reported for the year ended 2001. The decrease in labor and benefits expenses is mainly due to lower overtime, expatriate and temporary employee expenses.
Other operating expenses decreased $31 million, or 24%, to $100 million from the $131 million reported for the comparable 2001 period. The decrease was due to lower costs from equipment sold of $21 million and lower bad debt provisions of $10 million and a $3 million gain on the sale of land. These decreases were offset by an increase in facilities expenses of $3 million associated with the new CDMA network.
EARLY RETIREMENT AND VOLUNTARY SEPARATION PROVISIONS. In December 2002, the Company offered a voluntary separation program to qualified management employees. A non-cash provision of $0.5 million was recorded relating to 8 employee acceptances.
A total of $52 million was recorded for early retirement and voluntary separation programs during 2001 associated with four separate offerings to a total of 567 employees.
DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization expense of $262 million for the year ended December 31, 2002 was $9 million lower than for 2001, a decrease of 3%. The decrease in depreciation and amortization expense is mainly due to a change in wireline depreciation rates, which became effective July 1, 2002, reducing depreciation expense by $6 million and the discontinued amortization of goodwill and other indefinite life intangibles, as a result of the adoption of SFAS No. 142, which reduced amortization expense by $16 million for the year ended December 31, 2002. This decrease of $22 million was offset in part by higher gross plant balances, which produced approximately $13 million in depreciation expense.
INTEREST EXPENSE. Interest expense of $47 million for the year ended December 31, 2002 was $15 million lower than 2001 due to lower interest rates and lower debt balances.
EQUITY INCOME FROM JOINT VENTURE. Earnings of $3 million were generated for the year ended December 31, 2002 from our approximate 25% interest in VISI.
MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY. A $1 million minority interest included in the Company's results of operations for the year ended December 31, 2002 represents the minority share of the income or loss of Popular, Inc.'s 33% investment in Coqui.net.
INCOME TAXES. A $29 million tax provision for the year ended December 31, 2002 reflects the tax effect of the merger of Verizon Wireless into PRTC (See Note 1 to the consolidated financial statements). As a result of this merger, the Company released a deferred tax valuation allowance of $93 million, of which $51 million was recorded against goodwill and $42 million of which was recorded as a deferred tax benefit during the second quarter of 2002. The difference between the statutory tax and the effective rate of 15%, or $48 million, primarily reflects permanent differences related to the $42 million release of the valuation allowance and other permanent differences such as the internal accretion on the government subscription receivable and joint venture equity income.
YEAR ENDED DECEMBER 31, 2001 COMPARED WITH YEAR ENDED DECEMBER 31, 2000
REVENUES. Revenues for the year ended December 31, 2001 increased $3 million, to $1,397 million from $1,394 million in 2000.
WIRELINE:
Wireline revenues include local service, long distance, network access, directory revenues and other services. Wireline revenues for the year ended December 31, 2001 decreased $8 million, to $1,191 million from $1,199 million in 2000.
Local service revenues include basic voice, telephone and telecommunications equipment rental, value-added services, high-speed private line services, Internet access, and public phone service. Local service revenues for the year ended December 31, 2001 increased $12 million, or 2%, to $566 million from $554 million in 2000. The increase resulted primarily from an increase in revenues from high-speed private lines of $6 million and an increase of $4 million in revenues from each of: Internet access, value-added service, and deferred activation and installation. This increase was offset in part by a decrease in telephone and PBX rentals revenues of $5 million and lower public phone service revenues of $3 million.
The waiting list for basic service decreased to 4,800 at December 31, 2001, compared to 14,300 at December 31, 2000. The decrease in the waiting list with no significant change in residential access lines from December 2000 to December 2001 reflects a softening economy. Increases in high-speed private lines to business and Internet access to consumers reflect an increase in demand for this service for the year ended December 31, 2001. Increases in value-added service revenues reflect successful bundling programs, which involve long distance and Internet access. The increase in Internet access is directly related to an increase in customers of approximately 24,000, or 23%, to 127,000, as compared to the prior year. The decrease in public phone service is caused by a 7% reduction in the number of public phones, compared to prior year, as the installed base is rationalized for cost efficiencies. Also, industry wide public phone revenues will continue to decrease due to the proliferation of wireless telephony.
Long distance revenues include direct dial on-island and off-island, operator-assisted calls, prepaid calling card and on-island private line revenues. Long distance revenues increased $16 million, or 9%, to $186 million for the year ended December 31, 2001 from $170 million in 2000. The increase was due to an increase in intra-island long distance revenues of $9 million, an increase in long distance private line revenues of $6 million, an increase in off-island long distance revenues of $5 million and an increase in prepaid long distance cards revenue of $2 million. These increases were offset in part by a reduction in operator service revenues of $6 million. During the year 2001, we continued to recapture a portion of the intra-island long distance market and continued to increase our share of the off-island long distance market.
Network access revenues include services provided to long distance carriers, competitive local exchange carriers, and cellular and paging operators to originate and terminate calls on our network. Network access revenues for the year ended December 31, 2001 decreased $34 million, or 9%, to $355 million compared to $389 million in 2000. The decrease was due to a decrease in off-island access revenues of $22 million, caused by lower competitive access volumes and lower access rates. The decrease was also due to a decrease in interstate high cost fund subsidies of $16 million reflecting a phasing out of this subsidy. The decrease was offset in part by an increase in intra-island access revenues of $2 million from long distance and cellular carriers relating to higher access volumes.
Directory and other revenues include directory publishing rights, telecommunication equipment and billing and collection services to competitor long distance operators. Directory and other revenues for the year ended December 31, 2001 decreased $2 million, or 2%, to $84 million, from $86 million for the year ended December 31, 2000, mainly due to a reduction in billing and collection service revenues of $5 million and public phone access revenues of $1 million, offset in part by an increase in equipment sales revenues of $5 million.
During 2000 we changed the method of accounting for directory publishing revenues and related expenses from the amortization method to the publication method, which became effective on January 1, 2000. See Note 3 to the consolidated financial statements for more details related to this accounting change.
WIRELESS:
Revenues from cellular and paging services and related equipment sales for the year ended December 31, 2001 increased $11 million, or 6%, to $206 million from $195 million in 2000. Cellular service revenues increased $29 million, or 20%, as a result of higher combined ARPU of $6. Postpaid cellular ARPU of $60 increased by $9 as a result of higher customer usage.
Paging revenues declined $19 million, or 56%, to $15 million for the year ended December 31, 2001 from $34 million in 2000. The decrease was related to a reduction of approximately 77,000 customers due to the migration of customers to cellular services.
Wireless equipment sales increased $1 million, or 8%, to $14 million for the year ended December 31, 2001 from $13 million in 2000 due to an increase in gross customer additions.
OPERATING COSTS AND EXPENSES. Operating costs and expenses for the year ended December 31, 2001 decreased $21 million, or 2%, to $826 million from $847 million reported for 2000.
WIRELINE:
Wireline expenses for the year ended December 31, 2001 decreased $45 million, or 6%, to $661 million from the $706 million incurred in 2000.
Labor and benefit expenses decreased $23 million, or 6%, to $350 million from $373 million in 2000, mainly due to decreases in overtime expenses of $14 million, a decrease in pension and other post-employment benefits expenses of $8 million and a decrease in sick day provision of $5 million. These decreases were partially offset by an increase in salaries of $2 million and an increase in medical and life insurance expenses of $2 million. The net expense reduction reflects the results of cost containment measures.
Other operating expenses of $311 million for the year ended December 31, 2001, decreased $22 million, or 7%, as compared to the year ended December 31, 2000. The decrease is primarily due to a decrease in the provision for bad debt of $13 million, a decrease in management fees and royalties of $11 million, a decrease in operating tax provisions of $8 million and a $5 million gain on the sale of a 33% interest in Coqui.net to Popular, Inc., a shareholder of the Company. The lower bad debt provision is due to stricter collection and disconnection policies for non-payment related to residential and small business customers. The decrease in management fees and royalties is mainly due to a 1% rate decrease, which became effective in March 2001. The decrease in other operating expenses was partially offset by an increase in off-island access charges of $4 million, an increase in costs from equipment sales of $4 million, and increases in deferred activation charges of $4 million and regulatory fees of $4 million.
WIRELESS:
Wireless expenses for the year ended December 31, 2001, increased $24 million, or 17%, to $165 million from the $141 million reported in 2000.
Labor and benefit expenses decreased $1 million, or 3%, to $34 million from $35 million reported in the same 2000 period. The decrease is due to a decrease in temporary employees and contractor expenses of approximately $3 million and a decrease in overtime expenses of $1 million. These decreases were offset in part by higher salaries of $3 million due to an increase in full-time employees.
Other operating expenses increased $25 million, or 24%, to $131 million from the $106 million reported in 2000. The increase was due to an increase in costs from equipment sales of $17 million, an increase in bad debt provisions of $4 million, an increase in network management fees of $3 million, an increase in roaming charges of $3 million and the absence of the gain on sale of assets of prior years of $8 million. These increases were offset in part by reductions in commission expense of $8 million and management fees and royalties of $3 million. Higher equipment costs and lower commission expense reflect a change in the structure of compensating agents for prepaid service together with shifting more postpaid selling from agents to the internal sales force.
EARLY RETIREMENT AND VOLUNTARY SEPARATION PROVISIONS. A total of $52 million was recorded for early retirement and voluntary separation programs during 2001 involving 567 employees associated with four separate offerings as summarized in the table below:
(1) These 29 employees were initially determined not to be eligible for the program. In the third quarter of 2001, a qualified physician revaluated their disability status and determined that they were qualified for the program.
The Company offered a voluntary early retirement program to qualified management employees during the fourth quarter of 2000 and recorded a $19 million non-cash provision relating to 95 employees who accepted.
DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization expense of $271 million for the year ended December 31, 2001 was $27 million lower than in 2000, a decrease of 9%. The decrease in depreciation and amortization expenses is due to a change in useful lives.
The composite rate for outside plant was revised, effective January 1, 2001, resulting in an increase in the useful life of the remaining balance of assets from 5.7 to 7.2 years. This reflects our change in network modernization plans, the current economic environment and its impact on competition and a high level analysis of lives used by other telephone companies. Additionally, we have been recording depreciation in excess of capital expenditures from 1999 through year-end 2001 resulting in a decrease in net plant assets throughout these years.
We had recently begun to deploy DSL service to residential and business customers. This is a marked change in the modernization strategy that underlies our life estimates. Previously, we expected to deploy high-speed broadband services via optical cable with limited or no DSL deployment. Since then, the continuing high cost and technology hurdles of a fiber solution have made DSL an attractive solution. We now anticipate DSL will meet initial demands for broadband services and extend the relatively short remaining life of metallic cable.
The composite rate for transmission equipment was reduced to reflect the faster technological obsolescence of this equipment. The composite rate for other equipment was increased primarily due to recently capitalized software for a new wireless billing system involving approximately $30 million, which has a five-year useful life.
INTEREST EXPENSE. Interest expense of $62 million for the year ended December 31, 2001 was $15 million lower than in 2000 mainly due to lower interest rates on the Company's bank notes, lines of credit and commercial paper. Debt balances remained constant at $1.2 billion for December 31, 2001 and 2000. Average interest rates on the Company's short-term debt decreased from approximately 7% for the year ended December 31, 2000 to 4% for the year ended 2001. Also, in August 2001 we entered into an interest rate swap contract at a notional amount of $150 million. The swap receives interest at a fixed rate of 6.65% and pays interest at a variable rate equal to six month LIBOR plus approximately 170 basis points. For 2001, we experienced a reduction in interest expense of approximately $1 million, as a result of the interest rate swap.
EQUITY INCOME FROM JOINT VENTURE. Earnings of $3 million were generated from our approximate 25% interest in Verizon Information Services, Inc. (formerly AXESA), the largest yellow page publishing company in Puerto Rico.
INCOME TAXES. A $70 million tax provision for the year ended December 31, 2001 reflects a 37% effective tax rate. The difference between the effective and the statutory tax rate of 39%, or $4 million, primarily reflects permanent differences of $3 million related to interest accretion on the Government subscription receivable, which is a capital contribution, additional tax deductions not expensed for financial statement purposes amounting to $5 million (including the effect of additional deductible expenses determined during 2001 with regards to the Company's 2000 amended income tax filings), offset by other tax adjustments of $4 million.
LIQUIDITY AND CAPITAL RESOURCES
CONSOLIDATED FINANCIAL CONDITION
YEAR ENDED DECEMBER 31, 2002 COMPARED WITH YEAR ENDED DECEMBER 31, 2001
OVERALL LIQUIDITY ASSESSMENT
We believe that cash from operations is sufficient to meet working capital needs. For 2002 current assets exceeded current liabilities by $39 million. We believe our sources of funds, from operations and from readily available external financing arrangements, are sufficient to meet ongoing operating, investing and financing requirements. We expect that presently foreseeable capital requirements of approximately $190 million for 2003, will continue to be financed through internally generated funds.
We have an undrawn $400 million revolving credit facility maturing in March 2004, as well as a $50 million working capital facility which matures in June 2003, of which $40 million had been drawn as of year end. An aggregate principal amount of $300 million of the Company's senior notes matured on May 15, 2002. We refinanced these notes and the related interest payment through the issuance of new term loans totaling $225 million.
OPERATIONS
The increase in cash from operations of $189 million for the year ended December 31, 2002, as compared to the prior year was primarily due to a decrease in disbursements of management fees and royalties of $79 million, a decrease in pension contributions of $77 million, a decrease in income tax payments of $15 million and a decrease in expatriate reimbursements of $9 million.
Management fees and royalty payments for 1999 and 2000 were paid for the first time in 2001 pursuant to a deferral agreement as part of the Acquisition. This is also the primary reason for the lower expatriate expense in 2002 when compared to 2001.
Pension plan payments decreased by $77 million during 2002 due to the change in policy whereby we funded our pension obligation at the lower-end of the ERISA minimum-funding obligation. Full year 2002 and 2001 pension and other post-employment benefits contributions amounted to $99 million and $176 million, respectively.
Income tax payments for 2002 amounted to $40 million. Income tax payments decreased by $15 million because 2001 amounts also included a $34 million payment for the years 1999 and 2000 as the Company became a cash tax payer for the first time during 2001.
INVESTING
Net cash used in investing activities for the year ended December 31, 2002 was $206 million compared to $220 million for the same period in 2001. The decrease in cash used in investing activities of $14 million is mainly due to a decrease in capital expenditures and removal costs of $37 million, offset in part by a reduction of $7 million in retirements and the absence of the $16 million proceeds from the sale of a 33% interest in Coqui.net to Popular, Inc. in 2001.
The capital expenditure program for 2002 amounted to $205 million, which was financed from internally generated funds. The decrease in capital expenditures during 2002 despite an additional investment of $40 million in wireless CDMA is partially due to decreased spending on specific software projects, as well as general decreased spending as the Company has aligned its capital spending with softening demand for new wireline service.
We have invested approximately $900 million from the date of the Acquisition through year-end 2002 to expand and enhance our networks. In 2003, we expect to make up to approximately $190 million in capital expenditures.
FINANCING
Debt decreased $161 million for the year ended December 31, 2002, as compared to the year ended December 31, 2001. During 2002, the Company refinanced $300 million of senior notes, which matured on May 15, 2002, with new term credit agreements with four banks. The aggregate amount of the term loans is $225 million, with maturities ranging from two to three years, bearing interest at 70 to 100 basis points over LIBOR.
The shareholders' agreement, entered into at the time of the Acquisition, requires the payment of dividends equal to at least 50% of consolidated net income, payable quarterly to the extent funds are legally available therefore. The Company paid dividends of approximately $69 million for the year ended December 31, 2002. The senior note indentures and credit facility agreements do not contain restrictions on the payment of dividends.
In the Acquisition, the PRTA agreed to contribute cash or stock worth a total of $200 million as a capital contribution in five equal $40 million installments over five years beginning on March 2, 2000 to fund its underfunded pension and other post-employment benefit obligations. In March 2002, $40 million was received in cash from the PRTA for the third installment. See Note 14 to the consolidated financial statements.
CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS
(1) Pension obligations represent contributions based on ERISA minimum rules.
REGULATORY AND OTHER MATTERS
REGULATORY AND COMPETITIVE TRENDS
Regulatory activity at the federal and local levels was primarily directed at meeting challenges in maintaining existing access rates and retaining subsidies to support the costs of Universal Service and other services. We are also addressing local number portability requirements.
We continued to meet the wholesale requirements of new competitors and have signed agreements with wireless and wireline carriers. These agreements permit them to purchase unbundled network elements, to resell retail services, and to interconnect their networks with ours.
INTRA-ISLAND LONG DISTANCE ACCESS RATE DISPUTE
On February 28, 2002, the TRB issued a Resolution and Order (the "February 2002 Order") with respect to the reconsideration requested by the Company of the TRB October 10, 2001 order to reduce the access rates the Company charges to long distance carriers to originate and terminate intra-island long distance calls through the Company's network.
The February 2002 Order requires new rates for intra-island access to be implemented through phased-rate reductions over four years and directs PRTC to make a cash refund to end-user customers. The prospective access rate reductions (on a two-way basis) were ordered to take place on April 1st of each year as follows:
April 2002: From 9.3 cents per minute to 7.9 cents per minute
April 2003: From 7.9 cents per minute to 6.5 cents per minute
April 2004: From 6.5 cents per minute to 5.0 cents per minute
April 2005: From 5.0 cents per minute to 2.1 cents per minute
The February 2002 Order also requires PRTC to pay a $68 million refund to end-user customers. The TRB calculated this amount based on the difference between the 9.3 cents and 7.9 cents rate for TRB estimated traffic from the period April 1, 2000 through March 31, 2002. The refund can be made in 12 quarterly, equal installments starting April 1, 2002.
The Company filed with the Puerto Rico Circuit Court of Appeals ("Court") an appeal of the February 2002 Order in which the Company alleges the TRB made errors of law and procedure in its determination of access charges and its order to make the cash refund. The Court stayed the refund and the rate reduction on March 27, 2002 and is currently hearing the appeal.
On April 2, 2002, AT&T, Sprint and LTD ("Carriers") filed a petition with the Court for review of the February 2002 Order, requesting the Court to order the rate reduction without a phase-in period, remand the case back to the TRB and direct the TRB to calculate the refund from and after April 1997 instead of April 2000, with the Carriers receiving the refund instead of the end-user customers.
The hearing involving oral presentations by the parties was held on February 19, 2003. The parties will have a fifteen (15) day period to submit their post hearing final brief once the transcript of the oral argument is received. PRT has not received this transcript yet. At this stage it is too early to assess the probability of success in the appeals process. The Company believes the Carriers' petition for review is without merit.
PUBLIC TELEPHONE SERVICE PROVIDER - ANTI COMPETITIVE ACTIONS
Telefonos Publicos de Puerto Rico, Inc. ("TPPR") the largest competitive provider of public pay phones in Puerto Rico filed a suit in the United States District Court of Puerto Rico on November 8, 2001, claiming predatory, exclusionary and anticompetitive acts and seeking damages of $75 million. We have filed a motion to dismiss the case and are awaiting a decision of the court.
Pan American Telephone, Inc., Intouch Telecommunications, Inc., and Choicetel Communications, Inc., three additional competitive providers also filed a similar suit in the United States District Court of Puerto Rico on September 4, 2002 on the same grounds. On November 8, 2002, after having evaluated and determined that this claim is similar to TPPR claim, we have filed a motion to dismiss the case. At present, we are awaiting a decision of the court.
In August 16, 2002, PSA, the parent company for Phoenix of Puerto Rico ("Phoenix") filed a suit in the Delaware bankruptcy court claiming anti competitive acts. The claims have since been transferred to Federal District Court and the disputes between the two parties include PRT's amended administrative claim against PSA, and PSA's complaint for over $9 million against PRT. PRT has filed a motion to dismiss and change of venue which is pending before the Federal District Court.
The Company's management believes all of these claims are without merit.
TOUCHTONE CHARGES
On July 2, 2002, three residential telephone service subscribers and one business service subscriber filed a class action suit with the Superior Court of Puerto Rico (the "Superior Court") under the Puerto Rico Telecommunications Act of 1996 ("Act"). The plaintiffs claim that the Company's charges for touchtone service are not based on cost, and are therefore in violation of the Act. They have requested that the Court (i) issue an Order certifying the case as a class action, (ii) designate the plaintiffs as representatives of the class, (iii) find that the charges are illegal, (iv) establish a maximum charge based on cost, and (v) order the Company to reimburse every subscriber for excess payments made since September 1996.
On October 25, 2002, plaintiffs filed a motion requesting class certification. The plaintiffs filed on November 22, 2002, a voluntary request for dismissal as to some plaintiffs. On December 19, 2002, PRT filed its answer to the amended complaint. On February 18, 2003, PRT filed its respective opposition to plaintiff's motion for class certification. At present, we are awaiting for a decision with respect to the voluntary dismissals and our opposition to class certification.
MEASURED SERVICE UNIT CHARGES
On July 16, 2002, one residential telephone service subscriber and three business service subscribers filed a class action with the Court under the Act. The plaintiffs claim that the Company's unit charges for local measured service are not based on cost, and are therefore in violation of the Act. They have requested that the Court (i) issue an Order certifying the case as a class action, (ii) designate the plaintiffs as representatives of the class, (iii) find that the unit charges are illegal, (iv) establish a maximum unit charge based on cost, and (v) order the Company to reimburse every subscriber for excess payments made since September 1996.
On November 22, 2002 plaintiffs filed a request for voluntary dismissal without prejudice. On February 26, 2003, the Court issued an Order with respect to the motion requesting voluntary dismissal. Specifically, the Court ordered the plaintiffs to present within a period of twenty (20) days, that is until March 18, 2003, their position towards the class action suit if the dismissal is granted. However, on March 5, 2003 the Court issued an Order dismissing the case without prejudice.
CTI ASSET TRANSFER
Prior to the Acquisition, PRTC transferred its net wireless assets on September 1, 1998 to CTI (which became Verizon Wireless, a part of PRTC on May 1, 2002). Our Predecessors later filed a waiver request in 1998 with the FCC to record this transfer at book value instead of fair value. Since our Predecessors had not included the costs of wireless operations in the regulated rate setting process, we believe ratepayers did not bear the cost of our Predecessor's wireless investment.
The FCC denied the Company's petition in April 2001, but recognized that while there were questions concerning certain costs and expenses, the cellular and paging assets had been removed from the interstate rate base.
The TRB stated in its February 2002 Order that for any prospective rate increase that the Company may pursue to compensate for revenue deficiencies it must first be applied against the gain in the wireless asset transfer, equating to $56 million applicable to intrastate. We will contest this position based on the fact that the wireless entity was set up after the last regulated intrastate rate increase in 1982 and therefore these costs were not included in setting such rates.
Neither the FCC nor the TRB has commenced any further proceedings to address this issue. While we believe that the resolution of this matter and any related proceedings will not have a material effect on our financial condition and results of operations, we cannot provide assurance that any further regulatory actions will be favorable to the Company.
PRICE CAP REGULATION
The FCC requires that companies which set interstate access rates based on a price cap formula must use the price cap formula for all their affiliates. The price cap formula is based on a plan called Coalition of Affordable Local and Long Distance Service ("CALLS") that used rate-of-return as a basis for setting rates. We were, therefore, required to implement price caps no later than March 2, 2000.
However, the FCC delayed conversion to price cap regulation until June 30, 2002 and the Company has requested a further extension to June 30, 2003. As per Memorandum and Order released by the FCC on April 18, 2002, (DA 02-888), the Company is no longer required to file a waiver request until the FCC completes its review of the "all-or-nothing" rule.
INTERSTATE HIGH COST SUBSIDY
On October 21, 1999, the FCC adopted a new high cost support mechanism, which has resulted in the phase out of the Company's High Cost Subsidy revenues. These revenues were $49 million in 2000, $33 million in 2001 and $4 million for 2002. On February 28, 2003 PRT sent a letter to FCC, asking the Commission to take action to restore the high-cost universal service support that the Company lost due to FCC policies adopted for non-rural companies based on the cost characteristics of mainland companies. PRT request the FCC to address the loss of its universal service support by adopting rules for insular areas that are similar to those applied to rural carriers.
MESSAGE PROCESSING AND BILLING SYSTEM
The Company has an agreement for the implementation of a traffic polling and billing software system for its wireline operations. The billing portion of the project is currently behind schedule and management is evaluating the feasibility of continuing that portion. As of December 31, 2002 the Company has invested approximately $30 million in hardware, software and labor on the billing system portion of the project.
RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 4 to the consolidated financial statements in Item 8 (Part 1) of this Form 10-K for disclosure on recent accounting pronouncements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE SENSITIVITY
We are exposed to market risk in the normal course of business, resulting primarily from interest rate changes on our senior notes and interest rate swap agreements.
The following table summarizes the fair value of our senior notes and interest rate swap at December 31, 2002 and 2001 and provides a sensitivity analysis of the fair values of these instruments assuming a 100 basis point change in the yield curve. The sensitivity analysis does not include the fair values of our floating-rate debt since it is not significantly affected by changes in market interest rates.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 2002 and 2001
Consolidated Statements of Operations for the Years Ended December 31, 2002, 2001 and 2000
Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 2002, 2001 and 2000
Consolidated Statements of Cash Flows for the Years Ended December 31, 2002, 2001 and 2000
Notes to Consolidated Financial Statements for the Years Ended December 31, 2002, 2001 and 2000
Schedule II - Valuation and Qualifying Accounts for the Years Ended December 31, 2002, 2001 and 2000
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders of Telecomunicaciones de Puerto Rico, Inc.:
We have audited the accompanying consolidated balance sheet of Telecomunicaciones de Puerto Rico, Inc. and subsidiaries (the "Company") as of December 31, 2002 and 2001, and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for the years then ended. Our audit also included the financial statement schedule listed in the Index at Item 14 for the years ended December 31, 2002 and 2001. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Telecomunicaciones de Puerto Rico, Inc. and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note 4 to the financial statements, the Company changed its method of accounting for goodwill and other intangible assets in accordance with Statement of Financial Accounting Standards ("SFAS") No. 142 "Goodwill and other intangible assets", effective January 1, 2002.
Ernst & Young LLP San Juan, Puerto Rico
February 28, 2003
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders of Telecomunicaciones de Puerto Rico, Inc.:
We have audited the accompanying consolidated statements of operations, changes in shareholders' equity, and cash flows of Telecomunicaciones de Puerto Rico, Inc. and subsidiaries (the "Company") for the year ended December 31, 2000. Our audit also included the financial statement schedule listed in the Index at Item 15 for the year ended December 31, 2000. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of Telecomunicaciones de Puerto Rico, Inc. and subsidiaries for the year ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the 2000 basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note 3 to the consolidated financial statements, the Company changed its method of accounting for directory-publishing revenues and related expenses effective January 1, 2000, and adopted Securities and Exchange Commission Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," effective December 31, 2000.
Deloitte & Touche LLP San Juan, Puerto Rico
March 9, 2001
TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
The accompanying notes are an integral part of these financial statements.
TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
The accompanying notes are an integral part of these financial statements.
TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(In thousands)
The accompanying notes are an integral part of these financial statements.
TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
The accompanying notes are an integral part of these financial statements.
TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
1. BUSINESS / CORPORATE STRUCTURE
Telecomunicaciones de Puerto Rico, Inc., a Puerto Rico corporation (the "Company"), holds 100% of the common stock of Puerto Rico Telephone Company, Inc. ("PRTC"), PRT Larga Distancia, Inc. ("PRTLD"), and Datacom Caribe, Inc. ("Datacom"). The Company also holds a 67% interest in Coqui.net Corporation ("Coqui.net"), in which Popular, Inc., one of our shareholders, holds the remaining 33% interest, and a 25% interest in Verizon Information Services Puerto Rico, Inc. S. en C. ("VISI"), in which GTE Holdings (Puerto Rico) LLC, our majority shareholder, holds a 36% interest. The Company is the largest telecommunications service provider in Puerto Rico. PRTC is the incumbent local exchange carrier for the island of Puerto Rico. Wireline service is provided by PRTC and cellular and paging services are provided by the wireless division of PRTC. The Company's off-island long distance service is provided by PRTLD. The Company's dial-up Internet access service is provided by Coqui.net. The Company's directory publishing revenues are generated by VISI.
GTE Corporation ("GTE"), through its subsidiary GTE Holdings (Puerto Rico) LLC, acquired a 40% interest and management control over the Company on March 2, 1999 from Puerto Rico Telephone Authority ("PRTA"), an entity of the Commonwealth of Puerto Rico (the "Acquisition"). In the Acquisition, Popular, Inc. acquired a 10% interest in the Company. GTE and Bell Atlantic Corporation merged on June 30, 2000 to form Verizon Communications Inc. ("Verizon"). On January 25, 2002, GTE Holdings (Puerto Rico) LLC and Popular, Inc. acquired an additional 12% and 3% interest in the Company, respectively, by exercising an option each held since the Acquisition (the "Option Exercise"). Verizon and Popular, Inc. obtained the additional ownership interest from PRTA Holdings Corp., a subsidiary of the PRTA ("PRTA Holdings"). Verizon and Popular, Inc. paid PRTA Holdings $138 million and $34 million, respectively, for a total of $172 million in cash for the additional 3,750,000 shares at a $45.9364 per share price established in the Share Option Agreement, an agreement entered into at the time of the Acquisition. As a result, Verizon now owns 52%, PRTA owns 28%, Popular owns 13% and the Employee Stock Ownership Plan owns 7% of the outstanding capital stock of the Company. The Company is an affiliate of Verizon, which now consolidates the Company's financial results with its own financial results.
PRTC/VERIZON WIRELESS MERGER
On May 1, 2002, the Company completed a tax-free reorganization whereby it merged Verizon Wireless Puerto Rico, Inc. ("Verizon Wireless"), a wholly owned subsidiary of the Company, into PRTC. Prior to the merger, the Company created a new wholly owned subsidiary, PRTLD, to carry the off-island long distance business previously provided by Verizon Wireless. The objectives of the reorganization were to (i) integrate the wireline and wireless operations without jeopardizing the continuity of the off-island long distance license, (ii) simplify the overall corporate structure to reduce administrative costs, and (iii) provide better control and monitoring of the off-island long distance business and increase its potential for growth in Puerto Rico. As a result of this merger, the Company released a deferred tax valuation allowance, related to the Acquisition, of $93 million, of which $51 million was recorded against goodwill and $42 million was recorded as a deferred tax benefit in the Company's consolidated statement of income for the second quarter of 2002 in accordance with Statements of Financial Accounting Standards ("SFAS") No. 109.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying audited consolidated financial statements have been prepared in accordance with accounting principles accepted in the United States which require management to make estimates and assumptions that affect reported amounts and disclosures and with the rules and regulations of the Securities and Exchange Commission ("SEC"). In the opinion of management the financial statements include all adjustments consisting of normal recurring accruals, necessary to fairly present the results of operations and financial condition. The Company is a holding company with no significant assets or operations other than its investment in its subsidiaries. PRTC is a wholly owned subsidiary of the Company, and fully and unconditionally guarantee payment of the senior notes, term loans and the commercial paper.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and its controlled subsidiary companies, which are wholly owned or majority owned. All significant intercompany accounts and transactions have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles in the United States, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION
Revenues are recognized when services are rendered or products are delivered to customers.
Common carrier line access revenues are generated based on the participation by the PRTC in revenue pools with other telephone companies managed by the National Exchange Carriers Association ("NECA"), which are funded by access charges authorized by the Federal Communications Commission ("FCC") and long-term support amounts received from the Universal Service Fund. Pooled amounts are divided among telephone companies based on allocations of costs and investments in providing interstate services. Revenues are based on preliminary allocations and cost studies and are subject to final settlement in subsequent periods.
Revenues from prepaid cellular cards are recognized based upon usage with any residual balances recognized at the expiration date.
Directory revenues are recognized on the date that directories are published and substantially delivered (see Note 3).
Activation and installation revenues and certain related costs are deferred and amortized over the estimated life of the customer relationship, which is 5 years for wireline and 3 years for wireless (see Note 3).
CASH AND CASH EQUIVALENTS
Short-term investments with original maturities of three months or less are classified as cash equivalents.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The allowance for doubtful accounts is an amount that management believes will be adequate to absorb possible losses on existing receivables that may become uncollectible based on evaluations of the collectibility of the receivables and prior loss experience. Because of uncertainties inherent in the estimation process, management's estimate of losses and the related allowance may change. The Company is not dependent on any single customer.
INVENTORY AND SUPPLIES
Inventory and supplies are stated at average cost, net of obsolescence reserves.
PROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION
Property, plant and equipment is stated at original cost, including interest on funds borrowed to finance the acquisition of capital additions. Repairs and maintenance are expensed as incurred. Depreciable property disposed of in the ordinary course of business, together with the cost of removal, less salvage value, is charged to accumulated depreciation with no gain or loss recognized. Gains or losses from the sale of land are recorded in results of operations.
The Company's depreciation expense is based on the composite group remaining life method and straight-line composite rates. This method provides for the recognition of the cost of the remaining net investment in telephone plant, less anticipated net salvage value, over the remaining asset lives. This method also requires a periodic evaluation of the average remaining useful lives related to the expected recoverability of the carrying value of assets based on changes in technology, environmental factors, the federal and local regulatory environment, and other competitive forces. Effective on July 1, 2002, the Company changed its accounting estimates relating to depreciation. Refer to Note 4 to the consolidated financial statements for further details.
INTANGIBLE ASSETS
Intangible assets consist principally of goodwill, trade names, wireline concessions, cellular licenses, customer base and software licenses.
Effective January 1, 2002, the Company adopted SFAS No. 142 and therefore discontinued the amortization of goodwill and other long-lived assets such as cellular licenses and wireline concessions. The Company amortizes trade names and software licenses on a straight-line basis over 25 and 5 years, respectively. Refer to Note 4 to the consolidated financial statements for further information.
SOFTWARE COSTS
The Company defers and amortizes software development project costs over a five-year period beginning with the project completion.
ADVERTISING COSTS
The Company expenses advertising costs as incurred, and recorded advertising costs of $15 million and $20 million in 2002 and 2001, respectively.
EMPLOYEE BENEFIT PLANS
Pension and post-employment health care and life insurance benefits earned as well as interest on projected benefit obligations are accrued currently. Prior service costs and credits resulting from changes in plan benefits are amortized over the average remaining service period of the employees expected to receive the benefits.
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS
Assets are assessed for impairment when changes in circumstances indicate that their carrying values are not recoverable. Effective, January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets. Losses are recognized in circumstances where an impairment exists, at the amount by which the carrying value of assets exceeds fair value. Fair value is determined based on quoted market prices, if not available, the estimate of fair value is based on various valuation techniques, including a discounted value of estimated future cash flows and fundamental analysis.
In December 2001, the Company recorded an impairment charge of $1.3 million related to its paging business. In addition, in November 2001, the company recorded a write-off charge of $2.2 million related to its wireless brand name intangible. This resulted from the change of name of the Company's wireless business from Celulares Telefonica to Verizon Wireless.
INCOME TAXES
The Company uses an asset and liability approach in accounting for income taxes following the provisions of SFAS No. 109, "Accounting for Income Taxes." Deferred tax assets and liabilities are established for temporary differences between the way certain income and expense items are reported for financial reporting and tax purposes. Deferred tax assets and liabilities are adjusted, to the extent necessary, to reflect tax rates expected to be in effect when the temporary differences reverse. A valuation allowance is established for deferred tax assets for which realization is not likely.
INTEREST RATE RISK
The Company uses interest rate swap agreements to manage exposures to changes in the fair value of its senior notes to achieve a targeted mix of fixed and variable rate debt. The Company does not hold interest rate swaps for trading purpose. Interest rate swaps are marked-to-market in the consolidated balance sheet as a component of other assets.
MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY
The minority interest in the consolidated balance sheet reflects Popular Inc.'s 33% net investment in Coqui.net at year-end.
RECLASSIFICATIONS
Reclassifications of prior years' data have been made to conform to the current year's presentation.
3. ACCOUNTING CHANGE AND ADOPTION OF SEC STAFF ACCOUNTING BULLETIN
The Company changed its method of accounting for directory publishing revenues from the amortization to the publication method, effective January 1, 2000. Under the amortization method, revenues were recognized and amortized over the life of the directory, which is generally one year. Under the publication method, revenues are recognized when a directory is published and substantially delivered. The change was made to more accurately reflect the directory publishing cycle. The new method also conforms to revenue recognition practices in the telecommunications and publishing industries. Results for the year ended December 31, 2000 include the initial impact of applying this accounting change recorded as a cumulative effect of an accounting change of $11 million after-tax in the first quarter of 2000.
The SEC issued SAB 101 effective for fiscal years beginning after December 15, 1999. The Company previously recognized service activation and installation fees and related costs at the time of service initiation. Based on SAB 101, the Company began deferring revenues and related costs associated with activation and installation services over the life of the customer relationship. Costs are deferred only to the extent that revenue is deferred.
The effect of adopting SAB 101 resulted in deferring $34 million in activation and installation revenues and costs prior to January 1, 2000 and amortizing them over 5 years for wireline and 3 years for wireless. Because an equal amount of revenue and expense was deferred, there was no impact on net income for the accounting change. In accordance with SAB 101, the Company restated quarterly information for 2000.
4. SUMMARY OF RECENT ACCOUNTING PRONOUNCEMENTS
BUSINESS COMBINATIONS AND ACCOUNTING FOR GOODWILL AND OTHER INTANGIBLES
In June 2001, the Financial Accounting Standards Board ("FASB") issued 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. The adoption of SFAS No. 141 did not have an effect on the Company's financial statements.
Effective January 1, 2002, the Company adopted SFAS No. 142. SFAS No. 142 no longer permits the amortization of goodwill and other indefinite-lived intangible assets, which has resulted in reducing amortization expense by $16 million for the year ended December 31, 2002. Under SFAS No. 142 assets of each reporting unit must be reviewed annually (or, under certain conditions, more frequently) for impairment. The Company has three reporting units; wireline, wireless and dial-up Internet access.
The Company, together with an independent appraiser, performed the impairment test for the three reporting units. The evaluation revealed that the assets of the three reporting units were fully realizable. The Company intends to perform future tests for impairment at least annually and more often if the Company believes that events or circumstances warrant such action.
The following financial information represents the adjusted consolidated results of operations as if adoption of SFAS No. 142 had been applied to the prior period presented. Adjusted results presented below exclude the effects (net of tax) of the amortization of goodwill and other indefinite life intangibles.
The following table reconciles net income reported for the year December 31, 2002 to the adjusted net income for the same period, as required by the provisions of SFAS No. 142.
ASSET RETIREMENT OBLIGATIONS
On January 1, 2003, we adopted SFAS No. 143, "Accounting for Asset Retirement Obligations." This statement 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 part of the book value of the long-lived asset. We have determined that PRT does not have a material legal obligation to remove long-lived assets as described by this statement. However, we have included estimated removal costs in our group depreciation models. These costs have increased depreciation expense and accumulated depreciation for future removal costs for existing assets. These removal costs are recorded as a reduction to accumulated depreciation when the assets are retired and removal costs are incurred.
For some assets, such as telephone poles, the removal costs exceed salvage value. Under the provisions of SFAS No. 143, we are required to exclude costs of removal from our depreciation rates for assets for which the removal costs exceed salvage. Accordingly, in connection with the initial adoption of this standard on January 1, 2003, we have reversed accrued costs of removal in excess of salvage from our accumulated depreciation accounts for these assets. The adjustment was recorded as a cumulative effect of an accounting change, resulting in the recognition of an estimated gain of $116.5 million ($71 million after-tax). Effective January 1, 2003, we began expensing costs of removal in excess of salvage for these assets as incurred. The impact of this change in accounting will result in a decrease in depreciation expense and an increase in operational and support expenses. We estimate the net increase to operating income in 2003, excluding the cumulative effect adjustment, will be approximately $12 million ($7 million after-tax).
ACCOUNTING FOR IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS
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. The Company adopted SFAS No. 144 effective January 1, 2002 and the adoption did not have any material impact on its financial statements.
EXTINGUISHMENTS OF DEBT AND ACCOUNTING FOR CERTAIN CAPITAL LEASE OBLIGATIONS
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 62, Amendment of FASB Statement No. 13, and Technical Corrections." For most companies, SFAS No. 145 will require gain and losses on extinguishments of debt to be classified as income or loss from continuing operations rather than as extraordinary items as previously required under SFAS No. 4. However, extraordinary treatment will be required for certain extinguishments as provided in APB Opinion No. 30. This statement also amends SFAS No. 13 to require that certain modifications to capital leases be treated as sale-leaseback transactions and modifies the accounting for sub-leases. In addition, the FASB rescinded SFAS No. 44, which addressed the accounting for intangible assets of motor carriers and made numerous technical corrections. At this time, the Company is evaluating the impact, if any, of the adoption of SFAS No. 145 on its results of operations and financial condition.
ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other costs to Exit an Activity (including Certain Costs Incurred in Restructuring)." EITF Issue No. 94-3 required accrual of liabilities related to exit and disposal activities at a plan (commitment) date. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002. The Company believes that the adoption of SFAS No. 146 will not have a material effect on its results of operations and financial condition.
5. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consist of:
(1) These lives consider estimated removal costs and estimated proceeds from disposal.
Effective July 1, 2002, the Company changed its accounting estimates relating to depreciation, resulting from a detailed review of the lives underlying the depreciation rates. The rate changes reflect expected useful lives resulting from the impact of technology and future competition as well as more closely approximating the assumptions used by other telephone companies. These changes resulted in decreasing depreciation expense by approximately $6 million for the second half of 2002.
6. GOODWILL
Following is a breakdown of goodwill by reporting unit.
7. INTANGIBLES
The following table presents current and expected amortization expense of existing intangible assets as of December 31, 2002 and for each of the following years:
8. OTHER ASSETS
9. PENSION PLAN
The Company has noncontributory pension plans for full-time employees, which are tax qualified as they meet Employee Retirement Income Security Act of 1974 (the "ERISA") requirements. The Company realizes tax deductions when contributions are made to the trusts. The trusts invest in equity and fixed income securities to meet benefit obligation.
The pension benefit is composed of two elements. An employee receives an annuity at retirement when they reach the rule of 85 (age plus years of service). The annuity is calculated by applying a percentage times years of service to the last three years of salary. The second element is a lump sum based on years of service, approximating nine to twelve months of salary.
There are separate trust for the annuity and the lump sum benefit with a further separation of the annuity benefit into a plan for the UIET union and for the HIETEL union and management employees.
Health care and life insurance benefits are provided to retirees. The following table sets forth the status of the plans, the actuarial assumptions and the amounts in the financial statements as of December 31, 2002 and 2001:
(In thousands)
The health-care cost trend rate used to measure the December 31, 2002 liability was 11% in the first year, decreasing by 1% each year to an ultimate rate of 5% in 2009. The rate assumed to measure the December 31, 2001 liability was 10% in the first year, decreasing 1% each year to an ultimate rate of 5%.
The actuarial loss of $164 million for 2002 relating to the post-retirement benefits is principally due to higher medical claims for the prior year, higher assumed healthcare rates for future years and a reduction in the discount rate from 7.25% to 6.75%.
The actuarial loss of $53 million for 2002 relating to the pension benefits is principally due to the investment loss during 2002 and a reduction in the discount rate of .5%. The loss was offset somewhat by the decrease in the assumed rate of future wage progression from 5% to 4%.
For 2001, the actuarial loss resulted from a change in the assumed trend rate, participants retiring earlier than expected mainly due to early retirement windows, the decrease in the discount rate and higher than expected medical claims, resulting from higher medical costs and higher utilization.
The 2002 expense results reflect an expected return on assets of 9.25%. For 2003, the expected return asset assumption was lowered to 8.50% to reflect current market conditions and the allocation of plan investments.
An additional minimum pension liability adjustment of $12 million and $53 million was recorded at December 31, 2002 and 2001. The adjustment is necessary to reflect as a net liability at a minimum the fair value of benefit obligation less plan assets with the fair value of benefit obligation calculated on an accumulated benefit obligation basis. An offsetting deferred pension asset of $21 million and $15 million was recorded at December 31, 2002 and 2001 as part of this calculation to recognize all unrecognized prior service costs. The difference between the additional liability adjustment and the additional asset was recorded as a component of other comprehensive income and all accumulated amounts recorded in other comprehensive income is reflected as a separate account within shareholders equity.
In the Acquisition agreement, the PRTA agreed to contribute cash or stock worth a total of $200 million as a capital contribution in even $40 million installments over five years beginning on March 2, 2000. The Company will use the $200 million to fund its underfunded pension and other post-employment benefit obligations. The contribution must be in cash for the first two installments and cash or stock of the Company for the last three installments. During the year ended December 31, 2002, $40 million in cash was received corresponding to the third installment. Future receipts were originally recorded at their discounted present value of $159.7 million (at a 8% discount rate) as a specific component of shareholders' equity in 1999.
Net pension and other post-employment benefit expenses for the years 2002, 2001 and 2000 includes the following components (in thousands):
EARLY RETIREMENT AND VOLUNTARY SEPARATION PROVISION
The Company offered a voluntary separation program to qualified management employees during the fourth quarter of 2002 and recorded a $0.5 million non-cash provision relating to 8 employees accepting.
During 2001, the Company recorded a total of $52 million for early retirement and voluntary separation programs 2001 with four separate offerings to a total of 567 employees.
10. OTHER CURRENT LIABILITIES
Other current liabilities consist of:
11. DEBT
The senior notes, commercial paper, term credit facilities, working capital facility, and bank notes are unsecured and non-amortizing. PRTC is the guarantor of these instruments.
The Company has a $400 million commercial paper program, which is backed by a bank note facility, with maturities not to exceed 365 days. The commercial paper dealer agreement was signed in November 2000. The bank note is a syndicated five-year revolving facility expiring in March 2004. Amounts outstanding under this facility bear interest at 32.5 basis points over LIBOR. Effective November 2002, the bank note facility was decreased from $500 million to $400 million. The bank note credit agreement includes financial covenants, the most significant being that the outstanding principal balance will not exceed four times adjusted Earnings Before Interest, Taxes, Depreciation, and Amortization ("EBITDA"), as defined in the facility agreement.
The Company also has a $50 million working capital credit facility with Banco Popular de Puerto Rico, an affiliate of Popular, Inc. Amounts outstanding under this facility bear interest at a rate of 30 basis points over LIBOR. This facility was renewed in June 2002 with a term of one year. At December 31, 2002, the Company had drawn $40 million under this facility.
On August 31, 2001, the Company entered into an interest rate swap contract at a notional amount of $150 million. In September 2002, the Company drew the value out of the hedge position without changing the fixed/floating funding mix of the original swap transaction. This transaction resulted in cash proceeds of $11 million, reflected in cash from operations consistent with SFAS No. 104, and created a deferred derivative, which will be amortized until 2006. The purpose of the swap is to hedge against changes
in the fair market value of the Company's senior notes to achieve a targeted mix of fixed and variable rate debt. The swap receives interest at a fixed rate of 6.65% and pays interest at a net variable rate equal to six month LIBOR plus 170 basis points, with semiannual settlements and reset dates every May 15 and November 15 until maturity of the May 15, 2006 senior notes. The swap was entered into "at market" and as a result, there was no exchange of premium at the initial date of the swap. The Company designates the swap as a hedge of the changes in fair market value of the senior notes due to changes in the designated benchmark interest rate. PRTC is the guarantor of the interest rate swap.
Aggregate maturities of the senior notes and term credit facilities are as follow:
12. OTHER NON-CURRENT LIABILITIES
Other non-current liabilities consist of:
13. DEFERRED ESOP COMPENSATION
The Employee Stock Ownership Plan ("ESOP") acquired a 3% interest in the Company in 1999 with a $26 million, twenty-year note borrowed from the Company to establish a contributory investment fund for employees. The ESOP only invests in Company shares. Shares are maintained in a suspense account until released to participants. The yearly release of shares to participants is based on the greater of participant contributions plus a Company match of 30% up to 5% of wages or a minimum based on an amortization schedule. The minimum is based on the ratio of annual debt service to total debt service multiplied by the initial 750,000 shares.
The ESOP obtained a $2 million and $3 million advance from the Company in 2001 and 2000, respectively, that was used to purchase Company shares from retired employees. The capital contribution was reflected as additional deferred ESOP compensation in equity.
Compensation expense is recorded based on the release of shares at market value, based on an independent appraisal performed annually. The ESOP released approximately 39,800 and 40,800 shares in 2002 and 2001, respectively. This release resulted in compensation expense of $3 million for each of the two years, respectively, reflecting the market value of the shares. The release of shares, based upon the per share price established at the Acquisition, amounted to $1.4 million for both December 31, 2002 and 2001, which is reflected as a reduction of deferred ESOP compensation in equity.
14. SHAREHOLDERS' EQUITY
COMMON STOCK
Common stock consisted of fifty million authorized no par value shares, of which twenty five million shares were outstanding at December 31, 2002 and 2001.
SUBSCRIPTION RECEIVABLE
The subscription receivable reflects future receipts from the Puerto Rico Telephone Authority ("PRTA") at its present value (at an 8% discount rate). As part of the Acquisition agreement, the PRTA agreed to contribute cash or stock worth a total of $200 million as a capital contribution in even $40 million installments over five years beginning on March 2, 2000. The Company will use the $200 million to fund its underfunded pension and other post-employment benefit obligations. The stock purchase agreement requires that the Company contribute $66 million to the pension plan immediately upon receipt of the proceeds each year.
ACCUMULATED OTHER COMPREHENSIVE LOSS
The accumulated other comprehensive loss represents unrecognized losses, other than unrecognized prior service costs which are reflected as an other asset, associated with the hourly employee pension fund since the accumulated benefit obligation exceeds the fair value of plan assets.
The accumulated other comprehensive loss amount as of December 31, 2002 has been adjusted in the amount of $57.6 million in order to reflect it net of tax in accordance with the provisions of SFAS No.130.
DIVIDENDS
The shareholders agreement requires the payment of dividends equal to at least 50% of consolidated net income, to be paid in the following quarter to the extent funds are legally available.
Dividends payments were made in the following periods:
15. INCOME TAXES
The Company and its subsidiaries file individual income tax returns, as consolidated returns are not allowed under the provisions of the 1994 Puerto Rico Internal Revenue Code, as amended (the "Code").
Provision (benefit) for income tax is determined by applying the maximum statutory tax rate of 39% to pretax income. During the year 2002 and 2001, the Company recorded an income tax provision of $30 million and $70 million, respectively, as set forth below:
A reconciliation of the provision (benefit) to the amount computed by applying the statutory rate for the year ended December 31, 2002 and 2001, is as follows:
The amount of deferred income tax asset as of December 31, 2002 and 2001, is as follows:
Management believes that realization of the deferred income tax asset is more likely than not, based on its evaluation of the Company's anticipated taxable income over the period of years that the temporary differences are expected to become tax deductions.
At December 2001, the Company had a valuation allowance of approximately $28 million, against accumulated net operating losses reflected as a deferred tax asset, which relates to the Company's wireless business. This allowance was established since, based on currently available evidence, management did not believe that it was more likely than not that Verizon Wireless would generate a sufficient level and proper mix of taxable income within the appropriate period to utilize these tax benefits.
During the year 2002, as a result of the merger of Verizon Wireles into PRTC (see Note 1 of the consolidated financial statements for disclosure on business / corporate structure), management has determined that it is more likely them not that the net operating losses will be utilized and, accordingly, reduced such valuation allowance to zero.
16. RELATED PARTY TRANSACTIONS
During the years ended December 31, 2002 and 2001, the Company had the following significant transactions with affiliated companies:
- At December 31, 2002 and 2001, the Company maintained an outstanding $90 million and $50 million respectively, working capital credit facility with an affiliate. This affiliate provides the Company with general banking services, such as lock-box and payroll. In addition, the Company has a contract with this affiliate by which they print and send the monthly billings to the Company's wireless customers. The charges for all of these services amounted to approximately $7 million for the years ended December 31, 2002 and 2001.
- As a result of the Acquisition, the Company entered into a five-year Management and Technology License Agreement with Verizon. Under this agreement, affiliates of Verizon will provide advice and direction related to the administration and operations of the Company, as well as intellectual property or software. Fees for these services amounted to $39 million for both years ended December 31, 2002 and 2001.
- In January 2000, the Company entered into a joint venture agreement with VISI the largest yellow page publishing company in Puerto Rico. During the years ended December 31, 2002 and 2001, the Company generated earnings of $2 million and $3 million, respectively, for its approximate 25% share in VISI.
- The Company also enters into transactions with affiliates for the purchase of materials and supplies used in the construction and expansion of its telecommunications network. Such transactions are subject to conditions similar to transactions with independent third parties. The Company also participates with affiliates of shareholders in sharing the cost of development of computer software programs by third party vendors. The shareholders receive no compensation for arranging the development of such systems. In addition, the Company reimburses shareholders and affiliates for the direct cost of a limited number of employees that work at the Company in management positions.
17. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts and fair values of the Company's financial instruments at December 31 are as follows:
18. SEGMENT REPORTING
The Company has two reportable segments: Wireline and Wireless.
The Wireline segment consists of:
- Local services, including basic voice, telephone and telecommunications equipment rentals, value-added services, high-speed private line services, Internet access and public phone service;
- Access services to long distance carriers, competitive local exchange carriers, and cellular and paging operators to originate and terminate calls on our network;
- Long distance services including direct dial on-island and off-island, operator assisted calls, prepaid calling card and high-speed private line services;
- Directory publishing rights services; and
- Telecommunication equipment sales and billing and collection services to competing long distance operators in Puerto Rico.
The Wireless segment consists of:
- Cellular service; and
- Wireless equipment sales.
The Company measures and evaluates the performance of its segments based on EBITDA, which is a common industry profitability and liquidity measurement. The accounting policies of the segments are the same as those followed by the Company (see Note 2). The Company accounts for intersegment revenues at market prices.
Segment results for the Company are as follows (in thousands):
19. SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest for the year ended December 31, 2002 and 2001 amounted to approximately $60 million and $73 million, respectively. During the years ended December 31, 2002 and 2001, the Company paid income taxes amounting to $34 million and $49 million respectively. However, there were no cash payments for income taxes by the Company during the year ended December 31, 2000.
20. LEASES
The Company has capital and operating leases for certain facilities and equipment. Future minimum lease payments under non-cancelable capital and operating leases are as follows:
Lease costs for the years ended December 31, 2002, 2001 and 2000 amounted to approximately $12 million, $11 million and $10 million, respectively.
21. CONTINGENCIES AND REGULATORY MATTERS
The Company is a defendant in various legal matters arising in the ordinary course of business. The most significant legal and regulatory issues are as follows:
Intra-Island Long Distance Access Rate Dispute
On February 28, 2002 the TRB issued the February 2002 Order with respect to the reconsideration requested by the Company of the TRB October 10, 2001 order to reduce the access rates the Company charges to long distance carriers to originate and terminate intra-island long distance calls through the Company's network.
The February 2002 Order requires new rates for intra-island access to be implemented through phased-rate reductions over four years and directs PRTC to make a cash refund to end-user customers. The prospective access rate reductions (on a two-way basis) were ordered to take place on April 1st of each year as follows:
April 2002: From 9.3 cents per minute to 7.9 cents per minute April 2003: From 7.9 cents per minute to 6.5 cents per minute April 2004: From 6.5 cents per minute to 5.0 cents per minute April 2005: From 5.0 cents per minute to 2.1 cents per minute
The February 2002 Order also requires PRTC to pay a $68 million refund to end-user customers. The TRB calculated this amount based on the difference between the 9.3 cents and 7.9 cents rate for TRB estimated traffic from the period April 1, 2000 through March 31, 2002. The refund can be made in 12 quarterly, equal installments starting April 1, 2002.
The Company filed with the Puerto Rico Circuit Court of Appeals ("Court") an appeal of the February 2002 Order in which the Company alleges the TRB made errors of law and procedure in its determination of access charges and its order to make the cash refund. The Court stayed the refund and the rate reduction on March 27, 2002 and is currently hearing the appeal.
On April 2, 2002, AT&T, Sprint and LTD ("Carriers") filed a petition with the Court for review of the February 2002 Order, requesting the Court to order the rate reduction without a phase-in period, remand the case back to the TRB and direct the TRB to calculate the refund from and after April 1997 instead of April 2000, with the Carriers receiving the refund instead of the end-user customers.
The hearing involving oral presentations by the parties was held on February 19, 2003. The parties will have a fifteen (15) day period to submit their post hearing final brief once the transcript of the oral argument is received. PRT has not received this transcript yet. At this preliminary stage it is too early to assess the probability of success in the appeals process. The Company believes the Carriers' petition for review is without merit.
Public Telephone Service Provider - Anti Competitive Disputes
Telefonos Publicos de Puerto Rico, Inc. ("TPPR") the largest competitive provider of public pay phones in Puerto Rico filed a suit in the U.S. District Court on November 8th, 2001, claiming predatory, exclusionary and anticompetitive acts and seeking damages of $75 million. We have filed a motion to dismiss the case and are awaiting a decision of the court.
Pan American Telephone, Inc., Intouch Telecommunications, Inc., and Choicetel Communications, Inc., three additional competitive providers also filed a similar suit in the United States District Court of Puerto Rico on September 4, 2002 on the same grounds. On November 8, 2002, after having evaluated and determined that this claim is similar to TPPR claim, we have filed a motion to dismiss the case. At present, we are awaiting a decision of the court.
In August 16, 2002, PSA, the parent company for Phoenix filed a suit in the Delaware bankruptcy court claiming anti competitive acts. The claims have since been transferred to Federal District Court and the disputes between the two parties include PRT's amended administrative claim against PSA, and PSA's complaint for over $9 million against PRT. PRT has filed a motion to dismiss and change of venue which is pending before the Federal District Court.
The Company's management believes all of these claims are without merit.
Touchtone Charges
On July 2, 2002, three residential telephone service subscribers and one business service subscriber filed a class action suit with the Superior Court of Puerto Rico (the "Superior Court") under the Puerto Rico Telecommunications Act of 1996 ("Act"). The plaintiffs claim that the Company's charges for touchtone service are not based on cost, and are therefore in violation of the Act. They have requested that the Court (i) issue an Order certifying the case as a class action, (ii) designate the plaintiffs as representatives of the class, (iii) find that the charges are illegal, (iv) establish a maximum charge based on cost, and (v) order the Company to reimburse every subscriber for excess payments made since September 1996.
On October 25, 2002, plaintiffs filed a motion requesting class certification. The plaintiffs filed on November 22, 2002, a voluntary request for dismissal as to some plaintiffs. On December 19, 2002, PRT filed its answer to the amended complaint. On February 18, 2003, PRT filed its respective opposition to plaintiff's motion for class certification. At present, we are awaiting for a decision with respect to the voluntary dismissals and our opposition to class certification.
Measured Service Unit Charges
On July 16, 2002, one residential telephone service subscriber and three business service subscribers filed a class action with the Court under the Act. The plaintiffs claim that the Company's unit charges for local measured service are not based on cost, and are therefore in violation of the Act. They have requested that the Court (i) issue an Order certifying the case as a class action, (ii) designate the plaintiffs as representatives of the class, (iii) find that the unit charges are illegal, (iv) establish a maximum unit charge based on cost, and (v) order the Company to reimburse every subscriber for excess payments made since September 1996.
On November 22, 2002 plaintiffs filed the request for voluntary dismissal without prejudice. On February 26, 2003, the Court issued an Order with respect to the motion requesting voluntary dismissal. Specifically, the Court ordered the plaintiffs to present within a period of twenty (20) days, that is until March 18, 2003, their position towards the class action suit if the dismissal is granted. However, on March 5, 2003 the Court issued an Order dismissing the case without prejudice.
Message processing and billing systems
The Company has an agreement for the implementation of a traffic polling and billing software system for its wireline operations. The billing portion of the project is currently behind schedule and management is evaluating the feasibility of continuing that portion. As of December 31, 2002 the Company has invested approximately $30 million in hardware, software and labor on the billing system portion of the project.
Other
In connection with the privatization of the Company, the PRTA agreed to indemnify, defend and hold the Company harmless for specified litigation in excess of $50 million in the aggregate, including one environmental matter.
22. QUARTERLY FINANCIAL DATA
The following table reflects the unaudited quarterly results of the Company for the years ended December 31, 2002, 2001 and 2000.
(1) During the fourth quarter of 2000, the Company changed its revenue recognition accounting method, in accordance with SEC Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements," effective January 1, 2000 (see Note 3). The quarterly information for the first three quarters of 2000, which had been previously reported has been restated. No restatement of 1999 information was necessary.
(2) During the fourth quarter of 2000, the Company changed its method of accounting for directory-publishing revenues and related expenses from the amortization method to the point of publication method, effective January 1, 2000 (see Note 3). The quarterly information for the first three quarters of 2000, which had been previously reported has been restated. No restatement of 1999 information was necessary.
23. CONDENSED CONSOLIDATING INFORMATION
The Notes are guaranteed by PRTC, a wholly owned subsidiary of the Company (the "Guarantor Subsidiaries"), but not guaranteed by the Company's other subsidiaries, Coqui.net, PRTLD, and Datacom (the "Non-Guarantor Subsidiaries"). The guarantee by the guarantor subsidiary is full and unconditional.
The following condensed consolidating financial information as of December 31, 2002 and 2001 and for the years then ended, presents the financial position, results of operations and cash flows of (i) the Company as if it accounted for its subsidiaries on the equity method, (ii) the Guarantor Subsidiary; and (iii) the Non-Guarantor Subsidiaries on a combined basis. The consolidation entries eliminate investments in subsidiaries and intercompany balances and transactions.
CONDENSED CONSOLIDATING BALANCE SHEETS December 31, 2002 (In thousands)
CONDENSED CONSOLIDATING BALANCE SHEETS December 31, 2002 (In thousands)
CONDENSED CONSOLIDATING STATEMENTS OF INCOME For the year ended December 31,2002 (In thousands)
CONDENSED CONSOLIDATING STATEMENTS OF INCOME For the year ended December 31, 2001 (In thousands)
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS For the year ended December 31, 2002 (In thousands)
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS For the year ended December 31, 2001 (In thousands)
TELECOMUNICACIONES DE PUERTO RICO, INC.
SCHEDULE II - Valuation and Qualifying Accounts For The Years Ended December 31, 2002, 2001and 2000
NOTES:
(a) Reserved write-offs.
(b) Other adjustments and recoveries of amounts written off in prior years.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
BOARD OF DIRECTORS
As of March 25, 2003, the directors of the Company, all of whom serve until their successors are appointed are as follows:
Daniel C. Petri is the Group President-International responsible for Verizon's wireless and wireline operations in Mexico, Venezuela, the Dominican Republic, Puerto Rico and Canada. Prior to this appointment he served as President-International Europe & Asia. During his communications carrier of more than 30 years, Mr. Petri has held a number of key positions in domestic as well as international operations. He holds a bachelor's degree in mechanical engineering from Rutgers University and a master's degree in management science from Long Island University. He has also completed management programs in General Management, Finance and Marketing at the Columbia University Graduate School.
Alfred C. Giammarino was appointed Senior Vice President and Chief Financial Officer-Information Services and International, Verizon, in June 2000. Previously, he was the Senior Vice President of International Finance, Planning and Business Development for GTE since 1998. Mr. Giammarino has held a wide range of senior management financial positions in his 17-year Verizon/GTE career. He serves on the boards of CANTV, a Venezuelan telephone company, Iusacell, a Mexican cellular company, and CTI Movil, an Argentine telecommunications company. Mr. Giammarino is a Certified Public Accountant.
Gary S. Butler is Group Vice President International responsible for strategic and operational initiatives for Verizon Wireless and wireline operations in Mexico, Venezuela, the Dominican Republic, Puerto Rico and Canada. Previously he was Vice President-Europe and Asia. Prior to Bell Atlantic / GTE merger, Mr. Butler was Executive Vice President-Operations, TelecomAsia Corporation a position he held since 1998. Butler earned a BS from the U.S. Military Academy at West Point and an MBA from Golden Gate University.
Jon E. Slater was appointed our President and Chief Executive Officer in March 1999. Prior to that, he was Vice President Operations Support for GTE Wireless since 1997, having previously served in various positions with Verizon/GTE since 1971. Other positions that Mr. Slater has held with Verizon/GTE include Area President Texas for GTE Mobilnet's Texas region, Vice President and General Manager for GTE Telecom and GTE Government/Telecommunications Services, and Vice President Operations for GTE Airfone.
Steven R. Smith is the Vice President International Finance from Verizon Communications. Prior to this appointment, Mr. Smith was the group vice president international finance, Europe and Asia. Before the merger of Bell Atlantic and GTE to form Verizon, Mr. Smith was Director-Strategic Planning for Bell Atlantic International Telecommunications. Mr. Smith received a Bachelor's degree in Mechanical Engineering Technology from the State University of New York at Binghamton and an MBA from the University of Rochester. Mr. Smith is a Chartered Financial Analyst (CFA).
Richard L. Carrion has been Chairman, President and Chief Executive Officer of Popular, Inc., since 1990 and has been a director since 1982. Mr. Carrion is a director of Verizon and Wyeth.
Hector Mendez was appointed President of the Development Government Bank ("GDB") in July 2002. Previously he was the GDB Vice-President and Treasurer, a position he held since February 2001. Mr. Mendez has held various positions in the Puerto Rico banking industry, including Senior Vice President and Treasurer of the Hispanic Central Bank. His academic background includes a Bachelor's degree in Business Administration with a major in Accounting and Management from the University of Puerto Rico and a Master's Degree in Finance and International Trade from the Inter American University of Puerto Rico.
Hector Nevares is a private investor and serves on the boards of Suiza Foods Corp., First Bank of Puerto Rico, Caribbean Consolidated Schools, Indulac, and the Company for the Development of the Cantera Peninsula. Mr. Nevares was the Vice Chairman of Suiza Foods Corp. from 1996 to 1999 and President from 1982 to 1996.
Samuel H. Jove is a private investor and has been President of BMJ Foods PR, Inc. since the company was founded in 1984. Mr. Jove serves as President of the Metromedia International Franchisees Advisory Board. Mr. Jove also serves on the boards of the GDB and Puerto Rico Housing Finance Corporation.
Since March 17, 1999 the Board of Directors has had a standing Audit Committee. Currently, the Audit Committee is comprised of Alfred C. Giammarino, Hector Nevares and Steven R. Smith. The Audit Committee oversees the financial reporting process for which management is responsible, reviews the services provided by our independent auditors, consults with the independent auditors in regard to our audits and proposed audits, reviews the need for internal auditing procedures and the adequacy of internal controls and performs other fiduciary oversight responsibilities including but not limiting to significant business transactions.
EXECUTIVE OFFICERS
The executive officers of the Company as of March 25, 2003, are as follows:
Michael D. Mills was appointed Vice President Finance and Chief Financial Officer of the Company on December 17, 2002. Most recently he was Executive Director International Finance Mergers & Acquisitions for Verizon, a position from which he participated in GTE/Verizon's acquisition of a controlling interest in PRT. During his over 27 years with GTE/Verizon he held various controllership and financial planning positions within their telephone operating Company's, Telephone Headquarters and parent company World Headquarters organizations. Mr. Mills holds a Bachelor of Arts Degree in Environmental Design (Architecture) and an MBA in finance and accounting from the University of Washington.
Jose E. Arroyo was appointed Vice President Legal and Regulatory Affairs on March 17, 1999. He joined the Company in 1995 as Legal Counsel to the President and was later appointed as Vice President Human Resources, Legal and Regulatory Affairs. Prior to joining the Company, he was Associate Counsel for two law firms in Puerto Rico and also served as Special Assistant to the Attorney General of Puerto Rico. Mr. Arroyo holds a bachelors degree in Science and a juris doctorate from the University of Puerto Rico.
Cristina M. Lambert was appointed Vice President and General Manager of Wireline on June 3, 1999. She has over 26 years of experience in the telecommunications industry. After holding positions of ascending responsibilities in Verizon/GTE, in 1995 she was named General Manager, customer operations in Illinois, where she supervised wireline telephone services for nearly one million customers. In 1997, Mrs. Lambert became Assistant Vice President Integrated Process Planning for GTE. The following year she began directing and implementing business strategies for GTE national customer care organization. Mrs. Lambert holds a bachelor's degree in Business Management from Indiana University and a master's degree in Business Administration from Indiana Wesleyan University.
Beth De Winter was appointed Vice President and General Manager of Wireless on January 1, 2002. Prior to joining the Company, Mrs. Winter was General Manager of fixed wireless services for AT&T Wireless in Texas. Prior to that, Mrs. Winter had worked for BellSouth where she held several positions including Vice President-Broadband Product Development, for BellSouth.net, Inc., Vice President Sales and Marketing, for BellSouth-Ecuador, International Marketing Director, for BellSouth-Nicaragua and Senior International Marketing Manager, for BellSouth-Latin America. Mrs. Winter holds a masters degree in International Business Administration from the University of Arizona.
Francisco M. Arroyo was appointed Vice President Sales and Customer Contact on November 12, 2002. Mr. Arroyo has extensive experience in the telecommunication industry. Prior to joining the Company, Mr. Arroyo served as Senior Director of Calling Centers for WorldCom-Brazil. Previously, Mr. Arroyo worked for WorldCom International where he held several positions since 1993. Mr. Arroyo holds a bachelors degree in Biology from the University of Puerto Rico and a masters degree in Latin American Studies from the University of New Mexico.
Benito Fernandez was appointed Vice President Human Resources on June 11, 2001. Prior to joining the Company, Mr. Fernandez held the position of Vice President Human Resources for Montefiore Medical Center. Prior to that, he was Vice President Columbia Presbyterian Medical Center and Labor Counsel for Westvaco Corporation and also served as an associate in the law firm Arthur, Dry & Kalish. Mr. Fernandez holds a bachelors degree from the College of the City of New York and an L.L.M. from New York University School of Law and a J.D. from Brooklyn Law School.
Ileana Molina de Bachman was appointed Vice President Corporate Communications on August 30, 1999. Ms. Bachman has over 23 years of consumer goods marketing experience in Puerto Rico, Mexico, the Dominican Republic and with Hispanic markets in the United States. Prior to joining the Company, Ms. Bachman was Senior Vice President at Suiza Fruit Caribbean and from 1995 to 1998 with Frito Lay. She has also worked for Procter & Gamble, Young and Rubicam and RJ Reynolds. She holds a bachelors degree from the Boston College School of Management.
Roberto A. Correa was appointed Vice President Engineering and Technical Planning on February 2, 2000. Mr. Correa was previously the Director of Network Planning and Network Engineering and has held various management positions in his 21 years with the Company. He represents the Company on technical committees before the United States Telecommunications Association. He holds a bachelors degree in Electrical Engineering from the University of Puerto Rico and a masters degree in Electrical Engineering from Georgia Tech.
Kathy A. Thompson was appointed Vice President Information Technology on November 27, 2001. Mrs. Thompson has over 22 years of experience in Information Technology. Prior to joining the Company, she was Vice President Information Technology and Process Management for Verizon Communications. Mrs. Thompson began her career at Verizon/GTE in 1992. She holds a bachelors degree in Mathematics and Computer Science from Sam Houston State University and a masters degree in Business Administration from Texas A&M University.
Robert P. Huberty was appointed Controller and Chief Accounting Officer on June 1, 1999. He has over 23 years of Finance, Marketing and Information Technology experience with Verizon/GTE in their corporate, international and former equipment manufacturing groups. Prior to joining the Company, he was the Director of GTE International Mergers and Acquisitions involved in the privatization of the Company. He holds a bachelors degree in Accounting and a masters degree in Finance from Pace University and is a Certified Public Accountant.
Maria E. De La Cruz was appointed Treasurer of the Company on December 3, 2002. Ms. De La Cruz has been with the Company in the Treasury Department since May 2002 serving as Assistant Treasurer. Ms. De La Cruz has over 12 years of banking and financial management experience in private industry and public accounting. She holds a bachelors degree in Finance from the University of Puerto Rico and is a Certified Public Accountant.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth compensation of the five highest compensated company executives.
(1) Mr. Fernandez joined the Company on June 11, 2001. His 2001 bonus reflects a prorated amount based on start date.
(2) Mrs. De Winter joined the Company on January 1, 2002.
(3) Mr. Reagan joined the Registrant in September 2001 and left the Company in December 2002.
(4) For year 2000, the bonus column reflects the amounts each executive officer received under both the Verizon Short-Term Incentive Plan and the GTE Executive Incentive Plan.
(5) For 2002, the column "Other Annual Compensation" includes housing allowances Messrs. Slater, Fernandez, and Reagan and Ms. Lambert and De Winter in the amount of: $120,000; $60,000; $72,000; $85,800 and $66,000, respectively.
(6) The data reflects the dollar value of the one-time grant of restricted stock units based on the closing price of Verizon common stock on the grant date, September 7, 2000. These units vest over the next three years subject to meeting certain performance and time measures. On each dividend payment date, additional restricted units are credited to the participant's account. The number of restricted stock units is determined by dividing the dividend that would have been paid on the shares represented by the restricted stock units in the participant's account by the closing price of Verizon's common stock on the New York Stock Exchange Composite Transactions Tape on the dividend payment date. Mr. Slater and Ms. Lambert hold a total of: 4,743 and 1,617 restricted stock units, respectively, which had a dollar value of: $183,788 and $62,655, respectively, based upon the closing price of Verizon common stock on December 31, 2002.
(7) Messrs. Slater and Reagan and Ms. Lambert, as former GTE executives, received payments for the 2000 to 2002 award cycle, under the GTE Long-Term Incentive Plan of: $183,900; $71,720; and $57,800, respectively.
(8) "All Other Compensation" column includes Verizon contributions to qualified 401(k) plans for Messrs. Slater, Fernandez, and Reagan and Ms. Lambert, De Winter, and Bachman of: $16,142; $10,979; $10,665; $15,915; $8,462; and $8,128, respectively; contributions by the Company and its related companies to the non-qualified income deferral plan accounts of Messrs. Slater, Fernandez, and Reagan and Ms. Lambert in the amounts of: $122,835; $18,796; $31,325; and $47,991, respectively; the value of premiums paid by the Company for executive life insurance policies for Messrs. Slater, Fernandez, and Reagan and Ms. Lambert in the amounts of: $91,838; $21,778; $29,609; and $15,304, respectively.
The following table shows grants of options in Verizon shares to the named executive officers during 2002. Pursuant to SEC rules, the table also shows the value of the options granted at the end of the option terms if the stock price were to appreciate annually by 5% and 10%, respectively. There is no assurance that the stock price will appreciate at the rates shown in the table below. The table also indicates that, if the stock price does not appreciate, the potential realized value of the options granted would be zero.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
(1) One-third of the options are exercisable on January 24, 2003; two thirds are exercisable on January 24, 2004; and the balances are exercisable on January 24, 2005.
(2) Options became fully exercisable on December 21, 2002, with a 5-year term remaining per plan provisions.
The following table provides information as to options and stock appreciation rights (referred to as SARs) exercised by each of the named executive officers during 2002. The table sets forth the value of options and stock appreciation rights held by such officers at 2002 year-end.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
VERIZON RETIREMENT PROGRAMS
VERIZON PENSION PLANS
Effective January 1, 2002, Verizon merged the management pension plans of the predecessor companies to form the Verizon Management Pension Plan. The plan is a noncontributory, tax-qualified pension plan for salaried employees that provides for distribution of benefits in a lump sum or an annuity, at the participant's election. Pension benefits under this plan are calculated for all participants using a cash balance formula that provides for pay credits equal to 4 to 7 percent (depending on age and service) of annual eligible pay up to the statutory limit on compensation ($200,000 in 2002), for each year of service following the conversion to cash balance. Messrs. Slater, Fernandez, and Reagan, and Ms. Lambert, DeWinter, and Bachman began participating in the Verizon Management Pension Plan as of January 1, 2002.
In general, eligible pay includes base salary, commissions and short-term incentives, exclusive of overtime, certain senior manager or other incentive compensation, and other similar types of payments. Additionally, monthly interest credits are made to the participant's account balance based upon the prevailing market yields on certain U.S. Treasury obligations. In order to record these pay and interest credits, the plan administrator maintains a hypothetical account balance for each participant. However, as part of the transition to a cash balance formula, participants with at least 10 years of service with the Company as of January 1, 2002, receive benefits under an alternative formula, referred to as the "highest average pay formula," if that formula provides a higher benefit than the cash balance formula. Under this formula, pensions are computed until 2008 on 1.35% of eligible pay for average annual salary for the five highest consecutive years up to the statutory limit on compensation ($200,000 in 2002), for each year of service. In 2008, the Verizon Management Pension Plan shifts from this highest average pay formula to a career average pay formula under which an employee's pension is computed on 1.35% of eligible pay for average annual salary over the remainder of the employee's career with the Company up to the statutory limit on compensation, for each year of service. As of December 31, 2002, or the executive's date of separation in 2002, the actual years of service credited under the Verizon Management Pension Plan for Messrs. Slater, Fernandez, and Reagan, and Ms. Lambert, DeWinter, and Bachman are 32, 2, 16, 29, 1, and 4, respectively.
The following table illustrates the estimated annual benefits payable pursuant to the highest average pay formula under the Verizon Management Pension Plan based on a maximum compensation limit of $200,000. The table assumes normal retirement at age 65 and is calculated on a single life annuity basis, based upon final average earnings and years of service:
All former GTE employees with at least 10 years of service with the Company as of January 1, 2002, are eligible to receive benefits under a variant to the highest average pay formula described above if that formula provides a higher benefit. This formula provides a benefit that was integrated with social security and is available through May 31, 2004. For compensation under $37,200, which is the limit under the Federal Social Security Act, the formula was based on 1.15% of eligible pay, while the formula for pay above that amount was based on 1.45% of eligible pay.
The following table illustrates the estimated annual benefits payable pursuant to this alternative highest average pay formula, integrated with social security, under the Verizon Management Pension Plan based on a maximum compensation limit of $200,000. The table assumes normal retirement at age 65 and is calculated on a single life annuity basis, based upon final average earnings and years of service:
Employees who do not have at least 10 years of service generally do not qualify for the highest average pay formula under the plan. Accordingly, Mr. Fernandez's and Ms. DeWinter's and Bachman's cash balance accounts were $22,703; $10,114; and $51,707, respectively, as of December 31, 2002. Mr. Reagan's pension under the Verizon Management Pension Plan, based on the cash balance formula, was $179,792.
Section 415 of the Internal Revenue Code places certain limitations on pension benefits that may be paid from the trusts of tax-qualified plans, such as the Verizon Management Pension Plan. Pension amounts for certain executive officers that exceed such Section 415 limitations will be paid from the Company's assets under the Verizon Income Deferral Plan. Messrs. Slater, Fernandez, and Reagan, and Ms. Lambert, DeWinter, and Bachman began participating in the Verizon Income Deferral Plan as of January 1, 2002. This plan is a nonqualified, unfunded, supplemental retirement and deferred compensation plan under which an individual account is maintained for each participant. The plan allows the participants to defer voluntarily the receipt of up to 100% of their eligible compensation, and also provides retirement and other benefits to certain executives through Company credits to the participant's account under the plan. Eligible compensation consists of:
I. a participant's base salary in excess of the Internal Revenue Code limit on compensation for qualified retirement plans ($200,000 in 2002);
II. all of the participant's short-term incentive award; and
III. other bonuses that the plan administrator determines are eligible for deferral.
If a participant elects to defer eligible income, the Company provides a matching contribution equal to the rate of match under the qualified savings plan for management employees. That rate is 100% of the first 4% of eligible compensation deferred and 50% of the next 2% of eligible compensation deferred. In addition, for the first 20 years of participation in the plan for certain executives of the Company, the Company makes retirement contributions to a participant's account equal to 32% of the base salary, in excess of $200,000, and short-term incentive award components of the participant's eligible compensation. Thereafter, the Company makes retirement contributions equal to 7% of such eligible compensation.
The following table shows the aggregate portion of each participating named executive officer's account attributable to the Company's contributions as of December 31, 2002. In 2002, Messrs. Slater, Fernandez, and Reagan, and Ms. Lambert, and all other former GTE executives, had their Verizon Supplemental Executive Retirement Plan benefit converted to a present value and transferred to the Verizon Income Deferral Plan. As a result, Messrs. Slater, Fernandez, and Reagan, and Ms. Lambert are no longer entitled to receive a benefit under the Verizon Supplemental Executive Retirement Plan and instead began participating in the Verizon Income Deferral Plan along with all other Verizon executives effective January 1, 2002. Generally, the Verizon Income Deferral Plan provides a benefit at retirement comparable to the benefit provided under the Verizon Supplemental Executive Retirement Plan.
*Includes $2,037,275; $10,979; $72,792; and $476,717 for Messrs. Slater, Fernandez, and Reagan, and Ms. Lambert, respectively, representing a present value conversion and transfer of their earned benefits from the Verizon Supplemental Executive Retirement Plan.
The actual annual Company contribution for 2002 has been reflected in the "All Other Compensation" column of the Summary Compensation Table.
Pension benefits for Ms. DeWinter and Backman were calculated only under the Verizon Mangement Pension Plan using a cash balance formula that provides for pay credits equal to 4 to 7 percent (depending on age and service) of annual eligible pay both up to and greater than the statutory limit on compensation ($200,000 in 2002), for each year of service following the conversion. As of December 31, 2002, Ms. DeWinter's and Bachman's cash balance accounts were $10,114 and $51,707, respectively.
As of December 31, 2002, the actual years of service credited under the Verizon Management Pension Plan for Ms. DeWinter and Bachman are 1 and 4, respectively.
EXECUTIVE RETIRED LIFE INSURANCE PLAN
Verizon's Executive Retired Life Insurance Plan provides executives a postretirement life insurance benefit of up to three times final base salary. Benefits may be paid as life insurance or, alternatively, an equivalent amount equal to the present value of the life insurance amount as a lump sum payment, as an annuity or in installment payments.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Company has a Compensation Committee comprised of, Richard L. Carrion, Daniel C. Petri and Samuel H. Jove. This Committee is responsible for establishing and administering the policies and plans related to compensation of the Company's management, including the executives listed in the "Executive Officers" table included in Item 10 of this Form 10-K.
Richard L. Carrion, a Director of the Company, serves as Chairman of the Compensation Committee. Mr. Carrion is Chairman, President and Chief Executive Officer of Popular, Inc. He also serves as Director of Verizon.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
SHAREHOLDERS AND SHAREHOLDER RELATIONSHIPS
SHARE OWNERSHIP
There were 50 million authorized and 25 million outstanding shares of no par value common stock at December 31, 2002. The owners of the common stock as of March 25, 2003 are as follows:
CHANGE OF SHAREHOLDER OWNERSHIP PERCENTAGE
On January 25, 2002, Verizon, through its subsidiary GTE Holdings (Puerto Rico) LLC, and Popular, Inc. acquired an additional 12% and 3% interest in the Company, respectively, by exercising an option each held since the Acquisition on March 2, 1999. Verizon and Popular obtained the additional ownership interest from PRTA Holdings.
Verizon and Popular paid PRTA Holdings $138 million and $34 million, respectively, for a total of $172 million in cash for the additional 3,750,000 shares at a $45.936 per share price established in the Share Option Agreement.
OWNERSHIP REQUIREMENTS
Verizon must maintain at least a 35% ownership interest through March 2, 2004. If Verizon proposes to transfer shares as permitted by the shareholders agreement, other than to any of its affiliates or other than in a public offering or widely distributed private placement, which is for more than 7.5% of the total number of our shares or which would result in the transferee owning over 20% of our shares, then the Government of Puerto Rico shall have the right to participate in this sale, by selling the applicable pro-rata portion of the aggregate number of shares then owned by all of the Puerto Rico Entities. If the Puerto Rico Entities would own 5% or less of our shares after exercising this right, Verizon shall have the option of requiring that the Puerto Rico Entities sell all of their remaining shares to the buyer, or requiring that the Puerto Rico Entities sell to the buyer the shares that the buyer is willing to purchase and sell any remaining shares owned by the Puerto Rico Entities to Verizon.
Under the Popular Shareholders Agreement, Popular, Inc. has the right to require Verizon to permit Popular, Inc. to participate on a pro-rata basis in any transfer of shares to non-affiliates by Verizon, other than an underwritten public offering or widely distributed private placement.
The Company has agreed to use all commercially reasonable efforts to support an initial public offering ("IPO") of the Government's remaining 28% interest.
SHAREHOLDERS' AGREEMENT
The board of directors has 9 members, who are appointed as follows: 5 directors are appointed by Verizon; 1 director is appointed by Popular, Inc., pursuant to an agreement with Verizon; and 3 directors are appointed by PRTA Holdings (Government). The ESOP does not have the right to appoint any directors. The number of directors the Government of Puerto Rico can appoint is related to its share ownership in the Company. The PRTA is entitled to appoint 3, 2, or 1 director as long as it (or its successor) holds at least a 25%, 15%, or 4% ownership interest, respectively. Unanimous approval is required for the following actions:
- An acquisition, strategic alliance, or joint venture exceeding 15% of the Company's assets;
- Issuance of equity, convertible equity securities, or debt;
- Changes in the dividend policy; and
- Transactions with Verizon and Popular, Inc. exceeding $1 million, annually.
Unanimous approval is required for the additional following matters as long as the Government holds at least a 10% ownership interest:
- Asset sales of 25% or more of the Company's assets;
- Amendments to the Certificate of Incorporation, which adversely affect the Government; and
- The liquidation, merger or consolidation of the Company.
Verizon and the Government agreed that neither party, nor a Verizon affiliate, will compete in the telecommunications business (subject to certain exceptions) until the earlier of:
- The date when the Government ceases to own at least 5% of the shares,
- The later of 7 years after the sale or 1 year after an IPO.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
TRANSACTIONS WITH VERIZON
MANAGEMENT AND TECHNOLOGY LICENSE AGREEMENTS
Verizon provides advice and direction regarding the administration and operations of our business, as well as providing us with its existing intellectual property and software that is not restricted by patents or copyrights under a 5-year agreement, expiring March 2, 2004. Verizon is reimbursed for transportation, lodging, and meals and receives royalties and fees based on the following percentages of EBITDA, excluding provisions for voluntary severance programs:
- 8% for years 1 and 2 of the agreement;
- 7% for years 3 and 4 of the agreement;
- 6% for year 5 of the agreement.
Total royalties and fees accrued in 2002 and 2001 were $39 million for each of the two years.
REIMBURSEMENT AGREEMENT
The Company has a reimbursement agreement with Verizon, whereby actual out-of-pocket expatriate salaries and related benefit expenses are billed back to the Company. Total expatriate expenses for the year ended December 31, 2002 and 2001 amounted to $8 million and $13 million, respectively. Refer to the "Executive Compensation" section (Item 11) for further details.
OTHER AFFILIATED TRANSACTIONS
The Company also enters into transactions with affiliates for the purchase of materials and supplies used in construction and expansion of its telecommunications network. Such transactions are subject to conditions similar to transactions with independent third parties. The Company also participates with affiliates of shareholders in sharing the cost of development of computer software programs by third party vendors. The shareholders receive no compensation for arranging the development of such systems.
DIRECTORY AGREEMENTS
We entered into a new 95-year agreement in 1999 with VISI, a joint venture among VNU, Verizon, and ourselves which provides us a publishing right of 35% of yellow page advertising revenues, plus billing and collection fees which generated $20 million of directory advertising revenues for the year 2002.
TRANSACTIONS WITH POPULAR, INC.
Popular, Inc. provides wireline bill collection, lock-box, cash management, and wireless bill processing services for $7 million for each of 2002 and 2001. These services are negotiated at arms-length market value rates.
At December 31, 2002, the Company maintained a $50 million working capital credit facility with Banco Popular de Puerto Rico, a subsidiary of Popular, Inc. At December 31, 2002, the Company had drawn $40 million under this working capital credit facility.
ITEM 14.
ITEM 14. ONTROL AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Our chief executive officer and chief financial officer have evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) of the Securities Exchange Act of 1934), as of a date within 90 days of the filing date of this annual report (Evaluation Date), that ensure that material information relating to the Company which is required to be disclosed in this report is recorded, processed, summarized and reported, within required time periods. They have concluded that as of the Evaluation Date, the Company disclosure controls and procedures were adequate and effective to ensure that material information relating to the Company and its consolidated subsidiaries would be made known to them by others within those entities, particularly during the period in which this annual report was being prepared.
(b) Changes in Internal Controls
There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the Evaluation Date, nor were there any significant deficiencies or material weaknesses in these controls requiring corrective actions. As a result, no corrective actions were taken.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) and (2) List of Financial Statements and Financial Statements Schedules:
See Index to Consolidated Financial Statements on Item 8 "Financial Statements and Supplementary Data."
(All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and, therefore, have been omitted.)
(3) Exhibits
See Exhibit Index.
(b) Reports on Form 8-K
None filed during the fourth quarter 2002.
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this amended report to be signed on its behalf by the undersigned, thereunto duly authorized.
TELECOMUNICACIONES DE PUERTO RICO, INC.
By: /s/ JON E. SLATER ----------------------------------------- Name: Jon E. Slater Title: Chief Executive Officer Date: March 25, 2003
By: /s/ MICHAEL D. MILLS ----------------------------------------- Name: Michael D. Mills Title: Chief Financial Officer Date: March 25, 2003
By: /s/ ROBERT P. HUBERTY ----------------------------------------- Name: Robert P. Huberty Title: Chief Accounting Officer Date: March 25, 2003
CEO CERTIFICATION
I, Jon E. Slater, certify that:
1. I have reviewed this annual report on Form 10-K of Telecomunicaciones de Puerto Rico, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this annual report;
4. The Company's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Company and have:
a) designed such disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the Company's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The Company's other certifying officers and I have disclosed, based on our most recent evaluation, to the Company's auditors and the audit committee of the Company's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Company's ability to record, process, summarize and report financial data and have identified for the Company's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Company's internal controls; and
6. The Company's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date March 25, 2003 ---------------------------- /s/ JON E. SLATER ---------------------------- Jon E. Slater Chief Executive Officer (Principal Executive Officer)
CFO CERTIFICATION
I, Michael D. Mills, certify that:
1. I have reviewed this annual report on Form 10-K of Telecomunicaciones de Puerto Rico, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this annual report;
4. The Company's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Company and have:
a) designed such disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the Company's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The Company's other certifying officers and I have disclosed, based on our most recent evaluation, to the Company's auditors and the audit committee of Company's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Company's ability to record, process, summarize and report financial data and have identified for the Company's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Company's internal controls; and
6. The Company's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date March 25, 2003 ----------------------------- /s/ MICHAEL D. MILLS ----------------------------- Michael D. Mills Chief Financial Officer (Principal Financial Officer)
CERTIFICATION REQUIRED BY 18 U.S.C. SECTION 1350
Pursuant to 18 U.S.C. Section 1350 (as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002), the undersigned hereby certify that this Annual Report on Form 10-K fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that the information contained in this annual report fairly presents, in all material respects, the financial condition and results of operations of the registrant.
TELECOMUNICACIONES DE PUERTO RICO, INC.
By: /s/ JON E. SLATER ---------------------------------------- Name: Jon E. Slater Title: Chief Executive Officer Date: March 25, 2003
By: /s/ MICHAEL D. MILLS ---------------------------------------- Name: Michael D. Mills Title: Chief Financial Officer Date: March 25, 2003
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX