10-Q 1 d10q.txt VERIZON MARYLAND 3RD QUARTER FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------------- FORM 10-Q --------------------- (Mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number 1-6875 VERIZON MARYLAND INC. A Maryland Corporation I.R.S. Employer Identification No. 52-0270070 One East Pratt Street, Baltimore, Maryland 21202 Telephone Number (410) 539-9900 ------------------------- THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT PURSUANT TO GENERAL INSTRUCTION H(2). Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Verizon Maryland Inc. PART I - FINANCIAL INFORMATION Item 1. Financial Statements CONDENSED STATEMENTS OF INCOME

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

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

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

See Notes to Condensed Financial Statements. 4 Verizon Maryland Inc. NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation Verizon Maryland Inc. is a wholly owned subsidiary of Verizon Communications Inc. (Verizon Communications). The accompanying unaudited condensed financial statements have been prepared based upon Securities and Exchange Commission (SEC) rules that permit reduced disclosure for interim periods. These financial statements reflect all adjustments that are necessary for a fair presentation of results of operations and financial position for the interim periods shown including normal recurring accruals. The results for the interim periods are not necessarily indicative of results for the full year. The balance sheet at December 31, 2000 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For a more complete discussion of significant accounting policies and certain other information, you should refer to the financial statements included in our 2000 Annual Report on Form 10-K. We have reclassified certain amounts from prior year's data to conform to the 2001 presentation. 2. Revenue Recognition We recognize revenue when services are rendered based on usage of our local exchange network and facilities. For other products and services, revenues are generally recognized when services are rendered or products are delivered to customers. We defer nonrecurring service activation revenues and costs and amortize them over the expected term of the customer relationship. The deferred costs are equal to the activation fee revenue and any excess cost is expensed immediately. The deferred costs represent incremental direct costs associated with certain nonrecurring fees, such as service activation and installation fees. 3. Long-Lived Assets We assess the impairment of long-lived assets under Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" whenever events or changes in circumstances indicate that the carrying value may not be recoverable. A determination of impairment (if any) is made based on estimates of future cash flows. 4. Dividend On November 1, 2001, we declared and paid a dividend in the amount of $73.0 million to Verizon Communications. 5. Derivatives and Hedging Activities Effective January 1, 2001, we adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities." SFAS No. 133 requires that all derivatives, including derivatives embedded in other financial instruments, be measured at fair value and recognized as either assets or liabilities on our balance sheet. Changes in the fair values of derivative instruments not qualifying as hedges under SFAS No. 133 or any ineffective portion of hedges are recognized in earnings in the current period. Changes in the fair values of derivative instruments used effectively as fair value hedges are recognized in earnings, along with changes in the fair value of the hedged item. Changes in the fair value of the effective portions of cash flow hedges are reported in other comprehensive income (loss), and recognized in earnings when the hedged item is recognized in earnings. We presently do not have any derivative instruments or hedging activities and, consequently, SFAS No. 133 did not have an impact on our financial statements. 6. Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, "Business Combinations," and SFAS 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. 5 Verizon Maryland Inc. SFAS No. 142 no longer permits the amortization of goodwill and indefinite- lived intangible assets. Instead, these assets must be reviewed annually (or more frequently under certain conditions) for impairment in accordance with this statement. This impairment test uses a fair value approach rather than the undiscounted cash flows approach previously required by SFAS No. 121. The new statement also applies to goodwill and indefinite-lived intangible assets of investments accounted for under the equity method of accounting. Intangible assets that do not have indefinite lives will continue to be amortized over their useful lives and reviewed for impairment in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." We are required to adopt SFAS No. 142 effective January 1, 2002. We are currently evaluating our intangible assets to determine the impact, if any, the adoption of SFAS No. 142 will have on our results of operations or financial position. In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." This standard provides the accounting for the cost of legal obligations associated with the retirement of long-lived assets. SFAS No. 143 requires that companies recognize the fair value of a liability for asset retirement obligations in the period in which the obligations are incurred and capitalize that amount as a part of the book value of the long-lived asset. That cost is then depreciated over the remaining life of the underlying long-lived asset. We are required to adopt SFAS No. 143 effective January 1, 2003. We are currently evaluating the impact this new standard will have on our future results of operations or financial position. In August 2001, the FASB issued SFAS No. 144. This standard supersedes SFAS No. 121 and the provisions of Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," with regard to reporting the effects of a disposal of a segment of a business. SFAS No. 144 establishes a single accounting model for assets to be disposed of by sale and addresses several SFAS No. 121 implementation issues. We are required to adopt SFAS No. 144 effective January 1, 2002. We do not expect the impact of the adoption of SFAS No. 144 to have a material effect on our results of operations or financial position. 7. Merger Charges In connection with the merger of Bell Atlantic and GTE on June 30, 2000, we incurred charges associated with employee severance of $14.2 million pre-tax. Employee severance costs, as recorded under SFAS No. 112, "Employers' Accounting for Postemployment Benefits," represent the benefit costs for the separation of management employees who were entitled to benefits under pre-existing separation plans. During the second quarter of 2000, in connection with the merger, we also recorded a pre-tax charge of $12.2 million for direct, incremental merger- related costs, including compensation, professional services and other direct costs. In addition, we recorded pre-tax merger-related transition costs of $16.4 million in the first nine months of 2001 and $2.4 million for the first nine months of 2000. Transition costs consisted of costs to integrate systems, consolidate real estate, relocate employees and meet certain regulatory conditions of the merger. They also included costs for advertising and other costs to establish the Verizon brand. Transition costs since the date of the merger totaled $23.3 million. Transition costs are expensed as incurred. During the second quarter of 2000, we also recorded a $.2 million pre-tax charge for other actions in relation to the Bell Atlantic-GTE merger. This charge was related to the write-off of duplicate assets. 8. Shareowner's Investment

Net income and comprehensive income were the same for the nine months ended September 30, 2001 and 2000. 9. Commitments and Contingencies Various legal actions and regulatory proceedings are pending to which we are a party and claims which, if asserted, may lead to other legal actions. We have established reserves for specific liabilities in connection with regulatory and legal matters that we currently deem to be probable and1 estimable. We do not expect that the ultimate resolution of pending regulatory and legal matters 6 Verizon Maryland Inc. in future periods will have a material effect on our financial condition, but it could have a material effect on our results of operations. Several regulatory matters may require us to refund a portion of the revenues collected in the current and prior periods. The outcome of each pending matter, as well as the time frame within which each matter will be resolved, is not presently determinable. Regulatory conditions to the Bell Atlantic - GTE merger include certain commitments to, among other things, promote competition and the widespread deployment of advanced services, while helping to ensure that consumers continue to receive high-quality, low cost telephone services. In some cases, there are significant penalties associated with not meeting these commitments. The cost of satisfying these commitments could have a significant impact on net income in future periods. 7 Verizon Maryland Inc. Item 2. Management's Discussion and Analysis of Results of Operations (Abbreviated pursuant to General Instruction H(2).) This discussion should be read in conjunction with the Financial Statements and Notes to Financial Statements. RESULTS OF OPERATIONS --------------------- We reported net income of $284.4 million for the nine month period ended September 30, 2001, compared to net income of $276.0 million for the same period in 2000. Our results for 2001 and 2000 were affected by special items. The special items in both periods include our allocated share of charges from affiliates that provide various centralized services on behalf of Verizon Communications Inc. subsidiaries. The following table shows how special items are reflected in our condensed statements of income for each period:

What follows is a further explanation of the nature of these special items. Merger Charges In connection with the merger of Bell Atlantic and GTE on June 30, 2000, we incurred charges associated with employee severance of $14.2 million pre-tax. Employee severance costs, as recorded under SFAS No. 112, "Employers' Accounting for Postemployment Benefits," represent the benefit costs for the separation of management employees who were entitled to benefits under pre-existing separation plans. During the second quarter of 2000, in connection with the merger, we also recorded a pre-tax charge of $12.2 million for direct, incremental merger- related costs, including compensation, professional services and other direct costs. In addition, we recorded pre-tax merger-related transition costs of $16.4 million in the first nine months of 2001 and $2.4 million for the first nine months of 2000. Transition costs consisted of costs to integrate systems, consolidate real estate, relocate employees and meet certain regulatory conditions of the merger. They also included costs for advertising and other costs to establish the Verizon brand. Transition costs are expensed as incurred. During the second quarter of 2000, we also recorded a $.2 million pre-tax charge for other actions in relation to the Bell Atlantic-GTE merger. This charge was related to the write-off of duplicate assets. Other Charges and Special Items In the second quarter of 2000, we recorded other charges and special items totaling approximately $11.7 million. These charges included costs for the write-off of accounts receivable, legal contingencies and other miscellaneous items. These and other items affecting the comparison of our results of operations for the nine month periods ended September 30, 2001 and 2000 are discussed in the following sections. 8 Verizon Maryland Inc. OPERATING REVENUES ------------------ (Dollars in Millions) Nine Months Ended September 30, 2001 2000 -------------------------------------------------------------------------------- Local services $1,107.6 $1,098.9 Network access services 577.9 505.9 Long distance services 43.7 51.8 Other services 118.9 123.1 --------------------------------- Total $1,848.1 $1,779.7 ================================= LOCAL SERVICES 2001 - 2000 Increase -------------------------------------------------------------------------------- Nine Months $8.7 .8% -------------------------------------------------------------------------------- Local service revenues are earned from the provision of local exchange, local private line, wire maintenance, voice messaging and value-added services. Value-added services are a family of services that expand the utilization of the network, including products such as Caller ID, Call Waiting and Return Call. The provision of local exchange services not only includes retail revenues, but also includes local wholesale revenues from unbundled network elements (UNEs), interconnection revenues from competitive local exchange carriers, certain data transport revenues and wireless interconnection revenues. Local service revenues increased in the first nine months of 2001 primarily due to higher revenues from our value-added services as a result of new packaging of services and from our wire maintenance services. Higher payments received from competitive local exchange carriers for the purchase of unbundled network elements and higher customer demand and usage of our private line services also contributed to the increase in local service revenues in the first nine months of 2001. These increases were substantially offset by the effect of lower demand and usage of our basic wireline services, as reflected by a decrease in our switched access lines in service from September 30, 2000. This decrease primarily reflects the impact of an economic slowdown and competiton. In addition, the effect of technology substitution is increasing, as more customers are choosing wireless and Internet services in place of certain basic wireline services. NETWORK ACCESS SERVICES 2001 - 2000 Increase -------------------------------------------------------------------------------- Nine Months $72.0 14.2% -------------------------------------------------------------------------------- Network access revenues are earned from end-user subscribers and from long distance and other competing carriers who use our local exchange facilities to provide usage services to their customers. Switched access revenues are derived from fixed and usage-based charges paid by carriers for access to our local network. Special access revenues originate from carriers and end-users that buy dedicated local exchange capacity to support their private networks. End-user access revenues are earned from our customers and from resellers who purchase dial-tone services. Network access revenue growth in the first nine months of 2001 was mainly attributable to higher customer demand for special access services particularly for high-capacity, high-speed digital services. This increase was partially offset by price reductions associated with a federal price cap filing and other regulatory decisions. The Public Service Commission of Maryland (PSC) regulates us with respect to certain intrastate rates and services and certain other matters. The Federal Communications Commission (FCC) regulates rates that we charge long distance carriers and end- user subscribers for interstate access services. We are required to file new access rates with the FCC each year. In July 2000, we implemented the Coalition for Affordable Local and Long Distance Service (CALLS) plan. Rates included in the July 2000 CALLS plan were in effect through June 2001. Effective July 3, 2001, we implemented further rate reductions in accordance with the plan. The impact of the slowing economy also affected network access revenues in 2001. 9 Verizon Maryland Inc. LONG DISTANCE SERVICES 2001 - 2000 (Decrease) -------------------------------------------------------------------------------- Nine Months $(8.1) (15.6)% -------------------------------------------------------------------------------- Long distance revenues are earned primarily from calls made to points outside a customer's local calling area, but within our service area (intraLATA toll). IntraLATA toll calls originate and terminate within the same LATA, but generally cover a greater distance than a local call. These services are regulated by the PSC except where they cross state lines. Other long distance services that we provide include 800 services and Wide Area Telephone Service (WATS). Long distance service revenues declined in the first nine months of 2001 primarily due to competition and the effects of toll calling discount packages and product bundling offers of our intraLATA toll services. OTHER SERVICES 2001 - 2000 (Decrease) -------------------------------------------------------------------------------- Nine Months $(4.2) (3.4)% -------------------------------------------------------------------------------- Our other services include such services as billing and collections for long distance carriers and affiliates, facilities rentals to affiliates and nonaffiliates, public (pay) telephone, customer premises equipment (CPE) and sales of materials and supplies to affiliates. Other service revenues also include fees paid by customers for nonpublication of telephone numbers and multiple white page listings and fees paid by an affiliate for usage of our directory listings. Other service revenues decreased in the first nine months of 2001 primarily due to lower facilities rental revenues from affiliates and a decline in public telephone revenues, as more customers substituted wireless communications for pay phone services. These decreases were partially offset by an increase in sales and services to an affiliate. OPERATING EXPENSES ------------------ (Dollars in Millions) OPERATIONS AND SUPPORT 2001 - 2000 (Decrease) -------------------------------------------------------------------------------- Nine Months $(39.9) (4.3)% -------------------------------------------------------------------------------- Operations and support expenses consist of employee costs and other operating expenses. Employee costs consist of salaries, wages and other employee compensation, employee benefits and payroll taxes. Other operating expenses consist of contract services including centralized services expenses allocated from affiliates, rent, network software costs, operating taxes other than income, the provision for uncollectible accounts receivable, reciprocal compensation, and other costs. The decrease in operations and support expenses was primarily attributable to the effect of merger-related costs and other special items recorded in 2000 and 2001, as described in the Results of Operations section. Operations and support expenses were further reduced by lower employee overtime pay, business integration activities and effective cost control measures. These decreases were partially offset by annual salary and wage increases for management and non- management employees. We continue to incur expenditures related to reciprocal compensation arrangements with competitive local exchange carriers and other carriers to terminate calls on their network. In March 2000, the United States Court of Appeals for the District of Columbia Circuit reversed and remanded the FCC's February 1999 order that concluded that calls to the Internet through Internet service providers (ISP) do not terminate at the ISP but are single interstate calls. The FCC had concluded that calls to the Internet are not therefore subject to reciprocal compensation under section 251(b)(5) of the Telecommunications Act, but left it to state regulatory commissions to determine whether local interconnection agreements entered into with competing carriers required the payment of compensation on such calls. 10 Verizon Maryland Inc. On April 27, 2001, the FCC released an order responding to the court's remand. The FCC found that Internet-bound traffic is interstate and subject to the FCC's jurisdiction. Moreover, the FCC again found that Internet-bound traffic is not subject to reciprocal compensation under section 251(b)(5) of the Telecommunications Act. Instead, the FCC established federal rates that decline from $0.0015 to $0.0007 per minute over a three-year period. The FCC order also sets caps on the total minutes that may be subject to any intercarrier compensation and requires that incumbent local exchange carriers must offer to pay reciprocal compensation for local traffic at the same rate as they are required to pay on Internet-bound traffic. DEPRECIATION AND AMORTIZATION 2001 - 2000 Increase -------------------------------------------------------------------------------- Nine Months $40.8 11.6% -------------------------------------------------------------------------------- Depreciation and amortization expense increased in the first nine months of 2001 principally due to growth in depreciable telephone plant and increased software amortization costs. Higher rates of depreciation also contributed to the increase, but to a lesser extent. OTHER INCOME AND (EXPENSE), NET 2001 - 2000 (Decrease) -------------------------------------------------------------------------------- Nine Months $(35.3) (497.2)% -------------------------------------------------------------------------------- The change in other income and (expense), net, was primarily attributable to equity losses recognized from our investment in Verizon Advanced Data Inc. (VADI). VADI is a wholly owned subsidiary of Verizon Communications that provides new exchange access services. At September 30, 2001, our ownership interest in VADI was 14.65%. INTEREST EXPENSE 2001 - 2000 Increase -------------------------------------------------------------------------------- Nine Months $3.6 6.1% -------------------------------------------------------------------------------- Interest expense includes costs associated with borrowings and capital leases, net of interest capitalized as a cost of acquiring or constructing plant assets. Interest expense increased in the first nine months of 2001, over the same period in 2000, primarily due to higher levels of average short-term debt with an affiliate. This increase was partially offset by higher capitalized interest costs resulting from higher levels of average telephone plant under construction and the effect of lower rates of interest. EFFECTIVE INCOME TAX RATES Nine Months Ended September 30, -------------------------------------------------------------------------------- 2001 41.3% -------------------------------------------------------------------------------- 2000 39.4% -------------------------------------------------------------------------------- The effective income tax rate is the provision for income taxes as a percentage of income before the provision for income taxes. Our effective income tax rate was higher in the first nine months of 2001 principally due to equity losses associated with our investment in VADI, for which we do not recognize income tax benefits. 11 Verizon Maryland Inc. OTHER MATTERS ------------- Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141, which applies to business combinations occurring after June 30, 2001, requires that the purchase method of accounting be used and includes guidance on the initial recognition and measurement of goodwill and other intangible assets acquired in the combination. SFAS No. 142 no longer permits the amortization of goodwill and indefinite- lived intangible assets. Instead, these assets must be reviewed annually (or more frequently under certain conditions) for impairment in accordance with this statement. This impairment test uses a fair value approach rather than the undiscounted cash flows approach previously required by SFAS No. 121. The new statement also applies to goodwill and indefinite-lived intangible assets of investments accounted for under the equity method of accounting. Intangible assets that do not have indefinite lives will continue to be amortized over their useful lives and reviewed for impairment in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." We are required to adopt SFAS No. 142 effective January 1, 2002. We are currently evaluating our intangible assets to determine the impact, if any, the adoption of SFAS No. 142 will have on our results of operations or financial position. In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." This standard provides the accounting for the cost of legal obligations associated with the retirement of long-lived assets. SFAS No. 143 requires that companies recognize the fair value of a liability for asset retirement obligations in the period in which the obligations are incurred and capitalize that amount as a part of the book value of the long-lived asset. That cost is then depreciated over the remaining life of the underlying long-lived asset. We are required to adopt SFAS No. 143 effective January 1, 2003. We are currently evaluating the impact this new standard will have on our future results of operations or financial position. In August 2001, the FASB issued SFAS No. 144. This standard supersedes SFAS No. 121 and the provisions of Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," with regard to reporting the effects of a disposal of a segment of a business. SFAS No. 144 establishes a single accounting model for assets to be disposed of by sale and addresses several SFAS No. 121 implementation issues. We are required to adopt SFAS No. 144 effective January 1, 2002. We do not expect the impact of the adoption of SFAS No. 144 to have a material effect on our results of operations or financial position. 12 Verizon Maryland Inc. PART II - OTHER INFORMATION Item 1. Legal Proceedings There were no proceedings reportable under this Item. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: Exhibit Number ------ 12 Computation of Ratio of Earnings to Fixed Charges. (b) There were no Current Reports on Form 8-K filed during the quarter ended September 30, 2001. 13 Verizon Maryland Inc. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Verizon Maryland Inc. Date: November 13, 2001 By /s/ Edwin F. Hall -------------------------------- Edwin F. Hall Controller UNLESS OTHERWISE INDICATED, ALL INFORMATION IS AS OF NOVEMBER 8, 2001. 14 Verizon Maryland Inc. EXHIBIT INDEX Exhibit Number Description ------ ----------- 12 Computation of Ratio of Earnings to Fixed Charges. 15

VERIZON MARYLAND INC 10-Q