10-Q 1 d10479e10vq.txt FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended: SEPTEMBER 30, 2003 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 333-85503 TELECOMUNICACIONES DE PUERTO RICO, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) COMMONWEALTH OF PUERTO RICO 66-0566178 (STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.) INCORPORATION OR ORGANIZATION) 1515 FD ROOSEVELT AVENUE GUAYNABO, PUERTO RICO 00968 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) Registrant's telephone number, including area code: 787-792-6052 (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] Indicate by check mark whether the registrant is an accelerated filer. YES [ ] NO [X] Telecomunicaciones de Puerto Rico, Inc. had 25 million shares of no par common stock outstanding at November 14, 2003. ================================================================================ 1 TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES INDEX PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) 3 Condensed Consolidated Balance Sheets--September 30, 2003 and December 31, 2002 3 Condensed Consolidated Statements of Operations--Three Months Ended September 30, 2003 and 2002; Nine Months Ended September 30, 2003 and 2002 4 Condensed Consolidated Statements of Changes in Shareholders' Equity--Nine 5 Months Ended September 30, 2003 and Year Ended December 31, 2002 Condensed Consolidated Statements of Cash Flows--Nine Months Ended September 30, 2003 and 2002 6 Notes to Condensed Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 29 Item 3. Quantitative and Qualitative Disclosures About Market Risk 43 Item 4. Controls and Procedures 44 PART II. OTHER INFORMATION Item 1. Legal Proceedings 45 Item 2. Changes in Securities and Use of Proceeds 45 Item 3. Defaults Upon Senior Securities 45 Item 4. Submission of Matters to a Vote of Security Holders 45 Item 5. Other Information 45 Item 6. Exhibits and Reports on Form 8-K 45 SIGNATURES 46 EXHIBIT INDEX 47

2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands)

The accompanying notes are an integral part of these financial statements. 3 TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands)

The accompanying notes are an integral part of these financial statements. 4 TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (in thousands)

The accompanying notes are an integral part of these financial statements. 5 TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)

The accompanying notes are an integral part of these financial statements. 6 TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -------------------------------------------------------------------------------- 1. BUSINESS / CORPORATE STRUCTURE Telecomunicaciones de Puerto Rico, Inc., a Puerto Rico corporation ("we" or 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 the Company's shareholders, holds the remaining 33% interest. The Company also holds a 24% 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 service is provided by the wireless division of PRTC, under the brand of Verizon Wireless Puerto Rico, Inc. ("Verizon Wireless"). 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 connection with 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 had held since the Acquisition (the "Option Exercise"). Verizon and Popular, Inc. obtained the additional ownership interest from PRTA Holdings Corp., a subsidiary of 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 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, 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 for 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 approximately $93 million, approximately $51 million of which was recorded against goodwill and approximately $42 million of which was recorded as a deferred tax benefit in the Company's consolidated statement of income for the second quarter of 2002 in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States for annual financial statements have been condensed or omitted pursuant to such rules and regulations. Management believes the financial statements include all adjustments and recurring accruals necessary to present fairly the results of operations and financial condition for the interim periods shown. The Condensed Consolidated Balance Sheet at December 31, 2002 was derived from audited financial statements and should be read in conjunction with the notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002. 7 RECLASSIFICATIONS Reclassifications of prior periods' data have been made to conform to the current period's presentation. 3. ACCOUNTING CHANGE FOR DIRECTORY REVENUE RECOGNITION During the second quarter of 2003, the Company changed its method of accounting for directory-publishing revenues and related expenses from the point-of-publication method to the amortization method, effective January 1, 2003. Under the point-of-publication method, such revenues and related expenses are recognized on the date that the directory is published and substantially delivered. Under the amortization method, pre-publication revenues and expenses are deferred and capitalized, respectively. Subsequent to publication, revenues are recognized and expenses amortized over the lives of the directories, which is generally one year. While both methods fully comply with accounting principles generally accepted in the United States, the Company adopted the amortization method because it is becoming the industry standard. The cumulative effect of applying this accounting change to prior years is recognized as of January 1, 2003 as a one-time, non-cash loss of $17 million ($13 million, after tax). The effect of applying the new method for the nine months ended September 30, 2003 is a one-time non-cash revenue increase of $10 million, which has been included in operating income. The following table shows the pro forma effect on operating results for the three and nine months ended September 30, 2002 had the Company applied the amortization method during prior periods:

8 4. SUMMARY OF RECENT ACCOUNTING PRONOUNCEMENTS ACCOUNTING FOR GOODWILL AND OTHER INTANGIBLES The Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets" effective January 1, 2002, which provides guidance on the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 no longer permits the amortization of goodwill and other indefinite-lived intangible assets. Instead, these assets must be reviewed annually (or, under certain conditions, more frequently) for impairment in accordance with this statement. This impairment test uses a fair value approach rather than the undiscounted cash flow approach previously required by SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." 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." The Company has evaluated its assets using the fair value approach for each reporting unit to determine if there is an impairment exposure (transitional impairment test) and the impact it would have on the Company's results of operations for 2003. The evaluation of the two reporting units revealed no impairment exposure. ASSET RETIREMENT OBLIGATIONS On January 1, 2003, the Company 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. The Company has determined that PRTC does not have a material legal obligation to remove long-lived assets as described by this statement. However, the Company has included estimated removal costs in the Company's 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, the Company is required to exclude costs of removal from the Company's 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, the Company has reversed accrued costs of removal in excess of salvage from the Company's 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 $117 million ($71 million after tax). Effective January 1, 2003, the Company began expensing costs of removal in excess of salvage for these assets as incurred. The impact of this change in accounting resulted in a decrease in depreciation expense and an increase in operational and support expenses. The Company estimates that 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 Financial Accounting Standards Board (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, without any impact on its 2002 financial statements. 9 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 64, Amendment of FASB Statement No. 13, and Technical Corrections." For most companies, SFAS No. 145 requires 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 is 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 that are not substantive in nature to existing pronouncements. The Company evaluated the impact of the adoption of SFAS No. 145 and concluded that there is no material effect 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 previously required that a liability related to exit and disposal activities be recognized at the date of a company's commitment to an exit plan. By contrast, 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 evaluated the impact of the adoption of SFAS No. 146 and concluded that there is no a material effect on its results of operations and financial condition. AMENDMENTS OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES In April 2003, the FASB issued SFAS No. 149, "Amendments of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. In addition, all provisions of SFAS No. 149 should be applied prospectively. However, the provisions of this statement that relate to SFAS 133 Implementation Issues that have been effective for fiscal quarters beginning prior to June 15, 2003 continue to be applied in accordance with their respective effective dates. The Company evaluated the impact of the adoption of SFAS No. 149 and concluded that there is no material effect on its results of operations and financial condition. ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." This standard clarifies the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. SFAS No. 150 requires that those instruments be classified as liabilities in statements of financial position. The requirements of this statement apply to issuers' classification and measurement of freestanding financial instruments, including those that comprise more than one option or forward contract. SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company evaluated the impact of the adoption of SFAS No. 150 and concluded that there is no material effect on its results of operations and financial condition. ACCOUNTING FOR REVENUE ARRANGEMENTS WITH MULTIPLE DELIVERABLES In November 2002, the Emerging Issues Task Force ("EITF") of the FASB reached a consensus on EITF No. 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables." EITF No. 00-21 addresses how to account for arrangements that may involve multiple revenue-generating activities. Specifically, the issue addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. The consensus guidance will be applicable to agreements entered into in quarters beginning after June 15, 2003. The Company evaluated the impact of the adoption of EITF No. 00-21 and concluded that there is no material effect on its results of operations and financial condition. 10 5. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consist of:

Effective July 1, 2002, the Company revised its accounting estimates relating to depreciation, based on a detailed review of the lives underlying the depreciation rates. The depreciation rate revisions 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 revisions resulted in a decrease in depreciation expense by approximately $6 million for the second half of 2002 and approximately $9 million for the nine months ended September 30, 2003. 6. GOODWILL Following is a breakdown of goodwill.

11 7. INTANGIBLES Intangibles consist of:

8. OTHER ASSETS Other assets consist of:

12 9. VOLUNTARY SEPARATION AND RETIREMENT PROGRAMS 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 as a result of 8 employees accepting the program. In January 2003, an additional 29 qualified management employees accepted the voluntary separation program, representing an expense of $1.4 million, which was recorded in the first quarter of 2003. During the second quarter of 2003, the Company offered to members of one of the unions a voluntary separation program that closed on June 20, 2003, which 44 qualified employees accepted. Also, during the second quarter of 2003, an additional 147 employees in the craft union accepted a retirement program offered by the Company that closed on June 30, 2003. As a result of these two programs, an additional provision of $3.3 million was recorded. 10. DEFERRED ESOP COMPENSATION The Employee Stock Ownership Plan ("ESOP") acquired a 3% equity interest in the Company in 1999, which was financed by a $26 million, twenty-year note borrowed from the Company to establish a contributory investment fund for employees. The ESOP only invests in shares of the Company's common stock. Shares are held by the ESOP's trustee and maintained in a suspense account until they are released to employee 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. Compensation expense is recorded based on the release of shares at market value, which is based on an independent appraisal performed annually. The ESOP released approximately 39,800 shares in 2002. This release resulted in compensation expense of $3 million for the year ended December 31, 2002, 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 December 31, 2002, which is reflected as a reduction of deferred ESOP compensation in equity. 11. OTHER CURRENT LIABILITIES Other current liabilities consist of:

13 12. DEBT Debt consists of:

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 debt instruments. The Company has a $400 million commercial paper program with maturities not to exceed 365 days, which is backed by a bank note facility. The commercial paper dealer agreement for the program was signed in November 2000. The bank note facility is a syndicated five-year revolving facility expiring in March 2004. Amounts outstanding under this facility bear interest at 32.5 basis points over the London Interbank Offered Rate ("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 of which is that the outstanding principal balance under the bank note facility must not exceed four times adjusted Earnings Before Interest, Taxes, Depreciation, and Amortization ("EBITDA"), as defined in the facility agreement. The Company also has a $40 million working capital credit facility with Banco Popular de Puerto Rico, an affiliate of Popular, Inc., which was renewed on June 30, 2003 with a term of one year. Amounts outstanding under this facility bear interest at a rate of 30 basis points over LIBOR. At September 30, 2003, the Company did not have a balance outstanding under this facility. On August 31, 2001, the Company entered into an interest rate swap contract with 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 as required by SFAS No. 104, "Statement of Cash Flows - Net Reporting of Certain Cash Payments and Classification from Hedging Transactions" 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 semi-annual 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. 14 Aggregate maturities of the senior notes and term credit facilities are as follow:

13. OTHER NON-CURRENT LIABILITIES Other non-current liabilities consist of:

14. SHAREHOLDERS' EQUITY COMMON STOCK Common stock consists of fifty million authorized shares, no par value, twenty five million shares of which were outstanding at September 30, 2003 and December 31, 2002. SUBSCRIPTION RECEIVABLE The subscription receivable reflects future receipts from PRTA at its present value, using an 8% discount rate. As part of the Acquisition agreement, PRTA agreed to contribute a total of $200 million in cash or stock as a capital contribution in equal installments of $40 million over five years beginning on March 2, 2000. The Company will use the $200 million capital contribution to partially fund its underfunded pension and other post-employment benefit obligations. The stock purchase agreement requires that the Company contribute $66 million, which includes the $40 million received from PRTA, to the pension plan immediately upon receipt of the proceeds each year. The Company received the fourth $40 million installment in March 2003 and made the required pension payment of $66 million. 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 the after-tax amount in accordance with the provisions of SFAS No. 130, "Reporting Comprehensive Income." 15 DIVIDENDS The Company's shareholders' agreement requires the payment of dividends equal to at least 50% of consolidated net income, in the following quarter to the extent funds are legally available. Dividend payments were made in the following periods:

In March 2003, the Company declared a $17.8 million dividend for the fourth quarter of 2002, which was paid in the second quarter of 2003. In addition, in the second quarter of 2003, the Company paid a $50.3 million dividend for the first quarter of 2003. The senior note indentures and credit facility agreements do not contain any dividend restrictions. 15. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts and estimated fair values of the Company's financial instruments are as follows:

16 16. SEGMENT REPORTING The Company has two reportable segments: Wireline and Wireless. The Wireline segment consists of: o Local services, including basic voice, telephone and telecommunications equipment rentals, value-added services, high-speed private line services, Internet access and public phone service; o Access services to long distance carriers, competitive local exchange carriers, and cellular and paging operators to originate and terminate calls on the Company's network; o Long distance services including direct dial on-island and off-island, operator assisted calls, prepaid calling card and high-speed private line services; o Directory publishing rights services; and o Telecommunication equipment sales and billing and collection services to competing long distance operators in Puerto Rico. The Wireless segment consists of: o Cellular service; and o Wireless equipment sales. 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. 17 Segment results for the Company are as follow:

18 17. CONDENSED CONSOLIDATING INFORMATION The following summarizes the unaudited condensed consolidating financial information as of September 30, 2003 and December 31, 2002 and for the quarters then ended presents the financial position, results of operations and cash flows of (i) the Company as if it had accounted for its subsidiaries using the equity method, (ii) the Guarantor Subsidiary (as defined below); and (iii) the Non-Guarantor Subsidiaries (as defined below) on a combined basis. The consolidation entries eliminate investments in subsidiaries and intercompany balances and transactions. The Notes are guaranteed by PRTC (the "Guarantor Subsidiary"), a wholly-owned subsidiary of the Company, 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. 19 CONDENSED CONSOLIDATING BALANCE SHEETS September 30, 2003 (in thousands)

20 CONDENSED CONSOLIDATING BALANCE SHEETS December 31, 2002 (in thousands)

21 CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS For the three months ended September 30, 2003 (in thousands)

22 CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS For the three months ended September 30, 2002 (in thousands)

23 CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS For the nine months ended September 30, 2003 (in thousands)

24 CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS For the nine months ended September 30, 2002 (in thousands)

25 CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS For the nine months ended September 30, 2003 (in thousands)

26 CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS For the nine months ended September 30, 2002 (in thousands)

27 18. CONTINGENCIES AND REGULATORY AND OTHER MATTERS 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 condition 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, 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 United States Federal Communications Commission (the "FCC") for inter-state wireline services and by the Puerto Rico Telecommunications Board ("TRB") for intra-island wireline services. The Company has an agreement with a provider for the implementation of a traffic polling and billing software system for its wireline operations. While the traffic polling portion has been implemented, management has determined that it is in the Company's best interests to abandon the billing portion of the software system. The amount of capitalized costs for software and labor related to the billing portion of $32.3 million was written off and included in operating expenses during the second quarter of 2003. Management is currently in discussions with the provider of the system and seeking a satisfactory resolution of this matter. In September 2003, the Company established a pre-tax reserve of $73 million, including interest, for the end-user and AT&T refund referred to in the TRB Resolution and Order of February 28, 2002. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Other Matters - Intra-Island Long Distance Access Rate Dispute" for more information regarding the TRB Resolution and Order of February 28, 2002. 28 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS In this report, the Company has made forward-looking statements. These statements are based on the Company's 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 the Company's accounting assumptions that may be required by regulatory agencies, including the SEC, or that result from changes in the accounting rules 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. CRITICAL ACCOUNTING POLICIES GENERAL The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's unaudited condensed consolidated financial statements, which have been prepared in accordance with the accounting principles generally accepted in the United States for interim financial information and the rules and regulations of the SEC. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States for annual financial statements have been condensed or omitted pursuant to such rules and regulations. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported interim amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to bad debts, intangible assets, income taxes, financing operations, contingencies and litigation. The Company 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 condensed 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, the Company's estimate of losses and the related allowance may change. The Company does not depend on any single customer for its business. 29 DEFERRED TAXES The Company uses an asset and liability approach in accounting for income taxes in accordance with the provisions of SFAS No. 109, "Accounting for Income Taxes." Deferred tax assets and liabilities are recognized 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 condensed consolidated financial statements, on May 1, 2002, the Company completed a tax-free reorganization whereby it merged Verizon Wireless into PRTC. As a result of this merger, the Company released a deferred tax valuation allowance related to the Acquisition of approximately $93 million, approximately $51 million of which was recorded against goodwill and approximately $42 million of which 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 tax 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, less any 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 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 revised its accounting estimates relating to depreciation based on a detailed review of the lives underlying the depreciation rates. The depreciation rate revisions 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 revisions resulted in a decrease in depreciation expense by approximately $9 million for the nine months ended September 30, 2002 and approximately $9 million for the nine months ended September 30, 2003. See Note 5 to the condensed consolidated financial statements for further details. 30 RESULTS OF OPERATIONS The Company has two reportable segments, Wireline and Wireless. See Note 16 to the condensed consolidated financial statements for additional information on the Company's segments. Reclassifications of prior years' data have been made to conform to the 2003 presentation. The Wireline segment consists of: o Local services, including basic voice, telephone and telecommunications equipment rentals, value-added services, high-speed private line services, Internet access and public phone service; o Long distance services including direct dial on-island and off-island, operator assisted calls, prepaid calling card and high-speed private line services; o Access services to long distance carriers, competitive local exchange carriers, and cellular and paging operators to originate and terminate calls on the Company's network; o Directory publishing rights revenues; and o Telecommunication equipment sales and billing and collection services to competing long distance operators in Puerto Rico. The Wireless segment consists of: o Cellular services; and o Wireless equipment sales. 31 REVENUES

EXPENSES AND CHARGES

OPERATING DATA

32 QUARTER ENDED SEPTEMBER 30, 2003 COMPARED WITH QUARTER ENDED SEPTEMBER 30, 2002 REVENUES. Revenues for the quarter ended September 30, 2003 decreased $9 million, or 3%, to $309 million from $318 million for the same 2002 period. WIRELINE: Wireline revenues include revenues from local service, long distance, network access, directory and other services. Wireline revenues for the quarter ended September 30, 2003 decreased $14 million, or 6%, to $259 million from $273 million for the same 2002 period. Local service revenues include revenues from 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 quarter ended September 30, 2003 decreased $3 million, or 2%, to $142 million from $145 million for the same 2002 period. The decrease is due to decreased revenues from local voice services. The decrease in revenues from local voice services was driven by a decrease in revenues from measured services of $3 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 $1 million, or 3%, to $36 million for the quarter from $37 million for the same 2002 period. The decrease was due to a decrease in intra-island long distance revenues of $1 million. Intra-island long distance revenues have decreased mainly due to customer traffic migration to the cellular network and general economic conditions. Network access revenues include revenues from services provided to long distance carriers, competitive local exchange carriers, and cellular and paging operators to originate and terminate calls on the Company's network. These revenues for the quarter decreased $16 million, or 20%, to $64 million compared to $80 million for the same 2002 period. The decrease was driven by lower intra-island access revenues of $4 million, a decrease in off-island switching revenues of $7 million and lower carrier common line access revenues of $6 million that were partially offset by higher subscriber line charges of $1 million resulting from a rate increase in July 2002. Directory and other revenues include revenues from directory publishing rights, telecommunications equipment rental and billing and collection services to competitor long distance operators. Directory and other revenues for the quarter ended September 30, 2003 increased $6 million, or 55%, to $17 million, from $11 million for the quarter ended September 30, 2002. The increase was due to an increase in revenues from directory publishing rights of $5 million resulting from the change in the Company's method of accounting for revenues from directory publishing rights from the point-of-publication method to the amortization method and an increase of $1 million in wireline equipment sales. WIRELESS: Revenues from cellular and paging services and related equipment sales for the quarter ended September 30, 2003 increased $5 million, or 12%, to $50 million from $45 million for the comparable 2002 period. Cellular service revenues for the quarter ended September 30, 2003 increased $3 million, or 7%, to $46 million from $43 million for the same 2002 period. The increase was primarily the result of an increase of 15,000 cellular customers compared to the quarter ended September 30, 2002 due to attractive price plans and the implementation of a marketing strategy to align the Company's product and service offerings with those of Verizon Wireless in the U.S. Paging revenues declined $1 million for the quarter ended September 30, 2003. The decrease was related to a complete reduction of paging customers. The Company entered into an agreement to sell its paging division and received approval from the FCC of the negotiated agreement in July 2003. The Company closed the paging operations on August 2003. Wireless equipment sales increased $3 million to $4 million for the quarter ended September 30, 2003 from $1 million for the comparable 2002 period. This increase is a result of the increase in customers who subscribed for wireless services in 2003. 33 OPERATING COSTS AND EXPENSES. Operating costs and expenses for the quarter ended September 30, 2003 increased $81 million, or 42%, to $276 million from $195 million reported for the same period in 2002. WIRELINE: Wireline expenses for the quarter ended September 30, 2003 increased $76 million, or 47%, to $239 million from the $163 million reported for the same period in 2002. Labor and benefit expenses for the quarter ended September 30, 2003 increased $10 million, or 12%, to $93 million from $83 million reported for the same period in 2002, due to increases in pension and other post-employment benefits ("OPEBs") expense recognition of $7 million, which resulted from a decrease in the rate of return on plan assets in addition to a decrease in the discount rate, which reflects a softening economy. There was also an increase in contractors expense of $3 million. Other operating expenses of $146 million for the quarter ended September 30, 2003, increased $66 million, or 83%, compared to the same 2002 period. The increase is due to the pre-tax reserve of $66 million (including interest) established in September 2003 for the end-user and AT&T refund referred to in the TRB Resolution and Order of February 2002. See "Regulatory and Other Matters - Intra-Island Long Distance Access Rate Dispute" for more information regarding the TRB Resolution and Order of February 28, 2002. WIRELESS: Wireless expenses for the quarter ended September 30, 2003 increased $5 million, or 16%, to $37 million from the $32 million reported for the same period in 2002. Labor and benefit expenses remained constant at $8 million for the quarters ended September 30, 2003 and 2002. Other operating expenses for the quarter ended September 30, 2003 increased $5 million, or 21%, to $29 million from the $24 million reported for the comparable 2002 period. The increase was due to a higher subsidy on equipment sales of $4 million and higher network management fees of $1 million. DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization of $64 million remained constant for the quarters ended September 30, 2003 and 2002. INTEREST EXPENSE. Interest expense of $19 million for the quarter ended September 30, 2003 was $8 million higher than for the comparable 2002 period, mainly due to the additional $7 million in interest from the pre-tax reserve of $66 million established in September 2003 as a result of the TRB Resolution and Order of February 2002. EQUITY INCOME FROM JOINT VENTURE. Equity income from joint venture remained constant for the quarters ended September 30, 2003 and 2002. The equity income was generated from the Company's approximate 24% interest in VISI, the largest yellow page publishing company in Puerto Rico. INCOME TAXES. A $19 million tax benefit for the quarter ended September 30, 2003 was recognized. The decrease of $36 million when compared to the $17 million provision reported for the quarter ended September 30, 2002 was primarily due to the pre-tax reserve of $73 million (including interest) established for the end-user and AT&T refund referred to in the TRB Resolution and Order of February 2002. 34 NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH NINE MONTHS ENDED SEPTEMBER 30, 2002 REVENUES. Revenues for the nine months ended September 30, 2003 decreased $11 million, or 2%, to $961 million from $972 million for the same 2002 period. WIRELINE: Wireline revenues include revenues from local service, long distance, network access, directory and other services. Wireline revenues for the nine months ended September 30, 2003 decreased $25 million, or 3%, to $810 million from $835 million for the same 2002 period. Local service revenues include revenues from 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 nine months ended September 30, 2003 increased $3 million to $435 million from $432 million for the same 2002 period. The increase is due to increased local data services offset by decreased local voice services. The increase in local data services was mainly driven by an increase in Internet access revenues of $4 million and an increase in revenues from high- speed private line services of $1 million. The decrease in revenues from local voice services was mainly driven by a decrease in revenues from measured services of $4 million and telephone rent of $2 million, offset by an increase in deferred activation and installation 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 $10 million, or 9%, to $102 million for the nine months ended September 30, 2003 from $112 million for the same 2002 period. The decrease was due to a decrease in intra-island long distance revenues of $8 million and a decrease in on-island private line revenues of $4 million, partially offset by an increase of $2 million in off-island long distance revenues. Intra-island long distance revenues have decreased mainly due to customer traffic migration to the cellular network and general economic conditions. Network access revenues include revenues from services provided to long distance carriers, competitive local exchange carriers, and cellular and paging operators to originate and terminate calls on the Company's network. These revenues for the nine months ended September 30, 2003 decreased $21 million, or 9%, to $223 million compared to $244 million for the same 2002 period. The decrease was driven by lower intra-island access revenues of $11 million coupled with lower carrier common line access revenues of $7 million and lower off-island switching revenues of $6 million that were partially offset by higher subscriber line charges of $5 million (which resulted from a rate increase in July 2002). Directory and other revenues include revenues from directory publishing rights, telecommunications equipment rental and billing and collection services to competitor long distance operators. Directory and other revenues for the nine months ended September 30, 2003 increased $3 million, or 7%, to $50 million, from $47 million for the nine moths ended September 30, 2002. The increase was due to an increase in revenues from directory publishing rights of $3 million resulting from the change in the Company's method of accounting for revenues from directory publishing rights from the point-of-publication method to the amortization method. WIRELESS: Revenues from cellular and paging services and related equipment sales for the nine months ended September 30, 2003 increased $14 million, or 11%, to $151 million from $137 million for the comparable 2002 period. Cellular service revenues for the nine months ended September 30, 2003 increased $13 million, or 11%, to $141 million from $128 million for the same 2002 period. The increase was primarily the result of an increase of 15,000 cellular customers compared to the nine months ended September 30, 2002 due to attractive price plans and the implementation of a marketing strategy to align the Company's product and service offerings with those of Verizon Wireless in the U.S. Paging revenues declined $3 million for the nine months ended September 30, 2003. The decrease was related to a complete reduction of paging customers. The Company entered into an agreement to sell its paging division and received approval from the FCC of the negotiated agreement in July 2003. The Company closed the paging operations on August 2003. Wireless equipment sales increased $4 million, or 80%, to $9 million for the nine months ended September 30, 2003 from $5 million for the comparable 2002 period. This increase is a result of the increase in customers who subscribed for wireless services in 2003. 35 OPERATING COSTS AND EXPENSES. Operating costs and expenses for the nine moths ended September 30, 2003 increased $117 million, or 20%, to $711 million from $594 million reported for the same period in 2002. WIRELINE: Wireline expenses for the nine months ended September 30, 2003 increased $104 million, or 21%, to $600 million from the $496 million reported for the same period in 2002. Labor and benefit expenses for the nine months ended September 30, 2003 increased $24 million, or 10%, to $280 million from $256 million reported for the same period in 2002, due to increases in OPEBs expense recognition of $27 million, which resulted from a decrease in the rate of return on plan assets in addition to a decrease in the discount rate, which reflects a softening economy. These increases were partially offset by a decrease in contractor and temporaries expense of $2 million and overtime expenses of $1 million as part of cost-constraint measures taken. Other operating expenses of $320 million for the nine months ended September 30, 2003, increased $80 million, or 34%, compared to the same 2002 period. The increase is due to cancelled capital projects of $29 million, which is mainly due to the write-off for the billing software system abandoned by the Company (an additional $3 million write-off is included as interest) and the pre-tax reserve of $66 million (an additional $7 million is included as interest) established in September 2003 for the end-user and AT&T refund referred to in the TRB Resolution and Order of February 2002. This increase was partially offset by a decrease in interconnection charges of $14 million that resulted from an interconnection settlement agreement and a decrease in rates. WIRELESS: Wireless expenses for the nine months ended September 30, 2003 increased $13 million, or 14%, to $111 million from the $98 million reported for the same period in 2002. Labor and benefit expenses remained constant at $24 million for the nine months ended September 30, 2003 and 2002. Other operating expenses for the nine months ended September 30, 2003 increased $13 million, or 18%, to $87 million from the $74 million reported for the comparable 2002 period. The increase was due to a higher subsidy on equipment sales of $7 million, the absence of a gain on the sale of land of $3 million recognized during the nine months ended September 30, 2002, higher commission and rent expenses of $2 million and $1 million, respectively. VOLUNTARY SEPARATION AND RETIREMENT PROVISIONS. In January 2003, an additional 29 qualified management employees accepted the voluntary separation program offered by the Company in December 2002, which resulted in a provision of $1.4 million. During the second quarter of 2003, 191 union employees accepted a combined voluntary separation program and retirement program offered by the Company that closed on June 20, 2003 and June 30, 2003, respectively, which resulted in an additional provision of $3.3 million. DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization expense of $187 million for the nine months ended September 30, 2003 was $10 million lower than for the comparable 2002 period. The decrease in depreciation and amortization expense is mainly due to a revision in wireline depreciation rates, which became effective July 1, 2002, reducing depreciation expense by $9 million for the nine months ended September 30, 2003, and the adoption of SFAS No. 143, effective January 1, 2003, which required the exclusion of the costs of removal from the Company's depreciation rates for assets for which the removal costs exceed salvage value. The decrease was partially offset by higher gross plant balances. INTEREST EXPENSE. Interest expense of $43 million for the nine months ended September 30, 2003 was $7 million higher than for the same 2002 period, due to the additional $7 million in interest of the pre-tax reserve of $66 million established in September 2003 as a result of the TRB Resolution and Order of February 2002. EQUITY INCOME FROM JOINT VENTURE. Equity income from joint venture remained constant at $2 million for the nine months ended September 30, 2003 and 2002. This equity income was generated from the Company's approximate 24% interest in VISI, the largest yellow page publishing company in Puerto Rico. 36 MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY. A $1 million minority interest included in the Company's results of operations for the nine months ended September 30, 2003 represents Popular, Inc.'s 33% minority interest in Coqui.net. INCOME TAXES. A $5 million tax provision for the nine months ended September 30, 2003 reflects a 30% effective tax rate. The difference between the effective and the statutory tax rate of 39% equates to $5 million, primarily reflecting permanent differences related to interest accretion on the PRTA subscription receivable and equity income in subsidiary. The decrease of $5 million when compared to the $10 million provision reported for the nine months ended September 30, 2002 was due to lower earnings in 2003 and the recognition of a $42 million deferred tax benefit that resulted from the merger of Verizon Wireless into PRTC on May 1, 2002. (see Note 1) CUMULATIVE EFFECT OF ACCOUNTING CHANGE. Under the provisions of SFAS No. 143, the Company is required to exclude costs of removal from the Company's 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, the Company has reversed accrued costs of removal in excess of salvage value from the Company's accumulated depreciation accounts for these assets. The adjustment was recorded as a cumulative effect of an accounting change, resulting in the recognition of a non-cash gain of $117 million ($71 million after tax). Effective January 1, 2003, the Company began expensing costs of removal in excess of salvage value for these assets as incurred. Effective January 1, 2003, the Company changed its method of accounting for revenues from directory publishing rights and related expenses from the point-of-publication method to the amortization method. Although both methods fully comply with accounting principles generally accepted in the United States, the change was made because the amortization method is becoming the industry standard. The cumulative effect of applying this accounting change to prior years is recognized as of January 1, 2003 as a one-time, non-cash loss of $17 million ($13 million, after tax). 37 LIQUIDITY AND CAPITAL RESOURCES CONSOLIDATED FINANCIAL CONDITION NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED WITH NINE MONTHS ENDED SEPTEMBER 30, 2002

OVERALL LIQUIDITY ASSESSMENT The Company believes that cash from operations is sufficient to meet working capital needs. Current assets exceeded current liabilities at September 30, 2003 by $133 million. We believe our sources of funds, from operations and from readily available external financing arrangements, are sufficient to meet ongoing operating, financing and investing requirements. We expect that presently foreseeable capital requirements will continue to be financed through internally generated funds. We have an undrawn $400 million bank note facility maturing in March 2004, as well as a $40 million working capital credit facility maturing in June 2004. The bank note facility is a syndicated five-year revolving credit facility. At September 30, 2003, the Company had no outstanding balance under the working capital credit facility. An aggregate principal amount of $300 million of the Company's senior notes matured on May 15, 2002. During the year ended December 31, 2002, we refinanced these notes and the related interest payment through the issuance of new term loans in an aggregate principal amount of $225 million. OPERATIONS Cash from operations continued to be our primary source of funds. The $14 million increase in cash from operations for the nine months ended September 30, 2003 as compared to the same period in 2002 was primarily due to lower voluntary separation payments of $10 million, lower management fee and royalties disbursements of $7 million, partially offset by higher operating income tax and property tax payments of $5 million. A total provision of $16.4 million has been recorded related to early retirement and voluntary separation programs for the nine months ended September 30, 2001 involving 113 employees. During the fourth quarter of 2002, the Company offered a voluntary separation program to qualified management employees. Eight qualified management employees accepted the program, and the Company recorded a $0.5 million non-cash provision. In January 2003, an additional 29 qualified management employees accepted the voluntary separation program representing an additional expense of $1.4 million recorded in the first quarter of 2003. During the second quarter of 2003, 191 union employees accepted a combined voluntary separation program and retirement program offered by the Company that closed on June 20, 2003 and June 30, 2003, respectively, which resulted in an additional provision of $3.3 million. INVESTING Net cash used in investing activities for the nine months ended September 30, 2003 was $104 million compared to $134 million for the same period in 2002. The $30 million decrease in cash used in investing activities is mainly due to a decrease in capital expenditures and costs of removal. Effective January 1, 2003, under SFAS No. 143, costs of removal are expensed when incurred. The capital expenditure program for 2002 amounted to $205 million, which was financed from internally generated funds. The decrease in capital expenditures during 2003 is partially due to decreased spending on specific software projects, as well as a general decrease in spending as the Company aligned its capital spending with softening demand for new wireline service. 38 We have invested approximately $1.01 billion from the date of the Acquisition through September 30, 2003 to expand and enhance our networks. In 2003, we expect to make up to approximately $185 million in capital expenditures. FINANCING Debt outstanding, excluding capital leases, decreased $142 million for the nine months ended September 30, 2003 and increased $186 million for the nine months ended September 30, 2002. Borrowings under bank loans, working capital facilities and the commercial paper program decreased from $323 million at December 31, 2002 to $181 million at September 30, 2003 and increased from $194 million at December 31, 2001 to $380 million at September 30, 2002. 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 principal amount of the term loans is $225 million, with maturities ranging from two to three years, bearing interest at 60 to 100 basis points over LIBOR. During the third quarter of 2003, we issued advances to principal of term loans by $44 million reducing the term loans balance to $181 million at September 30, 2003. In the Acquisition, 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 partially fund its underfunded pension and other post-employment benefit obligations. In March 2003, $40 million was received in cash from PRTA for the fourth installment. See Note 14 to the condensed consolidated financial statements. The shareholders' agreement requires the payment of dividends equal to at least 50% of net income, payable quarterly to the extent funds are legally available. For the nine months ended September 30, 2002, the Company paid dividends of $53 million corresponding to the first and second quarter of 2002 and the fourth quarter of 2001. For the nine months ended September 30, 2003, the Company paid dividends amounting to $68 million corresponding to the first quarter of 2003 and the fourth quarter of 2002. The senior note indentures and credit facility agreements do not contain restrictions on the payment of dividends. CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS

(1) Pension obligations represent contributions based on ERISA minimum rules. 39 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's 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. 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 beginning on April 1, 2000 through March 31, 2002. The refund can be made in 12 equal quarterly installments beginning on April 1, 2002. The Company filed with the Puerto Rico Circuit Court of Appeals (the "Court") an appeal of the February 2002 Order in which the Company alleges that the TRB made errors of law and procedure in its determination of access charges and its order requiring the Company to make the cash refund. On March 27, 2002, the Court stayed the refund and the rate reduction until the hearing of the appeal. On April 2, 2002, AT&T, Sprint and LTD (the "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, direct the TRB to calculate the refund from the period beginning on April 1997 instead of April 2000, and require that the refund be paid to the Carriers instead of end-user customers. The hearing involving oral presentations by the parties was held on February 19, 2003. On April 22, 2003, the parties filed their corresponding post-hearing final briefs therefore finally submitting the case for adjudication. On August 19, 2003, the Court issued its final decision on the proceeding confirming the TRB Order on Reconsideration of February 28, 2002 in all respects and rejecting the claims of PRTC and the Carriers. On September 4, 2003, PRT requested reconsideration of the Court's determination on the grounds that although the Court correctly described the applicable legal standards the Court erred in applying those standards to the facts of the case. On October 2, 2003, the Court denied PRTC's reconsideration. As a result of the Court's decision, the Company established a pre-tax reserve of $73 million, including interest, in September 2003 for the end-user and AT&T refund referred to in the February 2002 Order. This reserve is in addition to the reserve established in connection with the stay of the TRB Order on Reconsideration issued by the Court. On October 30, 2003, the Company filed a petition for a writ for certiorari before PR Supreme Court challenging the $68 million refund portion of the Order. The phased down portion of the Order was settled with the major carriers. The Company believes that the Carriers' petition for review is without merit. In November 2003, the Company proposed, and two members of the TRB indicated their support for, a plan to revise the Board's end-user refund order and end the dispute over this issue. Under the terms of this plan, instead of making the refunds as ordered by the TRB, PRTC will eliminate the touchtone charge, implement expanded local calling areas and provide certain credits to the residential basic rent. The estimated 2003 cash flow impact is a reduction of $15 million. 40 CARRIER ACCESS BILLING During the first and second quarter of 2003, some carriers established a series of billing claims with the company regarding tariff interpretation, traffic routing at the network level and misclassification of access traffic for determination of applicable access elements. The company entered into negotiations with the major carriers and settled the billing claims and phased-rate reductions required by the February 2002 Order. Management deems there are no other material impacts to the company's financial results. PUBLIC TELEPHONE SERVICE PROVIDER - ANTI COMPETITIVE ACTIONS On November 8, 2001, 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, claiming predatory, exclusionary and anticompetitive acts and seeking $75 million in damages. We filed a motion to dismiss the case and are awaiting a decision from 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 suit is similar to TPPR's suit, we filed a motion to dismiss the case. We are currently awaiting a decision from the court. On August 16, 2002, PSA, the parent company for Phoenix of Puerto Rico filed a suit in the United States bankruptcy court in the District of Delaware, claiming anti competitive acts. The claims have since been transferred to the United States District Court of Delaware and the disputes between the two parties include PRTC's amended administrative claim against PSA, and PSA's complaint for over $9 million against PRTC. PRTC has filed a motion to dismiss and change of venue which is pending before the United States District Court of Delaware. The Company's management believes all of these claims are without merit. P.R. DEPARTMENT OF EDUCATION (THE "PRDOE") DEBT On June 30, 2003, PRTC filed a complaint against the PRDOE with the Superior Court, seeking collection of monies for $31 million due for services rendered under the Reeducate Program, which is based on the Federal E-Rate Program, from 1999 to June 30, 2003. The Reeducate Program funds Internet connections for schools throughout Puerto Rico and PRTC has provided services under contract to the PRDOE. The outstanding amount that PRDOE currently owes to PRTC is $34 million. PRTC intends to amend the complaint to reflect the proper amount owed. From the amount claimed, 89% would be paid by the Federal Communications Commission's School & Libraries Division ("SLD"), who administered the Federal E-Rate Program, if the funding for the fourth and fifth years under the program is released. PRTC is currently evaluating the outstanding amounts owed by PRDOE for the third year under the program, which is approximately $1.2 million, after SLD paid its corresponding percentage (87%) under the program. CTI ASSET TRANSFER Prior to the Acquisition, PRTC transferred its net wireless assets on September 1, 1998 to CTI (which became Verizon Wireless, a division 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 that 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. 41 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 the Company's 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 that set interstate access rates based on a price cap formula must use the price cap formula for all of their affiliates. The price cap formula is based on a plan called Coalition of Affordable Local and Long Distance Service that used rate-of-return as a basis for setting rates. The Company was originally required to implement price caps by March 2, 2000. However, the FCC delayed conversion to price cap regulation until June 30, 2002, and the Company has requested a further extension until June 30, 2003. Under an order released by the FCC on April 18, 2002, 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, PRTC sent a letter to the FCC, requesting the FCC 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. PRTC requested that the FCC address the loss of its universal service support by adopting rules for insular areas that are similar to those applied to rural carriers. In an order dated October 16, 2003 and released October 27, 2003, the FCC rejected PRTC's request for reconsideration of its non-rural high cost support mechanism, but did not deal with its February 28, 2003 request. MESSAGE PROCESSING AND BILLING SYSTEM The Company has an agreement with a provider for the implementation of a traffic polling and billing software system for its wireline operations. While the traffic polling portion has been implemented, management has determined that it is in the Company's best interests to abandon the billing portion of the software system. The amount of capitalized costs for software and labor related to the billing portion of $32.3 million was written off and included in operating expenses during the second quarter of 2003. Management is currently in discussions with the provider of the system and seeking a satisfactory resolution of this matter. BROTHERHOOD OF INDEPENDENT TELEPHONE WORKERS ("HIETEL") UNION CONTRACT In October 2003, one of our union contracts, a collective bargaining agreement with the HIETEL expired. The Company is currently in negotiations for a new agreement with the HIETEL. RECENT ACCOUNTING PRONOUNCEMENTS See Note 4 to the condensed consolidated financial statements contained in Part 1, Item 1 of this report for disclosure on recent accounting pronouncements. 42 ITEM 3. 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 swaps at September 30, 2003 and December 31, 2002 and provides a sensitivity analysis of the fair values of these instruments assuming a 100 basis point increase or decrease 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.

43 ITEM 4. CONTROLS AND PROCEDURES The Company maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) that are designed to ensure that information required to be disclosed in the Company's reports is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. In designing and evaluating the Company's disclosure controls and procedures, the Company's chief executive officer and chief financial officer recognized that any controls and procedures, no matter how well-designed and operated, can provide only reasonable assurance of achieving the desired control objectives. The Company's chief executive officer and chief financial officer have evaluated the effectiveness of the Company's disclosure controls and procedures, as of the end of the period covered by this report (the "Evaluation Date"). They have concluded that as of the Evaluation Date, the Company's disclosure controls and procedures were effective at the reasonable assurance level. There has been no change in the Company's internal control over financial reporting during the Company's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 44 PART II. OTHER INFORMATION ITEM 1. 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 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. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. ITEM 5. OTHER INFORMATION Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a) See Exhibits Index on page following signatures. b) No reports on Form 8-K were filed during the quarter for which this report is filed. 45 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. TELECOMUNICACIONES DE PUERTO RICO, INC. By: /s/ JON E. SLATER ------------------------------------- Name: Jon E. Slater Title: Chief Executive Officer Date: November 14, 2003 By: /s/ WALTER C. FORWOOD -------------------------------------- Name: Walter C. Forwood Title: Chief Financial Officer Date: November 14, 2003 By: /s/ ADAIL ORTIZ ----------------------------------------- Name: Adail Ortiz Title: Chief Accounting Officer Date: November 14, 2003 46 EXHIBIT INDEX

TELECOMUNICACIONES DE PUERTO RICO INC 10-Q