<PAGE>
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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: June 30, 2000
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 0-2908
VERIZON NORTHWEST INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
WASHINGTON 91-0466810
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
1255 Corporate Drive, SVC04C08, Irving, Texas 75038
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code 972-507-5000
GTE NORTHWEST INCORPORATED
(Former name, former address and former fiscal year,
if changed since last report)
THE REGISTRANT, A WHOLLY-OWNED SUBSIDIARY OF GTE CORPORATION, A WHOLLY-OWNED
SUBSIDIARY OF BELL ATLANTIC CORPORATION (D/B/A VERIZON COMMUNICATIONS), 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 [ ]
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<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
VERIZON NORTHWEST INC.
Condensed Consolidated Statements of Income (Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
(Dollars in Millions)
<S> <C> <C> <C> <C>
REVENUES AND SALES
Local services $ 135.6 $ 129.3 $ 272.8 $ 254.5
Network access services 134.1 135.9 263.7 252.5
Other services and sales 35.6 42.6 70.3 81.4
------------ ------------ ------------ ------------
Total revenues and sales 305.3 307.8 606.8 588.4
------------ ------------ ------------ ------------
OPERATING COSTS AND EXPENSES
Operations and support 136.7 139.9 260.1 265.9
Depreciation and amortization 59.3 55.1 114.9 108.6
------------ ------------ ------------ ------------
Total operating costs and expenses 196.0 195.0 375.0 374.5
------------ ------------ ------------ ------------
OPERATING INCOME 109.3 112.8 231.8 213.9
OTHER EXPENSE
Interest - net 13.7 13.9 27.2 27.8
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES 95.6 98.9 204.6 186.1
Income taxes 37.6 36.5 77.8 68.7
------------ ------------ ------------ ------------
NET INCOME $ 58.0 $ 62.4 $ 126.8 $ 117.4
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
1
<PAGE>
VERIZON NORTHWEST INC.
Condensed Consolidated Balance Sheets (Unaudited)
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
------------ ------------
(Dollars in Millions)
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $ 0.2 $ 1.4
Receivables, less allowances of
$13.1 million and $17.9 million 184.3 275.4
Receivables from affiliates 5.6 19.4
Inventories and supplies 27.7 16.9
Net assets held for sale 16.5 16.0
Prepayments and other 7.6 18.2
------------ ------------
Total current assets 241.9 347.3
------------ ------------
Property, plant and equipment, at cost 3,749.4 3,638.9
Accumulated depreciation (2,339.5) (2,269.9)
------------ ------------
Total property, plant and equipment, net 1,409.9 1,369.0
------------ ------------
Prepaid pension costs 245.3 176.7
Other assets 8.7 7.7
------------ ------------
Total assets $ 1,905.8 $ 1,900.7
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
2
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VERIZON NORTHWEST INC.
Condensed Consolidated Balance Sheets (Unaudited) - Continued
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
------------ ------------
(Dollars in Millions)
<S> <C> <C>
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities
Current maturities of long-term debt $ 201.6 $ 1.6
Note payable to affiliates 20.7 53.6
Accounts payable 49.6 67.0
Affiliate payables and accruals 49.1 35.4
Taxes payable 78.0 57.3
Dividends payable 56.0 64.0
Other 86.5 78.5
-------------- ------------
Total current liabilities 541.5 357.4
-------------- ------------
Long-term debt 566.1 765.8
Deferred income taxes 176.3 159.8
Employee benefit plans and other 36.2 37.1
-------------- ------------
Total liabilities 1,320.1 1,320.1
-------------- ------------
Shareholder's equity
Common stock (17,920,000 shares issued) 448.0 448.0
Additional paid-in capital 137.7 60.4
Retained earnings -- 72.2
-------------- ------------
Total shareholder's equity 585.7 580.6
-------------- ------------
Total liabilities and shareholder's equity $ 1,905.8 $ 1,900.7
============== ============
</TABLE>
The accompanying notes are an integral part of these statements.
3
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VERIZON NORTHWEST INC.
Condensed Consolidated Statements of Cash Flows (Unaudited)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
-----------------------------
2000 1999
------------ ------------
(Dollars in Millions)
<S> <C> <C>
OPERATIONS
Net cash from operations $ 317.6 $ 197.8
------------ ------------
INVESTING
Capital expenditures (155.8) (128.7)
Other - net (0.1) 1.5
------------ ------------
Net cash used in investing (155.9) (127.2)
------------ ------------
FINANCING
Long-term debt retired, including premiums paid
on early retirement -- (125.0)
Dividends (130.0) (64.0)
Net change in affiliate notes (32.9) 118.1
------------ ------------
Net cash used in financing (162.9) (70.9)
------------ ------------
Decrease in cash and cash equivalents (1.2) (0.3)
Cash and cash equivalents:
Beginning of period 1.4 0.4
------------ ------------
End of period $ 0.2 $ 0.1
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
4
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VERIZON NORTHWEST INC.
Consolidated Statement of Shareholder's Equity (Unaudited)
<TABLE>
<CAPTION>
Additional
Common Paid-In Retained
Stock Capital Earnings Total
------------ ------------ ------------- -------------
(Dollars in Millions)
<S> <C> <C> <C> <C>
Shareholder's equity, December 31, 1999 $ 448.0 $ 60.4 $ 72.2 $ 580.6
Net income 126.8 126.8
Dividends declared (122.0) (122.0)
Capital contribution from Parent 77.0 77.0
Dividend paid to Parent (77.0) (77.0)
Other 0.3 0.3
------------ ------------ ------------- -------------
Shareholder's equity, June 30, 2000 $ 448.0 $ 137.7 $ -- $ 585.7
============ ============ ============= =============
</TABLE>
The accompanying notes are an integral part of these statements.
5
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VERIZON NORTHWEST INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)
NOTE 1. BASIS OF PRESENTATION
Verizon Northwest Inc. (the Company), formerly GTE Northwest Incorporated, is a
wholly-owned subsidiary of GTE Corporation (GTE), which is a wholly-owned
subsidiary of Bell Atlantic Corporation (d/b/a Verizon Communications). The
accompanying unaudited condensed consolidated financial statements have been
prepared based upon Securities and Exchange Commission (SEC) rules that permit
reduced disclosure for interim periods. These financial statements include
certain reclassifications in presentation as a result of the merger of Bell
Atlantic Corporation (Bell Atlantic) and GTE (see Note 2). 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 and other items (see Note 2). The results
for the interim periods are not necessarily indicative of results for the full
year. For a more complete discussion of significant accounting policies and
certain other information, please refer to the consolidated financial statements
included in the Company's 1999 Annual Report on Form 10-K.
NOTE 2. BELL ATLANTIC - GTE MERGER
On June 30, 2000, Bell Atlantic and GTE completed a merger of equals under a
definitive merger agreement dated July 27, 1998. Under the terms of the
agreement, GTE became a wholly-owned subsidiary of Bell Atlantic. With the
closing of the merger, the combined company began doing business as Verizon
Communications. The merger has been accounted for as a pooling of interests.
Merger-Related and Severance Costs
Results of operations for June 30, 2000 includes merger-related pre-tax costs
totaling approximately $27.2 million consisting of direct incremental costs and
employee severance costs. These costs include the Company's allocated share of
merger-related costs from Verizon Services Group (Verizon Services), an
affiliate that provides centralized services on a contract basis. Costs
allocated from Verizon Services are included in Operations and Support Expenses.
Direct incremental costs consist of the Company's proportionate share of
expenses associated with completing the merger transaction such as professional
and regulatory fees, compensation arrangements and shareowner-related costs.
Employee severance costs, as recorded under SFAS No. 112, "Employers' Accounting
for Postemployment Benefits," represent the Company's proportionate share of
benefit costs for the separation of management employees who are entitled to
benefits under preexisting Verizon Communications separation pay plans. The
separations are expected to occur as a result of consolidations and process
enhancements. Accrued postemployment benefit liabilities for those employees are
included in the Company's balance sheets as a component of "Employee benefit
plans and other".
Conforming Accounting Adjustments
Results of operations also include adjustments that were required to conform the
Company's accounting policies and presentation to that of Verizon
Communications. As a result of these adjustments, operating income was increased
by $2.4 million for each of the six month periods ended June 30, 2000 and 1999.
NOTE 3. DIVIDEND
On July 30, 2000, the Company declared and paid a dividend in the amount of
$56.0 million to Verizon Communications.
Prior to the closing of the GTE merger with Bell Atlantic, dividends that
equaled the retained earnings balance reflected on the Company's financial
statements were declared and paid to GTE. Upon the payment of these dividends, a
capital contribution in the same amount was made by GTE to the Company.
6
<PAGE>
VERIZON NORTHWEST INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued
NOTE 4. NET ASSETS HELD FOR SALE
During May 1999, the Company entered into an agreement to sell approximately
14,000 switched access lines located in California to Citizens Utilities
Company. This agreement consummates the Company's previously announced 1998 plan
to sell selected access lines located in California. The sale is contingent upon
final agreements and regulatory approval and is expected to close in 2000. The
associated net assets, which approximate $16.5 million and $16.0 million at June
30, 2000 and December 31, 1999, respectively, consist of property, plant and
equipment, and have been classified as "Net assets held for sale" in the
consolidated balance sheets. The Company intends to continue to operate all of
these assets until sold. Based on the decision to sell, however, the Company
stopped recording depreciation expense for these assets. Accordingly,
depreciation expense was lowered by $0.7 million and $1.3 million for the three
and six months ended June 30, 2000 and $0.6 million and $1.2 million for the
three and six months ended June 30, 1999, respectively. No charges were recorded
for the access lines to be sold because their estimated fair values were in
excess of their carrying values. The access line agreement represents
approximately 1% of the switched access lines that the Company had in service at
the end of 1999, and contributed approximately 1% to 1999 consolidated revenues
and approximately 3% to 1999 consolidated operating income.
NOTE 5. DIRECTORY PUBLISHING REVENUES
Consistent with industry practice, effective January 1, 2000, the Company
changed its method of recognizing directory publishing revenues. Verizon
Directories Corp., a wholly-owned subsidiary of GTE, publishes telephone
directories for which it receives advertising revenue. Under the previous method
of revenue recognition, approximately 60% of the advertising revenue for
directories published in the Company's operating areas was recognized as revenue
by the Company. The remaining 40% was recognized as revenue by Verizon
Directories Corp. Under the new method, Verizon Directories Corp. now recognizes
100% of the directory publishing revenues. The Company, in-turn, bills Verizon
Directories Corp. for customer listing information and billing and collection
services. As a result, the Company's other services and sales revenues and
operating income decreased $7.4 million and $6.0 million, respectively, for the
six months ended June 30, 2000 compared to the same period in of 1999.
NOTE 6. RECENT ACCOUNTING PRONOUNCEMENTS
FASB Accounting Standards - Derivatives and Hedging Activities
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement requires that all
derivatives be measured at fair value and recognized as either assets or
liabilities on the Company's balance sheet. Changes in the fair values of
derivative instruments will be recognized in either earnings or comprehensive
income, depending on the designated use and effectiveness of the instruments.
The FASB amended this pronouncement in June 1999 to defer the effective date of
SFAS No. 133 for one year. The Company must adopt SFAS No. 133 no later than
January 1, 2001.
In June 2000, the FASB issued SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities," which amended SFAS No. 133. The
amendments in SFAS No. 138 address certain implementation issues and relate to
such matters as the normal purchases and normal sales exception, the definition
of interest rate risk, hedging recognized foreign-currency-denominated assets
and liabilities, and intercompany derivatives. SFAS No. 138 also amends SFAS No.
133 for decisions made by the FASB relating to the Derivatives Implementation
Group process.
The Company is currently evaluating the provisions of SFAS No. 133 and No. 138.
The impact of adoption will be determined by several factors, including the
specific hedging instruments in place and their relationships to hedged items,
as well as market conditions at the date of adoption.
7
<PAGE>
VERIZON NORTHWEST INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued
FASB Interpretation - Stock Compensation
In March 2000, the FASB issued Interpretation No. 44, "Accounting for Certain
Transactions involving Stock Compensation." Interpretation No. 44 was issued in
order to clarify certain issues arising from Accounting Principles Board (APB)
Opinion No. 25 "Accounting for Stock Issued to Employees," which was previously
issued in October 1972. Interpretation No. 44 is effective July 1, 2000, but
certain conclusions cover specific events that occur either after December 15,
1998 or January 12, 2000.
The main issues addressed by Interpretation No. 44 are: (a) the definition of an
employee for purposes of applying APB Opinion No. 25, (b) the criteria for
determining whether a plan qualifies as a noncompensatory plan, (c) the
accounting consequence of various modifications to the terms of a previously
fixed stock option or award, and (d) the accounting for an exchange of stock
compensation awards in a business combination.
Interpretation No. 44 will not have a material impact on the Company's results
of operations or financial position.
SEC Staff Accounting Bulletin - Revenue Recognition
In December 1999, the SEC issued Staff Accounting Bulletin (SAB) No. 101,
"Revenue Recognition in Financial Statements," which must be adopted by the
fourth quarter of 2000. SAB No. 101 provides additional guidance on revenue
recognition, as well as criteria for when revenue is generally realized and
earned, and also requires the deferral of incremental direct selling costs. The
Company is currently assessing the impact of SAB No. 101 on its results of
operations and financial position.
NOTE 7. COMMITMENTS AND CONTINGENCIES
The Company is subject to a number of proceedings arising out of the conduct of
its business, including those relating to regulatory actions, commercial
transactions and environmental, safety and health matters. Management believes
that the ultimate resolution of these matters will not have a materially adverse
effect on the results of operations or the financial position of the Company.
Federal and state regulatory conditions to the merger include certain
commitments to, among other things, promote competition and the widespread
deployment of advanced services, while helping ensure that consumers continue to
receive high-quality, low cost telephone services. In some cases, there are
significant penalties associated with not meeting theses commitments. The cost
of satisfying these commitments could have a significant impact on net income in
future periods. Over the remainder of 2000, based on preliminary estimates, the
cost of satisfying these commitments is likely to impact the net income of
Verizon Communications on a consolidated basis by approximately $275 to $325
million. The estimated impact on each operating telephone subsidiary is still
being assessed.
8
<PAGE>
VERIZON NORTHWEST INC.
Item 2. Management's Discussion and Analysis of Results of Operations
(Abbreviated pursuant to General Instruction H(2) of Form 10-Q)
RESULTS OF OPERATIONS
Net income increased $9.4 million or 8% for the six months ended June 30, 2000,
compared to the same period in 1999, primarily due to higher local service
revenues and lower operations and support expenses.
The Company's results for 2000 and 1999 were affected by special items. The
special items in both periods include the Company's allocated share of charges
from Verizon Services Group (Verizon Services), an affiliate that provides
centralized services on a contract basis.
The following table shows how special items are reflected in the Company's
condensed statements of income for each period:
(Dollars in Millions)
Six Months Ended June 30, 2000 1999
------------------------------------------------------------------------------
Revenues and Sales
Regulatory Contingency $ 1.4 $ --
--------------- -----------------
Operations and Support Expenses
Bell Atlantic-GTE merger costs 27.2 --
Conforming accounting adjustments (2.4) (2.4)
--------------- -----------------
24.8 (2.4)
--------------- -----------------
Interest Expense 0.1 --
--------------- -----------------
Total $ 26.3 $ (2.4)
=============== =================
What follows is a further explanation of the nature of these special items.
On June 30, 2000, Bell Atlantic and GTE completed a merger of equals under a
definitive merger agreement dated as of July 27, 1998. Under the terms of the
agreement, GTE became a wholly owned subsidiary of Bell Atlantic. With the
closing of the merger, the combined company began doing business as Verizon
Communications. The merger has been accounted for as a pooling of interests.
Merger-Related and Severance Costs
Results of operations for June 30, 2000 includes merger-related pre-tax costs
totaling approximately $27.2 million consisting of direct incremental costs and
employee severance costs.
Direct incremental costs consist of the Company's proportionate share of
expenses associated with completing the merger transaction such as professional
and regulatory fees, compensation arrangements and shareowner-related costs.
Employee severance costs, as recorded under SFAS No. 112, "Employers' Accounting
for Postemployment Benefits," represent our proportionate share of benefit costs
for the separation of management employees who are entitled to benefits under
preexisting Verizon Communications separation pay plans. The separations are
expected to occur as a result of consolidations and process enhancements.
Accrued postemployment benefit liabilities for those employees are included in
the Company's balance sheets as a component of "Employee benefit plans and
other."
9
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VERIZON NORTHWEST INC.
Management's Discussion and Analysis of Results of Operations - Continued
(Abbreviated pursuant to General Instruction H(2) of Form 10-Q)
Conforming Accounting Adjustments
Results of operations also include adjustments that were required to conform the
Company's accounting policies and presentation to that of Verizon
Communications. As a result of these adjustments, operating income was increased
by $2.4 million for each of the six month periods ended June 30, 2000 and 1999.
Regulatory Contingency
In the second quarter of 2000, the Company recognized a charge for a regulatory
matter totaling $1.5 million. The Company recorded a reduction to operating
revenue in the amount of $1.4 million and a charge to interest expense of $0.1
million. This matter relates to a specific issue currently under investigation
by federal regulatory commissions. The Company believes that it is probable that
the ultimate resolution of this matter will result in refunds to customers,
including interest.
<TABLE>
<CAPTION>
REVENUES AND SALES
(Dollars in Millions) Six Months Ended
June 30,
------------------------- Increase Percent
2000 1999 (Decrease) Change
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Local services $ 272.8 $ 254.5 $ 18.3 7%
Network access services 263.7 252.5 11.2 4%
Other services and sales 70.3 81.4 (11.1) (14)%
---------- ---------- -----------
Total revenues and sales $ 606.8 $ 588.4 $ 18.4 3%
========== ========== ===========
</TABLE>
Local Services Revenues
Local services 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.
Cellular service providers also pay access charges for cellular calls
transported by the Company. The increase in local services revenues for the six
months ended June 30, 2000, is primarily due to 4.1% growth in switched access
lines, generating $9.3 million of additional revenues for basic local services,
CentraNet(R) services, Integrated Services Digital Network and Digital Channel
Services. Revenues from enhanced customer calling services, such as SmartCall(R)
and CLASS services, contributed an $3.8 million to the year-to-date increase. In
addition, wire maintenance and service revenues generated $3.0 million in
revenue growth.
Network Access Services Revenues
Network access services revenues are earned from end-user subscribers and long
distance and other competing carriers who use the Company's 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 the 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 customers and from resellers
who purchase dial-tone services. Minutes of use increased 6%, generating
additional network access services revenues of $7.3 million for the six months
ending June 30, 2000 as compared to the same time period in 1999. Special access
revenues grew by $24.1 million as a result of greater demand for increased
bandwidth services by high-capacity users. These increases were partially offset
by the impact of mandated interstate and intrastate access price reductions and
rate element adjustments of $16.0 million. IntraLATA switched access revenues
declined by $5.0 million due to reduced settlements with other local exchange
carriers. In addition, revenues were reduced by a second quarter 2000 special
charge for a contingency associated with a regulatory matter (See "Results of
Operations").
10
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VERIZON NORTHWEST INC.
Management's Discussion and Analysis of Results of Operations - Continued
(Abbreviated pursuant to General Instruction H(2) of Form 10-Q)
Other Services and Sales Revenues
Other services and sales revenues include such services as inventory management
and purchasing services, customer premises equipment sales, public telephone and
billing and collection provided to affiliates and third parties. In addition,
other services and sales revenues include revenues from toll services which are
earned primarily from calls made outside a customer's local calling area but
with in the same LATA (intraLATA). The decrease in other services and sales
revenues for the six-month period ended June 30, 2000, compared to the same
period in 1999, was primarily due to the impact of a change in the recognition
of directory publishing revenues resulting in a decrease of $7.4 million (for
further information see "OTHER DEVELOPMENTS - Directory Publishing Revenues").
Lower rental revenues of $2.9 million also contributed to the decrease.
<TABLE>
<CAPTION>
OPERATING COSTS AND EXPENSES
(Dollars in Millions) Six Months Ended
June 30,
------------------------- Increase Percent
2000 1999 (Decrease) Change
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Operations and support $ 260.1 $ 265.9 $ (5.8) (2)%
Depreciation and amortization 114.9 108.6 6.3 6%
---------- ---------- ----------
Total operating costs and expenses $ 375.0 $ 374.5 $ 0.5 --
========== ========== ==========
</TABLE>
Operations and support expenses, representing employee costs and other operating
expenses, decreased $5.8 million in the first six months of 2000 compared to the
same period in 1999. The decrease is primarily due to the recognition of a
pretax gain of $45.8 million associated with lump-sum settlements of pension
obligations for former employees electing deferred vested pension cash-outs and
for current employees who met certain eligibility requirements. Partially
offsetting this decrease were second quarter 2000 special charges of $27.2
million for severance and direct incremental merger-related costs (see "Results
of Operations"), as well as higher access expenses of $11.9 million, primarily
resulting from increased competitive local exchange carrier (CLEC) activity.
The increase in depreciation and amortization expense in the first six months of
2000 compared to the same period in 1999 is due to the continuing investment in
the network necessary to support switched access line growth due to higher
demand from Internet Service Providers (ISPs) and customer line growth.
Partially offsetting the increase in depreciation and amortization expense were
reductions resulting from adjustments made to conform the accounting
policies of Bell Atlantic and GTE as a result of the merger (See "Results of
Operations").
OTHER INCOME STATEMENT ITEMS
Income tax expense increased 13% or $9.1 million for the six months ended June
30, 2000 as compared to the same period in 1999 primarily due to a corresponding
increase in pretax income.
11
<PAGE>
INTERSTATE REGULATORY DEVELOPMENTS
VERIZON NORTHWEST INC.
Management's Discussion and Analysis of Results of Operations - Continued
(Abbreviated pursuant to General Instruction H(2) of Form 10-Q)
INTERSTATE REGULATORY DEVELOPMENTS
FCC Regulation and Interstate Rates
On May 31, 2000, the Federal Communications Commission (FCC) approved the
industry proposal to restructure access charges (known as the "CALLS plan").
Under the terms of the plan, direct end-user access charges are increased while
access charges to long distance carriers are reduced. While the plan continues
the 6.5% (less inflation) annual reductions for most interstate access charges,
it provides for a price freeze when switched access transport prices reach
$0.0055 per-minute. In addition, in conjunction with provisions that will allow
carriers to deaverage their subscriber line charges by geographic zones, the
plan establishes a new $650 million universal service fund to support interstate
access rates. Of that amount, Verizon Communications expects approximately $320
million to be used to support interstate access services in Verizon
Communications' service territory. The price restructuring portions of the plan
are mandatory for all large local exchange carriers, including Verizon's
telephone operating companies. The price level portions of the plan are
mandatory only in the initial year of the plan. Carriers have until September
14, 2000 to decide whether to participate in the remaining four years of the
plan, or whether to submit cost studies as the basis of future price caps.
Consistent with the new access plan, Verizon Communications filed tariff
adjustments to take effect on July 1, 2000 (with modifications effective August
11, 2000). As a result of these tariff adjustments, former GTE carriers in ten
states, and former Bell Atlantic carriers in seven states reached the $0.0055
benchmark and, should Verizon Communications opt into the full five year CALLS
plan, they will not be subject to further annual interstate switched access
price reductions for the remaining life of the plan.
12
<PAGE>
VERIZON NORTHWEST INC.
Management's Discussion and Analysis of Results of Operations - Continued
(Abbreviated pursuant to General Instruction H(2) of Form 10-Q)
INTRASTATE REGULATORY DEVELOPMENTS
Idaho
In January 2000, the Idaho Public Utilities Commission (IPUC) opened a
consolidated proceeding to establish the Idaho Non-Rural Universal Service Fund
(USF). At the same time, the IPUC established a separate docket to investigate
and implement rules for the Idaho Non-Rural USF. The Company is requesting $7.6
million in state USF. Hearings are scheduled for the third quarter of 2000.
Oregon
In September 1999, the governor signed legislation that called for the Oregon
Public Utility Commission (OPUC) to establish a state USF by September 2000. In
June 2000, the OPUC issued its order creating a state USF that will provide
"comparable rates for basic telephone service in rural areas through a surcharge
on customers' bills." The Company is anticipating $18.5 million from this USF in
its first year. The Company will be filing revenue neutral tariffs in September
2000.
Washington
The Washington Utilities and Transportation Commission (WUTC) completed Phase
III of the Generic Costing and Pricing proceeding in May 2000 and ordered five
zones for deaverged unbundled network elements (UNEs). Also in May 2000, the
WUTC issued an order regarding additional UNE service rates as follows: (1) the
statewide average four-wire loop rate; (2) the Network Interface Device (NID)
rate; (3) the Minute of Use (MOU) transport termination rate; (4) the loop
conditioning rates for removal of load coil and bridge tap; and (5) the service
control point rate. The tariff became effective in June 2000.
OTHER DEVELOPMENTS
Net Assets Held for Sale
During May 1999, the Company entered into an agreement to sell approximately
14,000 switched access lines located in California to Citizens Utilities
Company. This agreement consummates the Company's previously announced 1998 plan
to sell selected access lines located in California. The sale is contingent upon
final agreements and regulatory approval and is expected to close in 2000. The
associated net assets, which approximate $16.5 million and $16.0 million at June
30, 2000 and December 31, 1999, respectively, consist of property, plant and
equipment, and have been classified as "Net assets held for sale" in the
consolidated balance sheets. The Company
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VERIZON NORTHWEST INC.
Management's Discussion and Analysis of Results of Operations - Continued
(Abbreviated pursuant to General Instruction H(2) of Form 10-Q)
intends to continue to operate all of these assets until sold. Based on the
decision to sell, however, the Company stopped recording depreciation expense
for these assets. Accordingly, depreciation expense was lowered by $0.7 million
and $1.3 million for the three and six months ended June 30, 2000 and $0.6
million and $1.2 million for the three and six months ended June 30, 1999,
respectively. No charges were recorded for the access lines to be sold because
their estimated fair values were in excess of their carrying values. The access
line agreement represents approximately 1% of the switched access lines that the
Company had in service at the end of 1999, and contributed approximately 1% to
1999 consolidated revenues and approximately 3% to 1999 consolidated operating
income.
Directory Publishing Revenues
Consistent with industry practice, effective January 1, 2000, the Company
changed its method of recognizing directory publishing revenues. Verizon
Directories Corp., a wholly-owned subsidiary of GTE, publishes telephone
directories for which it receives advertising revenue. Under the previous method
of revenue recognition, approximately 60% of the advertising revenue for
directories published in the Company's operating areas was recognized as revenue
by the Company. The remaining 40% was recognized as revenue by Verizon
Directories Corp. Under the new method, Verizon Directories Corp. now recognizes
100% of the directory publishing revenues. The Company, in-turn, bills Verizon
Directories Corp. for customer listing information and billing and collection
services. As a result, the Company's other services and sales revenues and
operating income decreased $7.4 million and $6.0 million, respectively, for the
six months ended June 30, 2000 compared to the same period in of 1999.
RECENT ACCOUNTING PRONOUNCEMENTS
FASB Accounting Standards - Derivatives and Hedging Activities
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement requires that all
derivatives be measured at fair value and recognized as either assets or
liabilities on the Company's balance sheet. Changes in the fair values of
derivative instruments will be recognized in either earnings or comprehensive
income, depending on the designated use and effectiveness of the instruments.
The FASB amended this pronouncement in June 1999 to defer the effective date of
SFAS No. 133 for one year. The Company must adopt SFAS No. 133 no later than
January 1, 2001.
In June 2000, the FASB issued SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities," which amended SFAS No. 133. The
amendments in SFAS No. 138 address certain implementation issues and relate to
such matters as the normal purchases and normal sales exception, the definition
of interest rate risk, hedging recognized foreign-currency-denominated assets
and liabilities, and intercompany derivatives. SFAS No. 138 also amends SFAS No.
133 for decisions made by the FASB relating to the Derivatives Implementation
Group process.
The Company is currently evaluating the provisions of SFAS No. 133 and No. 138.
The impact of adoption will be determined by several factors, including the
specific hedging instruments in place and their relationships to hedged items,
as well as market conditions at the date of adoption.
FASB Interpretation - Stock Compensation
In March 2000, the FASB issued Interpretation No. 44, "Accounting for Certain
Transactions involving Stock Compensation." Interpretation No. 44 was issued in
order to clarify certain issues arising from Accounting Principles Board (APB)
Opinion No. 25 "Accounting for Stock Issued to Employees," which was previously
issued in October 1972. Interpretation No. 44 is effective July 1, 2000, but
certain conclusions cover specific events that occur either after December 15,
1998 or January 12, 2000.
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VERIZON NORTHWEST INC.
Management's Discussion and Analysis of Results of Operations - Continued
(Abbreviated pursuant to General Instruction H(2) of Form 10-Q)
The main issues addressed by Interpretation No. 44 are: (a) the definition of an
employee for purposes of applying APB Opinion No. 25, (b) the criteria for
determining whether a plan qualifies as a noncompensatory plan, (c) the
accounting consequence of various modifications to the terms of a previously
fixed stock option or award, and (d) the accounting for an exchange of stock
compensation awards in a business combination.
Interpretation No. 44 will not have a material impact on the Company's results
of operations or financial position.
SEC Staff Accounting Bulletin - Revenue Recognition
In December 1999, the SEC issued Staff Accounting Bulletin (SAB) No. 101,
"Revenue Recognition in Financial Statements," which must be adopted by the
fourth quarter of 2000. SAB No. 101 provides additional guidance on revenue
recognition, as well as criteria for when revenue is generally realized and
earned, and also requires the deferral of incremental direct selling costs. The
Company is currently assessing the impact of SAB No. 101 on its results of
operations and financial position.
15
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VERIZON NORTHWEST INC.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
There are no proceedings reportable under this Item.
Item 6. Exhibits:
(a) Exhibits:
3.1 Articles of Incorporation and amendment (Exhibit 3.1 of the
Company's 1986 and 1987 Form 10-K's, respectively,
incorporated herein by reference)
3.3 Amendment to the Articles of Incorporation of
Verizon Northwest Inc., filed with the Secretary of the
State of Washington on June 30, 2000.
27 Financial Data Schedule
(b) The Company filed a report on Form 8-K dated June 30, 2000 under Item
1, "Changes in Control of Registrant."
16
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SIGNATURE
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 Northwest Inc.
-----------------------------
(Registrant)
Date: August 14, 2000 /s/ Edwin F. Hall
------------------- -----------------------------
Edwin F. Hall
Controller
(Principal Accounting Officer)
UNLESS OTHERWISE INDICATED, ALL INFORMATION IS AS OF AUGUST 10, 2000.
17
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EXHIBIT INDEX
Exhibit
Number Description
------- -----------
3.3 Amendment to the Articles of Incorporation of Verizon
Northwest Inc., filed with the Secretary of the State of
Washington on June 30, 2000.
27 Financial Data Schedule
