<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 2-36292
VERIZON SOUTH INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
VIRGINIA 56-0656680
(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 SOUTH 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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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
VERIZON SOUTH INC.
Condensed 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 $ 117.7 $ 180.6 $ 307.5 $ 357.1
Network access services 173.6 179.0 349.3 341.0
Other services and sales 47.3 56.4 93.2 115.3
------------ ------------ ------------ -------------
Total revenues and sales 338.6 416.0 750.0 813.4
------------ ------------ ------------ -------------
OPERATING COSTS AND EXPENSES
Operations and support 206.6 177.4 393.9 367.1
Depreciation and amortization 78.5 72.6 157.5 149.1
------------ ------------ ------------ -------------
Total operating costs and expenses 285.1 250.0 551.4 516.2
------------ ------------ ------------ -------------
OPERATING INCOME 53.5 166.0 198.6 297.2
OTHER EXPENSE
Interest - net 46.1 15.4 65.4 33.5
------------ ------------ ------------ -------------
INCOME BEFORE INCOME TAXES 7.4 150.6 133.2 263.7
Income taxes 7.9 58.9 57.2 103.1
------------ ------------ ------------ -------------
NET INCOME (LOSS) $ (0.5) $ 91.7 $ 76.0 $ 160.6
============ ============ ============ =============
</TABLE>
The accompanying notes are an integral part of these statements.
1
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VERIZON SOUTH INC.
Condensed Balance Sheets (Unaudited)
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
-------------- -------------
(Dollars in Millions)
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $ 0.4 $ 13.4
Receivables, less allowances of $20.5 million
and $18.6 million 246.4 297.5
Accounts receivable from affiliates 4.6 19.6
Inventories and supplies 24.2 22.1
Prepayments and other 19.0 64.4
-------------- -------------
Total current assets 294.6 417.0
-------------- -------------
Property, plant and equipment, at cost 4,739.6 4,616.2
Accumulated depreciation (2,979.7) (2,897.0)
-------------- -------------
Total property, plant and equipment, net 1,759.9 1,719.2
-------------- -------------
Prepaid pension costs 322.0 245.0
Other assets 4.7 1.1
-------------- -------------
Total assets $ 2,381.2 $ 2,382.3
============== =============
</TABLE>
The accompanying notes are an integral part of these statements.
2
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VERIZON SOUTH INC.
Condensed 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 $ 6.0 $ 4.3
Notes payable to affiliates 65.6 138.2
Accounts payable 54.2 90.8
Affiliate payables and accruals 74.1 29.1
Dividends payable 70.0 89.0
Taxes payable 26.4 27.1
Accrued payroll costs 39.2 29.7
Other 185.9 95.9
--------------- --------------
Total current liabilities 521.4 504.1
--------------- --------------
Long-term debt 791.5 793.1
Employee benefit plans 156.7 159.4
Deferred income taxes 146.6 164.0
Regulatory and other liabilities 188.7 132.3
--------------- --------------
Total liabilities 1,804.9 1,752.9
--------------- --------------
Shareholder's equity
Preferred stock -- 0.4
Common stock (21,000,000 shares issued) 525.0 525.0
Additional paid-in capital 63.3 63.0
Retained earnings (deficit) (12.0) 41.0
--------------- --------------
Total shareholder's equity 576.3 629.4
--------------- --------------
Total liabilities and shareholder's equity $ 2,381.2 $ 2,382.3
=============== ==============
</TABLE>
The accompanying notes are an integral part of these statements.
3
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VERIZON SOUTH INC.
Condensed 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 $ 403.4 $ 275.6
------------- ------------
INVESTING
Capital expenditures (195.4) (171.8)
Other - net -- 1.5
------------- ------------
Net cash used in investing (195.4) (170.3)
------------- ------------
FINANCING
Preferred stock retired, including
premiums paid on early retirement (0.4) --
Dividends paid (148.0) (123.3)
Net change in affiliate notes (72.6) 6.4
------------- ------------
Net cash used in financing (221.0) (116.9)
------------- ------------
Decrease in cash and cash equivalents (13.0) (11.6)
Cash and cash equivalents:
Beginning of period 13.4 12.8
------------- ------------
End of period $ 0.4 $ 1.2
============= ============
</TABLE>
The accompanying notes are an integral part of these statements.
4
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VERIZON SOUTH INC.
Statement of Shareholder's Equity (Unaudited)
<TABLE>
<CAPTION>
Additional
Preferred Common Paid-In Retained
Stock Stock Capital Earnings Total
------------- -------------- ------------- -------------- -------------
(Dollars in Millions)
<S> <C> <C> <C> <C> <C>
Shareholder's equity, December 31, 1999 $ 0.4 $ 525.0 $ 63.0 $ 41.0 $ 629.4
Net income 76.0 76.0
Redemption of preferred stock (0.4) (0.4)
Tax benefit from exercise of stock options 0.3 0.3
Dividends declared (129.0) (129.0)
------------- -------------- ------------- -------------- -------------
Shareholder's equity, June 30, 2000 $ -- $ 525.0 $ 63.3 $ (12.0) $ 576.3
============= ============== ============= ============== =============
</TABLE>
The accompanying notes are an integral part of these statements.
5
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VERIZON SOUTH INC.
Notes to Condensed Financial Statements (Unaudited)
Note 1. Basis of Presentation
Verizon South Inc. (the Company), formerly GTE South 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 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 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 $41.8 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 our balance sheets as a component of "Employee benefit plans."
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 $3.3 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
$70.0 million to Verizon Communications.
Note 4. Preferred Stock
In March 2000, the Company redeemed all 4,119 outstanding shares of preferred
stock and paid premiums of less than $0.1 million pretax on the early
redemption.
6
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VERIZON SOUTH INC.
Notes to Condensed Financial Statements (Unaudited) - Continued
Note 5. Net Assets Held for Sale
During December 1999, the Company entered into an agreement to sell
approximately 7,000 switched access lines located in Illinois to Citizens
Utilities Company. This agreement consummates the Company's previously announced
1998 plan to sell selected access lines located in Illinois. This sale is
contingent upon final agreement and regulatory approval and is expected to close
during 2000. The associated net assets, which approximate $3.5 million and $4.0
million at June 30, 2000 and December 31, 1999, respectively, consist of
property, plant and equipment, and have been classified as "Prepayments and
other" in the 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 $0.2 million and $0.4 million for the three
and six months ended June 30, 2000 and $0.3 million and $0.5 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 less than
1% of the switched access lines that the Company had in service at the end of
1999, and contributed less than 1% to 1999 revenues and less than 1% of
operating income.
Note 6. 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 $22.2 million and $19.9 million, respectively, for
the six months ended June 30, 2000 compared to the same period in of 1999.
Note 7. 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 SOUTH INC.
Notes to Condensed 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 8. 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 these commitments. The cost
of satisfying these commitments could have a significant impact on the 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 SOUTH INC.
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 decreased by $84.6 million or 53% for the six months ended June 30,
2000. The decrease is primarily the result of lower local services and other
services and sales revenues and higher interest expense.
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 condensed
statements of income for each period:
(Dollars in Millions)
Six Months Ended June 30, 2000 1999
------------------------------------------------- --------------- --------------
Revenues and Sales
Regulatory contingencies $ 21.3 $ --
------------ --------------
Operations and Support Expenses
Bell Atlantic-GTE merger costs 41.8 --
Conforming accounting adjustments (3.3) (3.3)
------------ --------------
38.5 (3.3)
------------ --------------
Interest Expense
Regulatory contingencies 29.8 --
------------ --------------
Total $ 89.6 $ (3.3)
============ ==============
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 $41.8 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
9
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VERIZON SOUTH INC.
Management's Discussion and Analysis of Results of Operations - Continued
(Abbreviated pursuant to General Instruction H(2) of Form 10-Q)
those employees are included in the Company's balance sheets as a component of
"Employee benefit plans."
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 $3.3 million for each of the six month periods ended June 30, 2000 and 1999.
Regulatory Contingencies
In the second quarter of 2000, the Company recognized charges for regulatory
matters totaling $51.1 million. The Company recorded a reduction to operating
revenue in the amount of $21.3 million and a charge to interest expense of $29.8
million. These matters relate to specific issues currently under investigation
by federal and state regulatory commissions. The Company believes that it is
probable that the ultimate resolution of these matters will result in refunds to
its 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 $ 307.5 $ 357.1 $ (49.6) (14)%
Network access services 349.3 341.0 8.3 2 %
Other services and sales 93.2 115.3 (22.1) (19)%
------------ ------------ ------------
Total revenues and sales $ 750.0 $ 813.4 $ (63.4) (8)%
============ ============ ============
</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 decrease in local services revenues was
primarily due to second quarter 2000 special charges for certain regulatory
matters. The decrease was partially offset by growth in access lines of 4%,
which generated additional revenues from basic local services, CentraNet(R)
services, Integrated Services Digital Network and Digital Channel Services. The
decrease was also partially offset by increased demand for enhanced custom
calling features, such as SmartCall(R) services. In addition, increased
maintenance and service revenues and growth in extended area service further
offset the decrease in local services revenues.
10
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VERIZON SOUTH INC.
Management's Discussion and Analysis of Results of Operations - Continued
(Abbreviated pursuant to General Instruction H(2) of Form 10-Q)
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. The increase in network access services
revenues was primarily attributable to a 6% increase in minutes of use for the
six months ending June 30, 2000 as compared to the same period in 1999. In
addition, special access revenues grew as a result of greater demand for
increased bandwidth services by high-capacity users and end-user surcharges
increased as a result of access line growth and implementation of the local
number portability (LNP) surcharge. These increases were substantially offset by
the impact of mandated interstate and intrastate access price reductions and
rate element adjustments. In addition, revenues were reduced by a second quarter
2000 special charge for a contingency related to a regulatory matter (see
"Results of Operations").
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
within the same LATA (intraLATA). Other services and sales revenues decreased
for the six months ended June 30, 2000, as compared to the same period in 1999,
primarily due to the impact of a change in the recognition of directory
publishing revenues resulting in a decrease of $22.2 million (for further
information see "OTHER DEVELOPMENTS - Directory Publishing Revenues").
<TABLE>
<CAPTION>
OPERATING COSTS AND EXPENSES
(Dollars in Millions) Six Months Ended
June 30,
------------------------------ Percent
2000 1999 Increase Change
------------- ------------- ------------- ------------
<S> <C> <C> <C> <C>
Operations and support $ 393.9 $ 367.1 $ 26.8 7%
Depreciation and amortization 157.5 149.1 8.4 6%
------------- ------------- -------------
Total operating costs and expenses $ 551.4 $ 516.2 $ 35.2 7%
============= ============= =============
</TABLE>
Operations and support expenses, representing employee costs and other operating
expenses, increased $26.8 million, or 7% in the first six months of 2000
compared to the same period in 1999. The increase is primarily due to second
quarter 2000 special charge of $41.8 million for severance and direct
incremental merger-related costs (see "RESULTS OF OPERATIONS"). Higher access
expenses resulting from increased competitive local exchange carrier (CLEC)
activity also contributed to the cost increases. Partially offsetting these
increases was the recognition of a pretax gain 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. A charge in the first quarter of 1999, associated with an
employee-reduction program, also contributed to the decrease in operating costs
for the first half of 2000 compared to the same period in 1999.
The increase in depreciation and amortization expense in the first six months of
2000 compared to the same period in 1999 reflects the continuing investment in
network to support access line growth due to higher demand from Internet Service
Providers (ISPs) and customer line growth. Partially offsetting the increases 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").
11
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VERIZON SOUTH INC.
Management's Discussion and Analysis of Results of Operations - Continued
(Abbreviated pursuant to General Instruction H(2) of Form 10-Q)
OTHER INCOME STATEMENT ITEMS
Interest-net increased for the six months ended June 30, 2000 compared to the
same period in 1999 primarily due to an accrual for additional interest
associated with certain regulatory matters.
Income tax expense decreased for the six months ended June 30, 2000 as compared
to the same period in 1999, primarily due to a corresponding decrease in pretax
income.
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's service
territory. The price restructuring portions of the plan are mandatory for all
large local exchange carriers, including Verizon Communication'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
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VERIZON SOUTH 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
Alabama
In December 1999, the Alabama Public Service Commission (APSC) issued a Further
Report and Order ordering the Company to submit plans and procedures detailing
their intended utilization of the federal high-cost universal service funding
(USF) for which it is eligible for the year 2000 by January 14, 2000. The
Company filed its proposed plan for the utilization of the revised incremental
amount of approximately $9.0 million. The APSC accepted the Company's plan and
certified it to the FCC.
The Company filed a proposed plan on July 21, 2000 seeking APSC approval of 2001
USF incremental funding of approximately $10.5 million.
North Carolina
In March 2000, the North Carolina Utility Commission (NCUC) issued an order to
further address Unbundled Network Elements (UNEs) and the impacts of the FCC's
UNE remand order and line sharing order. The NCUC order established proceedings
in two phases. Phase I addresses (1) geographically deaveraged UNEs, (2) the
13
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VERIZON SOUTH INC.
Management's Discussion and Analysis of Results of Operations - Continued
(Abbreviated pursuant to General Instruction H(2) of Form 10-Q)
impacts of the FCC's UNE remand order on the original UNEs for which the NCUC
has set permanent rates, and (3) rates for line sharing consistent with the
FCC's line sharing order. Phase II addresses (1) issues raised in certain UNE
arbitration proceedings that were deferred to this proceeding and (2) any new
UNEs to be considered as a result of the FCC's UNE remand order. Hearings for
Phase I and Phase II are scheduled to begin in September and October 2000,
respectively. This case may be effected by the recent U.S. Court of Appeals
decision invalidating certain FCC pricing guidelines.
Pursuant to the Company's price cap plans, tariff revisions were filed in June
2000 reflecting approximately $0.8 million in revenue reductions.
South Carolina
In July 2000, the Consumer Advocate filed a complaint with the Public Service
Commission of South Carolina (PSCSC) requesting a docket be opened to review the
rates, charges and earnings of the Company. The Company must respond to the
complaint by August 23, 2000.
Virginia
The Company is currently operating under an Annual Information Filing plan in
Virginia, which may produce refunds if returns exceed certain prescribed limits.
The Virginia State Corporation Commission (VSCC) is currently reviewing the
Company's earnings from 1995 to the present under various dockets. An
unfavorable ruling in these dockets could result in refunds or other reductions.
OTHER DEVELOPMENTS
Net Assets Held for Sale
During December 1999, the Company entered into an agreement to sell
approximately 7,000 switched access lines located in Illinois to Citizens
Utilities Company. This agreement consummates the Company's previously announced
1998 plan to sell selected access lines located in Illinois. This sale is
contingent upon final agreement and regulatory approval and is expected to close
during 2000. The associated net assets, which approximate $3.5 million and $4.0
million at June 30, 2000 and December 31, 1999, respectively, consist of
property, plant and equipment, and have been classified as "Prepayments and
other" in the 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 $0.2 million and $0.4 million for the three
and six months ended June 30, 2000 and $0.3 million and $0.5 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 less than
1% of the switched access lines that the Company had in service at the end of
1999, and contributed less than 1% to 1999 revenues and less than 1% to
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
14
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VERIZON SOUTH INC.
Management's Discussion and Analysis of Results of Operations - Continued
(Abbreviated pursuant to General Instruction H(2) of Form 10-Q)
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 $22.2 million and $19.9 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.
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
15
<PAGE>
VERIZON SOUTH INC.
Management's Discussion and Analysis of Results of Operations - Continued
(Abbreviated pursuant to General Instruction H(2) of Form 10-Q)
operations and financial position.
16
<PAGE>
VERIZON SOUTH INC.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
There were no proceedings reportable under this Item.
Item 6. Exhibits:
(a) Exhibits:
3.1 Restated Articles of Incorporation dated August 24, 1989
(Exhibit 3.1 of the Company's 1989 Form 10-K, incorporated
herein by reference)
3.3 Restated Articles of Incorporation of Verizon South Inc.,
filed with the Secretary of the State of Virginia 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."
17
<PAGE>
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 South 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.
18
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description
------- -----------
3.3 Restated Articles of Incorporation of Verizon South Inc.,
filed with the Secretary of the State of Virginia on June
30, 2000.
27 Financial Data Schedule
