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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
FORM 10-Q
 
 
(Mark one)
 
x
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2002
 
OR
 
¨
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to
 
Commission File Number 1-6417
 
VERIZON CALIFORNIA INC.
 
A California Corporation
     
I.R.S. Employer Identification
No. 95-0510200
 
1095 Avenue of the Americas, Room 3868, New York, New York 10036
 
Telephone Number (212) 395-2121
 
 
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT PURSUANT TO GENERAL INSTRUCTION H(2).
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.        Yes x        No ¨             

PART I—FINANCIAL INFORMATION
 
Item 1.    Financial Statements
 
VERIZON CALIFORNIA INC.
 
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 
      
Three Months Ended
September 30,
     
Nine Months Ended
September 30,
(Dollars in Millions) (Unaudited)
     
2002
     
2001
     
2002
     
2001
OPERATING REVENUES (including $51.8, $66.4, $192.3 and $165.8 from affiliates)
     
$
813.6
     
$
849.7
     
$
2,456.5
     
$
2,554.6
      
    
    
    
Operations and support expense (exclusive of items shown below)
(including $132.1, $111.8, $359.4 and $298.2 to affiliates)
     
 
380.7
     
 
368.5
     
 
1,144.2
     
 
1,058.1
Depreciation and amortization
     
 
154.2
     
 
168.0
     
 
470.0
     
 
491.5
      
    
    
    
      
 
534.9
     
 
536.5
     
 
1,614.2
     
 
1,549.6
      
    
    
    
OPERATING INCOME
     
 
278.7
     
 
313.2
     
 
842.3
     
 
1,005.0
OTHER INCOME, NET (including $0, $.1, $.1 and $.3 from affiliates)
     
 
.3
     
 
.1
     
 
1.0
     
 
.3
INTEREST EXPENSE (including $4.1, $8.3, $12.7 and $28.4 to affiliates)
     
 
34.5
     
 
38.3
     
 
100.3
     
 
117.6
      
    
    
    
INCOME BEFORE PROVISION FOR INCOME TAXES
     
 
244.5
     
 
275.0
     
 
743.0
     
 
887.7
PROVISION FOR INCOME TAXES
     
 
99.4
     
 
112.2
     
 
302.0
     
 
362.6
      
    
    
    
NET INCOME
     
$
145.1
     
$
162.8
     
$
441.0
     
$
525.1
      
    
    
    
 
See Notes to Condensed Consolidated Financial Statements.

1

VERIZON CALIFORNIA INC.
 
CONDENSED CONSOLIDATED BALANCE SHEETS
 
(Dollars in Millions)
   
September 30,
2002
   
December 31,
2001
    
(Unaudited)
     
ASSETS
              
CURRENT ASSETS
              
Cash
   
$
.9
   
$
1.4
Short-term investments
   
 
1.5
   
 
105.8
Accounts receivable:
              
Trade and other, net of allowances for uncollectibles of $85.1 and $47.0
   
 
565.8
   
 
598.6
Affiliates
   
 
51.7
   
 
45.5
Material and supplies
   
 
64.1
   
 
49.6
Prepaid expenses
   
 
.9
   
 
1.3
Deferred income taxes
   
 
100.9
   
 
75.3
Other
   
 
75.8
   
 
83.3
    
  
    
 
861.6
   
 
960.8
    
  
PLANT, PROPERTY AND EQUIPMENT
   
 
11,327.4
   
 
11,264.7
Less accumulated depreciation
   
 
7,627.8
   
 
7,386.4
    
  
    
 
3,699.6
   
 
3,878.3
    
  
PREPAID PENSION ASSET
   
 
2,014.6
   
 
1,849.2
    
  
OTHER ASSETS
   
 
190.1
   
 
187.4
    
  
TOTAL ASSETS
   
$
6,765.9
   
$
6,875.7
    
  
 
See Notes to Condensed Consolidated Financial Statements.

2

VERIZON CALIFORNIA INC.
 
CONDENSED CONSOLIDATED BALANCE SHEETS
 
(Dollars in Millions, Except Per Share Amount)
   
September 30,
2002
   
December 31,
2001
    
(Unaudited)
     
LIABILITIES AND SHAREOWNER’S INVESTMENT
              
CURRENT LIABILITIES
              
Debt maturing within one year:
              
Notes payable to affiliates
   
$
713.1
   
$
723.3
Other
   
 
2.5
   
 
2.5
Accounts payable and accrued liabilities:
              
Affiliates
   
 
158.4
   
 
145.0
Other
   
 
278.8
   
 
478.9
Other liabilities
   
 
292.2
   
 
273.0
    
  
    
 
1,445.0
   
 
1,622.7
    
  
LONG-TERM DEBT
   
 
1,659.6
   
 
1,659.1
    
  
EMPLOYEE BENEFIT OBLIGATIONS
   
 
322.8
   
 
308.3
    
  
DEFERRED CREDITS AND OTHER LIABILITIES
              
Deferred income taxes
   
 
1,192.5
   
 
1,099.7
Unamortized investment tax credits
   
 
1.6
   
 
2.6
Other
   
 
181.3
   
 
186.3
    
  
    
 
1,375.4
   
 
1,288.6
    
  
SHAREOWNER’S INVESTMENT
              
Common stock (one share, without par value, at September 30, 2002; $20 par value, authorized 100,000,000 shares, outstanding 70,000,000 shares at December 31, 2001)
   
 
1,400.0
   
 
1,400.0
Contributed capital
   
 
337.4
   
 
337.3
Reinvested earnings
   
 
225.7
   
 
259.7
    
  
    
 
1,963.1
   
 
1,997.0
    
  
TOTAL LIABILITIES AND SHAREOWNER’S INVESTMENT
   
$
6,765.9
   
$
6,875.7
    
  
 
See Notes to Condensed Consolidated Financial Statements.

3

VERIZON CALIFORNIA INC.
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
    
Nine Months Ended
September 30,
  
(Dollars in Millions) (Unaudited)
   
2002
     
2001
  
NET CASH PROVIDED BY OPERATING ACTIVITIES
   
$
647.3
 
   
$
998.1
 
    
  
CASH FLOWS FROM INVESTING ACTIVITIES
                  
Net change in short-term investments
   
 
104.3
 
   
 
57.7
 
Capital expenditures
   
 
(284.9
)
   
 
(455.3
)
Other, net
   
 
18.0
 
   
 
1.2
 
    
  
Net cash used in investing activities
   
 
(162.6
)
   
 
(396.4
)
    
  
CASH FLOWS FROM FINANCING ACTIVITIES
                  
Principal repayments of borrowings
   
 
—  
 
   
 
(300.0
)
Change in notes payable to affiliates
   
 
(10.2
)
   
 
208.1
 
Dividends paid
   
 
(475.0
)
   
 
(512.0
)
    
  
Net cash used in financing activities
   
 
(485.2
)
   
 
(603.9
)
    
  
NET CHANGE IN CASH
   
 
(.5
)
   
 
(2.2
)
CASH, BEGINNING OF PERIOD
   
 
1.4
 
   
 
2.5
 
    
  
CASH, END OF PERIOD
   
$
.9
 
   
$
.3
 
    
  
 
See Notes to Condensed Consolidated Financial Statements.

4

VERIZON CALIFORNIA INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
1.    Basis of Presentation
 
Verizon California Inc. is a wholly owned subsidiary of GTE Corporation (GTE), which is a wholly owned subsidiary of Verizon Communications Inc. (Verizon Communications). The accompanying unaudited condensed consolidated financial statements have been prepared based upon Securities and Exchange Commission rules that permit reduced disclosure for interim periods. These financial statements reflect all adjustments that are necessary for a fair presentation of results of operations and financial position for the interim periods shown including normal recurring accruals. The results for the interim periods are not necessarily indicative of results for the full year. The balance sheet at December 31, 2001 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For a more complete discussion of significant accounting policies and certain other information, you should refer to the financial statements included in our 2001 Annual Report on Form 10-K.
 
We have reclassified certain amounts from prior year’s data to conform to the 2002 presentation.
 
2.    Adoption of New Accounting Standards
 
Goodwill and Other Intangible Assets
 
Effective January 1, 2002, we adopted Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 no longer permits the amortization of goodwill and indefinite-lived intangible assets. Instead, these assets must be reviewed annually (or more frequently under prescribed conditions) for impairment in accordance with this statement. This impairment test uses a fair value approach rather than the undiscounted cash flows approach previously required by SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” The goodwill impairment test under SFAS No. 142 requires a two-step approach, which is performed at the reporting unit level, as defined in SFAS No. 142. Step one identifies potential impairments by comparing the fair value of the reporting unit to its carrying amount. Step two, which is only performed if there is a potential impairment, compares the carrying amount of the reporting unit’s goodwill to its implied value, as defined in SFAS No. 142. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized for an amount equal to that excess. Intangible assets that do not have indefinite lives are 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 adoption of SFAS No. 142 did not impact our results of operations or financial position because we had no goodwill or other intangible assets at December 31, 2001 and 2000.
 
Impairment or Disposal of Long-Lived Assets
 
Effective January 1, 2002, we adopted 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 adoption of SFAS No. 144 did not have a material effect on our results of operations or financial position.
 
3.    Recent Accounting Pronouncements
 
Asset Retirement Obligations
 
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143, “Accounting for Asset Retirement Obligations.” This standard provides the accounting for the cost of legal obligations associated with the retirement of long-lived assets. SFAS No. 143 requires that companies recognize the fair value of a liability for asset retirement obligations in the period in which the obligations are incurred and capitalize that amount as a part of the book value of the long-lived asset. That cost is then depreciated over the remaining life of the underlying long-lived asset. We are required to adopt SFAS No. 143 effective January 1, 2003. We are currently evaluating the impact this new standard will have on our future results of operations or financial position.

5

VERIZON CALIFORNIA INC.
 
Debt Extinguishment
 
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.” SFAS No. 145, among other things, eliminates the requirement that all gains and losses on the extinguishment of debt must be classified as extraordinary items on the income statement, thereby permitting the classification of such gains and losses as extraordinary items only if the criteria of APB No. 30 are met. We are required to adopt this provision of SFAS No. 145 effective January 1, 2003 and, upon adoption, we will reclassify in our statements of income previously reported extraordinary charges for the early extinguishment of debt to income from continuing operations.
 
Exit or Disposal Activities
 
In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This standard 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 a Restructuring).” EITF Issue No. 94-3 required accrual of liabilities related to exit and disposal activities at a plan (commitment) date. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. The provisions of this standard are effective for exit or disposal activities that are initiated after December 31, 2002.
 
4.    Dividend
 
On November 1, 2002, we declared and paid a dividend in the amount of $170.0 million to GTE.
 
5.    Shareowner’s Investment
 
    
Common Stock
   
Contributed Capital
   
Reinvested Earnings
  
    
(Dollars in Millions)
  
Balance at December 31, 2001
   
$
1,400.0
   
$337.3
   
$
259.7
 
Net income
               
 
441.0
 
Dividends declared to GTE
               
 
(475.0
)
Other
          
.1
         
    
  
  
Balance at September 30, 2002
   
$
1,400.0
   
$337.4
   
$
225.7
 
    
  
  
 
Net income and comprehensive income were the same for the nine months ended September 30, 2002 and 2001.
 
On August 12, 2002, pursuant to an amendment to our Restated Articles of Incorporation, we exchanged all of our issued and outstanding shares of Common Stock, $20 par value, for one share of Common Stock, without par value.
 
6.    Commitments and Contingencies
 
State regulatory conditions to the Bell Atlantic – GTE merger require us to contribute $2.5 million annually to a community fund through 2010.
 
Various legal actions and regulatory proceedings are pending to which we are a party and claims which, if asserted, may lead to other legal actions. We have established reserves for specific liabilities in connection with regulatory and legal matters that we currently deem to be probable and estimable. We do not expect that the ultimate resolution of pending regulatory and legal matters in future periods will have a material effect on our financial condition, but it could have a material effect on our results of operations.
 
Several regulatory matters may require us to refund to customers a portion of the revenues collected in the current and prior periods. The outcome of each pending matter, as well as the time frame within which each matter will be resolved, is not presently determinable.
 
Regulatory conditions to the Bell Atlantic – GTE merger include commitments to, among other things, promote competition and the widespread deployment of advanced services, while helping to ensure that consumers continue to receive high-quality, low cost telephone services. In some cases, there are significant penalties associated with not meeting these commitments. The cost of satisfying these commitments could have a significant impact on net income in future periods.

6

VERIZON CALIFORNIA INC.
 
7.    Employee Severance and Other
 
In connection with the Bell Atlantic – GTE merger on June 30, 2000, we incurred charges associated with employee severance of $51.5 million. These costs, as recorded under SFAS No. 112, “Employers’ Accounting for Postemployment Benefits,” represent the benefit costs for the separation of management employees who were entitled to benefits under pre-existing separation plans, as well as an accrual of ongoing SFAS No. 112 obligations for GTE employees. The severances in connection with the Bell Atlantic-GTE merger are complete.
 
During the fourth quarter of 2001, we recorded a charge of $9.1 million for the voluntary and involuntary separation of employees in accordance with SFAS No. 112. During the second quarter of 2002, we recorded a charge of $9.8 million in accordance with SFAS No. 112 associated with employee severance. As of September 30, 2002, a total of approximately 340 management and associate employees have been separated under the 2001 and 2002 severance programs. The remaining severance liability relating to these programs is $9.1 million, which includes future payments to employees separated as of September 30, 2002. We expect to complete the severance programs within a year of when the respective charges were recorded. Employee benefit costs are recorded in Operations and Support Expense in our Statement of Income.
 
In addition, during the second quarter of 2002, we recorded an impairment charge of $26.1 million driven by our financial statement exposure to WorldCom Inc.

7

VERIZON CALIFORNIA INC.
 
Item 2.    Management’s Discussion and Analysis of Results of Operations (Abbreviated pursuant to General Instruction H(2).)
 
This discussion should be read in conjunction with the Condensed Consolidated Financial Statements and Condensed Consolidated Notes to Financial Statements.
 
RESULTS OF OPERATIONS
 
We reported net income of $441.0 million for the nine month period ended September 30, 2002, compared to net income of $525.1 million for the same period in 2001. Our reported results included the following special items:
 
Employee Severance
 
During the second quarter of 2002, we recorded a charge of $9.8 million in accordance with Statement of Financial Accounting Standards (SFAS) No. 112, “Employers’ Accounting for Postemployment Benefits,” associated with employee severance.
 
WorldCom Inc.
 
During the second quarter of 2002, we recorded an impairment charge of $26.1 million driven by our financial statement exposure to WorldCom Inc. (WorldCom).
 
WorldCom, including its affiliates, purchases dedicated local exchange capacity from us to support its private networks and we also charge WorldCom for access to our local network. In addition, we sell local wholesale interconnection services and provide billing and collection services to WorldCom. We purchase long distance and related services from WorldCom. On July 21, 2002, WorldCom filed for Chapter 11 bankruptcy protection.
 
During the third quarter of 2002, we recorded revenues earned from the provision of primarily network access services to WorldCom of $42.3 million. If WorldCom terminates contracts with us for the provision of services, our operating revenues would be lower in future periods. Lower revenues as a result of canceling contracts for the provision of services could be partially offset, in some cases, by the migration of customers on the terminated facilities to us or other carriers who purchase capacity and/or interconnection services from us.
 
At September 30, 2002, accounts receivable from WorldCom, net of a provision for uncollectibles, was $14.3 million. We continue to closely monitor our collections on WorldCom account balances. WorldCom is current with respect to its post-bankruptcy obligations. We believe that we are adequately reserved for the potential risk of non-payment of pre-bankruptcy receivables from WorldCom.
 
OPERATING REVENUES
(Dollars in Millions)
 
    
Nine Months Ended September 30,
    
2002
   
2001
Local services
   
$
1,199.9
   
$
1,224.9
Network access services
   
 
929.4
   
 
974.5
Long distance services
   
 
98.5
   
 
110.4
Other services
   
 
228.7
   
 
244.8
    
  
Total
   
$
2,456.5
   
$
2,554.6
    
  
 
We recognize service revenues based upon usage of our local exchange network and facilities and contract fees. We recognize product and other service revenues when the products are delivered and accepted by the customers and when services are provided in accordance with contract terms.

8

VERIZON CALIFORNIA INC.
 
LOCAL SERVICES
 
2002—2001
   
(Decrease)
  
Nine Months
   
$
(25.0
)
   
(2.0
)%