UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------- FORM 10-K -------------------------- (Mark one) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number 1-7368 VERIZON WASHINGTON, DC INC. A New York Corporation I.R.S. Employer Identification No. 53-0046277 1710 H Street, N.W., Washington, D.C. 20006 Telephone Number (202) 392-9900 ------------------------------- Securities registered pursuant to Section 12(b) of the Act: None. Securities registered pursuant to Section 12(g) of the Act: None. THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION I(1)(a) AND (b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT PURSUANT TO GENERAL INSTRUCTION I(2). Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Verizon Washington, DC Inc. TABLE OF CONTENTS Item No. Page - -------- ---- PART I 1. Business (Abbreviated pursuant to General Instruction I(2).).............................................. 1 2. Properties ...................................................................................... 6 3. Legal Proceedings ............................................................................... 6 4. Submission of Matters to a Vote of Security Holders (Omitted pursuant to General Instruction I(2).) ................................................. 6 PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters ........................... 7 6. Selected Financial Data (Omitted pursuant to General Instruction I(2).) ................................................. 7 7. Management's Discussion and Analysis of Results of Operations (Abbreviated pursuant to General Instruction I(2).) ............................................. 8 7A. Quantitative and Qualitative Disclosures About Market Risk ...................................... 15 8. Financial Statements and Supplementary Data ..................................................... 15 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ............ 15 PART III (Omitted pursuant to General Instruction I(2).): 10. Directors and Executive Officers of the Registrant ............................................... 16 11. Executive Compensation ........................................................................... 16 12. Security Ownership of Certain Beneficial Owners and Management ................................... 16 13. Certain Relationships and Related Transactions ................................................... 16 PART IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ................................. 17 UNLESS OTHERWISE INDICATED, ALL INFORMATION IS AS OF MARCH 18, 2002. Verizon Washington, DC Inc. PART I Item 1. Business GENERAL Verizon Washington, DC Inc. is incorporated under the laws of the State of New York. We are a wholly owned subsidiary of Verizon Communications Inc. (Verizon). We presently serve a territory consisting of a single Local Access and Transport Area (LATA). A LATA is generally centered on a city or based on some other identifiable common geography and, with certain limited exceptions, a LATA marks the boundary within which we have been permitted by the "Modification of Final Judgment" (MFJ) to provide telephone service. We currently provide two basic types of telecommunications services: . Exchange telecommunication service is the transmission of telecommunications among customers located within a local calling area within a LATA. Examples of exchange telecommunications services include switched local residential and business services, local private line voice and data services and Centrex services. We also provide toll services within a LATA (intraLATA long distance). . Exchange access service links a customer's premises and the transmission facilities of other telecommunications carriers, generally interLATA carriers. Examples of exchange access services include switched access and special access services. BELL ATLANTIC-GTE MERGER On June 30, 2000, Bell Atlantic Corporation (Bell Atlantic) and GTE Corporation (GTE) completed a merger under a definitive merger agreement dated as of July 27, 1998 and began doing business as Verizon. The merger qualified as a tax-free reorganization and has been accounted for as a pooling-of-interests business combination. OPERATIONS We are one of 16 public operating telephone companies owned by Verizon. Verizon has organized certain telecommunications group functions into marketing units operating across its operating telephone subsidiaries. The units focus on specific market segments. Each of the operating telephone subsidiaries, including the company, remains responsible within its respective service area for the provision of telephone services, financial performance and regulatory matters. Verizon's five strategic marketing units are comprised of the following: The Enterprise unit markets communications and information technology and services to large businesses and to departments, agencies and offices of the executive, judicial and legislative branches of the federal, state and local governments. These services include voice switching/processing services (e.g., dedicated private lines, custom Centrex, call management, and voice messaging), end-user networking (e.g., credit and debit card transactions and personal computer-based conferencing, including data and video), internetworking (establishing links between the geographically disparate networks of two or more companies or within the same company), network optimization (disaster avoidance, 911 service, and intelligent vehicle highway systems) and other communications services such as distance learning, telemedicine, videoconferencing and interactive multimedia applications. The Enterprise unit also includes Verizon's Data Solutions Group which provides data transmission and network integration services (integrating multiple geographically disparate networks into one system) and Verizon's Strategic Markets unit which operates as a provider of network monitoring services and telecommunications equipment sales to medium and large businesses. The Retail unit markets communications and information services to residential customers and to small and medium-sized businesses within our territory, including our long distance services. Some of Verizon's long distance subsidiaries operate as a reseller of national and international long distance services and provide service in all 50 states to residential and business customers, including long distance services, calling cards, 800/888 services and operator services to its customers. This unit also provides operator and pay telephone services. The Retail unit includes Verizon Avenue, a subsidiary of Verizon that markets to customers located in multi-tenant buildings and Teleproducts, a subsidiary of Verizon that markets customer premises equipment to the end-user. 1 Verizon Washington, DC Inc. The Network unit markets (i) switched and special access to the telephone operations' local exchange networks, and (ii) billing and collection services, including recording, rating, bill processing and bill rendering. This unit also includes various technical planning groups that provide strategic technology and network planning, new service creation, and emerging business management. The Advanced Services unit markets Verizon's ADSL (asymmetrical digital subscriber line) and Internet access services. Verizon's Global Networks unit is building a next generation long distance network using ATM (asynchronous transfer mode) technology. The National Operations unit markets Verizon's Communications and Construction services that supply installation and repair labor and manages Verizon's Supply unit that is responsible for the procurement and management of inventory and supplies for the telephone operations, as well as other subsidiaries. The Supply unit also sells material and logistic services to third parties. Telecommunications Act of 1996 The Telecommunications Act of 1996 (1996 Act) became effective on February 8, 1996, and replaced the MFJ, a consent decree that arose out of an antitrust action brought by the United States Department of Justice against AT&T. In general, the 1996 Act includes provisions that open local exchange markets to competition and permit Bell Operating Companies, including ours, to engage in manufacturing and to provide long distance services under prescribed conditions. In-Region Long Distance Under the 1996 Act, our ability to offer in-region long distance services (that is, services originating in the jurisdiction where we operate as a local exchange carrier) is largely dependent on satisfying specified requirements. The requirements include a 14-point "competitive checklist" of steps which we must take to help competitors offer local services through resale, through purchase of unbundled network elements (UNEs), or by interconnecting their own networks to ours. We must also demonstrate to the Federal Communications Commission (FCC) that entry into the in-region long distance market would be in the public interest. Third-party testing of our operations support systems by the accounting and consulting firm of KPMG is in its final stages in the District of Columbia. In-region long distance would be offered by a separate non-regulated subsidiary of Verizon as required by law. FCC Regulation and Interstate Rates We are subject to the jurisdiction of the FCC with respect to interstate services and related matters. In 2001, the FCC continued to implement reforms to the interstate access charge system and to implement the "universal service" and other requirements of the 1996 Act. Access Charges and Universal Service On May 31, 2000, the FCC adopted a plan advanced by members of the industry (the Coalition for Affordable Local and Long Distance Service, or CALLS) as a comprehensive five-year plan for regulation of interstate access charges. The CALLS plan has three main components. First, it establishes a portable interstate access universal service support of $650 million for the industry. This explicit support replaces implicit support embedded in interstate access charges. Second, the plan simplifies the patchwork of common line charges into one subscriber line charge (SLC) and provides for de-averaging of the SLC by zones and class of customers in a manner that will not undermine comparable and affordable universal service. Third, the plan sets into place a mechanism to transition to a set target of $.0055 per minute for switched access services. Once that target rate is reached, local exchange carriers are no longer required to make further annual price cap reductions to their switched access prices. The annual reductions leading to the target rate, as well as annual reductions for the subset of special access services that remain subject to price cap regulation was set at 6.5% per year. On September 10, 2001, the U.S. Court of Appeals for the Fifth Circuit ruled on an appeal of the FCC order adopting the plan. The court upheld the FCC on several challenges to the order, but remanded two aspects of the decision back to the FCC on the grounds that they lacked sufficient justification. The court remanded back to the FCC for further consideration its decision setting the annual reduction factor at 6.5% and the size of the new universal service fund at $650 million. The entire plan (including these elements) will continue in effect pending the FCC's further consideration of its justification of these components. As a result of tariff adjustments which became effective in July 2001, we reached the $0.0055 benchmark. 2 Verizon Washington, DC Inc. The FCC has adopted rules for special access services that provide for pricing flexibility and ultimately the removal of services from price regulation when prescribed competitive thresholds are met. In order to use these rules, carriers must forego the ability to take advantage of provisions in the current rules that provide relief in the event earnings fall below prescribed thresholds. In 2001, Verizon was authorized to remove special access and dedicated transport services from price caps in 35 of the 57 Metropolitan Statistical Areas (MSAs) in the former Bell Atlantic territory and in three additional MSAs in the former GTE territory. In addition, the FCC found that in 10 MSAs Verizon had met the stricter standards to remove special access connections to end-user customers from price caps. Verizon has an application pending that, if granted, would remove special access services from price cap regulation in 16 additional MSAs. In November 1999, the FCC adopted a new mechanism for providing universal service support to high cost areas served by large local telephone companies. This funding mechanism provides additional support for local telephone services in several states served by Verizon. This system has been supplemented by the new FCC access charge plan described above. On July 31, 2001, the U.S. Court of Appeals for the Tenth Circuit reversed and remanded to the FCC for further proceedings. The court concluded that the FCC had failed to adequately explain some aspects of its decision and had failed to address any need for a state universal service mechanism. The current universal service mechanism remains in place pending the outcome of any FCC review as a result of these appeals. Unbundling of Network Elements (UNEs) In November 1999, the FCC announced its decision setting forth new unbundling requirements, eliminating elements that it had previously required to be unbundled, limiting the obligation to provide others and adding new elements. Appeals from this decision are pending. In addition to the unbundling requirements released in November 1999, the FCC released an order in a separate proceeding in December 1999, requiring incumbent local exchange companies also to unbundle and provide to competitors the higher frequency portion of their local loop. This provides competitors with the ability to provision data services on top of incumbent carriers' voice services. Appeals from this order are also pending. In July 2000, the U.S. Court of Appeals for the Eighth Circuit found that some aspects of the FCC's requirements for pricing UNEs were inconsistent with the 1996 Act. In particular, it found that the FCC was wrong to require incumbent carriers to base these prices not on their real costs but on the imaginary costs of the most efficient equipment and the most efficient network configuration. This portion of the court's decision has been stayed pending review by the U.S. Supreme Court. In addition, the court upheld the FCC's decision that UNEs should be priced based on a forward-looking cost model rather than historical costs. The U.S. Supreme Court currently has this case under review. In December 2001, the FCC opened its triennial review of UNEs. This rulemaking reopens the question of what network elements must be made available on an unbundled basis under the 1996 Act and will revisit the unbundling decisions described above. In this rulemaking, the FCC also will address other pending issues relating to unbundled elements, including the question of whether competing carriers may substitute combinations of unbundled loops and transport for already competitive special access services. Compensation for Internet Traffic On April 27, 2001, the FCC released an order addressing intercarrier compensation for dial-up connections for Internet-bound traffic. The FCC found that Internet-bound traffic is interstate and subject to the FCC's jurisdiction. Moreover, the FCC again found that Internet-bound traffic is not subject to reciprocal compensation under Section 251(b)(5) of the 1996 Act. Instead, the FCC established federal rates for this traffic that decline from $0.0015 to $0.0007 over a three-year period. The FCC order also sets caps on the total minutes of this traffic that may be subject to any intercarrier compensation and requires that incumbent local exchange carriers must offer to pay reciprocal compensation for local traffic at the same rate as they are required to pay on Internet-bound traffic. Several competing carriers and state regulators appealed this order to the U.S. Court of Appeals for the D.C. Circuit. The court denied a motion to stay the FCC order, and the order went into effect. The appeal remains pending. State Regulation of Rates and Services The District of Columbia Public Service Commission (DCPSC) regulates our intrastate rates and services and other matters. On February 28, 2002, the DCPSC approved a new price cap plan for local retail services provided by our company. Key provisions of the 2002 plan include: 3 Verizon Washington, DC Inc. . a two year term; . no earnings restrictions, service penalties or revenue sharing; . four service categories: basic residential, basic business, discretionary and competitive; . a cap on residential dial tone line rates for the term of the plan and a reduction in residential service connection charges; . annual pricing flexibility for all other basic residential services, with the increase in total revenues from these services limited to the annual inflation rate (as measured by the change in GDP-PI) and increases for any individual service in the category limited to 10%; . classification of all business services as competitive with complete pricing flexibility except for basic business dial tone lines, PBX trunks, local directory service and message units, which are subject to a 10% annual limit on any rate increase; . pricing flexibility on discretionary services, with a 15% annual limit on any rate increase; . flexibility to bundle or package existing services; and . assistance by our company to the District of Columbia government to set up "211" dialing for District of Columbia social services agencies, as well as additional social services infrastructure investments and one-time customer discounts. Competition We face increasing competition in all areas of our business. The 1996 Act, regulatory and judicial actions and the development of new technologies, products and services have created opportunities for alternative telecommunication service providers, many of which are subject to fewer regulatory constraints. Current and potential competitors in telecommunication services include long distance companies, other local telephone companies, cable companies, wireless service providers, foreign telecommunications providers, electric utilities, Internet service providers and other companies that offer network services. Many of these companies have a strong market presence, brand recognition and existing customer relationships, all of which contribute to intensifying competition and may affect our future revenue growth. Local Exchange Services The ability to offer local exchange services has historically been subject to regulation by state regulatory commissions. Applications from competitors to provide and resell local exchange services have been approved in our jurisdiction. The 1996 Act has significantly increased the level of competition in our local exchange markets. One of the purposes of the 1996 Act was to ensure, and accelerate, the emergence of competition in local exchange markets. Toward this end, the 1996 Act requires most existing local exchange carriers (incumbent local exchange carriers, or ILECs), including our company, to permit potential competitors (competitive local exchange carriers, or CLECs) to: . purchase service from the ILEC for resale to CLEC customers; . purchase UNEs from the ILEC; and/or . interconnect the CLEC's network with the ILEC's network. As a result, competition in our local exchange markets continues to increase. We are generally required to sell our services to CLECs at discounts from the prices we charge our retail customers. Long Distance Services We offer intraLATA long distance services. IntraLATA toll calls originate and terminate within the same LATA, but generally cover a greater distance than a local call. All such toll calls originating within the District of Columbia are inherently interstate (terminating in Maryland and Virginia). Federal regulators have jurisdiction over interstate toll services. The FCC also permits other carriers to offer intraLATA toll services originating or terminating within our service territory. Alternative Access Services A substantial portion of our revenues from business and government customers is derived from a relatively small number of large, multiple-line subscribers. We face competition from alternative communications systems, constructed by large end-users, interexchange carriers and alternative access vendors, which are capable of originating and/or terminating calls without the use of our plant. The 4 Verizon Washington, DC Inc. FCC's orders requiring us to offer collocated interconnection for special and switched access services have enhanced the ability of such alternative access providers to compete with us. Other potential sources of competition include cable television systems, shared tenant services and other noncarrier systems which are capable of bypassing our local plant, either partially or completely, through substitution of special access for switched access or through concentration of telecommunications traffic on fewer of our lines. Wireless Services Wireless services also constitute a significant source of competition, especially as wireless carriers (including Verizon Wireless) expand and improve their network coverage and continue to lower their prices to end-users. As a result, more end-users are substituting wireless services for basic wireline service. Wireless telephone services can also be used for data transmission. Public Telephone Services The growth of wireless communications has significantly decreased usage of public telephones, as more customers are substituting wireless services for public telephone services. In addition, we face competition from other providers of public telephone services. Operator Services Our operator services product line faces competition from alternative operator services providers and Internet service providers. EMPLOYEES As of December 31, 2001, we had approximately 1,470 employees. 5 Verizon Washington, DC Inc. Item 2. Properties GENERAL Our principal properties do not lend themselves to simple description by character and location. Our investment in plant, property and equipment consisted of the following at December 31: 2001 2000 - -------------------------------------------------------------------------------- Central office equipment 47% 44% Outside communications plant 17 17 Land and buildings 12 12 Furniture, vehicles and other work equipment 22 24 Other 2 3 -------------------------------- 100% 100% ================================ "Central office equipment" consists of switching equipment, transmission equipment and related facilities. "Outside communications plant" consists primarily of aerial cable, underground cable, conduit and wiring, and telephone poles. "Land and buildings" consists of land and land improvements, and principally central office buildings. "Furniture, vehicles and other work equipment" consists of public telephone instruments and telephone equipment, furniture, office equipment, motor vehicles and other work equipment. "Other" property consists primarily of plant under construction, capitalized computer software costs and leasehold improvements. All of our properties, located in Washington, DC, are generally in good operating condition and are adequate to satisfy the needs of our business. Our customers are served by electronic switching systems that provide a wide variety of services. Our network has full digital capability to furnish advanced data transmission and information management services. CAPITAL EXPENDITURES We have been making and expect to continue to make significant capital expenditures to meet the demand for communications services and to further improve such services. Capital expenditures were approximately $220 million in 2001, $275 million in 2000 and $205 million in 1999. Capital expenditures exclude additions under capital lease. Our total investment in plant, property and equipment was approximately $2.2 billion at December 31, 2001, $2.0 billion at December 31, 2000, and $1.9 billion at December 31, 1999, including the effect of retirements, but before deducting accumulated depreciation. Item 3. Legal Proceedings There are no proceedings reportable under Item 3. Item 4. Submission of Matters to a Vote of Security Holders (Omitted pursuant to General Instruction I(2).) 6 Verizon Washington, DC Inc. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters Not applicable. Item 6. Selected Financial Data (Omitted pursuant to General Instruction I(2).) 7 Verizon Washington, DC Inc. Item 7. Management's Discussion and Analysis of Results of Operations (Abbreviated pursuant to General Instruction I(2).) This discussion should be read in conjunction with the Financial Statements and Notes to Financial Statements listed in the index set forth on page F-1. OVERVIEW - -------- Description of Business Verizon Washington, DC Inc. is a wholly owned subsidiary of Verizon Communications Inc. (Verizon Communications). We presently serve a territory consisting of a single Local Access and Transport Area (LATA) in Washington, D.C. We have one reportable segment which provides domestic wireline telecommunications services. We currently provide two basic types of telecommunications services: . Exchange telecommunication service is the transmission of telecommunications among customers located within a local calling area within a LATA. Examples of exchange telecommunications services include switched local residential and business services, local private line voice and data services and Centrex services. We also provide toll services within a LATA (intraLATA long distance). . Exchange access service links a customer's premises and the transmission facilities of other telecommunications carriers, generally interLATA carriers. Examples of exchange access services include switched access and special access services. The communications services we provide are subject to regulation by the District of Columbia Public Service Commission (DCPSC) with respect to intrastate rates and services and other matters. The Federal Communications Commission (FCC) regulates rates that we charge long distance carriers and end- user subscribers for interstate access rates. For a further discussion of the Company and our regulatory plan, see Item 1 - "Description of Business." Critical Accounting Policies Significant accounting policies are highlighted in the applicable sections of this discussion and analysis of results of operations. See sections on "Transactions with Affiliates," "Employee Severance and Pension Enhancement Costs," "Operating Revenues," and "Depreciation and Amortization." In addition, all of our significant accounting policies are described in Note 1 to the financial statements. Transactions with Affiliates Our financial statements include transactions with Verizon Services Corp., Verizon Services Group and Verizon Corporate Services Group Inc. (collectively known as Verizon Services), Verizon Data Services Inc., GTE Communication Systems Corporation (GTE Communication Systems), Verizon Network Funding Corporation (VNFC), Verizon Communications and other affiliates. We have contractual arrangements with Verizon Services for the provision of various centralized services. Costs may be either directly assigned to one subsidiary or allocated to more than one subsidiary based on functional reviews of the work performed. We are also allocated a portion of Verizon Services employee benefit costs. We use the equity method of accounting for our investments in SMS/800 and Verizon Ventures III Inc. (Ventures III). SMS/800 is a venture jointly held by the Bell Operating Companies that administers the centralized national database system associated with toll free numbers. Ventures III is a wholly owned subsidiary of Verizon Communications that provides new exchange access services through a separate subsidiary. At December 31, 2001, our ownership interest in Ventures III was 5.83% (See Note 12). Verizon Data Services Inc. provides data processing services, software application development and maintenance, which generally benefit Verizon Communications' operating telephone subsidiaries, including us. GTE Communication Systems provides construction and maintenance equipment, supplies and electronic repair service to us. We have contractual arrangements with VNFC to provide short-term financing, investing and cash management services to us. 8 Verizon Washington, DC Inc. We also include miscellaneous items of income and expense resulting from transactions with other affiliates, including Verizon Advanced Data Inc. and Verizon Wireless. These transactions include the provision of local and network access services, billing and collection services, rental of facilities and equipment, and sales and purchases of material and supplies. We also earn fees from an affiliate for usage of our directory listings. See also Note 12 to the financial statements for additional information on affiliate transactions. RESULTS OF OPERATIONS - --------------------- We reported net income of $48,132,000 in 2001, compared to net income of $89,067,000 in 2000. Our results for 2001 and 2000 were affected by special items. The special items in both periods include our allocated share of charges from Verizon Services. What follows is a further explanation of the nature of these special items. Employee Severance and Pension Enhancement Costs During the fourth quarter of 2001, we recorded a charge of $19,360,000 (additionally $3,223,000 was allocated from Verizon Services) primarily associated with employee severance and related pension enhancements. The charge included severance and related benefits of $8,760,000, as recorded under Statement of Financial Accounting Standards (SFAS) No. 112, "Employers' Accounting for Postemployment Benefits," for the voluntary and involuntary separation of employees. We also included a charge of $10,600,000 recorded in accordance with SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Pension Plans and for Termination Benefits," for related pension enhancements. Completion of Merger On June 30, 2000, Bell Atlantic and GTE completed a merger under a definitive merger agreement dated as of July 27, 1998 and began doing business as Verizon Communications. The merger qualified as a tax-free reorganization and has been accounted for as a pooling-of-interests business combination. The following table summarizes the charges incurred for the Bell Atlantic-GTE Merger. (Dollars in Thousands) Years Ended December 31 2001 2000 - -------------------------------------------------------------------------------- Operations and Support Expenses Direct incremental costs $ --- $ 3,273 Severance costs --- 3,347 Transition costs 5,915 1,691 Other costs --- 49 ------------------------------------ Total costs $ 5,915 $ 8,360 ==================================== Direct Incremental Costs Direct incremental costs related to the Bell Atlantic-GTE merger of $3,273,000 (including $3,097,000 allocated from Verizon Services) include compensation, professional services and other costs. Compensation includes retention payments to employees that were contingent on the close of the merger. Professional services include investment banking, legal, accounting, consulting and other advisory fees incurred to obtain federal and state regulatory approvals and take other actions necessary to complete the merger. Other includes costs incurred to obtain shareholder approval of the merger, register securities and communicate with shareholders, employees and regulatory authorities regarding merger issues. Employee Severance Costs Employee severance costs related to the Bell Atlantic-GTE merger of $3,347,000 (including $2,605,000 allocated from Verizon Services), as recorded under SFAS No. 112, represent the benefit costs for the separation of management employees who are entitled to benefits under pre-existing separation plans. The separations either have or are expected to occur as a result of consolidations and process enhancements within our company. Accrued postemployment benefit liabilities for those employees are included in our balance sheets as a component of Accounts Payable and Accrued Liabilities - Other. The remaining severance liability under this program as of December 31, 2001 is $539,000. 9 Verizon Washington, DC Inc. Transition Costs In addition to the direct merger-related and severance costs discussed above, from the date of the Bell Atlantic-GTE merger, we incurred transition costs related to the Bell Atlantic-GTE merger. These costs were incurred to integrate systems, consolidate real estate, relocate employees and meet certain regulatory conditions of the merger. They also include costs for advertising and other costs to establish the Verizon brand. Transition costs related to the Bell Atlantic-GTE merger were $5,915,000 in 2001 and $1,691,000 in 2000 (including $5,382,000 in 2001 and $1,682,000 in 2000 allocated from Verizon Services). Other Costs During the second quarter of 2000, we also recorded a $49,000 charge to operations and support expenses for other actions in relation to the Bell Atlantic-GTE merger. This charge was related to the write-off of duplicate assets. Other Charges and Special Items In the second quarter of 2000, we recorded charges totaling $6,755,000 to operations and support expenses. These charges include costs for the write-off of accounts receivable and other miscellaneous items. These and other items affecting the comparison of our results of operations for the years ended December 31, 2001 and 2000 are discussed in the following sections. OPERATING REVENUES - ------------------ (Dollars in Thousands) Years Ended December 31 2001 2000 - ---------------------------------------------------------------- --------------- Local services $336,815 $338,001 Network access services 199,948 198,056 Long distance services 2,545 2,833 Other services 154,324 161,180 -------------------------------- Total $693,632 $700,070 ================================ 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. LOCAL SERVICES (Decrease) - -------------------------------------------------------------------------------- 2001 - 2000 $(1,186) (.4)% - -------------------------------------------------------------------------------- Local service revenues are earned from the provision of local exchange, local private line, wire maintenance, voice messaging and value-added services. Value-added services are a family of services that expand the utilization of the network, including products such as Caller ID, Call Waiting and Return Call. The provision of local exchange services not only includes retail revenues, but also includes local wholesale revenues from unbundled network elements (UNEs), interconnection revenues from competitive local exchange carriers, certain data transport revenues and wireless interconnection revenues. Local service revenues decreased in 2001 primarily due to the effect of lower customer demand and usage of our basic wireline services, as reflected by a decline in our switched access lines in service of 2.0% from December 31, 2000. This decrease primarily reflects the impact of an economic slowdown and competition. In addition, the effect of technology substitution is increasing, as more customers are choosing wireless and Internet services in place of some basic wireline services. Lower revenue from our value-added and wire maintenance services and the effect of an accrual in 2001 also contributed to the decrease in local service revenues. These decreases were substantially offset by higher payments received from competitive local exchange carriers for the purchase of UNEs. 10 Verizon Washington, DC Inc. NETWORK ACCESS SERVICES Increase - -------------------------------------------------------------------------------- 2001 - 2000 $1,892 1.0% - -------------------------------------------------------------------------------- Network access revenues are earned from end-user subscribers and from long distance and other competing carriers who use our local exchange facilities to provide usage services to their customers. Switched access revenues are derived from fixed and usage-based charges paid by carriers for access to our local network. Special access revenues originate from carriers and end-users that buy dedicated local exchange capacity to support their private networks. End-user access revenues are earned from our customers and from resellers who purchase dial-tone services. Network access revenue growth in 2001 was mainly attributable to higher customer demand for special access services, particularly for high-capacity, high-speed digital services. This increase was substantially offset by price reductions associated with a federal price cap filing and other regulatory decisions. The DCPSC regulates us with respect to intrastate rates and services. The FCC regulates rates that we charge long distance carriers and end-user subscribers for interstate access services. We are required to file new access rates with the FCC each year. In July 2000, we implemented the Coalition for Affordable Local and Long Distance Service (CALLS) plan. Rates included in the July 2000 CALLS plan were in effect through June 2001. Effective July 3, 2001, we implemented further rate reductions in accordance with the plan. In addition, network access revenues in 2000 included the effect of a reversal of an accrual from a prior period as the result of a favorable resolution of a regulatory matter. The impact of the slowing economy also affected network access revenues in 2001. LONG DISTANCE SERVICES (Decrease) - -------------------------------------------------------------------------------- 2001 - 2000 $(288) (10.2)% - -------------------------------------------------------------------------------- Long distance revenues are earned primarily from calls made to points outside a customer's local calling area, but within our service area (intraLATA toll). IntraLATA toll calls originate and terminate within the same LATA, but generally cover a greater distance than a local call. We also provide 800 services. Long distance service revenues declined in 2001 primarily due to competition and the effects of toll calling discount packages and product bundling offers of our intraLATA toll services. OTHER SERVICES (Decrease) - -------------------------------------------------------------------------------- 2001 - 2000 $(6,856) (4.3)% - -------------------------------------------------------------------------------- Our other services include such services as billing and collections for long distance carriers and affiliates, facilities rentals to affiliates and nonaffiliates, public (pay) telephone, customer premises equipment (CPE) and sales of materials and supplies to affiliates. Other service revenues also include fees paid by customers for nonpublication of telephone numbers and multiple white page listings and fees paid by an affiliate for usage of our directory listings. Other service revenues decreased in 2001 primarily due to lower revenues received from CPE services provided to government customers and lower facilities rental revenues received from affiliates. 11 Verizon Washington, DC Inc. OPERATING EXPENSES - ------------------ (Dollars in Thousands) OPERATIONS AND SUPPORT (Decrease) - -------------------------------------------------------------------------------- 2001 - 2000 $(8,613) (2.5)% - -------------------------------------------------------------------------------- Operations and support expenses consist of employee costs and other operating expenses. Employee costs consist of salaries, wages and other employee compensation, employee benefits and payroll taxes. Other operating expenses consist of contract services including centralized services expenses allocated from affiliates, rent, network software costs, operating taxes other than income, the provision for uncollectible accounts receivable, reciprocal compensation, and other costs. The decrease in operations and support expenses was primarily attributable to the effect of merger-related costs and other special items recorded in 2000, favorable pension plan income including gain amortization and effective cost control measures. These decreases were partially offset by higher employee costs. The increase in employee costs was largely due to additional severance and pension enhancement costs recorded in 2001. For additional information on merger-related costs and other special items and severance and pension enhancement costs, see Results of Operations. We continue to incur expenditures related to reciprocal compensation arrangements with competitive local exchange carriers and other carriers to terminate calls on their network. In March 2000, the United States Court of Appeals for the District of Columbia Circuit reversed and remanded the FCC's February 1999 order that concluded that calls to the Internet through Internet service providers (ISP) do not terminate at the ISP but are single interstate calls. The FCC had concluded that calls to the Internet are not therefore subject to reciprocal compensation under section 251(b)(5) of the Telecommunications Act, but left it to state regulatory commissions to determine whether local interconnection agreements entered into with competing carriers required the payment of compensation on such calls. On April 27, 2001, the FCC released an order addressing intercarrier compensation for dial-up connections for Internet-bound traffic. The FCC found that Internet-bound traffic is interstate and subject to the FCC's jurisdiction. Moreover, the FCC again found that Internet-bound traffic is not subject to reciprocal compensation under Section 251(b)(5) of the 1996 Act. Instead, the FCC established federal rates for this traffic that decline from $0.0015 to $0.0007 over a three-year period. The FCC order also sets caps on the total minutes of this traffic that may be subject to any intercarrier compensation and requires that incumbent local exchange carriers must offer to pay reciprocal compensation for local traffic at the same rate as they are required to pay on Internet-bound traffic. Several competing carriers and state regulators appealed this order to the U.S. Court of Appeals for the D.C. Circuit. The court denied a motion to stay the FCC order, and the order went into effect. The appeal remains pending. DEPRECIATION AND AMORTIZATION Increase - -------------------------------------------------------------------------------- 2001 - 2000 $6,270 3.5% - -------------------------------------------------------------------------------- Depreciation expense is principally based on the composite group remaining life method and straight-line composite rates. This method provides for the recognition of the cost of the remaining net investment in telephone plant, less anticipated net salvage value, over the remaining asset lives. This method requires the periodic revision of depreciation rates. Depreciation and amortization expense increased in 2001 principally due to growth in depreciable telephone plant and increased software amortization costs. These factors were partially offset by the effect of lower rates of depreciation. 12 Verizon Washington, DC Inc. OTHER RESULTS - ------------- (Dollars in Thousands) OTHER INCOME AND (EXPENSE), NET (Decrease) - -------------------------------------------------------------------------------- 2001 - 2000 $(38,882) - -------------------------------------------------------------------------------- Other income and (expense), net includes equity income (losses), interest income and other nonoperating income and expense items. The change in other income and (expense), net, was primarily attributable to higher equity losses recognized from our investment in Ventures III. INTEREST EXPENSE Increase - -------------------------------------------------------------------------------- 2001 - 2000 $2,559 14.8% - -------------------------------------------------------------------------------- Interest expense includes costs associated with borrowing and capital leases, net of capitalized interest costs. We capitalize interest associated with the acquisition or construction of plant assets. Capitalized interest is reported as a cost of plant and a reduction in interest expense. Interest expense increased in 2001 primarily as a result of higher levels of average short-term debt with an affiliate. This increase was partially offset by the effect of lower rates of interest. See Note 5 to the financial statements for additional information about our debt. EFFECTIVE INCOME TAX RATES For the Years Ended December 31 - -------------------------------------------------------------------------------- 2001 56.1% - -------------------------------------------------------------------------------- 2000 42.6% - -------------------------------------------------------------------------------- The effective income tax rate is the provision for income taxes as a percentage of income before the provision for income taxes. Our effective income tax rate was higher in 2001 principally as a result of higher equity losses associated with our investment in Ventures III, for which we do not recognize income tax benefits. You can find a reconciliation of the statutory federal income tax rate to the effective income tax rate for each period in Note 10 to the financial statements. OTHER MATTERS - ------------- In-Region Long Distance Under the Telecommunications Act of 1996, our ability to offer in-region long distance services (that is, services originating in the jurisdiction where we operate as a local exchange carrier) is largely dependent on satisfying specified requirements. The requirements include a 14-point "competitive checklist" of steps which we must take to help competitors offer local services through resale, through purchase of unbundled network elements (UNEs), or by interconnecting their own networks to ours. We must also demonstrate to the FCC that entry into the in-region long distance market would be in the public interest. Third-party testing of our operations support systems by the accounting and consulting firm of KPMG is in its final stages in the District of Columbia. In-region long distance would be offered by a separate non-regulated subsidiary of Verizon Communications as required by law. 13 Verizon Washington, DC Inc. Recent Accounting Pronouncements Business Combinations In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, "Business Combinations," which applies to business combinations occurring after June 30, 2001. SFAS No. 141 requires that the purchase method of accounting be used and includes guidance on the initial recognition and measurement of goodwill and other intangible assets acquired in the combination. Goodwill and Other Intangible Assets In June 2001, the FASB also issued 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 will continue to be amortized over their useful lives and reviewed for impairment in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." We are required to adopt SFAS No. 142 effective January 1, 2002. The adoption of SFAS No. 142 will not have a material effect on our results of operations or financial position. Asset Retirement Obligations In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." This standard provides the accounting for the cost of legal obligations associated with the retirement of long-lived assets. SFAS No. 143 requires that companies recognize the fair value of a liability for asset retirement obligations in the period in which the obligations are incurred and capitalize that amount as a part of the book value of the long-lived asset. That cost is then depreciated over the remaining life of the underlying long-lived asset. We are required to adopt SFAS No. 143 effective January 1, 2003. We are currently evaluating the impact this new standard will have on our future results of operations or financial position. Impairment or Disposal of Long-Lived Assets In August 2001, the FASB issued SFAS No. 144. This standard supersedes SFAS No. 121 and the provisions of Accounting Principles Board (APB) Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," with regard to reporting the effects of a disposal of a segment of a business. SFAS No. 144 establishes a single accounting model for assets to be disposed of by sale and addresses several SFAS No. 121 implementation issues. We are required to adopt SFAS No. 144 effective January 1, 2002. We do not expect the impact of the adoption of SFAS No. 144 to have a material effect on our results of operations or financial position. Contractual Obligations The following table provides a summary of our contractual obligations. Additional detail about these items is included in the notes to the financial statements. Payments Due by Period (Dollars in Thousands) ------------------------------------------------------------------------------------- Contractual Obligation Total Less than 1 year 1-3 years 4-5 years After 5 years - -------------------------------------------------------------------------------------------------------------------------- Long-term debt $165,000 $ --- $ --- $25,000 $140,000 Operating leases 113 44 69 --- --- ------------------------------------------------------------------------------------- Total contractual cash obligations $165,113 $ 44 $ 69 $25,000 $140,000 ===================================================================================== 14 Verizon Washington, DC Inc. Item 7A. Quantitative and Qualitative Disclosures About Market Risk We are exposed to interest rate risk in the normal course of our business. The majority of our debt is fixed rate debt and we did not have any derivatives as of December 31, 2001 and 2000. Our short-term borrowings from an affiliate expose our earnings to changes in short-term interest rates since the interest rate charged on such borrowings is typically fixed for less than one month. The following table summarizes the fair values of our long-term debt as of December 31, 2001 and 2000. The table also provides a sensitivity analysis of the estimated fair values of these financial instruments assuming 100-basis-point upward and downward parallel shifts in the yield curve. The sensitivity analysis did not include the fair values of our short-term borrowings from an affiliate since they are not significantly affected by changes in market interest rates. December 31 ----------------------------- (Dollars in Thousands) 2001 2000 - -------------------------------------------------------------------------------- Fair value of long-term debt $168,232 $160,520 Fair value assuming a +100-basis-point shift 160,019 150,298 Fair value assuming a -100-basis-point shift 173,529 168,742 Item 8. Financial Statements and Supplementary Data The information required by this Item is set forth on Pages F-1 through F-23. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The information required by this Item regarding a change in accountants is included in a Current Report on Form 8-K dated September 7, 2000. 15 Verizon Washington, DC Inc. PART III Item 10. Directors and Executive Officers of Registrant (Omitted pursuant to General Instruction I(2).) Item 11. Executive Compensation (Omitted pursuant to General Instruction I(2).) Item 12. Security Ownership of Certain Beneficial Owners and Management (Omitted pursuant to General Instruction I(2).) Item 13. Certain Relationships and Related Transactions (Omitted pursuant to General Instruction I(2).) 16 Verizon Washington, DC Inc. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) The following documents are filed as part of this report: (1) Financial Statements See Index to Financial Statements and Financial Statement Schedule appearing on Page F-1. (2) Financial Statement Schedules See Index to Financial Statements and Financial Statement Schedule appearing on Page F-1. (3) Exhibits Exhibits identified in parentheses below, on file with the Securities and Exchange Commission (SEC), are incorporated herein by reference as exhibits hereto. 3a Restated Certificate of Incorporation of the registrant, as amended September 14, 1990. (Exhibit 3a to the registrant's Annual Report on Form 10-K for the year ended December 31, 1990, File No. 1-7368.) 3a(i) Certificate of Amendment of the registrant's Certificate of Incorporation, dated January 12, 1994 and filed January 13, 1994. (Exhibit 3a(i) to the registrant's Annual Report on Form 10-K for the year ended December 31, 1993, File No. 1-7368.) 3a(ii) Certificate of Amendment of the Restated Certificate of Incorporation, filed August 1, 2000. (Exhibit 3a(ii) to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, File No. 1-7368.) 3b By-Laws of the registrant, as amended December 15, 1995. (Exhibit 3b to the registrant's Annual Report on Form 10-K for the year ended December 31, 1995, File No. 1-7368.) 3b(i) Consent of Sole Stockholder of Verizon Washington, DC Inc., dated December 15, 1995. (Exhibit 3b(i) to the registrant's Annual Report on Form 10-K for the year ended December 31, 1995, File No. 1-7368.) 4 No instrument which defines the rights of holders of long-term debt of the registrant is filed herewith pursuant to Regulation S-K, Item 601(b)(4)(iii)(A). Pursuant to this regulation, the registrant hereby agrees to furnish a copy of any such instrument to the SEC upon request. 12 Computation of Ratio of Earnings to Fixed Charges. 23a Consent of Independent Auditors. 23b Consent of Independent Accountants. (b) Reports on Form 8-K: There were no Current Reports on Form 8-K filed during the quarter ended December 31, 2001. 17 Verizon Washington, DC Inc. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 Washington, DC Inc. Date: March 25, 2002 By /s/ Edwin F. Hall ----------------------------- Edwin F. Hall Controller Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated. Signature Title Date - --------- ----- ---- /s/ Marie C. Johns President March 25, 2002 - ----------------------------------- (Principal Executive Officer) Marie C. Johns and Director /s/ William F. Heitmann Senior Vice President - Finance March 25, 2002 - ----------------------------------- (Principal Financial Officer) William F. Heitmann /s/ Edwin F. Hall Controller March 25, 2002 - ----------------------------------- Edwin F. Hall /s/ Sherry F. Bellamy Director March 25, 2002 - ----------------------------------- Sherry F. Bellamy /s/ Phoebe B. Dixon Director March 25, 2002 - ----------------------------------- Phoebe B. Dixon /s/ David A. Hill Director March 25, 2002 - ----------------------------------- David A. Hill /s/ William Ferinde Director March 25, 2002 - ----------------------------------- William Ferinde /s/ Mark J. Mathis Director March 25, 2002 - ----------------------------------- Mark J. Mathis /s/ Harry A. Coleman Director March 25, 2002 - ----------------------------------- Harry A. Coleman 18 Verizon Washington, DC Inc. Index to Financial Statements and Financial Statement Schedule Page ---- Report of Independent Auditors -- Ernst & Young LLP ...................................... F-2 Report of Independent Accountants -- PricewaterhouseCoopers LLP .......................... F-3 Statements of Income For the years ended December 31, 2001, 2000 and 1999 ................................ F-4 Balance Sheets -- December 31, 2001 and 2000 ............................................. F-5 Statements of Changes in Shareowner's Investment For the years ended December 31, 2001, 2000 and 1999 ................................. F-7 Statements of Cash Flows For the years ended December 31, 2001, 2000 and 1999 ................................ F-8 Notes to Financial Statements ............................................................ F-9 Schedule II -- Valuation and Qualifying Accounts For the years ended December 31, 2001, 2000 and 1999 ................................ F-23 Financial statement schedules other than those listed above have been omitted because such schedules are not required or applicable. F-1 Verizon Washington, DC Inc. REPORT OF INDEPENDENT AUDITORS The Board of Directors and Shareowner Verizon Washington, DC Inc. We have audited the accompanying balance sheets of Verizon Washington, DC Inc. (the Company) as of December 31, 2001 and 2000 and the related statements of income, changes in shareowner's investment, and cash flows for the years then ended. Our audits also included the financial statement schedule referenced in the index at Item 14(a). These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Verizon Washington, DC Inc. at December 31, 2001 and 2000, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP New York, New York January 31, 2002 F-2 Verizon Washington, DC Inc. REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareowner of Verizon Washington, DC Inc. In our opinion, the 1999 financial statements listed in the accompanying index present fairly, in all material respects, the results of operations and cash flows of Verizon Washington, DC Inc. for the year ended December 31, 1999, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the 1999 financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related financial statements. These financial statements and the financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit. We conducted our audit of these statements in accordance with auditing standards generally accepted in the United States of America which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. We have not audited the financial statements of Verizon Washington, DC Inc. for any period subsequent to December 31, 1999. /s/ PricewaterhouseCoopers LLP New York, New York February 14, 2000 F-3 Verizon Washington, DC Inc. STATEMENTS OF INCOME For the Years Ended December 31 (Dollars in Thousands) 2001 2000 1999 - ------------------------------------------------------------------------------------------------------------------- OPERATING REVENUES (including $167,992, $156,418 and $141,788 from affiliates) $693,632 $700,070 $668,242 --------------------------------------------- OPERATING EXPENSES Operations and support (including $141,697, $155,504 and $147,590 to affiliates) 338,787 347,400 336,445 Depreciation and amortization 187,102 180,832 175,466 --------------------------------------------- 525,889 528,232 511,911 --------------------------------------------- OPERATING INCOME 167,743 171,838 156,331 OTHER INCOME AND (EXPENSE), NET (including $(38,313), $(933) and $134 from affiliates) (38,211) 671 744 INTEREST EXPENSE (including $10,843, $8,126 and $5,307 to affiliate) 19,878 17,319 16,077 --------------------------------------------- INCOME BEFORE PROVISION FOR INCOME TAXES 109,654 155,190 140,998 PROVISION FOR INCOME TAXES 61,522 66,123 57,958 --------------------------------------------- NET INCOME $ 48,132 $ 89,067 $ 83,040 ============================================= See Notes to Financial Statements. F-4 Verizon Washington, DC Inc. BALANCE SHEETS (Dollars in Thousands) ASSETS ------ December 31 ----------------------------------- 2001 2000 - ------------------------------------------------------------------------------------------------------------------- CURRENT ASSETS Short-term investments $ 13,500 $ 8,358 Accounts receivable: Trade and other, net of allowances for uncollectibles of $11,601 and $11,361 202,823 169,238 Affiliates 41,109 30,029 Material and supplies 10,328 2,745 Prepaid expenses 1,564 3,769 Deferred income taxes 4,697 4,224 Other 12,428 13,347 ----------------------------------- 286,449 231,710 ----------------------------------- PLANT, PROPERTY AND EQUIPMENT 2,171,441 2,042,627 Less accumulated depreciation 1,208,739 1,101,187 ----------------------------------- 962,702 941,440 ----------------------------------- PREPAID PENSION ASSET 34,607 9,584 ----------------------------------- OTHER ASSETS 60,337 64,563 ----------------------------------- TOTAL ASSETS $1,344,095 $1,247,297 =================================== See Notes to Financial Statements. F-5 Verizon Washington, DC Inc. BALANCE SHEETS (Dollars in Thousands) LIABILITIES AND SHAREOWNER'S INVESTMENT --------------------------------------- December 31 ----------------------------------------- 2001 2000 - ----------------------------------------------------------------------------------------------------- CURRENT LIABILITIES Debt maturing within one year: Note payable to affiliate $ 266,151 $ 214,767 Accounts payable and accrued liabilities: Affiliates 64,908 60,596 Other 131,746 127,521 Other current liabilities 27,423 24,509 ----------------------------------------- 490,228 427,393 ----------------------------------------- LONG-TERM DEBT 164,353 164,334 ----------------------------------------- EMPLOYEE BENEFIT OBLIGATIONS 90,149 88,899 ----------------------------------------- DEFERRED CREDITS AND OTHER LIABILITIES Deferred income taxes 106,042 89,168 Unamortized investment tax credits 2,758 2,896 Other 44,253 38,926 ----------------------------------------- 153,053 130,990 ----------------------------------------- COMMITMENTS AND CONTINGENCIES (Notes 4 and 13) SHAREOWNER'S INVESTMENT Common stock - one share, owned by parent, at stated value 191,968 191,968 Capital surplus 66,039 28,549 Reinvested earnings 188,305 215,164 ----------------------------------------- 446,312 435,681 ----------------------------------------- TOTAL LIABILITIES AND SHAREOWNER'S INVESTMENT $1,344,095 $1,247,297 ========================================= See Notes to Financial Statements. F-6 Verizon Washington, DC Inc. STATEMENTS OF CHANGES IN SHAREOWNER'S INVESTMENT For the Years Ended December 31 (Dollars in Thousands) 2001 2000 1999 - ---------------------------------------------------------------------------------------------------------------- COMMON STOCK Balance at beginning of year $ 191,968 $ 191,968 $ 191,968 -------------------------------------------------------- Balance at end of year 191,968 191,968 191,968 -------------------------------------------------------- CAPITAL SURPLUS Balance at beginning of year 28,549 28,549 28,549 Capital contribution from Verizon Communications 37,490 --- --- -------------------------------------------------------- Balance at end of year 66,039 28,549 28,549 -------------------------------------------------------- REINVESTED EARNINGS Balance at beginning of year 215,164 200,810 166,452 Net income 48,132 89,067 83,040 Dividends paid to Verizon Communications (75,000) (74,800) (48,700) Other 9 87 18 -------------------------------------------------------- Balance at end of year 188,305 215,164 200,810 -------------------------------------------------------- ACCUMULATED OTHER COMPREHENSIVE LOSS Balance at beginning of year --- (152) (46) Minimum pension liability adjustment --- 152 (106) -------------------------------------------------------- Balance at end of year --- --- (152) -------------------------------------------------------- TOTAL SHAREOWNER'S INVESTMENT $ 446,312 $ 435,681 $ 421,175 ======================================================== COMPREHENSIVE INCOME Net income $ 48,132 $ 89,067 $ 83,040 Minimum pension liability adjustment --- 152 (106) -------------------------------------------------------- TOTAL COMPREHENSIVE INCOME $ 48,132 $ 89,219 $ 82,934 ======================================================== See Notes to Financial Statements. F-7 Verizon Washington, DC Inc. STATEMENTS OF CASH FLOWS For the Years Ended December 31 (Dollars in Thousands) 2001 2000 1999 - ----------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 48,132 $ 89,067 $ 83,040 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 187,102 180,832 175,466 Employee retirement benefits (21,410) (22,019) (10,771) Deferred income taxes, net 13,913 23,468 21,689 Provision for uncollectible accounts 7,489 11,222 3,777 Equity loss/(income) from affiliates 38,380 933 (126) Dividends received from equity affiliate 110 155 126 Changes in current assets and liabilities: Accounts receivable (52,154) (41,836) 6,495 Material and supplies (7,583) (1,941) 327 Other assets 3,124 (12,656) (2,871) Accounts payable and accrued liabilities 10,000 (1,815) 2,807 Other current liabilities 2,914 13,530 (3,572) Other items, net 30,080 (20,377) 7,692 -------------------------------------------------- Net cash provided by operating activities 260,097 218,563 284,079 -------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of short-term investments (13,500) (8,358) (7,400) Proceeds from sale of short-term investments 8,358 7,400 6,690 Capital expenditures (219,565) (275,081) (205,466) Investment in unconsolidated business (37,490) --- --- Other, net (8,521) (7,100) (6,684) -------------------------------------------------- Net cash used in investing activities (270,718) (283,139) (212,860) -------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Principal repayments of capital lease obligations --- --- (15) Net change in note payable to affiliate 51,384 134,388 (19,079) Dividends paid (75,000) (74,800) (48,700) Capital contribution from parent 37,490 --- --- Net change in outstanding checks drawn on controlled disbursement accounts (3,253) 4,285 (2,722) -------------------------------------------------- Net cash provided by/(used in) financing activities 10,621 63,873 (70,516) -------------------------------------------------- NET CHANGE IN CASH --- (703) 703 CASH, BEGINNING OF YEAR --- 703 --- -------------------------------------------------- CASH, END OF YEAR $ --- $ --- $ 703 ================================================== See Notes to Financial Statements. F-8 Verizon Washington, DC Inc. NOTES TO FINANCIAL STATEMENTS 1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of Business Verizon Washington, DC Inc. is a wholly owned subsidiary of Verizon Communications Inc. (Verizon Communications). We presently serve a territory consisting of a single Local Access and Transport Area (LATA) in Washington, D.C. We have one reportable segment which provides domestic wireline telecommunications services. We currently provide two basic types of telecommunications services: . Exchange telecommunication service is the transmission of telecommunications among customers located within a local calling area within a LATA. Examples of exchange telecommunications services include switched local residential and business services, local private line voice and data services and Centrex services. We also provide toll services within a LATA (intraLATA long distance). . Exchange access service links a customer's premises and the transmission facilities of other telecommunications carriers, generally interLATA carriers. Examples of exchange access services include switched access and special access services. The communications services we provide are subject to regulation by the District of Columbia Public Service Commission (DCPSC) with respect to intrastate rates and services and other matters. The Federal Communications Commission, (FCC) regulates that we charge long distance carriers and end- carriers subscribers for interstate access rates. Basis of Presentation We prepare our financial statements using generally accepted accounting principles which require management to make estimates and assumptions that affect reported amounts and disclosures. Actual results could differ from those estimates. Examples of significant estimates include the allowance for doubtful accounts and the recoverability of intangibles and other long-lived assets. We have a .53% ownership interest in SMS/800, a venture that is jointly owned by the Bell Operating Companies. SMS/800 administers the centralized national database system associated with toll free numbers. We use the equity method of accounting for our investment in SMS/800. Our investment in Verizon Ventures III Inc. (Ventures III), an affiliated company which provides new exchange access services through a separate subsidiary, is accounted for using the equity method of accounting. At December 31, 2001, our ownership interest in Ventures III was 5.83% (See Note 12). We have reclassified certain amounts from prior periods to conform with our current presentation. Revenue Recognition 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. We adopted the provisions of the Securities and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements," effective January 1, 2000, as required by the SEC. As a result of the adoption of SAB No. 101, we defer nonrecurring service activation revenues and costs and amortize them over the expected term of the customer relationship. The deferred costs are equal to the activation fee revenue and any excess cost is expensed immediately. The deferred costs represent direct costs associated with certain non-recurring fees, such as service activation and installation fees. Previously, these revenues and costs were recognized when the activation service was performed. This change in accounting did not have a material impact on our results of operations. F-9 Verizon Washington, DC Inc. Our balance sheet includes deferred activation costs and deferred activation revenues as follows: December 31 ----------------------------------- (Dollars in Thousands) 2001 2000 - ------------------------------------------------------------------------------------------ Deferred Activation Costs Current assets - other $11,626 $12,387 Other assets 19,573 22,021 Deferred Activation Revenues Current liabilities - other 11,626 12,387 Deferred credits and other liabilities - other 19,573 22,021 Maintenance and Repairs We charge the cost of maintenance and repairs, including the cost of replacing minor items not constituting substantial betterments, to Operations and Support Expenses as these costs are incurred. Cash and Cash Equivalents We consider all highly liquid investments with a maturity of 90 days or less when purchased to be cash equivalents, except cash equivalents held as short-term investments. Cash equivalents are stated at cost, which approximates market value. Short-term Investments Our short-term investments consist of cash equivalents held in trust to pay for certain employee benefits. Short-term investments are stated at cost, which approximates market value. Material and Supplies We include in inventory new and reusable materials which are stated principally at average original cost, except that specific costs are used in the case of large individual items. Long-Lived Assets We assess the impairment of long-lived assets under Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" whenever events or changes in circumstances indicate that the carrying value may not be recoverable. A determination of impairment (if any) is made based on estimates of future cash flows. (See "Recent Accounting Pronouncements - Impairment or Disposal of Long-Lived Assets" below.) Plant and Depreciation We record plant, property, and equipment at cost. Depreciation expense is principally based on the composite group remaining life method and straight-line composite rates. This method provides for the recognition of the cost of the remaining net investment in telephone plant, less anticipated net salvage value, over the remaining asset lives. This method requires the periodic revision of depreciation rates. We used the following asset lives: Average Lives (in years) ------------------------------------------------------------------------- Buildings 30 - 35 Central office equipment 5 - 10 Outside communications plant 17 - 50 Furniture, vehicles and other 3 - 15 When we replace or retire depreciable telephone plant, we deduct the carrying amount of such plant from the respective accounts and charge it to accumulated depreciation. We capitalize interest associated with the acquisition or construction of plant assets. Capitalized interest is reported as a cost of plant and a reduction in interest expense. F-10 Verizon Washington, DC Inc. Computer Software Costs We capitalize the cost of internal-use software which has a useful life in excess of one year in accordance with Statement of Position (SOP) No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." Subsequent additions, modifications or upgrades to internal-use software are capitalized only to the extent that they allow the software to perform a task it previously did not perform. Software maintenance and training costs are expensed in the period in which they are incurred. Also, we capitalize interest associated with the development of internal-use software. Capitalized computer software costs are amortized using the straight-line method over a period of 3 to 7 years. Income Taxes Verizon Communications and its domestic subsidiaries, including us, file a consolidated federal income tax return. Current and deferred tax expense is determined by applying the provisions of SFAS No. 109, "Accounting for Income Taxes" to each subsidiary as if it were a separate taxpayer. We use the deferral method of accounting for investment tax credits earned prior to the repeal of investment tax credits by the Tax Reform Act of 1986. We also defer certain transitional credits earned after the repeal. We amortize these credits over the estimated service lives of the related assets as a reduction to the Provision for Income Taxes. Advertising Costs We expense advertising costs as they are incurred. Stock-Based Compensation We participate in stock-based employee compensation plans sponsored by Verizon Communications. Verizon Communications accounts for stock-based employee compensation plans under Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations, and follows the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." Employee Benefit Plans We participate in the Verizon Communications benefit plans. Under these plans, pension and postretirement health care and life insurance benefits earned during the year as well as interest on projected benefit obligations are accrued currently. Prior service costs and credits resulting from changes in plan benefits are amortized over the average remaining service period of the employees expected to receive benefits. Derivative Instruments Effective January 1, 2001, we adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities." SFAS No. 133 requires that all derivatives, including derivatives embedded in other financial instruments, be measured at fair value and recognized as either assets or liabilities on our balance sheet. Changes in the fair values of derivative instruments not qualifying as hedges under SFAS No. 133 or any ineffective portion of hedges are recognized in earnings in the current period. Changes in the fair values of derivative instruments used effectively as fair value hedges are recognized in earnings, along with changes in the fair value of the hedged item. Changes in the fair value of the effective portions of cash flow hedges are reported in other comprehensive income (loss), and recognized in earnings when the hedged item is recognized in earnings. We had no derivative instruments as of December 31, 2001 and 2000. Recent Accounting Pronouncements Business Combinations In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, "Business Combinations," which applies to business combinations occurring after June 30, 2001. SFAS No. 141 requires that the purchase method of F-11 Verizon Washington, DC Inc. accounting be used and includes guidance on the initial recognition and measurement of goodwill and other intangible assets acquired in the combination. Goodwill and Other Intangible Assets In June 2001, the FASB also issued 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. 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 will continue to be amortized over their useful lives and reviewed for impairment in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." We are required to adopt SFAS No. 142 effective January 1, 2002. The adoption of SFAS No. 142 will not have a material effect on our results of operations or financial position. Asset Retirement Obligations In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." This standard provides the accounting for the cost of legal obligations associated with the retirement of long-lived assets. SFAS No. 143 requires that companies recognize the fair value of a liability for asset retirement obligations in the period in which the obligations are incurred and capitalize that amount as a part of the book value of the long-lived asset. That cost is then depreciated over the remaining life of the underlying long-lived asset. We are required to adopt SFAS No. 143 effective January 1, 2003. We are currently evaluating the impact this new standard will have on our future results of operations or financial position. Impairment or Disposal of Long-Lived Assets In August 2001, the FASB issued SFAS No. 144. This standard supersedes SFAS No. 121 and the provisions of 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. We are required to adopt SFAS No. 144 effective January 1, 2002. We do not expect the impact of the adoption of SFAS No. 144 to have a material effect on our results of operations or financial position. 2. COMPLETION OF MERGERS On June 30, 2000, Bell Atlantic and GTE completed a merger 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 qualified as a tax-free reorganization and has been accounted for as a pooling-of-interests business combination. Under this method of accounting, Bell Atlantic and GTE are treated as if they had always been combined for accounting and financial reporting purposes. In August 1997, Bell Atlantic and NYNEX completed a merger of equals under a definitive merger agreement entered into on April 21, 1996 and amended on July 2, 1996. Under the terms of the amended agreement, NYNEX became a wholly owned subsidiary of Bell Atlantic. The merger qualified as a tax-free reorganization and has been accounted for as a pooling-of-interests. F-12 Verizon Washington, DC Inc. The following table summarizes the one-time charges incurred for each merger. Amounts for 2001 and 2000 pertain to the Bell Atlantic-GTE merger. Transition costs for 1999 pertain to the Bell Atlantic-NYNEX merger. (Dollars in Thousands) Years Ended December 31, 2001 2000 1999 - -------------------------------------------------------------------------------- Direct incremental costs $ --- $ 3,273 $ --- Employee severance costs --- 3,347 --- Transition costs 5,915 1,691 3,017 --------------------------------------------- Total Merger-Related Costs $ 5,915 $ 8,311 $ 3,017 ============================================= The following table provides a reconciliation of the liabilities associated with Bell Atlantic-GTE merger-related costs, Bell Atlantic-NYNEX merger-related costs and other charges and special items described below: (Dollars in Thousands) 1999 2000 2001 --------------------------------------------------------------------------------------------------------- Asset Charged to Asset Asset Beginning Write-offs End of Expense or Write-offs End of Write-offs End of of Year Payments and Other Year Revenue Payments and Other Year Payments and Other Year - ---------------------------------------------------------------------------------------------------------------------------------- Merger-Related Direct incremental costs $ --- $ --- $ --- $ --- $3,273 $(3,273) $ --- $ --- $ --- $ --- $ --- Employee severance costs 3,068 (419) (427) 2,222 3,347 (2,766) (172) 2,631 (427) 482 2,686 Other Initiatives Write-off of duplicate assets --- --- --- --- 49 --- --- 49 --- (21) 28 Other charges and special items 2,504 --- --- 2,504 --- --- (2,504) --- --- --- --- --------------------------------------------------------------------------------------------------------- $5,572 $(419) $(427) $4,726 $6,669 $(6,039) $(2,676) $2,680 $(427) $ 461 $2,714 ========================================================================================================= Merger-Related Charges Direct Incremental Costs Direct incremental costs related to the Bell Atlantic-GTE merger of $3,273,000 (including $3,097,000 allocated from Verizon Services) include compensation, professional services and other costs. Compensation includes retention payments to employees that were contingent on the close of the merger. Professional services include investment banking, legal, accounting, consulting and other advisory fees incurred to obtain federal and state regulatory approvals and take other actions necessary to complete the merger. Other includes costs incurred to obtain shareholder approval of the merger, register securities and communicate with shareholders, employees and regulatory authorities regarding merger issues. All of the Bell Atlantic-GTE merger direct incremental costs had been paid as of December 31, 2001. Employee Severance Costs Employee severance costs related to the Bell Atlantic-GTE merger of $3,347,000 (including $2,605,000 allocated from Verizon Services), as recorded under SFAS No. 112, "Employers' Accounting for Postemployment Benefits," represent the benefit costs for the separation of management employees who are entitled to benefits under pre-existing separation plans. The separations either have or are expected to occur as a result of consolidations and process enhancements within our company. Accrued postemployment benefit liabilities for those employees are included in our balance sheets as a component of Accounts Payable and Accrued Liabilities - Other. The remaining severance liability under this program as of December 31, 2001 is $539,000. In 1997, employee severance costs related to the Bell Atlantic-NYNEX merger were approximately $3,400,000 (including approximately $2,300,000 allocated from Verizon Services), as recorded under SFAS No. 112 and relate to the separation of management employees during 1999, 1998 and 1997. Accrued postemployment benefit liabilities were included in our balance sheets as a component of Employee Benefit Obligations at December 31, 1999. There was no remaining severance liability as of December 31, 2000. Transition Costs In addition to the direct merger-related and severance costs discussed above, from the date of the Bell Atlantic-GTE merger, we incurred transition costs related to the Bell Atlantic-GTE merger. These costs were incurred to integrate systems, consolidate real estate, relocate employees and meet certain regulatory conditions of the merger. They also include costs for advertising and other costs to establish the Verizon brand. Transition costs related to the Bell Atlantic-GTE merger were $5,915,000 in 2001 (including $5,382,000 allocated from Verizon Services) and $1,691,000 in 2000 (including $1,682,000 allocated from Verizon Services). In connection with the Bell Atlantic-NYNEX merger, we incurred transition costs of a similar nature to the Bell Atlantic - GTE merger transition costs of $3,017,000 in 1999 (including $2,832,000 allocated from Verizon Services). F-13 Verizon Washington, DC Inc. Other Initiatives During the second quarter of 2000, we also recorded a $49,000 charge for other actions in relation to the Bell Atlantic-GTE merger. This charge was related to the write-off of duplicate assets. We recorded other charges and special items totaling approximately $17,900,000 (pre-tax) during 1997 in connection with consolidating operations and combining organizations, and for other special items arising during that year. These charges were comprised principally of the write-down of assets of $10,500,000, and regulatory contingencies and other post-merger initiatives of $7,400,000. 3. PLANT, PROPERTY AND EQUIPMENT The following table displays the details of plant, property and equipment, which is stated at cost: December 31 --------------------------------- (Dollars in Thousands) 2001 2000 - -------------------------------------------------------------------------------- Land $ 12,946 $ 12,946 Buildings 242,386 228,100 Central office equipment 1,021,775 908,659 Outside communications plant 358,641 343,175 Furniture, vehicles and other work equipment 483,935 482,611 Other 32,902 21,483 Construction-in-progress 18,856 45,653 --------------------------------- 2,171,441 2,042,627 Accumulated depreciation (1,208,739) (1,101,187) --------------------------------- Total $ 962,702 $ 941,440 ================================= 4. LEASES We lease certain facilities and equipment for use in our operations under both capital and operating leases. We did not incur any initial capital lease obligations in 2001, 2000 and 1999. At December 31, 2001 and 2000, we had no capital lease amounts included in plant, property and equipment. Total rent expense amounted to $24,233,000 in 2001, $9,548,000 in 2000 and $8,472,000 in 1999. Of these amounts, $23,439,000 in 2001, $8,589,000 in 2000 and $7,616,000 in 1999 were lease payments to affiliated companies. This table displays the aggregate minimum rental commitments under noncancelable operating leases for the periods shown at December 31, 2001: (Dollars in Thousands) Years - -------------------------------------------------------------------------------- 2002 $ 44 2003 36 2004 33 2005 --- 2006 --- Thereafter --- ----------------------- Total minimum rental commitments $113 ======================= F-14 Verizon Washington, DC Inc. 5. DEBT Debt Maturing Within One Year Debt maturing within one year consists of the following at December 31: (Dollars in Thousands) 2001 2000 - -------------------------------------------------------------------------------- Note payable to affiliate (VNFC) $266,151 $214,767 -------------------------- Total debt maturing within one year $266,151 $214,767 ========================== Weighted average interest rate for note payable outstanding at year-end 2.1% 6.6% ========================== We have a contractual agreement with an affiliated company, Verizon Network Funding Corporation (VNFC), for the provision of short-term financing and cash management services. VNFC issues commercial paper and obtains bank loans to fund the working capital requirements of Verizon Communications' network services subsidiaries, including us, and invests funds in temporary investments on their behalf. Long-Term Debt Long-term debt consists principally of debentures that we have issued. Interest rates and maturities of the amounts outstanding are as follows at December 31: Interest Description Rate Maturity 2001 2000 - ---------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Forty year debenture 5 5/8% 2006 $ 25,000 $ 25,000 Forty year debenture 7 2009 50,000 50,000 Thirty year debenture 7 3/4 2023 90,000 90,000 -------------------------- 165,000 165,000 Unamortized discount and premium, net (647) (666) -------------------------- Total long-term debt, including current maturities 164,353 164,334 Less maturing within one year --- --- -------------------------- Total long-term debt $164,353 $164,334 ========================== Our long-term debt outstanding at December 31, 2001 includes $75,000,000 that is callable. The call prices range from 100.0% to 100.45% of face value, depending upon the remaining term to maturity of the issue. Maturities of long-term debt outstanding at December 31, 2001, excluding unamortized discount and premium, are $25,000,000 in 2006 and $140,000,000 beginning in 2007 and thereafter. 6. FINANCIAL INSTRUMENTS Derivatives We did not have any derivatives as of December 31, 2001 and 2000, consequently, SFAS No. 133 did not have an impact on our results of operations or financial position. Concentrations of Credit Risk Financial instruments that subject us to concentrations of credit risk consist primarily of short-term investments and trade receivables. Concentrations of credit risk with respect to trade receivables other than those from AT&T are limited due to the large number of customers. We generated revenues from services provided to AT&T (primarily network access and billing and collection) of $30,404,000 in 2001, $30,322,000 in 2000 and $29,237,000 in 1999. F-15 Verizon Washington, DC Inc. While we may be exposed to credit losses due to the nonperformance of our counterparties, we consider this risk remote and do not expect the settlement of these transactions to have a material effect on our results of operations or financial position. Fair Values of Financial Instruments The table below provides additional information about our material financial instruments at December 31: Financial Instrument Valuation Method - --------------------------------------------------------------------------------------------------------------------------- Note payable to affiliate (VNFC) and short-term Carrying amounts investments Debt (excluding capital leases) Future cash flows discounted at current rates 2001 2000 ------------------------------------------------------------------ Carrying Carrying Amount Fair Value Amount Fair Value - --------------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Debt and note payable to affiliate $430,504 $434,383 $379,101 $375,287 7. COMPREHENSIVE INCOME Comprehensive income consists of net income and other gains and losses affecting shareowner's investment that, under generally accepted accounting principles, are excluded from net income. The change in other comprehensive loss, net of income tax expense (benefit), is as follows: Years ended December 31 --------------------------------------- (Dollars in Thousands) 2001 2000 1999 - -------------------------------------------------------------------------------------------------------------------------- Other comprehensive income (loss): Minimum pension liability adjustment (net of income taxes of $0, $106 and $(74)) $ --- $ 152 $ (106) --------------------------------------- $ --- $ 152 $ (106) ======================================= 8. STOCK INCENTIVE PLANS We participate in stock-based compensation plans sponsored by Verizon Communications. Verizon Communications applies APB Opinion No. 25 and related interpretations in accounting for the plans and has adopted the disclosure-only provisions of SFAS No. 123. If Verizon Communications had elected to recognize compensation expense based on the fair value at the grant dates for 1998 and subsequent awards consistent with the provisions of SFAS No. 123, our net income would have been changed to the pro forma amounts indicated below: Years ended December 31 ---------------------------------------- (Dollars in Thousands) 2001 2000 1999 - ------------------------------------------------------------------------------------------------------------------------- Net income: As reported $48,132 $89,067 $83,040 Pro forma 47,038 87,945 82,236 F-16 Verizon Washington, DC Inc. We determined the pro forma amounts using the Black-Scholes option-pricing model based on the following weighted-average assumptions: 2001 2000 1999 - -------------------------------------------------------------------------------- Dividend yield 2.7% 3.3% 3.4% Expected volatility 29.1% 27.5% 20.0% Risk-free interest rate 4.8% 6.2% 5.3% Expected lives (in years) 6 6 6 The weighted-average value of options granted during 2001, 2000 and 1999 was $15.24, $13.09 and $11.58, respectively. The structure of Verizon Communications' stock incentive plans does not provide for the separate determination of certain disclosures for our company. The required information is provided on a consolidated basis in Verizon Communications' Annual Report on Form 10-K for the year ended December 31, 2001. 9. EMPLOYEE BENEFITS We participate in Verizon Communications' benefit plans. Verizon Communications maintains noncontributory defined benefit pension plans for substantially all employees. The postretirement healthcare and life insurance plans for our retirees and their dependents are both contributory and noncontributory and include a limit on the company's share of cost for recent and future retirees. We also sponsor defined contribution savings plans to provide opportunities for eligible employees to save for retirement on a tax-deferred basis. The structure of Verizon Communications' benefit plans does not provide for the separate determination of certain disclosures for our company. The required information is provided on a consolidated basis in Verizon Communications' Annual Report on Form 10-K for the year ended December 31, 2001. Pension and Other Postretirement Benefits Pension and other postretirement benefits for the majority of our employees are subject to collective bargaining agreements. Modifications in benefits have been bargained from time to time, and Verizon Communications may also periodically amend the benefits in the management plans. Benefit Cost Years ended December 31 --------------------------------------------------------------------- Pension Healthcare and Life --------------------------------------------------------------------- (Dollars in Thousands) 2001 2000 1999 2001 2000 1999 - -------------------------------------------------------------------------------------------------------------------------- Net periodic benefit (income) cost $(35,262) $(19,184) $(9,225) $3,252 $(2,947) $(1,749) --------------------------------------------------------------------- Termination benefits 10,600 --- --- --- --- --- --------------------------------------------------------------------- Total (income) cost $(24,662) $(19,184) $(9,225) $3,252 $(2,947) $(1,749) ===================================================================== In 2001, Verizon Communications announced an employee severance plan. As a result, we recorded special termination benefits of $10,600,000 for related pension enhancements in accordance with SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Pension Plans and for Termination Benefits." Amounts recognized on the balance sheets consist of: December 31 --------------------------------------------------------------------- Pension Healthcare and Life --------------------------------------------------------------------- (Dollars in Thousands) 2001 2000 2001 2000 - -------------------------------------------------------------------------------------------------------------------------- Prepaid pension asset $ 34,607 $ 9,584 $ -- $ -- Employee benefit obligations (1,909) (1,871) (81,819) (80,380) The changes in benefit obligations from year to year were caused by a number of factors, including changes in actuarial assumptions (see Assumptions), plan amendments and changes in corporate allocations. F-17 Verizon Washington, DC Inc. Assumptions The actuarial assumptions used are based on market interest rates, past experience, and management's best estimate of future economic conditions. Changes in these assumptions may impact future benefit costs and obligations. The weighted-average assumptions used in determining expense and benefit obligations are as follows: --------------------------------------------------------------------- Pension Healthcare and Life --------------------------------------------------------------------- 2001 2000 1999 2001 2000 1999 - --------------------------------------------------------------------------------------------------------------------------------- Discount rate at end of year 7.25% 7.75% 8.00% 7.25% 7.75% 8.00% Long-term rate of return on plan assets for the year 9.25 9.25 9.00 9.25 9.25 9.00 Rate of future increases in compensation at end of year 5.00 5.00 4.00 4.00 4.00 4.20 Medical cost trend rate at end of year 10.00 5.00 5.50 Ultimate (year 2005) 5.00 5.00 5.00 Savings Plans and Employee Stock Ownership Plans Substantially all of our employees are eligible to participate in savings plans maintained by Verizon Communications. Verizon Communications maintains two leveraged employee stock ownership plans (ESOPs) for its employees of the former Bell Atlantic Companies. Under these plans, a certain percentage of eligible employee contributions are matched with shares of Verizon Communications' common stock. Verizon Communications recognizes leveraged ESOP cost based on the modified shares allocated method for these leveraged ESOPs that held securities before December 15, 1989. We recognize our proportionate share of total ESOP cost based on our matching obligation attributable to our participating employees. We recorded total savings plan costs of $2,351,000 in 2001, $1,687,000 in 2000 and 1,116,000 in 1999. Employee Severance Costs During the fourth quarter of 2001, we recorded a charge of $8,760,000 for severance and related benefits, in accordance with SFAS No. 112, "Employers' Accounting for Postemployment Benefits," for the voluntary and involuntary separation of employees. 10. INCOME TAXES The components of income tax expense are presented in the following table: Years ended December 31 ----------------------------------------- (Dollars in Thousands) 2001 2000 1999 - -------------------------------------------------------------------------------------------------------------------------- Current: Federal $36,685 $31,759 $27,522 State and local 10,924 10,896 8,747 --------------------------------------- 47,609 42,655 36,269 --------------------------------------- Deferred: Federal 10,515 18,936 17,023 State and local 3,536 4,735 4,903 --------------------------------------- 14,051 23,671 21,926 --------------------------------------- 61,660 66,326 58,195 Investment tax credits (138) (203) (237) --------------------------------------- Total income tax expense $61,522 $66,123 $57,958 ======================================= The following table shows the primary reasons for the difference between the effective income tax rate and the statutory federal income tax rate: Years ended December 31 --------------------------------------- 2001 2000 1999 - -------------------------------------------------------------------------------------------------------------------------- Statutory federal income tax rate 35.0% 35.0% 35.0% Investment tax credits (.1) (.1) (.1) State income taxes, net of federal tax benefits 8.6 6.6 6.3 Equity investments 12.3 .3 0 Other, net .3 .8 (.1) --------------------------------------- Effective income tax rate 56.1% 42.6% 41.1% ======================================= F-18 Verizon Washington, DC Inc. Deferred taxes arise because of differences in the book and tax bases of certain assets and liabilities. Significant components of deferred tax liabilities (assets) are shown in the following table: December 31 ---------------------------- (Dollars in Thousands) 2001 2000 - -------------------------------------------------------------------------------------------------------------------------- Depreciation $ 149,800 $ 135,400 Employee benefits (29,500) (36,700) Allowance for uncollectible accounts (4,100) (2,800) Investment tax credits (1,100) (1,200) Other, net (13,800) (9,800) ---------------------------- Net Deferred Tax Liabilities $ 101,300 $ 84,900 ============================ 11. ADDITIONAL FINANCIAL INFORMATION The tables below provide additional financial information related to our financial statements: December 31 ---------------------------- (Dollars in Thousands) 2001 2000 - ------------------------------------------------------------------------------------------------------------------------- BALANCE SHEETS: Accounts payable and accrued liabilities: Accounts payable - affiliates $ 64,433 $ 59,421 Accounts payable - other 83,953 103,281 Accrued vacation pay 6,619 6,528 Accrued taxes 21,584 6,471 Accrued expenses 14,443 6,108 Interest payable - other 5,147 5,133 Interest payable - affiliate 475 1,175 -------------- ------------- $196,654 $188,117 ============== ============= Other current liabilities: Advance billings and customer deposits $ 15,797 $ 12,122 Other 11,626 12,387 -------------- ------------- $ 27,423 $ 24,509 ============== ============= Years ended December 31 ------------------------------------------- (Dollars in Thousands) 2001 2000 1999 - ------------------------------------------------------------------------------------------------------------------------- STATEMENTS OF CASH FLOWS: Cash paid during the year for: Income taxes, net of amounts refunded $29,482 $42,899 $41,981 Interest, net of amounts capitalized 20,510 15,803 16,758 STATEMENTS OF INCOME: Interest expense incurred, net of amounts capitalized 19,878 17,319 16,077 Capitalized interest 2,999 2,811 1,302 Advertising expense 4,125 1,215 3,902 Advertising expense includes $4,113,000 in 2001, $1,215,000 in 2000 and $3,899,000 in 1999 allocated to us by Verizon Services. At December 31, 2001 and 2000, $6,158,000 and $9,411,000 of bank overdrafts were classified as accounts payable. F-19 Verizon Washington, DC Inc. 12. TRANSACTIONS WITH AFFILIATES Our financial statements include transactions with Verizon Services, (including Verizon Services Corp., Verizon Services Group, Verizon Corporate Services Group Inc. as previously described), Verizon Data Services Inc., GTE Communication Systems Corporation (GTE Communication Systems), Verizon Network Funding Corporation (VNFC), Verizon Communications and other affiliates. Transactions with affiliates are summarized as follows: Years ended December 31 ------------------------------------------- (Dollars in Thousands) 2001 2000 1999 - -------------------------------------------------------------------------------------------------------------------------- Operating revenues: Interstate revenue sharing from affiliates $ 2,550 $ 2,550 $ 2,550 Other revenue from affiliates 165,442 153,868 139,238 -------------- -------------- ------------- 167,992 156,418 141,788 -------------- -------------- ------------- Operating expenses: Verizon Services 127,734 133,556 120,373 Verizon Data Services Inc. 503 --- --- GTE Communication Systems 24 --- --- Other 13,436 21,948 27,217 -------------- -------------- ------------- 141,697 155,504 147,590 -------------- -------------- ------------- Other income/(expense): Equity income from SMS/800 88 315 126 Equity loss from Ventures III (38,468) (1,248) --- Interest income from VNFC --- --- 8 Interest income from Verizon Services 67 --- --- -------------- -------------- ------------- (38,313) (933) 134 -------------- -------------- ------------- Interest expense to VNFC 10,843 8,126 5,307 Equity contributed to Ventures III 37,490 --- --- Capital contribution from Verizon Communications in connection with asset reintegration 37,490 --- --- Dividends paid to Verizon Communications 75,000 74,800 48,700 Dividends received from SMS/800 110 155 126 Outstanding balances with affiliates are reported on the balance sheets at December 31, 2001 and 2000 as Accounts Receivable - Affiliates, Note Payable to Affiliate, and Accounts Payable and Accrued Liabilities - Affiliates. Verizon Services We have contractual arrangements with Verizon Services for the provision of various centralized services. These services are divided into two broad categories. The first category is comprised of network related services which generally benefit only Verizon Communications' operating telephone subsidiaries. These services include marketing, sales, legal, accounting, finance, data processing, materials management, procurement, labor relations, and staff support for various network operations. The second category is comprised of overhead and support services which generally benefit all subsidiaries of Verizon Communications. Such services include corporate governance, corporate finance, external affairs, legal, media relations, employee communications, corporate advertising, human resources, and treasury. Costs may be either directly assigned to one subsidiary or allocated to more than one subsidiary based on functional reviews of the work performed. F-20 Verizon Washington, DC Inc. Verizon Data Services Inc. Verizon Data Services Inc. provides data processing services, software application development and maintenance, which generally benefit Verizon Communications' operating telephone subsidiaries, including us. We are charged for these affiliated transactions based on proportional cost allocation methodologies. GTE Communication Systems GTE Communication Systems provides construction and maintenance equipment, supplies and electronic repair services to us. We record these purchases and services at cost, including a return realized by GTE Communication Systems. Verizon Network Funding Corporation We recognize interest expense/income in connection with contractual arrangements with VNFC to provide short-term financing, investing and cash management services to us (see Note 5). Other Affiliates Other operating revenues and expenses include miscellaneous items of income and expense resulting from transactions with other affiliates, including Verizon Advanced Data Inc. and Verizon Wireless. These transactions include the provision of local and network access services, billing and collection services, rental of facilities and equipment, and sales and purchases of material and supplies. We also earn fees from an affiliate for usage of our directory listings. Investment in Verizon Ventures III In December, 2000, we transferred certain advanced data assets to an affiliated company, Verizon Ventures III Inc. (Ventures III) in exchange for common stock of Ventures III. This transfer was done to satisfy a condition of the FCC's approval of the Bell Atlantic - GTE merger, which required the provision of advanced data services through a separate affiliate. Throughout 2000 and 2001, we continued to invest in Ventures III through the transfer of additional assets. As result of the transfers, we have an ownership interest in Ventures III, which we account for under the equity method of accounting. In September 2001, the FCC issued an order eliminating this merger condition. Following the FCC order, we made necessary filings with our regulatory commission for approval of the transfer of these assets back to us. Ventures III transferred assets back to us during the first quarter of 2002. In consideration of the transfer of these assets, we have surrendered our common stock in Ventures III and remitted certain cash compensation. In connection with this reintegration, we received a capital contribution from our parent of $37,490,000 in December 2001. This equity was immediately contributed to Ventures III. No gain or loss was recognized as a result of the reintegration of the assets to us. We do not expect this reintegration to have a material effect on our results of operations or financial condition. We recorded equity losses associated with our investment in Ventures III of $38,468,000 in 2001 and $1,248,000 in 2000. Our investment in Ventures III was $12,995,000 at December 31, 2001 and $9,464,000 at December 31, 2000. Ownership interest in Ventures III was 5.83% at December 31, 2001 and 5.50% at December 31, 2000. Investment in SMS/800 In June 1999, Bell Atlantic Full Services Channel, Inc., an affiliate, sold its ownership interest in SMS/800 to us and the other operating telephone companies of Verizon Communications at its fair value in accordance with a FCC order. SMS/800 is a venture jointly held by the Bell Operating Companies that administers the centralized national database system associated with toll free numbers. We paid $21,575 to receive a .42% ownership interest in SMS/800. Our ownership percentage has increased to .53% as a result of the merger of SBC Communications, Inc. and Ameritech Corporation. In connection with our investment, we record equity income/(loss) and receive cash dividends. F-21 Verizon Washington, DC Inc. 13. COMMITMENTS AND CONTINGENCIES Various legal actions and regulatory proceedings are pending to which we are a party and claims which, if asserted, may lead to other legal actions. We have established reserves for specific liabilities in connection with regulatory and legal matters that we currently deem to be probable 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 a portion of the revenues collected in the current and prior periods. The outcome of each pending matter, as well as the time frame within which each matter will be resolved, is not presently determinable. Regulatory conditions to the Bell Atlantic - GTE merger include certain commitments to, among other things, promote competition and the widespread deployment of advanced services, while helping to ensure that consumers continue to receive high-quality, low cost telephone services. In some cases, there are significant penalties associated with not meeting these commitments. The cost of satisfying these commitments could have a significant impact on net income in future periods. 14. SEGMENT INFORMATION We have one reportable segment, which provides domestic wireline telecommunications services. Specifically, we provide local telephone services including voice and data transport, enhanced and custom calling features, network access, directory assistance and private lines. In addition, we provide customer premises equipment distribution, billing and collection and pay telephone services. 15. SUBSEQUENT EVENTS On February 1, 2002, we declared and paid a dividend in the amount of $4,000,000 to Verizon Communications. On March 18, 2002, we redeemed the entire outstanding principal amount of the following series of debt: . $50,000,000 of 7% debentures, due February 1, 2009. . $25,000,000 of 5 5/8% debentures, due July 1, 2006. We expect these redemptions to result in an after-tax charge of approximately $331,000. F-22 Verizon Washington, DC Inc. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS For the Years Ended December 31, 2001, 2000 and 1999 (Dollars in Thousands) Additions ------------------------------------ Balance at Charged to Other Beginning of Charged to Accounts Deductions Balance at End Description Period Expenses Note(a) Note (b) of Period - ------------------------------------------------------------------------------------------------------------------------------ Allowance for Uncollectible Accounts Receivable: Year 2001 $11,361 $ 7,489 $7,959 $15,208 $11,601 Year 2000 $ 6,802 $11,227 $6,286 $12,954 $11,361 Year 1999 $ 7,688 $ 3,368 $6,709 $10,963 $ 6,802 Merger-Related Costs:: Year 2001 $ 2,680 $ --- $ 482 $ 448 $ 2,714 Year 2000 $ 4,726 $ 6,669 $ --- $ 8,715 $ 2,680 Year 1999 $ 5,572 $ --- $ --- $ 846 $ 4,726 (a) (1) Allowance for Uncollectible Accounts Receivable includes amounts previously written off which were credited directly to this account when recovered, (2) accruals charged to accounts payable for anticipated uncollectible charges on purchases of accounts receivable from others which we billed, and (3) accruals charged to employee benefit obligations for ongoing severance costs. (b) Amounts written off as uncollectible, utilized or paid. F-23 Verizon Washington, DC Inc. Form 10-K for 2001 File No. 1-7368 Page 1 of 1 EXHIBIT INDEX Exhibits identified in parentheses below, on file with the Securities and Exchange Commission (SEC), are incorporated herein by reference as exhibits hereto. 3a Restated Certificate of Incorporation of the registrant, as amended September 14, 1990. (Exhibit 3a to the registrant's Annual Report on Form 10-K for the year ended December 31, 1990, File No. 1-7368.) 3a(i) Certificate of Amendment of the registrant's Certificate of Incorporation, dated January 12, 1994 and filed January 13, 1994. (Exhibit 3a(i) to the registrant's Annual Report on Form 10-K for the year ended December 31, 1993, File No. 1-7368.) 3a(ii) Certificate of Amendment of the Restated Certificate of Incorporation, filed August 1, 2000. (Exhibit 3a(ii) to the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, File No. 1-7368.) 3b By-Laws of the registrant, as amended December 15, 1995. (Exhibit 3b to the registrant's Annual Report on Form 10-K for the year ended December 31, 1995, File No. 1-7368.) 3b(i) Consent of Sole Stockholder of Verizon Washington, DC Inc., dated December 15, 1995. (Exhibit 3b(i) to the registrant's Annual Report on Form 10-K for the year ended December 31, 1995, File No. 1-7368.) 4 No instrument which defines the rights of holders of long-term debt of the registrant is filed herewith pursuant to Regulation S-K, Item 601(b)(4)(iii)(A). Pursuant to this regulation, the registrant hereby agrees to furnish a copy of any such instrument to the SEC upon request. 12 Computation of Ratio of Earnings to Fixed Charges. 23a Consent of Independent Auditors. 23b Consent of Independent Accountants.