##### Table of Contents



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q þ
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 For the quarterly period ended: March 31, 2005 Or o
Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 For the transition period from _______ to _______ Commission File Number 333-85503 Telecomunicaciones de Puerto Rico, Inc.  Commonwealth of Puerto Rico
    
    66-0566178(STATE OR OTHER JURISDICTION OF
    
    (IRS EMPLOYER IDENTIFICATION NO.)INCORPORATION OR ORGANIZATION)1515 FD Roosevelt AvenueGuaynabo, Puerto Rico
    
    00968(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
    
    (ZIP CODE)
 Registrants telephone number, including area code: 787-792-6052 (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. YES þ NO o Indicate by check mark whether the registrant is an accelerated filer. YES
o NO þ At May 16, 2005, 25 million shares of no par common stock of the registrant were outstanding.   1




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INDEX Telecomunicaciones de Puerto Rico, Inc. and Subsidiaries Part I. Financial InformationItem 1. Financial Statements (Unaudited)
    
    
    3Condensed Consolidated Balance SheetsMarch 31, 2005 and December 31, 2004
    
    
    3Condensed Consolidated Statements of Operations Three Months Ended March 31,
2005 and 2004
    
    
    4Condensed Consolidated Statements of Changes in Shareholders EquityThree
Months Ended March 31, 2005 and Year Ended December 31, 2004
    
    
    5Condensed Consolidated Statements of Cash FlowsThree Months Ended March 31, 2005
and 2004
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    27Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    43Item 4. Controls and Procedures
    
    
    44Part II. Other InformationItem 1. Legal Proceedings
    
    
    45Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    45Item 3. Defaults Upon Senior Securities
    
    
    45Item 4. Submission of Matters to a Vote of Security Holders
    
    
    45Item 5. Other Information
    
    
    45Item 6. Exhibits
    
    
    45Signatures
    
    
    46Exhibit Index
    
    
    47Certification of Principal Executive OfficerCertification of Principal Financial OfficerCertification Pursuant to Section 906
  2




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PART I FINANCIAL INFORMATION  
 Item 1. Financial Statements
 Telecomunicaciones de Puerto Rico, Inc. and Subsidiaries 
 Condensed Consolidated Balance Sheets
 (Unaudited)March 31,
    
    
    December 31,2005
    
    
    2004ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    21,233
    
    
    $
    63,346Accounts receivable, net of allowance for doubtful accounts
of $106,493 and $106,090 in 2005 and 2004, respectively
    
    
    272,154
    
    
    
    270,914Deferred income tax
    
    
    29,173
    
    
    
    28,054Inventory and supplies, net
    
    
    23,054
    
    
    
    28,158Prepaid expenses
    
    
    32,683
    
    
    
    26,616Total current assets
    
    
    378,297
    
    
    
    417,088PROPERTY, PLANT AND EQUIPMENT, net
    
    
    1,426,427
    
    
    
    1,459,459GOODWILL
    
    
    126,927
    
    
    
    126,927INTANGIBLES, net
    
    
    195,002
    
    
    
    196,820DEFERRED INCOME TAX
    
    
    226,329
    
    
    
    235,886OTHER ASSETS
    
    
    108,185
    
    
    
    109,102TOTAL ASSETS
    
    $
    2,461,167
    
    
    $
    2,545,282LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIES:Short-term debt
    
    $
    93,131
    
    
    $
    93,168Other current liabilities
    
    
    199,152
    
    
    
    216,187Total current liabilities
    
    
    292,283
    
    
    
    309,355LONG-TERM DEBT, excluding current portion
    
    
    702,893
    
    
    
    703,556PENSION AND OTHER POST-EMPLOYMENT BENEFITS
    
    
    527,286
    
    
    
    607,115OTHER NON-CURRENT LIABILITIES
    
    
    180,828
    
    
    
    186,781Total liabilities
    
    
    1,703,290
    
    
    
    1,806,807MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY
    
    
    15,671
    
    
    
    15,010SHAREHOLDERS EQUITY:Common stock
    
    
    704,386
    
    
    
    704,386Deferred ESOP compensation
    
    
    (25,172
    )
    
    
    (25,172
    )Retained earnings
    
    
    229,697
    
    
    
    210,956Accumulated other comprehensive loss, net of taxes
    
    
    (166,705
    )
    
    
    (166,705
    )Total shareholders equity
    
    
    742,206
    
    
    
    723,465TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    2,461,167
    
    
    $
    2,545,282
 The accompanying notes are an integral part of these financial statements. 3




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##### Table of Contents



Telecomunicaciones de Puerto Rico, Inc. and Subsidiaries 
 Condensed Consolidated Statements of Operations
 For the Three Months EndedMarch 31,2005
    
    
    2004(Unaudited)REVENUES:Local services
    
    $
    149,249
    
    
    $
    145,289Access services
    
    
    65,782
    
    
    
    73,303Long distance services
    
    
    18,374
    
    
    
    29,516Cellular services
    
    
    55,750
    
    
    
    47,837Directory services and other
    
    
    23,188
    
    
    
    20,879Total revenues
    
    
    312,343
    
    
    
    316,824OPERATING COSTS AND EXPENSES:Labor and benefits
    
    
    92,747
    
    
    
    99,495Other operating expenses
    
    
    111,124
    
    
    
    100,858Early retirement and voluntary separation provision
    
    
    
    
    
    
    1,635Depreciation and amortization
    
    
    61,849
    
    
    
    64,478Total operating costs and expenses
    
    
    265,720
    
    
    
    266,466OPERATING INCOME
    
    
    46,623
    
    
    
    50,358OTHER INCOME (EXPENSE):Interest expense, net
    
    
    (11,088
    )
    
    
    (10,348
    )Equity income from joint venture
    
    
    863
    
    
    
    657Minority interest in consolidated subsidiary
    
    
    (661
    )
    
    
    (560
    )Total other income (expense), net
    
    
    (10,886
    )
    
    
    (10,251
    )INCOME BEFORE INCOME TAX EXPENSE
    
    
    35,737
    
    
    
    40,107INCOME TAX EXPENSE
    
    
    13,749
    
    
    
    15,335NET INCOME
    
    $
    21,988
    
    
    $
    24,772
 The accompanying notes are an integral part of these financial statements. 4




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##### Table of Contents



Telecomunicaciones de Puerto Rico, Inc. and Subsidiaries 
 Condensed Consolidated Statements of Changes in Shareholders Equity
 AccumulatedOtherCommon
    
    
    Deferred ESOP
    
    
    Subscription
    
    
    Retained
    
    
    ComprehensiveStock
    
    
    Compensation
    
    
    Receivable
    
    
    Earnings
    
    
    Loss
    
    
    TotalBALANCE, DECEMBER 31, 2003
    
    $
    703,884
    
    
    $
    (26,153
    )
    
    $
    (39,515
    )
    
    $
    164,520
    
    
    $
    (101,385
    )
    
    $
    701,351Dividends paid
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (61,953
    )
    
    
    
    
    
    
    (61,953
    )Accretion of discount on subscription
receivable
    
    
    
    
    
    
    
    
    
    
    (485
    )
    
    
    
    
    
    
    
    
    
    
    (485
    )PRTA capital contribution
    
    
    
    
    
    
    
    
    
    
    40,000
    
    
    
    
    
    
    
    
    
    
    
    40,000Release of ESOP shares
    
    
    502
    
    
    
    981
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,483Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    108,389
    
    
    
    
    
    
    
    108,389Other comprehensive loss, net of taxes:Minimum pension liability adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (65,320
    )
    
    
    (65,320
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    43,069BALANCE, DECEMBER 31, 2004
    
    $
    704,386
    
    
    $
    (25,172
    )
    
    $
    
    
    
    $
    210,956
    
    
    $
    (166,705
    )
    
    $
    723,465(UNAUDITED)Dividends declared
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,247
    )
    
    
    
    
    
    
    (3,247
    )Net income for the three months ended March 31, 2005
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    21,988
    
    
    
    
    
    
    
    21,988BALANCE MARCH 31, 2005
    
    $
    704,386
    
    
    $
    (25,172
    )
    
    $
    
    
    
    $
    229,697
    
    
    $
    (166,705
    )
    
    $
    742,206
 The accompanying notes are an integral part of these financial statements. 5




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Telecomunicaciones de Puerto Rico, Inc. and Subsidiaries 
 Condensed Consolidated Statements of Cash Flows
 For the Three Months EndedMarch 31,2005
    
    
    2004CASH FLOWS
FROM OPERATING ACTIVITIES:Net income
    
    $
    21,988
    
    
    $
    24,772Adjustments to reconcile net income to net
cash provided by operating activities:Depreciation and amortization
    
    
    61,849
    
    
    
    64,478Provision for uncollectible accounts
    
    
    12,997
    
    
    
    15,430Deferred income tax
    
    
    8,438
    
    
    
    10,761Accretion of discount on subscription receivable
    
    
    
    
    
    
    (485
    )Equity income from joint venture
    
    
    (863
    )
    
    
    (657
    )Early retirement and voluntary separation provision
    
    
    
    
    
    
    1,635Minority interest in consolidated subsidiary
    
    
    661
    
    
    
    560Changes in assets and liabilities:Accounts receivable
    
    
    (14,237
    )
    
    
    (15,998
    )Inventory and supplies
    
    
    5,104
    
    
    
    6,168Prepaid expenses and other assets
    
    
    (6,067
    )
    
    
    (7,631
    )Other current and non-current liabilities
    
    
    (25,155
    )
    
    
    (26,356
    )Pension and other post-employment benefits
    
    
    (79,828
    )
    
    
    (42,280
    )Net cash provided by (used in) operating activities
    
    
    (15,113
    )
    
    
    30,397CASH FLOWS FROM INVESTING ACTIVITIES:Capital expenditures, including removal costs
    
    
    (27,000
    )
    
    
    (19,559
    )Net cash used in investing activities
    
    
    (27,000
    )
    
    
    (19,559
    )CASH FLOWS FROM FINANCING ACTIVITIES:Capital contribution
    
    
    
    
    
    
    40,000Net repayments of short-term debt, including
capital leases
    
    
    
    
    
    
    (29,544
    )Net cash provided by financing activities
    
    
    
    
    
    
    10,456NET (DECREASE) INCREASE IN CASH
AND CASH EQUIVALENTS
    
    
    (42,113
    )
    
    
    21,294CASH AND CASH EQUIVALENTS AT BEGINNING
OF PERIOD
    
    
    63,346
    
    
    
    21,732CASH AND CASH EQUIVALENTS AT END OF PERIOD
    
    $
    21,233
    
    
    $
    43,026
 The accompanying notes are an integral part of these financial
statements. 6




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##### Table of Contents



TELECOMUNICACIONES DE PUERTO RICO, INC. AND SUBSIDIARIES 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
  1.
    Business / Corporate StructureTelecomunicaciones de Puerto Rico, Inc., a Puerto Rico corporation (weor the Company), holds
100% of the common stock of Puerto Rico Telephone Company, Inc. (PRTC), PRT Larga Distancia,
Inc. (PRTLD), and Datacom Caribe, Inc. (Datacom). The Company holds a 67% interest in
Coqui.net Corporation (Coqui.net), in which Popular, Inc., one of our shareholders, holds the
remaining 33% interest. The Company also holds a 24% interest in Verizon Information Services
Puerto Rico, Inc. S en C. (VISI), in which GTE Holdings (Puerto Rico) LLC, our majority
shareholder, holds a 36% interest. Wireline service is provided by PRTC, the incumbent local
exchange carrier for the island of Puerto Rico, and wireless services are provided by Verizon
Wireless, a division of PRTC. The Companys off-island long distance service is provided by
PRTLD and its dial-up Internet access service is provided by Coqui.net. Directory publishing
revenues are generated through VISI.GTE Corporation (GTE), through its subsidiary GTE Holdings (Puerto Rico) LLC, acquired a 40%
interest and management control over the Company on March 2, 1999 from Puerto Rico Telephone
Authority (PRTA), an entity of the Commonwealth of Puerto Rico (the Acquisition). In the
Acquisition, Popular, Inc. acquired a 10% interest in the Company. GTE and Bell Atlantic
Corporation merged on June 30, 2000 to form Verizon Communications Inc. (Verizon). On January
25, 2002, GTE Holdings (Puerto Rico) LLC and Popular, Inc. acquired an additional 12% and 3%
interest in the Company, respectively, by exercising an option each held since the Acquisition
(the Option Exercise). Verizon and Popular, Inc. obtained the additional ownership interest
from PRTA Holdings Corp., a subsidiary of the PRTA (PRTA Holdings). Verizon and Popular, Inc.
paid PRTA Holdings $138 million and $34 million, respectively, for a total of $172 million in
cash for the additional 3,750,000 shares at a $45.9364 per share price established in the Share
Option Agreement, an agreement entered into at the time of the Acquisition. As a result,
Verizon now owns 52%, PRTA owns 28%, Popular owns 13% and the Employee Stock Ownership Plan owns
7% of the outstanding capital stock of the Company. The Company is an affiliate of Verizon,
which consolidates the Companys financial results with its own financial results.2.
    Summary of Significant Accounting PoliciesBasis of PresentationThe accompanying unaudited condensed consolidated financial statements have been prepared in
accordance with U.S. generally accepted accounting principles for interim
financial information and the rules and regulations of the Securities and Exchange Commission
(SEC). Certain information and footnote disclosures normally included in financial statements
prepared in accordance with U.S. generally accepted accounting principles for annual financial
statements have been condensed or omitted pursuant to such rules and
regulations. Management believes the financial statements include all adjustments and recurring
accruals necessary to present fairly the results of its operations and financial condition for
the interim periods shown. The Condensed Consolidated Balance Sheet at December 31, 2004 was
derived from audited financial statements and should be read in conjunction with the notes
thereto included in the Companys Annual Report on Form 10-K for the fiscal year ended December
31, 2004.Impairment or Disposal of Long-lived AssetsAssets are assessed for impairment when changes in circumstances indicate that their carrying
values are not recoverable. Effective, January 1, 2002, the Company adopted SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets. Losses are recognized in
circumstances where impairment exists, at the amount by which the carrying value of assets
exceeds fair value. Fair value is determined based on quoted market prices, if not available,
the estimate of fair value is based on various valuation techniques, including a discounted value
of estimated future cash flows and fundamental analysis.For the last three years, the Company has been operating a TDMA network and CDMA network for its
wireless subscribers. During 2003, management decided to migrate all TDMA subscribers to the
CDMA network and 7




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subsequently dispose of the TDMA network. The expected undiscounted future cash flow from
operations on the TDMA network was estimated to be $27 million ($47.4 million estimated cash
flows from operations less $20.4 million of related expenses). The discounted fair value of the
network was estimated at $26 million determined by discounting anticipated future cash flows at a
risk free rate of 3.76%.Business Combinations and Accounting for Goodwill and Other IntangiblesThe Company adopted SFAS No. 142 Goodwill and Other Intangible Assets, effective January 1,
2002, which provides guidance on the initial recognition and measurement of goodwill and other
intangible assets acquired in a business combination. SFAS No. 142 no longer permits the
amortization of goodwill and other indefinite-lived intangible assets. Instead, these assets
must be reviewed annually (or, under certain conditions, more frequently) for impairment in
accordance with this statement. This impairment test uses fair value approach rather than the
undiscounted cash flow approach previously required by SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.Intangible assets that do not have indefinite lives will continue to be amortized over their
useful lives and reviewed for impairment in accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. The Company is currently undergoing its annual
evaluation of assets, using the fair value approach for each reporting unit, to determine if
there is an impairment exposure (transitional impairment test) and any impact it would have on
the Companys results of operations for 2005.ReclassificationsReclassifications of prior periods data have been made to conform to the current periods
presentation.3.
    Summary of Recent Accounting PronouncementsAccounting for Conditional Asset Retirement ObligationsIn March 2005, the Financial Accounting Standards Board (FASB) issued FASB Interpretation (FIN)
No. 47, Accounting for Conditional Asset Retirement Obligations  an interpretation of FASB
Statement No. 143. FIN No. 47 clarifies SFAS No 143, Accounting for Asset Retirement
Obligations, such that conditional asset retirement obligations require recognition at fair
value if they can be reasonably estimated. These rules are effective December 31, 2005, we are
currently evaluating the impact, if any, on our results of operations and financial
position. 8




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4.
    Property, Plant and EquipmentProperty, plant and equipment consist of: Remaining Useful
    
    
    March 31
    
    
    December 31,Lives (Yrs)
    
    
    2005
    
    
    2004Current
    
    
    Previous
    
    
    (In thousands)Outside plant
    
    
    9.2
    
    
    
    9.2
    
    
    $
    2,162,316
    
    
    $
    2,148,244Central office and transmission equipment
    
    
    4.4
    
    
    
    4.4
    
    
    
    1,236,264
    
    
    
    1,228,001Equipment and other
    
    
    2.7
    
    
    
    2.7
    
    
    
    304,754
    
    
    
    304,716Buildings
    
    
    11.0
    
    
    
    11.0
    
    
    
    324,710
    
    
    
    321,928Land
    
    
    N/A
    
    
    
    N/A
    
    
    
    26,003
    
    
    
    26,003Gross plant in service
    
    
    
    
    
    
    
    
    
    
    4,054,047
    
    
    
    4,028,892Less: accumulated depreciation
    
    
    
    
    
    
    
    
    
    
    2,685,528
    
    
    
    2,637,434Net plant in service
    
    
    
    
    
    
    
    
    
    
    1,368,519
    
    
    
    1,391,458Construction in progress
    
    
    
    
    
    
    
    
    
    
    57,908
    
    
    
    68,001Total
    
    
    
    
    
    
    
    
    
    $
    1,426,427
    
    
    $
    1,459,459
  Effective July 2004, the Company performed its periodic review of plant useful lives estimates
based on a comprehensive analysis of the useful lives underlying the depreciation rates. The
review incorporates the impact of technology, future competition and assumptions employed in the
industry relative to depreciation and retirement rates. The revision resulted in a decrease in
depreciation expense by approximately $3.3 million for the year ended December 31, 2004 and
approximately $1.6 million for the first quarter 2005. Accordingly, the Company revised the
method to calculate composite useful lives to be consistent with the current depreciation study.5.
    GoodwillFollowing is a breakdown of goodwill. CarryingValueMarch 31
    
    
    December 31,2005
    
    
    2004(In thousands)Wireline (PRTC)
    
    $
    102,731
    
    
    $
    102,731Dial-up Internet (Coqui.net)
    
    
    24,196
    
    
    
    24,196Total
    
    $
    126,927
    
    
    $
    126,927
 9




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6.
    Intangibles CarryingValueMarch 31
    
    
    December 31,2005
    
    
    2004(In thousands)Indefinite Life:Wireline concession
    
    $
    85,120
    
    
    $
    85,120FCC Cellular licenses
    
    
    23,855
    
    
    
    23,855Total Indefinite Life
    
    $
    108,975
    
    
    $
    108,975
 March 31, 2005
    
    
    December 31, 2004(In thousands)Definite Life:
    
    Cost
    
    
    Acc. Amort
    
    
    Book Value
    
    
    Cost
    
    
    Acc. Amort
    
    
    Book ValueWireline trade name
    
    $
    48,400
    
    
    $
    11,766
    
    
    $
    36,634
    
    
    $
    48,400
    
    
    $
    11,282
    
    
    $
    37,118Software licenses
    
    
    95,005
    
    
    
    45,612
    
    
    
    49,393
    
    
    
    91,759
    
    
    
    41,032
    
    
    
    50,727Total Definite Life
    
    $
    143,405
    
    
    $
    57,378
    
    
    $
    86,027
    
    
    $
    140,159
    
    
    $
    52,314
    
    
    $
    87,845Plus: Total Indefinite Life
    
    
    
    
    
    
    
    
    
    
    108,975
    
    
    
    
    
    
    
    
    
    
    
    108,975Total
    
    $
    143,405
    
    
    $
    57,378
    
    
    $
    195,002
    
    
    $
    140,159
    
    
    $
    52,314
    
    
    $
    196,820
  SFAS No. 142, Goodwill and Other Intangible Assets, no longer permits the amortization of
goodwill and other indefinite-lived intangible assets. Instead, these assets must be reviewed
annually (or, under certain conditions, more frequently) for impairment in accordance with this
statement. This impairment test is based on the fair value approach.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. For 2004, the Company has evaluated its assets
using the fair value approach, for each reporting unit, to determine if there is an impairment
exposure (transitional impairment test) and the impact it would have on the Companys results of
operations. The results of the evaluation did not reveal an impairment exposure.The following table presents current and expected amortization expense of existing intangible
assets as of March 31, 2005 and for each of the following years: Aggregate Amortization expense:For the three months ended March 31, 2005
    
    $
    5,085Expected amortization expense for
the years ending December 31,:2005
    
    $
    12,1232006
    
    
    10,8782007
    
    
    8,7492008
    
    
    4,8372009
    
    
    4,837
 10




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7.
    Other assetsOther assets consist of: 2005
    
    
    2004(In thousands)Deferred activation and installation costs
    
    $
    70,257
    
    
    $
    72,775Notes receivable-equipment sales
    
    
    4,443
    
    
    
    5,675Deferred pension asset
    
    
    23,747
    
    
    
    23,747Deferred financing costs, net
    
    
    2,082
    
    
    
    2,307Other deferred costs
    
    
    2,869
    
    
    
    1,516Interest rate swap
    
    
    
    
    
    
    3Investment in Verizon Information Services
    
    
    952
    
    
    
    88Other assets
    
    
    3,835
    
    
    
    2,991Total
    
    $
    108,185
    
    
    $
    109,102
  8.
    Pension PlanThe Company has noncontributory pension plans for full-time employees, which are tax qualified as
they meet Employee Retirement Income Security Act of 1974 (the ERISA) requirements. The
Company realizes tax deductions when contributions are made to the trusts. The trusts invest in
equity and fixed income securities to meet benefit obligations.The pension benefit is composed of two elements. First, an employee receives an annuity at
retirement when they reach the rule of 85 (age plus years of service). The annuity is calculated
by applying a percentage times years of service to the last three years of salary. The second
element is a lump sum based on years of service, up to a maximum of nine months of salary for
hourly employees and twelve months of salary for salaried employees.There are separate trusts for the annuity and the lump sum benefits. Furthermore, annuity
benefit trusts plans are segregated by the three employee groups: UIET union, HIETEL union, and
management employees. The Company also provides health care and life insurance benefits to
retirees.The components of the net pension and other post-employment benefit expenses for the
quarters ended March 31, 2005 and 2004 are presented below. Pension and Lump Sum Benefits
    
    
    Post-Retirement Benefits(In thousands)
    
    2005
    
    
    2004
    
    
    2005
    
    
    2004Service cost
    
    $
    5,714
    
    
    $
    5,186
    
    
    $
    1,556
    
    
    $
    2,565Interest cost
    
    
    18,259
    
    
    
    17,567
    
    
    
    8,218
    
    
    
    9,652Expected return on plan assets
    
    
    (18,135
    )
    
    
    (14,910
    )
    
    
    
    
    
    
    Amortization of unrecognized:Transition obligation
    
    
    90
    
    
    
    90
    
    
    
    551
    
    
    
    551Prior service cost (benefit)
    
    
    783
    
    
    
    1,179
    
    
    
    (2,463
    )
    
    
    (628
    )Actuarial loss, net
    
    
    5,562
    
    
    
    3,518
    
    
    
    4,579
    
    
    
    4,421Net amortization and deferral
    
    
    12,273
    
    
    
    12,630
    
    
    
    12,441
    
    
    
    16,561Effect of early retirement program
    
    
    
    
    
    
    939
    
    
    
    
    
    
    
    696Total
    
    $
    12,273
    
    
    $
    13,569
    
    
    $
    12,441
    
    
    $
    17,257
 11




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##### Table of Contents



Cash FlowsThe Company expects to contribute $128 million to the pension and lump sum plans, and $31
million for post-retirement benefits in year 2005. As of March 31, 2005, the Company has
contributed $98 million to the pension plan and has sufficient liquid resources to fund the
remainder of the contribution.Medicare Drug ActOn December 8, 2003, the Medicare Prescription Drug Improvement and Modernization Act of 2003
(Medicare Drug Act) was signed into law. The Medicare Drug Act introduces a prescription drug
benefit under Medicare (Medicare Part D) as well as a federal subsidy to sponsors of retiree
health care benefit plans that provide a benefit that is at least actuarially equivalent to
Medicare Part D. The Companys plan provides prescription drug benefits that are deemed
actuarially equivalent to the Medicare Part D and elected to recognize the impact of the federal
subsidy on our accumulated postretirement benefit obligation and net postretirement benefit costs
in the third quarter of 2004. The reduction in the APBO for the subsidy related to benefits
attributed to past service is $77.4 million for year 2004. The effect of the subsidy on the
measurement of net periodic postretirement benefit cost of $10.7 million for the current period
2004 consists of the following (in millions): Amortization of the actuarial experience gain
    
    $
    4.3Reduction in current period service cost
    
    
    1.6Resulting reduction in interest cost on APBO
    
    
    4.8Total
    
    $
    10.7
  9.
    Early Retirement and Voluntary Separation ProvisionIn January 2004, the Company recorded a provision of $1.6 million associated with 19 eligible
management employees who accepted the early retirement program offered by the Company in December
2003.In September 30, 2004, the Company offered a voluntary separation program, expiring on December
3, 2004, to eligible management employees, resulting in a provision of $1.2 million covering 24
employees who accepted the separation plan.10.
    Deferred ESOP CompensationThe Employee Stock Ownership Plan (ESOP) acquired a 3% interest in the Company in 1999, which
was financed by a $26 million, twenty-year note borrowed from the Company to establish a
contributory investment fund for employees. The ESOP only invests in shares of the Companys
common stock. Shares are held by the ESOPs trustee and maintained in a suspense account until
they are released to employee participants. The yearly release of shares to participants is
based on the greater of participant contributions plus a Company match of 30% up to 5% of wages
or a minimum based on an amortization schedule. The minimum is based on the ratio of annual debt
service to total debt service multiplied by the initial 750,000 shares.Also, during the year 2000 and 2001, subsequent to ESOPs commencement, the ESOP entered into
various loan agreements with the Company amounting to $4.9 million to finance the ESOPs
acquisition of Company stock from former employees.Salaried, regular, full and part-time employees of the Company actively employed on March 2, 1999
were eligible to receive a portion of the Initial Grant of the Companys stock. Employees that
were not actively employed on March 2, 1999 were also eligible to receive the Initial Grant
provided that they met the following condition:Employees who were on short-term disability, workers compensation, Family and Medical Care Leave
Act (FMLA) leave, layoff with recall rights, or other Company approved leave of absence; and the
employees returned to active employment with the Company as soon as they were eligible to do so
and within 180 days after March 2, 1999. 12




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##### Table of Contents



Compensation expense is recorded based on the release of shares at market value, which is based
on an independent appraisal performed annually. The ESOP released approximately 32,000 shares in 2004. This
release resulted in compensation expense of $1 million for the year ended December 31, 2004
reflecting the market value of the shares. The release of shares, based upon the per share price
established at the Acquisition, amounted to $1.5 million for December 31, 2004, which is
reflected as a reduction of deferred ESOP compensation in equity.11.
    Other Current LiabilitiesOther current liabilities consist of: March 31
    
    
    December 31,2005
    
    
    2004(In thousands)Accounts payable
    
    $
    11,852
    
    
    $
    35,368Accrued expenses
    
    
    92,379
    
    
    
    105,128Employee benefit accruals
    
    
    60,398
    
    
    
    52,630Carrier payables
    
    
    12,771
    
    
    
    14,825Taxes
    
    
    3,442
    
    
    
    1,868Interest
    
    
    18,310
    
    
    
    6,369Total
    
    $
    199,152
    
    
    $
    216,187
  12.
    DebtDebt consists of: March 31
    
    
    December 31,2005
    
    
    2004(In thousands)Senior notesDue May 15, 2006 at 6.65%
    
    $
    399,973
    
    
    $
    399,966Due May 15, 2009 at 6.80%
    
    
    299,915
    
    
    
    299,910Term credit facilities:Due May 16, 2005 at 57 basis points over LIBOR
    
    
    30,000
    
    
    
    30,000Due August 19, 2005 at 70 basis points over
LIBOR
    
    
    63,000
    
    
    
    63,000Deferred derivative
    
    
    2,985
    
    
    
    3,654Interest rate swap
    
    
    
    
    
    
    3Capital leases
    
    
    151
    
    
    
    191Total
    
    
    796,024
    
    
    
    796,724Less short-term debt
    
    
    93,131
    
    
    
    93,168Long-term debt
    
    $
    702,893
    
    
    $
    703,556
  The senior notes, commercial paper, term credit facilities, working capital facility, and bank
notes are unsecured and non- amortizing; where PRTC is the guarantor of these debt instruments. The senior notes indentures
and credit facility agreements do not contain dividend restrictions. 13




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##### Table of Contents



The Company has a $400 million commercial paper program with maturities not to exceed 364 days,
which is backed by one of our working capital facilities.In March 2005, the Companys existing $360 million bank note credit facility matured. On March 1,
2005 the Company entered into a new unsecured, $400 million 364-day revolving credit facility
with a syndicate of banks and other lenders for whom Citibank, N.A. acts as administrative agent,
Banco Bilbao Vizcaya Argentaria Puerto Rico and Bank of Nova Scotia act as co-syndication agents
and Banco Popular de Puerto Rico and FirstBank Puerto Rico act as co-documentation agents.
Amounts borrowed under this facility are guaranteed by PRTC, and bear interest at the applicable
LIBOR rate plus a margin or at the base rate; which is the higher of the base rate publicly
announced by the administrative agent from time to time or the Federal Funds rate plus 0.5%, plus
a margin. The Company is also required to pay a quarterly facility fee on commitments under the
facility and a quarterly utilization fee on borrowed amounts that exceed 50% of the commitments
under the facility. Accrued interest on Eurodollar rate borrowings is payable based on elected
intervals of one, two, three or six months or other interest period as the Company may select,
subject to certain conditions. Accrued interest on base rate borrowings is payable quarterly.
This facility matures on February 28, 2006, on which date the Company has the right to convert
outstanding amounts into a term loan that mature on February 28, 2007. This facility contains
negative covenants, including covenants which limit the Companys ability to grant or permit
liens on its or subsidiaries properties, merge or sell all or substantially all of its assets
and permit its subsidiaries to incur debt. This facility also requires that the Company maintain
certain financial ratios. Upon the occurrence of a default or an event of default, the lenders
have various remedies or rights, which may include termination of the lenders obligations to
make advances and declare all borrowed amounts and interest thereon immediately due and payable.
The intended purpose of this facility is for working capital purposes and serves as backstop
facility for the commercial paper program. At March 31, 2005, the Company had no outstanding debt
balance under this facility.The Company has a $40 million working capital credit facility with Banco Popular de Puerto Rico,
an affiliate of Popular, Inc. that matured on June 2004. On June 2004, the Company renewed the
undrawn $40 million working capital credit facility maturing on June 30, 2005. Amounts
outstanding under this facility bear interest at a rate of 40 basis points over LIBOR. This
facility also serves as additional backstop for the commercial paper program. At March 31, 2005,
the Company had no outstanding debt balance under this facility.At December 31, 2002, the Company had $225 million in term credit facilities with maturities
ranging from two to three years, and bearing interest from 60 to 100 basis points over LIBOR. By
October 29, 2003, the Company repaid one of the $50 million term loans, and prepaid principal in
an aggregate amount of $62 million of the outstanding term credit loans, while reducing interest
rate to 70 basis points over LIBOR. One of the $30 million term loans matured on May 16, 2004.
The Company renewed the $30 million term loan at an interest rate of 57 basis points over LIBOR
maturity due on May 17, 2005.On August 31, 2001, the Company entered into an interest rate swap contract with a notional
amount of $150 million. In September 2002, the Company drew the value out of the hedge position
without changing the fixed/floating funding mix of the original swap transaction. This
transaction resulted in cash proceeds of $11 million, reflected in cash from operations as
required by SFAS No. 104, and created a deferred derivative, which will be amortized until 2006.
As of March 31, 2005, the unamortized balance of the deferred derivative is $3 million. The
purpose of the swap is to hedge against changes in the fair market value of the Companys senior
notes to achieve a targeted mix of fixed and variable rate debt. The swap receives interest at a
fixed rate of 6.65% and pays interest at a net variable rate equal to six month LIBOR plus 170
basis points, with semiannual settlements and reset dates every May 15 and November 15 until
maturity of the May 15, 2006 senior notes. The swap was entered into at market and as a
result, there was no exchange of premium at the initial date of the swap. The Company designates
the swap as a hedge of the changes in fair market value of the senior notes due to changes in the
designated benchmark interest rate. PRTC is the guarantor of the interest rate swap. 14




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##### Table of Contents



Aggregate maturities of the senior notes and term credit facilities are as follow: Year
    
    
    

    Amount(In thousands)2005
    
    Term credit facilities
    
    $
    93,0002006
    
    Senior note
    
    
    400,0002009
    
    Senior note
    
    
    300,000Total
    
    
    
    $
    793,000
  Currently, the Company is in compliance with all debt covenant agreements and with the financial
ratios as specified in term facilities.13.
    Other Non-Current LiabilitiesOther non-current liabilities consist of: March 31
    
    
    December 31,2005
    
    
    2004(In thousands)Deferred activation and installation revenues
    
    $
    70,257
    
    
    $
    72,775Deferred directory-publishing revenues
    
    
    9,093
    
    
    
    14,065Customer deposits
    
    
    27,383
    
    
    
    26,521Other liabilities
    
    
    74,095
    
    
    
    73,420Total
    
    $
    180,828
    
    
    $
    186,781
  14.
    Shareholders EquityCommon StockCommon stock consists of fifty million authorized shares, no par value, of which twenty five
million shares were outstanding at March 31, 2005 and December 31, 2004.Subscription ReceivableThe subscription receivable reflects receipts from the PRTA originally recorded at its present
value (at an 8% discount rate). As part of the Acquisition agreement, the PRTA agreed to
contribute a total of $200 million in cash or stock as a capital contribution in equal
installments of $40 million over five years beginning on March 2, 2000. The Company employed the
$200 million capital contribution to partially fund its under funded pension and other
post-employment benefit obligations, as agreed. The stock purchase agreement required the Company to contribute
$66 million, which included the $40 million received from PRTA, to the pension plan immediately
upon receipt of the proceeds each year. The Company received the fifth and final $40 million
installment in March 2004 and made the required pension payment of $66 million. All installments
were received in cash. 15




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##### Table of Contents



Accumulated Other Comprehensive LossThe accumulated other comprehensive loss represents unrecognized losses, other than unrecognized
prior service costs which are reflected as an other asset, associated with the hourly employee
pension fund, since the accumulated benefit obligation exceeds the fair value of plan assets.The accumulated other comprehensive loss amount as of December 31, 2004 has been adjusted in the
amount of $65 million in order to reflect the after-tax amount in accordance with the provisions
of SFAS No.130, Reporting Comprehensive Income.DividendsThe Companys shareholders agreement requires the payment of dividends equal to at least 50% of
consolidated net income to be paid in the following quarter to the extent funds are legally
available.Dividends declared were made in the following periods: 2005
    
    
    2004(In thousands)
    
    
    (In thousands)4th Quarter
    
    $
    
    
    
    4th Quarter
    
    $
    3rd Quarter
    
    
    
    
    
    3rd Quarter
    
    
    49,5672nd Quarter
    
    
    
    
    
    2nd Quarter
    
    
    12,3861stQuarter
    
    
    3,247
    
    
    1st Quarter
    
    
    Total
    
    $
    3,247
    
    
    Total
    
    $
    61,953
  The senior notes indentures and credit facility agreements do not contain dividend restrictions.15.
    Fair Value of Financial InstrumentsThe carrying amounts and fair values of the Companys financial instruments are as follows: March 31,
    
    
    December 31,2005
    
    
    2004Carrying
    
    
    Fair
    
    
    Carrying
    
    
    FairAmount
    
    
    Value
    
    
    Amount
    
    
    Value(In thousands)Assets:Cash and cash equivalents
    
    $
    21,233
    
    
    $
    21,233
    
    
    $
    63,346
    
    
    $
    63,346Accounts receivable
    
    
    272,154
    
    
    
    272,154
    
    
    
    270,914
    
    
    
    270,914Liabilities:
    
    
    
    
    
    
    
    
    
    
    Other current liabilities
    
    $
    199,152
    
    
    $
    199,152
    
    
    $
    216,187
    
    
    $
    216,187Short-term debt
    
    
    93,131
    
    
    
    93,131
    
    
    
    93,168
    
    
    
    93,168Long-term debt, including interest rate swap
    
    $
    702,893
    
    
    $
    736,525
    
    
    $
    703,556
    
    
    $
    739,470
 16




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##### Table of Contents



16.
    Segment ReportingThe Company has two reportable segments: Wireline and Wireless.The Wireline segment consists of:  
    Local services, including basic voice, telephone and telecommunications equipment
rentals, value-added services, high-speed private line services, Internet access and public
phone service;
    Access services to long distance carriers, competitive local exchange carriers, and
cellular and paging operators to originate and terminate calls on our network;
    Long distance services including direct dial on-island and off-island, operator assisted
calls, and prepaid calling card services;
    Directory publishing rights services; and
    Telecommunication equipment sales and billing and collection services to competing long
distance operators in Puerto Rico.  The Wireless segment consists of:  
    Cellular services; and
    Wireless equipment sales.  The accounting policies of the segments are the same as those followed by the Company (see Note
2). The Company accounts for intersegment revenues at market prices. 17




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##### Table of Contents



Segment results for the Company are as follows: For the Three Months Ended March2005
    
    
    2004(In thousands)Wireline:Revenues-Local services
    
    $
    152,428
    
    
    $
    147,816Access services
    
    
    67,417
    
    
    
    73,678Long distance services
    
    
    17,588
    
    
    
    29,634Directory services and other
    
    
    14,488
    
    
    
    16,579Total revenues
    
    $
    251,921
    
    
    $
    267,707Operating income
    
    $
    46,614
    
    
    $
    51,971Wireless:Revenues-Cellular services
    
    $
    56,657
    
    
    $
    48,150Long distance services
    
    
    1,103
    
    
    
    Equipment sales and other
    
    
    8,803
    
    
    
    4,112Total revenues
    
    $
    66,563
    
    
    $
    52,262Operating income (loss)
    
    $
    9
    
    
    $
    (1,613
    )Consolidated:Revenues for reportable segments
    
    $
    318,484
    
    
    $
    319,970Elimination of intersegment revenues
    
    
    (6,141
    )
    
    
    (3,146
    )Consolidated revenues
    
    $
    312,343
    
    
    $
    316,824Operating income
    
    $
    46,623
    
    
    $
    50,358
 As of
    
    
    As ofMarch 31,
    
    
    December 31,Assets
    
    2005
    
    
    2004Wireline assets
    
    $
    2,439,498
    
    
    $
    2,474,296Wireless assets
    
    
    433,659
    
    
    
    357,290Segment assets
    
    $
    2,873,157
    
    
    $
    2,831,586Elimination of intersegment assets
    
    
    (411,990
    )
    
    
    (286,304
    )Consolidated assets
    
    $
    2,461,167
    
    
    $
    2,545,282
 18




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##### Table of Contents



17.
    Condensed Consolidating InformationThe following summarizes the unaudited condensed consolidating financial information as of March
31, 2005 and December 31, 2004 and for the quarters then ended presents the financial position,
results of operations and cash flows of (i) the Company as if it had accounted for its
subsidiaries using the equity method, (ii) the Guarantor Subsidiary (as defined below); and
(iii) the Non-Guarantor Subsidiaries (as defined below) on a combined basis. The consolidation
entries eliminate investments in subsidiaries and intercompany balances and transactions.The Notes are guaranteed by PRTC (the Guarantor Subsidiary), a wholly-owned subsidiary of
the Company, but not guaranteed by the Companys other subsidiaries, Coqui.net, PRTLD and
Datacom (the Non-Guarantor Subsidiaries). The guarantee by the Guarantor Subsidiary is full
and unconditional. 19




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##### Table of Contents



Condensed Consolidating Balance Sheets
March 31, 2005
(In thousands) Guarantor
    
    
    Non-Guarantor
    
    
    
    
    
    
    TotalParent
    
    
    Subsidiary
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    
    
    
    $
    (565
    )
    
    $
    21,798
    
    
    $
    
    
    
    $
    21,233Intercompany accounts receivable
    
    
    354,691
    
    
    
    156,586
    
    
    
    55,971
    
    
    
    (567,248
    )
    
    
    Accounts receivable, net
    
    
    
    
    
    
    271,823
    
    
    
    331
    
    
    
    
    
    
    
    272,154Deferred income tax
    
    
    718
    
    
    
    28,422
    
    
    
    33
    
    
    
    
    
    
    
    29,173Inventory and supplies, net
    
    
    
    
    
    
    23,053
    
    
    
    1
    
    
    
    
    
    
    
    23,054Prepaid expenses
    
    
    
    
    
    
    32,257
    
    
    
    426
    
    
    
    
    
    
    
    32,683Total current assets
    
    
    355,409
    
    
    
    511,576
    
    
    
    78,560
    
    
    
    (567,248
    )
    
    
    378,297PROPERTY, PLANT AND EQUIPMENT, net
    
    
    
    
    
    
    1,417,281
    
    
    
    9,146
    
    
    
    
    
    
    
    1,426,427GOODWILL AND OTHER INTANGIBLES, net
    
    
    
    
    
    
    297,375
    
    
    
    24,554
    
    
    
    
    
    
    
    321,929DEFERRED INCOME TAX
    
    
    
    
    
    
    227,288
    
    
    
    
    
    
    
    (959
    )
    
    
    226,329INVESTMENT IN SUBSIDIARIES
    
    
    572,171
    
    
    
    
    
    
    
    
    
    
    
    (572,171
    )
    
    
    OTHER ASSETS
    
    
    705,369
    
    
    
    107,846
    
    
    
    (1
    )
    
    
    (705,029
    )
    
    
    108,185TOTAL ASSETS
    
    $
    1,632,949
    
    
    $
    2,561,366
    
    
    $
    112,259
    
    
    $
    (1,845,407
    )
    
    $
    2,461,167LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIES:Short-term debt
    
    $
    93,000
    
    
    $
    93,131
    
    
    $
    
    
    
    $
    (93,000
    )
    
    $
    93,131Intercompany accounts payable
    
    
    73,101
    
    
    
    370,364
    
    
    
    36,740
    
    
    
    (480,205
    )
    
    
    Other current liabilities
    
    
    21,768
    
    
    
    164,843
    
    
    
    12,874
    
    
    
    (333
    )
    
    
    199,152Total current liabilities
    
    
    187,869
    
    
    
    628,338
    
    
    
    49,614
    
    
    
    (573,538
    )
    
    
    292,283LONG-TERM DEBT, excluding current portion
    
    
    702,874
    
    
    
    699,906
    
    
    
    
    
    
    
    (699,887
    )
    
    
    702,893OTHER NON-CURRENT LIABILITIES
    
    
    
    
    
    
    706,735
    
    
    
    1,193
    
    
    
    186
    
    
    
    708,114Total liabilities
    
    
    890,743
    
    
    
    2,034,979
    
    
    
    50,807
    
    
    
    (1,273,239
    )
    
    
    1,703,290MINORITY INTEREST
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,671
    
    
    
    15,671SHAREHOLDERS EQUITY:Common stock, Additional paid in capital and Treasury stock
    
    
    704,386
    
    
    
    485,590
    
    
    
    41,143
    
    
    
    (526,733
    )
    
    
    704,386Deferred ESOP compensation
    
    
    (25,172
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (25,172
    )Retained earnings
    
    
    229,697
    
    
    
    207,502
    
    
    
    20,309
    
    
    
    (227,811
    )
    
    
    229,697Accumulated other comprehensive loss
    
    
    (166,705
    )
    
    
    (166,705
    )
    
    
    
    
    
    
    166,705
    
    
    
    (166,705
    )Total shareholders equity
    
    
    742,206
    
    
    
    526,387
    
    
    
    61,452
    
    
    
    (587,839
    )
    
    
    742,206TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    1,632,949
    
    
    $
    2,561,366
    
    
    $
    112,259
    
    
    $
    (1,845,407
    )
    
    $
    2,461,167
 20




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##### Table of Contents



Condensed Consolidating Balance Sheets
December 31, 2004
(In thousands) Guarantor
    
    
    Non-Guarantor
    
    
    
    
    
    
    TotalParent
    
    
    Subsidiary
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    (149
    )
    
    $
    44,658
    
    
    $
    18,837
    
    
    $
    
    
    
    $
    63,346Intercompany accounts receivable
    
    
    342,749
    
    
    
    86,340
    
    
    
    47,423
    
    
    
    (476,512
    )
    
    
    Accounts receivable, net
    
    
    
    
    
    
    270,807
    
    
    
    107
    
    
    
    
    
    
    
    270,914Deferred income tax
    
    
    718
    
    
    
    27,303
    
    
    
    33
    
    
    
    
    
    
    
    28,054Inventory and supplies, net
    
    
    
    
    
    
    28,157
    
    
    
    1
    
    
    
    
    
    
    
    28,158Prepaid expenses
    
    
    
    
    
    
    25,228
    
    
    
    1,388
    
    
    
    
    
    
    
    26,616Total current assets
    
    
    343,318
    
    
    
    482,493
    
    
    
    67,789
    
    
    
    (476,512
    )
    
    
    417,088PROPERTY, PLANT AND EQUIPMENT, net
    
    
    
    
    
    
    1,449,809
    
    
    
    9,650
    
    
    
    
    
    
    
    1,459,459GOODWILL AND OTHER INTANGIBLES, net
    
    
    
    
    
    
    299,164
    
    
    
    24,583
    
    
    
    
    
    
    
    323,747DEFERRED INCOME TAX
    
    
    
    
    
    
    236,755
    
    
    
    
    
    
    
    (869
    )
    
    
    235,886INVESTMENT IN SUBSIDIARIES
    
    
    550,178
    
    
    
    
    
    
    
    
    
    
    
    (550,178
    )
    
    
    OTHER ASSETS
    
    
    706,035
    
    
    
    108,986
    
    
    
    
    
    
    
    (705,919
    )
    
    
    109,102TOTAL ASSETS
    
    $
    1,599,531
    
    
    $
    2,577,207
    
    
    $
    102,022
    
    
    $
    (1,733,478
    )
    
    $
    2,545,282LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIES:Short-term debt
    
    $
    93,000
    
    
    $
    93,168
    
    
    $
    
    
    
    $
    (93,000
    )
    
    $
    93,168Intercompany accounts payable
    
    
    73,337
    
    
    
    280,295
    
    
    
    36,298
    
    
    
    (389,930
    )
    
    
    Other current liabilities
    
    
    6,195
    
    
    
    202,878
    
    
    
    7,218
    
    
    
    (105
    )
    
    
    216,187Total current liabilities
    
    
    172,532
    
    
    
    576,342
    
    
    
    43,516
    
    
    
    (483,035
    )
    
    
    309,355LONG-TERM DEBT, excluding current portion
    
    
    703,534
    
    
    
    699,895
    
    
    
    
    
    
    
    (699,874
    )
    
    
    703,555OTHER NON-CURRENT LIABILITIES
    
    
    
    
    
    
    793,177
    
    
    
    1,103
    
    
    
    (384
    )
    
    
    793,896Total liabilities
    
    
    876,066
    
    
    
    2,069,414
    
    
    
    44,619
    
    
    
    (1,183,293
    )
    
    
    1,806,806MINORITY INTEREST
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,010
    
    
    
    15,010SHAREHOLDERS EQUITY:Common stock, Additional paid in capital and Treasury stock
    
    
    704,386
    
    
    
    485,590
    
    
    
    41,143
    
    
    
    (526,733
    )
    
    
    704,386Deferred ESOP compensation
    
    
    (25,172
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (25,172
    )Retained earnings
    
    
    210,956
    
    
    
    188,905
    
    
    
    16,260
    
    
    
    (205,165
    )
    
    
    210,956Accumulated other comprehensive loss, net of taxes
    
    
    (166,705
    )
    
    
    (166,703
    )
    
    
    
    
    
    
    166,703
    
    
    
    (166,705
    )Total shareholders equity
    
    
    723,465
    
    
    
    507,793
    
    
    
    57,403
    
    
    
    (565,195
    )
    
    
    723,466TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    1,599,531
    
    
    $
    2,577,207
    
    
    $
    102,022
    
    
    $
    (1,733,478
    )
    
    $
    2,545,282
 21




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Condensed Consolidating Statements of Operations
For the three months ended March 31, 2005  Guarantor
    
    
    Non-Guarantor
    
    
    
    
    
    
    TotalParent
    
    
    Subsidiary
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedREVENUES:Local services
    
    $
    
    
    
    $
    143,949
    
    
    $
    7,857
    
    
    $
    (2,557
    )
    
    $
    149,249Access services
    
    
    
    
    
    
    67,120
    
    
    
    
    
    
    
    (1,338
    )
    
    
    65,782Long distance services
    
    
    
    
    
    
    8,122
    
    
    
    10,617
    
    
    
    (365
    )
    
    
    18,374Cellular services
    
    
    
    
    
    
    55,750
    
    
    
    
    
    
    
    
    
    
    
    55,750Directory and other services and sales
    
    
    
    
    
    
    25,184
    
    
    
    365
    
    
    
    (2,361
    )
    
    
    23,188Total revenues
    
    
    
    
    
    
    300,125
    
    
    
    18,839
    
    
    
    (6,621
    )
    
    
    312,343OPERATING
COSTS AND EXPENSES:Labor and benefits
    
    
    
    
    
    
    92,197
    
    
    
    916
    
    
    
    (365
    )
    
    
    92,747Other operating expenses
    
    
    
    
    
    
    106,367
    
    
    
    11,014
    
    
    
    (6,256
    )
    
    
    111,124Depreciation and amortization
    
    
    
    
    
    
    61,282
    
    
    
    566
    
    
    
    
    
    
    
    61,849Total operating costs and expenses
    
    
    
    
    
    
    259,846
    
    
    
    12,496
    
    
    
    (6,621
    )
    
    
    265,720OPERATING INCOME
    
    
    
    
    
    
    40,279
    
    
    
    6,343
    
    
    
    
    
    
    
    46,623OTHER INCOME (EXPENSE), NET
    
    
    21,988
    
    
    
    (10,395
    )
    
    
    176
    
    
    
    (22,654
    )
    
    
    (10,886
    )INCOME BEFORE INCOME TAX EXPENSE
    
    
    21,988
    
    
    
    29,884
    
    
    
    6,519
    
    
    
    (22,654
    )
    
    
    35,737INCOME TAX EXPENSE
    
    
    
    
    
    
    1,128
    
    
    
    2,470
    
    
    
    
    
    
    
    13,749NET INCOME
    
    $
    21,988
    
    
    $
    28,756
    
    
    $
    4,049
    
    
    $
    (22,654
    )
    
    $
    21,988
 22




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##### Table of Contents



Condensed Consolidating Statements of Operations
For the three months ended March 31, 2004
(In thousands) Guarantor
    
    
    Non-Guarantor
    
    
    
    
    
    
    TotalParent
    
    
    Subsidiary
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedREVENUES:Local services
    
    $
    
    
    
    $
    140,204
    
    
    $
    8,232
    
    
    $
    (3,147
    )
    
    $
    145,289Access services
    
    
    
    
    
    
    75,316
    
    
    
    
    
    
    
    (2,013
    )
    
    
    73,303Long distance services
    
    
    
    
    
    
    18,039
    
    
    
    11,496
    
    
    
    (19
    )
    
    
    29,516Cellular services
    
    
    
    
    
    
    47,837
    
    
    
    
    
    
    
    
    
    
    
    47,837Directory and other services and sales
    
    
    
    
    
    
    23,013
    
    
    
    
    
    
    
    (2,134
    )
    
    
    20,879Total revenues
    
    
    
    
    
    
    304,409
    
    
    
    19,728
    
    
    
    (7,313
    )
    
    
    316,824OPERATING COSTS AND EXPENSES:Labor and benefits
    
    
    
    
    
    
    98,659
    
    
    
    836
    
    
    
    
    
    
    
    99,495Other operating expenses
    
    
    
    
    
    
    94,656
    
    
    
    13,515
    
    
    
    (7,313
    )
    
    
    100,858Early retirement provision
    
    
    
    
    
    
    1,635
    
    
    
    
    
    
    
    
    
    
    
    1,635Depreciation and amortization
    
    
    
    
    
    
    63,911
    
    
    
    567
    
    
    
    
    
    
    
    64,478Total operating costs and expenses
    
    
    
    
    
    
    258,861
    
    
    
    14,918
    
    
    
    (7,313
    )
    
    
    266,466OPERATING INCOME
    
    
    
    
    
    
    45,548
    
    
    
    4,810
    
    
    
    
    
    
    
    50,358OTHER INCOME (EXPENSE), NET
    
    
    23,948
    
    
    
    (9,753
    )
    
    
    62
    
    
    
    (24,508
    )
    
    
    (10,251
    )INCOME BEFORE INCOME TAX EXPENSE
    
    
    23,948
    
    
    
    35,795
    
    
    
    4,872
    
    
    
    (24,508
    )
    
    
    40,107INCOME TAX EXPENSE (BENEFIT)
    
    
    (824
    )
    
    
    14,333
    
    
    
    1,826
    
    
    
    
    
    
    
    15,335NET INCOME
    
    $
    24,772
    
    
    $
    21,462
    
    
    $
    3,046
    
    
    $
    (24,508
    )
    
    $
    24,772
 23




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##### Table of Contents



Condensed Consolidating Statements of Cash Flows
For the three months Ended March 31, 2005
(In thousands) Guarantor
    
    
    Non-Guarantor
    
    
    TotalParent
    
    
    Subsidiary
    
    
    Subsidiaries
    
    
    ConsolidatedCASH PROVIDED BY (USED IN) OPERATING ACTIVITIES:
    
    $
    
    
    
    $
    (18,106
    )
    
    $
    2,993
    
    
    $
    (15,113
    )CASH FLOWS FROM INVESTING ACTIVITIES:Capital expenditures, including removal costs
    
    
    
    
    
    
    (26,967
    )
    
    
    (33
    )
    
    
    (27,000
    )Net cash used in investing activities
    
    
    
    
    
    
    (26,967
    )
    
    
    (33
    )
    
    
    (27,000
    )CASH FLOWS FROM FINANCING ACTIVITIES:Borrowings/(repayment) intercompany loans
    
    
    149
    
    
    
    (149
    )
    
    
    
    
    
    
    Net cash provided by (used in) financing activities
    
    
    149
    
    
    
    (149
    )
    
    
    
    
    
    
    NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    149
    
    
    
    (45,222
    )
    
    
    2,960
    
    
    
    (42,113
    )CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
    
    
    (149
    )
    
    
    44,657
    
    
    
    18,838
    
    
    
    63,346CASH AND CASH EQUIVALENTS AT END OF PERIOD
    
    $
    
    
    
    $
    (565
    )
    
    $
    21,798
    
    
    $
    21,233
 24




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##### Table of Contents



Condensed Consolidating
Statements of Cash Flows
For the three months ended March 31, 2004
(In thousands) Guarantor
    
    
    Non-Guarantor
    
    
    TotalParent
    
    
    Subsidiary
    
    
    Subsidiaries
    
    
    ConsolidatedCASH PROVIDED BY (USED IN) OPERATING:
    
    $
    (672
    )
    
    $
    29,186
    
    
    $
    1,883
    
    
    $
    30,397CASH FLOWS FROM INVESTING ACTIVITIES:Capital expenditures, including removal costs
    
    
    
    
    
    
    (19,614
    )
    
    
    (9
    )
    
    
    (19,623
    )Net salvage on retirements
    
    
    
    
    
    
    65
    
    
    
    (1
    )
    
    
    64Net cash used in investing activities
    
    
    
    
    
    
    (19,549
    )
    
    
    (10
    )
    
    
    (19,559
    )CASH FLOWS FROM FINANCING ACTIVITIES:Capital contribution
    
    
    40,000
    
    
    
    
    
    
    
    
    
    
    
    40,000Net repayments of short-term debt, including
capital leases
    
    
    (29,490
    )
    
    
    (54
    )
    
    
    
    
    
    
    (29,544
    )Borrowings/(repayment) intercompany loans
    
    
    (9,829
    )
    
    
    9,829
    
    
    
    
    
    
    
    Net cash provided in financing activities
    
    
    681
    
    
    
    9,775
    
    
    
    
    
    
    
    10,456NET INCREASE IN CASH AND CASH EQUIVALENTS
    
    
    9
    
    
    
    19,412
    
    
    
    1,873
    
    
    
    21,294CASH AND CASH EQUIVALENTS AT BEGINNING
OF PERIOD
    
    
    
    
    
    
    12,438
    
    
    
    9,294
    
    
    
    21,732CASH AND CASH EQUIVALENTS AT END OF PERIOD
    
    $
    9
    
    
    $
    31,850
    
    
    $
    11,167
    
    
    $
    43,026
 25




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##### Table of Contents



18.
    Contingencies and Regulatory and Other MattersThe Company is a defendant in various legal matters arising in the ordinary course of business.
Management, after consultation with legal counsel, believes at this time that the resolution of
these matters will not have a material adverse effect on the Companys financial condition and
results of operations. See Managements Discussion and Analysis of Financial Condition and
Results of Operations  Regulatory and Other Matters for more information regarding legal and
regulatory matters.In connection with the privatization of the Company, PRTA agreed to indemnify, defend and hold
the Company harmless from specified litigation in excess of $50 million in the aggregate,
including one environmental matter.The Company is regulated by the United States Federal Communications Commission (the FCC) for
inter-state wireline services and by the Telecommunications Regulatory Board of Puerto Rico
(TRB) for intra-island wireline services. 26




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW We are the largest telecommunications service provider in Puerto Rico and the seventh largest
local exchange carrier in the United States as measured by access lines in service. We have two
reportable segments: Wireline and Wireless. Wireline service, which has been provided since 1914,
is marketed under the PRT brand. At March 31, 2005, we had approximately 1.2 million access lines
in service, including 881,000 residential and 280,000 business lines. We market our cellular
service under the Verizon Wireless brand. The Companys off-island long distance service is
provided by PRTLD and its dial-up Internet access service is provided by Coqui.net. Directory
publishing revenues are generated by VISI. The sections that follow provide information aspects of our operations and investments, both
at the consolidated and segment levels, and include discussions of our results of operations,
financial position and sources and uses of cash, as well as significant future commitments. In
addition, we have highlighted key trends and uncertainties to the extent practicable. The content
and organization of the financial and non-financial data presented in these sections are consistent
with information used by our chief operating decision makers for, among other purposes, evaluating
performance and allocating resources. We also monitor several key economic indicators as well as
the state of the economy in general, primarily in Puerto Rico, in evaluating our operating results
and analyzing and understanding business trends. While most key economic indicators impact our
operations to some degree, including gross domestic product, we have noted correlations to housing
starts, personal consumption expenditures and capital spending, as well as more macroeconomic
indicators such as inflation and unemployment rates. Our results of operations, financial position and sources and uses of cash in the current and
future periods reflect the managements focus on the following four key areas:  
    Revenue Growth  Our emphasis is on revenue transformation, devoting more resources from
traditional services, where we have been experiencing access line losses, to higher growth
markets such as wireless and local data services, including digital subscriber lines (DSL),
as well as expanded services to enterprise markets. In the three months ended March 31,
2005, revenues from the growth of wireless areas, in particular post-paid cellular services
and sale of wireless equipment increased by 28% compared to the same period in 2004. The
local data services increased by 7% compared to the same period in 2004. The wireless and
local data services represented 31% of the total revenues, up from 26% of total revenues
for the three months ended March 31, 2004. The revenue growth is reflected by the addition
of approximately 74,000 post-paid wireless customers, approximately 24,000 DSL customers
and approximately 7,000 internet dial-up lines compared to the same period in 2004.
    Operational Efficiency  While focusing resources on growth markets, we are continually
challenging our management team to lower expenses, particularly through technology-assisted
productivity improvements. The effect of these and other efforts, such as labor agreements
and early retirement and voluntary separation plans, has significantly changed the
Companys cost structure. The Company has significantly lower workforce levels, compared
to the same period in 2004, which will provide ongoing expense benefits. At March 31,
2004, the Company had approximately 5,220 employees compared to 5,034 at March 31, 2005.
Labor and benefits expenses declined by approximately $6 million for the three months ended
March 31, 2005 compared to the same period in 2004, largely as a result of year 2004s
early retirement and voluntary separation plans.
    Capital Allocation  Capital spending has been, and will continue to be directed toward
growth markets. Also, capital spending is focused on High-speed wireless data or Evolution
Data Optimized (EV-DO). Replacement of the TDMA network, as well as voice over the
Internet (VoIP) and expanded services offered to enterprise markets are examples of areas
of capital spending in support of theses growth markets.
    Cash Flow Generation  The financial statements reflect the emphasis of management on
using cash provided by our operating and investing activities to strategically reduce debt
and to fund our pension plans. Supporting these key focus areas are continuing initiatives to more effectively package and
add value to our products and services. In 2004, we introduced VoIP service that allows customers
with DSL or cable-modem broadband service to make telephone calls and utilize advanced service
features through an Internet connection rather than through the 27




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##### Table of Contents



traditional telephone network. Innovative product bundles include local wireline services,
long distance, wireless and DSL for consumer and general business retail customers. The Companys
marketing and operational efficiency efforts will enable the management to counter the effects of
competition and technology migration to alternative network platforms, such as wireless and VoIP.
During 2004, in response to the evolving competitive landscape and customer preferences the Company
reduced the number of local calling areas from 68 to 10 calling zones. During 2005, we expect to
consolidate the remaining 10 calling zones and implement a single calling area within Puerto Rico. PUBLIC TELEPHONES OPERATIONS In December 2004, the Company entered into an agreement to sell the public telephone assets,
subject to certain terms and conditions, to a local public telephone service provider. The
transaction has received regulatory approval and the transfer of assets is currently being
performed. The disposition of the public telephone assets will enable management to focus on
higher growth areas, such as wireless and broadband. CONSOLIDATED RESULTS OF OPERATIONS In this section, we discuss our overall results of operations and highlight special and
non-recurring items, while in the following section; we review the performance of our two segments. CONSOLIDATED REVENUES For the Three Months Ended March 31,2005
    
    
    2004
    
    
    % Change(In millions)Local
    
    $
    149
    
    
    $
    145
    
    
    
    3
    %Network Access
    
    
    66
    
    
    
    73
    
    
    
    (10
    )Long Distance
    
    
    18
    
    
    
    30
    
    
    
    (40
    )Cellular
    
    
    56
    
    
    
    48
    
    
    
    17Directory and Other
    
    
    23
    
    
    
    21
    
    
    
    10Consolidated revenues
    
    $
    312
    
    
    $
    317
    
    
    
    (2
    )%
 Consolidated revenues for the three months ended March 31, 2005 decreased $5 million, or 2%,
to $312 million from $317 million for the same period in 2004. The decrease was primarily the
result of lower revenues from intra-island long distance revenues, partially offset by higher
postpaid cellular revenues. Long distance revenues for the three months ended March 31, 2005 decreased $12 million, or
40%, to $18 million compared to $30 million for the same period in 2004. This decrease was mainly
the result of the impact of the reduction of the local calling areas. See Regulatory and Other
Matters  Intra-Island Long Distance Access Rate Dispute. Cellular revenues for the three months ended March 31, 2005 increased $8 million, or 17%, to
$56 million from $48 million for the same period in 2004. This increase was mainly the result of
an increase in the number of cellular postpaid customers due to attractive price plans and the
implementation of marketing strategies to align the Companys product and service offerings with
those of Verizon Wireless in the United States. CONSOLIDATED OPERATING EXPENSES For
the Three Months Ended March 31,2005
    
    

2004
    
    

%Change(In millions)Labor and benefits
    
    $
    93
    
    
    $
    99
    
    
    
    (6
    )%Other operating expenses
    
    
    111
    
    
    
    101
    
    
    
    10Total consolidated operating expenses
    
    $
    204
    
    
    $
    200
    
    
    
    2
    %
 Consolidated operating expenses for the three months ended March 31, 2005 increased $4
million, or 2%, to $204 million from $200 million for the same period in 2004. 28




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##### Table of Contents



Labor and benefit expenses for the three months ended March 31, 2005 decreased $6 million, or
6%, to $93 million from $99 million for the same period in 2004. This decrease was mainly due to
lower pension and OPEBs expenses mainly associated with the impact of the federal subsidy under
Medicare Drug Act of 2003 and the early retirement program offered during 2004. See note 8 and 9
to the unaudited consolidated financial statements. Other operating expenses for the three months ended March 31, 2005 increased $10 million, or
10%, to $111 million from $101 million for the same period in 2004, primarily due to the increase
in cost of equipment sold due to aggressive wireless offerings. OTHER CONSOLIDATED RESULTS For the Three Months Ended March 31,2005
    
    
    2004
    
    
    %Change(In millions)Retirement and voluntary separation provision
    
    $
    
    
    
    $
    2
    
    
    
    
    %Depreciation and amortization
    
    
    62
    
    
    
    64
    
    
    
    (3
    )Interest expense and others
    
    
    11
    
    
    
    11
    
    
    
    Equity income in joint venture
    
    
    (1
    )
    
    
    (1
    )
    
    
    Minority interest in consolidated subsidiary
    
    
    1
    
    
    
    1
    
    
    
    Income tax (benefit) expense
    
    
    14
    
    
    
    15
    
    
    
    (7
    )Total Other Consolidated Results
    
    $
    86
    
    
    $
    92
    
    
    
    (7
    )%
 Retirement and voluntary separation provisions In January 2004, 19 eligible management employees accepted the early retirement program
offered by the Company in December 2003, which resulted in a provision of $1.6 million. Depreciation and amortization expense Depreciation and amortization expense of $62 million for the three months ended March 31, 2005
was $2 million, or 3%, lower than for the comparable 2004 period due to the impact of the periodic
review of the plant useful lives estimates effective in July 2004. Interest expense, net Interest expense of $11 million for the three months ended March 31, 2005 remained constant in
comparison with the same period of 2004, as approximately 90% of our debt balance carries a fixed
interest rate. Equity income from joint venture The $1 million equity income from joint venture for the three months ended March 31, 2005 and
2004, respectively, were generated from our 24% interest in VISI, the largest yellow page
publishing company in Puerto Rico. Minority interest in consolidated subsidiary The $1 million minority interest included in the Companys results of operations for the three
months ended March 31, 2005 and 2004, respectively, reflects the 33% interest in Coqui.net, held by
Popular, Inc., one of our shareholders. Income taxes The effective income tax rate is the provision for income taxes as a percentage of income
before tax from continuing operations. A $13.7 million tax provision for the three months ended
March 31, 2005 reflects a 37.8% effective tax rate. The difference in the tax provision of $1.6
million between the effective and the statutory tax rate of 39%, primarily represents permanent
differences related to recognition of equity income from the joint venture and amortization of tax
deductible goodwill. 29




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##### Table of Contents



SEGMENT RESULTS OF OPERATIONS The Company has two reportable segments, Wireline and Wireless. See Note 16 to the unaudited
condensed consolidated financial statements for additional information on the Companys segments.
Reclassifications of prior periods data have been made to conform to the current periods
presentation. The Wireline segment consists of:  
    Local services, including basic voice, telephone and telecommunications equipment
rentals, value-added services, high-speed data services, Internet access and public phone
service;
    Long distance services including direct dial on-island and off-island, operator assisted
calls, and prepaid calling card;
    Access services to long distance carriers, competitive local exchange carriers, and
wireless operators for originating and terminating calls on the Companys network;
    Directory publishing rights services; and
    Telecommunication equipment sales and billing and collection services to competing long
distance operators in Puerto Rico. The Wireless segment consists of:  
    Postpaid and Prepaid services; and
    Wireless equipment sales. 30




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WIRELINE REVENUES For the Three Months Ended March 31,2005
    
    
    2004
    
    
    % Change(In millions)Local
    
    $
    152
    
    
    $
    148
    
    
    
    3
    %Network Access
    
    
    67
    
    
    
    74
    
    
    
    (9
    )Long Distance
    
    
    18
    
    
    
    30
    
    
    
    (40
    )Directory and Other
    
    
    14
    
    
    
    17
    
    
    
    (18
    )Total Wireline
    
    $
    252
    
    
    $
    268
    
    
    
    (6
    )%
 OPERATING DATA For the Three Months Ended March 31,2005
    
    
    2004
    
    
    % ChangeAccess Lines in Service (000s):Residential
    
    
    881
    
    
    
    926
    
    
    
    (5
    )%Business
    
    
    280
    
    
    
    288
    
    
    
    (3
    )%Total
    
    
    1,161
    
    
    
    1,214
    
    
    
    (4
    )%
 Wireline revenues include local service, network access, long distance, directory and
other revenues. For the three months ended March 31, 2005, wireline revenues decreased $16
million, or 6%, to $252 million from $268 million for the same period in 2004. The revenue
decrease is primarily attributed to lower intra island long distance revenues as the number of
calling areas were reduced from 68 to 10. Local Services Local service revenues include revenues from basic voice, telephone and telecommunications
equipment rental, value-added services, high-speed data services, Internet access, and public phone
service. Local service revenues for the three months ended March 31, 2005 increased $4 million, or
3%, to $152 million from $148 million for the comparable 2004 period. The increase is due to
increased revenues from local data services of $3 million and from local voice services of $1
million. The increase in revenues from local data services was primarily driven by an increase in
the number of customers requesting private services, such as T-1, and special services, such as
DSL, which resulted in a $3 million increase in both private services revenues and DSL revenue.
The increase in local voice services revenues was mainly driven by higher directory assistance
revenue of $1 million due to increase in directory assistance rates from $.50 to $.75 effective in
November 2004. Network Access Network access
revenues include revenues from services provided to long distance carriers,
competitive local exchange carriers, and cellular and paging operators to originate and terminate
calls on our network. These revenues for the three months ended March 31, 2005 decreased $7
million, or 9%, to $67 million compared to $74 million for the same 2004 period. The decrease was
driven by a decrease in intra-island access revenues of $4 million due to the implementation of the
phase rate reduction as agrred with the TRB in the February 2002 Order, later defined and included
in the integrated plan, and a decrease in off-island switching and special access revenue of $3
million due to decrease in average rates. See Regulatory and Other Matters  Intra-Island Long
Distance Access Rate Dispute. Long Distance Long distance revenues include direct dial on-island and off-island, operator-assisted calls
and prepaid calling cards revenues. Long distance revenues for the three months ended March 31,
2005 decreased $12 million, or 40%, to $18 million
from $30 million for the comparable 2004 period due to a decrease in intra-island long
distance revenues as a result of the reduction in local calling areas, from 68 to 10, and the
resulting lower intra-island call volumes. 31




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Directory and Other Directory and other revenues include revenues from directory publishing rights,
telecommunication equipment sales and billing and collection services provided to competing long
distance operators in Puerto Rico. Directory and other revenues for the three months ended March
31, 2005 decreased $3 million, or 18%, to $14 million from $17 million for the same period in 2004
due to a decrease in billing and collections revenues of $1 million and a decrease in wireline
equipment sales of $1 million. WIRELINE EXPENSES AND CHARGES For the Three Months Ended March 31,2005
    
    
    2004
    
    
    %Change(In millions)Labor and benefits
    
    $
    85
    
    
    $
    93
    
    
    
    (7
    )%Other operating expenses
    
    
    69
    
    
    
    71
    
    
    
    (3
    )Total Wireline
    
    $
    154
    
    
    $
    162
    
    
    
    (5
    )%
 Wireline expenses for the three months ended March 31, 2005 decreased $11 million, or 5%,
to $154 million from $162 million for the same period in 2004, as employee separation programs have
reduced the expense associated with labor and benefits. Labor and benefits Labor and benefit expenses for the three months ended March 31, 2005 decreased $6 million, or
7%, to $85 million from $91 million for the same period in 2004, due to a decrease in pension and
OPEB expenses of $5 million and a headcount reduction which resulted in a decrease in salary
expenses of $1 million. Other operating expenses Other operating expenses for the three months ended March 31, 2005 decreased $2 million, or
3%, to $69 million from $71 million for the same period in 2004, mainly due to a decrease in
management fees of $4 million, due to the expiration in March 2004 of the five-year Management and
Technology License Agreement with Verizon. The new Services Agreement, signed in April 2004,
provides for the provision of such services as the Company may request and continues with the
technology license previously granted. This expense decrease was partially offset in part by an
increase in advertising and vehicle expenses of $2 million, mainly as a result of the effort to
increase the high speed data services and private services. 32




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WIRELESS REVENUES For the Three Months Ended March 31,2005
    
    
    2004
    
    
    % Change(In millions)Postpaid Cellular
    
    $
    51
    
    
    $
    43
    
    
    
    19
    %Prepaid Cellular
    
    
    4
    
    
    
    5
    
    
    
    (20
    )Total Cellular
    
    
    55
    
    
    
    48
    
    
    
    15Long Distance
    
    
    
    
    
    
    
    
    
    
    Wireless Equipment
    
    
    9
    
    
    
    4
    
    
    
    125Total Wireless
    
    $
    64
    
    
    $
    52
    
    
    
    23
 OPERATING DATA For the Three Months Ended March 31,2005
    
    
    2004
    
    
    % ChangeCellular Customers (000s):Postpaid
    
    
    314
    
    
    
    240
    
    
    
    31
    %Prepaid
    
    
    101
    
    
    
    107
    
    
    
    (6
    )Total
    
    
    415
    
    
    
    347
    
    
    
    20Postpaid Cellular Average Revenue Per Unit (ARPU)
    
    $
    55
    
    
    $
    55
    
    
    
    
    %Prepaid Cellular ARPU
    
    
    14
    
    
    
    16
    
    
    
    (13
    )Combined Cellular ARPU
    
    
    45
    
    
    
    43
    
    
    
    5
    %
 Revenues from cellular services and related equipment sales for the three months ended
March 31, 2005 increased $13 million, or 25%, to $65 million from $52 million for the comparable
2004 period, driven by strong postpaid cellular subscriber growth. Cellular Services Cellular service revenues for the three months ended March 31, 2005 increased $7 million, or
15%, to $55 million from $48 million for the same period in 2004. This increase was primarily the
result of an increase of 74,000 postpaid cellular customers for the three months ended March 31,
2005 compared to the same period in 2004 due to attractive price plans and the implementation of
marketing strategies to align the Companys product and service offerings with those of Verizon
Wireless in the United States. Long Distance On April 2004, PRTC and PRTLD entered into a reseller agreement of wireless long distance
revenues generated by cellular customers, resulting in a revenue increase of $1 million during
three months ended March 31, 2005. Wireless Equipment Revenues from wireless equipment sales increased $5 million, or 125%, to $9 million for the
three months ended March 31, 2005, from $4 million for the comparable 2004 period. These increases
are the result of postpaid contract renewals and the strong customer acquisitions. 33




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WIRELESS EXPENSES AND CHARGES For the Three Months Ended March 31,2005
    
    
    2004
    
    
    %Change(In millions)Labor and benefits
    
    $
    8
    
    
    $
    8
    
    
    
    
    %Other operating expenses
    
    
    48
    
    
    
    33
    
    
    
    45Total Wireless
    
    $
    57
    
    
    $
    41
    
    
    
    39
    %
 Wireless expenses for the three months ended March 31, 2005 increased $16 million, or
39%, to $57 million from $41 million for the same period in 2004. Labor and benefits Labor and benefit expenses for the three months ended March 31, 2005 and 2004 were constant at
$8 million. Other operating expenses Other operating expenses for the three months ended March 31, 2005 increased $15 million, or
45%, to $48 million from $33 million for the comparable 2004 period. The increase was due to a
higher subsidy on equipment sales of $8 million, higher wireless commission expense of $2 million,
higher wireless interconnection charges of $1 million, higher cellular roaming expense of $1
million, and higher regulatory fees, bad debt expense and inventory obsolescence of $3 million. 34




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LIQUIDITY AND CAPITAL RESOURCES CONSOLIDATED FINANCIAL CONDITION Years Ended December 31,2005
    
    
    2004
    
    
    Change(in millions)Cash flows from (used in):Operations
    
    
    ($15
    )
    
    $
    30
    
    
    
    ($45
    )Investing
    
    
    (27
    )
    
    
    (20
    )
    
    
    (7
    )Financing
    
    
    0
    
    
    
    10
    
    
    
    (10
    )
 OVERALL LIQUIDITY ASSESSMENT The Company believes that cash from operations is sufficient to meet working capital needs.
Current assets exceeded current liabilities at March 31, 2005 by $86 million. We believe our
sources of funds, from operations and from readily available external financing arrangements, are
sufficient to meet ongoing operating, financing and investing requirements. We expect that
presently foreseeable capital requirements will continue to be financed through internally
generated funds. On March 1, 2005, the Company entered into a new unsecured, undrawn $400 million 364-day
revolving credit facility, which matures in February 28, 2006 and replaced the prior undrawn
facility which matured on March 2, 2005. The Company also has an undrawn $40 million working
capital credit facility, which matures on June 29, 2005 and replaced the prior facility which
matured in June 2004. See Note 13 to the unaudited condensed consolidated financial statements
for more detailed information. OPERATIONS Cash from operations continued to be our primary source of funds. The $45 million decrease
for the three months ended March 31, 2005 compared to same period in 2004 was primarily due to
higher pension contributions of $33 million, which are part of managements strategy to fully fund
the pension plans by 2007, and increased purchases of wireless handset inventory of $8 million. INVESTING Net cash used in investing activities for the three months ended March 31, 2005 was $27
million compared to $20 million for the same period in 2004. The $7 million increase in net cash
used in investing activities was due to an increase in capital expenditures on transmission
equipment, cable equipment and wireless network, as a result of the growth markets and the
Companys emphasis on revenue transformation. We have invested approximately $1.3 billion from the date of the Acquisition through March 31,
2005 to expand and enhance our networks. Our planned capital expenditures for 2005 are
approximately $155 million, which we expect to finance with internally generated funds. FINANCING We reduced outstanding debt, including capital leases by $1 million for the quarter ended
March 31, 2005, and $28 million for the quarter ended March 31, 2004. Borrowings under term credit
facilities, working capital facilities and commercial paper decreased from $93 million at December
31, 2003 to $63 million at March 31, 2004. During the first quarter ended March 31, 2004, the
Company paid $30 million of commercial paper reducing the balance at March 31, 2004 to zero. In connection with the Acquisition, PRTA agreed to contribute cash or stock worth a total of
$200 million as a capital contribution in five equal $40 million installments over five years
beginning on March 2, 2000 to partially fund its under funded pension and other post-employment
benefit obligations. In March 2004, the Company received the fifth and final $40 million
installment in cash from PRTA. See Note 14 to the unaudited condensed consolidated financial
statements 35




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##### Table of Contents



for more information. The shareholders agreement requires the payment of dividends equal to at least 50% of
consolidated net income, payable quarterly to the extent funds are legally available. For the
first quarter ended March 31, 2005 and 2004, the Company did not pay a dividend. The senior note
indentures and credit facility agreements do not contain restrictions on the payment of dividends. OFF-BALANCE SHEET ARRANGEMENTS The Company currently does not have any off-balance sheet arrangements that have or are
reasonably likely to have a material current or future effect on the Companys financial condition,
changes in financial condition, revenues or expenses, results of operations, liquidity, capital
expenditures or capital resources. 36




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##### Table of Contents



REGULATORY AND OTHER MATTERS REGULATORY AND COMPETITIVE TRENDS Regulatory activity at the federal and local levels has been primarily directed at meeting
challenges in reinstating support for local exchange rates and Universal Service while effecting
the rate rebalancing and restructuring required by an increasingly competitive environment. Among
the issues generating regulatory activity are the expansion of local calling areas, local number
portability requirements, interconnection agreements, the FCCs triennial review and the
elimination of reverse toll billing. We have continued to meet the wholesale requirements of new competitors and have signed
agreements with wireless and wireline carriers. These agreements permit carriers to purchase
unbundled network elements, resell retail services, and interconnect their networks with ours. INTRA-ISLAND LONG DISTANCE ACCESS RATE DISPUTE On February 28, 2002, the TRB issued a Resolution and Order (the February 2002 Order) with
respect to the reconsideration requested by the Company of the TRBs October 10, 2001 order to
reduce the access rates the Company charges to long distance carriers to originate and terminate
intra-island long distance calls on the Companys network and required other obligations from the
Company On
April 2005, the Company implemented the final reduction in access charges to 2.1 cents per minute. The last one time credit for single line residential customers equal to their basic monthly
service rate for May 2005 is in process. CARRIER ACCESS BILLING During the first and second quarters of 2003, certain carriers made a series of billing claims
against the Company regarding tariff interpretation, traffic routing at the network level and
misclassification of access traffic for determination of applicable access elements. The Company entered into negotiations with the major carriers and settled the billing claims
and phased-rate reductions required by the February 2002 Order. These settlements do not have a
material effect on the Companys results of operations. EXTENDED AREA SERVICE
(EAS) LOCAL CALLING ZONE DISPUTE/SINGLE ZONE FILING As of October 4, 2004, PRTC had completed all phases of its EAS implementation program
reducing the calling areas from 68 to 10. However, on October 21, 2004, AT&T and Sprint, made a joint filing before the TRB requesting
the initiation of a rulemaking proceeding for PRTs new local calling zones. This request for
rulemaking aims to obstruct any future local zone reductions by PRTC. On December 1, 2004, PRT
submitted its opposition to the petition. On March 15, 2005, PRT participated in a hearing scheduled by the TRB regarding the EAS
rulemaking petition filed by AT&T and Sprint. In this hearing the TRB agreed that the EAS
rulemaking procedure is not the adequate mechanism to entertain the rate restructuring proposed by
PRT. In this hearing the TRB decided to start a separate USF procedure to evaluate the impact of
the rate restructuring proposed by PRT. PRT, however, notified the TRB that it will continue with
its proposed rate restructuring schedule for April 2005. On
April 6, 2005, PRT filed before the TRB its single zone plan
(One Zone Tariffs), with an effective date of July 1, 2005.
Implementation of the One Zone Tariffs will eliminate the extended calling
area charge of $2.25. 37




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##### Table of Contents



Following
the filing of the One Zone Tariffs, the TRB announced the commencement of a new
proceeding for the adoption and development of a high cost telephone
fund for Puerto Rico in compliance with
the P.R. Universal Service Rules. A pleading cycle for comments was established as follows:
comments due date April 22; reply comments due May 2; and an oral argumentative hearing for May 10,
2005, respectively. Comment where filed on time. The vast majority of the participants agreed
that a high cost telephone fund is not needed in PR and supported the implementation of the Single
Zone proposed by the Company. CENTENNIAL 25% DISCOUNT IN SPECIAL ACCESS FACILITIES On April 8, 2005 the TRB decided a complaint in favor of our competitor, granting Centennial
the right to a 25% wholesale discount on certain high capacity loops. The
Company understands that the TRB erred in applying the Telecom Act of 1996, Section 251(c)
(4) wholesale discount for retail services and that the TRB decision is inconsistent with the FCC rulings
because special access services are not retail services. PUBLIC TELEPHONE SERVICE PROVIDER  ANTI COMPETITIVE ACTIONS On August 16, 2002, PSA, the parent company of Phoenix of Puerto Rico, filed a lawsuit against
PRTC in the United States Bankruptcy Court for the District of Delaware, claiming anti competitive
acts. The claims have since been transferred to the United States
District Court of Delaware. The disputes between the two parties
include an administrative claim by PRTC against PSA, and
a claim of over $9 million, PSA against PRTC. The United States
District Court of Delaware granted a PRTC motion to change venue to
Puerto Rico and the motion to dismiss is currently
pending before the United States District Court of Puerto Rico. On September 24, 2004, the Court
issued an Opinion and Order granting PRTCs motion to dismiss. PUERTO RICO DEPARTMENT OF EDUCATION (THE PRDOE) DEBT On June 30, 2003, PRTC filed a complaint against the PRDOE with the Puerto Rico Superior
Court, seeking collection of fees due for services rendered under the PRDOEs Reeducate Program,
which is based on the Federal E-Rate Program, from 1999 to June 30, 2003. The Reeducate Program
funds Internet connections for schools throughout Puerto Rico and PRTC has provided contracted
services to the PRDOE. Based on PRTCs review of its services rendered under the Reeducate
Program, the outstanding amount that PRDOE currently owes to PRTC is $34 million. Under the E-Rate
program, 89% of this amount is to be paid by the FCCs School & Libraries Division (SLD), which
administers the Federal E-Rate Program, if the funding for the fourth and fifth years under the
program is released. PRTC is currently evaluating the outstanding amounts owed by PRDOE for the
third year under the program, which we believe is approximately $1.2 million, after SLD paid its
corresponding percentage (87%) under the program. On March 4, 2004, PRTC filed a motion to dismiss the complaint based on an agreement with the
PRDOE to attempt to settle the amounts owed out of court. On March 24, 2004, the court dismissed
the case without prejudice. In November 2003, the FCC directed SLD to audit the PRDOEs compliance with the E-Rate program
rules as well as billings for the Reeducate Program for years one through three of the program
before the funds would be released. The audit of the PRDOE began on May 15, 2004. The auditor has
contacted PRTC and PRTC is cooperating with the audit. There is no scheduled timetable for the
completion of the audit process. Upon completion of that audit, SLD will determine if there is a
need to recover any, or all, of the funds that were distributed during those years to the PRDOE and
its vendors, including PRTC. On June 17, 2004, the United States House Energy and Commerce Committee Subcommittee on
Oversight and Investigations held a hearing entitled Problems with the E-Rate Program: Waste,
Fraud, and Abuse Concerns in the Wiring of Our Nations Schools to the Internet. Representatives
from PRTC, as well as representatives from the PRDOE testified at the hearing. This hearing was
one of a series of ongoing hearings focused on the E-Rate program nationwide. At the beginning of July, 2004, the Universal Service Administrative Company (USAC), the
E-Rate programs administrator commenced the audit directed by the FCC. The audit was divided into
two time periods: Years 1 to 3 (1999 to June 2001) and Years 4 and 5 (July 2001 to June 2003).
PRTC has been providing information with respect to contracts, 38




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billing, payments and the network designed and installed by PRTC, and service levels provided
in response to requests from the auditors. On July 30, 2004, the FCC released its Fourth Report and Order addressing the manner in which
funds would be recovered under the E-Rate program. On August 13, 2004, the FCC released its Fifth
Report and Order (Order) in the same proceeding adopting measures to address issues raised in the
audit conducted as part of ongoing oversight of the schools and libraries support mechanisms and
program concerns noted by its Office of Inspector General. Based on the standards established by
the FCC, PRTC does not believe that amounts it has received from the E-Rate program are subject to
recovery. PRTC is implementing procedures to ensure compliance with the requirements established
by the Order. USAC has indicated that they are close to finalizing the audit report for Years 4 and 5.
There is a possibility that there would be some funding issued this summer for these years.
However, the amount of funding to be released is unclear. They also indicated that the audit report for Years 1 to 3 would be finalized in the summer.
The audit is being conducted pursuant to an agreed upon procedures audit process, where KPMG only
makes specific findings but no conclusions or recommendations. These findings will be delivered to
the FCC, who will make a determination how to proceed. KPMG has been somewhat concerned about the
lack of data of the level of service provided to the PRDOE during those years. PRTC has responded
indicating KPMG that no further monitoring of the level of services was required either as a matter
of industry practice, customer requirements, or E-Rate rules. TOUCHTONE CHARGES On November 17, 2003, six residential subscribers and eight business service subscribers filed
a class action suit with the Superior Court of Puerto Rico (the Superior Court) under the Puerto
Rico Telecommunications Act of 1996 (Act) and the Puerto Rico Class Action Act of 1971. The
plaintiffs have claimed that the Companys charges for touchtone service are not based on cost, and
therefore violate the Act. The plaintiffs have requested that the Superior Court (i) issue an
order certifying the case as a class action, (ii) designate the plaintiffs as representative of the
class, (iii) find that the charges are illegal, and (iv) order the Company to reimburse every
subscriber for excess payments made since September 1996. On December 30, 2003, PRTC filed its
answer to the complaint and requested dismissal on the grounds that the claim is not a legitimate
class action suit. On February 17, 2004, the plaintiffs filed their first set of interrogatories
and request for admissions to initiate discovery. A status conference was held on April 30, 2004 and the Superior Court ruled that at this
stage of the proceedings the discovery process would be addressed, but not limited to the
determination of the class. On June 28, 2004, a second hearing was held. During this hearing PRTC was ordered to submit
responses to the plaintiffs request for admissions and to their first and second sets of
interrogatories. PRTC submitted its responses to the plaintiffs request for admissions and to
their first and second sets of interrogatories on July 6 and July 16, 2004, respectively. However,
these responses were limited to the issue of class certifications, and the interrogatories and
requests for admissions relating to the merits of the case were objected to and a protective order
was requested. The Superior Court denied PRTCs requests and ordered full responses. On July 16,
2004, PRTC filed a writ of certiorari with the Puerto Rico Court of Appeals seeking reversal of the
Superior Courts order allowing discovery concerning the merits of the case before the class
certification issue is resolved. On October 13, 2004, plaintiffs filed a motion opposing PRTCs
writ of certiorari. On October 8, 2004, plaintiffs filed with the Superior Court a motion requesting the dismissal
and substitution of one of the plaintiffs. The PR Court of Appeals denied PRTCs writ of certiorari requesting the reversal of a Superior
Court order allowing unlimited discovery. PRTC had intended to limit discovery to the class
certification issue. On November 15, 2004, the Superior Court held an evidentiary hearing in order to determine if
this case will be certified as a class action. At the hearing, the Judge ordered PRTC to comply with the plaintiffs merits
discovery requests and PRTC has now done so. On May 9, 2005, the
Court issued a Resolution and Order certifying the class. PRTC
intends to appeal such Resolution and Order before the Circuit Court
of Appeals. 39




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CTI ASSET TRANSFER Prior to the Acquisition, PRTC transferred its net wireless assets on September 1, 1998 to CTI
(which became Verizon Wireless, a division of PRTC, on May 1, 2002). Our predecessors later filed
a waiver request in 1998 with the FCC to record this transfer at book value instead of fair value.
Since our predecessors had not included the costs of wireless operations in the regulated rate
setting process, we believe that ratepayers did not bear the cost of our predecessors wireless
investment. The FCC denied the Companys petition in April 2001, but recognized that while there were
questions concerning certain costs and expenses, the cellular and paging assets had been removed
from the interstate rate base. In the February 2002 Order, the TRB provided that any prospective rate increase must first be
applied against the gain from the wireless asset transfer, equating to $56 million applicable to
intrastate. We plan to contest this position on the grounds that the wireless entity was set up
after the last regulated intrastate rate increase in 1982 and therefore these costs were not
included in setting such rates. Currently, the TRB is performing an agreed upon procedures audit, which includes an audit of
the CTI asset transfer. The audit is in the field work stage. While we believe that the
resolution of this matter and any related proceedings will not have a material impact on the
Companys financial condition and results of operations, we cannot predict the effect of any
further regulatory actions. PRICE CAP REGULATION Under the FCCs all or nothing rule, telecommunications carriers that set interstate access
rates based on a price cap formula are required to use the price cap formula for all of their
affiliates. The price cap formula is based on a plan adopted by the FCC called the Coalition of
Affordable Local and Long Distance Service (CALLS), which uses rate-of-return as a basis for
setting rates. The Company would have been required to implement price caps by March 2, 2000 under
the FCCs rules. Prior to March 2, 2000, the Company had set its interstate access rates based on
rate-of-return principles. The FCC delayed conversion to price cap regulation until June 30, 2002, and the Company
requested an extension until June 30, 2003. Under an order issued by the FCC on April 18, 2002, the
Company is no longer required to file a waiver request until the FCC completes its review of the
all-or-nothing rule. In addition, upon the issuance of an Order and Second Further Notice of
Proposed Rulemaking (the Order) by the FCC on February 28, 2004, the FCC deferred further action
on the all-or-nothing rule until it reviews the record compiled in response to the further notice
included in the Order. Additionally, in the Order the FCC stated that all outstanding interim
waivers of the all-or-nothing rule that depend on the FCCs decision shall continue to be effective
until the FCC issues a final order on this matter. As a result, the Company currently continues to
set its interstate access rates based on rate-of-return principles. On May 10, 2004, PRTC filed comments in response to the Order, requesting that the FCC
eliminate the all or nothing rule or, in the alternative, if the rule is not eliminated, that the
FCC grant PRTCs 1999 waiver request to permit PRTC to remain a carrier that sets its interstate
access rates based on rate-of-return principles. The basis of PRTCs request is that if PRTC were
no longer eligible to receive Interstate Common Line Support (ICLS), PRTC would require $139
million in additional universal service support to offset lost ICLS revenues and that the CALLS
plan cannot accommodate PRTC since there is a $650 million cap on the equivalent support in the
CALLS plan, which was based on the anticipated universal service needs of price cap carriers that
were participating in the plan at the time of its adoption. There has been no announcement
regarding the expected timing for the completion of this proceeding. 40




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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS In this report, the Company has made forward-looking statements. These statements are based
on the Companys estimates and assumptions and are subject to certain risks and uncertainties.
Forward-looking statements include information concerning possible or assumed future results of
operations, as well as those statements preceded or followed by such words as anticipates,
believes, estimates, expects, hopes, targets or similar expressions. Future results could be affected by subsequent events and could differ materially from those
expressed in the forward-looking statements. If future events and actual performance differ from
the Companys assumptions, the actual results could vary significantly from the performance
projected in the forward-looking statements. The following important factors could affect future results and could cause those results to
differ materially from those expressed in the forward-looking statements: (1) materially adverse
changes in economic and industry conditions in Puerto Rico, and labor matters, including workforce
levels and labor negotiations, and any resulting financial and/or operational impact, in the
markets served by us; (2) material changes in available technology; (3) the final resolution of
regulatory initiatives and proceedings, including arbitration proceedings pertaining to, among
other matters, the terms of interconnection, access charges, universal service, unbundled network
elements and resale rates; (4) changes in our accounting policies that may be required by
regulatory agencies, including the Securities and Exchange Commission (SEC) or that result from
changes in the accounting policies or their application, which could result in an impact on
earnings; and (5) the extent, timing, success and overall effects of competition from others in the
Puerto Rico telecommunications service industry. Although the Company believes the expectations reflected in its forward-looking statements are
reasonable, the Company cannot guarantee its future performance or results of operations. All
forward-looking statements in this filing are based on information available to the Company on the
date of this filing; however, the Company is not obligated to update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise. The risks
described above and elsewhere in this report, including in Item 2, Managements Discussion and
Analysis of Financial Condition and Results of Operations, should be considered when reading any
forward-looking statements in this filing. Given these uncertainties and risks, the reader should
not place undue reliance on these forward-looking statements. CRITICAL ACCOUNTING POLICIES General The Companys discussion and analysis of its financial condition and results of operations are
based upon the Companys unaudited condensed consolidated financial statements, which have been
prepared in accordance with the U.S. generally accepted accounting principles for
interim financial information and the rules and regulations of the SEC. Certain information and
footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted
accounting principles for annual financial statements have
been condensed or omitted pursuant to such rules and regulations. The preparation of these financial statements requires the Company to make estimates and
judgments that affect the reported interim amounts of assets, liabilities, revenues and expenses,
and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company
evaluates its estimates, including those related to bad debts, intangible assets, income taxes,
financing operations, contingencies and litigation. The Company bases its estimates on historical
experience and on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions. The Company believes the following critical accounting policies affect its more significant
judgments and estimates used in the preparation of its condensed consolidated financial statements. 41




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Allowance for Doubtful Accounts The Company maintains allowances for doubtful accounts for estimated losses resulting from the
inability of its customers to make required payments. If the financial condition of the Companys
customers were to deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required. Because of uncertainties inherent in the estimation
process, the Companys estimate of losses and the related allowance may change. The Company does
not depend on any single customer for its business. Deferred Taxes The Company uses an asset and liability approach in accounting for income taxes following the
provisions of SFAS No. 109, Accounting for Income Taxes. Deferred tax assets and liabilities are
established for temporary differences between the way certain income and expense items are reported
for financial reporting and tax purposes. The Company records a valuation allowance to reduce its deferred tax assets to the amount that
is more likely than not to be realized. While the Company has considered future taxable income and
ongoing prudent and feasible tax planning strategies in assessing the need for the valuation
allowance, in the event the Company were to determine that it would be able to realize its deferred
tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax
asset would increase income in the period such determination was made. Likewise, should the Company
determine that it would not be able to realize all or part of its net deferred tax asset in the
future, an adjustment to the deferred tax asset would be charged to income in the period such
determination was made. As provided by law, the Puerto Rico Treasury Department is currently conducting an ordinary
audit of our corporate income tax returns. We do not expect the results of this audit to have a
material impact on the Companys financial condition and result of operations. Property, Plant and Equipment and Depreciation Property, plant and equipment is stated at original cost, including interest on funds borrowed
to finance the acquisition of capital additions. Repairs and maintenance are expensed as incurred.
Depreciable property disposed of in the ordinary course of business, less salvage value, is
charged to accumulated depreciation with no gain or loss recognized. Gains or losses from the sale
of land are recorded in results of operations. The Companys depreciation expense is based on the composite group remaining life method using
straight-line composite rates. This method provides for the recognition of the cost of the
remaining net investment in telephone plant over the remaining asset lives. This method also
requires a periodic evaluation of the average remaining useful lives related to the expected
recoverability of the carrying value of assets based on changes in technology, environmental
factors, the federal and local regulatory environment, industry and other competitive forces.
Effective July 2004, the Company revised its plant useful lives estimates based on a detailed
review of the lives underlying the depreciation rates. The depreciation rate revisions reflect
expected useful lives resulting from the impact of technology and future competition and more
closely approximate the assumptions used by other telephone companies. The revision resulted in a
decrease in depreciation expense by approximately $3.3 million for the year 2004. The Company revised the method to calculate the composite useful lives to be consistent with
the current depreciation study. RECENT ACCOUNTING PRONOUNCEMENTS For disclosure of recent accounting pronouncements, see Note 3 to our unaudited condensed
consolidated financial statements. 42




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK INTEREST RATE SENSITIVITY We are exposed to market risk in the normal course of business, resulting primarily from
interest rate changes on our senior notes and interest rate swap agreements. The following table summarizes the fair value of our senior notes and interest rate swap at
March 31, 2005 and December 31, 2004 and provides a sensitivity analysis of the fair values of
these instruments assuming a 100 basis point increase or decrease in the yield curve. The
sensitivity analysis does not include the fair values of our floating-rate debt since it is not
significantly affected by changes in market interest rates. Fair ValueAssuming 100 Basis PointBook Value
    
    
    Fair Value
    
    
    Increase
    
    
    Decrease(In thousands)March 31, 2005:Senior notes
    
    $
    699,887
    
    
    $
    733,520
    
    
    $
    717,838
    
    
    $
    749,769Interest rate swap
    
    
    
    
    
    
    
    
    
    
    (2,606
    )
    
    
    1,048Total
    
    $
    699,887
    
    
    $
    733,520
    
    
    $
    715,232
    
    
    $
    750,817December 31, 2004:Senior notes
    
    $
    699,876
    
    
    $
    735,790
    
    
    $
    718,569
    
    
    $
    753,663Interest rate swap
    
    
    3
    
    
    
    3
    
    
    
    (1,813
    )
    
    
    1,834Total
    
    $
    699,879
    
    
    $
    735,793
    
    
    $
    716,756
    
    
    $
    755,497
 43




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ITEM 4. CONTROLS AND PROCEDURES The Company maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) of the Securities Exchange Act of 1934, as amended) that are designed to ensure that
information required to be disclosed in the Companys reports is recorded, processed, summarized
and reported, within the time periods specified in the SECs rules and forms. In designing and
evaluating the Companys disclosure controls and procedures, the Companys Chief Executive Officer
and Chief Financial Officer recognized that any controls and procedures, no matter how
well-designed and operated, can provide only reasonable assurance of achieving the desired control
objectives. The Companys Chief Executive Officer and Chief Financial Officer have evaluated the
effectiveness of the Companys disclosure controls and procedures, as of the end of the period
covered by this report (the Evaluation Date). They have concluded that as of the Evaluation
Date, the Companys disclosure controls and procedures were effective at the reasonable assurance
level. There has been no change in the Companys internal control over financial reporting during the
Companys most recent fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the Companys internal control over financial reporting. 44




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PART II. OTHER INFORMATION 
 Item 1. Legal Proceedings The Company is a defendant in various legal matters arising in the ordinary course of
business. Management, after consultation with legal counsel, believes that the resolution of these
matters will not have a material adverse effect on the Companys financial position and results of
operations. See Part I, Item 2, Managements Discussion and Analysis of Financial Condition and
Results of Operations  Regulatory and Other Matters, which is incorporated herein by reference,
for more information regarding legal and regulatory matters, including a regulatory dispute
regarding intra-island access fees charged to long distance carriers. 
 Item 2. Changes in Securities and Use of Proceeds Not applicable. 
 Item 3. Defaults Upon Senior Securities Not applicable. 
 Item 4. Submission of Matters to a Vote of Security Holders Not applicable. 
 Item 5. Other Information Not applicable. 
 Item 6. Exhibits a) See Exhibit Index on page following signatures. 45




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. TELECOMUNICACIONES DE PUERTO RICO, INC. By:
    
    /s/ Cristina M. LambertName:
    
    Cristina M. LambertTitle:
    
    President and Chief Executive OfficerDate:
    
    May 16, 2005By:
    
    /s/ Adail OrtizName:
    
    Adail OrtizTitle:
    
    Vice President Finance and Chief Financial OfficerDate:
    
    
    
    May 16, 2005By:
    
    /s/ Raúl E. GarcíaName:
    
    Raúl E. GarcíaTitle:
    
    ControllerDate:
    
    May 16, 2005
 46




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EXHIBIT INDEX EXHIBITNUMBER
    
    DESCRIPTION3.1
    
    Certificate of Incorporation of Telecomunicaciones de Puerto
Rico, Inc. (Incorporated by reference to Exhibit 3.1 of the
Companys Registration Statement filed on Form S-4, as
amended (File 333-85503)).3.2
    
    Certificate of Amendment to the Certificate of Incorporation
of Telecomunicaciones de Puerto Rico, Inc. (Incorporated by
reference to Exhibit 3.2 of the Companys Annual Report on
Form 10-K for the year ended December 31, 1999 (File
333-85503)).3.3
    
    By-Laws of Telecomunicaciones de Puerto Rico, Inc.
(Incorporated by reference to Exhibit 3.4 of the Companys
Registration Statement filed on Form S-4, as amended (File
333-85503)).4.1
    
    Trust Indenture dated as of May 20, 1999 between
Telecomunicaciones de Puerto Rico, Inc. and The Bank of New
York. (Incorporated by reference to Exhibit 4.1 of the
Companys Registration Statement filed on Form S-4, as
amended (File 333-85503)).10.1
    
    Shareholders Agreement, dated as of March 2, 1999, by and
among Telecomunicaciones de Puerto Rico, Inc., GTE Holdings
(Puerto Rico) LLC, GTE International Telecommunications
Incorporated, Popular, Inc., Puerto Rico Telephone Authority
and the shareholders of Telecomunicaciones de Puerto Rico,
Inc., who shall from time to time be parties thereto as
provided therein. (Incorporated by reference to Exhibit 10.5
of the Companys Registration Statement filed on Form S-4, as
amended (File 333-85503)).10.2
    
    Non-Competition Agreement, dated as of March 2, 1999, by and
among Telecomunicaciones de Puerto Rico, Inc, GTE Holdings
(Puerto Rico) LLC, GTE International Telecommunications
Incorporated, Popular, Inc., Puerto Rico Telephone Authority,
and the Government Development Bank for Puerto Rico.
(Incorporated by reference to Exhibit 10.9 of the Companys
Registration Statement filed on Form S-4, as amended (File
333-85503)).10.3
    
    Trust Agreement of the Employee Stock Ownership Plan of
Telecomunicaciones de Puerto Rico, Inc., dated as of March 2,
1999, by and between U.S. Trust, National Association and
Telecomunicaciones de Puerto Rico, Inc. (Incorporated by
reference to Exhibit 10.12 of the Companys Registration
Statement filed on Form S-4, as amended (File 333-85503)).10.4
    
    ESOP Loan Agreement, dated as of March 2, 1999, by and
between the Trust of the Employee Stock Ownership Plan of
Telecomunicaciones de Puerto Rico, Inc. and
Telecomunicaciones de Puerto Rico, Inc. (Incorporated by
reference to Exhibit 10.13 of the Companys Registration
Statement filed on Form S-4, as amended (File 333-85503)).10.5
    
    Pledge Agreement, dated as of March 2, 1999, by and between
the Trust of the Employee Stock Ownership Plan of
Telecomunicaciones de Puerto Rico, Inc. and
Telecomunicaciones de Puerto Rico, Inc. (Incorporated by
reference to Exhibit 10.15 of the Companys Registration
Statement filed on Form S-4, as amended (File 333-85503)).10.6
    
    Tag Along Agreement, dated as of March 2, 1999, by and among
GTE Holdings (Puerto Rico) LLC, GTE International
Telecommunications Incorporated, and the Trust of the
Employee Stock Ownership Plan of Telecomunicaciones de Puerto
Rico, Inc. (Incorporated by reference to Exhibit 10.16 of
the Companys Registration Statement filed on Form S-4, as
amended (File 333-85503)).10.7
    
    Commercial Paper Dealer Agreement 4(2) Program among
Telecomunicaciones de Puerto Rico, Inc., as Issuer; Puerto
Rico Telephone Company, Inc. and Celulares Telefónica, Inc.,
as Guarantors; and Merrill Lynch Money Markets Inc., as
Dealer for notes with maturities up to 240 days; Merrill
Lynch, Pierce, Fenner & Smith Incorporated, as Dealer for
notes with maturities over 270 days up to 365 days.
Concerning notes to be issued pursuant to an Issuing and
Paying Agency Agreement dated as of November 9, 2000 between
the Issuer and The Chase Manhattan Bank, as Issuing and
Paying Agent. (Incorporated by reference to Exhibit 10.25 of
the Companys Annual Report on Form 10-K for the year ended
December 31, 2000 (File 333-85503)).
 47




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EXHIBITNUMBER
    
    DESCRIPTION10.8
    
    Commercial Paper Dealer Agreement 4(2) Program among
Telecomunicaciones de Puerto Rico, Inc., as Issuer; Puerto
Rico Telephone Company, Inc. and Celulares Telefónica, Inc.,
as Guarantors; and Salomon Smith Barney Inc., as Dealer.
Concerning notes to be issued pursuant to an Issuing and
Paying Agency Agreement dated as of November 9, 2000 between
the Issuer and The Chase Manhattan Bank, as Issuing and
Paying Agent. (Incorporated by reference to Exhibit 10.26
of the Companys Annual Report on Form 10-K for the year
ended December 31, 2000 (File 333-85503)).10.9
    
    Commercial Paper Dealer Agreement 4(2) Program among
Telecomunicaciones de Puerto Rico, Inc., as Issuer; Puerto
Rico Telephone Company, Inc. and Celulares Telefónica, Inc.,
as Guarantors; and Banc of America Securities LLC.
Concerning notes to be issued pursuant to an Issuing and
Paying Agency Agreement dated as of November 9, 2000 between
the Issuer and The Chase Manhattan Bank, as Issuing and
Paying Agent. (Incorporated by reference to Exhibit 10.27 of
the Companys Annual Report on Form 10-K for the year ended
December 31, 2000 (File 333-85503)).10.10
    
    Commercial Paper Dealer Agreement 4(2) Program among
Telecomunicaciones de Puerto Rico, Inc., as Issuer; Puerto
Rico Telephone Company, Inc. and Celulares Telefónica, Inc.,
as Guarantors; and Popular Securities, Inc., as Dealer for
notes with maturities up to 365 days. Concerning notes to be
issued pursuant to an Issuing and Paying Agency Agreement
dated as of November 9, 2000 between the Issuer and The Chase
Manhattan Bank, as Issuing and Paying Agent. (Incorporated
by reference to Exhibit 10.28 of the Companys Annual Report
on Form 10-K for the year ended December 31, 2000 (File
333-85503)).10.11
    
    Issuing and Paying Agency Agreement dated as of November 9,
2000, by and among Telecomunicaciones de Puerto Rico, Inc.,
as Issuer, Puerto Rico Telephone Company and Celulares
Telefónica, Inc., as Guarantors, and The Chase Manhattan
Bank, as Issuing and Paying Agent. (Incorporated by
reference to Exhibit 10.29 of the Companys Annual Report on
Form 10-K for the year ended December 31, 2000 (File
333-85503)).10.12
    
    Letter Amendment, to the March 2, 1999 Shareholders
Agreement, dated as of May 25, 2001, by and among
Telecomunicaciones de Puerto Rico, Inc., GTE Holdings (Puerto
Rico) LLC, GTE International Telecommunications Incorporated,
Popular, Inc., and the Puerto Rico Telephone Authority.
(Incorporated by reference to Exhibit 10.25 of the Companys
Quarterly Report on Form 10-Q for the period ended June 30,
2001 (File 333-85503)).10.13
    
    ISDA Master Agreement, dated August 29, 2001, by and among
Telecomunicaciones de Puerto Rico, Inc., as the Counterparty,
Puerto Rico Telephone Company and Celulares Telefónica, Inc.,
as Guarantors, and Bank of America, N.A., as the Bank.
(Incorporated by reference to Exhibit 10.27 of the Companys
Quarterly Report on Form 10-Q for the period ended September
31, 2001 (File 333-85503)).10.14
    
    ISDA Master Agreement, dated August 29, 2001, by and among
Telecomunicaciones de Puerto Rico, Inc., as the Counterparty,
Puerto Rico Telephone Company and Celulares Telefónica, Inc.,
as Guarantors, and Citibank, N.A., as the Bank.
(Incorporated by reference to Exhibit 10.28 of the Companys
Quarterly Report on Form 10-Q for the period ended September
31, 2001 (File 333-85503)).10.15
    
    $75,000,000 3-Year term credit agreement dated as of August
19, 2002, among Telecomunicaciones de Puerto Rico, Inc., as
Borrower, Puerto Rico Telephone Company, Inc., as Guarantor,
and The Bank of Nova Scotia, as Lender and Administrative
Agent. (Incorporated by reference to Exhibit 10.28 of the
Companys Quarterly Report on Form 10-Q for the period ended
September 30, 2002 (File 333-85503)).10.16
    
    Collective Bargaining Agreement between the Puerto Rico
Telephone Company and the Independent Union of Telephone
Employees of Puerto Rico effective from January 18, 2003
until January 17, 2006. Approved on February 13, 2003.
(Incorporated by reference to Exhibit 10.30 of the Companys
Annual Report on Form 10-K for the year ended December 31,
2002 (File 333-85503)).10.17
    
    Collective Bargaining Agreement between the Puerto Rico
Telephone Company and the Independent Brotherhood of
Telephone Company Employees effective from January 1, 2004
until December 31, 2008. Approved on April 15, 2004.
(Incorporated by reference to Exhibit 10.29 of the Companys
Quarterly Report on Form 10-Q for the quarter ended March 31,
2004 (File 333-85503)).
 48




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EXHIBITNUMBER
    
    DESCRIPTION10.18
    
    $40,000,000 working capital revolving credit agreement dated
as of June 30, 2004, among Telecomunicaciones de Puerto Rico,
Inc., as Borrower, Puerto Rico Telephone Company, Inc., as
Guarantor and Banco Popular de Puerto Rico, as Lender and
Administrative Agent. (Incorporated by reference to Exhibit
10.30 of the Companys Quarterly Report on Form 10-Q for the
quarter ended June 30, 2004 (File 333-85503)).10.19
    
    Collective Bargaining Agreement between the Puerto Rico
Telephone Company and the Independent Union of Telephone
Employees of Puerto Rico effective from January 18, 2003
until January 17, 2006. Approved on February 13, 2003.
English Version. (Incorporated by reference to Exhibit 10.31
of the Companys Quarterly Report on Form 10-Q for the
quarter ended June 30, 2004 (File 333-85503)).10.20
    
    Collective Bargaining Agreement between the Puerto Rico
Telephone Company and the Independent Brotherhood of
Telephone Company Employees effective from January 1, 2004
until December 31, 2008. Approved on April 15, 2004.
English Version. (Incorporated by reference to Exhibit 10.32
of the Companys Quarterly Report on Form 10-Q for the
quarter ended June 30, 2004 (File 333-85503)).10.21
    
    $30,000,000 1-Year term credit agreement dated as of May 17,
2004, among Telecomunicaciones de Puerto Rico, Inc., as
Borrower, Puerto Rico Telephone Company, Inc., as Guarantor
and Banco Bilbao Vizcaya Argentaria Puerto Rico, as
Administrative Agent. (Incorporated by reference to Exhibit
10.33 of the Companys Quarterly Report on Form 10-Q for the
quarter ended June 30, 2004 (File 333-85503)).10.22
    
    364-Day Credit Agreement dated as of March 1, 2005, among
Telecomunicaciones de Puerto Rico, Inc., as Borrower, Puerto
Rico Telephone Company, Inc., as Guarantor, the Initial
Lenders named therein, Citibank, N.A., as Administrative
Agent, Banco Bilbao Vizcaya Argentaria Puerto Rico and Bank
of Nova Scotia, as Syndication Agents, and Banco Popular de
Puerto Rico and Firstbank Puerto Rico, as Co-documentation
Agents. (Incorporated by reference to Exhibit 10.34 of the
Companys Annual Report on Form 10-K for the year ended
December 31, 2004 (File 333-85503)).31.1
    
    Certification of Principal Executive Officer (Filed herewith).31.2
    
    Certification of Principal Financial Officer (Filed herewith).32.1
    
    Certification Required by 18 U.S.C. Section 1350 as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002 (Filed herewith).
 49