Management’s Discussion and Analysis
of Financial Condition and Results of Operations

CONSOLIDATED FINANCIAL CONDITION (1 OF 2)

(dollars in millions)

Years Ended December 31,

2008

 

2007

 

2006

 

Cash Flows Provided By (Used In)

Operating Activities:

Continuing operations

$

26,620

 

$

26,309

 

$

23,030

 

Discontinued operations

 

 

 

(570

)

 

1,076

 

Investing Activities:

 

 

 

 

 

 

 

 

 

Continuing operations

 

(31,579

)

 

(16,865

)

 

(17,422

)

Discontinued operations

 

 

 

757

 

 

1,806

 

Financing activities:

 

 

 

 

 

 

 

 

 

Continuing operations

 

13,588

 

 

(11,697

)

 

(5,752

)

Discontinued operations

 

 

 

 

 

(279

)

Increase (Decrease) In Cash and Cash Equivalents

$

8,629

 

$

(2,066

)

$

2,459

 

We use the net cash generated from our operations to fund network expansion and modernization, repay external financing, pay dividends, purchase Verizon common stock for treasury and invest in new businesses. Additional external financing is obtained when necessary. While our current liabilities typically exceed current assets, our sources of funds, primarily from operations and, to the extent necessary, from readily available external financing arrangements, are sufficient to meet ongoing operating and investing requirements. We expect that capital spending requirements will continue to be financed primarily through internally generated funds. Additional debt or equity financing may be needed to fund additional development activities or to maintain our capital structure to ensure our financial flexibility.

Although conditions in the credit markets through December 31, 2008 did not have a significant impact on our ability to obtain financing, such conditions resulted in higher fixed interest rates on borrowings than those we have paid in recent years. The recent disruption in the global financial markets has also affected some of the financial institutions with which we do business. A continuing sustained decline in the stability of financial institutions could affect our access to financing. We completed $21.9 billion of new financing in 2008, including the issuance of $9.2 billion of new notes during the fourth quarter of 2008. As of December 31, 2008, more than two-thirds in aggregate principal amount of our total debt portfolio consisted of fixed rate indebtedness (including the effect of all interest rate swap agreements on our debt portfolio). Furthermore, we have had, and continue to have, access to the commercial paper markets, although we were required during a brief period of time in the third quarter of 2008 to pay interest rates on our commercial paper that were significantly higher than the rates we have paid in recent years. If the national or global economy or credit market conditions in general were to deteriorate further, it is possible that such changes could adversely affect our cash flows through increased interest costs or our ability to obtain external financing or to refinance our existing indebtedness.


Cash Flows Provided By (Used In) Operating Activities

Our primary source of funds continues to be cash generated from operations. Net cash provided by operating activities – continuing operations in 2008 increased $0.3 billion, compared to 2007, primarily due to higher earnings, partially offset by lower dividends received from Vodafone Omnitel. The increase in Net cash provided by operating activities – continuing operations in 2007, compared to 2006, was primarily due to the distributions from Vodafone Omnitel and CANTV, increased operating cash flows from Domestic Wireless and lower interest payments on outstanding debt, partially offset by changes in working capital.

The net changes in cash flow from operating activities – discontinued operations for the periods presented were primarily due to income taxes paid in 2007 related to the fourth quarter 2006 disposition of Verizon Dominicana, as well as the disposal of the discontinued operations in the fourth quarter of 2006.


Cash Flows Provided By (Used In) Investing Activities

Capital expenditures continue to be our primary use of cash flows from operations, as they facilitate the introduction of new products and services, enhance responsiveness to competitive challenges and increase the operating efficiency and productivity of our networks. Capital spending at Domestic Wireless represents our continuing effort to invest in this high growth business. We invested $6.5 billion in our Domestic Wireless business in 2008, compared to $6.5 billion and $6.6 billion in 2007 and 2006, respectively. We invested $9.8 billion in our Wireline business in 2008, compared to $11.0 billion and $10.3 billion in 2007 and 2006, respectively.

In 2008, we invested $15.9 billion in acquisitions and investments in businesses and wireless licenses. We invested $9.4 billion to acquire twenty-five 12 MHz licenses in the A block, seventy-seven 12 MHz licenses in the B Block and seven 22 MHz (nationwide, except Alaska) licenses in the C block resulting from participation in the FCC’s Auction 73. On August 7, 2008, Verizon Wireless completed its acquisition of Rural Cellular for cash consideration of $0.9 billion, net of cash acquired after an exchange transaction with another carrier to complete the required divestiture of certain markets. In connection with the Alltel transaction, Verizon Wireless purchased from third parties approximately $5.0 billion aggregate principal amount of debt obligations of certain subsidiaries of Alltel for approximately $4.8 billion plus accrued and unpaid interest. On January 9, 2009, Verizon Wireless paid approximately $5.9 billion for the equity of Alltel (see “Recent Developments”). In 2007, we paid $0.4 billion, net of cash received, to acquire a network security business and $0.2 billion to purchase several wireless properties and licenses. In 2006, we invested $1.4 billion in acquisitions and investments in businesses, including $2.8 billion to acquire thirteen 20 MHz licenses in connection with the FCC Advanced Wireless Services auction, as well as the acquisition of other wireless properties. This was offset by MCI’s cash balances of $2.4 billion we acquired at the date of the merger.

Our short-term investments include cash equivalents held in trust accounts for payment of employee benefits. In 2008, we decreased our annual trust funding to $0.1 billion, which is included in Short-term investments in the consolidated balance sheets. In 2007 and 2006, we invested $1.7 billion and $1.9 billion, respectively, in short-term investments, primarily to pre-fund active employees’ health and welfare benefits. Proceeds from the sales of all short-term investments, principally for the payment of these benefits, were $1.8 billion, $1.9 billion and $2.2 billion in the years 2008, 2007 and 2006, respectively.

Other, net investing activities in 2008 primarily include cash proceeds of $0.3 billion from the sale of properties and sale of select non-strategic assets, a cash payment of $0.2 billion in connection with the settlement of foreign currency forward contracts and $0.1 billion receivable from a money market fund managed by a third party, which is in the process of being liquidated and returned to Verizon. Other, net investing activities in 2007 primarily included cash proceeds of $0.8 billion from property sales and sales of select non-strategic assets, as well as $0.5 billion from the disposition of our interest in CANTV. Other, net investing activities in 2006 primarily included cash proceeds of $0.3 billion from property sales.

In 2007, investing activities of discontinued operations primarily included gross proceeds of approximately $1.0 billion in connection with the sale of our investment in TELPRI. In 2006, investing activities of discontinued operations included net pretax cash proceeds of $2.0 billion in connection with the sale of Verizon Dominicana.


Cash Flows Provided By (Used In) Financing Activities

During 2008, net cash provided by financing activities was $13.6 billion, compared with the net cash used in financing activities of $11.7 billion in 2007. Proceeds from borrowings during 2008 were approximately $24.0 billion. Cash flow used in financing activities primarily included net debt repayments of $4.1 billion, dividend payments of $5.0 billion, and purchases of Verizon common stock for treasury of $1.4 billion.

Our total debt increased by $20.8 billion in 2008. Verizon Communications issued $11.5 billion of fixed rate debt with varying maturities. Domestic Wireless issued $10.4 billion of debt for the purchase of Alltel’s debt obligations acquired in the second quarter, the purchase of Rural Cellular and subsequent repayment of Rural Cellular debt, and to raise cash to finance a portion of the purchase price of the Alltel acquisition which closed on January 9, 2009. Partially offsetting the increase in total debt, including an increase in commercial paper outstanding, was the repayment of $4.1 billion of term debt.

In November 2008, Verizon issued $2.0 billion of 8.75% notes due 2018 and $1.3 billion of 8.95% notes due 2039, which resulted in cash proceeds of $3.2 billion net of discount and issuance costs. In April 2008, Verizon issued $1.3 billion of 5.25% notes due 2013, $1.5 billion of 6.10% notes due 2018, and $1.3 billion of 6.90% notes due 2038, resulting in cash proceeds of $4.0 billion, net of discounts and issuance costs. In February 2008, Verizon issued $0.8 billion of 4.35% notes due 2013, $1.5 billion of 5.50% notes due 2018, and $1.8 billion of 6.40% notes due 2038, resulting in cash proceeds of $4.0 billion, net of discounts and issuance costs. In January 2008, Verizon utilized a $0.2 billion fixed rate vendor financing facility due 2010.

Verizon Wireless’s financing activities included:

  • On December 19, 2008, Verizon Wireless and Verizon Wireless Capital LLC as the borrowers, entered into a $17.0 billion credit facility (Bridge Facility) in order to complete the acquisition of Alltel and repay certain of Alltel’s outstanding debt. On December 31, 2008, the Bridge Facility was reduced to $12.5 billion. On January 9, 2009, Verizon Wireless borrowed $12.4 billion under the Bridge Facility and the unused commitments under the Bridge Facility were terminated. The Bridge Facility has a maturity date of January 8, 2010. Interest on borrowings under the Bridge Facility is calculated based on the London Interbank Offered Rate (LIBOR) for the applicable period, the level of borrowings on specified dates and a margin that is determined by reference to our long-term credit rating issued by Standard and Poor’s Rating Service (S&P). If the aggregate outstanding principal amount under the Bridge Facility is greater than $6.0 billion on July 8, 2009 (the 180th day after the closing date of the Alltel acquisition), we are required to repay $3.0 billion on that date (less the amount of specified mandatory or optional prepayments that have been made as of that date). The remaining aggregate outstanding principal amount must be repaid on the maturity date. We expect to refinance or repay the borrowings under the Bridge Facility within the next 12 months by utilizing a combination of internally generated free cash flows, net proceeds from the required disposition of assets in connection with the Alltel acquisition and new borrowings.
  • In December 2008, Verizon Wireless obtained net proceeds of $2.4 billion from the issuance of €0.7 billion of 7.625% notes due 2011, €0.5 billion of 8.750% notes due 2015 and £0.6 billion of 8.875% notes due 2018. Concurrent with the borrowings, Verizon Wireless entered into cross currency swaps primarily to exchange the proceeds from British Pound Sterling and Euros into U.S. dollars and fix its future interest and principal payments in U.S. dollars. As a result of these swaps, Verizon Wireless exchanged the aggregate principal amounts for cash proceeds of $2.4 billion, which were used to finance a portion of the purchase price of the Alltel acquisition on January 9, 2009.
  • In November 2008, Verizon Wireless obtained proceeds of $3.5 billion, net of discounts and issuance costs, from the issuance in a private placement of $1.3 billion of 7.375% notes due November 2013 and $2.3 billion of 8.500% notes due November 2018.
  • On September 30, 2008, Verizon Wireless and Verizon Wireless Capital LLC entered into a $4.4 billion Three-Year Term Loan Facility Agreement (Three-Year Term Facility) with Citibank, N.A., as Administrative Agent, with a maturity date of September 30, 2011. Verizon Wireless borrowed $4.4 billion under the Three-Year Term Facility in order to repay a portion of the 364-Day Credit Agreement as described below. Of the $4.4 billion, $0.4 billion must be repaid at the end of the first year, $2.0 billion at the end of the second year, and $2.0 billion upon final maturity. Interest on borrowings under the Three-Year Term Facility is calculated based on the LIBOR rate for the applicable period and a margin that is determined by reference to the long-term credit rating of Verizon Wireless issued by S&P and Moody’s Investors Service (if Moody’s subsequently determines to provide a credit rating for the Three-Year Term Facility). Borrowings under the Three-Year Term Facility currently bear interest at a variable rate based on LIBOR plus 100 basis points. The Three-Year Term Facility includes a requirement to maintain a certain leverage ratio.
  • On June 5, 2008, Verizon Wireless entered into a $7.6 billion 364-Day Credit Agreement with Morgan Stanley Senior Funding Inc. as Administrative Agent, which included a $4.8 billion term facility and a $2.8 billion delayed draw facility. On June 10, 2008, Verizon Wireless borrowed $4.8 billion under the 364-Day Credit Agreement in order to purchase the Alltel debt obligations acquired in the second quarter and, during the third quarter, borrowed $2.8 billion under the delayed draw facility to complete the purchase of Rural Cellular and to repay Rural Cellular’s debt and pay fees and expenses incurred in connection therewith. During 2008, $4.4 billion of the 364-Day Credit Agreement was repaid using proceeds from the Three-Year Term Loan Facility; the remainder of the borrowings under the 364-Day Credit Agreement was also repaid during 2008.
  • On February 4, 2009, Verizon Wireless and Verizon Wireless Capital LLC co-issued in a private placement $3.5 billion of 5.55% notes due 2014 and $0.8 billion of 5.25% notes due 2012, resulting in cash proceeds of $4.2 billion, net of discounts and issuance costs. Verizon Wireless will use the net proceeds from the sale of these notes to repay a portion of the borrowings outstanding under the Bridge Facility described above.

As of December 31, 2008, we had current assets of $26.1 billion, including cash and cash equivalents of $9.8 billion and short-term investments of $0.5 billion. Our current liabilities of $25.9 billion included debt maturing within one year of $5.0 billion.

Historically, we fund our operations primarily with cash from operations, cash on hand, and access to the commercial paper markets. However, if the economic conditions should worsen or we do not maintain our cash flows from operations, we could see a negative impact on our liquidity in 2009. We believe we can meet our debt service requirements in the next twelve months as we expect to continue to generate free cash flow and maintain access to the commercial paper markets.

As of December 31, 2008, we had approximately $5.6 billion of unused bank lines of credit consisting of a three-year committed facility that expires in September 2009. We also entered into a vendor provided credit facility that provided $0.2 billion of financing capacity. We have a shelf registration available for the issuance of up to $6.8 billion of additional unsecured debt or equity securities.

In addition to the repayments of the $7.6 billion 364-Day Credit Agreement, we made other debt repayments of approximately $4.1 billion in 2008, including $0.2 billion of 5.55% notes issued by Verizon Northwest Inc.,
$0.1 billion of 6.0% notes issued by Verizon South Inc., $0.3 billion of 6.0% notes issued by Verizon New York, $0.1 billion of 7.0% notes issued by Verizon California Inc., $0.3 billion of 6.9% notes issued by Verizon North Inc., $0.3 billion of 5.65% notes issued by Verizon North Inc., and $3.0 billion of other corporate borrowings, which included the repayment of Rural Cellular’s debt and $1.0 billion of Verizon Communications Inc. 4.0% notes. As a result of the spin-off of our local exchange business and related activities in Maine, New Hampshire and Vermont, in March 2008, our net debt was reduced by approximately $1.4 billion.

Our total debt was reduced by $5.2 billion in 2007. We repaid approximately $1.7 billion of Wireline debt, including the early repayment of previously guaranteed $0.3 billion 7.0% debentures issued by Verizon South Inc. and $0.5 billion 7.0% debentures issued by Verizon New England Inc., as well as approximately $1.6 billion of other borrowings. Also, we redeemed $1.6 billion principal of our outstanding floating rate notes, which were called on January 8, 2007, and the $0.5 billion 7.9% debentures issued by GTE Corporation. Partially offsetting the reduction in total debt were cash proceeds of $3.4 billion in connection with fixed and floating rate debt issued during 2007.

Cash of $1.9 billion was used to reduce our debt in 2006. We repaid $6.8 billion of Wireline debt, including premiums associated with the retirement of $5.7 billion of aggregate principal amount of long-term debt assumed in connection with the MCI merger. The Wireline repayments also included the early retirement/prepayment of $0.7 billion of long-term debt and $0.2 billion of other long-term debt at maturity. We repaid approximately $2.5 billion of Domestic Wireless 5.375% fixed rate notes that matured on December 15, 2006. Also, we redeemed the $1.4 billion accreted principal of our remaining zero-coupon convertible notes and retired $0.5 billion of other corporate long-term debt at maturity. These repayments were partially offset by our issuance of long-term debt resulting in cash proceeds of approximately $4.0 billion, net of discounts, issuance costs and the receipt of cash proceeds related to hedges on the interest rate of an anticipated financing. In connection with the spin-off of our domestic print and Internet yellow pages directories business, we received net cash proceeds of approximately $2.0 billion and retired debt in the aggregate principal amount of approximately $7.1 billion.

Our ratio of debt to debt combined with shareowners’ equity was 55.5% at December 31, 2008 compared to 38.1% at December 31, 2007.

The amount of cash that we need to service our debt substantially increased with the acquisition of Alltel. Our ability to make payments on our debt will depend largely upon our cash balances and future operating performance. While we anticipate the challenging credit environment to continue in 2009, we do not expect this to have a material impact on our ability to obtain financing due to our investment grade ratings which we expect to maintain. The debt securities of Verizon Communications and its subsidiaries continue to be accorded high ratings by the three primary rating agencies.

S&P assigns an ‘A’ Corporate Credit Rating and an ‘A-1’ short-term debt rating to Verizon Communications. In early June 2008 S&P revised its outlook on Verizon’s ratings to negative from stable following the announcement of the agreement to acquire Alltel. At the same time, S&P affirmed all Verizon’s ratings, including its ‘A’ Corporate Credit Rating, ‘A-1’ short-term rating and the ‘A’ Corporate Credit Rating on Cellco Partnership (d/b/a Verizon Wireless). In November 2008 S&P affirmed the ‘A’ Corporate Credit Rating with a negative outlook on Cellco Partnership and Verizon Communications.

Moody’s Investors Service (Moody’s) assigns an ‘A3’ long-term debt rating and a ‘P-2’ short-term debt rating to Verizon Communications. In June 2008 Moody’s placed Verizon on “Review for Possible Downgrade” following the announcement of the agreement to acquire Alltel. In October 2008 Moody’s concluded its review and revised the outlook on Verizon Communication’s ratings from stable to negative. The ‘P-2’ short-term rating was affirmed. In November 2008 Moody’s initiated a Cellco Partnership (d/b/a Verizon Wireless) long-term debt rating of ‘A2’ with a negative outlook.

Fitch Ratings (Fitch) assigns an ‘A’ long-term Issuer Default Rating and an ‘F1’ short-term rating with stable outlook to Verizon Communications. In June 2008 Fitch placed Verizon Communications on “Rating Watch Negative” following the announcement of the Alltel acquisition. In November 2008 Fitch downgraded the long-term debt rating of Verizon to ‘A’ from ‘A+’ with a stable outlook, affirmed the ‘F1’ short-term rating and removed Verizon’s ratings from “Rating Watch Negative”. In that same action, Fitch initiated a Cellco Partnership (d/b/a Verizon Wireless) rating at ‘A’ with a stable outlook.

While we do not anticipate a ratings downgrade, the three primary rating agencies have identified factors which they believe could result in a ratings downgrade for Verizon Communications and/or Cellco Partnership in the future including sustained leverage levels at Verizon Communications and/or Cellco Partnership resulting from: (i) diminished wireless operating performance as a result of a weakening economy and competitive pressures; (ii) failure to achieve significant synergies in the Alltel integration; (iii) accelerated wireline losses; or (iv) a material acquisition or sale of operations that causes a material deterioration in its credit metrics. A ratings downgrade would increase the cost of refinancing existing debt and might constrain Verizon Communications’ access to certain short-term debt markets.

Both the Verizon Wireless Three-Year Term Credit Facility and $12.5 billion Bridge Facility contain covenants including a Leverage Ratio of 3.25:1 as defined in the agreement. Each also contains events of default that are customary for companies maintaining an investment grade credit rating. As of December 31, 2008, we and our consolidated subsidiaries were in compliance with all of our debt covenants.

Common stock has been used from time to time to satisfy some of the funding requirements of employee and shareowner plans. On February 7, 2008, the Board of Directors replaced the current share buy back program with a new program for the repurchase of up to 100 million common shares terminating no later than the close of business on February 28, 2011. The Board also determined that no additional shares were to be purchased under the prior program. We repurchased $1.4 billion, $2.8 billion and $1.7 billion of our common stock during 2008, 2007 and 2006, respectively.

As in prior periods, dividend payments were a significant use of cash flows from operations in 2008. We determine the appropriateness of the level of our dividend payments on a periodic basis by considering such factors as long-term growth opportunities, internal cash requirements and the expectations of our shareowners. During the third quarter of 2008, Verizon’s Board of Directors increased the Company’s quarterly dividend payments 7.0% to $.460 per share from $.430 per share in 2007, with a goal of moving to an annual dividend increase model. In the third quarter of 2007, we increased our dividend payments 6.2% to $.430 per share from $.405 per share in the first two quarters of 2007.