Management’s Discussion and Analysis
of Financial Condition and Results of Operations
Verizon Communications Inc. (Verizon, or the Company), is one of the world’s leading providers of communications services. Our domestic wireless business, operating as Verizon Wireless, provides wireless voice and data products and services across the United States (U.S.) using one of the most extensive and reliable wireless networks. Our wireline business provides communications products and services, including voice, broadband data and video services, network access, long distance and other communications products and services, and also owns and operates one of the most expansive end-to-end global Internet Protocol (IP) networks. Stressing diversity and commitment to the communities in which we operate, we have a highly diverse workforce of approximately 222,900 employees.
In the sections that follow, we provide information about the important aspects of our operations and investments, both at the consolidated and segment levels, and discuss our results of operations, financial position and sources and uses of cash. In addition, we highlight 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 maker 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 the United States where the majority of our operations are located, in evaluating our operating results and assessing the potential impacts of these trends on our businesses. While most key economic indicators, including gross domestic product, affect our operations to some degree, we historically have noted higher correlations to non-farm employment, personal consumption expenditures and capital spending, as well as more general economic indicators such as inflationary or recessionary trends and housing starts.
Beginning in 2009, we changed the manner in which the Wireline segment reports Operating revenues to align our financial presentation to the continued evolution of the wireline business. Accordingly, there are four revenue-producing lines of business within the Wireline segment: Mass Markets, Global Enterprise, Global Wholesale and Other. Mass Markets includes consumer and small business revenues. Global Enterprise includes retail revenue from enterprise customers, both domestic and international. Global Wholesale includes wholesale revenues, both domestic and international, including switched and special access revenues, local wholesale and wholesale services from our global and IP networks. Other primarily includes operator services, payphone services and revenues from the former MCI mass markets customer base. In providing services to former MCI mass market customers, we principally use other carriers’ networks.
On May 13, 2009, we announced plans to spin off a newly formed subsidiary of Verizon (Spinco) to our stockholders. Spinco will hold defined assets and liabilities of the local exchange business and related landline activities of Verizon in Arizona, Idaho, Illinois, Indiana, Michigan, Nevada, North Carolina, Ohio, Oregon, South Carolina, Washington, West Virginia and Wisconsin, and in portions of California bordering Arizona, Nevada and Oregon, including Internet access and long distance services and broadband video provided to designated customers in those areas. Immediately following the spin-off, Spinco plans to merge with Frontier Communications Corporation (Frontier) pursuant to a definitive agreement with Frontier, and Frontier will be the surviving corporation. Consummation of the transactions contemplated in the agreements is subject to customary closing conditions. The merger will result in Frontier acquiring approximately 4 million access lines and certain related businesses from Verizon, which collectively generated annual revenues of approximately $4 billion for Verizon’s Wireline segment. The Company does not currently have plans to divest its remaining switched or special access lines.
Our results of operations, financial position and sources and uses of cash in the current and future periods reflect our focus on the following strategic imperatives:
Revenue Growth — To generate revenue growth we are devoting our resources to higher growth markets such as the wireless voice and data markets, the broadband and video markets, and the provision of strategic services to business markets, rather than to the traditional wireline voice market. During 2009, consolidated revenue growth was 10.7% compared to 2008, primarily due to the acquisition of Alltel Corporation (Alltel) in January 2009 and higher revenues in growth markets partially offset by lower revenue in the Wireline segment. We continue developing and marketing innovative product bundles to include local, long distance, wireless, broadband data and video services for consumer and general business retail customers. We anticipate that these efforts will help counter the effects of competition and technology substitution that have resulted in access line losses, and will enable us to continue to grow consolidated revenues.
Market Share Gains — In our wireless business, our goal is to continue to be the market leader in providing wireless voice and data communication services in the U.S. We are focused on providing the highest network reliability and innovative products and services such as Mobile Broadband and our Evolution-Data Optimized (EV-DO) service. We also continue to expand our wireless data, messaging and multi-media offerings for both consumer and business customers. With our acquisition of Alltel, we became the largest wireless provider in the U.S. as measured by the total number of customers and revenues. In our wireline business, our goal is to become the leading broadband provider in every market in which we operate. During 2009, as compared to 2008:
- Domestic Wireless total customers increased 26.6% to 91.2 million as of December 31, 2009, primarily due to the acquisition of Alltel;
- average revenue per customer per month (ARPU) from service revenues decreased by 1.6% to $50.77, primarily due to the inclusion of customers acquired in connection with the acquisition of Alltel; and
- total data ARPU grew by 17.9% to $15.20 due to increased use of Mobile Broadband, e-mail and messaging.
As of December 31, 2009, we passed 15.4 million premises with our high-capacity fiber optics network operated under the FiOS service mark.
During 2009, at Wireline:
- total broadband and video revenues exceeded $6 billion;
- we added 547,000 net wireline broadband connections, including 952,000 net new FiOS Internet subscribers, for a total of 9.2 million connections, including 3.4 million FiOS Internet subscribers; and
- we added approximately 943,000 net new FiOS TV subscribers, for a total of 2.9 million FiOS TV subscribers.
With FiOS, we have created the opportunity to increase revenue per customer as well as improve profitability as the traditional fixed-line telephone business continues to decline due to customer migration to wireless, cable and other newer technologies.
We are also focused on gaining market share in the enterprise business through the deployment of strategic service offerings – including expansion of our VoIP and international Ethernet capabilities, the introduction of video and web-based conferencing capabilities, and enhancements to our virtual private network portfolio. In 2009, revenues from total strategic services grew 4.3% compared to 2008 led by sales of IP data services.
Profitability Improvement — Our goal is to increase operating income and margins. While our wireless, FiOS and IP services offerings continue to positively impact operating results, economic and secular conditions continue to affect parts of our wireline business, which we expect to continue into 2010. Specifically, business customers continue to be adversely affected by the economy, including delaying decision-making regarding spending on information technology and customer premises equipment. The cumulative effect of unemployment is impacting usage volumes, which is pressuring our margins. In addition, higher costs related to severance, pension and benefit charges and merger integration activities also negatively impacted our operating results. However, we remain focused on cost controls with the objective of reducing expenses to offset lower revenue.
Operational Efficiency — While focusing resources on revenue growth and market share gains, we are continually challenging our management team to lower expenses, particularly through technology-assisted productivity improvements, including self-service initiatives. The effect of these and other efforts, such as real estate consolidation and call center routing improvements, has led to changes in our cost structure with a goal of maintaining and improving operating income margins. Through our deployment of the FiOS network, we expect to realize savings annually in our ongoing operating expenses as a result of efficiencies gained from fiber network facilities. As the deployment of the FiOS network continues and installation and automation improvements occur, average costs per home connected have begun to decline. In addition, the integration of Alltel’s operations will continue, and we believe that the use of the same technology platform is facilitating the integration of Alltel’s operations with ours.
Customer Service — Our goal is to be the leading company in customer service in every market we serve. We view superior product offerings and customer service experiences as a competitive differentiator and a catalyst to growing revenues and gaining market share. We are committed to providing high-quality customer service and continually monitor customer satisfaction in all facets of our business. We believe that we have the most loyal customer base of any wireless service provider in the United States, as measured by customer churn.
Performance-Based Culture — We embrace a culture of accountability, based on individual and team objectives that are performance-based and tied to Verizon’s strategic imperatives. Key objectives of our compensation programs are pay-for-performance and the alignment of executives’ and shareowners’ long-term interests. We also employ a highly diverse workforce, since respect for diversity is an integral part of Verizon’s culture and a critical element of our competitive success.
We expect that competition will continue to intensify with traditional, non-traditional and emerging service providers seeking increased market share. We believe that our networks differentiate us from our competitors, enabling us to provide enhanced communications experiences to our customers. We believe our focus on the fundamentals of running a good business, including operating excellence and financial discipline, gives us the ability to plan and manage through changing economic conditions. We will continue to invest for growth, which we believe is the key to creating value for our shareowners.
Customer and Operating Trends
We expect to achieve revenue and segment operating income growth in our Domestic Wireless segment by continuing to attract and maintain the loyalty of high-quality retail postpaid customers, capitalizing on customer demand for data services, and bringing our customers new ways of using wireless services in their daily lives. We expect that future customer growth may slow as a result of higher wireless market penetration that is driving increased competition for customers within the wireless industry on the basis of price, service quality and data service offerings. We recently launched a simplified pricing structure for both voice and data plans that we believe will drive increased penetration of data bundles as well as attract and retain higher value customers, while keeping our pricing within a reasonable competitive range versus our competitors. Although we have experienced increases in our churn, the rate at which customers disconnect individual lines of service, primarily as a result of economic conditions, we expect that the combination of improvements in economic conditions as well as these recent pricing structure changes will result in higher customer retention. We expect future growth opportunities will become more dependent on expanding both the number and penetration of our wireless data offerings, offering innovative wireless devices for both consumer and business customers, and increasing the number of ways that our customers can connect with our network and services
In recent years, we have experienced continuing access line losses in our Wireline segment as customers have disconnected both primary and secondary lines and switched to alternative technologies, such as wireless, VoIP and cable for voice and data services. We expect to continue to experience access line losses as customers continue to switch to alternate technologies.
Despite this challenging environment, we expect that aspects of our business will continue to grow by providing superior network reliability as we continue to offer innovative product bundles that include high-speed Internet access, digital television and local and long distance voice services and offering more robust IP products and services. Our FiOS TV subscribers grew by 943,000 and 975,000 in 2009 and 2008, respectively, and we achieved penetration rates of 24.5% and 20.8% for 2009 and 2008, respectively. We will continue to focus on cost efficiencies to attempt to offset adverse impacts from unfavorable economic conditions and secular changes.
We expect to experience service revenue growth in our Domestic Wireless segment, primarily as a result of data revenue growth driven by increased use of data services such as messaging, e-mail and Internet access. However, during 2009, we began to experience sequential declines in our overall wireless voice revenue, as any increases as a result of new customer additions were offset by lower voice revenues per customer due to factors such as the popularity of bundled plans and an increase in the number of customers on our Family Share Plan as a result of customers seeking to optimize the value they derive from our offerings. We expect that our future service revenue growth will be substantially derived from data revenue growth as we continue to expand our wireless data offerings on our third generation (3G), and starting in 2010, our fourth generation (4G) wireless network and increase our sales and usage of innovative wireless multimedia and smartphone devices, such as the Motorola Droid. We also expect that recently announced changes in our pricing structure will contribute to service revenue growth by increasing data penetration and attracting customers. We believe the economic conditions in 2009 adversely impacted our customers’ ability and desire to maintain both wireline and wireless services.
As we continue the rollout of FiOS, we expect it to positively impact our Mass Market revenues and subscriber base, but we expect to continue to experience declining revenues in our Wireline segment primarily due to access line losses as a result of wireless substitution, current economic conditions and the transaction with Frontier described above.
Operating Costs and Expenses
Although our overall operating costs and expenses increased in 2009 as a result of the acquisition of Alltel, we expect to realize further synergies in 2010 as we continue the integration of Alltel’s operations. Additionally, complementary technology standards will facilitate the continuing integration of Alltel’s network operations, resulting in reduced costs to operate our network. We expect to continue to achieve reduced advertising expense as a result of completing the conversion of the retained Alltel customers to the Verizon Wireless brand, and to eliminate duplicate overhead, facility and headcount expenses. We anticipate that labor costs will decrease in our Wireline segment as a result of headcount reductions which will be partially offset by increased content costs for video in our growth businesses. We also expect earnings will be negatively affected by non-cash pension and retiree benefit costs in 2010.
Our 2010 capital program includes capital to fund the introduction of advanced networks and services, including FiOS and LTE, the continued expansion of our core networks, including our IP and wireless EV-DO networks, integration activities, maintenance and support for our legacy voice networks and other expenditures. During 2009, we continued to develop our wireless LTE network, which we intend to deploy in 25 to 30 markets in 2010 and to cover substantially all of the United States by the end of 2013. The amount and the timing of the Company’s capital expenditures within these broad categories can vary significantly as a result of a variety of factors outside our control, including, for example, accelerations or delays in obtaining franchises or material weather events. We are not subject to any agreement that would constrain our ability to control our capital expenditures by requiring material capital expenditures on a designated schedule or upon the occurrence of designated events. Capital expenditures declined in 2009 compared to 2008. We believe that we have sufficient discretion over the amount and timing of our capital expenditures on a company-wide basis that we can reasonably expect to have capital expenditures in the range of $16.8 billion to $17.2 billion in 2010. Additionally, we plan to substantially complete the FiOS deployment program by the end of 2010.
Cash Flow from Operations
We create value for our shareowners by investing the cash flows generated by our business in opportunities and transactions that support our strategic imperatives, thereby increasing customer satisfaction and usage of our products and services. In addition, we use our cash flows to maintain and grow our dividend payout to shareowners. Verizon’s Board of Directors increased the Company’s quarterly dividend 3.3% during 2009. This is the third consecutive year in which we have raised our dividend, reflecting the strength of our cash flow and balance sheet. Net cash provided by operating activities for the year ended December 31, 2009 of $31.6 billion increased by $4.0 billion from $27.6 billion for the year ended December 31, 2008.
We do not currently expect that legislative efforts relating to climate control will have a material adverse impact on our consolidated financial results or financial condition. We believe there may be opportunities for companies to increase their use of communications services, including those we provide, in order to minimize the environmental impact of their businesses.