VZ

Business Context and Reporting Period

This Form 10-Q covers Verizon Communications Inc. for the quarterly period ended September 30, 2006. The reporting period reflects the full integration of the MCI merger, which closed on January 6, 2006. Consequently, the company now reports three primary segments: Wireline (including former MCI operations), Domestic Wireless, and Information Services. International operations in the Caribbean and Latin America (Verizon Dominicana and TELPRI) are classified as discontinued operations pending sale.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Consolidated revenues increased 25.8% in the third quarter and 25.4% year-to-date compared to 2005. This growth was primarily driven by the inclusion of MCI revenues in the Wireline segment and strong performance in Domestic Wireless.
• Wireline Segment: Revenues surged 35.5% in the quarter due to the MCI acquisition. However, legacy wireline access lines declined 7.5% due to technology substitution (wireless and VoIP), while broadband connections grew 45.1%.
• Domestic Wireless: Revenues grew 18.2% in the quarter. The customer base reached 56.7 million (up 15.1% year-over-year), with data revenues increasing 95.3%.
• Net Income: While revenues grew significantly, Net Income for the nine months ended September 30, 2006, decreased 10% to $5.165 billion compared to $5.739 billion in 2005. This was impacted by higher operating expenses, increased minority interest (due to Wireless earnings), and special charges.
• Special Charges: The company recorded significant non-recurring charges in 2006, including $300 million for employee severance, $157 million for MCI merger integration, and $138 million for facility relocation costs.

Guidance, Outlook, and Risks

• Capital Expenditures: Management expects full-year 2006 capital expenditures to range between $17.0 billion and $17.4 billion, focusing on FiOS deployment and wireless network expansion.
• Spectrum Acquisition: Verizon Wireless won 13 licenses in the FCC's Advanced Wireless Services (AWS) auction for $2.809 billion, with payment completed in October 2006.
• Strategic Dispositions:
  • Information Services Spin-off: The Board approved the spin-off of the U.S. print and Internet yellow pages business into a new company, Idearc Inc., expected to occur in November 2006. This is expected to reduce Verizon's debt by approximately $7 billion and generate $2 billion in cash.
  • International Sales: Agreements are in place to sell Verizon Dominicana and TELPRI to América Móvil, with closing expected in 2006 or 2007 pending regulatory approval.
• Accounting Changes: Adoption of SFAS No. 158 (pension accounting) effective December 31, 2006, is expected to result in a net decrease to shareowners' investment of approximately $10 billion.
• Risks: Key risks include regulatory proceedings regarding access charges and broadband regulation, competition from VoIP and cable providers, and the timing of closings for international asset sales.

Investor Verification Checklist

• MCI Integration Synergies: Verify the realization of the projected $550 million in merger synergies against the $250 million in integration expenses incurred.
• Wireline Access Line Trends: Monitor the rate of decline in legacy switched access lines versus the growth rate of FiOS and broadband connections to assess the success of the revenue transformation strategy.
• Information Services Spin-off: Confirm the timing and financial impact of the Idearc spin-off, specifically the $7 billion debt reduction and $2 billion cash inflow.
• Pension Liability Impact: Review the impact of SFAS No. 158 adoption on the balance sheet and shareowners' equity in the upcoming year-end filing.
• Debt Covenants and Ratings: Monitor debt ratings (currently A3/A with stable/negative outlooks) and compliance with covenants given the increased debt load from the MCI merger and AWS auction.