Verizon Communications Inc. — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013; unaudited. Verizon operates Wireless and Wireline segments. Comparisons below are with the corresponding 2012 periods unless noted.
Financial results and key metrics
- Q3 revenue: $30.279 billion, up 4.4%. Operating income was $7.128 billion, up from $5.483 billion; operating margin was approximately 23.5%, versus 18.9%. Consolidated net income was $5.578 billion, of which $2.232 billion was attributable to Verizon. Diluted EPS was $0.78, versus $0.56.
- Nine-month results: Revenue was $89.485 billion, up 4.3%; operating income was $19.905 billion, versus $16.329 billion. Consolidated net income was $15.631 billion, with $6.430 billion attributable to Verizon. Diluted EPS was $2.24, versus $1.79.
- Cash flow, nine months: Operating cash flow was $28.387 billion, up $3.629 billion. Capital expenditures were $11.807 billion; reported free cash flow, a non-GAAP measure calculated as operating cash flow less capex, was $16.580 billion, up $3.137 billion.
- Debt and liquidity: Debt totaled $99.140 billion at September 30, compared with $51.987 billion at year-end 2012. Cash and equivalents were $56.710 billion, versus $3.093 billion; the large cash increase principally reflects debt raised for the pending Vodafone transaction, not operating cash generation alone. Current liabilities were $30.291 billion and current assets $73.705 billion. Verizon reported compliance with debt covenants.
- Margins and segments: Wireless Q3 revenue rose 7.2% to $20.399 billion; segment operating income increased 13.9% to $6.886 billion, and EBITDA service margin was 51.1% versus 50.0%. Wireline revenue declined 1.0% to $9.814 billion; operating income was $155 million versus $41 million, while nine-month operating income fell 37.3% to $242 million.
- Dividends: Quarterly dividend declared was $0.53 per share, up from $0.515. Cash dividends paid in the first nine months were $4.420 billion, versus $3.887 billion.
Material changes and business drivers
- Wireless growth was supported by postpaid connection growth, smartphone and data-device adoption, and Share Everything plans. Retail postpaid connections increased 5.3% year over year, but Q3 postpaid net additions fell 39.6% and postpaid churn rose to 0.97% from 0.91%. Postpaid ARPA increased 7.1% to $155.74.
- Verizon said its 4G LTE network reached approximately 97% of the U.S. population. Smartphones represented 67.2% of its retail postpaid phone base, versus 53.2% a year earlier.
- Wireline pressure reflected declining traditional voice, Global Enterprise Core and wholesale revenues. FiOS supported consumer growth: FiOS Internet and Video subscribers each increased 12.6% year over year. Strategic services revenue rose 5.2% in Q3, while Global Enterprise and Global Wholesale revenue declined.
- Q3 results included a $278 million pretax spectrum-transaction gain. Nine-month results also included a $237 million pension remeasurement credit. The prior-year comparison included a $384 million Q3 2012 litigation charge; these items affect comparability.
Outlook, transaction, risks and contingencies
- Capital spending outlook: Verizon raised expected 2013 capital expenditures to approximately $16.6 billion, citing stronger connection growth and 4G LTE demand; its prior expectation was broadly in line with 2012.
- Vodafone transaction: Announced September 2, 2013, the proposed acquisition of Vodafone’s 45% Verizon Wireless interest was valued at approximately $130 billion. Consideration includes about $58.89 billion cash, $60.15 billion in Verizon shares, $5.0 billion of Verizon notes, transfer of a Vodafone Omnitel interest valued at $3.5 billion and other consideration of about $2.5 billion. Closing was expected in Q1 2014, subject to shareholder, regulatory and other conditions. Verizon had issued $49.0 billion of notes to help finance the deal and arranged a term loan facility of up to $12.0 billion after the quarter.
- The transaction materially increases leverage and financing costs; Moody’s, S&P and Fitch downgraded Verizon debt ratings during Q3. If the deal is not completed by the specified deadline or is terminated, the $49 billion of transaction notes are subject to redemption at 101% plus accrued interest. Termination fees can reach $10 billion in specified circumstances. Verizon also disclosed potential dilution from issuing approximately 1.18–1.28 billion shares.
- Management cited competition, economic conditions, technology substitution, regulation, network security and service disruption, supplier dependence, labor negotiations, benefit costs and financing access as risks. Verizon said pension assets and obligations would be remeasured in Q4; resulting charges or credits could be significant.
- Legal matters include an appeal in the Idearc spin-off litigation after judgment for Verizon, and a FairPoint actual fraudulent-transfer claim set for trial in December 2013. Verizon disclosed approximately 50 patent-infringement actions. It said pending legal and regulatory matters were not expected to materially affect financial condition, but could materially affect results in a particular period; reasonably possible excess losses could not be estimated. Hicksville environmental remediation costs remain subject to reassessment.
Important facts for investors to verify
- Whether the Vodafone transaction closed as planned, its final consideration and financing mix, and resulting share dilution, debt, ratings and interest burden.
- Whether cash balances and free cash flow remain adequate after transaction funding, dividends and the approximately $16.6 billion 2013 capital-spending program.
- Whether wireless connection growth, churn and service economics sustain revenue and margin gains as smartphone commissions and network investment rise.
- Whether FiOS and Strategic services growth can offset continuing Wireline declines in legacy voice, Global Enterprise Core and wholesale services.
- Subsequent developments in the Idearc, FairPoint, patent and environmental matters, as well as the Q4 pension remeasurement and unrecognized tax-benefit exposures.