Verizon Communications Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Unaudited results; dollar amounts below are in billions unless noted. Verizon operates Wireless and Wireline segments.
Financial results and liquidity
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $31.586 | $30.279 | $93.887 | $89.485 |
| Operating income | $6.890 | $7.128 | $21.735 | $19.905 |
| Net income | $3.794 | $5.578 | $14.104 | $15.631 |
| Net income attributable to Verizon | $3.695 | $2.232 | $11.856 | $6.430 |
| Diluted EPS attributable to Verizon | $0.89 | $0.78 | $3.03 | $2.24 |
| Dividends declared per share | $0.55 | $0.53 | $1.61 | $1.56 |
- Q3 revenue rose 4.3%; operating income fell 3.3%. Nine-month revenue rose 4.9% and operating income rose 9.2%.
- Operating margin was approximately 21.8% in Q3, versus 23.5% a year earlier. Nine-month operating margin was approximately 23.1%, versus 22.2%.
- Q3 consolidated net income declined, while income attributable to Verizon increased, principally because Verizon acquired Vodafone’s remaining 45% interest in Verizon Wireless on February 21, 2014. The prior-year periods included a larger share of Wireless income attributable to noncontrolling interests; results are therefore not directly comparable.
- Q3 interest expense was $1.255 billion versus $0.555 billion; nine-month expense was $3.633 billion versus $1.606 billion. The increase principally reflects debt incurred to finance the Wireless acquisition.
- For the nine months, operating cash flow was $23.157 billion, capital expenditures were $12.624 billion, and free cash flow (a non-GAAP measure) was $10.533 billion, down from $16.580 billion. Cash dividends paid were $5.653 billion.
- At September 30, cash and cash equivalents were $7.218 billion, versus $53.528 billion at year-end 2013. Current assets were $24.773 billion and current liabilities $26.889 billion.
- Debt maturing within one year was $1.603 billion and long-term debt $107.627 billion, totaling $109.230 billion, versus $93.591 billion at year-end. Verizon reported compliance with debt covenants and approximately $7.9 billion of unused capacity under its $8 billion credit facility.
Business performance and material changes
- Wireless: Q3 revenue grew 7.0% to $21.835 billion; nine-month revenue grew 7.2% to $64.197 billion. Q3 service revenue increased 4.8% and equipment revenue 28.9%. Retail postpaid connections increased 5.2% year over year; postpaid churn rose to 1.00% from 0.97%. Wireless segment operating income was $6.955 billion in Q3, up 1.0%; its EBITDA service margin was 49.5%, down from 51.1%.
- Wireline: Q3 revenue declined 0.8% to $9.576 billion; nine-month revenue was nearly flat at $28.869 billion. FiOS-supported Mass Markets revenue grew, while Global Enterprise and Global Wholesale declined amid legacy-service contraction and competition. Q3 segment operating income increased to $225 million from $147 million; EBITDA margin was 23.0%, unchanged.
- Verizon completed the approximately $130 billion Wireless transaction in February, obtaining full ownership. Consideration included $58.89 billion cash, approximately 1.27 billion Verizon shares valued at $61.3 billion, $5 billion of notes, and other consideration. Verizon recorded a $13.5 billion deferred tax liability related to the transaction.
- The transaction materially changed financing and ownership: long-term debt increased, cash was used for the purchase, and noncontrolling interests fell. Verizon recorded a $1.9 billion pretax gain on selling its Vodafone Omnitel interest. Spectrum transactions generated approximately $2.4 billion cash proceeds and a $0.7 billion pretax gain during the nine months.
Outlook, commentary, risks and unusual items
- Management emphasized investment in wireless data, network capacity, fiber, FiOS and strategic services including cloud. It reported 4G LTE coverage for approximately 98% of the U.S. population and said it was shifting wireless capital spending toward capacity and network density. No quantified company-wide earnings or revenue guidance is provided in the supplied filing text.
- Management expects Verizon Edge adoption to support operating income, while continuing to weigh on retail postpaid ARPA and service revenue and support equipment and other revenue. Verizon Edge had a $0.7 billion guarantee liability at September 30; estimates depend on customer upgrades and handset values.
- Nine-month free cash flow fell by $6.047 billion, which management attributed mainly to higher income-tax payments, interest payments and pension contributions, as well as higher capital expenditures. It expects capital spending to be funded primarily by internally generated funds, with external financing available as needed.
- Unusual items include $0.9 billion of early debt-redemption costs, the $1.9 billion Omnitel gain, and $0.7 billion of spectrum-sale gains. A 2013 pension remeasurement credit of $0.237 billion also affects the comparison. The nine-month effective tax rate increased to 26.4% from 15.6%, primarily due to Verizon’s post-acquisition ownership of Wireless income.
- Risks identified include acquisition integration and benefits, increased leverage and credit-market conditions, competition, technology substitution, regulation, cybersecurity and service disruption, labor matters, tax uncertainty, and pension costs and asset returns. About 70 patent-infringement actions were pending; the company said it could not estimate reasonably possible losses above recorded accruals. It did not expect pending legal or regulatory matters to materially affect financial condition, though a period’s results could be affected.
- Verizon expected a fourth-quarter 2014 pretax loss of approximately $0.1 billion from winding down Redbox Instant. It was evaluating new revenue-recognition guidance expected to affect revenue allocation and timing, with adoption planned for 2017.
Important facts for investors to verify
- How post-acquisition Wireless growth, margins, churn and cash generation compare on a like-for-like basis with prior periods.
- Debt trajectory, interest expense, refinancing terms, leverage and capacity to fund network investment and dividends.
- Drivers and sustainability of the decline in free cash flow, including taxes, pension contributions and capital expenditures.
- Whether FiOS and strategic-services growth can offset continuing Wireline declines in legacy enterprise, wholesale and voice services.
- Potential outcomes of tax audits, patent litigation, environmental remediation and other contingencies, for which some losses cannot currently be estimated.
- Actual fourth-quarter Redbox wind-down costs and the eventual financial-statement effects of the new revenue-recognition standard.