VERIZON COMMUNICATIONS INC quarterly report, Q2 FY2010

Verizon Communications Inc. — Q2 2010 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2010. Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise. Verizon operates Domestic Wireless and Wireline; its 55%-owned Verizon Wireless partnership is consolidated, with Vodafone’s 45% interest reported as noncontrolling interest.

Financial performance

Metric	Q2 2010	Q2 2009	Six months 2010	Six months 2009
Revenue	$26,773	$26,861	$53,686	$53,452
Operating income	$2,039	$4,418	$6,390	$9,112
Net income	$1,547	$3,160	$3,831	$6,370
Net income (loss) attributable to Verizon	$(198)	$1,483	$211	$3,128
Verizon diluted EPS	$(0.07)	$0.52	$0.07	$1.10

Consolidated operating margin was approximately 7.6% in Q2 versus 16.4% a year earlier; for the first half it was approximately 11.9% versus 17.0%. The decline largely reflects unusual charges described below.
Segment results, Q2: Domestic Wireless revenue rose 3.4% to $16.0 billion and operating income rose 8.6% to $4.8 billion. Wireline revenue fell 3.3% to $11.1 billion and operating income fell 61.4% to $214 million.
Wireless service revenue increased 5.2%; data revenue reached $4.8 billion, or 34.5% of service revenue. Total wireless customers grew 5.0% year over year to 92.1 million, while retail net additions were lower than in Q2 2009. Total service ARPU declined 1.3%, although data ARPU increased 16.1%.
Wireline continued to lose traditional access lines, down 9.2% year over year. Growth in FiOS partly offset pressure: FiOS Internet subscribers rose 23.8% to 3.8 million and FiOS TV subscribers rose 27.3% to 3.2 million.
First-half operating cash flow was $16.9 billion, capital expenditures were $7.7 billion, and reported free cash flow (operating cash flow less capital expenditures) was $9.2 billion. Dividends paid were $2.7 billion.
At June 30, cash and cash equivalents were $4.8 billion; current assets were $21.1 billion and current liabilities $31.8 billion. Debt maturing within one year was $7.9 billion and long-term debt $49.6 billion, for total balance-sheet debt of $57.5 billion. Debt-to-debt-plus-equity was 59.4%.

Material changes and unusual items

Q2 results included $2.314 billion of severance, pension and benefit charges, principally associated with a voluntary program and planned workforce reductions of approximately 11,000 employees. The remaining severance liability was $2.422 billion at June 30.
Other Q2 operating charges included $268 million to defer previously recognized wireless data revenue, $187 million of merger integration charges and $195 million of costs related to the Frontier transaction. The revenue adjustment reduced Q2 net income attributable to Verizon by $92 million.
The first half included a one-time, non-cash $962 million income tax charge related to the 2010 health-care legislation and a roughly $192 million tax charge on the Alltel-market divestiture gain. Q2’s tax benefit and negative effective tax rate were affected by the Verizon-attributable loss and the Alltel divestiture tax charge.
Verizon completed the Frontier spin-off and merger on July 1, 2010, after quarter-end. Frontier acquired about 4 million access lines and businesses that generated approximately $4 billion of 2009 Wireline revenue. Verizon received approximately $3.1 billion cash and a $250 million reduction in consolidated indebtedness; stockholders received Frontier shares.
Alltel-related market divestitures were completed during Q2 for approximately $2.6 billion in proceeds; Verizon Wireless’ customer base was reduced by about 2.1 million as a result.

Outlook, liquidity, and risks

Management expected 2010 capital expenditures of $16.8–$17.2 billion. It anticipated continued wireless service and data growth and further reseller customer additions, while warning that economic and competitive pressures could persist through the rest of 2010. No consolidated earnings guidance is provided in the supplied filing text.
Management cited an early indication of economic recovery, particularly in business markets, and continued investment in wireless LTE, broadband and FiOS. It also emphasized cost controls amid traditional wireline declines.
Verizon reported compliance with debt covenants and approximately $6.1 billion of unused capacity under a new $6.2 billion three-year credit facility. After quarter-end, it used Frontier-related proceeds to redeem $2.0 billion of notes and repay other short-term borrowings; Verizon Wireless also reduced term-loan borrowings.
Rating agencies’ potential downgrade factors included weaker wireless performance, competitive pressure, unsuccessful Alltel integration, accelerated wireline losses, underfunded pension and postretirement obligations, or transactions that weaken credit metrics. A downgrade could raise refinancing costs or constrain short-term market access.
In June, the FCC opened an inquiry into possible reclassification of broadband services; Verizon warned that a change could adversely affect its broadband business, competition and returns on network investment. Other disclosed risks include economic conditions, competition, technology substitution, labor matters, benefit costs, regulation, financing access, and execution of strategy.
Verizon said pending legal and regulatory matters were not expected to materially affect financial condition, but could materially affect results in a particular period. A consolidated appeal concerning alleged government access to communications information remained pending. Environmental remediation costs, including at a former Hicksville, New York facility, may change.

Important facts for investors to verify

How much of the sharp decline in operating income and Verizon-attributable earnings is attributable to the workforce, revenue-deferral and transaction charges, and what recurring profitability looks like after those items.
Whether wireless customer and data-revenue growth can offset lower voice ARPU, weaker retail net additions and rising network and sales costs.
Whether FiOS and enterprise growth can counter access-line losses, wholesale price pressure and other Wireline revenue declines, including the effect of the Frontier separation.
Cash generation, capital spending against the $16.8–$17.2 billion plan, debt maturities and repayments, and the adequacy of liquidity given current liabilities exceeding current assets.
Progress on the approximately 11,000 planned workforce reductions, severance payments and pension obligations; also monitor tax audits, FCC broadband proceedings and environmental and legal contingencies.