Verizon Communications Inc. — Q3 2016 Form 10-Q
Business context and reporting period. Verizon is a communications provider with Wireless and Wireline reportable segments. This unaudited filing covers the quarter and nine months ended September 30, 2016, compared with the same 2015 periods. Verizon completed the sale of its California, Florida and Texas local exchange businesses to Frontier on April 1, 2016; the transaction affects year-over-year comparability.
Financial results and key metrics
Amounts are in U.S. dollars; financial statement amounts are in millions unless otherwise noted.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Operating revenue | $30,937 | $33,158 | $93,640 | $97,366 |
| Operating income | $6,540 | $7,535 | $19,036 | $23,316 |
| Net income | $3,747 | $4,171 | $9,008 | $12,862 |
| Net income attributable to Verizon | $3,620 | $4,038 | $8,632 | $12,488 |
| Diluted EPS | $0.89 | $0.99 | $2.11 | $3.05 |
| Operating cash flow | Not separately provided | Not separately provided | $17,629 | $28,426 |
| Capital expenditures | Not separately provided | Not separately provided | $11,398 | $12,540 |
| Free cash flow (company-defined, non-GAAP) | Not separately provided | Not separately provided | $6,231 | $15,886 |
- Revenue and segments: Q3 consolidated revenue fell 6.7%; nine-month revenue fell 3.8%. Wireless revenue declined 3.9% in Q3 and 3.1% year to date; Wireline revenue declined 2.3% and 2.1%, respectively. Q3 segment operating income was $7.647 billion for Wireless and $156 million for Wireline.
- Margins and adjusted measures: Q3 consolidated operating income was $6.540 billion, versus $7.535 billion a year earlier. Company-defined consolidated adjusted EBITDA was $11.279 billion in Q3 versus $11.169 billion; for nine months it was $33.679 billion versus $33.439 billion. These are non-GAAP measures.
- Cash generation: Nine-month operating cash flow declined $10.8 billion and free cash flow declined $9.7 billion year over year. Verizon cites working-capital effects from asset-backed securitizations, higher tax payments, lower earnings and the absence of prior-year tower-transaction proceeds; lower capital expenditures partly offset the decline.
- Debt and liquidity: Total debt was $106.6 billion at September 30, down from $109.7 billion at December 31, 2015; cash and equivalents were $6.4 billion, up from $4.5 billion. Current assets were $25.6 billion and current liabilities $30.3 billion. Verizon reported $8.9 billion of unused capacity under its amended $9.0 billion credit facility and stated it was in compliance with financial and restrictive covenants.
- Capital returns: Verizon paid $6.9 billion in dividends during the first nine months. The quarterly dividend was raised 2.2% to $0.5775 per share. No shares were repurchased during the period.
Material changes versus prior comparable periods
- Wireless service revenue continued to be pressured by customers moving to unsubsidized service plans: about 60% of retail postpaid phone connections used such pricing at September 30, 2016, versus 33% a year earlier. Retail postpaid connections grew 3.0%, but Q3 net additions fell 65.7% and postpaid churn rose to 1.04% from 0.93%.
- Verizon said service revenue plus recurring device-payment billings increased 2.3% in Q3, even as reported service revenue fell 5.2%. Device-payment-plan receivables, net, rose to $6.8 billion from $3.1 billion at year-end; the allowance for credit losses increased to $601 million from $444 million.
- Wireline faced declines in enterprise and wholesale services amid competition and technology substitution. Fios revenue increased to $2.8 billion in Q3 from $2.7 billion; Fios Internet subscribers rose 4.7% year over year. A union work stoppage from April 13 to June 1 affected costs, marketing, installations and capital spending.
- Nine-month results included $4.512 billion of severance, pension and benefit charges, compared with $342 million in 2015, and $1.8 billion of early debt-redemption costs. These were partly offset by a $1.007 billion pre-tax gain on the Frontier sale and a $142 million spectrum-transaction gain. The early debt-redemption costs drove the $1.697 billion net other expense for the nine-month period.
- The Frontier sale generated $9.9 billion of cash proceeds, which Verizon used to reduce debt. The sold businesses had contributed approximately $1.3 billion in Verizon revenue and $0.7 billion in operating income in the first nine months of 2016 before closing.
Outlook, management commentary, risks and unusual items
- No specific earnings or revenue guidance is stated in the supplied filing text. Management expects customer migration to unsubsidized wireless pricing to continue through the rest of 2016 and expects higher device-payment activations to reduce overall wireless operating costs versus the prior year.
- Management describes a strategy centered on network connectivity, video and Internet of Things platforms, and content and applications. Verizon reported Q3 IoT revenue of $0.2 billion, up 36% year over year, and continued investment in LTE capacity, fiber and future 5G capability.
- Verizon agreed to acquire Yahoo’s operating business for approximately $4.83 billion. Yahoo disclosed that information associated with at least 500 million accounts had been stolen in 2014; Verizon said the event could constitute a material adverse effect under the agreement and that it was evaluating the transaction’s impact.
- Other strategic transactions included the $0.9 billion Telogis acquisition, the proposed approximately $2.4 billion Fleetmatics acquisition (expected to close in Q4 2016, subject to conditions), and the proposed approximately $1.8 billion XO wireline acquisition (targeted for Q1 2017, subject to approvals).
- Verizon warned that fourth-quarter pension and postretirement plan remeasurement could result in significant charges or credits. The filing reports a substantial sensitivity to discount-rate and healthcare-cost assumptions, including a Q3 pension remeasurement charge and earlier 2016 benefit-plan remeasurement charges.
- Other stated risk factors include intense competition, technology substitution, regulation, cybersecurity incidents, high indebtedness, credit-market and rating changes, labor matters, benefit-plan costs, tax changes, litigation and failure to realize strategic-transaction benefits. Verizon said it could not estimate a reasonably possible loss range above accrued amounts for pending legal matters; it did not expect their ultimate resolution to materially affect financial condition, though period results could be affected.
Important facts for investors to verify
- Whether wireless service-revenue pressure is offset by device-payment billings and whether customer additions, churn and receivable credit performance remain satisfactory.
- How much of the decline in operating and free cash flow reflects recurring business conditions versus timing, securitization, taxes and prior-year one-time proceeds.
- The impact of pension and postretirement remeasurement, including the fourth-quarter review, on reported earnings and future benefit costs.
- The status, purchase economics and potential liabilities of the Yahoo transaction following the disclosed data breach, and the completion and integration of other acquisitions.
- Debt maturities, financing costs and the availability and terms of asset-backed funding; reported total debt includes $2.6 billion of asset-backed debt secured by device-payment receivables.
- The effects of the Frontier divestiture and work stoppage on comparisons, and the underlying performance of Wireline as legacy voice and wholesale services contract.