Verizon Communications Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. Unless otherwise noted, financial figures are in U.S. dollars.
Business context and reporting period
Verizon provides wireless and wireline communications services and equipment, principally in the United States. It reported two segments, Wireless and Wireline, and approximately 161,000 employees at quarter-end. The company’s stated 2017 priorities included retaining and growing its customer base, leveraging its networks, developing media and telematics, and monetizing network capabilities.
Financial performance and liquidity
| Metric | Q1 2017 | Q1 2016 or comparison |
|---|---|---|
| Operating revenue | $29.814 billion | $32.171 billion; down 7.3% |
| Operating income | $7.181 billion | $7.942 billion |
| Net income attributable to Verizon | $3.450 billion; diluted EPS $0.84 | $4.310 billion; diluted EPS $1.06 |
| Operating margin | 24.1% (calculated) | 24.7% (calculated) |
| Net cash from operating activities | $1.681 billion | $7.497 billion |
| Capital expenditures | $3.067 billion | $3.387 billion |
| Free cash flow | $(1.386) billion | $4.110 billion |
| Cash and cash equivalents at period-end | $4.307 billion | $2.880 billion at Dec. 31, 2016 |
| Total debt at period-end | $116.546 billion | $108.078 billion at Dec. 31, 2016 |
Operating cash flow fell $5.816 billion year over year. Management attributed the decline mainly to a $3.4 billion discretionary pension contribution, changes in working capital, lower earnings, and a shift in device-receivable monetization from operating cash flows to financing cash flows. Verizon paid $2.354 billion in cash dividends. The $9.0 billion credit facility had approximately $8.9 billion of unused capacity; the filing states the company was in compliance with its covenants.
Wireless revenue was $20.878 billion, down 5.1%, and segment operating income was $7.076 billion, down 10.2%; its EBITDA margin was 45.1%, versus 46.2%. Wireline revenue was $7.876 billion, down 0.6%; segment operating income was $293 million versus a $67 million loss, and EBITDA margin was 22.7%, versus 19.0%. Fios revenue rose to $2.9 billion from $2.8 billion.
Material changes versus the prior comparable period
- Reported revenue declined $2.357 billion. Wireless service revenue fell 6.1%, reflecting lower overage revenue, promotional activity, fewer postpaid customers in the quarter, and migration to unsubsidized service pricing. Verizon also reported negative retail postpaid net additions of 307,000 and postpaid churn of 1.15%, compared with 640,000 net additions and 0.96% churn in Q1 2016.
- The revenue comparison includes $1.280 billion of revenue in Q1 2016 from local exchange operations sold to Frontier on April 1, 2016; there was no corresponding divested-operations revenue in Q1 2017.
- Net income attributable to Verizon decreased $860 million. The quarter included $0.8 billion of pretax early debt redemption costs, recorded in other income and expense. Lower operating income was also a factor; the effective tax rate declined to 31.4% from 34.5%, partly due to favorable resolution of tax matters.
- Debt increased by approximately $8.5 billion from year-end, primarily amid new borrowings. Verizon issued approximately $14.3 billion of long-term and asset-backed borrowings and repaid $5.6 billion of long-term borrowings and capital lease obligations during the quarter.
- Verizon completed its approximately $1.8 billion acquisition of XO Holdings’ wireline business in February. It recorded approximately $0.4 billion of goodwill and $0.3 billion of other intangible assets.
Guidance, outlook, management commentary, risks and unusual items
- The filing provides no specific full-year revenue, earnings, or cash-flow guidance. Verizon said it expected to launch fixed commercial 5G wireless service in 2018, subject to the results of ongoing trials.
- The planned Yahoo operating-business acquisition had an amended purchase price of approximately $4.48 billion, subject to adjustments and closing conditions, and was expected to close around mid-2017. Yahoo retained 50% of certain specified post-closing liabilities related to user security and data breaches; Yahoo retained responsibility for shareholder lawsuits and SEC investigations and actions.
- Verizon agreed to sell 23 U.S. and Latin American data-center sites to Equinix for approximately $3.6 billion, subject to adjustments and approvals; closing was expected in the first half of 2017. In April, Verizon exercised an option to buy XO’s spectrum-holding subsidiary for approximately $0.2 billion, subject to approvals, with closing expected by year-end.
- The $3.4 billion discretionary pension contribution reduced current-quarter cash flow; management expected mandatory pension funding through 2020 to be minimal and total 2017 qualified-plan funding to be approximately $4.0 billion.
- Risks identified include competition, technology substitution, cybersecurity or network breaches, high indebtedness and financing conditions, regulatory changes, labor matters, benefit-plan costs, tax changes, and failure to realize strategic-transaction benefits. Management said pending legal and regulatory matters were not expected to materially affect financial condition, though a given period’s results could be affected. The reasonably possible loss beyond accrued amounts could not be estimated.
- Unrecognized tax benefits were $1.7 billion at March 31, 2017; the company said this liability could change significantly over the next twelve months, but it could not estimate a range. Verizon also reported approximately 35 patent-infringement actions and environmental reserves, including for the former Hicksville, New York site.
- Verizon adopted the simplified goodwill impairment standard early in 2017. It expected the 2018 pension-cost presentation standard to increase reported 2016 operating income by approximately $2.2 billion on a retrospective basis, with no effect on net income. The company planned to adopt the new revenue standard in 2018 and expected more revenue to be allocated to wireless equipment and recognized earlier, as well as capitalization and amortization of a substantial portion of sales commissions.
Most important facts for investors to verify
- Whether wireless service revenue, customer additions, churn, and postpaid account economics stabilize following plan changes and increased promotional activity.
- How much the cash-flow decline reflects one-time pension funding and the device-receivable financing reclassification, versus underlying operating and working-capital trends.
- Debt trajectory, refinancing needs, interest-rate exposure, and the effect of acquisition spending, dividends, and capital investment on liquidity.
- Closing and integration of the Yahoo and Equinix transactions, and the ultimate financial exposure from Yahoo-related security-breach claims.
- Actual 2017 pension funding, tax-audit developments, and updates to legal, regulatory, environmental, and cybersecurity exposures.