Verizon Communications Inc. — Q1 2010 Form 10-Q
Reporting period: Three months ended March 31, 2010; unaudited. Comparisons are with Q1 2009 unless noted. Verizon operates Domestic Wireless and Wireline businesses; Vodafone owns 45% of the Verizon Wireless joint venture, reflected in noncontrolling interest.
Financial performance
| Metric | Q1 2010 | Q1 2009 | Change |
|---|---|---|---|
| Operating revenue | $26.913 billion | $26.591 billion | +1.2% |
| Operating income | $4.351 billion | $4.694 billion | -7.3% |
| Net income, consolidated | $2.284 billion | $3.210 billion | -28.8% |
| Net income attributable to Verizon | $409 million | $1.645 billion | -75.1% |
| Diluted EPS attributable to Verizon | $0.14 | $0.58 | |
| Operating cash flow | $7.117 billion | $6.622 billion | +$495 million |
| Capital expenditures | $3.456 billion | $3.707 billion | -$251 million |
| Free cash flow (non-GAAP) | $3.661 billion | $2.915 billion | +$746 million |
| Dividends declared per share | $0.475 | $0.460 |
Reported operating margin was approximately 16.2%, down from 17.7%. The effective tax rate rose to 40.7% from 18.7%, principally due to a one-time, noncash $962 million tax charge related to the 2010 health care legislation’s treatment of Medicare Part D subsidies. Verizon said the ongoing 2010 effect of the changed deduction was not expected to be significant.
Liquidity and debt: Cash and cash equivalents were $3.037 billion at March 31, up $1.028 billion from year-end. Short- and long-term debt totaled $61.553 billion, down from $62.256 billion at December 31, 2009; $7.129 billion was due within one year. Current assets were $22.405 billion versus current liabilities of $28.063 billion. Verizon reported compliance with debt covenants. On April 14, it replaced its $5.3 billion 364-day facility with a $6.2 billion three-year facility.
Segment results and changes
- Domestic Wireless: Revenue grew 4.4% to $15.783 billion; operating income rose 6.6% to $4.554 billion. Service revenue increased 5.9%, supported by customer growth and data services. Total customers rose 7.2% to 92.8 million, while data ARPU increased 18.0% to $16.71. Service ARPU declined 1.2% to $50.15, reflecting lower voice ARPU and customer mix. Q1 2009 additions included approximately 13.2 million Alltel customers, making year-over-year net additions incomparable without that acquisition effect.
- Wireline: Revenue declined 2.9% to $11.232 billion; operating income fell 75.1% to $172 million. Switched access lines declined 9.5% to 31.8 million amid competition and technology substitution. FiOS Internet subscribers increased 30.2% to 3.6 million and FiOS TV subscribers rose 36.6% to 3.0 million, partly offsetting traditional voice declines.
Consolidated revenue growth was driven by Wireless and data services, but higher operating expenses and declining Wireline revenue reduced operating income. Verizon’s share of earnings was also affected by the tax charge and by higher earnings allocated to noncontrolling interests, primarily Vodafone’s 45% share of Wireless.
Cash flow, outlook, and material developments
- Operating cash flow increased by $495 million year over year. Free cash flow, a company-defined non-GAAP measure equal to operating cash flow less capital expenditures, was $3.661 billion.
- Verizon expects 2010 capital expenditures of $16.8 billion to $17.2 billion, primarily for growth markets, including Wireless network investment and the LTE build-out. It expects capital spending to be funded primarily from internally generated cash.
- Management expects continued Wireless service and data revenue growth, while noting competitive pressure, traditional Wireline declines, and economic headwinds. It anticipated cost controls would remain important through the rest of 2010. No full-year earnings or revenue guidance is provided in the filing text.
- The planned Spinco separation and merger with Frontier covers approximately 4 million access lines and businesses that generated about $4 billion of 2009 Wireline revenue. Verizon expected the transaction to close by the end of Q2 2010, subject to regulatory and other conditions. Verizon expected approximately $3.3 billion of value from cash payments and debt reduction, and shareholders were expected to receive approximately $5.3 billion of Frontier stock under stated assumptions. Spinco completed a $3.2 billion notes financing on April 12; Verizon recorded $145 million of related separation-preparation charges in Q1.
- Verizon Wireless completed the sale of 26 Alltel divestiture markets to ATN in April 2010; the sale of 79 markets to AT&T remained subject to regulatory approval and was expected to close in Q2. Q1 included $105 million of merger integration charges, primarily associated with Alltel, and $136 million of noncash pension settlement losses.
Risks and contingencies
- Management cited economic conditions, competition, technology substitution, Wireline access-line losses, execution of the Alltel integration, benefit-plan costs and funding, credit ratings and financing conditions, regulation, and execution of acquisitions and dispositions as risks to results.
- Rating agencies identified sustained leverage, weaker Wireless performance, failure to achieve Alltel synergies, accelerated Wireline losses, underfunded benefit plans, or transactions that weaken credit metrics as potential downgrade factors. Verizon said it did not anticipate a downgrade.
- Legal and regulatory proceedings, including environmental remediation at the Hicksville, New York site, could materially affect results in a particular period, though Verizon did not expect pending matters to materially affect financial condition. An appeal remained pending in litigation concerning alleged government access to communications; the complaints had been dismissed in 2009.
- Unrecognized tax benefits were $3.305 billion at March 31. Verizon said the balance could change significantly over the next 12 months, but it could not estimate the range; tax examinations were ongoing in the U.S. and other jurisdictions.
- Temporary enhancements to union separation programs were agreed in April. Their financial impact could be significant and depends on employee participation.
Investor verification priorities
- Separate consolidated net income from the $409 million attributable to Verizon, and assess the $962 million one-time tax charge and Vodafone’s noncontrolling share when evaluating earnings and EPS.
- Check whether Wireless growth and data monetization can offset lower voice ARPU, promotional equipment pressures, and Wireline access-line and revenue declines.
- Track Wireline profitability and FiOS subscriber growth, including whether growth covers content and other operating costs.
- Verify delivery of the $16.8–$17.2 billion capital expenditure plan, cash generation, dividend funding, and the effect of debt maturities and refinancing.
- Confirm closing terms and regulatory approvals for the Frontier transaction and remaining Alltel market divestitures, along with associated cash, debt, and revenue impacts.
- Monitor pension and healthcare obligations, tax audits, remediation and litigation exposures, and credit-rating sensitivities.