Verizon Communications Inc. — Q1 2014 Form 10-Q
Business context and period: Unaudited results for the three months ended March 31, 2014, compared with Q1 2013. Verizon operates Wireless and Wireline segments. On February 21, 2014, it acquired Vodafone’s remaining 45% interest in Verizon Wireless, giving Verizon 100% ownership; Q1 results therefore include 55% ownership through closing and full ownership thereafter.
Financial performance
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Operating revenue | $30.818 billion | $29.420 billion | +4.8% |
| Operating income | $7.160 billion | $6.222 billion | +15.1% |
| Net income | $5.986 billion | $4.855 billion | +23.3% |
| Net income attributable to Verizon | $3.947 billion | $1.952 billion | +102.2% |
| Diluted EPS | $1.15 | $0.68 | +$0.47 |
| Operating cash flow | $7.139 billion | $7.531 billion | -$0.392 billion |
| Capital expenditures | $4.150 billion | $3.602 billion | +$0.548 billion |
| Free cash flow | $2.989 billion | $3.929 billion | -$0.940 billion |
- Margins and segments: Wireless operating income was $7.318 billion, up 14.0%; its operating margin was 35.0% versus 32.9%, and EBITDA service margin was 52.1% versus 50.4%. Wireline operating income was $147 million versus $13 million; its operating margin was 1.5% versus 0.1%, and EBITDA margin was 22.3% versus 21.4%.
- Revenue mix: Wireless revenue rose 6.9% to $20.879 billion, led by 7.5% growth in service revenue. Wireline revenue declined 0.4% to $9.790 billion: Mass Markets grew 4.9%, while Global Enterprise fell 4.4% and Global Wholesale fell 6.4%.
- Debt and liquidity: Total debt was approximately $109.8 billion at March 31, up from $93.6 billion at year-end. Cash and cash equivalents were $2.907 billion, down from $53.528 billion, primarily reflecting the cash consideration for the Wireless Transaction. Unused capacity was approximately $6.1 billion on a $6.2 billion credit facility and $2.0 billion on a $2.0 billion revolving facility. Verizon reported compliance with debt covenants.
- Other metrics: Interest expense was $1.214 billion versus $537 million, reflecting higher debt following the transaction. Dividends declared were $0.530 per common share versus $0.515. The effective tax rate was 13.9% versus 15.1%.
Material changes and unusual items
- The approximately $130 billion Vodafone transaction was funded with about $58.9 billion cash, 1.27 billion Verizon shares valued at about $61.3 billion, $5.0 billion of Verizon notes, the sale of Verizon’s Omnitel interest valued at $3.5 billion, and other consideration. Verizon also assumed preferred-stock obligations valued at approximately $1.7 billion.
- The Omnitel disposal generated a $1.9 billion pretax gain, included in equity earnings of unconsolidated businesses. A $0.9 billion net early-debt-redemption charge was included in other income and expense. These items materially affected period-to-period earnings comparisons.
- Verizon recorded an approximately $13.5 billion deferred tax liability associated with the Wireless Transaction. Noncontrolling-interest income fell to $2.039 billion from $2.903 billion as Verizon’s ownership increased. The 1.27 billion shares issued in the deal also increased the weighted-average share count.
- Operating cash flow declined despite higher earnings, mainly due to increased interest payments and pension contributions. Capital spending rose, principally to expand 4G LTE capacity.
Outlook, management commentary and risks
- No specific consolidated revenue, earnings, cash-flow or capital-spending guidance was provided in the supplied filing text. Management said capital needs are expected to be funded primarily from internally generated funds, with debt or equity financing possible for additional investments or to maintain financial flexibility.
- Management cited continued Wireless growth from 4G LTE adoption, higher smartphone and tablet penetration, and the More Everything plans. It also noted higher postpaid churn and lower postpaid net additions year over year. Verizon Edge is expected to support operating income, while potentially pressuring postpaid ARPA and service revenue and increasing equipment and other revenue.
- Wireline growth opportunities include FiOS and strategic services, including cloud and data-center offerings. Management identified continuing pressure from traditional voice declines, technology substitution, competition, and enterprise customers’ focus on cost reduction.
- Verizon expected T-Mobile spectrum transactions to close in 2014, including a sale expected to provide approximately $2.4 billion cash and spectrum exchanges; expected gains would be determined at closing.
- Risks highlighted include realizing expected Wireless Transaction benefits, increased indebtedness and financing costs or availability, economic and competitive conditions, regulation, technology changes, cybersecurity or network disruption, labor matters, taxes, benefit-plan costs, litigation, and execution of business strategies. Approximately 83% of debt was fixed-rate; a 100-basis-point move on floating-rate debt was estimated to change annual interest expense by about $0.2 billion.
- Legal and environmental matters include approximately 50 patent-infringement actions, the appealed Idearc case, the FairPoint litigation, and remediation at the former Hicksville facility. Verizon said pending matters were not expected to materially affect financial condition, though a period’s results could be affected; reasonably possible losses beyond accruals could not be estimated. A California hazardous-waste investigation was also disclosed, with penalties not expected to be material.
Important facts for investors to verify
- How full ownership of Verizon Wireless changes future reported earnings, cash flows, taxes, and comparability with periods when Vodafone held a 45% interest.
- The debt and interest-cost trajectory following the acquisition, including floating-rate exposure, covenant requirements, and planned debt repayment.
- Whether Wireless revenue growth and subscriber economics remain durable given higher churn and lower net additions, and the effects of device-financing and plan changes on service revenue and ARPA.
- Whether FiOS and strategic-services growth can offset ongoing Wireline voice, Global Enterprise Core, and wholesale declines.
- Completion, proceeds, and accounting gains for the pending spectrum transactions, and any meaningful developments in tax, litigation, or remediation contingencies.