Verizon Communications Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted. A major comparability factor is Verizon’s February 21, 2014 acquisition of Vodafone’s 45% interest in Verizon Wireless, giving Verizon 100% ownership from that date.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Operating revenue | $31,483 | $29,786 | $62,301 | $59,206 |
| Operating income | $7,685 | $6,555 | $14,845 | $12,777 |
| Net income | $4,324 | $5,198 | $10,310 | $10,053 |
| Net income attributable to Verizon | $4,214 | $2,246 | $8,161 | $4,198 |
| Diluted EPS attributable to Verizon | $1.01 | $0.78 | $2.15 | $1.46 |
| Net cash from operating activities | Not separately provided | Not separately provided | $14,804 | $17,148 |
| Capital expenditures | Not separately provided | Not separately provided | $8,494 | $7,616 |
| Free cash flow | Not separately provided | Not separately provided | $6,310 | $9,532 |
- Q2 revenue grew 5.7%; operating income increased 17.2%. Revenue growth was led by Wireless, while Wireline was nearly flat.
- Although consolidated net income declined in Q2, Verizon-attributable earnings and EPS rose substantially as less income was allocated to Vodafone and other noncontrolling interests following the acquisition.
- Wireless Q2 revenue was $21.5 billion, up 7.5%; segment operating income was $7.0 billion, up 8.1%. Its EBITDA service margin was 50.3%, versus 49.8%.
- Wireline Q2 revenue was $9.8 billion, up 0.3%; segment operating income was $259 million versus $74 million, and EBITDA margin was 23.2% versus 22.2%. Wireline operating income included gains on asset sales.
- Consolidated adjusted EBITDA, a non-GAAP measure, was $11.1 billion in Q2, compared with $10.5 billion. It excludes the 2014 spectrum-license gain and the 2013 pension remeasurement credit.
- Reported Q2 consolidated operating income included a $707 million spectrum-license transaction gain. First-half results also included a $1.9 billion pre-tax gain on the sale of Verizon’s Vodafone Omnitel interest.
Liquidity, debt and cash flows
- At June 30, cash and cash equivalents were $5.8 billion, down from $53.5 billion at year-end, primarily reflecting the Wireless Transaction. Current assets were $22.9 billion and current liabilities were $26.5 billion.
- Total debt, including debt maturing within one year, was approximately $110.0 billion, compared with $93.6 billion at December 31, 2013. Long-term debt was $107.7 billion. The company cited increased borrowing to finance the acquisition.
- First-half operating cash flow fell $2.3 billion year over year. Management attributed the decline mainly to higher income-tax and interest payments and increased pension contributions.
- First-half capital expenditures rose to $8.5 billion, or 13.6% of revenue, from $7.6 billion. Free cash flow declined to $6.3 billion, with higher capex also contributing.
- Financing cash outflow was $56.2 billion, including $58.9 billion paid in cash for the Wireless Transaction. Verizon raised $20.2 billion through long-term borrowings and paid $3.6 billion in dividends.
- Available unused borrowing capacity was approximately $6.1 billion under a $6.2 billion credit facility and $2.0 billion under a revolving credit agreement. Verizon reported compliance with debt covenants. Certain agreements require a leverage ratio no greater than 3.50:1.00 until specified credit ratings are reached.
Material changes and management commentary
- The approximately $130 billion Vodafone transaction consideration included $58.9 billion cash, approximately 1.27 billion Verizon shares valued at $61.3 billion, $5.0 billion of Verizon notes, the Omnitel interest valued at $3.5 billion and other consideration. The transaction materially increased debt and common shares outstanding.
- Wireless growth reflected higher postpaid connections, smartphone and tablet penetration, and equipment sales, including through Verizon Edge. Retail postpaid connections grew 4.6% year over year; postpaid net additions and tablet activations increased. Verizon reported that its LTE network reached approximately 98% of the U.S. population.
- Management expects Verizon Edge adoption to contribute positively to operating income, while weighing on retail postpaid ARPA and service revenue and positively affecting equipment and other revenue.
- Wireline gains in FiOS and strategic services were offset by continued declines in traditional voice, core enterprise and wholesale services. Management described continued investment in wireless capacity, fiber, cloud and advanced business services.
- Management said operating and investing requirements could be funded primarily from internally generated cash, while noting that debt or equity financing may be used for additional investments or capital-structure needs. No numerical earnings or revenue guidance is provided in the supplied filing text.
Risks, contingencies and unusual items
- Acquisition-related debt increased interest expense: Q2 interest expense was $1.2 billion versus $514 million; first-half expense was $2.4 billion versus $1.1 billion. The first-half effective tax rate rose to 23.6% from 15.6%, largely due to income previously attributable to Vodafone becoming taxable to Verizon.
- Verizon recorded $0.9 billion of net early-debt-redemption costs during the first half. It also recorded the $707 million spectrum gain and $1.9 billion Omnitel disposal gain; these items affect comparisons and should be distinguished from recurring operations.
- Market risks include interest-rate and foreign-currency exposure. Approximately 84% of debt was fixed-rate at June 30; management estimated that a 100-basis-point move affecting floating-rate debt would change annual interest expense by about $0.2 billion. Derivatives are used for risk management, not trading.
- Verizon disclosed approximately 60 patent-infringement actions. It said pending legal and regulatory matters were not expected to materially affect financial condition, though they could materially affect results in a particular period; it could not estimate possible losses above accruals. The filing also discusses environmental remediation and tax audits, with possible significant changes in unrecognized tax-benefit liabilities that could not then be estimated.
- Forward-looking risks include realizing acquisition benefits, higher indebtedness and financing costs, competition, technology substitution, regulation, cybersecurity, labor matters, economic conditions and benefit-plan costs. Management reported disclosure controls were effective at June 30, 2014.
Important facts for investors to verify
- How much reported earnings growth reflects full ownership of Verizon Wireless versus underlying operating growth, and how the acquisition affects future comparisons.
- Debt reduction, interest expense, credit ratings and covenant headroom following the transaction; also the sustainability of dividends relative to free cash flow.
- Whether Wireless subscriber growth, churn, Verizon Edge economics and network investment sustain service revenue and margins.
- Whether FiOS and strategic-services growth can offset ongoing Wireline declines in traditional voice, core enterprise and wholesale.
- The recurring contribution of spectrum and asset-sale gains, and the eventual resolution or financial impact of tax, litigation and environmental matters.