Verizon Communications Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016; unaudited. Verizon operates Wireless and Wireline segments. Comparisons are with the corresponding 2015 periods unless noted.
Financial performance
| Metric | Q2 2016 | Q2 2015 | H1 2016 | H1 2015 |
|---|---|---|---|---|
| Operating revenue | $30.5B | $32.2B | $62.7B | $64.2B |
| Operating income | $4.6B | $7.8B | $12.5B | $15.8B |
| Net income attributable to Verizon | $0.7B | $4.2B | $5.0B | $8.5B |
| Diluted EPS | $0.17 | $1.04 | $1.23 | $2.06 |
| Operating margin | 14.9% | 24.3% | 19.9% | 24.6% |
Q2 consolidated adjusted EBITDA, a non-GAAP measure, was $11.1B, essentially unchanged from $11.1B a year earlier. Reported operating income and earnings included large pension remeasurement charges and debt-redemption costs; see unusual items below. The Q2 dividend declared was $0.565 per share, versus $0.550.
- Segments: Q2 Wireless revenue fell 4.0% to $21.7B, while segment operating income rose 4.2% to $8.0B. Wireline revenue declined 2.4% to $7.8B and segment operating loss widened to $463M from $199M. Fios revenue increased to $2.8B from $2.7B.
- Cash flow, H1: Operating cash flow was $12.8B, down from $18.9B; capital expenditures were $7.3B, down from $8.2B; free cash flow was $5.6B, down from $10.8B. The company attributed the operating cash-flow decline in part to prior-year tower-transaction proceeds, higher taxes paid, lower earnings, and higher working capital.
- Liquidity and debt: Cash and equivalents were $2.9B at June 30, down from $4.5B at year-end 2015. Total debt was $99.7B, down from $109.7B; current debt was $6.8B and long-term debt $92.9B. The $8.0B credit facility had approximately $7.9B unused. Current assets were $20.8B and current liabilities $34.4B. Verizon reported compliance with its financial and restrictive covenants.
- Cash returns: H1 cash dividends paid were $4.6B. Verizon made no share repurchases in H1.
Material changes and operating drivers
- Wireless service revenue declined 5.4% in Q2, mainly as customers shifted to unsubsidized service pricing. That pricing applied to 53% of retail postpaid phone connections, versus 26% a year earlier. Retail postpaid connections grew 3.9%, but Q2 net additions declined 45.8% year over year. Postpaid ARPA fell 5.6%; I-ARPA, which includes recurring device-payment billings, rose 2.6%.
- Wireline faced traditional voice and data declines and competition. A union work stoppage from April 13 through June 1 delayed Fios installations and added approximately $0.4B of costs; management said Fios connection growth was lower than in prior quarters.
- The April 1 sale to Frontier of landline operations in California, Florida, and Texas generated $9.9B net cash proceeds and a reported $1.0B pretax gain. Verizon used the proceeds to reduce debt. The divested operations generated approximately $1.3B of revenue and $0.7B of operating income in H1 before sale; reported revenue comparisons therefore reflect the divestiture.
- Wireless capital investment continued to target 4G LTE capacity and network densification. Verizon said approximately 93% of June data traffic used its 4G LTE network and described 5G, video, and Internet of Things as strategic areas.
Unusual items, outlook, and risks
- Pension and benefits: Verizon recorded $3.6B of Q2 pretax pension and benefit remeasurement charges, primarily reflecting a lower discount rate and updated healthcare-cost assumptions; the weighted-average discount rate fell from 4.60% at year-end 2015 to 3.99% at May 31, 2016. It also recorded a $0.5B pretax curtailment gain associated with the Frontier sale. New labor agreements reduced postretirement obligations by about $5.1B and increased pension obligations by about $0.4B; the net $2.9B after-tax benefit-plan adjustment was recorded in other comprehensive income. Further 2016 remeasurements could produce significant charges or credits.
- Debt costs: Early redemptions and tender offers generated $1.8B of net pretax loss in Q2. After quarter-end, Verizon agreed to issue $6.2B of notes, expecting approximately $6.1B net proceeds, including to repay $2.25B of notes due in September 2016.
- Acquisitions: On July 23, 2016, Verizon agreed to acquire Yahoo’s operating business for approximately $4.83B, subject to approvals and other conditions, with closing expected in Q1 2017. It also expected the approximately $1.8B XO wireline acquisition to close in H1 2017 and a cloud-based mobile enterprise software acquisition in H2 2016.
- Outlook: The filing gives no specific consolidated revenue, earnings, or EPS guidance. Management said internally generated funds were expected to finance capital spending primarily, and described ongoing investment in networks and digital platforms. It cautioned that pension remeasurements and regulatory, competitive, labor, technology, debt, and benefit-cost developments could affect results.
- Other risks and contingencies: Verizon cited uncertainty around FCC broadband and network-neutrality regulation, competition and technology substitution, labor matters, security incidents, and its high indebtedness. It disclosed about 50 patent-infringement actions; accruals for pending matters were not material, but the potential excess loss range could not be estimated. The filing stated that legal or regulatory resolutions could materially affect results in an individual period.
Investor verification priorities
- Reconcile the $3.6B pension remeasurement charge, the Frontier-related gain, and the $1.8B debt-redemption loss to reported GAAP earnings and assess their recurrence and cash implications.
- Track wireless service-revenue trends, postpaid additions and churn, and the effect of migration to device-payment and unsubsidized plans on total customer economics.
- Assess whether Wireline can restore Fios installation and connection growth after the work stoppage, while managing continued legacy voice, enterprise, and wholesale declines.
- Monitor operating cash flow, working capital, capital spending, dividend coverage, debt maturities, and the financing effects of the announced acquisitions and post-quarter note issuance.
- Verify closing conditions, consideration, and integration outcomes for Yahoo, XO, and the other announced acquisitions, and follow regulatory, labor, pension, and litigation developments.