Verizon Communications Inc. — Q3 2012 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012; financial statements are unaudited. Verizon operates Verizon Wireless and Wireline. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Change |
|---|---|---|---|
| Operating revenue | $29,007 | $27,913 | +3.9% |
| Operating income | $5,483 | $4,647 | +18.0% |
| Net income attributable to Verizon | $1,593 | $1,379 | +15.5% |
| Diluted earnings per share | $0.56 | $0.49 | +14.3% |
- Q3 operating margin was approximately 18.9%, versus 16.6% a year earlier. Verizon-attributable net income was $1.6 billion; consolidated net income of $4.3 billion includes $2.7 billion attributable to noncontrolling interests, primarily Vodafone’s 45% Verizon Wireless stake.
- For the first nine months, revenue was $85.8 billion (+4.1%), operating income $16.3 billion (+16.7%), net income attributable to Verizon $5.1 billion (+15.3%), and diluted EPS $1.79 versus $1.56.
- Q3 Wireless revenue grew 7.3% to $19.0 billion and segment operating income rose 17.4% to $6.0 billion. Wireline revenue declined 2.3% to $9.9 billion; segment operating income declined to $41 million from $53 million. Wireless growth reflected service revenue and customer expansion; Wireline gains in FiOS and strategic services were offset by declines in traditional enterprise and wholesale services.
- Consolidated operating expenses increased 1.1% in Q3. Selling, general and administrative expense rose 8.8%, while cost of services and sales fell 3.6%. Q3 included a $384 million charge for patent litigation settlements.
Cash flow, capital spending, debt and liquidity
- For the first nine months, operating cash flow was $24.8 billion, up from $21.5 billion. Capital expenditures were $11.3 billion versus $12.5 billion; reported free cash flow, a non-GAAP measure calculated as operating cash flow less capital expenditures, was $13.4 billion versus $9.0 billion.
- Investing cash outflow was $15.4 billion, including $3.8 billion for wireless licenses. Financing cash outflow was $13.0 billion, including a $4.5 billion distribution to Vodafone. Cash declined $3.6 billion from year-end to $9.7 billion.
- At September 30, total debt was $52.8 billion ($6.3 billion current and $46.5 billion long-term), down from $55.2 billion at December 31, 2011. Cash and short-term investments totaled $10.3 billion. The filing reports debt fair value of $64.1 billion, above its $52.5 billion carrying amount excluding capital leases.
- Current assets were $27.7 billion and current liabilities $28.8 billion. Verizon reported approximately $6.1 billion of unused capacity on its $6.2 billion credit facility, extended to August 2016, and stated that it complied with debt covenants.
- Nine-month dividends paid were $3.9 billion. The quarterly dividend increased 3% to $0.515 per share; no common shares were repurchased in Q3.
Outlook, management commentary and notable items
- Management emphasized investment in wireless data, FiOS, strategic services, cloud offerings and LTE. Verizon said LTE covered more than 250 million people in 419 markets as of October 18, 2012, and expected to extend LTE to virtually its current 3G footprint in 2013. This is management’s stated plan, not formal earnings guidance.
- Management expected Wireline Global Wholesale revenue to continue declining approximately 10% per quarter year over year, with traditional voice declines only partly offset by Ethernet and IP growth. It cited economic pressure and delayed customer IT spending as headwinds for enterprise services.
- Verizon completed major AWS spectrum purchases for $3.9 billion and other license transactions; it also acquired HUGHES Telematics for $0.6 billion. The spectrum is intended to support LTE capacity. A Coinstar/Redbox joint venture planned to introduce subscription services in Q4 2012.
- After quarter-end, Verizon agreed to transfer approximately $7.5 billion of pension liabilities covering about 41,000 retirees to Prudential through a group annuity contract, subject to closing conditions. Verizon anticipated a December 2012 closing, approximately $2.5 billion of contributions in connection with the transaction, and a significant Q4 charge after pension remeasurement and the annuitization. It revised expected 2012 qualified pension contributions to $3.4 billion from $1.3 billion previously estimated.
- Patent settlements resulted in a Q3 charge of $384 million, with an additional $200 million to be paid and recognized over six years. Recovery of some amounts from other parties is uncertain.
- Verizon identified risks including competition, economic conditions, labor matters, technology substitution, cybersecurity and network disruption, regulation, financing conditions, benefit-plan costs, and execution of its strategy. It disclosed a pending Idearc-related claim seeking more than $9 billion and a FairPoint-related claim seeking approximately $2 billion; outcomes and potential losses are uncertain. It stated that no accrual in currently pending matters was material and that it could not estimate reasonably possible losses above accruals.
- Management said disclosure controls were effective at September 30, 2012, with no material Q3 change in internal control over financial reporting.
Most important facts for investors to verify
- Whether Wireless revenue, subscriber growth and margins can offset ongoing Wireline declines and rising wireless sales commissions.
- Actual cash costs and accounting impact of the pension annuity transaction, including the final contribution, Q4 charge and transaction closing.
- LTE spectrum deployment costs and returns, alongside the continued level of capital spending and dividend funding.
- Developments in the Idearc, FairPoint and patent matters, tax examinations and other contingencies; the filing does not provide a clear estimate of potential losses for several proceedings.
- Whether reported cash generation remains durable after working-capital timing effects, spectrum spending and distributions to noncontrolling interests.