Verizon Communications Management Discusses Q1 2014 Results - Earnings Call Transcript
Verizon Communications Inc. (VZ) Q1 2014 Earnings Conference Call April 24, 2014 8:30 AM ET
Executives
Michael Stefanski – SVP, IR
Fran Shammo – CFO
Analysts
Phil Cusick – JPMorgan
Simon Flannery – Morgan Stanley
David Barden – BofA Merrill Lynch
Mike McCormack – Jefferies & Company
Michael Rollins – Citi Investment Research
John Hodulik – UBS
Amir Rozwadowski – Barclays Capital
Kevin Smithen – Macquarie
Joseph Mastrogiovanni – Credit Suisse
Operator
Good morning and welcome to the Verizon First Quarter 2014 Earnings Conference Call. At this time, all participants have been placed in a listen-only mode and the floor will be opened for questions following the presentation. (Operator Instructions) Today’s conference is being recorded. If you have any objections, you may disconnect at this time.
It is now my pleasure to turn the call over to your host, Mr. Michael Stefanski, Senior Vice President, Investor Relations.
Michael Stefanski
Thanks David. Good morning and welcome to our first quarter 2014 earnings conference call. This is Mike Stefanski and I am here with our Chief Financial Officer, Fran Shammo. Thank you for joining us this morning.
Before we get started, let me remind you that our earnings release, financial and operating information, the investor quarterly and the presentation slides are available on our Investor Relations website. Replays and a transcript of this call will be made available on our website.
I would also like to draw your attention to our Safe Harbor statement. Information in this presentation contains statements about expected future events and financial results that are forward-looking and subject to risks and uncertainties. Discussion of factors that may affect future results is contained in Verizon’s filings with the SEC, which are also available on our website. This presentation contains certain non-GAAP financial measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are also available on our website.
The quarterly growth rates disclosed in this presentation are on a year-over-year basis, unless otherwise noted as sequential.
Before Fran takes you through the details of our quarterly performance, I would like to cover a few details about our reported results. For this discussion, let’s turn to Slide 3. For the first quarter, we reported earnings of $1.15 per share on a GAAP basis. Our reported results reflect a partial quarter with 55% ownership of Verizon Wireless in just over five weeks to full ownership. Since this transaction to acquire Vodafone’s stake closed on February 21.
The weighted average common shares outstanding for the first quarter were 3,430 million. Given the issuance of 1,275 million new shares of Verizon as part of the deal consideration. The timing of the closing had no effect on our consolidated income statement for Wireless segment above the operating income line since we’ve always had operating control of Verizon Wireless.
All of the post-closing effects of full ownership are below the operating income line. Our reported first quarter EPS of $1.15 includes several non-operational items that I would like to review. The first item is a gain on the sale of our minority interest in Vodafone Omnitel.
This resulted in a one-time after-tax gain of approximately $1.9 billion or $0.55 per share. This is a non-cash item as it was part of the transaction consideration. The next item is a non-operational charge related to debt redemption. During the first quarter, we announced a partial make whole redemption and a cash tender offer for various notes with maturities over the next five years and coupons of 5.5% entire. We regained $5.4 billion of notes through the make whole redemption and tender offer.
The associated net pretax costs were $923 million. After tax this resulted in a charge of $575 million or $0.17 per share. We also incurred interest in financing costs related to the wireless transaction. As we did in the third and fourth quarters, we are excluding these charges from adjusted results for the period January 1 through the February 21 closing.
These transaction costs total $411 million on a pretax basis resulting in an after tax charge of $260 million or $0.08 per share. Excluding the effect of these three non-operational items, adjusted earnings per share was $0.84 for the first quarter compared with $0.68 a year ago or growth of 2013.5%.
Adjusted EPS of $0.84 reflects 55% ownership of Verizon Wireless for the period January 1 through February 21 and full ownership for the remainder of the quarter. Of course, future quarters will include a 100% of the Wireless net income and access to all the Wireless cash flows.
For an illustrated non-GAAP view of adjusted earnings, assuming full ownership of Verizon Wireless for the entire first quarter, let’s take a look at Slide 4. The elements for this illustrated view are based on the adjustments in the pro forma financial statements filed with the SEC for the periods ending September 30 and December 31 2013. We also review these transaction effects on February 24 call when we provided some guidance for items below operating income.
Adjusted EPS of $0.84 would have been $0.91 per share assuming 100% ownership of Wireless for the full quarter. Again, on a non-GAAP illustrated basis. The adjustments required to demonstrate this are relatively straightforward.
The 45% of Wireless net income attributable to Vodafone for the period January 1 to February 21 totaled $1.2 billion and would be added to adjusted earnings.
The transaction related cost for the same time period would be subtracted. Accounting for these effects, adjusted earnings would be $3.8 billion with an effective tax rate of about 35%.
The diluted shares outstanding that we use for this illustrated EPS calculation were 4,149 million shares, which assumes the newly issued shares were outstanding for the entire quarter.
In summary, the impact of having a 100% ownership of Wireless for only part of the first quarter was worth $0.07 of earnings per share.
With that, I will now turn the call over to Fran.
Fran Shammo
Thanks Mike. Good morning everyone. As I stated on our last few conference calls, we have great confidence in our ability to generate strong financial performance in 2014.
Over the years, our steady and consistent investments in networks and platforms have supported innovative products and services and fueled our growth. Our wireless and wireline networks will continue to be the hallmark of our brands and provide the fundamental strength upon which we build our competitive advantage.
Now that the Wireless transaction is behind us, we have the immediate financial benefit of earnings accretion from the deal and full access to the very significant cash flows of Verizon Wireless. As we have previously stated, we are targeting 4% consolidated top-line growth in 2014 with an expansion of our consolidated EBITDA margin.
The ingredients for success are unchanged, solid operational execution and a disciplined focus on meeting our financial objectives and creating value for our shareholders. With an eventful first quarter behind us, I’d say we are off to a strong start.
We maintained our growth momentum and delivered excellent top-line and bottom-line results. While the timing of the Wireless transaction closing caused some reporting complexity, our $0.84 adjusted earnings per share represent a growth of 23.5% and would be even greater if we assume full ownership of Wireless for the entire quarter.
We have consistently delivered high quality earnings growth with double-digit increases in reported and adjusted earnings per share in eight of the last nine quarters. Our cash flow generation in the quarter was also impressive and we continue to invest in our networks and platforms.
Our Wireless results were very good with service revenue growth of 7.5% and a service EBITDA margin of 52.1%, an expansion of a 170 basis points. In FiOS, our positive revenue growth trends and scale drove a 6.2% increase in consumer revenue. Total wireline operating revenues declined 0.4% in the quarter which is our best result in nearly three years.
In terms of profitability, our EBITDA margin was 22.3%, up 90 basis points. Now, let’s get into our first quarter performance in more detail starting with consolidated results on Slide 6.
Total operating revenues grew 4.8% in the first quarter continuing our consistent top-line growth trend and was our highest growth rate in the past five quarters. Top-line growth was once again driven by Wireless and FiOS. In terms of new revenue streams, machine-to-machine and telematics were still relatively small are beginning to emerge and make positive contributions with revenue growth in excess of 40%.
Our focus on operating efficiency and cost controls is enabling our ability to compete effectively and drive consistent profitable growth. In the first quarter, consolidated operating expenses grew 2%. Operating income growth was 15.1%. We have posted double-digit growth in operating income in eight of the last nine quarters.
Consolidated EBITDA grew 9.3% while our EBITDA margin expanded by 160 basis points to 36.7%. Let’s take a look at cash flow results next on Slide 7. When looking at our cash flows, it is important to keep in mind that post transaction, we have immediate access to the full Verizon Wireless cash flows.
And apart from a contractual tax distribution in the second quarter for the stub period, we will no longer be making any cash distributions to Vodafone. As a result, the amount of cash available to us will be significantly greater this year. This is true for the simple reason that under the partnership structure, 45% of excess cash at Wireless would at some point be distributed to Vodafone.
As we discussed on our February 24 call, there will be some lack of comparability between current and prior periods in the statement of cash flows. In 2014, the cash flows from operations line will include higher cash payments for interest and taxes. The cash flows from financing section will have lower cash distributions to Vodafone and higher overall dividend payments to our shareholders due to the increase in shares outstanding.
In the first quarter, cash flows from operations were $7.1 billion, which included an incremental $1.3 billion of cash interest payments and $200 million of pension funding that we did not had in the first quarter of 2013. In spite of these additional uses of cash and higher capital spending, free cash flow totaled $3 billion in the quarter.
For illustrative purposes, free cash flow available to Verizon in the first quarter was more than $1 billion higher than a year ago assuming that 45% of the free cash flow at Wireless would have been distributed to Vodafone. Again, the point here is more free cash flow available at the corporate level than prior to the transaction even after higher interest payments and cash taxes.
Capital expenditures in the quarter totaled $4.2 billion, up $548 million with all the increase in Wireless. With our 4G LTE coverage build complete, Wireless spending is now focused on adding capacity intensity to our existing coverage and utilizing our AWS spectrum to further optimize the network.
As we have previously stated, our estimate for total capital spending in 2014 will be in the range of $65 billion to $70 billion. In addition to the transaction closing, we had a large amount of financing activities in the quarter.
At closing, our gross debt was approximately $114 billion. Since then, we announced the make whole redemption and a tender offer did some debt restructuring and had $2.5 billion of notes mature. We ended the quarter with gross debt of just under $110 billion and net debt to adjusted EBITDA ratio of 2.5 times.
Our balance sheet remains strong and we have the financial flexibility needed to grow the business. Our priorities for cash utilization are unchanged. We will continue to invest in our networks, acquire Spectrum and return to our pre-transaction credit ratings profile within four to five years.
We do not need to execute any major acquisitions to drive our business model. We understand the importance of our dividends and our board of directors has shown its support by approving dividend increases in each of the last seven years. In terms of acquiring new spectrum, we will continue to be opportunistic.
Earlier this month, we signed agreements to acquire the wireless licenses of Cincinnati Bell along with some power lease. We will continue to look at the secondary markets and we will consider the opportunities in the upcoming FCC auctions.
Now let’s move into a review of the segments starting with Wireless on Slide 8. Our consistent investment in Wireless is the foundation of our success and drives our leadership in network quality, reliability and the overall customer experience. We will continue to build and expand our network advantage in 4G LTE.
Our focus is on deploying capital to add density to our network and deliver new services such as VoLTE and multicasting to enrich our customers’ wireless experience. Regardless of what others claim, recent national surveys from widely recognized third-party organizations confirm our leadership.
Our own dry testing which we have been doing for years shows that we consistently deliver the best customer experience market-by-market and day-by-day across the United States.
Total Wireless revenues grew to $20.9 billion, up 6.9% driven by strong service revenue growth of 7.5%. We generated $9.4 billion of EBITDA in the quarter, an increase of 11.3%. Our Service EBITDA margin in the quarter was 52.1%. There has certainly been a lot of investor attention centered on the effects of equipment monthly payment plan options for customers.
Let me be very clear and provide the financial impacts of our Verizon EDGE plans for the first quarter. As you would expect, the number of customer activations on EDGE increased sequentially and is also running ahead of our expectations. The estimated EBITDA benefit from the accounting treatment under these plans was worth about $165 million, which equates to less than 2% of total EBITDA in the quarter.
The benefit to our service EBITDA margin was approximately 90 basis points. While EDGE had a favorable effect on profitability, our results demonstrate that we delivered EBITDA growth and margin expansion over and above the benefits of equipment monthly payment plans.
Let’s now turn to a more detailed look at Wireless revenue per account beginning on Slide 9. Service revenue in the first quarter was driven by 4G smartphone adoption and tablet growth and increasing data usage. In mid of February, we introduced our More Everything plan which provides more value through simplified data allowances and more choice for customers.
In addition, we revised our monthly pricing under Verizon EDGE for customers who buy their devices on installment payments. Last week, we extended this reduced monthly pricing to customers who are currently out of contract. These pricing actions improve the customer value proposition and will help drive further penetration of 4G smartphones and tablets and stimulate usage on our very cost-effective 4G LTE network.
Retail postpaid revenue per account or ARPA grew 6.3% to nearly $160 per month in the first quarter. The lower monthly pricing under the EDGE plans had a minimal impact on ARPA this quarter.
Going forward, continued EDGE adoption will likely have a greater impact on ARPA due to the shift from service to equipment revenue. Our reduced monthly pricing for out of contract customers will also affect the rate of service revenue growth over time. We ended the quarter with 35.1 million postpaid accounts and connections per account grew to 2.77 up 3.7% from a year ago.
More Everything plan adoption continues and we ended the quarter with 50% of postpaid accounts on these shared data plans. The majority of these accounts are in data tiers of 4 gigabytes or higher and usage continues to drive migration to the higher data tier.
Let’s take a closer look at connections growth on Slide 10. In the first quarter, postpaid gross adds totaled 3.6 million, up 4.1%, about 56% of our gross adds were smartphones and 33% were tablets and other internet devices.
Retail postpaid churn was 1.07%, up six basis points year-over-year. On a net basis, we added 549,000 new retail connections in the first quarter. Postpaid net adds were 539,000 and prepaid were 10,000. At the end of March, we had 103.3 million total retail connections.
Our industry-leading postpaid connections base reached 97.3 million and prepaid totaled just over 6 million. The first quarter postpaid add mix included 866,000 4G smartphones and a record 634,000 tablets. We also had 56,000 other connected device adds primarily home phone connects.
These additions were offset by net declines in basic and 3G smartphones resulting in a negative total phone net adds. Our postpaid upgrade rate was 6.5% in the quarter; more than 88% of these upgrades were smartphones.
Consistent with our plan to drive smartphone penetration and 4G adoption, about 1.5 million or 27% of our smartphone upgrades were from basic phones. More than 50% of the remaining smartphone upgrades were 3G to 4G which we monetized through higher data usage and lower cost to serve.
Next, let’s turn to Slide 11 and take a look at device sales and our progress on 4G LTE. Postpaid device activations which include both gross adds and upgrades totaled 9.9 million, an increase of 2%. We have 7.6 million smartphone activations, of which nearly 90% were 4G.
Smartphone penetration increased to 72% of our total phones. We ended the quarter with 61.3 million smartphones and about 64% of those were 4G. So we still have about 22 million 3G smartphones and a little more than 23 million basic phones in our base which provides us with a good opportunity to move customers upgrade 4G smartphones.
We had our best tablet quarter ever, activating 814,000 postpaid tablets, virtually all of which were 4G. This is more than double the amount from the first quarter last year and about 3% more than the fourth quarter.
Our postpaid tablet base now stands at 4.3 million, so again, we have a great opportunity to expand this category and generate growth in 2014 and beyond. Overall, 4G device penetration continues to steadily increase. At the end of the first quarter, 49% of our retail postpaid connections were 4G, up from 28% a year ago.
Data and video usage on our network continues to rise; currently about 73% of our total data traffic is carried on the 4G LTE network. We will continue to focus on expanding our network advantage, investing to add density and to optimize our 4G LTE network ensuring that customers are receiving the quality and consistent reliability they expect from our network.
Let’s move next to our Wireline segment starting with the review of our consumer and mass markets’ revenue performance on Slide 12. In the Consumer business, we continue to see positive revenue trends driven by FiOS.
For the last seven quarters, Consumer revenues have grown in excess of 4%. In the first quarter, Consumer revenues were up 6.2% mass markets which include small business grew 4.9%.
FiOS now represents about 74% of Consumer revenue and we are sustaining strong double-digit growth. In the first quarter, FiOS consumer revenue grew 14.6% driven by customer additions, pricing actions and quantum penetration. About 51% of our FiOS internet customers subscribe to Quantum which speeds ranging from 50 megabits to 500 megabits per second.
We continue to focus on adding quality customers and generating profitable growth. Residential broadband and video are very competitive markets and we continue to be disciplined in rational in our approach to customer acquisitions. In Broadband, we added 98,000 new FiOS internet customers in the first quarter and now have 6.2 million subscribers representing just under 40% penetration.
Overall, net broadband subscribers in the quarter were a positive 16,000. In FiOS video, we added 57,000 new subscribers in the quarter. Total FiOS video customers reached 5.3 million representing 35% penetration. We also continue to make steady progress with fiber migration.
During the quarter, we converted about 78,000 customers from copper to superior fiber technology. This network initiative is important as we systematically reduce our dependence on older technologies. We’ve begun to see the benefits from a maintenance perspective in what was one of the worst winters in recent memory in the Northeast.
Aside from maintenance savings and improvements in customer satisfaction, conversions to fiber also provide a long-term opportunity for customers to purchase FiOS services which will result in additional recurring revenues.
Let’s turn to Slide 13 and review our overall Wireline segment revenue and profitability. In the Enterprise space, we continue to work through secular and economic challenges. In the first quarter, Global Enterprise revenue declined $164 million or 4.4%. Revenue declines in Legacy Transport Services and CPE continue to outweigh growth in newer applications which are smaller in scale.
Strategic Services which include Private IP, Ethernet, Datacenter, Cloud, Security and Managed Services, grew 1.8%. This category includes some revenue from the public sector where we continue to experience revenue pressure.
In general, Enterprise customers continue to be more focused on improving their cost structure rather than investing for growth which creates top-line pressure for us. In our Global Wholesale business, quarterly revenues declined $108 million or 6.4%.
While we had healthy demand in Ethernet services in the quarter, it was not enough to offset the impact of technology migration, price compression and other secular challenges.
From an overall Wireline perspective, total operating revenues were down 0.4%, EBITDA was $2.2 billion, up 3.4% resulting in an EBITDA margin of 22.3% for the quarter. Our strategic investments in network technology enable us to deliver reliable and high quality services and solutions to consumers, small businesses and enterprise customers.
As we scale these key products and services, they will improve our overall revenue mix and drive further operating efficiency. We are focused on network operating efficiency through improvements in service provisioning and dispatch and repair rates. We remain confident in our ability to increase Wireline EBITDA and expand the margin in 2014. Our financial performance in the first quarter was a good start.
Let’s move next to our summary slide. We are off to a strong start with a 4.8% increase in consolidated revenues and a 160 basis points EBITDA margin expansion. We continue to post high-quality double-digit adjusted earnings growth and have a strong cash position with full access to growing wireless cash flow.
We are on track to achieve our revenue growth, margin expansion and capital spending targets for the year. We have good momentum in Wireless and expect to build on that strength driving further penetration of devices, and extending our leadership position in 4G LTE.
In FiOS, we expect to drive higher penetration in existing markets, and continue to differentiate ourselves with the superior broadband products and are recently introduced FiOS Quantum TV service.
In the Enterprise space, we will continue to aggressively market key platforms, demonstrating that we have the unique set of capabilities to provide customer solution. We remain focused on cost structure improvements, to drive productivity and operating efficiencies throughout the entire business utilizing our Verizon Lean Six-Sigma principles.
With that, I will turn the call back to Mike, so we can get to your questions.
Michael Stefanski
Thank you, Fran. David, we are now ready to take the questions.
Earnings Call Part 2:
