Verizon Communications Inc. (VZ) Q2 2013 Earnings Call July 18, 2013 8:30 AM ET
Michael Stefanski - SVP, Investor Relations
Fran Shammo - EVP & CFO
Phil Cusick - JPMorgan
Jason Armstrong - Goldman Sachs
John Hodulik - UBS
Simon Flannery - Morgan Stanley
Michael Rollins - Citi Investment Research
Mike McCormack - Nomura
Jennifer Fritzsche - Wells Fargo
Brett Feldman - Deutsche Bank
David Barden - Bank of America Merrill Lynch
Tom Seitz - Jefferies
Amir Rozwadowski - Barclays
Tim Horan - Oppenheimer
Good morning and welcome to the Verizon second quarter 2013 earnings conference call. [Operator instructions.] It is now my pleasure to turn the call over to your host, Mr. Michael Stefanski, senior vice president, investor relations.
Thanks, operator. Good morning, and welcome to our second quarter 2013 earnings conference call. This is Mike Stefanski, and I’m 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 available on our website later today.
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.
Before Fran takes you through the details, I would like to make you aware of a non-operational item included in the quarterly results. For the second quarter, we reported earnings of $0.78 per share on a GAAP basis. These results include $147 million after tax, or $0.05, for the favorable effect of an interim actuarial remeasurement associated with one of our pension plans, due to settlement accounting.
The noncash credits were due primarily to an increase in the discount rate assumption used to determine our current pension liability. On an adjusted basis, EPS was $0.73, compared with $0.64 a year ago.
Our discussion of consolidated results and growth rates in this presentation exclude the effect of the nonoperational gain. In addition, the quarterly growth rates disclosed in this presentation are on a year-over-year basis, unless otherwise noted as sequential.
With that, I will now turn the call over to Fran.
Thanks, Mike. Good morning everyone. Our strategic investments in 4G LTE, FiOS, global IP, and cloud services continue to drive strong operating performance. We are executing well in these key growth areas.
Overall, consistent top line growth, along a strong focus on cost efficiency and profitably, resulted in double-digit growth in operating income and earnings per share in the second quarter. In fact, we have posted double digit earnings growth in five of the last six quarters.
Second quarter adjusted EPS was $0.73, up 14.1%. Year to date, adjusted earnings per share were $1.41, representing 14.6% growth. As you know, our strategy focus is on building networks and platforms as the foundation for innovation and growth.
Underpinning our success is the consistent investment in these networks and platforms, which position us to take advantage of growth opportunities in the rapidly evolving wireless and wireline markets for broadband, video, and cloud services.
Operationally, we are focused on increasing value by delivering products and services to customers in the most efficient and effective way possible. In wireless, our Share Everything plans are a great example. We have simplified decisions for customers, making it easy to add new devices and manage their shared data usage.
Our FiOS Quantum offer, where customers can upgrade broadband speeds themselves, is another example of improving service quality and increasing operational efficiency. Throughout the entire business, there are many examples where Verizon Lean Six Sigma principles are being adopted, and we are realizing efficiency gains in a number of areas, including customer care, supply chain, and system support.
As we move through the year, we are confident that successful execution in our key strategic areas will continue to drive incremental revenue and promote operating efficiency, resulting in sustainable growth in free cash flow and earnings.
Let me shift now to our second quarter performance, hitting a few highlights. Our wireless results were strong, once again effectively balancing growth and profitability. We added 941,000 retail post-paid connections, up nearly 40% sequentially. Service revenue grew more than 8%, EBITDA growth was up double digits, and our EBITDA service margin was 49.8%, solidly within our annual margin guidance.
We also had a strong quarter of customer and revenue growth in FiOS. Revenues were up nearly 15%, and we added 161,000 new subscribers in FiOS internet and 140,000 in FiOS video, roughly 20% more than we added in the second quarter last year.
In global enterprise, strategic services revenue grew 4.8%. Our consistent operating performance, together with disciplined capital spending, is driving higher free cash flow. Through the first half of the year, free cash flow increased by more than 20%, resulting in an improving return on investment profile for the entire business.
Now let’s take a brief look at consolidated results, starting with slide four. Total operating revenue grew 4.3%, sustaining our solid top line growth performance. For the quarter, the increase in consolidated revenues, coupled with effective cost management, resulted in 11.8% growth in adjusted operating income.
On an adjusted basis, consolidated EBITDA increased to $10.5 billion, and our EBITDA margin expanded by 90 basis points to 35.1%. Now let’s move into a review of the segments, starting with wireless on slide five.
We have emphasized that consistent investment in wireless drives our leadership in network quality, reliability, and the overall customer experience. Our commitment to 4G LTE covers a wide range of activities, including the securing of necessary spectrum, the allocation and deployment of capital for both coverage and capacity, our leadership in fostering a robust device and application ecosystem, and the success of our Share Everything plans in driving device adoption and stimulating usage.
Once again, our second quarter wireless results demonstrate the effective execution of this strategy. Total wireless revenues grew to $20 billion, representing 67% of Verizon’s consolidated revenue. We sustained strong service revenue growth of 8.3%, making it the third consecutive quarter of growth in excess of 8%. EBITDA increased to $8.5 billion, and our EBITDA service margin expanded by 80 basis points year over year to 49.8%, representing another very strong quarter of growth and profitably.
Let’s now turn to a more detailed look at wireless revenue per account, beginning on slide six. Service revenue growth continues to be driven by increasing connections, smartphone penetration gains, and data usage. The simplicity and value proposition of our Share Everything plans is driving device adoption and stimulating higher usage, resulting in increases in both the number of devices and revenue per account.
During the second quarter, retail post-paid service revenue per account, or RPA, grew 6.4% to $152.50 per month. We have 35 million post-paid accounts, and the average connection per account increased to 2.7, up 5.5%.
Our Share Everything plans have been very successful. The plans have been available since June 28 of last year, and customer adoption has been very strong. In just one year, more than 36% of our post-paid accounts are on a Share Everything plan. The value proposition is simple and straightforward, and customers increasingly recognize the value of shared data across multiple devices.
Let’s take a closer look at connections growth on slide 7. As I highlighted earlier, we added 941,000 new retail post-paid connections, up from 677,000 in the first quarter, and about 6% higher than a year ago. We also added 97,000 retail prepaid connections, so our retail net connections totaled just over 1 million in the quarter.
As I stated on our last earnings call, we expect to continue to see sequential quarterly net add improvement in 2013. Total retail connections topped the 100 million mark in the quarter. Our industry-leading post-paid base stood at 94.3 million, and we have more than 5.8 million prepaid connections.
Our connections growth was driven by another strong quarter of gross additions. Postpaid gross adds of 3.6 million were up 14.2% year over year. The number of customer upgrades also increased by sequentially and year over year, with a postpaid upgrade rate of 7% for the quarter. We continue to expect that our annual upgrade rate will be about the same as last year. Our upgrades remain high quality, with 36% of customers purchasing a smartphone for the first time.
We also maintained a high quality mix within our postpaid net adds. We added 472,000 in the phone category. Of this total, 974,000 were smartphones, with the balance representing the decline in basic phones. We added 371,000 internet devices, including tablets. The balance of just below 100,000 included Home Phone Connect, Home Fusion, and other connected devices.
Our churn metrics continue to be market-leading. Retail postpaid churn was 0.93%. The sequential improvement was due primarily to an expected reduction in involuntary churn, as discussed coming out of the first quarter.
Next, let’s turn to slide eight and take a look at device sales and our progress in 4G LTE. Postpaid device activations totaled 10.1 million in the quarter, representing both a sequential and year over year increase. We had a high quality device mix once again, with 88% of the activations being phones.
Smartphone activations totaled 7.5 million, and 72% of them were 4G LTE. The smartphone mix was fairly balanced; roughly 51% of the activations were iPhones. Our smartphone penetration continued to improve, and we ended the quarter at over 64%. We had another strong quarter for internet devices. Activations of these devices, which include mobile hotspots, jet packs, and tablets, topped 1 million again this quarter.
Adoption of 4G LTE smartphones and devices continued to accelerate. One-third of our retail postpaid connections are now 4G LTE, compared to just 12% one year ago. 46% of our smartphones, and more than two-thirds of our internet devices are 4G LTE. Currently, 59% of our total data traffic is carried on the 4G LTE network, which is five times more efficient than the 3G network.
In terms of geographic coverage, we now cover 500 U.S. markets with 4G LTE, and have essentially completed our buildout by matching our 3G footprint. Our LTE network covers more than 99% of our 3G footprint, and when you include our rural America partners, LTE is available to about 301 million across the nation.
Throughout the rest of this year, we will continue to invest, adding capacity to our existing 4G coverage, ensuring that customers are receiving the quality and consistent reliability that they expect from our network and devices. I will cover our capital spending outlook in more detail during our discussion of cash flows.
Let’s move next to our wireline segment, starting on slide nine. Our wireline investments and platforms, such as FiOS, global IP, security, cloud services, and machine-to-machine, enable us to deliver the services and leading-edge applications and solutions that customers want. As these services scale, they will become increasingly efficient, and will help improve our cost structure in the long run.
Total wireline revenues decreased 2% in the second quarter, as growth in FiOS and strategic services were offset by softer global enterprise and wholesale revenue from legacy transport services and CPE.
In terms of wireline segment margin, second quarter EBITDA increased to $2.2 billion, and the margin was 22.2%, up 80 basis points sequentially. We continue to believe we can improve the wireline segment margin in 2014. Let’s take a closer look at the revenue components, starting on slide 10.
In the consumer and mass markets business, we continue to see positive signs, highlighted by sustained FiOS revenue growth. Consumer revenues grew 4.7%, driven by FiOS, which now represents 71% of consumer revenue. Our overall consumer monthly RPU increased 9.4% to more than $109, and we sustained a blended FiOS RPU at over $150 per month.
Two-thirds of our FiOS customers are triple play, which have a higher amount of recurring revenue per month. As I highlighted earlier, we had a good quarter of FiOS customer growth. In terms of broadband, we had 161,000 new FiOS internet additions and now have 5.8 million subscribers, representing penetration of 39%.
Overall, net broadband subscribers were a positive 45,000. In FiOS video, we added 140,000 new subscribers in the quarter, bringing our total to 5 million, which is over 34% penetration.
In addition to the customer growth and increased penetration, we are also gaining traction with our FiOS Quantum offers for higher broadband speeds. Sales of our FiOS internet product, at speeds in excess of 50 MB per second, increased during the quarter, and existing customers continue to buy up in the speed. At the end of the quarter, one-third of FiOS internet customers subscribed to Quantum, with speeds ranging from 50 to 300 MB per second.
We continue to make steady progress with copper migrations, increasing the number of service upgrades each quarter. During the second quarter, we converted more than 86,000 customers. Through the first half, our total was 169,000, so we are more than halfway to our target of 300,000 for the year.
This network evolution initiative is important for us as we reduce our dependency on older technologies. Aside from the maintenance expense savings, and improvements in customer satisfaction, conversions to fiber also provide customers the opportunity to purchase FiOS services, which could result in additional RPU over time.
Another positive result in the quarter was the steady improvement in our residential connection trends. Retail residential connections declined by 5.2%, compared with a loss of 6.6% at this time last year. We expect that continued strength of FiOS, the copper migration initiative, and the benefits of labor contracts and work rule flexibility will have a positive effect on wireline profitably this year.
Let’s move to our enterprise markets next, on slide 11. In the second quarter, global enterprise revenue declined $184 million, or 4.8%. CPE sales, which were down 34% year over year, represented $162 million of the decrease. Excluding the decline in CPE, global enterprise revenue was down less than 1% on a year over year basis.
Strategic services, which now comprise 57% of enterprise revenue, grew 4.8%. In the second quarter, the continued decline in legacy transport services more than offset the growth in strategic services.
We continue to work through economic challenges in the enterprise space. Many of our customers are focused on improving their cost structure, which can result in reduced services with us. In addition, many customers continue to be cautious regarding new investment decisions.
Moving next to global wholesale, quarterly revenues declined $141 million, or 7.7%, due primarily to continued declines in the transport services. Again, our strategy is to better monetize our global IP and fiber network by driving a more efficient migration to next-generation Ethernet services.
In terms of profitably, while growth in the enterprise strategic services is improving the revenue mix, volume declines in the rest of global enterprise and wholesale continue to put pressure on wireline margins. Through our Verizon Lean Six Sigma program, we are making good progress in our cost restructuring programs and retooling efforts, which we believe will improve our operating efficiency.
Let’s turn to slide 12 for a discussion of our cash flow results. Our cash generation remained very strong. For the first half of this year, cash flows from operations increased by 12%. Free cash flow was up by more than 21%.
Capital expenditures for the quarter totaled $4 billion and were $7.6 billion year to date, up 2.5%. Wireless capital spending in the second quarter totaled $2.3 billion. Through the first half, wireless capex totaled $4.3 billion, 8.6% higher than last year.
As I noted earlier, we have essentially completed our initial LTE buildout by matching our 3G footprint. Throughout the rest of the year, we will continue to invest by adding capacity to our existing coverage as we begin to deploy AWS spectrum throughout the network.
In wireline, capital expenditures totaled $1.5 billion in the quarter and $2.9 billion year to date, which was down 5.9% from last year. Strong connections growth, driven by 4G LTE, and our Share Everything plans, has resulted in higher demand forecasts and a need for increased capital investment.
As such, we are increasing our full year capital spending outlook from flat at $16.2 billion to between $16.4 billion and $16.6 billion. We remain focused on improving investment returns and capital efficiency, and we continue to expect our capex to revenue ratio for the full year to improve, even with the additional investments in 4G LTE.
Our balance sheet and credit metrics remain very strong. Total debt at the end of the second quarter was just under $50 billion, and our net debt to adjusted EBITDA ratio was about 1.2x. Let’s summarize on slide 13.
Our second quarter results showed consistently good performance in the key strategic growth areas, so at the halfway point, the key year to date financial and operating metrics are strong: consolidated revenue growth of 4.2%; operating income up 15.6%; adjusted earnings of $1.41 per share, representing 14.6% growth.
In wireless, service revenue growth up a very strong 8.4%; average revenue per account up 6.7%; retail post-paid additions of 1.6 million, up 16.5%; EBITDA growth of 14%, and an EBITDA service margin of 50.1%. We are on track to deliver on our 49-50% margin guidance for the full year.
In wireline, consumer revenue growth of 4.5%, driven by FiOS growth of nearly 15%, 349,000 subscribers in FiOS internet, and 309,000 in FiOS video. We are on track to meet our 600,000-plus FiOS customer growth target.
Free cash flow generation is up better than 20% year over year, and our balance sheet remains very strong. All in all, a very good first half. We are now focused on continuing the momentum, which should result in a strong second half of the year.
With that, I will turn the call back to Mike, so we can get to your questions.
Fran, thank you. Operator, we’re now ready to take questions.
Earnings Call Part 2: