Why did reported net income drop so sharply in 2002 despite rising operating income?

Operating income rose to $15.0 billion, but net income fell to $4.1 billion in 2002 from $11.8 billion in 2000 and $389 million in 2001 was depressed by investment write-downs. Verizon recorded about $6.2 billion of pretax losses on investments in Genuity, CANTV, TELUS, MFN and others, plus $1.3 billion of after-tax severance and pension charges and a $496 million cumulative-effect charge for goodwill accounting. Tax benefits of about $2.1 billion partly offset these losses. Note that 2002 operating income also benefited from $2.7 billion of net asset-sale gains that are not recurring.

How is the wireline business performing, and what is the outlook?

Domestic Telecom revenue fell 3.3% to $40.7 billion. Local service revenue declined 5.4% because of lower demand, mandated intrastate price reductions, technology substitution to wireless and broadband, and a 3.7% drop in switched access lines. Offsetting trends include data transport (special access and DSL) growth and long distance gains, with long distance now offered in 47 states. Management expects continued pressure from competition and regulation, and it is cutting costs (about 18,000 fewer employees in 2002) to protect margins. Pension income is also expected to decline by $0.30 to $0.32 per share in 2003.

What is the Verizon Wireless opportunity and what are the main obligations tied to it?

Domestic Wireless is Verizon's fastest-growing segment, with revenue up 10.7%, segment income up 80% to $966 million, and 32.5 million customers. Verizon owns 55% of the joint venture; Vodafone owns 45%. Vodafone can require Verizon or Verizon Wireless to buy up to $20 billion of its interest between 2003 and 2007, with up to $10 billion exercisable in summer 2003 or 2004. This is a material potential cash or stock obligation. Verizon also agreed to buy Northcoast spectrum licenses for about $750 million, expected to close in the first half of 2003, and withdrew the planned Verizon Wireless IPO in January 2003.

How strong is the balance sheet and cash generation?

Operating cash flow of $22.1 billion comfortably funded $12.0 billion of capital expenditures and $4.2 billion of dividends. Verizon used asset-sale proceeds and cash to cut total debt by about $11.6 billion, reducing the debt-to-debt-plus-equity ratio to 62.4% from 66.4%. Short-term borrowings fell sharply, with commercial paper dropping from $12.8 billion to $2.1 billion. Moody's cut the long-term rating to A2 in December 2002 and S&P moved its outlook to stable in February 2003. Capital spending guidance for 2003 is $12.5 to $13.5 billion, including capitalized software.

What are the biggest risks investors should monitor?

Key risks include regulatory outcomes on unbundled network elements, access charges, Internet traffic compensation and long-distance entry in Maryland, West Virginia and D.C., which the FCC was due to act on by March 19, 2003. Competitive erosion from wireless and cable substitution threatens wireline revenue. Credit exposure to WorldCom (about $2.1 billion of 2002 revenue, $300 million of net receivables) and to telecom investees could lead to further write-downs. Equity-market and currency exposure remains significant, including $5.2 billion of exchangeable notes sensitive to TCNZ and C&W share prices. Finally, the Vodafone put on the wireless joint venture could require substantial cash or stock.

VZ 10-K FY2002 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 14, 2003. Cited figures are marked; the original filing is the authoritative source.

Verizon Communications' 10-K for fiscal 2002 shows a company with a large, cash-generative core business under pressure from wireline erosion, offset by growth at Verizon Wireless.

Consolidated operating revenues rose 0.6% to $67.6 billion^a, and operating income climbed 30% to $15.0 billion, though the increase is flattered by $2.7 billion of net gains on asset sales, primarily the sale of about 1.27 million non-strategic access lines. Domestic Telecom revenues fell 3.3% as local service declined 5.4% amid weak demand, mandated price cuts, and technology substitution. Domestic Wireless revenues rose 10.7% to $19.3 billion, with 32.5 million customers and churn improving to 2.3%.

Net income was $4.1 billion^b ($1.49 per diluted share), down from the prior year's depressed level but well below 2000's $11.8 billion. The gap reflects roughly $6.2 billion of pretax investment-related losses, principally write-downs of Genuity, CANTV, TELUS and MFN, plus $1.3 billion of severance and pension charges and a $496 million cumulative-effect accounting charge. Operating cash flow was strong at $22.1 billion, capital spending fell to $12.0 billion, and total debt was reduced by about $11.6 billion, lowering the debt-to-capital ratio to 62.4% from 66.4%.

The dividend was held at $1.54^c per share. Investors should weigh the quality of earnings.

Gains from asset sales and tax benefits on investment losses flatter reported results, the wireline business is shrinking, and Verizon faces a potential cash call of up to $10 billion^d in 2003 or 2004 under the Vodafone put option on its wireless joint venture stake. Regulatory uncertainty around unbundling, access charges and long-distance entry, and WorldCom's bankruptcy exposure (about $2.1 billion of 2002 revenue from WorldCom) remain key risks.

02—Key points

Key Highlights

Consolidated operating revenues rose 0.6% to $67.6 billion; Domestic Wireless grew 10.7% to $19.3 billion while Domestic Telecom fell 3.3% to $40.7 billion.
Operating income rose to $15.0 billion from $11.5 billion, but included $2.7 billion of net pretax gains on asset sales, mainly the 2002 sale of 1.27 million access lines to CenturyTel and ALLTEL.
Net income was $4.1 billion ($1.49 per diluted share) versus $389 million in 2001, after roughly $6.2 billion of pretax investment-related losses (Genuity $2.9 billion, CANTV $1.4 billion) partly offset by $2.1 billion of tax benefits.
Operating cash flow was $22.1 billion; capital expenditures fell to $12.0 billion from $17.4 billion, and free cash flow funded $11.6 billion of debt reduction.
Verizon Wireless ended 2002 with 32.5 million customers, churn of 2.3%, and average revenue per customer of $48.35; 88% of subscribers were on CDMA digital service.
Wireline access lines declined 3.7% in 2002, with local service revenue down 5.4%, while DSL lines reached 1.79 million (up over 50%) and long distance customers reached 10.4 million.
Vodafone holds a put on up to $20 billion of its Verizon Wireless interest (up to $10 billion exercisable in summer 2003 or 2004), a significant potential cash or stock obligation; the dividend was held at $1.54 per share.

03—Questions

Frequently Asked Questions

Why did reported net income drop so sharply in 2002 despite rising operating income?
Operating income rose to $15.0 billion, but net income fell to $4.1 billion in 2002 from $11.8 billion in 2000 and $389 million in 2001 was depressed by investment write-downs. Verizon recorded about $6.2 billion of pretax losses on investments in Genuity, CANTV, TELUS, MFN and others, plus $1.3 billion of after-tax severance and pension charges and a $496 million cumulative-effect charge for goodwill accounting. Tax benefits of about $2.1 billion partly offset these losses. Note that 2002 operating income also benefited from $2.7 billion of net asset-sale gains that are not recurring.
How is the wireline business performing, and what is the outlook?
Domestic Telecom revenue fell 3.3% to $40.7 billion. Local service revenue declined 5.4% because of lower demand, mandated intrastate price reductions, technology substitution to wireless and broadband, and a 3.7% drop in switched access lines. Offsetting trends include data transport (special access and DSL) growth and long distance gains, with long distance now offered in 47 states. Management expects continued pressure from competition and regulation, and it is cutting costs (about 18,000 fewer employees in 2002) to protect margins. Pension income is also expected to decline by $0.30 to $0.32 per share in 2003.
What is the Verizon Wireless opportunity and what are the main obligations tied to it?
Domestic Wireless is Verizon's fastest-growing segment, with revenue up 10.7%, segment income up 80% to $966 million, and 32.5 million customers. Verizon owns 55% of the joint venture; Vodafone owns 45%. Vodafone can require Verizon or Verizon Wireless to buy up to $20 billion of its interest between 2003 and 2007, with up to $10 billion exercisable in summer 2003 or 2004. This is a material potential cash or stock obligation. Verizon also agreed to buy Northcoast spectrum licenses for about $750 million, expected to close in the first half of 2003, and withdrew the planned Verizon Wireless IPO in January 2003.
How strong is the balance sheet and cash generation?
Operating cash flow of $22.1 billion comfortably funded $12.0 billion of capital expenditures and $4.2 billion of dividends. Verizon used asset-sale proceeds and cash to cut total debt by about $11.6 billion, reducing the debt-to-debt-plus-equity ratio to 62.4% from 66.4%. Short-term borrowings fell sharply, with commercial paper dropping from $12.8 billion to $2.1 billion. Moody's cut the long-term rating to A2 in December 2002 and S&P moved its outlook to stable in February 2003. Capital spending guidance for 2003 is $12.5 to $13.5 billion, including capitalized software.
What are the biggest risks investors should monitor?
Key risks include regulatory outcomes on unbundled network elements, access charges, Internet traffic compensation and long-distance entry in Maryland, West Virginia and D.C., which the FCC was due to act on by March 19, 2003. Competitive erosion from wireless and cable substitution threatens wireline revenue. Credit exposure to WorldCom (about $2.1 billion of 2002 revenue, $300 million of net receivables) and to telecom investees could lead to further write-downs. Equity-market and currency exposure remains significant, including $5.2 billion of exchangeable notes sensitive to TCNZ and C&W share prices. Finally, the Vodafone put on the wireless joint venture could require substantial cash or stock.

04—Continue

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