Why did reported net income more than double in 2004?

Net income rose to $7.8 billion from $3.1 billion mainly because 2003 included roughly $5.5 billion of pretax severance and pension charges and a $1.0 billion pretax loss on the Iusacell sale. 2004 benefited from the $787 million pretax gain on the TELUS stake sale, the $1,017 million pretax gain on Verizon Information Services Canada (discontinued operations), and a $204 million MCI claim credit. Investors should separate these non-recurring items from the core operating trend.

Is Verizon's wireline business still growing?

Not on a total-revenue basis. Domestic Telecom revenues declined 2.7% in 2004, with local services down 4.8% due to access line losses from competition, wireless substitution, and UNE pricing rules. Growth came from long distance (up 10.4%) and DSL (3.6 million lines, up 53.5%), which are offsetting but not yet fully replacing traditional voice revenue.

What does the MCI acquisition mean for shareholders?

The February 2005 agreement would combine Verizon with MCI using a mix of Verizon common shares and cash, and Verizon would assume MCI's net debt, subject to adjustment. The filing cites regulatory approvals targeted in about a year, possible downgrades of Verizon's debt ratings by Standard & Poor's and Moody's, and the risk that another company may bid for MCI. Shareholder dilution, integration costs, and the revenue synergies that management expects are key items to evaluate.

How strong is Verizon's balance sheet and cash generation?

Operating cash flow was $21.8 billion in 2004, down from $22.5 billion, and capital expenditures were $13.3 billion, leaving substantial but reduced free cash flow after the $4.3 billion dividend. Total debt fell to $39.3 billion, the debt-to-capital ratio improved to 51.1% from 57.6%, and the company had about $5.8 billion of unused bank credit lines. Verizon reported compliance with all debt covenants.

What regulatory risks could affect Verizon's wireline earnings?

The FCC's February 2005 unbundling order eliminated the requirement to offer mass market local switching on a nationwide basis, with a one-year transition for existing arrangements. Other open issues include intercarrier compensation reform, access charge treatment of VoIP, universal service contribution changes, and a pending refund determination in interstate access rate investigations. Several state price-cap plans are also under review, which could further constrain local pricing.

VZ 10-K FY2004 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 14, 2005. Cited figures are marked; the original filing is the authoritative source.

Verizon Communications' 2004 10-K (filed March 14, 2005) shows a company in transition: consolidated operating revenues rose 5.7% to $71.3 billion^a, driven almost entirely by Domestic Wireless (revenues up 23.0% to $27.7 billion, with 6.3 million net customer additions to 43.8 million subscribers).

Domestic Telecom, the wireline business, continued to shrink, with revenues down 2.7%^b as access lines and switched minutes declined and regulatory pricing pressure on unbundled network elements persisted. Wireline is still the largest segment by revenue (about 54%), but wireless is now the profit engine, and Verizon Wireless is described as the most profitable U.S. wireless operator by operating income. Reported earnings were strong, but the quality of the improvement needs context.

Net income rose to $7.8 billion^c ($2.79 diluted EPS) from $3.1 billion, helped by a $787 million pretax gain on the sale of the TELUS stake, a $516 million after-tax gain on selling Verizon Information Services Canada, and the absence of the large 2003 severance charges (the 2003 voluntary separation plan cost about $5.5 billion). Operating income rose to $13.1 billion from $7.4 billion, though the 2003 base was depressed by those charges. Segment income excluding special items fell 17.6% in Domestic Telecom and 13.7% in Information Services, while Domestic Wireless segment income rose 51.9%.

Free cash flow was constrained by $13.3 billion^d of capital expenditures against $21.8 billion of operating cash flow, and total debt fell to $39.3 billion from $45.4 billion. The filing's most significant forward-looking item is the February 14, 2005 agreement to acquire MCI for a mix of Verizon shares and cash, plus assumption of MCI's net debt. The company expects regulatory approval in about a year and warned that the deal could lead to credit rating downgrades.

Other pending items include the planned $3.0 billion NextWave spectrum purchase, the $1.65 billion sale of Hawaii wireline operations, and ongoing FCC unbundling and intercarrier compensation rulemakings that could further affect wireline economics. Investors will need to weigh the wireless growth engine against continued access line erosion and the balance-sheet and integration risks of the MCI transaction.

02—Key points

Key Highlights

Consolidated operating revenues rose 5.7% to $71.3 billion in 2004, led by Domestic Wireless revenue growth of 23.0% to $27.7 billion.
Verizon Wireless added 6.3 million net customers, ending 2004 with 43.8 million subscribers, and posted average revenue per customer of $50.22 per month with monthly churn improving to 1.5%.
Domestic Telecom revenues fell 2.7% to $38.6 billion as switched access lines declined 4.6% and local service revenues dropped 4.8%, though long distance and DSL grew strongly.
Net income nearly tripled to $7.8 billion ($2.79 diluted EPS), but results include one-time gains such as the $787 million pretax TELUS sale and the $516 million after-tax gain on the Canadian directory sale.
Total debt was reduced by $6.1 billion to $39.3 billion, and the company maintained its $1.54 annual dividend per share.
In February 2005 Verizon agreed to acquire MCI for Verizon shares and cash plus assumption of net debt, with regulatory approval expected in about one year and possible credit rating downgrades flagged.
Capital spending was $13.3 billion in 2004 and is expected to rise about 10% in 2005, with the company targeting growth areas such as FiOS fiber-to-the-home, EV-DO wireless data, and VoIP.

03—Questions

Frequently Asked Questions

Why did reported net income more than double in 2004?
Net income rose to $7.8 billion from $3.1 billion mainly because 2003 included roughly $5.5 billion of pretax severance and pension charges and a $1.0 billion pretax loss on the Iusacell sale. 2004 benefited from the $787 million pretax gain on the TELUS stake sale, the $1,017 million pretax gain on Verizon Information Services Canada (discontinued operations), and a $204 million MCI claim credit. Investors should separate these non-recurring items from the core operating trend.
Is Verizon's wireline business still growing?
Not on a total-revenue basis. Domestic Telecom revenues declined 2.7% in 2004, with local services down 4.8% due to access line losses from competition, wireless substitution, and UNE pricing rules. Growth came from long distance (up 10.4%) and DSL (3.6 million lines, up 53.5%), which are offsetting but not yet fully replacing traditional voice revenue.
What does the MCI acquisition mean for shareholders?
The February 2005 agreement would combine Verizon with MCI using a mix of Verizon common shares and cash, and Verizon would assume MCI's net debt, subject to adjustment. The filing cites regulatory approvals targeted in about a year, possible downgrades of Verizon's debt ratings by Standard & Poor's and Moody's, and the risk that another company may bid for MCI. Shareholder dilution, integration costs, and the revenue synergies that management expects are key items to evaluate.
How strong is Verizon's balance sheet and cash generation?
Operating cash flow was $21.8 billion in 2004, down from $22.5 billion, and capital expenditures were $13.3 billion, leaving substantial but reduced free cash flow after the $4.3 billion dividend. Total debt fell to $39.3 billion, the debt-to-capital ratio improved to 51.1% from 57.6%, and the company had about $5.8 billion of unused bank credit lines. Verizon reported compliance with all debt covenants.
What regulatory risks could affect Verizon's wireline earnings?
The FCC's February 2005 unbundling order eliminated the requirement to offer mass market local switching on a nationwide basis, with a one-year transition for existing arrangements. Other open issues include intercarrier compensation reform, access charge treatment of VoIP, universal service contribution changes, and a pending refund determination in interstate access rate investigations. Several state price-cap plans are also under review, which could further constrain local pricing.

04—Continue

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