How did the MCI acquisition change Verizon's financial profile in 2006?

The MCI merger, which closed January 6, 2006, is the main driver of the 26.8% increase in consolidated revenue to $88.1 billion. Wireline revenue rose 35.0% to $50.8 billion, and Verizon Business gained a new enterprise and wholesale franchise. Headcount rose to 242,000 from 206,000. Management cited synergy savings and about 9,200 wireline headcount reductions, but the acquisition also brought higher depreciation, amortization of about $14.5 billion in total, and roughly $1.2 billion of integration and severance-related charges.

Why did net income decline even though operating income increased?

Operating income rose 6% to $13.4 billion, but net income fell 16% to $6.2 billion. The main reasons are higher minority interest expense ($4.0 billion versus $3.0 billion, mostly Vodafone's 45% share of Verizon Wireless), a $541 million after-tax loss on the Verizon Dominicana sale, and special charges including merger integration costs of $232 million and severance of $425 million. Equity earnings also increased, but not enough to offset these items.

What are the main risks and uncertainties for investors?

Key risks include intensifying competition from cable, VoIP and wireless substitution that continues to reduce wireline access lines; the Broadcom ITC case, where an exclusion order could disrupt supply of Qualcomm EV-DO handsets to Verizon Wireless; a likely first-quarter 2007 loss on CANTV after Venezuela's nationalization; ongoing litigation over alleged government surveillance cooperation; the pending $2.8 billion FCC AWS spectrum investment that must be deployed; and a $5.7 billion Verizon Wireless-related Vodafone put option exposure, with a $10 billion put window in 2007. Regulatory outcomes on intercarrier compensation and UNE pricing are also pending.

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

Operating cash flow of $24.1 billion covered capital expenditures of $17.1 billion, with the remainder used for debt reduction and shareholder returns. Debt fell by $1.9 billion in 2006 and the debt-to-capital ratio improved to 42.8%. The company had no bank borrowings at year-end, about $6.2 billion of unused credit lines, and ratings of A3 (Moody's), A (S&P, negative outlook) and A+ (Fitch). Pension and postretirement obligations rose sharply, with a $6.9 billion equity reduction from adopting SFAS 158. Shareholder returns included $4.7 billion in dividends and $1.7 billion in buybacks.

What is the outlook for dividends and capital returns?

Management recommended maintaining the dividend at no less than the level in place before the Idearc spin-off, which equals $0.405 per quarter ($1.62 annually, or about $4.8 billion). It plans to continue share repurchases at levels similar to 2006, when Verizon bought back $1.7 billion. The board authorized repurchases of up to 100 million shares through February 2008, with 49.9 million remaining at year-end.

VZ 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 1, 2007. Cited figures are marked; the original filing is the authoritative source.

Verizon's 2006 Form 10-K (filed March 1, 2007) shows a company transformed by the January 2006 MCI acquisition.

Consolidated operating revenues rose 26.8% to $88.1 billion^a, driven by Wireline growth of 35.0% (to $50.8 billion, including MCI) and Domestic Wireless growth of 17.8% (to $38.0 billion). Operating income grew modestly to $13.4 billion from $12.6 billion, while net income fell to $6.2 billion ($2.12 diluted EPS) from $7.4 billion, weighed down by a $541 million after-tax loss on the sale of Verizon Dominicana, higher minority interest expense of $4.0 billion (mostly Vodafone's 45% share of Verizon Wireless), and $1.4 billion of pension and postretirement expense. Diluted EPS from continuing operations was $1.88 versus $2.16 in 2005.

Balance sheet and cash flow improved. Total debt fell to $36.4 billion^b from $38.3 billion, helped by the Idearc spin-off, which removed roughly $7 billion of debt and delivered about $2 billion in cash, and by the Dominicana sale. The debt-to-capital ratio dropped to 42.8% from 49.1%.

Operating cash flow reached $24.1 billion, and cash and equivalents rose to $3.2 billion^c. Capital expenditures rose to $17.1 billion, and 2007 guidance is $17.5 to $17.9 billion. Verizon also repurchased $1.7 billion of stock and kept the dividend at $0.405 per quarter.

Key forward-looking items include the pending FairPoint spin-off of Maine, New Hampshire and Vermont access lines (about $2.7 billion^d in value), the expected TELPRI sale (about $900 million), a likely first-quarter 2007 loss on the CANTV investment after Venezuela's nationalization move, and the Broadcom ITC case, which could restrict Qualcomm EV-DO handset supply. FiOS passed more than 6 million homes and reached 207,000 TV customers, and Verizon Wireless ended the year with 59.1 million customers.

02—Key points

Key Highlights

Revenue grew 26.8% to $88.1 billion, primarily from the MCI acquisition (closed January 6, 2006) and 17.8% growth at Domestic Wireless.
Net income declined to $6.2 billion ($2.12 diluted EPS) from $7.4 billion ($2.65), reflecting a $541 million after-tax loss on the Verizon Dominicana sale, higher minority interest ($4.0 billion), and higher pension and benefit costs.
Total debt was reduced to $36.4 billion from $38.3 billion, and the debt-to-capital ratio improved to 42.8% from 49.1%, aided by the Idearc spin-off that removed about $7 billion of debt.
Operating cash flow rose to $24.1 billion, and capital spending increased to $17.1 billion, with 2007 guidance of $17.5 to $17.9 billion.
Verizon Wireless added 7.7 million customers to reach 59.1 million, with ARPU of $49.80 and data revenue up 99.5% to $4.5 billion; churn improved to 1.17%.
FiOS passed more than 6 million homes and added 517,000 data connections; the company reports 7.0 million broadband lines in service, up 35.7%.
Portfolio actions continue: a pending FairPoint access-line spin-off valued at about $2.7 billion, a TELPRI sale expected to yield about $900 million, and a likely Q1 2007 loss on CANTV after Venezuela's nationalization MOU.

03—Questions

Frequently Asked Questions

How did the MCI acquisition change Verizon's financial profile in 2006?
The MCI merger, which closed January 6, 2006, is the main driver of the 26.8% increase in consolidated revenue to $88.1 billion. Wireline revenue rose 35.0% to $50.8 billion, and Verizon Business gained a new enterprise and wholesale franchise. Headcount rose to 242,000 from 206,000. Management cited synergy savings and about 9,200 wireline headcount reductions, but the acquisition also brought higher depreciation, amortization of about $14.5 billion in total, and roughly $1.2 billion of integration and severance-related charges.
Why did net income decline even though operating income increased?
Operating income rose 6% to $13.4 billion, but net income fell 16% to $6.2 billion. The main reasons are higher minority interest expense ($4.0 billion versus $3.0 billion, mostly Vodafone's 45% share of Verizon Wireless), a $541 million after-tax loss on the Verizon Dominicana sale, and special charges including merger integration costs of $232 million and severance of $425 million. Equity earnings also increased, but not enough to offset these items.
What are the main risks and uncertainties for investors?
Key risks include intensifying competition from cable, VoIP and wireless substitution that continues to reduce wireline access lines; the Broadcom ITC case, where an exclusion order could disrupt supply of Qualcomm EV-DO handsets to Verizon Wireless; a likely first-quarter 2007 loss on CANTV after Venezuela's nationalization; ongoing litigation over alleged government surveillance cooperation; the pending $2.8 billion FCC AWS spectrum investment that must be deployed; and a $5.7 billion Verizon Wireless-related Vodafone put option exposure, with a $10 billion put window in 2007. Regulatory outcomes on intercarrier compensation and UNE pricing are also pending.
How strong is Verizon's balance sheet and cash generation?
Operating cash flow of $24.1 billion covered capital expenditures of $17.1 billion, with the remainder used for debt reduction and shareholder returns. Debt fell by $1.9 billion in 2006 and the debt-to-capital ratio improved to 42.8%. The company had no bank borrowings at year-end, about $6.2 billion of unused credit lines, and ratings of A3 (Moody's), A (S&P, negative outlook) and A+ (Fitch). Pension and postretirement obligations rose sharply, with a $6.9 billion equity reduction from adopting SFAS 158. Shareholder returns included $4.7 billion in dividends and $1.7 billion in buybacks.
What is the outlook for dividends and capital returns?
Management recommended maintaining the dividend at no less than the level in place before the Idearc spin-off, which equals $0.405 per quarter ($1.62 annually, or about $4.8 billion). It plans to continue share repurchases at levels similar to 2006, when Verizon bought back $1.7 billion. The board authorized repurchases of up to 100 million shares through February 2008, with 49.9 million remaining at year-end.

04—Continue

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