Verizon Annual Report Evaluation

A merger in 2000 between Bell Atlantic Corporation and GTE Corporation formed the present corporation known as Verizon Communications Incorporated with July 3, 2000 its first day of trading on the New York Stock Exchange. The logo, VZ, “was selected because it uses the two letters of the Verizon logo that graphically portray speed, while also echoing the genesis of the company name: veritas, the Latin word connoting certainty and reliability, and horizon, signifying forward-looking and visionary”.

The reasoning behind the merger was to blend two very successful companies into one which would have “the scale and scope to compete as one of the telecommunications industry’s top-tier companies” (Verizon, nd). Based on the company’s 2006 and 2007 annual reports, they are meeting the initial goal behind the merger decision. With that being said, let us examine a variety of information extracted from the annual report to get a more accurate picture of the company’s financial health.

To do so will require a review of the financial statements found in the financial performance section of the annual report: the balance sheet, the income statement, the statement of retained earnings and the statement of cash flows. The different ratios use different criteria so it is important to first determine your objective in order to know which ratio would give the information needed to make a more accurate assessment.

For example, liquidity ratios give a picture of the company’s “ability to meet short-term financial obligations” whereas asset management ratios are a picture of the company’s use of their assets “to generate sales” (Moyer, McGuigan, Rao, 2007). In other words, the liquidity ratio gives us a picture of the level of risk if Verizon needed to immediately pay its short-term bills, debts which normally must be paid in one year or less. Current ratio is determined by current liabilities into current assets. In 2006 Verizon reported a total of $32,380 million in current liabilities and $22,538 million in current assets.

Based on those figures, the current ratio for 2006 would be 0. 70 or $0. 70 in current assets for every $1 in liabilities. In 2007 current liabilities was reported to be $24,741 million and $18,698 million in current assets which equates to a current ratio of $0. 756 or rounded up to $0. 76, indicating assets of $0. 76 for every $1 in liabilities. Current Ratio 20062007 (in millions)(in millions) Current Assets22,53818,698 Current Liabilities32,28024,741 Current Ratio0. 700. 76 National Averages 1. 1 to 41 to 4. 1 Figure 1 Current Ratio / National Averages

The industry average for 2006 ranged for companies with assets up to $25 million ranged from a low of 1. 1 to a high of 4. In 2007 the industry average ranged from a low of 1 to a high 4. 1. Verizon’s current ratios for both years were lower than the national average which could indicate an investment into Verizon could be considered risky but to get a better picture, let us look the “acid test” as Moyer, et al. (2007), referred to the quick ratio. The current liabilities into current assets minus inventory will provide the quick ratio. Verizon’s quick ratios were 1. 2 for 2006 and 1. 11 for 2007. The national averages for 2006 ranged from 0. 6 to 1. 7 and 0. 7 to 1. 2 for 2007. Based on the national averages, Verizon’s quick ratio was within the national averages and therefore is beginning to look less risky than when looking at the current ratio. Quick Ratio 20062007 (in millions)(in millions) Current Assets22,53828,698 Marketable Securities2,4342,244 Accounts Receivable10,89111,736 Current Liabilities32,28024,741 Quick Ratio1. 321. 11 National Averages0. 6 to 1. 70. 7 to 1. 2 Figure 2 Quick Ratios / National Averages

Figure 3 2005 – 2007 Current & Quick Ratio Chart (ADVFN Financials, 2008) The next group of ratios are referred to as asset management ratios which give a picture of how well the company is utilizing its resources to produce sales. Resources are the company’s inventory, equipment, property, and receivables. This picture allows anyone from the investor to the Chairman of the Board to see if the company is managing what assets they have or if adjustments are required. Inventory turnover ratio is the average inventory into cost of sales.

Verizon’s figures for 2006 and 2007 were relatively steady. The 2006 ratio was near the median while 2007’s figures were nearer the lower range rather than median. This could possibly Inventory Turnover Ratio 20062007 (in millions)(in millions) Cost of Sales35,30937,547 Inventories (beginning + ending / 2)1,5181,621. 50 Inventory Turnover Ratio23. 2623. 16 (rounded up) National Averages12. 7 to 45. 62. 1 to 212. 9 Figure 4 Inventory Turnover Ratio / National Averages indicate either too much inventory or, at the least, inventory is not moving as quickly as anticipated.

Keeping an eye on this ratio over a period of time will help the investor make a decision regarding “the company’s ability to manage inventory while attempting to increase sales” (Spireframe Software, 2008). Debt ratio is total assets into total debt. This figure shows the percentage of “total assets … financed with creditor’s funds” (Moyer, et al. , 2007) Based on this information, Verizon is financing a little over 70% of their debt and is remaining fairly steady although there was a slight increase in financing in 2007 compared to 2006 and definitely above the national average.

These numbers gives an investor some concern since it puts the company at risk in case of a slow economy. A decrease in debt ratio generally indicates either the company “may be paying off its short-term debt or possibly refinancing its short-term debt into long-term debt” but it serves the investor well to watch the situation to determine whether or not “they are reducing the total value of the long-term debt” (Spireframe Software, nd). As an investor, I am beginning to wonder if this company is a good investment or if it is too risky. Debt Ratio 20062007 (in millions)(in millions) Total Debt140,274136,378

Total Assets188,804186,959 Debt Ratio74. 2%72. 9% National Averages-22. 9 to 70. 5-28. 4 to 65 Figure 5 Debt Ratio / National Averages The next three ratios to be examined are considered profitability ratios, figures which show the company’s ability to make “investment and financing decisions” or “how effectively a firm’s management is generating profits on sales, total assets, and, most importantly, stockholders’ investment”, (Moyer, et al. , 2007). Net profit margin ratios is sales into net income, a reflection of how well sales have done once you take expenses out of the equation.

Net Profit Margin Ratio 20062007 (in millions)(in millions) Net Income6,1975,521 Sales88,18293,469 Net Profit Margin Ratio0. 0700. 059 National Averages-3. 7 to 6. 5-20. 8 to 3. 9 Figure 6 Net Profit Margin Ratio Again the figures show Verizon’s ratio is better than the lower national average but is not better than the national average. This again makes the investor wonder if buying Verizon’s stock would be too risky. Return on investment (ROI) ratio tells us the firm’s proportion of net income to the total asset investment. The income that an investment provides in a year” (InvestorWords, nd) is another way to look at it. Naturally, as an investor, one wants a higher ROI ratio. Return on Investment (ROI) 20062007 (in millions)(in millions) Net Income6,1975,521 Total Assets18,804186,959 ROI Ratio0. 330. 030 (rounded up) National Averages-9 to 15. 3-67 to 5. 1 Figure 7 Return on Investment (ROI) Ratio / National Averages Verizon has not done as badly as nor better than the national averages. If there is a positive to it, it is that Verizon has not had negative figures. Although the ROI ratio is very low, it is still a positive number.

The return on stockholders’s equity, also referred to as “return on equity” is the “rate of return that the firm earns on stockholders’ equity” (Moyer, 2007). This tells us “how well the company used reinvested earnings to generate additional earnings … used as a general indication of the company’s efficiency” (InvestorWords. com, nd). The stockholders provide the resources with their investments and this ratio shows if the company is using this resource wisely and in a manner which earns additional monies for both the stockholders and the company.

Return on Stockholders’ Equity (ROE) 20062007 (in millions)(in millions) Net Income6,1975,521 Stockholders’ equity48,53550,581 ROE Ratio0. 1280. 109 National Averages1. 8 to 45. 3-13. 4 to 28 Figure 8 Return on Stockholders’ Equity / National Averages It seems Verizon is not using their resources wisely when compared to the national averages. Granted, Verizon’s ratios are positive numbers but the 2006 ratio is well below the lower national average ratio which indicates the company could do a better job of using the stockholders’ equity to generate more income. As Moyer, et al. ndicates, the aforementioned ratios were based on information contained in the accounting income statement and balance sheet and “serve as ‘flags’ indicating potential areas of strength or weakness”. Other financial ratios which should be considered are market-based ratios. “The market-based ratios for a firm should parallel the accounting ratios of that firm”. Higher risk will mean a lower stock price for that company. Price-to-earnings ratio is determined by current earnings per share into market price per share. Another, very simple, definition is “the p/e ratio is the price an investor is paying for $1 of the company’s earnings.

In other words, if a company is reporting basic or diluted earnings per share of $2 and the stock is selling for $20 per share, the p/e ratio is 10” (Kennon, nd). Price-to-Earnings (P/E) Ratio 20062007 (in millions)(in millions) Market price per share37. 25 43. 69 Current earnings per share2. 131. 91 P/E Ratio(rounded up)17. 49 22. 874 Figure 9 Price-to-Earnings (P/E) Ratio Now that we looked at the basic ratios, it is time to go a step further in our analysis. Working capital is the current assets, $18,698 million, minus current liabilities, $24,741 million.

Based on Verizon’s information, its working capital is -$6043 million. This calculation tells me the company does not have adequate working capital to fund current or future projects. This also means that Verizon would not be able to pay off its short-term liabilities with its current assets (cash, accounts receivable and inventory). Based on this information, it would seem Verizon is not using its operating cash as well as it could. However, there are other factors to consider before making a final decision regarding this issue. Verizon has been making major changes in their cost-structuring.

Additionally, the company has recently began implementing a new network which resulted in higher-than-normal operating costs but have not yet realized any of the projected savings. The company is also anticipating installation costs to decrease as the new network becomes available to more customers. The merger with MCI is reflected in the lower amount of current assets. The company also lost access lines to their competition which again resulted in loss of profit. So, between the merger, new network project and other projects-in-progress, the working capital figure makes more sense.

I would have to say I do believe the company is doing well with its working capital and expect to see higher numbers at this time next year. The below chart lists the company’s long-term debt, maturity dates and the yield-to-maturity: Long-term DebtInterest RatesMaturities2007 (dollars in millions)2006 (dollars in millions) Notes payable4. 00 – 8. 232008-203714,92314,805 Telephone Subsidiaries – debentures4. 63 – 7. 002008 – 203310,58011,703 7. 15 – 7. 632012 – 20338501,275 7. 85 – 8. 752010 – 20311,6791,679 Other subsidiaries – debentures6. 46 – 8. 52008 – 20282,4502,977 Employee stock ownership plan loans – NYNEX debentures9. 5520107092 Capital lease obligations (avg rate 6. 8% and 8. 0%)312360 Unamortized discount, net of premium-97-106 Total long-term debt, including current maturities30,76732,785 Less: debt maturing w/in one year-2,564-4,139 Total long-term debt 28,20328,646 Figure 10 Long-term Debt Verizon’s annual report indicates they are anticipating $5,781 to be paid on long-term debt within the next three years. Weighted Average Cost of Capital (WACC): 136,378 / 1,53888. 6723 .046 x 0. 580. 02668 88. 6723 x 0. 026682. 365777 3. 22231 2. 65777 WACC – 20075. 588087 2006 100,478 / 1,56464. 24425 1. 62 / 37. 250. 04349 84. 301 x 0. 038222. 793978 140,269 / 1,56489. 68606 .053 x 0. 580. 03074 88. 6723 x 0. 026682. 75695 2. 793978 2. 75695 WACC – 20065. 550927 The weighted average cost of capital tell the company how much it has to earn with the current assets in order to pay its debts. It is calculated taking all capital from common and preferred stock, bonds and all other long-term debt. Since all the assets are going to be financed by “debt or equity … the WACC is the average of the costs of these sources of these sources of financing. This basically tells us the amount of interest Verizon is paying for every dollar it finances. With that being the case, Verizon paid approximately $5. 55 in interest for every dollar it financed. In 2007 that figure increased to $5. 59 (rounded up from $5. 588). So if in 2007 it had to pay $5. 59 for each dollar financed, it also means that was the amount of the “overall required rate of return”. This figure also allows the board to look at whether or not future projects would be feasible. As stated earlier, Verizon has been making major changes in their cost-structuring.

Additionally, the company has recently began implementing a new network which resulted in higher-than-normal operating costs but have not yet realized any of the projected savings. The company is also anticipating installation costs to decrease as the new network becomes available to more customers. The merger with MCI is reflected in the lower amount of current assets. The company also lost access lines to their competition which again resulted in loss of profit. Even though the ratios do not necessarily support my decision as an investor, I would buy this company’s stock.

As the annual report states, the board acted to decrease the total debt “by $5. 2 billion, due to repayments of approximately $1. 7 billion of Wireline debt, including the early repayment of previously guaranteed $300 million 7% debentures issued by Verizon South, Inc. and $480 million 7% debentures issued …. ”. There was a major move to reduce debt and moved ahead with major projects which have not shown income as of yet. So, regardless of what the ratios indicate, based on other factors, I do believe this would be a good investment.

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