Verizon Communications Inc.
Q1 2007 Earnings Call Transcript

Published: 30 Apr 2007

[Operator:]

Good morning and welcome to the Verizon first quarter 2007 earnings conference call. (Operator Instructions) It is now my pleasure to turn the call over to your host, Mr. Ron Lataille, Senior Vice President, Investor Relations of Verizon.

[RonLataille:]

Good morning and welcome to our first quarter 2007 earnings conference call. Thanks for joining us this morning, I'm Ron Lataille. With me this morning are Ivan Seidenberg, our Chairman and CEO; Denny Strigl, our President and Chief Operating Officer; and Doreen Toben, our Chief Financial Officer. Before we get started, let me remind you that our earnings release, financial statements, the investor quarterly publication and the presentation slides are on the investor relations website. This call is being webcast. If you would like to listen to a replay, you can do so from our website. 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. A discussion of factors that may affect future results is contained in Verizon's filings with the SEC, which are available on our website. This presentation also contains certain non-GAAP financial measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are also on our website. Before turning the call over to Doreen for a review of our results, I would like to cover the differences between reported and adjusted earnings for the first quarter. Reported earnings per diluted share were $0.51. Adjusted earnings, or EPS, before the effects of special items were $0.56. The special items which we are excluding from adjusted results are as follows

[Doreen Toben:]

Thanks, Ron and good morning, everyone. As you'll see, our first quarter results show that we're off to a strong start in 2007. The improving trends we saw in the fourth quarter of 2006 continue this quarter, with top line adjusted revenues growing 6.5% year over year, operating income increased 19.5% and double-digit growth in adjusted EPS from continuing operations. It is clear that organic growth is accelerating across our broadband, mobile and global IT networks, and it's showing up in the top line. At the same time, we continue to transform our cost structure and drive profitable growth. As Ron mentioned earlier, the acquisition of MCI was completed early in the first quarter of 2006. So let's look at consolidated revenues on a pro forma basis on slide 4. Again, the revenue growth trends are strong. Consolidated revenues grew 5.4%, or $1.2 billion, year over year. These results were driven by continued strong wireless revenue growth of 17%, and growth in both the consumer and large business markets; excellent top line growth in all areas of the business. We also successfully turned these accelerating revenues into profitable growth. Consolidated operating income margins expanded to 17.3%, an increase of 110 basis points sequentially and 210 basis points year over year. Wireless profitability was very strong, as operating income increased to $2.7 billion, up 29% from first quarter last year. We continue to focus on controlling costs, as cash expense per customer was under $28. We also saw some improvement in wire line operating income margins. Operating income increased 6.8% year over year, due in part to a 1.7% decline in cash expenses. We see many new opportunities to further reduce costs. In our centralized services organization, which was just recognized as the best new shared services organization by a leading industry trade group, we made some early progress achieving sourcing and procurement savings with vendor contracts. We see further opportunities in real estate consolidation, supply chain logistics, customer call center productivity and several initiatives to leverage building common platforms across the business. As you know in wireless, our retail customer results demonstrate that we have the number one brand. We added more than 1.6 million retail net adds, increasing our retail customer base to 58.5 million, or 96.3% of total. Retail postpaid customers grew 1.5 million to 56.1 million. Customer loyalty remains very strong, with retail churn of 1.08% and retail postpaid churn of only 0.89%, continuing our industry leadership. Retail growth adds increased 8.8% compared with the same quarter last year, with nearly two-thirds of these sales coming from direct channels. Turning to slide 7, total service revenues grew 18% in the first quarter, with retail service ARPU of $50.73, up 2.8% year over year. The 2.8% was the highest quarterly growth rate we've seen for the past two years. Our sustained growth in service revenues is driven by increased data usage as well as customer growth. In fact, about 50% of the growth in service revenues is from data. Data revenues now account for more than 17% of total service revenue, up from 11% a year ago. 36 million of our retail customers are now data users, and retail data ARPU grew more than 54% year over year to $8.95. Almost 60% of our data revenue growth comes from services other than messaging. In fact, about 39% of retail data revenues came from business applications like Internet access and email, where revenues more than doubled year-over-year. Our customers also completed 106 million downloads of music, videos, games, ringtones, ringback tones and exclusive content this quarter. You can expect us to continue enhancing our data capabilities and offer new products and services to take advantage of the data opportunities that will increasingly drive growth. As you can see on slide 8, total quarterly revenue of $10.3 billion was up 17% year over year. EBITDA of 4 billion grew 17.6%. EBITDA margins should continue in the 43% to 45% range, even as we maintain industry-leading growth. Our first-quarter margin was 44.3%. Verizon Wireless continues to lead the industry in retail customers, total revenue, customer loyalty and profitability. We've been doing a lot of things to sustain our leadership by differentiating ourselves from the competition. Some examples

[RonLataille:]

Thanks, Doreen. Ivan, Denny and Doreen are now available to take questions.

[Operator:]

(Operator Instructions) Your next question comes from John Hodulik - UBS.

[John Hodulik:]

Thanks, good morning. On the FiOS, could you talk about how you expect dilution from FiOS to proceed going through the year, and whether you're sticking to your original guidance from last quarter? Also, talk about the cost side, what kind of progress you're making in terms of both the capital and the expense side. Consumer ARPU was quite a bit stronger than we thought this quarter. I know there's some price increases associated with that, and a lot of it driven by FiOS. Could you talk about how you expect that to proceed going forward? Does it go up from here, or is the bulk of the increase coming from the price side? Thanks.

[Denny Strigl:]

First of all, on the FiOS dilution, let me talk about FiOS overall. We had a really good quarter in growth. We think that the growth that we've seen in this quarter is sustainable. There is no change in our guidance on FiOS dilution. We expect dilution will improve in the second quarter and, as we have said before, overall this year will be in the mid $0.30 range. Looking at the cost side, your question on costs, we're making some good progress in improving productivity. I would say that's across the board. We're seeing improvements in our cost to pass, our cost to connect, and we're also reducing the time that we're spending in the home. Some of this comes from the time and motion studies that we have done to better understand the key drivers. We've done a significant amount of work on those key drivers. We've introduced some timesaving technologies like MOCA. We have software tools to quickly help configure the PCs and the TVs in the home. We're also doing some very simple improvements like time out of the garage, inventory levels and so forth, and this has helped us overall.

[Doreen Toben:]

I might just add some more color. John, we gave you cost-per-pass targets of 700 in 2010 and connect of 650. The numbers we gave you last quarter of 800 for passing and 842 for connecting; I think what we said is I'm not going to give them to you every quarter anymore because we're getting so close to where we need to be. We've made great improvements from both of those numbers from '06, and we're not that far away from the targets.

[John Hodulik:]

On the ARPU side? The consumer ARPU, the growth, how do you expect that to proceed going through the year?

[Denny Strigl:]

Our expectation is that we will see continued growth in the ARPU side, driven by customers just buying bigger packages. We've seen that where we have been established in the markets for some period of time.

[Doreen Toben:]

Clearly, in the states where we have FiOS in particular, the ARPUs have come up significantly. As we increase penetration with DSL and with FiOS and with satellite TV, you would expect that those ARPUs should continue to increase.

[Operator:]

Your next question comes from Chris Larsen - Credit Suisse.

[Chris Larsen:]

I'm actually going to follow-on with that, Denny. You nearly doubled the number of FiOS video solutions sequentially. How do you balance the land grab that's out there? Isn't there a case to be made to push on faster and grow more on the video side, and let the dilution stay where it is? You're doing nearly 2,000 installs a day. How fast can your installers go? What's the gating factor? How high could we see that number going? High-speed data was up modestly sequentially, but it was down year over year. Do you have a sense for your share of high-speed data subs relative to your cable competition?

[Denny Strigl:]

Let me comment on your second question first. We feel very good about our first-quarter Internet net adds. The first quarter is usually seasonally lower, but overall, broadband adds were very good. The penetration increased in the first quarter to 16% on the Internet side. What I would say about the service is everybody loves the service, the speed, the quality, and the reliability. We are now focused, as Doreen said in her comments, on the triple play. I think we've got some very good upside going forward. Looking specifically on the point of taking share, we could comment a bit on what we have done in Texas in some of our more advanced markets. We think we're getting very good share there. Our Texas rate, I think, is in the 34%, so I think we're doing very well.

[Chris Larsen:]

The balance of the dilution, and how fast can you grow the video installs?

[Denny Strigl:]

I think at this point we're growing about as fast as we can. Obviously, we have a focus on the capital costs. So we're doing a balancing act of growing out the bill plan and as quickly as we can, penetrating the market that we've passed.

[Operator:]

Your next question comes from David Barden - Banc of America Securities.

[David Barden:]

Looking at the wireline side of the business, if business is growing mostly in the 5% range and the legacy businesses are growing in the 1% to 2% range, it would seem that really the only big anchor on the wireline business right now is maybe the legacy MCI consumer and mass-market business. I was wondering if you could maybe speak to the issue of how big is that business now? At what rate is it declining? Also, with respect to the old UNE-P lines that MCI had, is that really driving the line loss year-over-year? The second part of that was, just from the surge in strength we saw in the first quarter, is that a first quarter specific variable with a lot of the new products and a lot of the new wins you've had? Or are we looking at a trajectory of growth emerging for the rest of the year in the enterprise segment? Thanks a lot.

[Doreen Toben:]

The old MCI business, mass-market, small business and consumer is going down about 30% to 32% a quarter, so it's a very big drag on the business, as you would imagine. I don't have the number in front of me, but it's around 700 million, 750 million going down, as I said, 30%. So it is, as you said, the consumer legacy, old consumer, because of the ARPU and the volumes, is now actually growing. The small business is growing at the market rate, and you've got the enterprise customers growing. So, it really is the big negative, as you said, the mass-market. What was the second part of the consumer question?

[David Barden:]

There was a UNE-P element to that old MCI business, and how that was dragging on the overall line performance.

[Doreen Toben:]

That is certainly dragging. You can define the old MCI mass market in different ways. You could have left it as a UNE-P, because in fact it is a UNE-P. We actually chose to put them in retail because we consider them a retail customer. So, when you look at our wholesale number, the UNE-P losses don't appear there; they actually appear in our retail numbers.

[Denny Strigl:]

As I had mentioned at the end of the last quarter, our objective is to lose less lines this year. We've not backed off from that objective at all. We continue to look for ways to retain and win back lines. Our bundles with wireless and some of the things that Doreen talked about in her opening comments, I think, lead us to that

[David Barden:]

That's helpful. Just on the enterprise side, whether we're seeing a trend, or is this a first quarter surge?

[Denny Strigl:]

By the way, on that line loss side, I would say you guys may have us modeled at about 2.1 to 2.2 million loss and our goal is, clearly, to beat that substantially. On the small business market, we're seeing that we are growing at about the market rate, about the 5% level. I believe our number was about 4.7%. We do believe that we are recognized as the market leader in that space. The differentiator that we have is on the basis of reliability and quality. We also have a dedicated sales team and we think a very good product portfolio. We are using FiOS, in addition to DSL where it's available, as a primary focus on retention.

[Doreen Toben:]

On the enterprise side, Dave, we would not see it as an anomaly. We would expect, as we said last year, to continue to see enterprise growth throughout the year, and continues to be really strong. We've been real pleased with the sales so far, the sales channel is full. We continue to see growth in enterprise.

[Operator:]

Your next question comes from Mike McCormack - Bear Stearns.

[Mike McCormack:]

On enterprise again, could you just give us a little more detail or color on how far along we are on the contract repricing schedule from some of the old contracts from legacy MCI? Also, AT&T was mentioning some concerns around mix shift, and customers moving away from traditional products to IP and the pressures that creates on revenue; just your thoughts on that. Lastly, it looked like there was a change there in D&A on the wireline side. Can you give us a little more detail there? Thanks.

[Denny Strigl:]

I'm not sure, Mike, about the D&A on the wireline side.

[Mike McCormack:]

Down from historical levels there. I don't know if there's a change in lifetime of the plant or something else that we're missing. It just seems like with higher CapEx you should have a higher number there.

[Doreen Toben:]

I'll take the first part, and then we'll see who wants to do the enterprise. On the depreciation side, what I would say is we look at technical updates, we look at assets, plants, the reserve ratios. We do this every year, and we also benchmark against our peers. As you would expect, the FiOS depreciation is really high because they're putting new plants in. However, as we look at some of our reserve ratios, they were extremely high, which means we would have been out of some of the equipment in periods that were too short. So we made some changes. I don't think they're anything major from the depreciation piece. You want to do enterprise, Denny?

[Denny Strigl:]

On the question about the contracts, I would say two things. First of all, we are seeing stabilization on prices for a lot of our product portfolio. Secondly, we are seeing customers going after longer term contracts. What have typically been three-year contracts we're now seeing customers asking for five-year contracts. So we think that those are both very positive trends. On the IP conversion, we have done this conversion over the period of the last year or so, and we think that we're in good standing with our conversion to IP.

[Doreen Toben:]

We think that in general, in the past, the contracts have been three-year so through '06 we are down through to one year through '07, sort of through the second year. So, we have a vast amount of contracts that are now behind us.

[Operator:]

Your next question comes from Simon Flannery - Morgan Stanley.

[Simon Flannery:]

If I could turn to the wireless sector please. Great results, again, on the adds and on the ARPU side. Can you talk a little bit about the competitive conditions, the move to unlimited messaging and pressure on handset pricing? One of your competitors is talking about a big swing in net adds in Q2. Are you seeing any changes in the marketplace that would lead to changes in your ability to take share out there in the marketplace? Any updated thoughts on 700 MHz, particularly in terms of timing? Thanks.

[Denny Strigl:]

Simon, we are not seeing any impacts that are coming from some of these all you can eat pricing packages. As Doreen had mentioned, we're pleased with the strength of our wireless brand. We are appealing to a large and different slice of the market than what these unlimited plans appeal to. So, we don't discuss our pricing strategy, but I would tell you that we have not seen any impact. You can see that, incidentally, in our local number portability rates

[Operator:]

Your next question comes from David Janazzo - Merrill Lynch.

[David Janazzo:]

Good morning. This question relates to Vonage and the litigation, the ongoing litigation. What's your objective in that process, and in your desire to protect your intellectual property does this apply to other voice over IP providers, namely the cable companies?

[Ivan Seidenberg:]

The way we look at this is that we always seek to protect our intellectual property across the board in all our businesses. We think we had a particularly good case here in the Vonage with the three patent violations. Actually, when you look at it, not only was the judge there, but a jury found there were violations. So I think what we need to do is now that we have an appeals schedule working, which has accelerated, and there's also some sanctions on royalty accruals that they have to keep so I think that the best thing at this point the lawyers advise me is let's work through the appeal process. We think we have a strong case. Once we get the final disposition of this, we'll be in a position to decide the next step. I do think it's fair to say that all of these issues with respect to voice over IP are different for different segments of the industry. I wouldn't draw anything general from this. But once this case is over, we'll go back to do what we always do, which is protect our intellectual property.

[Operator:]

Your next question comes from Tim Horan - CIBC.

[Tim Horan:]

Good morning. I was going to ask more of a general kind of question to you, Denny. On the wireless side, you did a great job of focusing on fundamentals. You clearly have the highest quality network and service, and it drove your market share and costs. I think, Ivan, that's been your strategy to drive the wireline business going forward. Denny, I was just kind of curious on your take; you've been in the organization on the wireline side a little while. Where do you think we're at in that process, and are there things that you can do organizationally or structurally to make the wireline business much more cost-efficient and higher quality on a relative basis? Or is it just continuing to improve on the margins with what you're doing with FiOS and on the enterprise side? Thanks.

[Denny Strigl:]

The answer is yes, and those programs are underway. Ivan and I share the conviction of high growth in our wireline business, as in our wireless business. We think that our first quarter results show that we have that well underway.

[Tim Horan:]

Are there any major changes you have to make organizationally on the wireline front? Do you think they are going to have most of the pieces in place?

[Ivan Seidenberg:]

I think Denny might be a little bit too modest here. I think when we look at what we've done in the last six months we've made a lot of organizational changes. I think that rather than make the changes, the we have identified the strategy and started executing this to put some people in place. Under Denny, we have, in addition to the three operating unit heads, we have three other positions

[Operator:]

Your next question comes from Tom Sykes - Lehman Brothers.

[Tom Sykes:]

On the FiOS side, could you just give us an update on how the MDU equipment is progressing and any updates on state-wide approvals? On the wireless side, I was wondering if in first quarter '08 there is any sort of material opportunity to improve margins related to the analog shutdown? Last question, can you remind us when your union contracts are up and how many states are impacted? I totally understand this isn't a forum that you want to talk in depth about that, but any sort of general comments related to the pre-negotiation would be appreciated. Thanks.

[Denny Strigl:]

Tom, let me start off with your question on the state coverage for our video approvals and also the MDUs. Looking at the states where we have statewide approval now

[Ivan Seidenberg:]

The union contracts, you need to think about this as a continuum. We've had contracts expire and ratify over the last couple years across the country. So, the issue is this is an ongoing process. We have a big chunk of them that expire in August of '08 and so we have plenty of time to work through that. So, that's the status of that.

[Tom Sykes:]

The last question was the analog shutdown.

[Doreen Toben:]

You're on the wireless side, right?

[Tom Sykes:]

Yes.

[Doreen Toben:]

I think we'll stay with our guidance on wireless margin at this point, and we'll see what '08 brings us.

[Operator:]

Your next question comes from Jonathan Chaplin – JP Morgan.

[Jonathan Chaplin:]

On the wireless side, I'm wondering if you could talk a little bit about subscriber acquisition costs. One of your competitors had mentioned that they'd seen some fairly aggressive discounting on the handset side, and was concerned that subscriber acquisition costs would creep up during the course of the year. Secondly on the DSL side, backing out the phenomenal growth you guys are seeing in FiOS data, it looks like the DSL product is beginning to slow. I'm wondering if that's a marketing decision, you're just deemphasizing that product, or whether it's an industrial condition that we're getting close to saturation in some parts of the market. Thanks.

[Denny Strigl:]

Looking first of all at the wireless cost of acquisition side, we will not comment on cost of acquisition. But I would ask you to focus on our margins. We have said our margins can be between 43% and 45%. We're sticking to that guidance. Of course, a significant piece of our overall cash flow margin is cost of acquisition, among other things. We too see handset competition. But by the way, throughout the course of any year that I recall, prices of handsets have ranged anywhere from zero to $400. So, at this point I can't say that we are really concerned about cost of acquisition other than a look at our margin projections. Relative to the DSL side of the business, DSL churn was at the lowest level we've seen during the first quarter. Just to go a little step further, our FiOS Internet churn is below 1.5%. So we are certainly not seeing churn as an issue in our territory.

[RonLataille:]

Operator, I'd like to now turn the call over to Denny Strigl for some concluding remarks.

[Denny Strigl:]

Ron, thank you. Thank you, everybody, for joining us. I would like to just summarize a couple of things that we have said in our call this morning. First, on the telecom side of the business, the first quarter revenue results reflect a strong turnaround in revenue for the consumer segment. What drove the turnaround, we believe, was the significant increase that Doreen talked about in ARPU, which more than offset the impacts of our consumer access line losses throughout the quarter. We expect this trend to continue, and it will lead to sustainable organic growth and validates the benefits of our FiOS strategy. As you heard, our ARPU growth is at a high for us at 8.5%. But also, as we mentioned, our Texas market, which is the most mature market we have, we're seeing ARPU growth of 20% and we're seeing other areas with double-digit ARPU growth as well. Also in telecom, we have programs in place to improve our access line losses. We have an aggressive win-back strategy in place, and we have begun to see some improvements in the later part of the first quarter. On Verizon business, just a couple of concluding comments. Our first quarter results reflect a continuation of the operational trends that we had established throughout 2006. We have good strategic services revenue growth, market share gains, and good contract stabilization. In addition, we've seen our international retail unit grow, and that, of course, is consistent with our strategy to focus on multinational companies. As mentioned, we have price trends that we've seen some stabilization over the past several quarters and our customers are showing a willingness to engage in longer-term contracts. Of course, both of those very good signs for our enterprise market. Finally, in Verizon Wireless, in the first quarter we continued our long-term trend of delivering stellar results. We've clearly separated ourselves from the rest of the industry, both in terms of growth performance and our business model. Wireless continues to take share across the board, as evidenced by our local number portability rates and our leading customer loyalty, as you see in our churn rates. We are also very pleased with the ARPU increase that we saw in wireless and we think, in part, that's a reflection upon our focus on the music business. Digital music, for us, is comprised of full songs, ringtones, ringback tones and we had 30 million paid downloads in the quarter. Finally, we believe we our track record in wireless is sustainable, and we're confident that we can maintain EBITDA margins in the 43% to 45% range. So overall, at the end of the first quarter, we believe that we're well positioned for the remainder of the year to produce some solid revenue growth.

[RonLataille:]

Operator, that concludes our call. Thanks, everybody, for joining us today.