Verizon Communications Inc.
Q1 2009 Earnings Call Transcript

Published: 27 Apr 2009

[Operator:]

Good morning and welcome to the Verizon first quarter 2009 earnings conference call. (Operator Instructions) It is now my pleasure to turn the call over to your conference host, Ron Lataille, Senior Vice President, Investor Relations of Verizon.

[Ron Lataille:]

[Inaudible] our 2009 earnings conference call. Thanks for joining us this morning. I'm Ron Lataille. With me this morning are Denny Strigl, our President and Chief Operating Officer, and John Killian, 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. 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. Next I'd like to quickly cover the difference between reported and adjusted earnings for the first quarter of 2009. In the first quarter reported earnings per diluted share were $0.58. Adjusted earnings per share before the effects of special items were $0.63. The $0.05 per share difference is due to the exclusion of certain merger integration costs and acquisition-related charges due to their nonrecurring and/or non-operational nature. These specific income statement line item effects are detailed in the reconciliation table. Merger integration costs totaled $50 million after tax or $0.02 per share. Acquisition-related charges totaled $96 million after tax or $0.03 per share. This includes transaction costs and nonrecurring finance fees associated with the bridge loan. The finance fees include upfront and duration fees amortized over the life of the loan. I would also point out that the amortization expense related to customer lists is not part of the special items that we've normalized from adjusted results. This represented a little more than $0.01 of EPS in the quarter and should be about $0.05 for the full year. Before turning the call over to John, I'd like to make sure that you are aware that for purposes of comparability and modeling future performance we have made available on our website historical pro forma financial and metric information for the Alltel acquisition, historical Wireline revenue under the new reporting classification, and a required financial statement presentation change due to the adoption of FAS No. 160, Non-Controlling Interests in Consolidated Financial Statements. With that I will now turn the call over to John Killian.

[John F. Killian:]

Thanks, Ron, and good morning to everyone. Before I get into the review of first quarter's results I would like to provide a few opening comments. First, I would like to offer my congratulations and best wishes to Doreen Toben as she soon enters retirement. The CFO baton was passed to me less than two months ago, but I can tell you that I intend to build on the strong foundation she helped create. Like Doreen, I will be very focused on continuing Verizon's strong legacy of financial discipline, transparent reporting, stringent control requirements, and prudent risk management. One of my first priorities as CFO was to review the business plan in detail and ensure that I can help the business achieve not only this year's financial and operating targets but also the long-term goal of sustainable value creation for shareholders. As a member of Ivan's leadership council for the last few years, I can tell you that the executive team has never been more optimistic about the outlook of the business. Everyone recognizes the current economic challenges, but we remain confident in our ability to execute and to compete well. In fact, I think our first quarter results prove this point. We're also focused on improving shareholder value. As I reviewed the business plan and talked to business unit heads about their opportunities and challenges, it's clear to me that the investments in strategic changes we have made over the last several years have positioned us well for the future. It is also clear to me that we need to transition from building a competitive advantage to a model that more closely links this competitive advantage with strong and sustainable growth in earnings and cash flow. I understand that you as shareholders and prospective shareholders look for Verizon to be a market leader and to demonstrate financial and operational stability and strength. My goal as CFO is to enhance business performance and shareholder value. I feel strongly that Verizon's ability to grow cash flow and deliver a competitive dividend is an important vehicle for generating shareholder returns over the long term. As you know, it is our policy not to provide point estimate guidance on earnings and other key metrics. We believe it's more important to help investors identify the key drivers and how management thinks about growth and total shareholder returns. For example, at a conference in January Ivan discussed the outlook for 2009 and highlighted some of the headwinds expected from the economy and pension plan performance. But he felt that we were well positioned in the market and despite the headwinds we could see some earnings growth this year, and we're off to a good start in the first quarter. From a total shareholder returns perspective, management's goal was to provide shareholders consistent returns in the low double digits, driven by both earnings growth and a commitment to a strong and growing dividend. So as I look at current results, the business plan, capital allocation and potential M&A I will be asking

[Operator:]

(Operator Instructions) Your first question comes from John Hodulik – UBS.

[John Hodulik:]

[Break in audio] and about 45% for the second quarter in a row. Previously you've talked about 43% to 45% as a good range, but going forward, with a lot of the Alltel synergies still ahead of you, can we expect margins to remain above this level going forward? And then a second quick one. There's another article today about Verizon potentially getting access to the iPhone. Is that something that you expect to potentially happen before the conversion to LTE or just any color around that would be great, Denny.

[John F. Killian:]

We're very pleased with our Wireless results in the quarter. Yes, we've had a very strong focus on both growing revenue and cash flow and margins in the business. We grew service revenue in the quarter by 10.5% and we were pleased with the 46% service margin level. From my perspective the EBITDA margin target of 43% to 45% that we've had out there is really no longer that helpful. As you can see, we don't manage exactly to that particular range. We came in at 46%. You are right that we do believe Alltel will give us additional opportunities in the future as we go through this year. We don't think it makes sense to put out a new range, so I really would just focus on the overall performance in the quarter and you get the strong feeling here that we are very focused on both growth and profitability. Denny will take the iPhone question.

[Denny Strigl:]

You know, we have said in the past we're always open to discussion with any suppliers. We have no announcements to make relative to Apple today. But let me say that we historically have not been dependent on any one device. We're very well positioned with high-value customers. We believe that we have currently a strong handset lineup; you'll see more from us as the year goes on. And smart phones and PDA sales overall in the quarter were very strong at 41% of our direct device sales and at the end of the first quarter we had 19.3 million integrated devices and that's in our core - the VZW base, in other words, not counting what is in Alltel - and, of course, those integrated devices are PDAs, smart phones, other devices with a keyboard and that's double what we had in the same quarter last year. So, John, a bit more than what you asked for, but we're always to talking to suppliers.

[Operator:]

Your next question comes from Michael Rollins - Citigroup.

[Michael Rollins:]

First, I was wondering on Wireline side if you could talk a little bit more about the wholesale business in terms of maybe what some of the factors were in the step down of revenue sequentially? And then secondly I was wondering if you could talk a little bit more in detail about the opportunities for you to grow margins per your comments earlier in the call on the Wireline side and maybe just give us a sense of some of the key priorities over the next 12 to 18 months as you look to execute on that goal.

[John F. Killian:]

The wholesale business, yes, our revenue performance was down 9.2% in the quarter. FX did affect that. If you adjust out FX, we were down by about 7.4%. There are several different pieces of this business. We continued to see growth in our special access business in the quarter. The areas of the business where we saw the decline were really twofold. One was a decline we've seen before in the local wholesale business, which is really the UNEP business, so we have a decline in UNEP lines there. We're holding in pretty good on revenue per unit in that business, which is good. The second one, really, where the bigger impact was was really the carrier side of the business, which is really driven by the economy and long distance minutes in many ways. It's both a domestic and an international business. We did take some decisions, particularly on the international side, where on some of our routes we did do some price increases there. Some of that resulted in volume declines. Now to be quite candid with you, it wasn't very profitable in those particular routes and we were trying to improve the profitability there. So that gives you a good sense here in terms of the wholesale business. I think Denny's going to add a comment and then we'll come back and talk about the EBITDA margin in the Wireline business.

[Denny Strigl:]

Well, John, I was going to comment on margin. You're welcome to go ahead, please. I just had a couple of comments for Mike on the Wireline margin.

[John F. Killian:]

So, Mike, we continue to resize the business, reducing our force in areas that are not growing. And if you look, for example, in our traditional telecom business, that is non-FiOS, the work force is down by nearly 13,000 from the end of '07 through the first quarter of this year. We are in the process of consolidating our network organizations across telecom and our business groups and we expect to generate greater efficiency and productivity improvements in network planning and engineering and in our maintenance functions. In addition to that, we look continually for new technologies and training of our force to save us time and gain efficiency.

[Operator:]

Your next question comes from David Barden - BAS-ML.

[David Barden:]

Just following up on two things real quick, just on data ARPU and kind of the outlook as you see it for this year. I think we heard some comments from AT&T about drivers of slowing data ARPU, revenue growth, corporate liable subscriptions, some price downs, even some talk around the margin potentially of getting to some point of saturation in devices in the base. I think you've given us some new data there. It sounds like you guys are roughly equivalently penetrated. I wonder if you could kind of give us your thoughts about how we should think about the data ARPU trend in the current economic climate? And if I could, just returning to an earlier question on the Wireless margins, I know you guys don't want to give out a target, but philosophically you've got more firepower now from a margin standpoint with the Alltel merger done. Is the objective to focus on the cash flows and the growth year-over-year and bring those margins back to the stockholder or is it to kind of see what opportunities can be derived from deploying that margin back down into the lower 40% to kind of go out and mine the last units of market share out there?

[John F. Killian:]

Let me just start with the second part of the question and then Denny will come back on the data ARPU. You know, as you can see in the quarter, we drove to a 46% margin. We have always said our focus in this business is to drive both to growth and profitability. We're not going to limit the profitability in the business. We do have more synergies coming in. We also do believe there continues to be growth opportunities out in the marketplace. I said in my opening remarks we're very focused on shareowner returns. We have a very healthy dividend. And we will continue to be focused on that. We're also, let me just reiterate, very pleased with the cash flow in the quarter. If you look at cash flow from ops, that was up $1 billion year-over-year. With the discipline we had on CapEx, free cash flow was up $1.5 billion. We understand the importance of that and we're not going to lose focus on that.

[Denny Strigl:]

Dave, I guess I would add in this way. As John said in his opening remarks, the data ARPU was a very solid result of $14.16, up 25% year-over-year. We believe going forward that there is more penetration to be mined in data devices. We have a very robust lineup and I think we've got some good upside, particularly with the introduction of LTE and our open development initiative later this year and into next. So I think we have good data upside.

[Operator:]

Your next question comes from Simon Flannery - Morgan Stanley.

[Simon Flannery:]

You talked about the strong CapEx driving free cash flow and I think up to now your guidance has been CapEx down year-over-year before the Alltel impact, but it looks like at the moment at least you're running at a pretty significant year-over-year decline. Now that you've got a little bit more visibility do you think there's an opportunity here for sort of a 10% - 15% drop in CapEx year-over-year? And secondly, on Alltel you talked about $1 billion in synergies by the end of '10. Can you just talk a little bit more about, again, now that you've had a better look at it, what's in Q1 in terms of synergies - roaming and stuff like that - and what should we look at for the rest of '09 to come through from that?

[John F. Killian:]

I'll start with the first part on CapEx and then Denny will hit the second part of your question. We were pleased with our CapEx performance in the first quarter. We had indicated to everybody that we were going to start off this year in a disciplined fashion. Coming out of the fourth quarter no one knew how bad the economy was going to be so we thought it was prudent for us to do that. So we ran at a $3.7 billion level in the first quarter. If you annualize that you're at $15 billion for the full year. The first quarter isn't representative of the run rate for the full year. Now that being said, we have said before that our intention this year is to bring CapEx as a percent of revenue down and we will continue to be very disciplined as we go through the year. We recognize the importance that that has on our cash flow performance. We also recognize that our business is weathering the economic situation in a very strong fashion, with good growth numbers on both sides of the business, on the FiOS side and on the Wireless side. So I think you can expect some uptick from the first quarter, but again, if you look at the full year as a percent of revenue, we will be down and we are going to be very disciplined.

[Denny Strigl:]

So, Simon, then, if I may, I'll comment specifically on your point on roaming and then comment on Alltel in general. So not much roaming in the first quarter. We really have been focused on integration. So in that regard we have found no surprises with Alltel following the acquisition and our integration plans have remained on track. We've targeted synergies. They're visible; they're achievable. And they're in the order of over $9 billion in net present value and John and I are both comfortable with that number. From an operating perspective, our goal is to achieve the expense and the capital synergies as soon as we possibly can, and I think we can have a significant portion of the synergy initiatives in place by the end of this year. And then just a comment regarding the overall integration effort, we're preparing to convert former Alltel customers to our billing system over the next several months and you will see our store and overall signage changes made before the fourth quarter, in time for our holiday season selling. The bottom line for John and I is that we're on plan and we're where we discussed June of last year and we know how to integrate acquisitions and extract synergies and we're in the process of doing just that.

[Operator:]

Your next question comes from Tom Seitz - Barclays Capital.

[Tom Seitz:]

If I could, Denny, maybe I'll just follow up on the Alltel acquisition for a second. I know you want to talk about the business as a whole, but can you give us some sort of sense as to what subscriber trends were in the Alltel legacy market? They were running at roughly about a 300,000 net add run rate and I'm wondering was that a little bit lower because you were in the middle of transforming the business to the Verizon platform, a little bit higher because everybody was excited about Verizon? Just sort of some trend there. And then the second question, with respect to strategic services growth you mentioned in the remarks that consulting revenue on the managed platforms is an opportunity that you're looking at. Is that a capability you can build out internally or is this an area that we might expect you to do some sort of acquisition in a bolt-on fashion to add those capabilities?

[Denny Strigl:]

Tom, I will take the first part of your question. Looking at Alltel and actually looking at our overall results, as we've indicated, we're quite pleased with our Wireless net add results for the quarter. We do not comment specifically on any pieces of either our partners or properties that we've acquired. I would say that overall we've acquired 13.4 million Alltel customers and the Alltel properties grew during the first quarter, primarily all retail. So we feel good about what Alltel has done for us during the quarter. And, Tom, I'm going to leave it at that.

[John F. Killian:]

I'll take the second part. If you think about our enterprise business, as we've always said, it builds off the strength of the global network that we have. We believe we have the leading global IP network in place when you look at, really, the entire world, but we are focused around also building out more and more capability on the higher-margin strategic services. That includes IP; it's network services offering, our IP services. On the professional services there's a couple of different areas where we have some strength. We did make an acquisition in mid-2007 of a company by the name of Cybertrust, who brought a number of professional service individuals to us with particular expertise in security but also in the IT area. Through some reorganization within the enterprise group we've added to some of those capabilities. It's actually a very good time in the marketplace to get skill sets there. And not really additive to the total force, but as we've changed out some of the force we have had the opportunity. We also look here to partnerships so, you know, we announced and Denny mentioned late last year or maybe it was the first quarter the relationship with have with Accenture and we will continue to explore other kinds of partnership vehicles to get that done.

[Operator:]

Your next question comes from Mike McCormack - J.P. Morgan.

[Mike McCormack:]

On the enterprise side, can you give us, John, maybe a little more sense on the trends, maybe domestic versus international, with respect to economic impact - obviously there's an FX impact on your international side - but demand trends and economic trends between those two areas? And then lastly, Wireline D&A took a step back, which it sometimes does, in the first quarter of the year. Is that something we should be building off of for the rest of the year or how should we be looking at that?

[John F. Killian:]

Let me give you a couple of reactions here. Look, the global economy is having an impact on our enterprise business both domestically and outside the United States. Currency clearly had an impact. If you look at our performance, we were down 3.4% year-over-year. If you break out the impact of FX we were down about a point and a half. So, you know, I wouldn't say, Mike, to be honest that outside the U.S. is worse than the U.S. I think we're all kind of suffering right now from the same kind of situation. Now related to that the very good news is our customer relationships are very much intact, so we have not lost them. That's very important for when business comes back because the big driver here clearly is employment. As you're losing jobs, it has some effect on revenue. But as that economy turns our customer relationships are very much intact. We've had no losses and we've actually picked up some new ones. I wouldn't read anything major into the change in the Wireline depreciation. It was up slightly but, as you know, we go through an annual review process here. Our CapEx in '08 was down from the '07 level slightly. Our fiber program, those are longer-lived assets that we're investing in. The copper network's lives have shorted over time, but the remaining life on a lot of that depreciation has also shortened down. So I think we'll run similar to how we have run the last couple of years.

[Denny Strigl:]

And, John, if I could just add more color for Mike here. On the enterprise side overall, as John indicated, we're still making new sales; a number of wins in the quarter. The economy has slowed down buying decisions overall. And we're not necessarily seeing things get worse during the first quarter; I think I would classify the trends as consistent. And just one more piece I would say as we have made this point in the past, we're being very disciplined on pricing. We're focused on eliminating costs and, as John has indicated, we're looking very closely at capital expenses. So I think overall we're well positioned to delivery products and services when the economy starts improving.

[Mike McCormack:]

I think, Denny, last quarter you guys had made mention that your nearest peer got maybe slightly more aggressive on some areas of pricing. Is that still occurring or has that sort of straightened out?

[Denny Strigl:]

I have no further comment on that at this point.

[Operator:]

Your next question comes from Christopher King - Stifel Nicolaus & Company, Inc..

[Christopher King:]

First of all, just a follow up to Mike's question. Assuming then that the enterprise revenue decline year-over-year from an overall demand standpoint is generally usage based just in terms of lower headcount reductions worldwide by some of your customers, I just wanted to clarify that if I could. And then the second question relates to the hub product offering. You guys are obviously putting some more marketing muscle behind that it appears over the course of the last couple of months. I just was wondering if that was a material driver in the quarter of either Wireline churn or Wireless net adds during the first quarter? And then just generally speaking with respect to the hub what your feedback has been from the broader customer base with respect to that product offering? Is it trending in line with your expectations?

[John F. Killian:]

Chris, on your first part of that, which was the usage component, yes, it is minutes of use, it's LD, voice minutes that we're talking about there in particular. And then Denny will comment on the hub.

[Denny Strigl:]

Chris, on the hub, yes, we have been aggressive in promoting the hub. It has not been material to what we've been doing in Wireless. We do tend to believe that it is of some modest assistance on churn, but frankly, Chris, it's way too early to tell.

[Operator:]

Your next question comes from Jason Armstrong - Goldman Sachs.

[Jason Armstrong:]

Maybe first on just Wireless ARPU, lots of moving parts here. Can you help us get behind the numbers a bit more, maybe talk about trend rates and smart phone ARPUs versus non-smart phone ARPUs and what elements of ARPU ultimately are proving to be impacted by macro? And then maybe second quarter just on netbooks. You mentioned that upfront as an opportunity. A fair amount of industry buzz around this one. What do you think about sort of the economic model behind netbooks for you? Obviously, this is sort of going to test the economics of high capacity wireless data without really the ability for voice to contribute to the model so, given this, how shall we think about the subsidy model that you'll think about putting around networks?

[Denny Strigl:]

Jason, if I may, I'll start here and to put your question into perspective, I would first note on the Wireless side, of course, revenues grew, as John mentioned, at 10.5%, so I would say that our Wireless business continues to perform well in a challenging environment. We do see pockets of pressure due to the economy; I would say more the economy than competition related. So trying to give you some perspective on the overall ARPU, we continue to see very good growth on the data side. We have no evidence of customers trading down on plans or features. Churn ticked up a bit compared to the prior year, about a 15 basis point increase on postpaid predominantly economy related. And like we said in the fourth quarter, about half of the impact is from broadband access cards, which probably reflects layoffs by many businesses, but broadband access is still growing very nicely. The economy probably has led to seeing some third, fourth, fifth-line disconnects. On a pro forma basis, as John mentioned, ARPU increased 1.1%. Our data revenue continued to grow at 37%. Our non-messaging revenue increased 47%, so demand is resilient on average and we find that new customers to VZW spend more on services. In fact, on BlackBerry devices we tend to see that the ARPU is around $100. We also believe that Alltel presents us with some data upside. As you may know, Alltel's reported data ARPU was about $4 below the historical Verizon Wireless level, so we think some good upside there. On netbook, frankly, we have nothing more, Jason, to add. We did say that we would introduce it later this year and as we have more information on it we certainly will let you know.

[Operator:]

Your next question comes from Timothy Horan - Oppenheimer & Co..

[Timothy Horan:]

Denny first, on the wireless data front, I would assume with the PDAs and all the new netbooks coming out that you're seeing some fairly explosive growth on your wireless networks. Can you maybe talk about what that growth rate is year-over-year? And I guess with non-messaging up over 50% that would translate into a lot more volume growth. Can you handle this continued rate of growth with this level of CapEx spending? And then, John, maybe with the threshold that you've kind of taking here, where do you think the most opportunity to create stockholder value is with the business? Is it on the M&A front, acquisitions, divestitures, internal restructuring, or do you think it's just going to be kind of more execution on what you have at this point?

[John F. Killian:]

Tim, on the first thought, our Wireless network is in a very good position. We've always prided ourselves as network being our crown jewel of our business. It's holding up very well and is a differentiator for us. So we will continue to invest along the normal lines that we have been doing from a data side. If you look at our data ARPU, we've talked about it, up very nicely. Denny mentioned the opportunity or Alltel. We think there's a great opportunity because of where they were to lift that. So, you know, on stockholder value, just a couple of thoughts here for you. There's nothing more important than execution, so continuing to build and drive the business day in, day out, and we have great leaders running the different units, so we're in a very good position there. We've done a lot in the last several years. If I date back, Tim, when I knew you several years ago, obviously the business has changed a lot and that was done intentionally. So our reliance on lower-growth areas of the business, we've taken care of a lot of that, particularly if you think about what we did with the directory business, some of the things we've done on the access line side. So continued strong execution in blocking and tackling; we also recognize how important free cash flow generation is, so there will be a lot of focus around free cash flow generation.

[Ron Lataille:]

[Stacy], I'd now like to turn the call over to Denny for some closing comments.

[Denny Strigl:]

Okay, Ron, thank you and thank you all for joining us and thank you for your questions. And let me take just the last couple of minutes here and try to wrap up. As expected, we had some headwinds this quarter, but the results reflect the combination of solid execution and the strength of our consolidated business model. The resilience in our top line growth in this challenging environment reflects both the continuous transition of our business and our focus on key growth markets. We've evolved to a stronger position over the last few years by investing in our crown jewels - our Wireless network, our FiOS network and our global IP network - and at the same time we have strategically transformed the business. We divested our directories business. We monetized most of our international equity holdings. We sold some access lines and acquired assets that improved our position in the global enterprise and also the Wireless markets. So if we look at the business overall, 57% of Verizon's total revenue comes from Wireless. And as John discussed, Wireless service revenues grew 10.5% in the first quarter. I would say that we're weathering the effects of the economy very well. And I believe that we also extended our industry leadership position in Wireless, in postpaid subscribers, in revenue growth and also, of course, in margin. And there are significant opportunities ahead of us with Alltel, with our LTE deployment and our open development initiative, as I mentioned earlier, and we're excited about some of the handsets, software and applications that we'll be introducing later this year. All of this will help deliver solid data growth opportunities for many years to come. In Wireline our strategy has been to focus on our growth markets, drive continuous cost reductions, especially in our legacy businesses, and therefore to narrow the scope of risk. We've spun off or sold some landline assets and FiOS now covers over 40% of our remaining households; that will grow to over 60% by year end. And looking at the results in the first quarter, consumer retail revenues were up 2% and broadband and video revenue grew by over 30%. Again, this was excellent performance in a challenging economy, but I believe that we can do even better, primarily by focusing on our cost structure or particularly on our cost structure. On the business side, strategic services grew over 7%. We did, as John indicated, see some cyclical impacts. This market will turnaround and we have the assets and capabilities in place to capitalize on future growth. The other key takeaway today is the framework that John laid out in his opening remarks. We will continue to tap into new opportunities for growth, but at the same time we'll transform our cost structure and leverage our assets to grow shareowner value. John described a business model that is disciplined and focused on balancing the key drivers in growing the top line, cash flow and total shareholder returns. So thank you all very much for joining us on our call today.

[Ron Lataille:]

Okay, that concludes our call today. Thank you, everybody, for joining us.