Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Kurt Fawkes – SVP, IR

Ed Mueller – Chairman and CEO

Teresa Taylor – COO

Joe Euteneuer – EVP and CFO

Analysts

Michael Rollins – Citigroup

Analyst for Mike McCormack – J.P. Morgan

John Hodulik – UBS

Chris Larsen – Piper Jaffray

David Barden – Merrill Lynch

Simon Flannery – Morgan Stanley

Brett Feldman – Deutsche Bank

Vijay Jayant – Barclays Capital

Peter Rhamey – BMO Capital Markets

David Coleman – RBC Capital Markets

Todd Rethemeier – Hudson Square

Analyst for Frank Louthan – Raymond James

Qwest Communications International Inc. (Q) Q4 2009 Earnings Call February 16, 2010 9:00 AM ET

Operator

Welcome everyone to the Qwest conference call. All lines have been placed on mute to prevent background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator instructions) Mr. Fawkes, you may begin your conference.

Kurt Fawkes

Thank you. Good morning everybody. Welcome to our call. We appreciate your interest in Qwest. I am joined by Ed Mueller, our Chairman and CEO; Teresa Taylor, our COO; and Joe Euteneuer, our CFO.

We will begin today's call with a few comments on the quarter from Ed Mueller. Teresa will provide a review of business unit results. Joe will conclude our prepared remarks with the discussion of our consolidated financial results and the 2010 outlook. We will then open it up to your questions.

As we begin our call, let me point you to slide three and remind everyone that today's discussion contains forward-looking statements. These statements are subject to significant risk and uncertainties. These risks and uncertainties are discussed in detail in our periodic filings with the SEC and I strongly encourage you to thoroughly review them. Additionally, we do not adopt analyst estimates nor do we necessarily commit to updating forward-looking statements that we are going to be making this morning.

Also, let me mention that in order to supplement the reporting of our consolidated financial information, we will discuss certain non-GAAP financial measures, including adjusted EBITDA, adjusted free cash flow, and net debt. A full reconciliation of these measures is available on our Web site.

Moving on to slide four, earnings per share for the quarter was $0.06 compared to $0.10 in the fourth quarter of 2008. Current quarter earnings includes a $0.02 charge for severance costs. The year-ago period includes a $0.01 charge for severance. Full year reported earnings per share for 2009 was $0.38 and that compares to $0.37 for 2008. One-time charges for severance and litigation in 2009 netted to zero. The prior year includes net charges of $0.03 per share from a combination of severance, realignment litigation and property tax settlements.

In addition to these adjustments, 2009 reported earnings have been impacted by dilution from incremental noncash pension and OPEB expense. In the current quarter this dilution was $0.02 per share and the full year impact was $0.07.

With that I am going to turn it over to Ed.

Ed Mueller

Thanks Kurt and good morning everyone and thank you for joining us today. I want to begin by saying we were very pleased with our financial performance for both the quarter and for the full year. Under challenging economic conditions and competitive pressures we delivered strong cash flows, improved margins and we made great progress on several key initiatives to drive long-term shareholder value.

Throughout the course of 2009 we delivered solid growth in our strategic revenues and we are pleased with the increasing margins for these services. Our business markets group had very good relative performance in the fourth quarter and throughout 2009. As far as our overall revenues we would have liked to have reported better growth. However, I would point out that in addition to the tough economy our reported revenues were also impacted by our initiatives to improve profitability. These include our move to a new wireless business model which accounted for 30% of our revenue decline and the elimination of poor margin, wholesale long distance revenue. While these initiatives will continue to impact our reported comparisons for the next couple of quarters we should have easier comps in the second half of the year.

Our efforts to improve margins was another area where we had strong success in 2009. For the full year our adjusted EBITDA margin was at its best level since the merger with U.S. West in 2000. Adjusted free cash flow generated for the year was also at its highest level since the merger. Our performance continues to demonstrate our initiatives are working and we are carrying this momentum into 2010.

In the fourth quarter we improved our revenue mix and continued to transition away from a legacy revenue base. This transition is supported by our state of the art nationwide network. This is a tremendous asset that delivers best in class services to businesses and government agencies throughout the country and supports all of our fiber deployment strategies. Much of our margin improvement in 2009 was from these services and we remain focused on leveraging growth from this asset.

Over the course of the year we continued to make progress in enhancing our market position by delivering on simplified, integrated solutions, improving partnerships and expanding broadband capabilities. Midyear we announced a five year extension to our strategic partnership with DIRECTV. In addition we jointly launched a new suite of integrated services to maximize the combination of DIRECTV and Qwest High Speed Internet.

We have also made progress on our wireless partnership and in the fourth quarter we concluded a very successful transition to the Verizon wireless reseller model. Finally, we continue to deploy fiber to the node reaching more than 3.5 million homes at year-end and serving 420,000 subscribers. Our broadband initiatives remain a top priority as we look to 2010. We have had some early success in marketing our fiber to the cell side product and we expect to build on this momentum in 2010.

To drive transport efficiencies we announced plans to upgrade our backbone capacities to 100 GB speeds and we will continue to deploy fiber to the node across our residential footprint. In 2009 we strengthened our balance sheet. Despite a tough capital markets environment, especially early in the year, we were able to access the credit markets at favorable rates. We also announced a new four-year revolving credit facility. Collectively, these actions have significantly improved our maturity profile and enhanced our financial flexibility.

Finally, we remain committed to our balanced approach to investment returns. For all of 2009 our direct shareholder returns in the form of cash dividends were $550 million. In addition we reduced net debt by $1.2 billion during the year. To sum up, I think we had a solid year in nearly every level of the company. The Qwest team’s ability to deliver these results in tough markets has really been quite remarkable throughout 2009. In 2010 you will continue to see the results of our efforts to improve efficiency and productivity and we will remain dedicated and focused on the top line.

Now I will hand it off to Teresa who will discuss our business unit performance.

Teresa Taylor

Thank you Ed. Good morning everyone. I am pleased to give you an update on our operations.

In the fourth quarter we maintained solid operating performance. Overall we continued to see strong demand for broadband strategic products which grew 4% for the quarter and 6% for the full year. This was driven by 37% full-year growth in enterprise IP services and higher take rates for fiber based consumer broadband services. We also remained disciplined in our expense controls. This focus produced margin gains across all three segments, a significant accomplishment in light of the challenging market conditions.

In 2009 we demonstrated we can adjust to the market and manage the bottom line. In the coming year our goals are to improve our revenue trajectory while retaining a bottom line discipline. As we turn to 2010 we see encouraging signs in each of our segments.

Let’s start with the business market segment on slide 8. Results reflect our continued success in growing our strategic revenue and expanding our margins. Business markets reported total revenues of $1 billion in the fourth quarter. In the quarter business markets revenue performance outpaced major competitors although revenue decreased 2% from the fourth quarter of 2008 and declined 1% sequentially.

As we have previously noted a key metric we monitor is recurring service revenue. In the fourth quarter recurring revenues were down 1% year-over-year and were flat to the third quarter. For the full year recurring revenues were modestly ahead of 2008. Strategic revenues within business markets increased 7% compared to the fourth quarter of 2008. This was driven by strong demand for our MPLS IP services which increased 26%.

In the quarter strategic revenues were 40% of total business revenues, an increase of 36% from a year ago. In the fourth quarter legacy revenues declined 8% compared to a year ago due to lower local voice revenues and legacy WAN data services as customers continued to migrate to next generation services. This was partially offset by growth in demand for call center applications and we are deep into the transition of customers from legacy data transport services such as [APM and frame relay]. Revenues from those services were under 6% of total business market revenues in the fourth quarter compared to 8% a year ago.

The decline in data integration revenue in the quarter reflects lower equipment sales partially offset by growth in demand for professional services. In the fourth quarter business markets segment income of $405 million improved 3% year-over-year but declined 1% sequentially. Segment income for the full year improved 7% primarily due to channel efficiencies and lower network and facility expense.

For 2010 our plans in business markets are to build on the success from the past year. We have a diverse customer portfolio. We offer unique support and have a strong mix of managed and next generation data IP services. These key strengths provide a strong foundation for us to grow our enterprise top line as the economy improves in the coming quarters.

The results for our wholesale segment are summarized on slide 9. Wholesale results reflect an improved strategic product mix and continued progress on improving profitability. Revenue for the quarter totaled $679 million. This was an annual decline of 14% and a sequential decline of 3%. In the quarter strategic revenues were stable and increased to 45% of total wholesale revenues from 39% a year ago. Legacy revenue decreased 22% year-over-year and 6% sequentially. The annual decline was in part due to proactively managing long distance profitability. The sequential decline was mainly due to ongoing local voice and access revenue pressure.

In the quarter long distance revenue was a little under 20% of total wholesale segment revenue, declined by more than 30% from the quarter of 2008. Even with this significant decrease the profit contribution from long distance was relatively flat with the year ago. Segment income for the quarter was $447 million, an 8% decline from a year ago and a 3% sequential decline. Segment margin was 65.8%, a 410 basis point improvement from the fourth quarter of 2008. Margins improved 660 basis points for the full year.

In 2010 we expect wholesale long distance revenue comparisons will improve beginning in the second quarter. Our wholesale group continued to seize the opportunity to leverage our broadband fiber investments and capitalize on growing demand for wireless backhaul services. We currently have contracts to provide fiber based access to nearly 2,000 wireless cell sites. These contracts provide an avenue for strategic revenue growth while protecting existing copper backhaul services. We will begin to recognize revenues in 2010. However, the full-year impact will be minor. Over the next couple of years this could add 1-2% to our annual consolidated revenues.

Now we will turn to mass market results on slide 10. As Ed mentioned we completed the migration to our new wireless reseller business model during the quarter. Excluding the impact of this transition, mass market revenue for the quarter declined 7% year-over-year and 1% sequentially. Strategic revenue improved 3% sequentially and 4% year-over-year. In the quarter strategic revenue was 30% of total mass market revenue compared to 25% a year ago. In the fourth quarter legacy revenue declined due to lower demand for traditional local voice services.

Segment income of $685 million declined 7% compared to the fourth quarter of 2008. On a sequential basis, expense reductions outpaced revenue declines and this drove a 2% improvement in segment income and a 220 basis points improvement in margin. For the full year segment income was down 3% as a result of continued top line pressure that was offset by substantial expense reductions. For the full year margins improved 550 basis points.

Our quarterly subscriber results are contained on slide 11. We made solid progress on retention efforts during the quarter. In fact, the absolute number of consumer access line losses is at the lowest level in two years. We also continued to grow the revenues from customers we retained. Consumer ARPU improved during the quarter to $60, up 6% compared to the fourth quarter of 2008. Net broadband subscriber additions were 23,000 for the quarter and we ended the year with nearly 3 million subscribers. Our fiber investments continue to pay dividends in the quarter we added 80,000 new subscribers on fiber. We ended the period with 420,000 broadband fiber subscribers or about 14% of our total high speed internet customers.

On average FTTN customers generate a 15% lift on ARPU compared to DSL customers and therefore we believe migrations alone provide a great growth opportunity. In addition, about 35% of households in our territory, or about 4 million homes, do not have any high speed internet service today. This also represents an opportunity for us.

We achieved solid performance in bundled services in the quarter and we enhanced subscriber retention through our video and wireless service offerings. In the quarter we added 23,000 DIRECTV subscribers. These additions were partially offset by the elimination of 5,000 Qwest legacy video customers. The efforts to wind down the Qwest branded video in Arizona and Colorado are now complete. In the fourth quarter we had success in acquiring new Verizon wireless customers and moving existing subscribers to a single bill offered by Qwest. In total we increased the number of Qwest billed Verizon users by 64,000 in the quarter and ended the year with 850,000 total customers.

In 2010 our mass markets group is focused on acquiring and retaining customers by providing a differentiated customer experience. As a result of our initiatives we are seeing early signs of success. For example, our new [on boarding] process for consumer broadband users has increased install rates and improved take rates on value added services. Additionally we have implemented a new regional operating structure. This creates new customer touch points while enhancing our ability to drive market based solutions.

Before I close I want to touch on our ongoing efforts to match our workforce to workload which is depicted on slide 12. Our total employee count declined by more than 1,200 in the fourth quarter and by 2,800 or 8% for the full year. The vast majority of fourth quarter reductions occurred in the latter stages of the quarter. While these were difficult decisions I am confident we will continue to provide a superior customer experience.

In closing, I am pleased with our execution for the quarter and full year. In one of the most difficult economic times we remained disciplined and actively managed resources to reflect market conditions. We successfully grew strategic revenue and associated margins while driving expenses out of the legacy business. In 2010 we will continue to focus on growth through disciplined investments. I look forward to meeting many of you and providing more details on our progress and future plans at our upcoming Investment Community meeting.

Now I will turn it over to Joe.

Joe Euteneuer

Thank you Teresa. Good morning everyone and thank you for joining us on the call. I am pleased to report that this was another quarter of consistent performance and we finished with strong results for the year. We delivered solid EBITDA, improved margins and generated strong free cash flow despite unprecedented market conditions.

We successfully accessed the capital markets during the year and in doing so we eliminated refinancing risks for the foreseeable future while improving our financial flexibility. We continued to provide a balanced mix of returns for our shareholders including paying out $550 million in dividends, reducing net debt levels by $1.2 billion and investing $1.5 billion of capital back into the business. This investment will fund future growth and return for our shareholders.

Now I would like to turn to the income statement on slide 14. In the fourth quarter consolidated net operating revenues of $3 billion declined 10% compared to the prior year. Without the impacts of the wireless transition revenues declined only 7%. Teresa provided you some sense of the efforts on our reported top line associated with our efforts to improve wholesale long distance margins. For the full year revenue declined 9% or 6% after adjusting for the wireless MVNO transition.

Consolidated strategic services revenue improved 4% in the quarter and 6% for the full year. We continued to improve our revenue mix by shifting to fiber based initiatives and IP based data solutions. In the quarter strategic revenue accounted for 36% of total revenue versus 31% a year ago. Total operating expenses improved 1% sequentially and 8% year-over-year. For the full year total expenses improved 9%. The improved operating costs in the quarter and for the full year are driven by our continued efforts to increase operating efficiency through innovative process improvement, increased productivity and lower unit costs for purchased goods and services.

Fourth quarter adjusted EBITDA was $1.09 billion compared with $1.18 billion a year ago. The adjusted EBITDA margin improved 60 basis points for the same period. The current quarter includes $44 million of incremental noncash pension and OPEB expense compared to prior year’s quarter. For the full year adjusted EBITDA was $4.4 billion on a margin of 35.9%. Excluding the impact of incremental noncash pension and OPEB expense of $210 million, the margin improved 390 basis points for the year. On this same basis we would have reported 2% growth in full-year adjusted EBITDA. The improved profitability was mainly due to the transition to a new wireless business model and improved revenue mix in wholesale and substantial reductions in direct channel expense and overhead costs.

Moving onto slide 15, we continued to strengthen the balance sheet in the fourth quarter and improve our financial flexibility. As a result of our strong free cash flows we ended the year with net debt of $11.8 billion compared to $13 billion at the end of 2008. Cash and cash equivalents increased to $2.4 billion from $565 million a year ago. Net debt to annualized adjusted EBITDA was 2.7 times at year-end, a significant improvement from the year-ago period.

During the quarter we completed a new four year revolving credit facility which was upsized to $1.04 billion and it currently remains undrawn. In January of 2010 we issued $800 million of notes with a coupon of 7.125%. While our success in the capital markets has substantially removed refinancing risks we are also taking efforts to put these resources to productive use, calling $525 million of notes that were scheduled to mature in February of 2011.

Finally, we may decide to call our $1.27 billion convertible debt later this year. These actions along with our planned redemptions over the next 12 months would reduce total debt by nearly $3.5 billion. This will further improve our net debt to EBITDA ratio.

Details on adjusted free cash flow and capital expenditures are shown on slide 16. In the quarter we continued to maintain a strong management of receivables and payables. Both DSOs and DPOs improved year-over-year. Our collections staff has done an outstanding job all year for us. Bad debt expense was 0.6% of revenue in the quarter and 1.1% for the full year. Adjusted free cash flow for the quarter was $506 million and it was $1.9 billion for the full year. Strong EBITDA, lower capital expenditures and working capital contributions drove these results.

Capital expenditures were $386 million in the quarter. Capital spending for the full year totaled $1.4 billion plus we leased capital of a little over $100 million. This compares to capital spending of $1.8 billion in 2008. The principal reasons for our lower capital expenditures are lower customer demand, moderation of network traffic growth and lower requirements associated with the slowdown in new housing construction. We also benefited from our efforts within our purchasing, engineering and operations group which have produced vendor savings, improved inventory levels and lowered our capital unit costs.

Now I would like to close my remarks with a discussion on guidance on slide 17. In 2009 we focused our efforts and the guidance we provided on EBITDA and free cash flow. We realize we cannot simply cut costs to achieve long-term prosperity. In addition the markets are starting to stabilize and therefore we feel the time is appropriate to provide some guidance commentary on our efforts to improve the top line.

For the near-term we continue to see a stable outlook for business markets with revenue continuing to beat industry averages. In wholesale we are likely to continue to report significant year-over-year declines but as Teresa noted the wholesale long distance comparisons should start to improve beginning in the second quarter.

Mass markets revenue in the short run will continue to follow access line trends partially offset by increased ARPU from bundled services and growth in high speed internet subscribers. In looking at overall consolidated revenues we expect our year-over-year comparisons will improve over the course of the year. As a reminder, there was a little over $100 million of wireless MVNO revenues that we reported in the first three quarters of 2009 that won’t be repeated in 2010.

Our goal is to reduce our year-over-year revenue declines to a low to mid single digit rate by the fourth quarter of this year. We will continue to be keenly focused on efficiently managing our business to maintain or improve margins. We expect adjusted EBITDA to be in a range of $4.3-4.4 billion. We are expecting noncash pension and OPEB expense to be approximately $130 million in 2010 which would be a $70 million improvement from 2009. The outlook for capital investment is $1.7 billion or less. We may use lease financing in 2010 for some portion of this capital spending. Our capital spending program will reflect our opportunity in fiber to the cell while we continue to invest in fiber to the node on an integrated basis.

The combination of continued solid cash flows from operating activities and strong investment in the business is expected to produce adjusted free cash flow of $1.5-1.6 billion for the full year of 2010. We do not expect to make any funding contributions to the pension plan in 2010. In 2011 we believe our pension funding requirements could be in a range of zero to $120 million but the information necessary to finalize our contribution calculation will not be available until later in 2010.

On the subject of cash taxes, our available NOLs continue to limit federal cash tax payments to the alternative minimum tax which is approximately 2%. We currently expect this will be the case for approximately the next five years. It is our current expectation that we will continue to pay a quarterly dividend of $0.08 per share in 2010. For now, we are deferring on any additional comments on our free cash flow allocations beyond these dividends and paying off unregulated debt maturities. We will continue to assess the best use of future excess cash flows, including reinvestment back into the business, stock buybacks, dividend increases and additional de-leveraging actions.

In closing I would like to reiterate how pleased I am with 2009 results. The Qwest team has consistently demonstrated its ability to drive productivity and efficiency, to improve EBITDA and free cash flow despite a challenging environment. This success has been achieved against a backdrop of high unemployment rates, competition from wireless, more aggressive promotions from cable service providers and continued business weakness with low levels of investment.

We are looking forward to applying our considerable capabilities under better market conditions in the month ahead. Before I turn the call over to the operator for questions, Ed, Teresa and I along with the management team would like to congratulate the workforce for a job well done in 2009 and thank them for all their hard work.

With that I will turn the call back over to the operator and open up the line for questions.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Michael Rollins – Citigroup.

Michael Rollins – Citigroup

I was wondering if you could talk a little bit more about what you are seeing in the business markets in terms of where you are winning share and where you are seeing some share loss. If you could give us a balance of the two? Then also as you are going through that an update on the pricing environment.

Teresa Taylor

Let me answer a couple of those. As far as where we are taking share it is really in the data and IP space from a product perspective and it is generally a tier right below the Fortune 100. So it is a spot where we continue to be successful in. I would also say our success has been based on retention. So where we had the growth last year was really based on holding onto our existing customers, growing them inside accounts and acquiring new accounts.

As far as pricing, it is pretty stable. We don’t see anything that is too crazy out there. Like always you have a couple of individual companies that might focus on a particular account or a particular product but in general it feels pretty stable.

Michael Rollins – Citigroup

On the small business side it looks like the revenue erosion was a little bit larger there. Is that a share loss issue? Or is that an economy issue? How would you rate the two?

Teresa Taylor

In the small, small business which is only inside of our 14 states it is definitely economy driven. We clearly see bankruptcies are still rather high there. It has always been a very competitive market. I wouldn’t say it has become more competitive but it has always been a very interesting place to be in the really small business space.

Operator

The next question comes from the line of Analyst for Mike McCormack – J.P. Morgan.

Analyst for Mike McCormack – J.P. Morgan

First, on the mass market margins you saw a nice step up there. I wonder if there were some additional wireless costs that had kind of come out that led to that and whether that is kind of a sustainable level or whether there was some lower selling or headcount that really drove that margin improvement? Then maybe if you could expand a little bit on the previous question and talk about some of the puts and takes for both business and wholesale? I know you gave some comments on wholesale improving beginning in the second quarter but just some more of the details behind some of the puts and takes on business and wholesale in 2010?

Teresa Taylor

On the mass markets on the consumer side it was not the wireless piece. We were pretty much done with that earlier. The lift up you saw in the fourth quarter was driven by efficiencies. One example is we went to the regional structure that I described before and that actually took costs out which I know sounds counterintuitive but that gave us a chance to focus locally on individual markets and remove some layers and some [people] management there.

The second driver was we are efficiently moving our customers online. As much as we can we are moving the sales channel to an online structure as well as support. The answer to your question is it is sustainable. That was not just driven by the wireless piece.

BMG and wholesale, as I commented earlier we expect BMG to continue to pace along as it has. Actually assuming a bit of an uptick there. As the economy improves we are seeing signs of customers starting to move even though they didn’t make any decisions last year they are now in a position where they have to expand their data network and they have to expand their broadband networks. We plan on being there. I think we have been very good at focusing on the products we are good at and the space we are good as far as segmentation.

On the wholesale side, any growth that comes will be from fiber to the cell. We are very excited we are already at 2,000 cell sites that are under contract and there is many more behind that. That is a very big number for us. We know we can deliver. We are very good at fiber build out. This is our spot. It also allows us to retain the copper backhaul that we offer today to the wireless providers.

The long distance revenue in wholesale I think will continue to stabilize. We have been through the rough part where we created the margins we want and now we will keep that stable.

Mike McCormack – J.P. Morgan

Are you seeing grooming coming to an end here?

Teresa Taylor

No. It is not coming to an end. It is slowing down but it is not coming to an end.

Operator

The next question comes from the line of John Hodulik – UBS.

John Hodulik – UBS

A quick follow-up to the wholesale question the 2,000 cell sites I think there are about 17,000 cell sites in the region. How quickly are these contracts going out? Are you bidding on thousands of other cell sites to build out to? Could you talk about the economics of that business and maybe how much capital is going to be spent in this area in 2010?

Teresa Taylor

Let me back up to talk about how we see the market. Again, this is inside the 14 states. There is about 18,000 cell sites throughout the 14 states and about 8,000 towers. We believe that approximately 50% of the sites will need fiber by 2014. If you think about simple math there about 9,000 cell sites at some point by 2014 will need fiber. Not because it is in the concentrated areas of Colorado, Arizona, Washington and Minnesota. We currently have 2,000 under contract today that are in construction and are moving along. There are absolutely thousands behind that. Those are in negotiation right now and we feel very confident about the service that we offer and the pricing structure we have in place to win those bids.

Right now we feel like we are taking a large market share inside the 14 states. The other good news is it also protects our copper. While some cell sites will continue to have copper that allows us to maintain that revenue and then overlay with fiber into it.

John Hodulik – UBS

Can you talk about the step up in revenues as you move from copper to fiber in some of these [inaudible]?

Teresa Taylor

It is all demand driven. Broadband 50 mg or 100 mg is how it is priced out. The step up is significant in that we currently have a copper piece in there and you move up into the fiber piece. We are maintaining current revenue as well as increasing new revenue. I think we have talked about in the next couple of years that will give us 1-2% on our total top line.

Ed Mueller

Think about it this way, we are signing guaranteed contracts of a fixed duration of anywhere of 5-10 years. We know what our revenue generation is going to be. We know what our return is going to be. Once we sign the contract and before we put the first shovel into the ground so this is great business and a great use and return of our capital investment.

Teresa Taylor

To answer your second question, this is where we are spending our capital. The majority of our new growth is coming into fiber and we are spending it in this spot as well as fiber to the node as well as fiber to building on the BMG side. So we take the fiber, run it down a particular street and serve all three of our business segments. A very efficient use of our capital.

Operator

The next question comes from the line of Chris Larsen – Piper Jaffray.

Chris Larsen – Piper Jaffray

Can you give us a sense for where you think the right leverage ratio should be for Qwest? Teresa, what is the gating factor on fiber to the node build? You talked about wanting to spend more on the fiber to the tower but it seems the DSL penetration or the high speed internet penetration worked much better there and why wouldn’t you push a bit faster on the FTTN?

Joe Euteneuer

On the answer to your leverage question we continue to work towards moving towards investment grade, down in the lower 2%. If you see with all of the debt that will get paid off here over the next 12 months that helps us move there and with our goal to turn the top line it will help drive better EBITDA and therefore give you a better ratio. We are working at both sides of the equation.

Teresa Taylor

As far as the fiber to the node, we are still going to pass one million homes this year, incremental homes. So this is an integrated build on the fiber where we are actually, as I mentioned, using all three business units to drive the build and it is like I said still one million homes we are going to pass. We are pushing hard on fiber to the node also.

Operator

The next question comes from the line of David Barden – Merrill Lynch.

David Barden – Merrill Lynch

A couple of related questions, Joe obviously you have set the goal of moving towards investment grade metrics. Could you kind of give us an update now of what the conversations with the rating agencies are like inasmuch as the business has improved so dramatically from a debt standpoint in the last year? Your outlook for the free cash flow you and your dealing with the converts is much improved. I would have to imagine the rating agencies must be contemplating at least putting you on positive watch at this stage in the game.

The second question is just related to you kind of said you don’t want to talk about deploying cash but it kind of is the investment story for the equity is the cash and what the equity options are. When might we hear more from you on this topic? Do we have to wait until 2011? How do you think about dividend taxes going up in that thought process?

Joe Euteneuer

Let me work backwards. How about if I promise you no later than 2011 I will talk to you about it?

David Barden – Merrill Lynch

Not good enough.

Joe Euteneuer

The fact of the matter is look, we have come off a pretty strong year in 2009 in stabilizing our EBITDA and now our focus is turning to the top line. I think we need to sort of get a couple of quarters under our belt and get the confidence level that is in the sight to accomplish. When you look at our guidance you can really see we are trying to exit the year on a positive note so we can get to a 2011 growth story. I think as you see that execution and you will see the confidence happen then you will get more of a discussion about what will happen in the deployment of cash. Don’t forget the capital we are spending is to provide that proper return so the whole fiber to the cell and fiber to the node we have delivered on a consistent basis, increasing our penetration levels on fiber to the node will also help us generate the additional cash you want us to deploy to our investors.

In regard to the rating agencies, we have had a good year. We clearly have had some preliminary talks with the ratings agencies. Post our analyst day next week we will go back in and have some more formal talks. I am not going to put words in their mouth but clearly with our execution one would think they would look favorably at us.

David Barden – Merrill Lynch

Following-up on that how do you think about dividend taxes going up and kind of how you want to manage that process?

Joe Euteneuer

It is a little hard to manage per se. Yes the dividend will be taxable this year just as a result of the calculation so it is really hard for me to predict whether we could get into a non-taxable situation. I would probably predict it is probably going to be taxable.

Operator

The next question comes from the line of Simon Flannery – Morgan Stanley.

Simon Flannery – Morgan Stanley

I wonder if you could just talk about Washington for a second. There are a lot of headlines about the upcoming broadband review and special access and other issues on the table. Can you give us some perspective on how you are thinking about that and how you have incorporated that into guidance? Then also we have also seen some IPTV announcements, Cincinnati Bell last week, Bell Canada, the technology really seems to be improving right now and the results have been encouraging. What are you thinking about using the fiber network in terms of more video type products either from you or enabling others?

Ed Mueller

Let’s take Washington first. We continue to watch what is going on there. As you know, everybody can read, they are having trouble dispersing the first chunk of money. We are actively pursuing the second phase of this and if we can make money at it we think the rules have improved. With all of our work we have done before we will jump in there if we can make an adequate return and meet our hurdle rates.

I would say we are cautiously optimistic about being able to participate but there is still, I think, a lot of confusion. There is also not a clear strategy of what broadband would look like in the long haul and what really is unserved or under-served but more to come there. It would all be upside for us with no downside.

Secondly, on the IPTV front, as you know that is the reason we built this architecture was to take advantage of the continued movement of what I would call ala carte video and we are still very bullish on that. We work with people right now, it would be primarily an enablement. We would enable others. We closed down our retail video product in our two regions which has been good for us. We would have had to have a large capital spend to even upgrade it and I really believe this will continue. The momentum is hot and heavy. I also think the other part of this that will make a huge difference is that we are seeing content people that are not just traditional content people and so I think that is also encouraging.

We have had contact with people in Silicon Valley, primarily people in California who have a little different model of how to monetize this. I think there is more to come which is both subscription and what I would call an ad-based model. I think it is coming faster than some would have predicted and I think that is all good news for us.

Kurt Fawkes

We also want to mention we will be filing our K probably today. We will be providing some disclosure on access revenues and costs. I know a lot of you have been interested in that area with a lot of speculation going on about what is going to happen on pricing. Take a look at our K and you will see some new disclosure there.

Operator

The next question comes from the line of Brett Feldman – Deutsche Bank.

Brett Feldman – Deutsche Bank

You did a great job talking about all of your revenue initiatives for the next year or two. But in the meantime, if we look at where your revenue guidance is, it is probably going to be a high single digit decline for the year but potentially flat EBITDA. Can you talk about where some of your biggest cost initiatives are focused in the near-term? Do you expect to continue managing the headcount the same way and are there other areas where you think you still have some efficiency opportunities?

Teresa Taylor

The one thing I want to say about cost is we manage it every day. It is not a special project process or things we do temporarily. It really comes from two angles. One is matching the market to the workforce. If we have areas where the market is declining then we adjust the workforce accordingly. The second piece is really just being more creative and innovative on how we run the company. The things I have mentioned around moving to the internet, on the IT side half of our development now occurs in our Bangalore Company. The network side we have managed the facility costs very efficiently. Constantly grooming our cells and re-architecting our cells to make our network the most efficient that it can be. To answer your question yes we do believe there continues to be room and we continue to match the market conditions to the expense side and are confident we can continue on that path.

Brett Feldman – Deutsche Bank

So it is my interpretation that it is a little bit here and there and not necessarily any large thing or line item where you still think you have the most opportunity?

Ed Mueller

I think it is balanced across the board. We would go across our entire P&L and challenge all of our expenses as we go out throughout the year so it is not just a point in time. It is a day to day effort across all of these whether it is admin and operating, sales and marketing, etc.

Operator

The next question comes from the line of Vijay Jayant – Barclays Capital.

Vijay Jayant – Barclays Capital

I wanted to get some understanding on the correlation of CapEx to top line growth. Obviously you said up to $1.7 billion and your growth on the top line seems to be down in the mid to high single digits. If things go better, excluding obviously fiber to the cell and your fiber to the node upgrades can you talk about how much of the CapEx is truly variable?

Joe Euteneuer

A portion of the capital is totally variable. We do clearly put in capital that is based on what we think subscribers will need as we grow our business markets group, etc. As the market continues to get better and we think we have enough room in there to meet the demand for what we think the growth can be in the business market segment. The other thing, the one thing you should know is this year because we are doing the integrated build from fiber to the cell and as a result of that can hit the homes and hit the businesses, it is a far more efficient dollar being spent this year than it was last year. Also in addition in 2009 we reduced the rates for what we pay on CapEx by over $100 million so we are getting also the additional benefit from that. So our capital this year is far more efficient and is driving us far more than we have in historical use.

Teresa Taylor

About 50% of our capital is volume driven at a high level so it does give us a lot of flexibility to be success based and as volume moves up and down we can move that budget accordingly which is what we did last year and we will continue to do that this year also.

Operator

The next question comes from the line of Peter Rhamey – BMO Capital Markets.

Peter Rhamey – BMO Capital Markets

To follow-up on the CapEx question and one on EBITDA guidance, 2009 CapEx with leasing is $1.5 billion and you are going to $1.7 billion. Is that fair to say that most of the increase in capital spending here is a small amount in fiber to the cell and the remainder is some assumption you have made on the economy? Could you give us some color on that? The second question, EBITDA guidance, in 2009 EBITDA was down just over $100 million and I am just wondering looking forward given you are getting a benefit on the OPEB why you are forecasting flat to down EBITDA if you are keeping pressure on the cost line?

Teresa Taylor

On the incremental capital you can assume it is all fiber. So it is very fiber driven on all three segments. So on the consumer side, fiber to the node. On the wholesale side, fiber to the cell. On the business side, fiber to buildings and customer locations. So that is driven by that.

Joe Euteneuer

I think the way to look at it is we are going into 2010 with a goal of turning the top line. We have given you early on guidance on what we think is going to happen and we can continue to update as we move throughout the year. If you look at 2009 had progress during the year. We continue to provide you better results than we thought and we have upgraded our guidance on a go-forward basis. I think we have looked to deliver a pretty balanced approach. I think you have seen over 2009 a very consistent execution by the operating team and we look for that going into 2010 and improving as we go through the year.

Peter Rhamey – BMO Capital Markets

It sounds like you are being conservative here with your guidance. I don’t want to put words in your mouth but is it also fair to say with your focus on revenue growth I guess you are making some investments that will hopefully pay back in 2011. Is that how to also think about it?

Joe Euteneuer

You are not going to grow the top line without making some sort of investment. That is what we are committed to is bringing the company back to growth on the top line. Sure, we are cautiously optimistic. The economy hasn’t turned around totally yet. Unemployment is still high. Bankruptcies both on a personal and business level. We are trying to be cautious and not get out ahead of our [schemes] as we go forward in the start of this year.

Operator

The next question comes from the line of David Coleman – RBC Capital Markets.

David Coleman – RBC Capital Markets

I am just wondering if you could talk about access line trends with about a 20 basis point quarter-over-quarter improvement and the rate of loss? I was wondering if that improvement is from reduced churn or increased gross adds or a mix of the two? On the IP services business, can you talk about how much of that growth is coming from new versus existing customers? I know it is not a one-for-one exchange but I was wondering if a decline in the legacy business translates into an equal amount increase in the IP services business?

Teresa Taylor

As far as access line trends I would attribute it mostly to churn. There is not a lot of new activity going on if you watch the consumer market there is not a lot of growth in there. The majority of that change that you saw was based on churn and our bundling services and keeping our customer on the package that we offer. As far as IP services it is a combination of existing customers upgrading under bandwidth which we are very happy with because that drives ARPU. As well, there are some new customers coming into that at a lower bandwidth. In my comments I mentioned a good chunk of our market that doesn’t have any form of broadband services. So it is really a combination of both of them. We have a very concerted effort to upgrade our base to move our base into the broadband space.

Operator

The next question comes from the line of Todd Rethemeier – Hudson Square.

Todd Rethemeier – Hudson Square

If you could give us a little more color on the fiber to the node, remind us of the home path at this point and what kind of penetration rates are you seeing or adoption rates are you seeing in some of the markets that have been up for awhile with the higher speed products?

Teresa Taylor

Currently we have passed 3.5 million homes on fiber to the node. Our plans for 2010 are to build past another one million so we will be up to 4.5 million at a minimum. As far as the penetration levels, it varies quite a bit by market. So it really depends if we were already there with the lower speed and we are overlaying or going into a new market. Our geography is quite diverse. So depending on what the competition looks like across the board.

Operator

The next question comes from the line of Analyst for Frank Louthan – Raymond James.

Analyst for Frank Louthan – Raymond James

You mentioned the converts earlier. Could you talk a little bit about the parameters about buying those back? On the wholesale trends is that something driven by pricing or lower MOUs? Any color there would be great.

Teresa Taylor

The wholesale piece let me just clarify, are you talking about the total revenue of the long distance piece? How are you referencing that?

Analyst for Frank Louthan – Raymond James

Just the wholesale in general.

Teresa Taylor

The two pressure points on wholesale are long distance, yes, since we were driving minutes off the network that were unprofitable. The second pressure on the revenue is in the local access side and that is some declining minutes also.

Ed Mueller

In regard to your last question the fact is we have a lot of cash on our balance sheet right now and we want to put it to productive use. That is why we called the $525 million of notes that weren’t scheduled to mature in 2011 so if the right economic deal could be struck to call the converts back early we would clearly take advantage of that.

I think that concludes our Q&A session. Thank you everyone for joining the call. We look forward to having you come to our analyst day in a week.

Operator

Ladies and gentlemen this does conclude today’s presentation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Qwest Communications International Inc. Q4 2009 Earnings Call Transcript
This Transcript
All Transcripts