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Verizon Communications Inc. (NYSE:VZ)

Q4 2013 Earnings Conference Call

January 21, 2014 08:30 ET

Executives

Michael Stefanski - Senior Vice President, Investor Relations

Fran Shammo - Chief Financial Officer

Analysts

John Hodulik - UBS

Phil Cusick - JPMorgan

Michael Rollins - Citi Investment Research

Brett Feldman - Deutsche Bank

David Barden - Bank of America

Mike McCormack - Jefferies

John Mark Warren - Morgan Stanley

Kevin Smithen - Macquarie

Joe Mastrogiovanni - Credit Suisse

Jonathan Chaplin - New Street Research

Jennifer Fritzsche - Wells Fargo

Operator

Good morning and welcome to the Verizon Fourth Quarter 2013 Earnings Conference Call. At this time, all participants have been placed in a listen-only mode and the floor will be opened for questions following the presentation. (Operator Instructions) Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

It is now my pleasure to turn the call over to your host, Mr. Michael Stefanski, Senior Vice President, Investor Relations.

Michael Stefanski

Thanks Evan. Good morning and welcome to our fourth quarter 2013 earnings conference call. This is Mike Stefanski and I am here with our Chief Financial Officer, Fran Shammo. Thank you for joining us this morning.

Before we get started, let me remind you that our earnings release, financial and operating information, the investor quarterly and the presentation slides are available on our Investor Relations website. Replays and a transcript of this call will be made available on our website.

I would also like to draw your attention to our Safe Harbor statement and other legends on slides two and three. 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 also available on our website. This presentation contains certain non-GAAP financial measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are also available on our website.

Before Fran takes you through the details of our results, I would like to cover a few special items that are included in our reported results. These are displayed on Slide 4. For the fourth quarter, we reported earnings of $1.76 per share on a GAAP basis. This includes several significant non-operational items that I would like to highlight. The largest item is a pre-tax gain of $6 billion related to the year-end mark-to-market adjustment of pension and OPEB liabilities. This favorable accounting adjustment is primarily non-cash and is caused by an increase in the discount rate, changes in actuarial assumptions and a greater than projected return on planned assets. On an after-tax basis, this gain amounted to $3.7 billion or $1.29 per share. Partially offsetting this favorable item were pre-tax charges of $865 million related to the transaction to acquire Vodafone’s 45% stake in Verizon Wireless. These transaction costs include net incremental interest expense of $616 million related to the debt raised in connection with the acquisition and the bridge financing and other cost of $249 million. On an after-tax basis, these transaction charges totaled $540 million or $0.19 per share.

Excluding these non-operational effects, adjusted earnings per share was $0.66 in the quarter compared with $0.38 a year ago, which included a $0.07 per share charge for the direct impact from Superstorm Sandy. For the full year, adjusted earnings per share were $2.84 compared with $2.24 last year, an increase of 26.8%. If you exclude the Sandy impact from last year the increase was 22.9%. The quarterly growth rate disclosed in this presentation are on a year-over-year basis unless otherwise noted as sequential. Also the results and growth rates exclude the effects of the non-operational items. With that I will now turn the call over to Fran.

Francis Shammo

Thanks Mike. Good morning everyone and Happy New Year. Before we get into the details I like to start with an overview with our results in a proper context. 2013 was a great year for Verizon from both a strategic and financial perspective. Of course the big strategic milestone was in our agreement to purchase Vodafone’s 45% stake in Verizon Wireless which will give us sole ownership of the best asset in the global wireless industry. We have all the necessary financing in place, the special shareholder meetings for both companies are scheduled for one week from today on January 28th and a closing is planned for February 21st. As we have stated the transaction will be accretive to earnings per share by about 10% on day one. Full ownership will also provide access to all the cash flows and give us greater flexibility to develop converged solutions without any integration and due diligence risks.

Our strategy is to build upon the foundation and strength of our network assets as a platforms for the future growth and innovation. To the end we’re extremely well-positioned in the center of the trends that are driving growth in our industry. Mobility, broadband, video, cloud services and security. Sole ownership of Verizon Wireless along with our portfolio of other assets will enable us to better leverage our capabilities across the entire business. In wireless we completed our LTE coverage build and continue to invest in our 4G network to take advantage of the significant opportunities enabled by this technology as we innovate around our customer solutions. In 2013, we further strengthened our portfolio of enterprise strategic services with the development of a new cloud services product suite. The launch of a mobile healthcare platform and several targeted acquisitions which will enhance our capabilities in mobile video delivery.

Collectively these moves further strengthen the business and improved our competitive position in key areas of growth. Underlining these strategic imperatives has been consistently strong operational and financial performance driven by solid execution and a disciplined focus on meeting our financial objectives. In 2013 we achieved or exceeded all of our key financial targets delivering on what we said in January of 2013. In wireless we had an excellent year, we added 4.1 million new postpaid connections generated service revenue growth of more than 8% and drove a 15% increase in EBITDA. Our growth in EBITDA was significant, $4.5 billion in absolute terms and we expanded our annual service EBITDA margin nearly 300 basis points to 49.5% squarely within our 49% to 50% guidance for the full year.

In FiOS we increased our penetration of data and video services by adding more than 600,000 new customers during the year. The scale of our FiOS business and the popularity of our FiOS Quantum speeds drove annual consumer revenue growth for 4.9% up sharply from 3.2% in 2012. In the enterprise space inspite of continued economic challenges strategic services revenue grew 4.6% in 2013. In terms of wireline profitability we got it to a flat EBITDA margin and that is what we produced at 22.2%. In the area of capital spending we met our revised guidance of $16.6 billion which was up 2.7% over 2012. Even with that increased spending level we improved our overall CapEx to revenue ratio as we said we would.

2013 was a great year of significant earnings and free cash flow growth. Adjusted earnings per share increased to $2.84 up over 26% for the year. Our free cash flow growth was also very significant increasing by $6.9 billion to 22.2 billion, an increase of 45% from 2012. In terms of shareholder value, we generated a total return of 18.6% in 2013 for a combination of stock price appreciation and dividends. For the seventh consecutive year, our Board of Directors approved a dividend increase indicating their confidence in our future cash flows and earnings growth. From my perspective, 2013 was a great year of execution resulting in impressive customer growth and significant improvements in profitability and cash flows.

Now, let’s look at our fourth quarter and full year performance in more detail starting with consolidated results on Slide 6. Total operating revenue grew 3.4% in the fourth quarter continuing our consistent top line growth trend. For the year, we added $4.7 billion to consolidated revenue, an increase of 4.1%. On a full year basis, the increase in consolidated revenues along with effective cost management resulted in more than 21% growth in adjusted operating income. On the same adjusted basis, consolidated EBITDA increased $4.6 billion, up 12.3% for the year. Our adjusted EBITDA margin expanded 260 basis points to 34.9%, the highest consolidated margin in eight years. As we highlighted earlier, adjusted earnings per share in the fourth quarter of $0.66 was significantly higher than a year ago. Our earnings performance has been very strong and very consistent with double-digit year-over-year growth throughout 2013.

Now, let’s move into a review of the segments starting with Wireless on Slide 7. Our consistent investment in Wireless is the foundation of our success and drives our leadership in network quality, reliability and the overall customer experience. We will continue to build on our network advantage in 4G LTE by deploying capital to increase capacity and density to our network. Our fourth quarter and full year Wireless results were excellent. We continued the strong momentum built during the quarter and fitted very strong. Total Wireless revenues grew by $5.2 billion in 2013 and totaled $81 billion representing two-thirds of Verizon’s consolidated revenue. We sustained our strong service revenue performance with 8% growth in the fourth quarter making this our fifth consecutive quarter of at least 8% growth.

For the year, service revenue grew 8.3%. We generated $8.3 billion of EBITDA in the fourth quarter, up 22.6% from the same quarter last year. Our service EBITDA margin in the quarter was 47% compared with 41.4% in the fourth quarter of 2012. For the year, EBITDA grew to $34.2 billion, up $4.5 billion or 15%. This is a very impressive accomplishment and a testament to the efficiency of our network and our continuous focus on improving productivity and efficiency throughout the business by applying our Verizon Lean Six Sigma principles. Our 2013 EBITDA service margin of 49.5% improved by 290 basis points, a very significant expansion and is clearly within the guidance we provided during the year. The other point I would emphasize is the consistency of our Wireless profitability. We have posted margins of 49% or higher in the five of the last seven quarters.

Now, let’s turn to a more detailed look at Wireless revenue per account beginning on Slide 8. Service revenue growth continued to be driven by more customers and devices, increased data usage and smartphone penetration. Our Share Everything Plans are doing exactly what we expected driving device adoption and stimulating higher usage resulting in increases in both the number of devices and revenue per account. During the fourth quarter, retail postpaid revenue per account or ARPA grew 7.1% to more than $157 per month. We have seen consistent growth in this metric. For the full year, ARPA was up nearly $10 or 6.9%. We ended the year with 35.1 million postpaid accounts and average connections per account grew from 2.64 to 2.76, an annual increase of 4.5%.

As we said, customer adoption of our Share Everything Plans has been exceptional. In just 18 months, more than 46% of our postpaid accounts are on these plans. In 2013 we effectively doubled the number of accounts on Share Everything from 8.1 million to 16.2 million. The value proposition is simple and straightforward and customers recognize the value of share data across multiple devices. Let’s take a closer look at connections growth on slide 9.

We had a strong quarter of quality customer growth. Retail net additions totaled 1.7 million, postpaid net adds were 1.6 million and prepaid were 80,000. In terms of the makeup of our postpaid net adds we added 1.4 million new 4G smartphone customers. Total phone net adds were 824,000 when you include the net change in 3G smartphone and basic phone customers. We had a very strong quarter of internet device growth with 675,000 net adds, 625,000 of which were tablets. The remaining net adds of about 74,000 were primarily Home Phone Connect. As usual we finished the year with strong customer growth and have great momentum heading into 2014. To recap the full year we had a total of 4.1 million new postpaid net adds and 4.2 million new 4G LTE smartphone customers. We added 1.8 million new internet devices with tablets representing about 1.5 million of this total. We also added about 360,000 other devices primarily Home Phone Connect.

The offset to these additions was the net change in basic phones. Total phone net adds were 1.9 million for the year representing about 47% of the total. We ended the year with 102.8 million total retail connections. Our industry leading postpaid connection space reached 96.8 million and prepaid totaled 6 million. Postpaid growth adds increased sequentially to 4.3 million and total of 15.1 million for the full year up 1.7% roughly 60% of our growth adds for the quarter and the full year were smartphones.

Our postpaid upgrade rate was 7.4% in the fourth quarter and our quarterly average was 7% for the year. As you would expect a significant percentage of our upgrades are smartphones which benefits us from a service revenue perspective. About 23% of upgrades in the quarter were basic phone customers getting a smartphone for the first time. The majority of the remaining upgrades were 3G smartphone customers moving up to a 4G smartphone which we were able to monetize through higher data usage and lower cost to serve.

Our churn metrics continued to be market leading. Our retail postpaid churn was 0.96%in the fourth quarter down one basis point sequentially and up one basis point year-over-year. Next let’s turn to slide 10 and take a look at device sale and our progress in 4G LTE. Postpaid device activations, which include both gross adds and upgrades, totaled 11.52 million in the quarter. This is higher than any prior quarter in 2013. For the full year total postpaid activations totaled 41.5 million. Smartphone activations totaled 8.8 million in the quarter, an 87% were 4G LTE. For the year smartphone activations increased 7.8% to 31.1 million. Smartphone penetration increased to 70% of total phones. About 58% of our smartphones are 4G. We still have approximately 25.5 million basic phones and 24.7 million 3G smartphones in our customer base which gives us plenty of opportunity in 2014.

We had our best quarter of tablet activations since they were first introduced in late 2010. We activated about 790,000 postpaid tablets in the quarter and 1.9 million for the full year. Our tablet base now stands at 3.6 million, so again we have a great opportunity in 2014 to expand this category and generate growth. 4G device penetration within our postpaid base really picked up in 2013. At year-end 44% of our retail postpaid connections were 4G up from 23% one year ago. Usage on our network continues to rise; currently about 69% of our total data traffic is carried on the 4G LTE network.

Going forward we will continue to add capacity and optimize our 4G LTE network ensuring that customers are receiving the quality and consistent reliability that they expect from our network and devices.

Let’s move next to our Wireline segment starting on Slide 11. Our Wireline investments in platforms such as FiOS, global IP, security, cloud services and machine-to-machine enabled us to deliver the services, applications and solutions that our customers want. As these services scale, they will become increasingly efficient and will improve our overall cost structure.

In the consumer and mass markets business, we continue to see positive revenue trends. For the last six quarters, consumer revenues have grown in excess of 4%. In the fourth quarter, these revenues were up 6.4%, driven by FiOS price increases and incremental revenue from FiOS Quantum. We believe that consumer revenue growth in excess of 4% in 2014 is sustainable. FiOS now represents about 73% of consumer revenue and we sustained strong double-digit growth throughout the year. FiOS consumer revenue grew 14.9% in the fourth quarter and 14.3% for the full year. Within our base, 46% of our FiOS Internet customers subscribed to Quantum with speeds ranging from 50 to 500 megabits per second. In the fourth quarter, 55% of our FiOS Internet sales were at speeds in excess of 50 megabits per second.

Our overall consumer monthly ARPU increased to $117, up 10.8%. Roughly two-thirds of our FiOS customers are triple-play, which have a much higher amount of recurring revenue per month. In terms of adding new customers, we are focused on profitable growth and have been disciplined in our approach in this very competitive market. In broadband, we had 126,000 new FiOS Internet additions in the fourth quarter and now have 6.1 million subscribers, representing 39.5% penetration. Overall, net broadband subscribers were a positive 20,000.

In FiOS Video, we added 92,000 new subscribers in the quarter. Total FiOS Video’s customers reached 5.3 million, representing 35% penetration. We also continue to make steady progress with Copper migrations. During the fourth quarter, we converted about 80,000 customers. For the full year, we converted 330,000 customers exceeding our target of 300,000. This network initiative is important for us as we systematically reduce our dependence on older technologies. At the end of the year, less than 1 million consumer customers remained on Copper services within our FiOS footprint. Aside from the maintenance savings and improvements in customer satisfaction, conversions to fiber also provide customers the opportunity to purchase FiOS services, which would result in additional recurring revenue. Looking at access lines, retail residential connections declined by 5.2% compared with a loss of 6.2% at this time last year.

Let’s move to our enterprise markets next on Slide 12. In the fourth quarter, Global Enterprise revenue declined $200 million or 5.2%. Legacy CPE sales were down 25%. Excluding the quarterly decline in CPE, Global Enterprise revenue was down 2.6%. We also continued to see pressure in revenue from the public sector, which declined at a double-digit rate. This decline included both soft demand and product rationalization at the federal, state and local levels.

Strategic services, which now comprised 59% of enterprise revenue, grew 2.3%. Key areas of investment such as datacenters, cloud and security services are growing at higher rates. We continue to work through economic challenges in the enterprise space in addition to public sector pressures. In the private sector, many enterprise customers are more focused on improving their cost structure, which puts pressure on our top line revenue. In general, enterprise customers continue to be cautious regarding new investment decisions.

Moving next to global wholesale, quarterly revenues declined $138 million or 7.8%. The revenue pressure is caused by the continued decline in legacy transport services. As we have stated, our wholesale strategy is to better monetize our global IP and fiber network by driving a more efficient migration to next generation Ethernet services. In terms of profitability, while growth in enterprise strategic services is improving the revenue mix, volume declines in the rest of global enterprise and wholesale continue to put pressure on Wireline margins. Through our Verizon Lean Six Sigma program, we are making good progress in our cost restructuring programs and retooling efforts which we believe will ultimately improve our operating efficiency.

Let’s turn now to slide 13, to summarize our overall wireline results. Total operating revenues were down 1.5% in the fourth quarter and 1.4% for the full year. FiOS and certain strategic services continued their positive growth trends. While global enterprise and wholesale were pressured by declines in legacy transport services, DTE and challenges in the public sector. In terms of wireline profitability fourth quarter EBITDA was $2.2 billion resulting in an EBITDA margin of 22.4%. For the full year EBITDA increased 2.5% to $8.7 billion with an EBITDA margin of 22.2%.

As expected our margin is similar to 2012. As I’ve stated in the past we’re confident that we will increase our wireline EBITDA margin in 2014. Let’s turn to slide 14 for our discussion of our cash flow results. Our cash generation in the quarter remained very strong. For the full year cash flows from operations increased to $38.8 billion an increase of more than 23%. Free cash flow increased to $22.2 billion up 45%. Capital expenditures for the quarter totaled $4.8 billion and were $16.6 billion for the full year, an increase of 2.7%. We continue to be very focused on improving an investment returns and capital efficiency and our annual CapEx to revenue ratio improved from 14% in 2012 to 13.8% in 2013. At the segment level wireless capital spending was $2.7 billion in the fourth quarter and $9.4 billion for the full year up 6.4%.

In wireline capital expenditures were $1.8 billion in the quarter and $6.2 billion for the year down 1.8% from 2012. The strength of our financial position enabled us to raise a record setting amount of capital in the debt markets last September. We ended the year with total debt of $93.6 billion with all the permanent financing in place related to the pending Vodafone transaction.

We have a positive track record in terms of deleveraging the balance sheet. Our pre-transaction leverage ratios were very low and we utilize cash for an entire 8.1 billion in bonds during 2013. Even though we have more debt our balance sheet remained strong and we retained the financial flexibility needed to grow the business. In 2014 our priorities for uses of cash are unchanged. We will continue to invest in our networks, purchase spectrum and delever the balance sheet in a prudent and disciplined manner.

We do not need to execute any major acquisitions to drive our business model. We understand the importance of our dividend and our Board of Directors have shown us support by improving dividend increases in each of the last seven years. In terms of capital spending we estimate total spending in 2014 to be in the range of $16.5 billion to $17 billion with continued improvement in our annual CapEx to revenue ratio.

We will be opportunistic in terms of acquiring new spectrum and has consistently demonstrated our ability to execute on this through a number of secondary market transactions. Our willingness to sell or swap lower band spectrum with competitors shows our industry leadership and strong belief that spectrum to be in the hands of companies that plan to deploy this spectrum and put it to use. As far as pension funding requirements our minimum required for 2014 is $1.2 billion based on our current plan assumptions.

As far as additional forward-looking information for 2014 we intend to provide that on our first quarter earnings conference call in April. Let’s move next to our summary slide. We enter 2014 with confidence and our ability to take advantage of the growth opportunities in our key strategic markets. We will continue to invest in our networks as the platforms for future growth and innovation. We have strong momentum in wireless and we expect to build on that strength driving further penetration of devices and extending our leadership position in 4G LTE. In FiOS we expect to drive higher penetration in existing markets and continue to differentiate ourselves with our FiOS Quantum product and quality of our video services.

In the enterprise space, we will continue to aggressively market key platforms like cloud, security, machine-to-machine and video delivery demonstrating to customers that we have a unique set of capabilities to provide customer solutions in a rapidly changing mobile first environment.

In terms of our cost structure, we will continue to drive productivity improvements and operating efficiencies throughout the entire business utilizing our Verizon Lean Six Sigma principles. At the end of the day, it’s all about execution. 2013 was a great year. Our focus on the customer and improving the value proposition drove consistent top line performance and resulted in significant growth in profitability and cash flows improving our investment returns. For 2014, Lowell and I have challenged our business leaders to build on the strong foundation we have, accelerate the momentum we have achieved, improve the returns on our investments and create more shareholder value. We look forward to another great year in 2014.

With that, I will turn the call back to Mike, so we can get to your questions.

Michael Stefanski

Fran thank you. Evan, we are now ready for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Your first question comes from John Hodulik of UBS. Please go ahead with your question.

John Hodulik - UBS

Okay, thanks. Good morning guys.

Francis Shammo

Hey John.

John Hodulik - UBS

Hi. Wireless margins were better than we thought. It looks like partially due to the lower upgrade rate. Is Edge putting pressure on the number of upgrades and do you expect that the number to be lower in ‘14 than it was in ‘13? And then secondly, T-Mobile’s new strategy with ETFs has been getting a lot of attention, how do you see that? Is that sort of an incremental change or do you think more of a fundamental change to the industry and how do you expect that to affect your business as you look out to ‘14? Thanks.

Francis Shammo

Hi, thanks John. Good morning. On the upgrades side, obviously the volume of upgrades this year were less than last year given all of the policy changes that we made and also keep in mind that at the end of 2012, we also had a free iPhone for the first time on our network, so that drove a lot of upgrade activity year-over-year so we had less volume this year. As far as the Edge program, the Edge program is going very well for us, but I would tell you just to give you a sense, it’s generating less than 1% of our profitability right now. So this is not a significant portion of our portfolio, but obviously given the competitive environment here. First off, let me just reiterate the fact that I know there has been a lot of questions around a price war and if you really look at what’s going on really what’s the shift of pricing is between service and equipment and really when you do the math, there really isn’t much of a price decrease here. It’s just a shift of how that’s marketed into the consumer market. So obviously, Edge is important to us from a competitive standpoint, but I am not going to give guidance John on where our upgrade rate will be in ‘14. As I said, I will give more guidance here once we close the Vodafone transaction. We have a shareholder vote here in a week. So I think it’s – it would put us in a – at a very peculiar situation to give a further guidance at this point in time. So I will give more guidance on that at the end of the first quarter. So that’s where we stand.

John Hodulik - UBS

Great, thanks.

Michael Stefanski

Evan, let’s take the next question please.

Operator

Your next question comes from Phil Cusick of JPMorgan. Please go ahead with your question.

Phil Cusick - JPMorgan

Hey guys. Thanks. I guess two. One, can you help us think about Wireline margins next year, how do you think about the issues of total revenue being sort of flat to down and mix issues versus cost cutting just trying to sort of scale the potential for Wireline margin growth? And then second on the OnCue platform, can you give us some more color do you envision a full MSO over Wireless are out of region eventually versus more of a in region and sort of ancillary product? Thank you.

Francis Shammo

Hi, thanks Phil. Good morning. So Wireline margin, look I think that I had been pretty clear on this. Coming into this year, I said we would be flat given a lot of headwinds that we have from some of these startup products we have, especially around the Redbox joint venture, VDMS and some other things in there. So look, we are very optimistic that we can improve this margin in 2014. As far as top line, what I gave here today is we are very confident that we can sustain the 4% plus top line growth on the Wireline consumer piece of this. And as you noticed, we did our price ups here in the fourth quarter of this year which is different than what we have done in the past and that was to prepare us for obviously the January 1st which is when content cost go up in all of our contractual arrangements. So we have put ourselves in a position this year to offset that content increase which we weren’t in a position last year. So we have done some strategic things from a top line perspective. Obviously enterprise continues to be a press point and I would say that we don’t plan for that to change in ’14 and I’ve said that coming into ’13 and leaving ’13 that I don’t think we’re going to see much of a change in our enterprise that top-line position in ’14. So I think that the cost cutting measures of Verizon Lean Six Sigma some of the improvement in some of these other ancillary platforms where obviously we acquired Hughes Telematics that is now growing topline revenue coming into the fourth quarter of this year. You probably saw today we just signed another agreement with Hyundai to acquire their business.

This is a growing platform but it does put pressure on us because we’re hiring people and it was a loss when we acquired it and continued to be a loss through ’13 and I think that could change some in ’14.

So there is a number of things here and I guess what I would say is I’m confident that we can improve the margin of our wireline business going into ’14. As far as the OnCue acquisition, look the focus here is really to accelerate the availability of the next generation IP Video service which will integrate into the FiOS video service and really what we’re trying to do is differentiate this even more so with fiber to the home versus others with the TV offerings and reducing the point in cost and this really accelerates us from if we were try to build IPTV versus buying the IPTV technology.

From a FiOS customer perspective we expect the benefits that they will have more elegant search and discovery interactivity and cost screen, ease of use but also keep in mind with the acquisition of Verizon Wireless and becoming 100% ownership of that we also plan to take that platform and integrate it more deeply with our Verizon Wireless 4G LTE network. So that really was the strategy behind this. As far as we enable this platform to take us over the top obviously we have our video digital media services that we have been working on for 2.5 years, we have just made two acquisitions related to that platform. So look I mean we’re positioning ourselves strategically to be in a position to competitively compete around the whole mobile first world and video. So I think that’s where we are.

Michael Stefanski

Okay Evan let’s take the next question please.

Operator

Your next question comes from Michael Rollins of Citi Investment Research. Please go ahead with your question.

Michael Rollins - Citi Investment Research

First Fran if you can just give an update on the net debt for Verizon Wireless and then secondly can you talk about the total amount of cost cutting that the Verizon Wireless business achieved during 2013 that contributed to the margin expansion you have had in the past few different initiatives that you were working on. And I was wondering if you can also share your aspirations in terms of the cost cutting potential for 2014. Thanks.

Francis Shammo

So I guess this will be the last and final quarter that I ever have to do this, hopefully. Gross debt of $5.3 billion, cash of $3.6 billion and net debt of $1.7 billion. As far as the cost cutting side goes look I mean coming into ’13 we said that Verizon Wireless had already cut about $5 billion worth of cost out of their infrastructure. We said that we were targeting them for another $2 billion in 2013, they actually exceeded that benchmark in 2013 and again I’m going to hold on 2014 here and I will give you more guidance when we get to the end of the first quarter and again it is all around our shareholder vote and the acquisition of the Vodafone transaction.

Michael Rollins - Citi Investment Research

If I can just follow-up with a different question then. On the pension side you mentioned the cash investment that you’re planning to make for ’14 where are you starting off the year in terms of the funding status and then where would that 1.2 billion roughly get you to?

Francis Shammo

Yeah so with the change in the discount rate and our assumptions around the return on assets are actual unfunded liability from the end of last year to the end of this year has improved by $2.6 billion. So our unfunded liability at the end of the year is for pension is at $5.9 billion. Now that also is very helpful from us well in the annuitization [ph] that we also did there in the – during the year of ‘13. So it puts us in a very good position with the $1.2 billion minimum contribution that we have into the plan to really start to make this a 100% funded plan. On the OPEB side of the house, our unfunded liability went from $24 billion at the end of 2012 to $19 billion, so a $4.2 billion improvement on that unfunded liability. So when you look at our balance sheet, even with the $8.1 billion of bonds that I paid off, we also had a decrease of over $6 billion in our unfunded liability. So the strength of our balance sheet has really taken off this year with almost $14 billion of a decline in our liabilities.

Michael Rollins - Citi Investment Research

Thank you.

Michael Stefanski

Evan, let’s take the next question please.

Operator

Your next question comes from Brett Feldman of Deutsche Bank. Please go ahead with your question.

Brett Feldman - Deutsche Bank

Thanks for taking the question. Since we have seen some changes in competitive behavior, I feel like we have been getting sort of gathered data points around who is taking share from who, in the past, you guys have always had pretty positive reporting ratios versus all your peers, I know you don’t give that on a regular basis. I am just curious can you either qualitatively or even quantitatively talk about how you feel about your net share gains versus your peers in light of the current environment?

Francis Shammo

Yes, thanks Brett. Well, I think the fourth quarter will stand on its own at 1.7 million ads and 824,000 net phone ads with the best quarter we have had since we launched tablets of 625,000. And I think that in a combination of itself will stand on its own. But let’s just go back here a second from a competitive environment standpoint and I have said before we will compete and respond accordingly where we need to. And if you recall coming out of the third quarter this question came up and I said look we are seeing a segment of our base that is responding to some of the competitive offers and we will make the necessary changes that we need to, to compete against those changes. And if you look at our churn in the fourth quarter which was unusual because of a seasonal season, we normally would go up in churn from the third quarter to the fourth quarter. In this year, we sequentially declined by 1 basis point. So I think that tells you that we responded to our base, we listened to our customers and this is what we do. Now, the competitive environment has changed again here in the fourth quarter and you can expect us to respond accordingly.

The other thing I would hedge ourselves on that we have built our brand. They are very long-term and we built loyalty with our customers and they come to us because of our network quality and superiority. We have, if you look at the coverage of our LTE network compared to our coverage, we are by far multiple times more coverage than our competitors and some as much as five and six times more coverage than our competitors. If you look at our Share Everything Plans, we continue to change them. We launched a new price plan. You probably picked up yesterday to go after our basic phone customers. And look I mean, we are going to compete in all devices in all markets. I think that another competitive advantage we have is our customer service and the quality of that customer service.

If you look at the new store we launched which we call our destination store in Minneapolis, I mean we are going after smartphone customers, but it goes well beyond that from a competitive standpoint. I mean, if you look at that store, we now are going after the sports and fitness with all kinds of devices, music, gamers. We have a whole home section. And of course, we have been talking about the machine-to-machine and tablets for a while now. So again, I think there is more competitiveness than just one little price plan and we will respond accordingly and aggressively and continue to do what we are doing.

Brett Feldman - Deutsche Bank

Great, thanks for that color.

Michael Stefanski

Evan, we can take the next question now.

Operator

Your next question comes from David Barden of Bank of America. Please go ahead with your question.

David Barden - Bank of America

Hi guys. Good morning. Thanks for taking my questions. Just first one Fran on FiOS and the quarter was a little soft relative to the trend, but what I noticed was that the footprint path is inching up towards about 19 million, the homes marketed to looks like it’s more in the mid 15 million. Could you talk a little bit about kind of the plans for mining out the rest of the FiOS opportunity and how that might contribute to the expectations for healthy consumer growth? I guess that’s number one.

And number two, if I can just follow-up on something you have talked about on the Verizon Vodafone transaction, I think Fran you have some estimates about what you thought the flow back was going to be and how it’s going to impact trading in your stock and obviously, I am sure there has been a lot of hedging and things that have moved around. If you could maybe give us a little bit of an update on what you think the movement around the stock is going to be around the transaction based on your latest data will be super helpful. Thanks.

Francis Shammo

So on FiOS yeah so let’s put it in perspective I mean we came out of the third quarter with an extremely good quarter of growth and the environment became extremely competitive and that the competition went after price and dropped pricing accordingly and we were pretty cautious on how we responded to that. We didn’t believe that we wanted to chase some of those price points in the fourth quarter because we know from our customer experience that a lot of customers do not want us intruding in their houses during the holiday season. So we were cautious on how we responded to that and obviously that led to some slower growth that we had from a net add perspective but here is what I would say is if you look at what we have done in 2013 and the concentration of the Copper to fiber migration which we believe is a more profitable customer at the end of the day. They are just voice and DSL customers.

So if you look at our internet volumes we actually did over 42,000 more net adds in ’13 with internet on FiOS than we did in 2012. So that really was the concentration and we exceeded that by 30,000. So we came into the year thinking we would get 300,000 and we did 330,000 and what we’re seeing from this space is once we move them with the same price plans either by voice or DSL they are then buying up as their only voice. They are coming over to our FiOS Quantum offer and if they come over they are buying up FiOS Quantum pretty significantly which is generating ARPUs in the range of $15 to $20 over and above what they were as a Copper customer.

And as you know we gave a disclosure of 55% of these folks are coming in at 50 megabits and above and we will continue to increase our speeds. We’re working on a new router that’s going to give better in-home performance with all the extra wireless devices that are going on. So when you think about profitability and topline growth FiOS Quantum is extremely important because when you look at broadband versus TV if you look you don’t have the contents of broadband is actually more profitable than the TV product.

Now having said that as I said in the third quarter there is a lag, once we move these people in marketing to them and getting to move to the TV. So TV did lag this quarter and I expected it to lag this quarter and I expected to lag as we continue to migrate this extra less than 1 million homes that we have, less than our FiOS footprint. But also want to be clear that we’re not going to build beyond what our current LFAs are and as you said we have 18.5 million homes pass now with about 15.3 open for sale on internet and about 15 for TV. So we have plenty of opportunity here but I would also tell you that again with even with the slower growth in the fourth quarter we still took market share and continue to increase our penetration and New York continues to be our fastest growing market with the most penetration this year over any other market we had in the TV arena. So I think that’s what sets us up for ’14. We will continue to execute on the same things that we have done this year which is concentration on migration and getting those quality customers to buy up in their bundles.

On the second question of flow back, look I think it's getting harder and harder for me to zero in on what the flow back is given what the market has done and the short positions and everybody positioning where they are. As we said when we came into this transaction we thought the net flow back would be around 300 million shares but keep in mind we will have somewhere between 4.1 billion and 4.2 billion shares outstanding. So it's a pretty insignificant minimal amount based on the volume of daily trading that we think we will have. So that’s really all the thought I can give you on the flow back at this point in time.

Michael Stefanski

Evan next question please.

Operator

Your next question comes from Mike McCormack of Jefferies. Please go ahead with your question.

Mike McCormack - Jefferies

Maybe a couple of things, you commented regarding the Edge program. It seems like some of the competitors out there moving to EIP which you can argue is a pretty bad deal for consumer and a pretty good for carriers. You know why wouldn’t you guys just get more active in the Edge marketplace and also that subsidy back for the consumer and then secondly on the enterprise side it seems like the industry overall is pretty weak. Can you just comment like the different pushback pieces [ph] there between legacy and new migration? What is the pricing environment look like from a competitive standpoint? Are you seeing any change there? Thanks.

Francis Shammo

Look on the Edge program as I said earlier we will respond where we think we need to respond. I’m not going to get into what others have done between Edge and subsidy. I mean we had a very successful fourth quarter and what we launched in the marketplace they were receptive to that. We ran a lot of promotions in the fourth quarter and it drove a lot of growth to our business and look, I mean again we will continue to do what we do best, which is we add customers and we are profitable. On the enterprise side of the house, look I mean this is becoming a more and more struggling event here given the uncertainty of the government. Then as you now look to what is more concerned now is the President has nominated Senator Baucus, which who was leading the tax rate format. He has now been nominated to Ambassador of China, which means now that could delay some reform. Now, others are picking it up, but this just gives more room for caution as to what is going to happen in ‘14, are we going to get tax reform, what about the expenders, they haven’t talked about expenders at all. There is a large cliff that we hit here on December 31, which was we lost a lot of credits and obviously the accelerated depreciation deduction is gone. So there is a lot of things that are putting enterprise back on their heels and people are just looking for cost-cutting measures, which mean that means I take a top line decrease in order to maintain that business.

From a public sector perspective, look I mean the federal government, our sector there is declining double-digits year-over-year and that is obviously putting a lot of pressure here. There are opportunities in that segment that we are exploring, but the way I would look at this is you have seen us make some moves here around EdgeCast and upLynk and video digital media services and you have seen us make some other moves in our cloud and what we have recently launched with our new cloud products in a beta test. So within security, cloud, datacenters and our advanced communications arena, we are growing revenue year-over-year, even more significantly even strategic services overall. So there are certain niches that are growing, but unfortunately have not enough to offset the other declines that we are seeing just form the public sector and some of these other pressures that we are getting from the large enterprise customers. So again, I think ‘14 will be pretty much flat with where ‘13 was. I don’t expect it to get any worse, but it will be a tough slope for ‘14.

Mike McCormack - Jefferies

Fran, you have talked about in the past, I think the percentage of customers just because that many years probably but percentage of customers have already moved from legacy product into IP Ethernet, is there a metric you can put around that as far as the customer base goes?

Francis Shammo

Mike, to be honest, I don’t know that off the top of my head, I am sorry.

Mike McCormack - Jefferies

Okay, thank you.

Michael Stefanski

Evan, let’s take the next question please.

Operator

Your next question comes from John Mark Warren of Morgan Stanley. Please go ahead with your question.

John Mark Warren - Morgan Stanley

Thanks. I was just wondering on FiOS Quantum, you have seen had a lot of success getting customers to upgrade from lower speeds like 10 megabits per second to 50, are you – is that typically a one-time boost or do you see customers continuing to come back for more speed?

Francis Shammo

Yes, John thanks for the question. We actually continue to see customers come back. And if you think about this, this is like when you are in your home if you have one or two wireless devices running off of that WiFi at 10 megabits and you start to put three or four devices on that, guess what, you are not getting 10 megabits to those wireless devices anymore, you are getting something significantly less than that. So the only way to compensate for that is to increase the speed into that router, so we see customers 50, 75, 100. I mean as I said, we are going to come out with a new proprietary router that’s going to even increase the speeds even more that are available for those wireless devices as people start to saturate the inside at their homes with tablets and other machine-to-machine connections. So this is an ongoing upgrade that customers are doing. We do this very seamlessly within the Verizon’s FiOS TV product or online, where we pop up things within your TV. You can just click the okay button if you want to upgrade right there and then it automatically does it. There is no phone call needed. So we make it very easy for customers to do that, but yes, we see customers coming back for the second time.

Michael Stefanski

Okay. Evan, if we can take the next question that will be great.

Operator

Your next question comes from Kevin Smithen of Macquarie. Please go ahead with your question.

Kevin Smithen - Macquarie

Thanks. We started to see a bit of a resurgence in access line M&A activity in the industry. Are there opportunities for Verizon to divest Wireline assets in 2014 or 2015 in order to increase the Wireless mix and de-leverage the balance sheet and if Wireline is a third of revenue today, where would you like to see that in three years?

Francis Shammo

Well, thanks for the question Kevin. It’s pretty little foresight there on divestitures, but look I think Lowell and I have always said, we will always look at opportunities for anything. And if we feel that we can get an adequate return on our – for our shareholders based on the investments we have and the properties we have, then we will execute on that. So look I guess, I would say we always have an open mind but at this point there is nothing on the table for us around that. The properties we have are performing extremely well and we will continue to execute on that. As far as the three year view I guess I will talk maybe a little bit more of that when we get to the end of the first quarter call but again I’m not going to give anymore further guidance. But look I think we’re very satisfied with the asset portfolio we have and with the acquisition of Verizon Wireless and only 100% of that asset you’re going to see us do more things around converged solution. So the wireline assets in my view will actually become more valuable over the longer term here with our footprint. So at this point I would say we’re open but nothing on the table at this point in time.

Kevin Smithen - Macquarie

And you mentioned the loss some of the tax credits for bonus appreciation et cetera. When you think about your capital budget for the year you know are you going to continue to spend (indiscernible) you spend last year for wireless given some of the spectrum and strong subscriber growth or are there risk to the CapEx number to fund some of the tax prior to cash taxes that are likely?

Francis Shammo

No because I think look we gave guidance on CapEx, it's 15.5 billion to 17 billion. As I said before obviously wireless won't take a higher percentage of that CapEx spend and on the other areas of the business will take a lower portion of that CapEx spend especially as the FiOS builds continues to slow here. But no there is no strategic change in the way we view our investments and I don’t do investments based on tax law. I didn’t accelerate CapEx spending when the accelerated depreciation went into effect. I don’t anticipate on the slow capital spending because it's not there anymore. So I think we will just continue to drive and execute on what we have from a cash tax standpoint as I said before obviously our cash taxes will go up with the acquisition of the 45% of wireless. I guided for next year when we announce the acquisition that we would be somewhere in 35% to 36% ETR. So I think at this point that’s where we will keep it and I will give you more color once we come out of the first quarter.

Michael Stefanski

Evan let’s take another question please.

Operator

Your next question comes from Joe Mastrogiovanni of Credit Suisse. Please go ahead with your question.

Joe Mastrogiovanni - Credit Suisse

Fran you have potentially some spectrum opportunities in the secondary market and ten you’ve a couple of spectrum options coming up. How should we think about the way you prioritize the low band spectrum versus maybe the mid and high band spectrum.

Francis Shammo

Well look I mean it's obviously I think we have shown that we have made the secondary market a very viable market. We have done a number of swaps with Leap, T-Mobile. Sales with T-Mobile and AT&T and some swaps even with AT&T in that key sale that we did. As far as our portfolio obviously we like the 700 megahertz for the coverage of LTE that we did. AWS is our sweet spot at this point in time which is the spectrum that we have been swapping for. So we have a very efficient portfolio of spectrum and I think we have shown through the years that we are very efficient on how we use spectrum. Keep in mind that as I said we will participate in the auctions because we will need more spectrum but right now our current position is with the AWS we have and that we’re launching in markets that you know in New York and San Francisco, Chicago. We’re lighting that spectrum up. It's pretty much completed in New York. We will continue to add to that but keep in mind though too that we will also reappropriate our 3G spectrum to 4G. We will take that PCS spectrum that’s been running in our 3G network as the (indiscernible) of the volume of that network continues to decrease as we move more 3G phones to 4G.

We will reappropriate that spectrum over to the 4G LTE. So again you know 3 to 4 years we’re in a very good space from a spectrum holding position but we will participate in the upcoming auctions.

Michael Stefanski

Evan next question please.

Operator

Your next question comes from Jonathan Chaplin of New Street Research. Please go ahead with your question.

Jonathan Chaplin - New Street Research

I wonder if I can just follow-up on that last question. So I think the next lot [ph] of spectrum is going to come on to be on to the market as AWS-3. So two questions around that, first of all do you see that as a valuable spectrum block that you really want to be a part of or is there enough opportunity within repurposing some of your 3G spectrum for 4G that that’s not critical and then in terms of deploying that spectrum as it is valuable to you, does it require you to put more equipment on the tower or because it’s contiguous to existing spectrum that you are deploying, can you do it with all existing equipment? Thanks.

Francis Shammo

Yes. So Jonathan on this one, look we will participate in the options that are coming up whether it’s the AWS-3 or if it’s the broadcast or whatever the FCC is going to auction here in the future. We have to build our portfolio for the next 10 years out. So as we have done in the past and we have shown that when auctions come up, it’s opportunistic they only come up one time, so you need to participate. And that’s what we showed when we won our 700 megahertz and we won the A and the B blocks a while ago and now we have repositioned that portfolio. We have launched the 700 megahertz in the AWS that we have. So AWS-3 is pleasing to us. Some of the higher frequencies is pleasing to us. So again, I won’t get into – I am not an engineer, so I am not quite sure what happens to have it within the network in order to enable these spectrums, but don’t think it’s much based on what we have done with AWS. So we will participate in upcoming auction.

Jonathan Chaplin - New Street Research

Great, thank you very much.

Michael Stefanski

Okay, Evan last question and then we’ll wrap up.

Operator

Your last question comes from Jennifer Fritzsche of Wells Fargo. Please go ahead with your question.

Jennifer Fritzsche - Wells Fargo

Great, thanks. Fran, I just wanted to see if you could give us a little quantify this what I’d call the smart to smartphone device upgrade opportunity, you said you are seeing ARPA lift there, but between the 3G and 4G, I know there is more usage, but is there a way to quantify that kind of ARPA lift you are seeing with these smart to smart movers?

Francis Shammo

Yes. Look, I am probably not going to give you that, Jennifer. Look, if you look at a 3G usage moving to a 4G, we know that and we have seen it in our base that as soon as you get on the 4G with video consumption and the quality of video, your usage goes up. So obviously, it’s hard for us to quantify this, because with our Share Everything Plan, you are obviously buying a bundle of minutes that you can share among all devices. But as you can see from our service revenue growth, our ARPA lift, our increasing connections, it’s all coming together as to how these plans were designed. And as I said, we still have a lot of 3G customers and a lot of basic customers for ‘14 that give us a lot of opportunity. So I think I will leave it there and the numbers will speak for itself.

Jennifer Fritzsche - Wells Fargo

Thanks, Fran.

Michael Stefanski

Thank you for your questions today. Before we end the call, I’d like to turn it back over to Fran.

Francis Shammo

Okay, thanks Mike. Look, our industry has a very healthy competitive environment and we are forecasting continued strong demand for video and broadband across multiple networks. As I said, Verizon will compete aggressively in all of our markets. We will focus on delivering a superior customer experience, one of the best networks in the world. Our customer value proposition and the efficiency delivery of our services will generate growth and profitability. This focus on profitable growth will create value for our shareholders, provide the earnings and cash flow necessary to reinvest in our networks and platforms for future growth and innovation. We are very excited about the future. We will continue to invest, innovate around solutions deliver for our customers, our shareholders and our Verizon employees. So again, Happy New Year everyone and thank you for joining our call this morning.

Operator

Ladies and gentlemen, that does conclude the conference call for today. Thank you for your participation and for using Verizon Conference Services. You may now disconnect.

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