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Verizon Communications Inc. (NYSE:VZ)

Q1 2010 Earnings Call

April 22, 2010 8:30 am ET

Executives

Ron Lataille - Senior Vice President, Investor Relations

John F. Killian - Chief Financial Officer

Analysts

John Hodulik - UBS

Tim Horan - Oppenheimer

Simon Flannery - Morgan Stanley

David Barden - Bank of America-Merrill Lynch

Michael Rollins – Citi Investment Research

Mike McCormack - JPMorgan

Operator

Good morning and welcome to the Verizon First Quarter 2010 Earnings Conference Call. At this time all participants have been placed in 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. Ron Lataille, Senior Vice President, Investor Relations of Verizon.

Ron Lataille

Good morning and welcome to our First Quarter 2010 Earnings Conference Call. Thanks for joining us this morning. I’m Ron Lataille and with me this morning is John Killian our Chief Financial Officer.

Before we get started, let me remind you that our earnings release, financial statements, the investor quarterly publication and the presentation slides are available on our investor relations website. This call is being webcast. If you would like to listen to a replay you can do so from our website.

I would also like to draw your attention to our Safe Harbor Statement. Information in this presentation contains statements about expected future events and financial results that are forward looking and subject to risks and uncertainties. Discussion of factors that may affect future results is contained in Verizon’s filings with the SEC which are available on our website. This presentation also contains certain non- GAAP financial measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are also on our website.

As we indicated on our last earnings conference call, beginning this quarter we are no longer adjusting reported earnings results. Instead, we are only reporting GAAP earnings, consistent with trends in corporate reporting. Of course we will continue to provide the detailed information you need to understand and analyze our reported results, including the identification of material, non-operational items.

For the first quarter GAAP earnings were $0.14 per share. These earnings results include a total of $0.42 of non-operational charges, the largest of which is for reduced tax benefits related to retiree healthcare. This onetime, non-cash tax charge totaled $962 million or $0.34 per share. In addition, we incurred a non-cash charge of $0.03 per share related to pension settlement losses resulting from our previously announced separation plan. As you know, pension accounting rules require that settlement losses be recorded once prescribed payment thresholds have been reached.

We also incurred non-operational costs in connection with the spinoff of our local exchange business in 14 states. As we’ve previously discussed, these costs are related to network, software and other activities required for these facilities to function as a separate company. This quarter these get ready costs amounted to $0.04 per share. Lastly, we incurred $0.01 per share this quarter related to Alltel merger integration costs.

I would also point out that all of these non-operational items are reported at the consolidated level and therefore do affect any comparison for wireless or wireline segment results to prior periods.

One last item I’d like to mention relates to certain revenue reclassifications within the wireline segment, due primarily to business customer shifts between mass market, global enterprise and global wholesale. The largest shift involved businesses with 20 or more employees. These accounts are now being managed by our enterprise sales teams and the corresponding revenues will be reported on the global enterprise line. Revenue from businesses with less than 20 employees will continue to be included in the mass market line.

Prior period history has been reclassified and is provided in the supplemental schedule and historical files on our website. These changes in revenue line item reporting did not have a significant effect on historical growth rates. With that, I will now turn the call over to John Killian.

John F. Killian

Thanks, Ron, and good morning everyone. Before we get into the operational details, let me start with some brief comments on the business overall and add some perspective to the results for this quarter. In January, we outlined our key focus areas for 2010. In summary, we said that we expect to continue generating solid cash flows and maintain tight control over capital spending.

Second, we would continue to capitalize on our investments in wireless, FiOS and global IP networks to grow revenues and market share, drive deeper penetration and increase ARPU. Finally, we would remain focused on our cost structure, achieve meaningful cost reductions, and make sure the business is ready to quickly benefit from improvements in employment figures in the overall economy.

In the first quarter, we executed on the business plan we described to you. Free cash flow grew over 25% this quarter, driven by strong cash flow from operations and a lower capital spending. We saw good customer growth in wireless and FiOS and we may be seeing some positive early signs of recovery in the business markets.

Revenue trends this quarter were better on a consolidated basis, as well as in the wireless and wireline segments. In wireless, data growth was particularly strong this quarter driven by the significant amount of smart phone sales and upgrades. We feel very good about our retail postpaid ARPU and customer retention performance this quarter.

On the cost side, we continue to benefit from the synergy savings of the Alltel acquisition and wireless margins expanded this quarter. In our wireline segment we continue to be aggressive and persistent in our cost restructuring to preserve margins. Cost reductions of 5,000 last quarter and 2,300 this quarter resulted in cost savings of about $80 million in the first quarter. However, the continued economic pressures on the top line, incremental pension and retiree benefit costs, and a higher cost related to record setting storms, affecting much of our franchise territory, resulted in a lower margin.

My goal continues to be to stabilize the wireline margin this year. We are on track with our plans to accomplish this goal. I am confident that we can achieve this objective and expand margins in the future. Lastly, on the strategic front, our pending transactions involving the sale of the Alltel divestiture markets and the spinoff of access lines are both moving forward. With this as an overview, let’s turn to Slide 4 and start our detailed discussion of the quarter.

As Ron indicated earlier, our first quarter earnings results included the non-operational charges you see here. A majority being non-cash and related to deferred tax and pension expense recognition. Our cash summary presents a much different growth picture. Cash flow from operations in the quarter was strong, up 7.5% over last year. Our capital spending was down $251 million or 6.8%. Free cash flow at the end of the quarter was $3.7 billion up almost $750 million or 25.6%.

In wireline, first quarter capital expenditures of $1.6 billion were down $437 million year over year. In wireless, capital costs were higher by $219 million. Although we’ve started the year conservatively, I’d reiterate that our 2010 guidance for capital spending is in the $16.8 billion to $17.2 billion range. As far as the balance sheet is concerned, we continue to reduce leverage. In the first 3 months we’ve reduced net debt by $1.7 billion and net debt is down more than 10% from a year ago.

Let’s now turn to revenue trends, which are on Slide 5. Consolidated revenues for the quarter were $26.9 billion, up 1.2% from the first quarter a year ago; a better growth rate than each of the last two quarters. This reflects improvements in both wireless and wireline. Wireless revenues were up $661 million or 4.4% driven primarily by data. Wireline revenues were down 2.9% this quarter due primarily to continued economic pressures in our business markets. FiOS revenue growth continues to be strong, up 40% year on year. This is the third consecutive quarter of lower year over year revenue decline in wireline.

With that snapshot of revenues, let’s move to the segments next, starting with wireless on Slide 6. In the first quarter, total service revenues were up $770 million or 5.9% versus the year ago quarter and we saw strong sequential improvement of 2.2% which is the highest sequential growth rate we’ve see in the last six quarters.

This revenue performance is of course driven by our strong focus on expanding the data market. Data revenues, which comprised one-third of total service revenues in the quarter, grew 26.4% year-over-year. Total ARPU was 18% higher than a year ago.

In terms of the components of data growth, quarterly revenues from web and email services was $2.4 billion, up 43.5% from first quarter last year. Messaging revenues of $1.8 billion grew 16.2%.

Our strategy continues to center on taking advantage of the expanding smart phone category. Our approach has been to feature a number of different operating systems and platforms which gives us the opportunity to not only attract new customers, but aggressively upgrade existing customers to high end data capable devices.

In addition to the obvious benefits to metrics like ARPU and churn, this will drive sustained data revenue growth. We have plenty of upside in terms of data penetration. At the end of the first quarter, more than 30% of our retail postpaid base had 3G multimedia devices or smartphones, up from 26% at the end of 2009. 17% had smartphones and 13% had 3G multimedia devices. We believe customer demand for data mobility for connections not previously disclosed were counted in our subscriber metrics in the past.

At the end of the first quarter we had 92.8 million customers and more than 100 million total connections. Our high quality customer base is heavily weighted toward retail postpaid customers which comprised 89% of our subscriber base.

This customer segment remains our key focus as we continue to drive revenue growth through increased data usage in penetration. In the first quarter we added more than 1.5 million net new customers with 423,000 retail postpaid net adds and 1.3 million reseller additions.

With regard to the change in mix, we typically see seasonal effects in the first quarter. In any given year the sequential decline in retail postpaid net adds between fourth and first quarter can be about 25% to 30%. This quarter the decline was magnified. But we did not see any significant shift in market share, overall porting ratios or any increase in churn. In fact our churn rates improved. Total churn showed declines both on a year over year basis and sequentially.

In postpaid, churn posted a 6% improvement compared to the first quarter last year. I would also add that these improvements are from already remarkably low industry leading churn levels. Although total wireless market penetration is above 90%, we are still very bullish about our growth opportunities in the retail postpaid market.

By continuing to strengthen our smart phone device lineup, in ordering differentiated services like NFL mobile and Skype mobile, we will stimulate upgrades within our existing base as well as attract and retain high value customers.

Net adds in our reseller channel were very strong again this quarter which is not surprising given typical prepaid seasonality. The reseller market is a low-cost channel for us and an effective way for us to attract the incremental prepaid customer. I would also remind you that we do not have unlimited pricing arrangements with our reseller partners.

The new category – other connections – totals 7.3 million at this time and will include all kinds of machine to machine devices like vehicle tracking, telematics, e-readers, consumer electronics, smart grid solutions, medical alert devices, essentially anything that has a wireless chip in it.

Looking ahead, particularly when we commercialize LTE, the proliferation of these types of devices will be another source of incremental wireless growth. As we’ve mentioned in the past we have a separate organization dedicated to open development and Verizon wireless is taking a leadership role in facilitating and stimulating innovation in this area. Examples include nPhase which is our joint venture with Qualcomm to provide advanced M2M solutions, the establishment of the Verizon Technology Innovation Center in Waltham and the creation of the 4G Venture Forum.

Let’s take a closer look at our retail performance on Slide 8. Our focus continues to be on the retail postpaid market. It is the largest and most important portion of our business. Retail service revenue -- which accounts for about 85% of total wireless revenues -- grew 5% in the first quarter on a year over year basis.

As I mentioned earlier, our retail postpaid ARPU grew 0.6% versus the year ago quarter. This accretion is driven by our data growth strategy with an increasing percentage of our customers using smart phones and multimedia devices.

Device upgrades were strong as 8.6% of our postpaid base upgraded in the first quarter representing an increase of almost 15% from a year ago. This is extremely positive from a churn and ARPU accretion perspective.

Customers are responding very well to our portfolios, smart phones, and multimedia devices. 36% of device sales from our direct channels were smart phones with a $30 monthly data plan and 24% were from multimedia devices, which have a minimum $10 monthly data plan attached.

The pricing simplification we implemented in January is helping to drive some of these excellent metrics and the results were exactly what we anticipated. While we experienced the downward migration of customers from the $99 unlimited price point, we also saw a healthy migration of customers up to new $69 unlimited price point.

Another positive development is an increasing percentage of gross adds or new customers opting for voice plans at 900 minutes per month or more, which obviously bodes well for revenue and ARPU.

As [Lowell] described on the investor call in January, our goal is to drive further smart phone penetration and stimulate data growth; which will offset some of the voice declines. In addition, as we launch LTE later this year, having a large number of data customers provides us with a great opportunity to meet their increasing need for higher speed and more sophisticated application-based devices.

The first quarter results indicate that this is the right strategy. Revenue growth improved, our key customer retention metrics improved, and we saw retail postpaid ARPU accretion.

In terms of profitability, we had another excellent quarter, generating 6.4 billion of EBITDA up 5.7% from first quarter last year. Our first quarter margin performance of 46% is a strong result, reflecting both lower retail gross additions and stronger upgrades to higher end devices.

I think the wireless team did a great job this quarter driving this margin result given our aggressive upgrade strategy. Looking ahead, you can expect us to continue achieving both growth and profitability, with a focus on gaining share in the retail postpaid market and increasing the penetration of smart phones and other data devices which will further expand the data market.

Let’s move now to our wireline segment on Slide 10. As I mentioned earlier, we continued to see both cyclical and secular pressures in our wireline consumer and business markets, with total wireline revenues down 2.9% from a year ago.

Our broadband and video products are driving a significant shift in our consumer revenue mix and we continue to be very pleased with the success of FiOS. FiOS revenues are up 40% and ARPU increased 5% year over year.

Managed and IP services continue to transform the business revenue mix. In the first quarter, strategic services revenue and enterprise was up 4.2%. Let’s take a closer look at both the consumer and business markets starting on Slide 11.

A year ago FiOS made up about 30% of our consumer revenue. At the end of this quarter, FiOS represented more than 41%, a significant increase in just four quarters. The strength of our broadband and video products continues to drive consumer revenue and ARPU growth.

Consumer revenue in the first quarter grew 0.9% on a year over year basis and we continue to see strong growth in consumer ARPU which increased to more than $78 this quarter, up 12.3% from a year ago.

The entire FiOS initiative continues to be very successful and we saw very positive levels of customer additions for both FiOS TV and internet this quarter. We have surpassed the three million customer mark in FiOS TV, with 168,000 net adds this quarter, and with 12 million homes open for sale, penetration of FiOS TV is 25%. In FiOS internet we added 185,000 customers this quarter bringing our total to 3.6 million. With 12.6 million homes open for sale, internet penetration is 29%.

Let’s move next to our business markets on Slide 12 which shows our global enterprise and global wholesale revenue performance. As you can see, revenue in each of these categories has been relatively stable for the last five quarters.

As a result we’re seeing improved comparisons on a year over year basis. Global enterprise revenues was down $57 million or 1.4% in the first quarter, compared with a 4.8% year over year decline in the fourth quarter.

The steady increase in the number of private IT site activations is an encouraging indicator, as are CPE sales, which were higher than we typically see in the first quarter. Enterprise long distance usage volumes which have typically seasonal fluctuations show year over year growth for the first time in quite a while. All of these factors point to early signs of a recovery. That should help our review performance in future quarters.

Global wholesale revenue in the first quarter declined $69 million but 2.9% year-over-year compared with a 4.9% decline in the fourth quarter. While we continue to see growth in ethernet services related to wireless back wall, we are not seeing a pick-up in wholesale long distance usage volumes yet. Foreign currency effects this quarter were similar to what we have experience in the fourth quarter. So the key point here is that revenue is stable and there is some optimism for improved performance in a recovery starting in the second half of the year.

Let’s cover wireline profitability next. From my perspective we’re competing well in the market and we remain focused within the wireline segment on four key strategies, driving FiOS growth, improving enterprise, driving costs out, and capital efficiency. In the first quarter, the fundamental trends underline the overall wireline results have not changed. The secular changes in the consumer market and the impact of the economic downturn in our business markets are still quite evident and while wireline revenues are still declining it is at a lower rate which is positive.

The facts are that in the first quarter the sequential decline in wireline revenues was nearly a quarter of a billion dollars. We did realize about $80 million in savings this quarter attributable to force reductions. However, these savings were more than offset by a combination of cost pressures including, an unusually high amount of storm related costs and incremental pension and retiree benefit expenses. I am confident that as we go through the year we will be able to stabilize the wireline margin with a combination of better revenue performance and our cost restructuring efforts. Every line item of expense is being attacked within our wireline business.

Let’s take a look at some of the key areas. First, head counts. In January I indicated that our plans were to reduce the wireline workforce by a similar level to what we achieved in 2009. A reduction of 10,000 people for example results in an annual run rate cost savings of about $600 million. In the first quarter we reduced our workforce by 2,300. Keep in mind that our teams have executed well in this area with more than 28,000 reductions since the beginning of 2008.

Next, real estate. We have been doing an extensive amount of work rationalizing our real estate portfolio to reduce costs. This included plans to close facilities and reducing square footage, reductions in energy usage as well as facility maintenance savings. Our plan identifies roughly $125 million in cost savings in 2010 alone. Over the course of the next three years we plan to reduce our total square footage by about 10%.

Other initiatives involve cost savings from network convergence which include center consolidations, operating and support system eliminations and new technology efficiencies. We’ve identified $100 million in projected savings here by the end of 2010. Other areas of projected savings include managing third part interconnecting, content costs and a variety of reduction initiatives associated with supply chain inventory management and energy. Over the course of the next two years we have plans in place to resize our cost structure and capture run rate savings in the range of $1.5 to $2 billion. Once again we have a well organized and realistic plan and I am confident that we will capture these savings.

To sum up, as we move into the second quarter we remain focused on the key areas I mentioned earlier. First, continuing to generate solid cash flows and maintaining tight control over capital spending. Second, continuing to capitalize our investments and wireless FiOS and global IP networks to grow revenue in market share, drive deeper penetration and increase output. and third remaining focused on our cost structure, achieving meaningful cost reductions and making sure the business is ready to quickly benefit from improvements in the employment rates and the overall economy.

Ron, I will turn it back to you now for questions.

Question and Answer Session

Ron Lataille

Thanks John. Brad, John is now available to take questions.

Operator

Thank you. We will now begin the question and answer session. (Operator Instructions) Our first question comes from John Hodulik of UBS.

John Hodulik - UBS

Maybe just a couple of quick questions on wireless. The growth seems to be draining out of the postpaid market in general pretty quickly. Is this a good sort of mix of net adds that we can expect between post paid and reseller going forward? And if so I know there’s a lot of moving parts including some pretty some pretty strong postpaid ARPU trends but what are the margin implications here, we typically in the past talked about sort of mid 40s but given this potential shift in growth going forward, how do you see margins playing out from here?

Ron Lataille

Let me give you a couple of thoughts here on this. If you look at the quarter we gained 423,000 post paid customers. Typically the first quarter is down seasonally somewhere in the range of 20% to 30%. Obviously that was magnified in this quarter. We came off a very strong fourth quarter as you know where we had gained 1.1 million. Really, on the back of the strong introduction of the Droid and the Android based operating devices.

We had no really major new devices launched in Q1. The Android itself based operation system continues to do very well, in fact when you look at actually gross numbers we moved more of them in Q1 than we did in Q4 so we’re very satisfied with what we would label as the Droid franchise and you’re going to hear a lot more about that in the coming months, particularly with an important launch for us coming up shortly which is the HTC Incredible which the early reviews on is extremely positive.

Now the other thing in the quarter, we put a lot of emphasis around upgrades and we did see an uptick of about 15% in our upgrade level. Now that’s great news for us, it’s great news for ARPU, it’s great news for retention and by the way we see a lot of ability with tailwinds there to continue to do well with that.

Now as we go forward, just a couple of thoughts for you, we believe we can do better from a post paid perspective than we did in Q1 that will be particularly on the backs of new product introductions. We are not ready to throw the towel in to say that postpaid growth is going to be substantially lower now, by the way we recognize where penetration is, we don’t think we’re going to have $2 million quarters but we think we can do better than we did in Q1.

Now I would also underpin this saying we are going to be very responsible in terms of how we go after that. We are very focused on profitability, making sure we got the right mix, we do have a huge upgrade opportunity as I mentioned before, and the other thought I would give you here is that this is really a foundation as we look at it for our LTE launch later this year. We’re more excited than ever about the prospects and the capability of LTE so as we get more and more of our customers with smart phone based devices it’s going to be a very nice transition into the LTE launch.

Now a couple of thoughts for you here on margin. We had a very good quarter from a margin perspective, 46%. As you know we don’t have particular point guidance out there. We have seen particularly in these economic times a bit of a mixed shift towards the all you can eat plans, that’s really driven more on the lower end of the marketplace. We’ve seen some of our prepaid base move to the reseller plans. We’ve seen some of the lower end of the market. That will probably continue for a little while but we still believe that we’ll be a lot of strength on postpaid.

Now just to refresh you on this, our reseller pricing is not unlimited, okay? It’s really a bucket of minutes.

Reseller customers that we're attracting now carry much higher ARPUs than our traditional ones, and are very profitable and are not dilutive to our overall margin. So we think we can continue to grow margin quite nicely in the wireless business and be in a very good position.

Operator

Our next question comes from Tim Horan - Oppenheimer.

Tim Horan – Oppenheimer

John, just a clarification on the postpaid ads, and then a strategic question. Can you maybe talk a little bit about how postpaid ads progress through the quarter? And I guess you're saying you're not really seeing shifts in market share, because I guess we're hearing Sprint and Team Mobile, Sprint particularly, is doing a little bit better with some of their new pricing moves. But just to clarify, you're not really seeing any shifts there?

John F. Killian

Tim, on that is our market share remains strong. We're still quite positive here. And I'd say we're pretty even in performance as we went through the quarter. We probably picked up a little bit towards the March timeframe. But again just to reiterate, we believe there still is postpaid growth out there for us. We believe our network and our offerings are a differentiator.

Tim Horan – Oppenheimer

And then just on the strategic front, there's been a lot of articles lately about Vodafone and their ownership of Verizon Wireless, and some speculation. On how to kind of simplify that, what do you think is the most likely outcome here? Is it maybe just status quo, find you guys the next couple of years?

And related to this, there were a few articles, I think some misunderstandings on the dividends. I got a lot of calls you might have to cut the dividend because the wire link can't support it. Do you see any issue importing cash up from the wireless unit up to the corporate unit? I mean I don't see what the concern is other than you have to pay some of that cash to Vodafone, but they're a shareholder like everyone else.

John F. Killian

Tim, it's a real surprise I'm getting this question by the way. So let me give you a couple of thoughts here. One is we've just passed the 10th year anniversary, hard to believe, of Verizon Wireless being created. And in partnership with Vodafone, I think our teams have done a great job. We've had a great working relationship with them over the last 10 years and the business is doing extremely well.

Now let me hit the dividend issue first because I think it's important. I want to make sure from our perspective that our shareholders understand that we view the dividend as being very safe. We're a business that generates a lot of cash flow, over $30 billion of cash flow. We have a lot of different levers we can pull to make sure we have the ability to pay the dividend.

And you know I'm surprised that becomes as big of a question as it does become given all of the levers and all of the cash flow that we have. We have numerous sources of cash that is being generated. And by the way paying the dividend to our shareholders, our shareholders are a priority for us. So the dividend and making sure we have stability and being in a position to recommend to the board dividend increases is highly, highly important to us.

Now on the strategic side of it Tim, you know, over the last 10 years you and I have both watched, there are kind of cycles where the whole ownership question gets more and more attention. We're in one of those times right now. From where I sit, the business is working extremely well. We've never made a secret of the fact that under the right conditions, right terms, of course we would be interested in buying out the minority interest for 45%. Why wouldn't we be in a business that's working as well as it is?

Now from my perspective as a CFO, that's very much a financial transaction. We run the business today, we operate the business, we manage it, we control it. So I would look at, you know, what is the price tag that the other party if they were interested in selling. What's the price tag? What's the multiple? Does it make sense to us from a financial perspective?

I don't know where that's going to go, but our view is pretty clear on that from that perspective. The discussions around merger that had been out there in the press, you know, I've made a comment on that recently and it kind of does reflect the belief of the management team. We're not convinced there's industrial logic behind putting the two organizations together.

By the way, not that we're not open to listening, hearing new information on that, but we do not see a significant level of synergies, cross border mergers, you know, have not been historically highly successful. A lot of management complexity comes with that. So while we're always interested to hear about that, we don't really see the industrial logic.

Now on the cash flow from wireless, the great news is there's a lot of cash flow. It's growing, it's getting better. It's going to continue to get better. We've been clear what our view is of that in the short-term, which is to use it to delever Verizon Wireless. That is still our view.

We have an annual discussion with Vodafone in December of each year. We'll have another next year. There is not [religion] though. I don't want you to think that we would never dividend cash out of Verizon Wireless. At some point when we're in a position where leverage is much lower than it is today, and when it is appropriate, we will dividend cash out of Verizon Wireless. It's just not a 2010 event. We'll be looking at that again as we get into 2011, but it's an event off into the future.

Operator

Our next question comes from Simon Flannery - Morgan Stanley.

Simon Flannery – Morgan Stanley

A couple of FiOS questions. There's been a lot of talk about your FiOS, sort of build plans here. And I note that wireline Cap Ex was down about 22% year-over-year, although you reiterated your full year guidance. Perhaps you can just clarify your build year-to-date and your build plans for the rest of the year and what's going on there. And then on the FiOS ARPU up about 5%. What's driving that? Is that changes in the mix? Is that price increases? And where do you see that going over time?

John F. Killian

Obviously I said in the prepared remarks, we're very satisfied with where we are from a FiOS perspective. We're very focused on growing penetration. Our build plans, we're still on the path to build alternately to about 18 million premises within our franchise territories.

This year we're going to pass about 1 million premises in 2010. You know, give or take 100,000 or 200,000 on either side. Part of that is an intentional strategy, Simon, this year to focus down on a lot of the inventory we have. A very strong focus around the NPU population within our franchise territory.

We don't believe we've had enough focus there, and it's a great opportunity and a very cost effective way to drive new subscribers in new retention. Now from an RCM perspective you are right. We've had very good growth in FiOS RCM, more focused on the video side. We have had some price increases there which are natural, you know, in terms of the video side.

We've also seen improvements in some of our Video on Demand kind of services that are also contributing to that. So yes, we're very pleased with FiOS. The profitability continues to improve. We've been operating income positive the last couple of quarters. The cost metrics that we believed we would see ultimately with FiOS has positioned us very well.

And, you know, we think we've got a great foundation here on the wireline side for the future. That, you know, we will have somewhere in the range of post Frontier spinout 70% to 80%, in that range, of footprint covered with fiber. And that's going to position us very well for the future. You know, we've also got focus on making sure we've got capital discipline within the wireline business. We have suffered a little bit from the economy and some of the cyclical change. So there is focus on making sure we're investing at the right level in that business.

Simon Flanner – Morgan Stanley

So just to be clear, are you going to be finished with the FiOS build at the end of this year or might some of it now. If you're going to do 1 million a year instead of 2 million or 3 million, you're going to be a little bit more. Still in 11, 12 --

John F. Killian

We'll have a little more to do in the 2011, and maybe even the 2012. We're just stretching it out a little bit longer. We felt that was appropriate given where the economy was, given some of the attention we've got around the Frontier spinout. Don't read this at all to be at all we're not satisfied with FiOS. We are very satisfied with FiOS and will continue to evaluate that going forward.

Operator

Your next question comes from David Barden – Bank of America-Merrill Lynch

David Barden – Bank of America-Merrill Lynch

First would be a following up on the FiOS side, have you seen any change over the course of the quarter in the competitive dynamic in both DSL and FiOS relative to the incremental push the cable companies have been making on DOCSIS 3.0 especially on Comcast, how do you think competitively, looking into 2010 to ‘11, do you think you’re stacking up now relative to cable in 2008 and ’09?

The second question would be on the iPhone, not the question you think. It’s clearer now, I think, than it’s been that there’s probably an iPhone refresh coming around the middle of the year. Obviously, last year’s game plan was to wait, it came, you really got more aggressive on your smart phone portfolio than you’d really ever been in the third quarter and that led to a market share swing back in your favor. Looking at it this year, what would be the game plan this year that you would do differently, if anything, to make sure that there isn’t a market share swing in AT&T’s favor the way we saw last year?

John F. Killian

From a competitive environment, from cable on video and HSI, we really see no change. It is a very competitive environment, as you know and continues to be but I don’t see anything in the quarter or this year that has really shifted. When you look at our results, we did better in the first quarter than we did in the fourth quarter.

Our total broadband was 89,000 just short of 100,000. That was up on [30] in fourth quarter a year ago. We continue to do reasonably well here. We’d like to drive to a little bit higher numbers as we go through the next several quarters. We think with the economy starting to come back a little bit we’re positioned for that. Our wireline team is very focused on it. We don’t see…and you know Dave, customer satisfaction and independent reports continue to put FiOS at the top of the list in all areas. We think we’ve got a great product here. You’re incenting people to change, right? They’ve already got service, typically, so that’s the trick for us.

On the second question, it’s really more of what we’re doing now. We think we have found a very strong lineup, and again, not just based on one operating system but the DROID, Android based system, the [REM] systems, we’ve had some Microsoft launches recently, but you will see a lot of emphasis around the DROID as we go through the year. We think we have a very competitive lineup.

There’s no question, Apple’s done a great job with the iPhone, but look at our results. We’ve performed very well both from a growth, our revenue growth this quarter on the wireless side is better than it was last quarter, our service revenue is upticking . We have several different, new devices coming as the year goes on, most notably the one I just mentioned, which is the HTC Incredible. So, I think we’ll be earlier in the process this year of having very strong devices to be very competitive. But again, based on multiple systems, we think we’ll be in a very good position.

Operator

Your next question comes from Michael Rollins – Citi Investment Research

Michael Rollins – Citi Investment Research

Thinking a little bit more about what you said on the wireline and cost cutting, I think I got the numbers right, you’re saying $1.5 billion to $2 billion cost cutting goal. If you take the higher end of that on wireline revenue, I think it’s a little over 400 basis points on the revenue. Is your goal to take the margin level from 21.7 and assume pension is unchanged from here just to take that out of the equation, are you thinking that the margin over a couple year periods will get back to a 26%? As you benchmark yourself around your competition, where do you have conviction as to where wireline margins should be for your company over time?

John F. Killian

Mike, let me give you a couple thoughts here. You know we don’t put out guidance numbers on that and point estimates. Let me just give you a little color to what we think happened in the quarter, where we’ll focus on and where we think we’re going.

If you look at the margin on the quarter at 21.7, we had to eat through a sequential revenue decline of about $225 million. By the way, we see good news there because rate of revenue decline in the quarter was only 2.9%, it was 3.9% in the fourth quarter, so we see improvement there.

We had a couple of unique issues in the quarter that hurt us a little bit. We had mentioned that this year that we do have some incremental pension and OpEx costs. That was about $40 million in the quarter. We had, and this is one we don’t usually like to point to and talk to, but it was such a factor in this quarter that I’m going to mention it, we did have extraordinary weather conditions on the east coast. That minimally cost us $50 million in the quarter. That was related to a lot of overtime because of the flooding conditions and record snowfall in the Mid-Atlantic States, which you usually don’t have that caused complications. There are a lot of issues that contributed to the first quarter.

Now when you look at our focus going forward, it’s really focused around four items. It’s continuing to focus on FiOS. We’re very pleased with the profitability where FiOS is but we think it can get a lot better as we continue to get more and more scale. So that’s going to continue to ramp up and help us.

We think our enterprise and businesses services, as the economy gets better as we go through ’10, probably saw a little sign of that in the first quarter. I don’t think there was much of it in our numbers, but we think we’ll see more of that particularly in the second half of the year. That will be very helpful to us.

Now, on the cost side, I hope you get the feel here that we are very focused on improving and continuing to improve the cost structure. I mentioned on previous calls the last couple of years we’ve reduced our wireline workforce by about 13,000 per year and I said we would do the same this year. I actually think we have now the ability to do more than that this year.

You’ll probably read in the press later today that we did reach agreement with our unions and our east coast unions, the CWA and the IBEW, on an enhanced incentive offer last night. That is going to allow us to take out a significant number of associates. One of our limitations on our ability to downsize the workforce was we were limited in our ability to layoff in our east coast contracts. We could layoff post 2003 hired employees and we did some of that last year, but beyond that it was voluntary incentives that drove it.

We reached agreement on an enhancement and I think this year we should be able to beat the 13,000 number. I’m not going to put an exact number on that yet because we’re still factoring through that based on the agreement. But I think we’ll be very focused on additional force reductions this year.

In addition to that, Mike, we’re also very focused around cash flow in the wireline business. That ties back to some of the other questions and capital efficiency will improve. I’m not going to put a number or a date on when this is going to turn, but I am convinced we have all of the right initiatives in place. We have the conviction to get it done and that we should see the ability to stabilize and then improve our wireline margins over time.

Michael Rollins – Citi Investment Research

If I could just ask one follow up, when you typically lose revenue, you’re typically able to take some costs out of that as well. Should we look at the cost cutting target of $1.5 billion to $2 billion as incremental to what you normally are able to take out with revenue? So, this extra turbo boost, if you would, to the reduction in cost or does that $1.5 billion to $2 billion incorporate what you expect to save as revenue erodes for whatever period of time you’re forecasting?

John F. Killian

Just a couple of thoughts here, Mike, I think with the news of last night, we might be able to do better than even the $2 billion. I’m not going to give you a break out of how much is tied to…What I think you’re going to see is improving top line within the wireline business based on FiOS and the enterprise side. And you’re going to see very visible cost reductions. Some of that is incremental to the normal but I’m not going to place an exact number on that.

Operator

Our next question comes from Mike McCormack – JPMorgan

Mike McCormack – JPMorgan

John, can you go into a little more detail about your comment about market share shift in wireless and you guys not seeing that, sort of the metrics that you’re looking at there, certainly it seems like the [inaudible] marketplace is taking more and more share of growth after the market. If you’re looking at purely churn then your base or just lost of gross [inaudible] overall and then secondly, in enterprise stuff it sounds like you’ve got some good data plans coming from both AT&T as well you guys. Can you just give us a little more color on where you’re seeing that, whether its demand for new orders, things coming through the pipeline and then sorry to bother you with the last one, in addition to the enterprise comment, how important is the enterprise recovery to your margin stability comment and why [inaudible] is it that, is it equally with cost reduction or is there one more important than the other? Thanks.

John F. Killian

Okay hey Mike, you know on your first one on market share, we look at really every month we get studies from Nielsen on share shifts and all of that. Obviously we look at our churn numbers which are terrific, the postpaid churn at 1.07, we look at our porting ratio, so from our view we’re hanging in there very nicely, and that’s at a time where there is a little slowdown as you’ve mentioned on the postpaid side so we feel good about where we are on wireless market share and we think we’ll continue to do well as we go through the year.

From an enterprise perspective, a couple thoughts here for you, our number in the quarter only down, 1.4, had been down 4.8 in fourth quarter, 6.2 in third quarter. Even would you adjust for FX we were down 2.3 in the quarter versus 5.6 in the fourth, 5.3. So were definitely seeing improvement here from an enterprise perspective. We’ve repeatedly said we’ve been very successful in winning new opportunities in the marketplace. We continue to do that, a number of those are incremental. We’re still seeing moves on both a private IP perspective as well as security services. We did see some benefits in the quarter also from CPE, now that’s a good indicator I think of the economy, so that all puts us in a good position.

Now on how important is it? It’s important but relevantly there are four or five different major contributors that we need to get them all clicking. Cost is probably number one right now in terms of biggest contribution but continuing the progress on FiOS, continuing the progress on enterprise are all very important.

So I know you have another call at 9:30 so I think we’re going to call this [inaudible] but I want to leave you with a couple of closing comments here. First of all let me thank you for joining us today. If you look at our wireless business we continue to see great opportunities to grow the business and to make the business more efficient. Our strategy around aggressive 4G deployment and increased smart phone penetration for multiple operating platforms will drive data growth and continue to differentiate us from our competitors.

We remain committed to maintaining reasonable growth and strong profitability in our wireless segment. On the wireline side, we believe that the strategy we put in place a few years ago, that is having a smaller footprint with the majority covered by FiOS, coupled with a more global enterprise business focused on multinationals is the right strategy that also differentiates us from our peers and will help drive growth for the long term.

I also recognize that the issue on the wire line segment is stabilizing and improving profitability. I do not want to overstate what we can do here in the short term but I believe our cost reduction initiatives will gain traction and with an improving economy we will see better wireline modules. Finally we continue to deliver strong cash flow metrics. Our dividend is strong and safe. We’re maintaining good discipline in our capital spending and our balance sheet is solid.

Thanks again for joining us today on the call.

Ron Lataille

Thanks, John and Brad that concludes our call and thank everybody for joining us today.

Operator

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

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Source: Verizon Communications Inc. Q1 2010 Earnings Call Transcript
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