BellSouth Corporation Q4 2005 Earnings Conference Call Transcript (BLS)

Jan.26.06 | About: BellSouth Corp. (BLS)

BellSouth Corporation (BLS)

Q4 2005 Earnings Conference Call

January 25th 2006, 10:00 AM.

Executives:

Patrick Shannon, Chief Financial Officer, Principal Accounting Officer, Sr. VP of Fin. and Controller

Nancy Davis, VP, IR

Analysts:

Simon Flannery, Morgan Stanley

Jonathan Chaplin, J.P.Morgan Chase & Company

Frank Louthan, Raymond James & Associates

Michael Rollins, Smith Barney Citigroup

David Janazzo, Merrill Lynch

Jason Armstrong, Goldman Sachs

Kevin Moore, Wachovia Securities

David Barden, Banc of America Securities

Timothy Horan, CIBC World Markets

Mike McCormack, Bear, Stearns & Company

Christopher Larsen, Prudential Equity Group

Operator

Good morning. My name is Judy and I will be your conference facilitator today. At this time I would like to welcome everyone to the BellSouth Fourth Quarter 2005 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer period. If you would like to ask a question during that time simply press “*”, then the “1” on your telephone keypad. As a reminder, ladies and gentlemen, this call is being recorded today, Wednesday, January 25, 2006. Should anyone need assistance at any time during this conference please press “*” then “0” and an operator will assist you. Thank you.

At this time I would like to turn the call over to Nancy Davis. You may begin your conference.

Nancy Davis, VP, IR

Thank you, Judy. Good morning. Thank you for joining BellSouth's Fourth Quarter 2005 Earnings Conference Call. During this call we will refer to a slide presentation. The presentation, earnings press release, investor news and our financial statements are posted on our website at bellsouth.com.

Before we get started, let me point out that some of our remarks today may contain forward-looking statements. Actual results could differ materially from those projected statements. For a discussion of the factors that could cause actual results to differ, I refer you to our various reports on file with the Securities and Exchange Commission.

I will begin our discussion by covering BellSouth's consolidated financial results. To supplement the reporting of BellSouth's consolidated financial information under Generally Accepted Accounting Principles, the Company presents certain non-GAAP financial measures including normalized operating results and operating free cash flow.

Normalized results include BellSouth's 40% share of Cingular Wireless and exclude events that are generally nonrecurring in nature. I will review the normalizing items for the fourth quarter of 2005. A complete list of normalizing items, as well as a full reconciliation of normalized results to GAAP reporting, is included in the quarterly financial statements which are also available on our Investor website.

Slide 4. As disclosed in our press release this morning, BellSouth is conforming its normalized financial reporting to align to industry practices for the treatment of purchased intangible assets. Normalized results include the non-cash amortization of purchased intangibles created in Cingular's acquisition of AT&T Wireless. Prior periods have been recast for the change. A full reconciliation is available with our press release on our Website.

The 2005 net income impact was $374 million. Slide 4 provides an estimate of future net income impacts to BellSouth for the purchased intangible amortization that will be normalized from our reported results. If you have further questions about this change, please contact the Investor Relations team.

Slide 5 shows BellSouth's consolidated GAAP results from continuing operations for the fourth quarter and for the full year of 2005. Revenue was $5.2 billion, up 2% compared to the same quarter of the previous year. Full-year revenue also increased by more than 1% compared to 2004.

Operating margin was 19% for the quarter and 22.7% for the full year. Year-over-year reported operating margin comparisons reflect ongoing challenges in the wireline business as well as financial impacts associated with Hurricane Katrina.

Reported earnings per share was $0.34, up 36% compared to the same quarter a year ago. For the full year GAAP earnings per share was $1.59.

BellSouth's normalized results for the fourth quarter of 2005 are on Slide 6. Normalized earnings per share for the quarter was $0.53, a 36% increase compared to the same quarter of the previous year, reflecting improved performance at Cingular.

Full-year earnings per share was $2, a 7% increase compared to 2004 as higher contributions from the combined Cingular/AT&T Wireless offset financing costs associated with the Cingular transaction and pressures in the wireline business.

Fourth quarter 2005 revenue was $8.7 billion, up 2% sequentially. For the full year, BellSouth's normalized revenues were $34 billion, of which over 40% came from Cingular Wireless.

Operating margin for the fourth quarter was 20.7%, reflecting significant year-over-year improvement for Cingular and stable results in wireline and improvements from the Advertising and Publishing Group. On Slide 7, you can see the details of the normalizing items for the fourth quarter of 2005.

Adjustments to reported earnings per share from continuing operations include costs associated with Hurricane Katrina, wireless merger integration costs and intangible amortization, and costs associated with our planned workforce reduction. Adjustments to reported earnings also include a reduction from earnings for a deferred revenue adjustment.

At this point, I will turn the call over to BellSouth's CFO, Pat Shannon. Pat will begin his comments from Page 8.

Patrick Shannon, Chief Financial Officer, Principal Accounting Officer, Sr. VP of Fin. and Controller

Thank you, Nancy, and good morning. The fourth quarter reflects strong results across all three asset groups: wireline, wireless and yellow pages. The 36% increase in normalized earnings per share is driven by operational improvements and reflects the value of our asset mix.

First, let me cover some highlights for the quarter. Wireline revenues grew 1% year-over-year and 2% sequentially, driven by solid retail results as our consumer and small business segments continued to reach growth trends and our large business segment showed some signs of stabilization with fourth quarter revenue up 0.4% year-over-year. Data revenue grew an impressive 7.7%, driven by a strong DSL revenue growth as we continue to profitably penetrate our markets with broadband services. In addition, year-over-year wireline operating margins held steady during the quarter.

Cingular's results reflect solid execution against their four strategic imperatives focused on the building the best network, improving customer service, providing unmatched distribution and delivering new products. Their strong net ads, improving churn and income and margin expansion demonstrate Cingular's continued progress.

Our Yellow Page business ended with strong sales results and continued to improve its profitability. As we look forward to 2006, our cash flow and balance sheet are strong, providing a solid financial foundation for the business.

Slide 9 outlines the full year financial impacts from Hurricane Katrina. Total revenue credits across all three asset groups were $111 million. We booked billing credits totaling 48 million during the fourth quarter to proactively address service outages and significant dislocation in the hardest hit areas.

These revenue credits are not normalized from our reported results, as we are unsure of the timing or extent of the return demand. For the full year, there were approximately 100,000 lines reported as disconnects as a result of Katrina. Approximately 40,000 disconnected in the third quarter and another 60,000 during the fourth quarter. And while there are still lines in the area that have not completed a call since September, most of these lines represent paying business customers who desire to retain their phone numbers and billing credits will not continue.

The next two expense items on the slide show full-year costs for uncollectible reserves and other expenses incurred predominantly in the third quarter. Year-to-date wireline network restoration costs, both expense and capital, totaled approximately $500 million.

On September 6th, we estimated that the total cost of restoration would be between 4 and 600 million. Based on current assessments to complete the restoration work we now expect this amount to total between 7 and 900 million.

We also expect a portion of our costs to be covered by insurance. While the exact amount has not been determined, our current estimate of the amount of covered losses net of our deductible is approximately 250 million. The actual recovery will vary depending on the outcome of the insurance loss adjustment effort.

Restoration and recovery in the areas impacted by Katrina have been unprecedented, to say the least. Hurricane restoration usually occurs in two phases. The initial phase is temporary restoration to accomplish a quick return to service, followed by a phase of permanent repair of facilities. We are well into the permanent repair phase with Katrina. With respect to Katrina, there will be a prolonged third phase. That is the phase of repopulation, or rebuild of the devastated areas, which, from an expense and capital perspective we will consider new growth in the future. While there's no clear delineation between restoration and new growth, we will stop normalizing for the costs associated with Hurricane Katrina after June 30th.

Now turning back to our results on Slide 11. For 2005, more than 75% of our revenue came from segments that grew year-over-year. Cingular, which now represents more than 40% of BellSouth's normalized revenue provided 6.6% full-year pro forma revenue growth.

Advertising and publishing, an important contributor to our profitability and free cash flow, continues to lead its industry with 2% revenue growth for the full year despite absorbing some significant billing credits in the Gulf Coast area.

Consumer delivered a solid full-year revenue growth of 2.3% driven by higher DSL and long distance revenues that outpaced revenue erosion from residential access line losses.

During 2005, our small business segment contributed more than 2.3 billion in revenue and added over 124,000 margin-rich access lines. This segment grew revenues 6.4% in 2005.

Their efforts to retain and reacquire customers are paying off with market share gains and stable revenue per unit.

Large business revenues declined 2.1% as pricing pressure played a key role in this competitive marketplace. But trends in the second half of the year improved with revenues breaking into positive growth in the fourth quarter.

And while we view this trend optimistically, we expect continued challenges in this market segment. Wholesale revenues were down only 1.4% despite significant volume declines in UNE-P.

Transport services sold to wireless carriers continued to grow at a double-digit rate in 2005 offsetting declines in traditional wholesale data transport services.

Looking specifically at Communications Group results on Slide 12, we ended the fourth quarter of 2005 on a strong note.

Communication group revenue grew nearly 1% year-over-year and 2% sequentially showing an improving trend. And while these growth rates aren't huge they are significant in the context of access line declines.

All of our retail units, consumer, small business, and large business, experienced year-over-year growth and sequential growth in revenues in the fourth quarter, driven largely big growth in data and long distance services. Year-over-year data revenue grew 7.7%, the highest quarterly growth rate for the past few years, with strong growth in DSL at 29% and other retail data at 4.4%.

Our business is moving beyond voice with data services becoming a larger component of our revenue stream.

For the fourth quarter, operating margin was 21.9%, 30 basis points higher than the same quarter of '04. We have only normalized hurricane costs associated with Katrina as we recognized that some level of storm activity is an ongoing part of our business.

Other weather-related restoration costs reduced reported margins by 130 basis points in the quarter. For the full year, Communications Group operating margin was 23%, down 200 basis points compared to the full year of 2004.

The 200 basis point reduction breaks down as follows. 50 basis points for the impact of storms other than Katrina, 50 basis points for the revenue impacts of Katrina, 50 basis points for net increases from pension and other post retirement benefits and another 50 basis points for all other items, including increase in the cost for broadband systems development, and pricing pressure in our large business segment.

Slide 13 illustrates BellSouth's successful efforts in the broadband market. We added 204,000 net new DSL customers in the fourth quarter.

Our DSL subscriber base totaled nearly 2.9 million at the end of 2005, up more than 786,000 subscribers or a total of 37% compared to 2004. This represents a 15% penetration of our retail access lines.

DSL churn reached its lowest level ever in the fourth quarter reflecting the positive impact of our simplified DSL pricing plan, improved customer retention and tighter credit policy.

DSL revenue grew to 1.2 billion, up 26% compared to 2004, driving growth in the total wireline business. DSL revenue per unit also increased sequentially to $42, and recurring service revenue per unit grew from 37 to more than $39 sequentially.

Revenue per unit improvements were driven by customer migrations to the higher speeds, and the roll-off from promotional pricing plans that we offered if the first half of the year. The key point here is that we have not seen an increase in churn as customers rolled off promotional pricing.

In addition, BellSouth added a 6-megabit product in November. And this month we reduced our monthly price of the residential 3-megabit service by $5 to just under $38, making it attractive for customers to double their speed from a 1.5-megabit product to a 3-megabit product.

And in the fourth quarter over 50% of our net adds were 3 or 6-megabit and 75% were in the top three speeds of 1.5 through 6-megabit.

Slide 14 shows our continued progress with long distance services. BellSouth added more than 1.1 million long distance customers in 2005. During the fourth quarter, we added 186,000 net additional customers to reach a total of 7.2 million customers and a 58% penetration of our mass market customer base.

Mass market and complex long distance revenue totaled 1.7 billion in 2005, an increase of 35% from 2004. This revenue stream is a strong contributor to operating margin for BellSouth.

Churn has improved and revenue per unit has remained stable on this service all year. About 36% of our base has unlimited long distance and another 35% has plans that charge a monthly recurring and per minute usage fee.

Slide 15 shows recent access line trends. As a reminder, land loss as a result of Katrina totaled 40,000 in the third quarter and 60,000 in the fourth quarter. Other than lines lost as a result of Katrina, residential line loss trends have remained at consistent levels for the past three quarters with wireless substitution being the main driver of line loss and cable and VoIP competition have a lesser impact. We continue to estimate that losses to cable and VoIP providers account for about 15 to 20% of total residential losses.

Second line in disconnects remained in the 50,000 per quarter range. For the past two quarters, business net line loss was primarily driven by wholesale losses while retail business lines were positive.

Small business has been gaining lines since the third quarter of 2004, and large business line loss has mitigated over the same period with large business access lines declining only 8,000 over the past two quarters.

Now let's shift our discussion to Cingular's performance on Slide 16. Cingular saw a dramatic improvement in revenue and margins compared to results we saw just following the merger.

Service revenue was up 580 million compared to pro forma results in the same quarter last year. That translates into 8.1% top line growth.

The service margin on operating income before depreciation and amortization was up 760 basis points year-over-year to 31%. The year-over-year margin improvement reflects progress on merger synergies including increased productivity, economies of scale and lower churn.

These improvements are clear evidence that the integration is working and bodes well for continued margin expansion.

Slide 17 shows Cingular's customer growth and churn improvement. Cingular added 5 million customers in 2005 and ended the year with over 54 million customers. In the fourth quarter, Cingular added 1.8 million customers.

Gross ad momentum along with falling churn rates drove great customer growth.

Retail customer additions were approximately 840,000, reflecting steady growth in post-paid customers and an increase in go phone prepaid customers. In addition, seasonal reseller promotional activity drove strong resale customer additions.

The churn was down 30 basis points year-over-year to 2.1%, it's lowest level, and post-paid churn is down 30 basis points compared to fourth quarter last year to 1.9%.

Slide 18 illustrates Cingular's increasing contribution to BellSouth's earnings per share. In the fourth quarter of 2005, Cingular's contribution to our normalized EPS was $0.12. This represents a $0.12 improvement year-over-year.

And for the full year, Cingular drove a $0.38 contribution to BellSouth's bottom line, driving BellSouth normalized EPS up 7% year-over-year.

For the fourth quarter, Cingular represented 41% of BellSouth's consolidated top line at 31% of our consolidated normalized operating income before depreciation and amortization. So you can see that what is good for Cingular is obviously good for BellSouth.

Turning to our Yellow Page business, on Slide 19. This is the fifth consecutive quarter year-over-year revenue growth at A&P. Growth continues to come from the success of online and companion directories.

Online advertising revenue grew 39% for the full year of 2005. During the quarter, we enhanced our online services further by completing the rollout of Yellowpages.com.

In the fourth quarter total revenue grew 3.2% year-over-year adjusting for the unusual circumstances in New Orleans, but our reported growth, including the credits, was .2%. And while the revenue credits have stopped for the most part, we expect some incremental revenue pressure during 2006 due to business displacement in the New Orleans area, but outside of this area the underlying health of the business remains strong and our A&P group is positioned for continued strong revenue growth.

This business continues to generate strong margins and free cash flow for BellSouth. A&P's fourth quarter operating margins were again resilient increasing 100 basis points year-over-year to 46.3%.

Additional key financial metrics on our cash flow and balance sheet are found on Slide 20. BellSouth generated 3.3 billion in operating free cash flow during 2005 and consistently executed on each of our priorities for the use of cash.

During 2005 we directed 3.2 billion in capital investments back into our wireline business with about 40% going towards the improvement of our broadband capabilities. We also invested an additional 211 million in wireline network restoration in New Orleans and the Gulf Coast region.

We continue to maintain a strong balance sheet. In 2005 we paid down 3.4 billion in debt.

Our dividend remains competitive with that of our peers, and we're returning additional value to our shareholders through our $2 billion share buy back program and have repurchased nearly a billion through the end of the year.

Before I wrap up my comments, let's take a look at an important slide that compares 2005 normalized results to 2004.

With the acquisition of AT&T Wireless, BellSouth's normalized revenues reached 34 billion in 2005. Cingular is over 40% of that number.

The Communications Group revenue was stable in 2005, and the Advertising and Publishing Group grew revenue. Our total normalized operating income was up approximately 10% to 7.1 billion with a significant shift in the mix towards wireless.

The result is that in the face of market challenges BellSouth grew operating income. Even though the Communications Group profit came under pressure, Cingular more than offset this decline by increasing their profitability throughout the year.

In the end our normalized operating income was up for the full year showing that we are manage through the changes in the industry and turning the changes into benefits for BellSouth shareholders. Now I'll be happy to take you questions.

Question-and-Answer Session

Operator

Operator Instructions We will pause for just a moment to compile the Q&A roster. Your first question comes from the line of Jonathan Chaplin with J.P.Morgan.

Q - Jonathan Chaplin

Good morning. Thanks for taking the question. Great quarter, guys. I just had two quick questions. First, the add back for severance, I'm wondering, is this from the reduction in management employees that you discussed after the Analyst Day? My understanding is that most of those employees were going to come off towards the end of the first quarter and I noticed that there wasn't much of change in the employee base in the fourth quarter so I'm just wondering what the driver of the charge was? And then secondly, when I look at free cash flow it came in much stronger than expected, especially when you add back the Katrina CapEx. I get to a free cash number of 3.45 billion compared to your initial guidance of about 3 billion. It seems like a chunk of the upside came from deferred taxes, which I thought was going to be a drag rather than a contribution this year. At least I think that was the expectation going into the year. I'm wondering if there was anything, you know, beside deferred taxes where, the surprise to free cash flow came and then what the expectations are for cash taxes in '06? Thanks.

A - Patrick Shannon

Yeah. Okay, Jonathan. As far as the workforce reduction, yes, we did announce it in December. The workforce reduction was around 1500 employees. They will come off of in the payroll in around the April time frame. Through the first quarter but it will be over by the end of April. It's about, it represents about 7 to 8% of management and about 2 to 3% of total employees. The charge is, is sort of comes in two stages. The first charge was in the fourth quarter for severance, and that represented the involuntary level of expenditures for the workforce reduction. There will be a subsequent charge that will be smaller in the first quarter to the extent that we had voluntary offers that are a little bit richer than the involuntary offers. We did expect a year-over-year decrease in expense of around 175 million pretax. On the free cash flow, yeah, we did anticipate a higher level of cash taxes in – for the 2005 time frame. That did not happen to the extent that we believed at the beginning of the year. But as we pointed out our guidance on cash taxes for next year is around the $2 billion range. So we will have an increase in cash taxes on a year-over-year basis in '06 is what we're expecting today.

Q - Jonathan Chaplin

Thank you very much.

A - Patrick Shannon

Okay. Thank you.

Operator

Your next question comes from the line of Simon Flannery with Morgan Stanley.

Q - Simon Flannery

Okay, thank you very much. Good morning, Pat. If we could stay on the expense side of things, can you just comment on the trends in pension and OPEB given some of the moves by Verizon, IBM and others. Do you think you have the ability to try to make some changes to, particularly, your white collar plans and get some more leverage add over the next few years? And also any update we have on the IPTV trials? Thanks.

A - Patrick Shannon

Okay. As far as the pension goes, as we pointed out in December at our analyst meeting, pensions for the first time on a year-over-year basis is not part of our guidance because we don't expect a significant increase in expense on a year-over-year basis for pensions and OPEB. We had a pretty large increase from '04 to '05 because of an accounting change, but we continue to make progress on changes, you call it the white collar side of the benefits, and we stopped providing post retirement medical benefits to new employees after 2001. That was one of the significant changes we made. And then this year we made some pretty significant changes in the sharing models between management and that is helping us to offset the medical inflation that we would have otherwise seen in '06. So that certainly helped. On the pension side, you know, our pension plan is overfunded by a significant amount, so we continue to look at ways to whittle away our benefits, but there's not a huge benefit at this point to us in addressing, you know, pensions, but we continue to look at that on a going forward basis. I think Verizon had some needs and they had some changes in their employee mix and that they were probably required to do some things. As far as, what was your other question? Oh, the IPTV trial?

Q - Simon Flannery

IPTV, yeah.

A - Patrick Shannon

We're currently extending our, we had a field test that we had around 50 friendly users on. We've extended that field test. We now have over 250 users on our network using DSL IPTV delivered over DSL today. As we announced in December, our plan is to roll out a market trial in Cobb County in Atlanta to around 1,000 homes and we'll be doing that over the year, but so far the user experience is positive and, you know, the technology seems to be working.

Q - Simon Flannery

But there's no real go, no go decision for a couple of quarters until the back half of the year? Isn’t it?

A - Patrick Shannon

Our next step is the 1,000-home trial in Cobb County. Until we get results from that we don't really know what the next step will be.

Q - Simon Flannery

Thank you.

Operator

Your next question comes from the line of Frank Louthan with Raymond James.

Q - Frank Louthan

Good morning. Just a couple of quick questions on the enterprise side. Can you give us some color on what you're seeing the trends in pricing there for special access? I'm hearing anecdotally some evidence of maybe some price firming there. And can you give us an idea on the trends in wholesale excluding UNE-P or what the UNE-P impact was would those have looked better. And then, just sort of a more broadly looking out there give us an update on and how you're looking at the large business side, how you look to compete with some of the other RBOCs that are, have just gotten into that business in a larger way? Thanks.

A - Patrick Shannon

Okay Frank. Most of the stabilization that we've seen in the large business area has been volume related. We have seen an improvement in access line trends. As I mentioned on the call, comments, we've only lost about 8,000 lines in the last two quarters and many of those lines, you know, we still see migration to higher speed data products within our base. So volumes are picking up. We're seeing a good growth in emerging data products like VPN and Metro Ethernet that are driving top line growth. We've seen no real reduction in price pressure, but we're just being able to overcome that with some new volume growth. So that's a positive statement that we're seeing. On the wholesale side, we continue to see a large roll-off of UNE-Ps. You can see the numbers in our data pack. We are going to have some more revenue increases, or pricing increases during 2006 so I don't really see that roll-off dissipating any time soon. The good news is that outside of the local wholesale business the revenue stream seems to be pretty stable as the wireless growth, which is still in the double-digit range, is offsetting more of the traditional transfer services that we would sell to the IXE. So for now, we still see stabilization in that revenue stream. As for as competing, going forward in LDS, I think as we pointed out in December, we have a very strong capability, network capability and product capability set in the Southeast and our goal is to focus heavily on customers that are located in the Southeast, have the preponderance of their business in the Southeast, and we will be able to compete just like we have in the past very effectively in that business with just minor augmentations of our product set outside of our region, which we get through partnerships with Qwest and Sprint. Qwest on the more traditional data services and Sprint now on the higher end MPLS-type services. So again, we're cautiously optimistic about the stabilization and feel good about our prospects, but it will still be tough sledding I think in the next year.

Q - Frank Louthan

Okay, great. Thank you.

Operator

Your next question comes from the line of Michael Rollins with Citigroup.

Q - Michael Rollins

Hi. Good morning.

A - Patrick Shannon

Hi Mike.

Q - Michael Rollins

Just a couple of questions. First as you look at the residential ARPU, how much of that has been driven by broadband versus the traditional wireline voice, and are you taking any pricing actions in your local markets as competition intensifies? The sort of second question and separate subject is, just as you think about the dividends you've made comments before that you want to keep your dividend competitive. What is the potential to move toward a payout strategy whereby you would say, okay, we're going to pay out a certain percentage of our earnings in the form of a dividend versus, you know, looking at the yield? Thanks.

A - Patrick Shannon

As far as the consumer ARPU, as you'll notice in the data that we sent you, the ARPU did cross over $60 for the first time. And again it's continued reflection of the penetration of DSL and LD. In addition to just increased penetration of those two products, in the fourth quarter we also saw a pretty nice ramp-up in the DSL revenue per unit. There's an increase in revenue per unit of a good 7 to 8% in the quarter as customers migrate at a higher speed, therefore higher priced products. And promotional pricing from early in the year rolled off. So it's mostly that on the voice side, there continues to be pressure, I mean, the voice ARPUs are clearly not expanding. They're also not dropping significantly in the trend. And we do take measured competitive responses even on the voice side and offering in some cases, you know, $39 unlimited voice products, but again, only in very targeted ways in some of our higher markets from a competitive standpoint. On the dividend front, I don't mean to give you the impression the only thing we look at is dividend yield. I think yield is sort of a visible number that you would look at as far as comparing us to other companies, but as you know there's two sides to the yield equation, there's the stock price and also the payout. So we look at not only yield, we look at payout curves, our payout ratios between us and the peers, and I think clearly if you look at payout ratios we're sort of in the middle between SBC and Verizon, and, you know, we think we're at a competitive payout level. As we've stated before and I'll restate again, dividend growth is still our highest priority for free cash flow. We have announced a share buyback but dividend growth still ranks very high on our radar screen.

Q - Michael Rollins

Thanks very much.

A - Patrick Shannon

Thank you, Michael.

Operator

Your next question comes from the line of David Janazzo with Merrill Lynch.

Q - David Janazzo

Good morning.

A - Patrick Shannon

Hi, David.

Q - David Janazzo

Can you update us on thought process on access line divestitures? We've got a few larger more natural consolidators possibly developing this year and what would your thought process be?

A - Patrick Shannon

Yeah, I mean, we have looked at that issue several times and I won't tell that you we won't look at it again, but it's not something that's on our radar screen at this point to make major divestitures of access lines. So again, having said that, we look at everything and decide whether it makes sense for our shareholders. But right now that's not on our radar screen.

Q - David Janazzo

Okay. Just a quick one. Have you or to your knowledge Cingular had any discussions with AT&T on the branded wireless service topic?

A - Patrick Shannon

In what way were you talking about?

Q - David Janazzo

AT&T branding and selling some sort of wireless service offer.

A - Patrick Shannon

Yes, I think clearly they've stated an intention of bundling some services together, and the Cingular joint venture agreement clearly allows them to do that, but I think they have stated their intention to you know, use that in the enterprise space mainly, so that's really the only thing that we have at this point.

Q - David Janazzo

Okay. Thank you.

Operator

Your next question comes from the line of Jason Armstrong with Goldman Sachs.

Q - Jason Armstrong

Great. Thanks. Good morning. A couple of questions. First, on margins, Pat, can you help us think about Comm Group margins as we go into 2006? I know you've talked previously at the analyst day about a little bit of pressure there but given the factors you mentioned that contributed to the 200 basis points of margin pressure in '05, it seems like a lot of that goes away. 100 basis points tied to hurricane, 50 basis points tied to pension and OPEB, 50 basis points tied to pricing pressure in large business which is abating at this point, so can you help us think about 2006 margins? I mean it seems through a lot of the stuff you've mentioned, it seems like 2006 margins could actually get better in the Comm Group segment. And then second question is just related to the buy back. You did a billion dollars in the first quarter. What's the pace like since the first quarter? Has it continued at that pace, and then, you know, if you get through it pretty quickly what's the decision process after that? I know you touched on wanting to hike the dividend, keep it competitive, but might we see another share buy back program after this? Thanks.

A - Patrick Shannon

I don't know if that was a weather forecast for 2006 or not, but we certainly hope that this unprecedented level of hurricanes won't repeat but there's no assurance that that's not going to happen. We have stated that the margin pressure on pensions and OPEBs should not repeat, so that is a data point that we have thrown out, so that's certainly going to help the current trajectory. I think, you know, the headcount reduction that we just announced will certainly help, if nothing else, offset labor inflation and benefit inflation for 2006. So that will certainly help. If this stabilization and LDS is real, then that margin pressure in there, that will certainly help. So those are all the things that I think you have to take a look at. Weather, who knows. I mean, I'm very hopeful. We've been through a couple of tough years. We're getting too good at putting networks back together after hurricanes hit them, but we'll have to wait and see what happens in the hurricane season in 2006. As far as the buy back goes, as you pointed out, we did complete half of our announced $2 billion program in the fourth quarter, and as we pointed out when we announced the $2 billion program, we don't have any intention really of giving any specific guidance on the timing of the repurchases, so, you know, just have to be reported after the fact as we do them, but we're not really at this point in a position to give any sort of guidance on what the timing of the other billion dollars of buy back would be other than we remain committed to it.

Q - Jason Armstrong

Okay. Thanks, Pat.

A - Patrick Shannon

Okay.

Operator

Your next question comes from the line of Kevin Moore with Wachovia Securities.

Q - Kevin Moore

Good morning. A couple of questions. On your ARPU, your consumer ARPU continues to strengthen as well as the impact of cable continues to be relatively muted. How do you see those playing out in'06? Do you still see that sort of ratio 15 to 20% impact and continued growth in consumer ARPU?

A - Patrick Shannon

Okay. Yes, sure. Again, to make sure that you understand, the growth in consumer ARPU is not, you know, price increase related. I just want to make sure that everybody understands that. The growth in the ARPU is a result of selling additional services and bundles to customers, so it's further penetration of DSL, further penetration of LD. So as we further penetrate those products, yes, you would continue to see the current trend that you've seen. As far as cable competition goes, the level of line loss to cable over the last three quarters, as we've stated, has been relatively stable in the 15 to 20% of line loss range. If you do the math, that means we're losing somewhere between 50 and 70,000 lines a quarter to cable and VoIP competition. Currently at the end of the year, approximately 50% of our access lines are located in MSAs that have a cable VoIP circuit switch to offer. And then obviously, there's a larger percentage of those access lines that have a VoIP offer from somebody like a Vonage or other company. So as Comcast and others roll out VoIP across their further base, that 50% increases, you could very well, and we anticipate a pickup in the losses to cable. It doesn't mean that necessarily access line losses will go up, but the portion that goes to cable will certainly increase just because there's a competitor coming into the market. So hopefully that helps.

Q - Kevin Moore

Thanks.

Operator

Your next question comes from the line of David Barden with Banc of America Securities.

Q - David Barden

Hey, good morning, guys. Just a couple of questions. The first would be on the UNE-P, obviously we're going see the rates ratcheting up on that over the course of the year with the commercial agreements. You've been winning back about half of that and that's been a benefit to the retail line performance. If you could just talk a little bit about any kind of game plan to maybe try to tweak that number up and, you know, in terms of win backs and what the game plan that would be for '06. And then second, if you could just give a quick kind of sense, maybe if you could quantify what your sense is of maybe the active cable competition in your markets. Is it actively in a quarter or a half of your markets? And then last, if I could, Pat, the answer might not be different than it was at the analyst meeting, but as you've settled into the CFO chair and you're starting to meet with the bankers and kind of get the strategy lined up for '06, could you kind of talk us through, again, your thinking about, as you address the BellSouth strategic structure for the long run, setting aside M&A for a second, is it the right answer to have directories with BellSouth? What makes that decision for you and what helps you make that decision, and then even bigger decisions like the line divestitures and things like that? Thanks.

A - Patrick Shannon

Sure. On UNE-P, I think as we've stated before, the win back rate that we can measure, and I say it that way because we know the number of lines that are reported back to the retail side has been hovering around that 50% range. But we believe that, you know, as these lines are thrown back into the retail market that we're getting more than just a 50% range of those. Just because of the math, it wouldn't work out if you didn't. The other, and I clearly think that the losses of UNE-P lines coming back into the retail market, if they don't accelerate, it will certainly remain at the current levels, and most of the, the reason is because they're not adding. What we pointed out on the last call is still the same trend. The UNE-P providers, the kind of gross disconnects, haven't really picked up that great, they're just not adding. They had a tremendous churn before they stopped selling, and now the negative churn is the same and they're really just not adding anything back.

So I don't know that the line loss on UNE-P should accelerate with rate increases, but it certainly means that it's going to be that much harder for any of them to turn the acquisition engine back on. I forget the -- you had three questions. What was the second one?

Q - David Barden

The cable kind of active competition.

A - Patrick Shannon

I think I just kind of addressed that in the last call. We have about 50% of our access lines today in MSAs that have sort of an active cable VoIP or circuit switch offer. And then the VoIP footprint is bigger than that because you have to add Vonage and other sort of non-cable providers. Again, the most aggressive has been Time Warner in the Carolinas. Comcast is beginning to roll out, they've rolled out in Atlanta, in, I think, Jacksonville, somebody rolled out in Macon, I think Comcast. So they're beginning to roll it out in the fourth quarter and then also, obviously, in earlier parts of the year but so far we've seen no sort of significant pick up in line loss as a result of it. You know, we are priced very competitively in these markets. We have a good solid triple play offer, we added 63,000 DIRECTV bundles in the fourth quarter. About the same level that we added in the third quarter. So we're, in the fourth quarter we lost 50 to 70,000 access lines to cable and VoIP. We added 63,000 DIRECTV lines. About two-thirds of those were new customers to satellite TV, not opt-ins, and that's the trend we've seen over the last three quarters so we feel pretty good about going into it. Pricing has been relatively rationale between us and the cable providers. We've seen no sort of aggressive moves that we've seen in some other parts of the country. So again, I think it's a controllable competitive threat and we'll continue to respond to it in time. As far as the structure of the Company, I mean, nothing's really changed. We're very pleased with our A&P group, as I pointed out on the call. They continue to generate great sales results, industry leading sales results. They continue to generate very strong free cash flow. Most if not all of that free cash flow is given back to shareholders in the tune of dividends or share buy backs, so no real changes about our feelings of the business. As you know, we look at everything. The only reason we would do anything like that is if it makes sense for our shareholders. There's no need for to us do it for our balance sheet and there's no need for to us to do it to fund our wireline strategy.

Q - David Barden

All right, great. Thanks, Pat.

A - Patrick Shannon

Sure.

Operator

Your next question comes from the line of Timothy Horan with CIBC World Markets.

Q - Timothy Horan

Good morning. Great quarter. Two questions, Pat, if you don't mind. Hate to beat a dead horse here but on the access line side, last year in '04 your lines declined about 900,000, this year they were down about 1.2 million, but it seemed like maybe an awful lot of that came out of the UNE-P side because UNE-P was down about 800,000, so if you're just getting 50% win backs on that, that could have been almost a 400,000 impact. Is that the right way to think about it, that as UNE-P starts to run off here some of the pressures on your total access lines will be alleviated somewhat so next year maybe we're not down 1.2, we're down maybe something less than that? And then secondly, can you talk about on the residential broadband side where you are on your thinking of the ability to kind of charge prioritize services and service level agreements to both content providers and to the end users? Thanks.

A - Patrick Shannon

Sure. As far as, let me take the last one first on that neutrality. Our position on the issue is it should be left to the marketplace. I mean if there's a value proposition that we can offer an application provider or a customer for high quality or priority delivery of some content then, you know, it could become a product in the future, and if it does, we'll sell it. If there's no value proposition for such a product, then it won't materialize over time. So that's really that issue. There's really nothing to update. I think there's a lot is discussion about it, but I think it will be sorted out in the marketplace. As far as access line goes, I think, when you look at UNE-P roll-off, I think it is, the right way to look at I think access lines is on net or off net. And so looking at UNE-P, the reason that line loss we have off-net line loss really comes from wireless substitution, VoIP, or cable competition in the residential area, or second line displacement. And what we've said is that second line displacement, we have 1.1 million second lines left. The trends have been relatively consistent. I think certainly the loss of second lines has mitigated somewhat from what it was running a few years ago, but pretty consistently over the last several quarters it's been about 50,000 lines a quarter. Over the last three quarters we've seen VoIP in the 50 to 70,000 range and wireless substitution has been in the 150 to 175,000 range. So that's been a clear and steady trend over the last three quarters. I think rather than focusing on UNE-P and the roll-off of UNE-P you really need to look at those three indicators and model them that way. So do you believe wireless substitution will mitigate? I'll let you come one your own assumption. Do you believe that VoIP will go up and at what level in '06? And then, you know, the additional lines at about 50,000 a quarter has been a pretty consistent trend. So I think I would focus less on the UNE-P roll-off and more just on the, what it causes off-net line loss and what are the trends of those off-net line loss and then worry more about the profitability mix between wholesale and retail.

Q - Timothy Horan

Thanks.

A - Patrick Shannon

Does that make sense?

Q - Timothy Horan

Yes.

A - Patrick Shannon

Okay.

Operator

Your next question comes from the line of Mike McCormack with Bear Stearns.

Q - Mike McCormack

Thanks. Good morning, Pat. How are you?

A - Patrick Shannon

Good, Mike. How are you?

Q - Mike McCormack

Good, thanks. Just a couple of questions with respect to first to DSL pricing. I guess you guys took some recent pricing actions there. Your thoughts on, you know, was that a response to a cable threat that you saw in the marketplace? And then on voice over IP, you've talked about it a lot today, but it seems like it's been a fairly steady threat, and I guess with Comcast getting more aggressive I would have expected at least some tick-up there. Are you seeing any change behavior there, and then just maybe just pricing on their offering as well. And lastly on wireless wireline convergence, I guess you guys had indicated at the analyst day you were talking about a converged product for the consumer, a trial beginning sometime in '06. Just getting an update on the timing of that.

A - Patrick Shannon

Okay. Sure. As far as the 3-meg pricing, we did drop the price on our 3-megs by $5. There's more sort of product positioning. We also during the quarter added a 6-megabit product, and so two things. One, you know, dropping 3-megabits $5, you know, caused the upgrade premium from 1.5 to 3- megabits to be a relative small upgrade premium of $5, and that's a good price point for consumers to make that call to go to the higher speed versus 1.5. And what we've found in our research is that there's higher customer satisfaction with the higher speed, even if they're paying a little bit more, and the churn, you know, will be reduced at those higher levels, so it's a good sort of value investment for us to have customers on these higher speed products versus the lower speed products.

Q - Mike McCormack

So you haven't seen a compression on the cable side then?

A - Patrick Shannon

Not really. They've been pretty consistent with their pricing at premium over the RBOCs and it's certainly the case in our region as well. VoIP, as I said, we have more cable providers rolling out VoIP in their market. For the most part, pricing, like in Time Warner's case I think they're charging around $40 for unlimited voice bundled with their video service, and that's typically what we've been seeing. At our Analyst Day I shared price points of triple play bundles in some of our key markets. For the most part they're in the 135 to 140 range and were very consistent with that range. We've seen no sort of breakout moves from any of the providers in our region. And I don't really have an update on wireless wireline integrated trials at Cingular. It is still planned for '06 but there's no updates for months or quarter.

Q - Mike McCormack

Great. Thanks, Pat.

A - Patrick Shannon

Yeah.

Operator

We'll take our final one from the line of Christopher Larsen with Prudential.

Q - Christopher Larsen

Thanks, Pat. A clarification and a couple of follow-ons. The $42 of ARPU from DSL that's just the residential DSL? And then on the ARPU theme, the wireline ARPU continues to go up. Are you getting some sort of Darwinian natural selection there where the lower-end users are rolling off but it's naturally helping some of your ARPU boost? And then lastly, on the share buy back I know you said not going to talk about the pace of the last billion, but assuming that that last billion gets taken out, is it your preference to get back in the market with another billion, two billion, whatever the number is? I mean if you look at it, your after tax cost of your debt is probably a little bit lower than your dividend yield and maybe some thoughts there on levering up to buy back some shares at these yields. Thanks.

A - Patrick Shannon

As far as the DSL ARPU, it is a blended rate between the consumer business and, you know, business, mainly in small business for that product. And clearly our business pricing is a little bit higher but there's more volume on the consumer side. We haven't really split it out. You can look at the prices that we charge and the volumes and kind of come up with a split, but it is a blended rate between the two. As far as the consumer ARPU, it is clearly a factor of bundled pricing. As we, again, add DSL and we add LD and we add, you know, those products to our mix, the ARPU's going to go up just because there's more of our customers buying multiple products from us. There's no clear delineation between sort of the quality of the lines that we're losing and those we're saving, it's a pretty even mix. As far as share buy back I probably said all I'm going to say about that. We're not going to really give any guidance of the timing of our share buy back. We announced the $2 billion and that's what we got for you right now.

Q - Christopher Larsen

If I could follow-on on that, one of the things about bundling is it's supposed to reduce churn. Are you seeing the reductions in churn? I just want to clarify what you said. Are you seeing more churn or more customer line losses, customers that don't have the multiple products?

A - Patrick Shannon

I mean clearly churn is lower with the more products. One of our best bundles over the last year, a clear winner has been DIRECTV. A bundle that has the DIRECTV video product in it, which we now have around 530,000, is clearly the lowest propensity to churn off the network and followed-up by a bundle that has DSL in it. That's also a very resilient bundle for us. So, no, I mean clearly it's a huge winner for to us bundle these services together on churn and ARPU and margins.

Q - Christopher Larsen

Thanks.

Operator

Ladies and gentlemen, we have reached the end of the allotted time for questions and answers. I will now turn the call back over the management for closing comments.

Patrick Shannon, Chief Financial Officer, Principal Accounting Officer, Sr. VP of Fin. and Controller

Okay. In closing, we appreciate your time and interest in BellSouth today. Should you have any further questions I encourage you to contact Nancy Davis and the other members of the Investor Relations team, and thank you for joining us this morning.

Operator

Thank you for participating in today's BellSouth conference call. You may now disconnect.

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