Verizon Communications Inc. (NYSE:VZ)
Q4 2005 Earnings Conference Call
January 26th 2006, 8:30 AM.
Ron Lataille, Verizon, SVP, IR
Doreen Toben, Verizon, EVP, CFO
Ivan Seidenberg, Verizon, Chairman, CEO
David Barden, Banc of America Securities, Analyst
John Hodulik, UBS Warburg, Analyst
Viktor Shvets, Deutsche Bank, Analyst
Simon Flannery, Morgan Stanley, Analyst
Jeff Halpern, Sanford C. Bernstein & Company, Inc, Analyst
David Janazzo, Merrill Lynch, Analyst
Good morning and welcome to the Verizon Fourth Quarter 2005 Earnings Conference Call. At this time, all participants have been placed in a listen-only mode and the floor will be open for questions following the presentation. Operator Instructions. 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, SVP, IR
Good morning, everyone. Welcome to our Fourth Quarter 2005 Earnings Conference Call. Thanks for joining us this morning. I'm Ron Lataille. With me this morning are Ivan Seidenberg, our Chairman and CEO and Doreen Toben, our Chief Financial Officer. Before we get started, let me remind you that our earnings release, financial statements, the investor quarterly publication and the presentation slides are on the Investor Relations website. This call is being webcast. If you would like to listen to a replay, you can do so from our website.
I would also like to draw your attention to our Safe Harbor statement. Information in this presentation contains statements about expected future events and financial results that are forward-looking and subject to risks and uncertainties. Discussion of factors that may affect future results is contained within this presentation and is also contained in our SEC filings, which are on our website. This presentation also contains certain non-GAAP financial measures as defined under the SEC rules. As required by these rules, we have provided reconciliations of these non-GAAP measures to the most directly-comparable GAAP measures on the same web page as our presentation slides. As you know, we closed our merger transaction with MCI on January 6, 2006. As such, the results we will be discussing today are of those of the Verizon stand-alone business for the fourth quarter and full year 2005.
Before turning the call over to Doreen, I would like to direct you to some information on our reported and adjusted earnings. Adjusted earnings per diluted share for the fourth quarter were $0.64. On a reported basis, EPS was $0.59. For full year 2005, adjusted EPS was $2.56, representing 2% growth over $2.51 of adjusted EPS in 2004. Reported EPS was $2.65 in 2005 and $2.79 in 2004. The special items that make up the differences between reported and adjusted EPS are discussed in the earnings release and provided in reconciliation tables within our financial statements. For the fourth quarter of 2005, these items principally related to previously announced changes to management benefit plans, severance and relocation costs. With that, I will now turn the call over to Doreen.
Doreen Toben, EVP, CFO
Thanks, Ron and good morning to everyone. Verizon delivered another quarter of strong operational and financial performance. Our strong fourth quarter capped the year in which we achieved some major strategic goals and strengthened our position in key growth markets. Our strategies are really starting to take hold and you can see it in our financial and operating results this quarter. As a result, we enter 2006 with excellent momentum and a business that is performing extremely well across the board.
I'll take you through the details of our fourth quarter results but here are the headlines. Customers are responding very strongly to our products. In fact, we set industry records in both wireless and broadband net adds. More new customers than any other wireless company, Telco or cable company has posted in a single quarter. We accelerated our revenue growth at 6.7%. We made important progress in creating the growth markets of the future with our EV-DO and FiOS initiatives, which are both gaining scale and customers. We also prepared for our merger with MCI, which positions us for growth in the large business market. And we showed, once again, that we can invest in growth and still generate solid cash flows, margin and earnings growth. All in all, we are pleased with the strong finish to the year with great momentum going into a very exciting 2006.
Now, let's take a closer look at our consolidated results, starting with revenues. On chart four, you can see our steady growth trajectory. Quarterly revenues increased by 1.2 billion or 6.7% and annual revenues grew 4.2 billion or 6%. Full year revenues were just shy of 75 billion, representing more than a 9 billion increase in three years. Our key growth areas are becoming an increasingly larger piece of our total revenues and compose nearly 60% of our fourth quarter total.
The next chart shows the components of our revenue stream and clearly demonstrates the increasing diversification of our revenue profile. We have three network businesses, Wireless, wireline, serving residential and business customers. Wireline also includes a large and very healthy wholesale business and an enterprise business. As you know, earlier this month, we completed our acquisition of MCI, which will increase our presence in the large business market. Our growth initiatives are diversifying our revenue profile and helping to mitigate our competitive risk. We are also gaining momentum with these initiatives across the entire business. You can see for yourself on this slide. Customer connections, the combination of switched access lines, broadband connections and wireless subscribers, up 5.7%, wireless data revenue, now a 2.2 billion annual revenue stream, up more than 100%. Wholesale data traffic volumes with double-digit growth. And an increasing appeal among residential customers for some kind of bundle or package of products from us. Another key point here is that we are seeing increasing demand for our services across the board.
Turning to margins, we delivered our fourth straight quarter of margin growth, even as we're continuing to invest today for better growth tomorrow. Adjusted operating income margins, excluding pension and OPEB costs were 22.1% in the fourth quarter, an increase of 90 basis points sequentially and 190 basis points year-over-year. And as you know, growth initiatives initially create downward pressure on margins. Since we are committed to margin stability and ultimately to margin expansion, it is mission critical to drive other costs out of the business by increasing efficiencies and productivity throughout the entire organization. And I can assure you we never lose sight of that fact. We view driving down costs as a critical matter of financial execution, especially as we expect to continue to grow our customer base or have existing customers take multiple products and services from us. This is extremely important as we remain committed to capturing the growth opportunities that will drive future revenue and earnings growth.
During 2005, we maintained fairly consistent quarterly earnings performance, as you can see on the top of slide seven. For the year, adjusted EPS was $2.56, representing 2% growth over 2004. While this is modest growth, I believe it demonstrates our capacity to manage cost-effectively and offset the initially dilutive effects of growth initiatives. Final solutions for the full year 2005 was worth $0.15 as compared to the $0.04 in 2004. In addition, I would point out that the net pension and OPEB expense had a $0.30 negative impact on EPS in 2005, compared to a $0.21 in 2004. So, from a bottom line perspective, we were able to preserve earnings stability, even as we made significant investments in network platforms that will fuel future revenue and earnings growth.
Let's take a look at slide 8. 2005 was another year of strong cash generation and our balance sheet is stronger than ever, something that I'm particularly proud of. CFFO, which totaled 22 billion for the year, was strong in both the wireline and wireless business. Our 2005 capital spending was on target with previous guidance. The increase over 2004 spending reflects our focus on growth opportunities. In fact, 69% of our capital spending in 2005 was related to growth initiatives. Total debt levels were maintained in spite of the increase in capital spending and wireless spectrum purchases. Our credit metrics are the strongest they've ever been. For example, our net cash flow to debt ratios finished the year at over 50%, our best ever.
Let's begin our segment review with wireless. Simply put, these are the best wireless quarterly results from any carrier ever. If you take a look at any of the metrics from growth through profitability to loyalty, Verizon Wireless has equaled or surpassed its own industry record results. And we continue to demonstrate that the growth engine we have built just keeps getting better with time. Net adds for the quarter were an industry record 2.05 million. Retail post-paid net adds were 1.76 million for the quarter. Total customers now stand at 51.3 million, which is 17.2% higher than last year. For the full year, we added 7.5 million customers. I think that's a number that bears repeating. We added 7.5 million customers during the year. 7.1million of whom were retail post-paid. Our success is the result of capitalizing on opportunities and leveraging our strong fundamentals and networks to capture market share. And with our commitment to quality, we are seeing very strong customer loyalty. Our customer base is about 96% retail. Total churn of 1.22% tied our previous record and our retail post-paid churn of 1.02% was also near all-time lows. These results show that it really is the network and our award-winning service that attracts and retains customers.
Slide 10 shows our very strong revenue growth trends over the past five quarters. Total revenues grew 18.3%, reflecting the phenomenal growth that we had this quarter. Quarterly revenues have increased over $1.3 billion in just one year, which is incredible. As a matter of fact, I suggest there are very few 30 billion plus businesses that are growing revenues at this kind of pace. Service revenue was up 963 million or almost 15% compared with fourth quarter last year, driven by data usage and the good customer profile of new adds. Service ARPU was $49.36, down 1.9% year-over-year, representing about 100 basis point improvement in the year-over-year run rates from the second and third quarter. This improvement is attributable to increasing data usage as well as strong customer mix. Wireless data is an increasingly big part of the Verizon Wireless story. At 731 million, data revenue accounted for almost 10% of fourth quarter service revenues. Data contributed $4.85 of ARPU, up from $4.23 last quarter very strong sequential growth.
Almost half of our retail customers are data users, up significantly from this time a year ago. And we're seeing strong uptake on Broadband Access cards and PDAs from corporate customers, thanks to our extensive EV-DO network. The key to our success in wireless data is our commitment to investing in the network. The result is a first-mover advantage, which has really separated us from our competition in terms of coverage and experience in delivering broadband services. Our EV-DO network gives us, by far, the most pervasive wireless broadband coverage of any carrier in the marketplace. We now offer 24 different EV-DO broadband devices, the most of any carrier. We have six PC cards, eight PDAs and 10 handsets in the market today. We have partnerships with Dell, HP and Lenovo to embed EV-DO chips in their laptops. We also recently launched the Windows Mobile Treo device. Customers are snapping up these products because of the growing set of multimedia applications that can be delivered to a mobile device. Verizon Wireless is leading this wave, as well.
We continue to see strong growth in V CAST and our just-launched V CAST music service has gotten rave reviews. V CAST music is unique. It is the most comprehensive mobile music service in the world. You can download full songs over-the-air to your handset and your Windows PC and you can transfer your existing collection of music downloads and CDs to your phone. The exciting thing is that we're really just at the beginning of the wireless broadband revolution. And we have the network and the products to really take advantage of this growth trend.
Of course, growth is only part of the Verizon Wireless story. We focus on profits and growth, not one or the other, but both. And you can see on slide 12 that's what we delivered in had the fourth quarter. We continue to grow with increasing profitability as our operating income margin expanded to a record 25.8% for the quarter. Quarterly EBITDA margins were 46.8%, up 36% year-on-year with a run rate of over 3 billion in each of the last three quarters. This is the best in the industry. Our already-low cash expense per subscriber hit its lowest level ever. And all of this, while we increased retail gross adds, very impressive.
Our low cost structure is the result of many efficiencies in the business, as well as our very balanced distribution mix. As you can see on slide 13, we have excellent cost metrics across the board. One key element is our superior distribution network, which saw 69% of our retail post-paid gross adds coming in through our direct channels in the quarter. Acquisition cost declined by 18.6%. Network costs continued to decline. Expenses per minute of use are down nearly 18%. We continue to drive customers to the most efficient means of doing business with us. The number of self-service transactions increased nearly 48% over the past year. Employee productivity increased by almost 5% as our focus on efficiency and quality in our call centers is paying off. When you're able to increase quality and decrease costs at the same time, you have the ingredients for a winning business model.
Let me wrap up wireless by saying this was another record-breaking quarter in which we expect that Verizon Wireless has increased its lead as a top carrier in the industry. Verizon Wireless has size and scale and a superb management team and organization that is executing its business model. This model is built upon the fundamentals of the best network, excellent customer service and innovative products and services. As you can see from our results, the Verizon Wireless machine is hitting on all cylinders. We have built significant momentum and are generating growth and profitability. We have an extremely loyal customer base, very low churn and a very high percentage of our customers on one or two-year contracts and we've introduced lots of new products and services. We also enter this year with a significantly enhanced spectrum position. And we have a business culture that is driven to deliver continuous improvement quarter-after-quarter, year-after-year. Our consistent investment has created the platform for innovations that will drive our growth.
Let's move to wireline, where we are seeing continued customer growth across the broadband, enterprise and wholesale markets. The big news is in broadband, where we now have 5.1 million customers, an increase of 1.7 million customers for the year, we added 613,000 in the fourth quarter alone. Our bundle penetration ended the year at 65%, up from 55% a year ago. And Freedom for Business packages have passed the 1 million mark, up 38% since last year. Almost half of these customers are on an annual contract. In wholesale, we also saw strong demand for DS1s and DS3s, which grew by 12.5% year-over-year. All in all, we have seen steady increases in growth product penetration and we expect to see more of the same in 2006 which will help drive revenue growth in future quarters.
Our emphasis on growth products is transforming the revenue mix in the consumer market. As we have said before, this makes the traditional access line metric much less important as a gauge of revenue growth than it used to be. As you see on slide 16, growth in revenue generating units, RGUs, which we introduced last quarter, track much more closely with revenue performance than do access lines. We did lose 426,000 retail access lines in the quarter, which is an improvement over the last two quarters and from the fourth quarter of last year. We believe that the increase in broadband subscribers, the introduction of Freedom Essentials and other marketing activities help retain and win back customers. As a matter of fact, the fourth quarter marks the first time that our broadband net adds exceeded the decline in retail residential access lines. With regard to retail business line losses, we continue to see improvements over last year, especially when we exclude dial-up port disconnects as these contracts expire. Total wholesale voice connections, both UNE-P and retail declined by 323,000 during the quarter. So, overall, the increasing use of broadband connections by our customer base is redefining the traditional view of the wireline business and creating new opportunities.
Looking at wireline revenue trends, we did see increasing competition and technology substitution in 2005. We are responding in the marketplace with our broadband initiatives, new products and services, increased use of bundling and some pricing changes. As you can see, we were able to maintain a stable revenue base of about 9.4 billion each quarter. Although revenues were essentially flat on a sequential basis, fourth quarter revenues were down 1.8% year-on-year and full-year revenues were down 1.1%. Among the reasons, which contributed to the fourth quarter and full year decline are the loss of revenues from discontinued activities. In the fourth quarter of 2005, this amounted to 127 million decrease over fourth quarter a year ago. For the full year, this represented a decline of 269 million. A large part of this decrease is from the termination of a large logistics management contract this past summer. You can expect about 80 to 100 million unfavorable effect in each of the next two quarters as a result of this issue. Another factor adversely affecting the fourth quarter comparison were revenues from our CPE business, which were lower than last year. In previous years, we saw CPE sales spike up in the fourth quarter but that did not occur this year. In the consumer market, fourth quarter revenues were down on a sequential basis and 1.1% year-over-year. For the full year, consumer revenues, which totaled 15.2 billion in 2005, were down only .4%. As I said earlier, this shows that we are mitigating the loss of revenue from access lines, with broadband, long distance and other services.
In the fourth quarter, average monthly revenue per customer was $51.50, up 3.9% year-over-year. Wholesale revenues increased by 33 million or 1.6% on a year-over-year basis. Sequentially, revenues were essentially flat. This market includes switched access, local wholesale products like UNE-P and retail. It also includes high speed, high capacity growth products, which are driving data growth in this market. I would mention that we now have 92% of our base of UNE-P customers on commercial agreements. We are scheduled to see some UNE-P price increases in 2006, which should provide an incremental margin opportunity.
Looking at business, revenues in the business market were 2.75 billion, down slightly on a sequential basis and down 126 million or 4.4% versus fourth quarter last year. As I mentioned before, our CPE business was part of the reason for this decline. In the highly-competitive small and medium-size business market, we have had success in retaining customers and have been actively marketing our Verizon Freedom for Business as well as DSL. Within the enterprise space, we are obviously looking forward to the upside opportunities now that the MCI merger has closed. More on this in a few minutes.
Quarterly data revenues continue to grow, increasing 9% year-over-year, driven by strong demand for high capacity and broadband products. Data transport drove most of the quarterly growth with 9.7% higher revenue than last year. For the full year, data revenues totaled 8.5 billion, an increase of 10.5%. Importantly, data is also becoming a more significant percentage of our overall wireline revenues, now standing at 23.4%. Between our data products for business and the growing popularity of our consumer broadband products, we are well-positioned to benefit from the ongoing expansion of the market for high-speed, high-capacity services.
Now let's move to FiOS. We continue to see a strong and growing customer response to our FiOS data and video product offerings. Looking at the penetration rates for FiOS data, we are ahead of plan. We are seeing good customer acceptance and consistent monthly penetration gains. Last quarter, we told you that in the 35 markets where we have been actively marketing in for six months or more, average penetration was 12.4%. I want to give you an update, but in a slightly different and better way to look at our progress. In markets where we have been selling FiOS data for at least six months, the average penetration at the six-month mark for each was 9.2%. At this point, this includes more than 90 central offices. In markets where we have been selling FiOS data for at least nine months, the average penetration at the nine-month mark for each was 14%. At this point, this includes more than 35 central offices. These markets are spread throughout our footprint and compete with all the major cable players. These early penetration rates indicate that we are well on our way to achieving our goal of 30% penetration in five years.
In video, we are seeing great initial acceptance by customers. In Keller, Texas, our first video market, we have already achieved 21% penetration in only four months. Within the last few months, we also began selling FiOS TV in some other Texas markets as well as Temple Terrace in Florida and Herndon, Virginia. While it's a bit early to give you penetration rates, we are very pleased with our initial sales and just this week, we launched video in Massapequa Park, New York and Woburn, Mass. We will also be selling services in a California market very shortly. As we move forward, we expect to continually enhance our video product and differentiate it even more with converged capabilities. So, we're off to a strong start. From a deployment standpoint, by the end of 2006, we expect to have passed a cumulative total of 6 million premises or about 20% of our households. Going forward, we expect to pass about 3 million per year. As we gain scale and connections, we will also be able to drive more costs out of the business and we also expect that technology improvement will further drive down our network costs, as well.
Moving to our wireline margin, operating income margin, excluding pension and OPEB was 16.1% for 2005. In fact, we're targeting about a 16% margin for 2006. Of course, we normally see some variability in operating margins on a quarterly basis. The fourth quarter difference was largely driven by our very high growth in DSL and FiOS deployment. I would mention that as we gain scale in DSL, we have turned the corner on EBITDA profitability, which should continue to improve and help margins going forward. Quarterly cash expenses were up 2.6% year-over-year. We continue to see significant opportunities for additional cost savings. We have many new cost initiatives, which I'll discuss in a minute, which will help stabilize telecom margin performance.
As you would expect, we continue to be focused on improving the wireline cost base. We closely manage our force levels, balancing them with our work volumes, shifting manpower whenever possible to support the fiber initiative. Our overall wireline head count ended the year at 141,000. We are also replicating the success achieved by our Partner Solutions Group, which significantly automated wholesale orders and reduced head count and costs. Over time with higher in the fourth quarter on both a sequential and year-over-year basis. This was a result of us having to shift manpower to deal with the inordinately high damage and repair caused by the heavy rains, mainly in the month of October. Online bill payments are up 16% as we continue to drive customers to more efficient transaction-based services and we see further opportunities for savings in the areas of real estate and call center management.
So to sum up wireline, we are rapidly transforming this business around the customer's growing demand for broadband. We are investing in broadband capacity in our access network, developing differentiated broadband products across all segments of the market and creating new revenue opportunities in markets such as video. You see this strategy taking hold in the fourth quarter with our record-setting performance in DSL, strong performance in data and our earlier success with FiOS. In the meantime, we're holding our ground with steady revenues, stable margins and a relentless focus on costs. We're confident in our strong wireline business model. And our network will give us an unsurpassed strategic and product platform for growth in the broadband era.
I want to spend a few minutes sharing some information about our new business unit called Verizon Business, created by the acquisition of MCI. We believe this acquisition provides us with a great opportunity to further strengthen the power of the unified Verizon brand, particularly now that we can add wireless services to the product portfolio. We have an experienced management team in place with great leaders from wireline, Verizon Wireless and MCI. We have challenged these seasoned professionals with some very aggressive integration plans and some aggressive financial targets.
We have a lot of experience in mergers and acquisitions, both wireless and wireline, and I'm very confident in our ability to achieve the synergies. On slide 24, you see these synergy targets by year. These run rates are about 10% higher than we originally announced, primarily from realizing these savings earlier than originally forecast. The net present value of the synergies has increased from 7 to 8 billion. Network savings represent nearly half of the total, with workforce reductions and IT savings each representing about 20% of the totals we estimate at this time. One significant area for savings in the network category is third party access savings, that is, bringing more traffic on net. These savings will be realized through a combination of moving more Verizon Wireless traffic on net as well as moving our out of footprint access and long haul LD traffic to the former MCI network. In 2006, we expect these savings across Verizon to be well over 200 million. In the area of workforce reductions, we anticipate achieving a workforce reduction of about 7,000 people within a three-year period. More than half of this reduction will be from eliminating duplicate corporate staff and from the mass market business area. In the IT and systems integration area, we also see significant opportunities. As far as the transition costs needed to capture these synergies, you can see our estimated annual spread of these costs on the slides. In total, we expect to spend about 1 billion over the next three years. Integration capital spending is estimated to be between 1.6 and 1.9 billion over the same three-year period. We estimate about 550 million of that will be spent in 2006.
We have an aggressive go-to-market plan that will introduce the new Verizon Business to the marketplace. We hope to immediately enhance the customer experience with a more integrated approach to the sale of our wireless products. You can expect us to build upon Verizon and MCI's reputation for excellent service by transforming the service experience for our customers. We have a unique approach to business service delivery, called "Customer Service Surround". Our unique brand sales office structure places our account teams closer to our customers. Similarly, the Verizon Business Customer portal will put online service and account management tools at our customer's fingertips. From at your side support to online self-service and all points in between, our objective is to deliver an unmatched customer experience, geared to a customer's personal preferences. This will be a major element of the Verizon Business difference. And I want to emphasize that we see huge opportunities for margin improvement Verizon Business.
As we look across all three network businesses, we continue to see significant cost savings opportunities over the next several years. Verizon Services, our recently created organization to provide back office and support services across our businesses, is an example of how we intend to increase efficiencies through economies of scale and reduce duplication of efforts. We are also conducting an extensive review of our expansive real estate portfolio. We are convinced that we can capture savings and unlock value through this portfolio rationalization. Web-based customer self-service applications are also examples of ways we can increase the efficiency of our business. Our network investments are intended to grow revenues and significantly reduce maintenance and operating costs. Our fiber build is a perfect example of this. Our innovative and competitively priced products and services are increasing customer retention and helping to reduce the cost of churn. As we strive to stimulate revenue growth in all of our businesses, you can expect us to continue our relentless focus on reducing our cost structure.
Let me give you a couple of thoughts about how we're looking at 2006. As I said at the beginning of today's discussion, we are entering 2006 with excellent momentum. Our strategies are taking hold and customers are responding to our wireless and broadband products and services at record-setting levels, helping to diversify our revenue profile. These customer successes will continue to drive revenue growth in 2006. Our capital investments also enable growth. The investments in our network will result in market share gains and revenue growth. In addition, the resulting increase scale helps improve margins, earnings and return on invested capital. We previously stated that capital spending in 2006, excluding MCI, would be between 15.4 and 15.7 billion. With MCI, all-in capital spending is expected to be between 17 billion and 17.4 billion. The 1.6 billion to 1.7 billion incremental spending as a result of MCI, includes about 550 million of integration capital in 2006. With the MCI merger now complete, more experience with fiber and our EV-DO plans on track, we have a high degree of confidence in the stability of our 2006 capital program. From a total telecom capital spending perspective, we see 2006 as the peak expenditure level. We are very focused on maintaining stability in our margin as we grow the business. This morning, I have shared with you some of the cost-saving opportunities we see. Related to 2006 costs, let me give you a sense for net pension and OPEB expenses. As I noted earlier, net pension OPEB costs resulted in an unfavorable EPS impact of $0.30 in 2005. In 2006, we expect this total to be about $0.04 to $0.06 worse or $0.34 to $ 0.36 in total. As you know, we've taken steps to control future post-employment costs through changes in our management plan. As far as CFFO, we see improving cash flows, which will fund future investments in our networks and return value to shareowners.
We have set specific goals and targets for our three network businesses. All of these are focused on growth, both top and bottom line, and creating value for shareowners. Lastly, this past December, we announced our plans to divest our Verizon Information Services Directories business. We are moving full steam ahead with our bankers. We are well along in developing the necessary planning to successfully accomplish this disposition in 2006. We will provide you more information on this value-creating transaction when our exact plans become more definitive. Thanks, Ron and I will turn it back to you.
Ron Lataille, SVP, IR
Thanks Doreen. Operator we're now ready to take some questions.
Questions & Answers
Operator Instructions. Your first question is from David Barden of Banc of America Security. Please go ahead with your question.
Q - David Barden
Hey, guys, good morning. Congrats on the quarter. Just wanted to ask a couple of questions on a couple of topics, first on the wireless side obviously and typically what's usually a lower margin fourth quarter, there was a big step down in CPGA, a big step down in cash costs per user. If we look ahead in '06, I was wondering if you could address some of those sustainability issues on those forces as we kind of look for where margins might wind up in the coming year. The second issue would be on the FiOS metrics that are coming out. Could you talk a little bit about whether those are being driven by conversions of existing subscribers in DSL or competitive winbacks? And then maybe the last issue would be on the directory spin. You know, whatever, how it happens, there's going to be probably incremental borrowing capacity or cash coming into the parent company. Any early thoughts on what the intentions are to do with that incremental flexibility? Thanks a lot.
A - Doreen Toben
Hey, David thanks. If I start with, I guess the first question on wireless margins. I guess what I would say is we target wireless margins in the, you know, sort of mid to low 40s. That would be normal. To the extent that you didn't have the kind of growth, you know, you might actually kick it up a little bit. But I would think about the fact that we think there's lots more opportunity out there, there's a lot more at only 70% penetration, we think there's a lot more opportunity to grow, but the target sort of, you know, mid to low 40s. On your the metrics, I guess, for fiber, I guess the, the conversion rate from DSL is around 35%. Was there more with the DSL? That was it for DSL. Okay. And then Ivan, do you want to do the…
A - Ivan Seidenberg
Yeah, David, on the question of use of cash with the directory divestiture, the way we think about this is, as Doreen pointed out in her opening remarks, we feel pretty good about the visibility of our -- of our spending this year, where we're going to put our capital. So, we don't see the issue of the use of cash from the directory as impacting the run rate of what we would do with organic investments in the, in all three businesses, Wireless and Verizon Business as well as the Telco. Now, once we get a little further along into the year and we look at the form of the actual divestiture, our first focus there is to try to figure out a way to return value to shareholders using that cash. And as Doreen has talked about in the past, there are options to do lots of things, which is balance sheet improvement, reduce debt, buyback shares. So we'll, as this unfolds during the year, we'll -- we'll take a careful look at that.
Q - David Barden
A - Ron Lataille
Operator, we're ready for the next question.
Your next question comes from John Hodulik of UBS. Please go ahead with your question.
A - Doreen Toben
Okay, thanks. Good morning.
Q - John Hodulik
Hi. A couple of questions, first on the wireline margins, you had said in the past that FiOS would, would create dilution of about $0.14 in '05. Can you update us on that, on how that, how that turned out here in the fourth quarter? And then looking out into, into '06, we got the 16% EBIT premargin or prepension margin guidance. What kind of dilution from FiOS and potentially from the, you know, video rollouts are included in that number? And then just real quick follow-up on the DSL growth, is this kind of you know similar to David's question on wireless, is this a sustainable number? Is it being driven by the $15 plan? And how much, you know, if you can maybe in round numbers, are you getting a nice kick from FiOS, as well?
A - Doreen Toben
Okay, I think on the FiOS question, it was $0.04 in the third quarter, it kicked up to $0.05 in the, in the fourth quarter. So, that was the incremental dilution. I think I did say, you know, in the text, that in '06, we sort of expect a $0.10 to, you know, $0.15 additional dilution on top of that. A lot of it based on success base, so that's sort of why the range. Yeah, that would be already built into the 16% target that we're, that we've talked about. On the DSL, I think, you know, about 50% of the net adds are coming from you know, from the 1495. However, very, very, very low migration, which is, which is something that's good. The people are really staying with their existing higher speeds. And as far as the ability to kick up, I mean the penetration of broadband is still very low, you know, in the country at 35%. So, we do think that there's a lot more opportunity, you know, we still have all the dialup guys converting, that's a lot of what's happening with the 1495. So, we think that there is still a lot more opportunity on broadband into '06.
Q - John Hodulik
Okay, great. Thanks.
A - Doreen Toben
A - Ron Lataille
Thank you, John, operator, next question.
Thank you. Your next question comes from Viktor Shvets of Deutsche Banc. Please go ahead with your question.
Q - Viktor Shvets
Yes, good morning, everybody. Thank you very much. Just looking at the dilution from media products, just following in from John's comment, how should we think about programming cost as well as subscriber position costs in 2006? You've launched a number of media markets this year and you're going to launch further as we go through 2006. What kind of operational expenses should we reporting into our models? And how media expenses and SAK are going to be amortized through the P&L? Thank you.
A - Doreen Toben
Okay, hi, Viktor. Let's make sure I understand your question. The $0.10 to $0.15 obviously has the video piece in it. I would suggest that it probably ramps during the year, you know, as you start to have more success base, if you're thinking about how it spreads, right, you're going to, you're going to ramp it up through the end of the year. And on, as far as the, you're asking like what we're capitalizing and what we're expensing piece of it? On the video piece, I guess it's really mostly capital.
Q - Viktor Shvets
Right, so, you'll be, you'll be, you'll be capitalizing and then amortizing over a number of years, is it?
A - Doreen Toben
Yes and I guess different pieces would have different lives to, you know, what we're, what we're amortizing in.
Q - Viktor Shvets
Okay. Thank you.
A - Ron Lataille
Thanks, Viktor. Operator, next question.
Thank you, your next question comes from Simon Flannery of Morgan Stanley. Please go ahead with your question.
Q - Simon Flannery
Okay, thanks very much. Good morning. Ivan, there's been a lot of talk out of Europe about Vodafone being pressured to sell their stake in Verizon Wireless. Can you just talk about whether that's something you would still like to do and whether do you think there might be some more opportunity this year? And secondly, can you talk about the regulatory environment around video franchising? Any sort of movement in Washington or in the states, to try to get that moving along more quickly? Thanks.
A - Ivan Seidenberg
Yeah, on the Vodafone question, like everyone else, we were very interested in what we read and heard about the, the Vodafone earnings call. Our position has pretty much been the same all along and maybe I, and there, I take a moment to clarify where we are in this. First of all, we've had no direct indication from Vodafone that they've changed their position. So, we're as anxious as anyone else is to see how the, the conversation that started the other day materializes. To the extent, however, that there is a change of a view coming from Vodafone, we clearly would be interested in increasing ownership of Verizon Wireless, whether in stages or actually acquiring 100% of it. I would add that we also recognize that the put option is not the preferred vehicle for Vodafone to facilitate any transaction. That was exactly the issue we had when they were considering the purchase of AWE. So, so, Simon, we are very open and willing to consider negotiation around that to make sure that it's efficient for both sides and it's, we can maximize value for both parties. You know, when you think about it, Verizon Wireless has gone through an extraordinary run here. It's, it's created a lot of value for both sides. And that I think that it's a good time to think about this and so we would stand ready to work on that. One other point that, that I would make is that, as we think about this, just so that Verizon shareholders would understand how we think about this, Doreen and I have, have talked about this, and our view is to the extent possible, we would try to do anything here if it was, if it was given to us by Vodafone, with as much cash as possible. And so, for example, like everybody understands, the Omnitel ownership, perhaps the, the divestiture of VIS would all be, be part of how we would think about funding, funding the whole operation. So, I think we need to give Vodafone some room to think through what they want to do. But our position, Simon, has been what it's always been. If the opportunity came to be, we would be, we would stand ready to work with them.
Q - Simon Flannery
Good and on the video franchising?
A - Ivan Seidenberg
Yeah, on that we feel that we're making good progress here. We got a few more franchises working. We’ve got plans for several hundred more to file. There've been a couple of breakthroughs in several states, in which legislatures have taken votes on it. We even have one state, believe it or not, where the, where the local cable association has taken a positive position on, on where we are. So, I think, Simon, the way we see this, is we're going to continue the, the sort of community by community approach that we've started. But we feel we are getting traction in several states. We're taking a look at the broader picture. I'm sure you know that next week there's a hearing in Washington on this subject. So, I think there's a lot of momentum building, and we're taking the position we're going to do this step by step, but also look for the sort of broader policy opportunity and we feel that the, the stars are lining up for public officials to take a more aggressive stance on this over the next several months.
Q - Simon Flannery
Great. Thank you.
A - Ron Lataille
Thanks, Simon. Operator next question please.
Thank your next question is from Jeff Halpern of Sanford Bernstein. Please go ahead with your question.
Q - Jeff Halpern
Good morning, guys. Ivan, if I could just follow up, two questions, if I could follow up on your answer to Simon's question just now. I was wondering if you have any sense of what the difference in timing looks like between a state level approval process for franchising versus a municipal, municipality by municipality one? And then, Doreen, is there any way you can give us a similar kind of update as you did last quarter on where we are on things like operating expense savings and capital savings that you're seeing in markets that have had FiOS for six or nine months or longer?
A - Ivan Seidenberg
Yes, quickly, I don't think there's a big issue associated with timing. I don't think there's, by the way, any story there. I think that the law is the law. I think we have to go out and get, and get franchise approvals and we're doing that and we're doing it aggressively. And we're queued up. We don't feel that there's any impediment to our rolling out FiOS during the year, 2006. Admittedly as we go into two seven and '08, we'll need to be more aggressive because we'll be in more communities. But by that time, I'm sure we will have so much success with, with the early deployment, that the whole political environment starts to, to change as we go forward. We've already seen that. And as I, we've said before, every place where we, we instigate a vote, the vote usually comes out, you know, let's, let's create competition in this, in this marketplace. So, we do have some, some things in the regulatory process we need to work through, but I don't think there's any, any timing issue that we have to face anytime in 2006.
Q - Jeff Halpern
A - Doreen Toben
Okay, and Jeff, on the operation, operation savings or on the capitol savings, I think at this point, the scale, the amount of how homes that we really have connected, it's really to small to have, you know, to have a lot of data. What we get is antidotal at this point. So, it is, it is, we do track, say when there's weather-related, you can see that the trouble reports from those, those homes, you know, don't vary at all. But as far as, you know, being able to say it's "X" amount of dollars at this point, I think we need, you know, some more time and some more scale before we can really get our hands on that definitively.
Q - Jeff Halpern
A - Ron Lataille
Thanks, Jeff. Operator, next question, please.
Thank you. Your next question is from David Janazzo of Merrill Lynch. Please go ahead with your question.
Q - David Janazzo
Good morning. Doreen, you had talked about workforce and, of course, with, with MCI you'll have about 250,000 employees, and you had mentioned 7,000 over, over a three-year period. Can you comment a bit on, on the overall strategy of, of head count management?
A - Doreen Toben
In all well, in the different units if I starting like with wireless, in wireless, I think what we've seen is, you know, you'll see increases because of its growth, plus we've had different strategies in wireless, where we're actually putting people in stores. So, to the extent that you're actually putting a store within a store, you're actually growing your head count. If I move over to the Telco, they will have, you know, some reduction level this year and part of it will be, you know, a straight reduction. The other piece is, you know, they're going to move some people really on to the FiOS plan. So, they have a fairly significant number that they're going down. But some of it is, in fact, a shift from the base into capital. And the 7,000 that we talked about, a lot of it, very heavily front-end loaded of that 7,000 over the first two years. So, you'll see a substantial number going down, a lot in the mass markets initially. Okay?
Q - David Janazzo
And then in terms of the Telco, you mentioned a reduction level in, in '06 any further clarification on that?
A - Doreen Toben
No, at this time I'm not going to give you a number.
Q - David Janazzo
Okay. Thank you.
A - Doreen Toben
A - Ron Lataille
Thanks Dave. Operator, now I'd like to turn the call over to Ivan Seidenberg for some concluding comments.
Ivan Seidenberg, Chairman, CEO
Okay, just a couple of thoughts here. Hopefully as, as investors and owners look at our
Company this quarter, there's a couple of things that, that we would like you to consider as you do your analysis and you look out into the future about us. First of all, hopefully you see that, or as Doreen said, our strategies are taking root, we're gaining some momentum. There is a greater shift of our overall top line focused on the growth markets. You can see that in all of the markets that we have significant opportunities. Our Telco is gaining customers. We recognize we need to convert the investments in FiOS and DSL and LD into bottom line results and we're anxious to, to prove that. The VZ Business to us, that is a bottom line story of getting synergies out and generating improvements in, in cash year-over-year. The wireless story speaks for itself. It's both the top and the bottom line story and it's one of raising the bar and widening the lead. But while that's happening, hopefully that, that everyone sees that wireless looks at the market as having more unlimited opportunities, rather than a closing, a ceiling on it. There's plenty of growth available for us, and with the kind of engine that our team has built, we're in good shape.
There's always a lot of discussion about returning value to shareholders. The only comment that I would like to make on that is, that as we finish 2005, we took steps with our pension for management. We, we just took a step, last month, to increase our share buyback capability from 80 million to 100 million shares. We have focused on the divestiture of VIS and the quick go-to-market for the MCI combination. So, we feel we're in a better position, as we move into 2006, by executing on our plan, showing that we have good solid results and good, good operating focus. But at the same time, the Company will have increased flexibility to deal with how we return value to shareholders during the year. The, the new starter this week, as we were preparing for this call, obviously the new interest and perhaps acquiring a greater ownership share in Vodafone. While there's still a lot of work to be done and we have to be sure we, we know where Vodafone comes out, that's another opportunity that, if it came to us, we would be more than delighted to, to go forward. So, with that, we feel like we had a good quarter. And that we're poised to continue the momentum into 2006. Thanks.
Ron Lataille, SVP, IR
Thank you, everybody. For joining our call. And have a good day.
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