Qwest Q4 2005 Earnings Conference Call Transcript (NYSE:Q)
February 14, 2006
Dick Notebaert, Chairman and CEO
Oren Shaffer, Vice Chairman and CFO
David Varden, Bank of America
Jeff Halpern, Sanford C. Bernstein
John Hojeleck, UBS
Jonathan Chaplain, JP Morgan
Frank Loethan, Raymond James
Blake Bath, Lehman Brothers
Thank you. Good morning everybody. Welcome to our call. We’re here to discuss our fourth quarter and full year results and with us on the call this morning are Dick Notebaert, Chairman and CEO, and Oren Shaffer, Vice Chairman and CFO. Before I turn the call over to Dick, I would like to remind everyone that we will be making forward looking statements. These statements contain risks and uncertainties this could cause actual results to differ materially from those expressed (inaudible) in the call, these risks and uncertainties are on file with the SEC. In addition, we do not adopt analysts estimates nor do we necessarily commit to updating the forward looking statements that we make here. Also, let me mention that in order to supplement the reporting of Qwest’s consolidated financial information the company will discuss certain non GAAP financial measures including EBIDA, free cash flow and MET Dep. Full reconciliation of these non-GAAP measurements can be found in the quarterly earnings section of our website. With that, I’d like to turn the call over to Dick.
Dick Notebaert, Chairman and CEO
Thank you Stephanie. Good morning everybody. Welcome. I am especially pleased to report our results for the full year 2005. Because we delivered our performance goals for revenue EBITDA and EBDA margin and free cash flow. We also achieved new highs in customer service levels across the board. And I am most proud of this accomplishment. As I have said many times, we must differentiate Qwest based on service to customers to win in our industry. Our progress and our performance continue to demonstrate that our strategies are working and our intentions are to carry that momentum into 2006.
In the fourth quarter, in addition to our operating performance, we significantly improved our financial flexibility with the successful completion of a tender offer that eliminated all of Qwest’s high coupon legacy debt. It reduced interest expense and reached break even EPS excluding special items.
That’s an important milestone for our company. Most important, as we look to the future, we continue to invest in growth and value to our constituents. I know we frequently remind everyone that we have made significant progress over the last three years, but our team has truly accomplished so much in that time. We have removed many obstacles, financial re-statement, legal settlements, significant cost reduction that included elimination of impossible contracts and equally significant, debt reduction. That’s just to name a few. We’ve done this while at the same time investing in a growth strategy that could prove successful in a highly competitive industry environment. At the end of the day, we have made steady and demonstrable progress over the last three years. And our goal is to continue to do so over the next three years.
Here are the highlights of 2005: At $13.9 billion, revenue grew modestly as higher value, higher AARPU growth products and improved bundle penetration offset slowing retail access line offers. This is the first revenue increase since 2001 and I should add, that we have reported the third consecutive quarter of year over year revenue improvement. Customer demands, and a clear value proposition for our portfolio of growth products including long-distance, broadband, advanced data processing, voice over internet protocol or VOIP, video, wireless are driving volume, AARPU and bundle penetration.
When customers take the challenge to compare bundle and save, we are positioned to win the business. Qwest may have lagged the industry in developing and investing in these growth products, but we’re catching up. We now have the opportunity to achieve benchmark or better market penetration and average revenue per customer and that is our focus. For the year, in addition to strong metrics on our growth products, mass market, and business revenues grew while wholesale on the back of our pricing initiative improved profitability. Adjusted EBIDA increased to $4 billion in 2005 with our quarterly run rate just over $1 billion and improving. Our adjusted EBIDA margin on the same basis improved to 29% for the full year and approached 30% in the fourth quarter.
As a reminder our new term goal is an EBIDA margin in the low 30% range and our longer term goal is a very competitive mid-30% margin. We exceeded our goal for free cash flow in 2005 and generated more than $900 million before one-time payments with much of the increased driven by improved EBIDA margin. With the success of our recent $3 billion tender offer, we completed a major piece of our plan to transform the company’s financial flexibility. We have reduced our net debt by over $11 billion from the peak in 2002 to $14.5 billion at year end. As well, we significantly reduced our interest expense. Our leverage ration improved and our credit ratings were upgraded. We continue to expect a $450 million to $600 million increase in free cash flow in 2006 from both the interest savings I mentioned and the benefit of operational improvement; with some potential for variability due to balance sheet changes. We expanded our Board in 2005 with the addition of five outstanding independent directors. And finally, based on our performance and prospects, we were able to delver a total return to shareholders of 27.3% in 2005. In a few moments, Oren will review the fourth quarter detail with you. But first my comments again this quarter will focus on how we believe we are creating sustaining value for our constituents. Successful financial transactions and the elimination of obstacles are certainly important. And there is much we have accomplished in these areas. But we recognize that long-term value creation is based on delivering sustainable competitive growth in revenue, earnings and cash flow and this is our on-going focus.
The components of value creation per Qwest includes: top-line growth, continued cost reduction, including productivity improvement, improving EBIDA margins to competitive levels, reaching profitability and sustaining it and free cash flow growth driven increasingly by operating performance.
So let me take each of these in turn and just say a few words. First, top line growth. Our strategy for revenue growth is to continue to drive higher penetration and AARPU on our growth products. And to close the gap on our peer group benchmarks for these metrics, while we stabilize access line offers. This strategy requires selective and disciplined investment in both the terms of capital investment and marketing support. We continue to carefully review and adjust our pricing as appropriate. We are making progress in achieving this strategy. First while we continue to see a decline in access lines, the rate has stabilized and in fact, improved versus our peer group. We grew overall mass markets as far as the retail net connections for the year. This is because we continue to focus on this issue, expanding State by State through targeting advertising, beat on the street and other directed campaigns. It’s also because we can now offer customers the products and the bundles they want; the right pricing and the value propositions they need. And we continue to improve customer service. This is a winning combination.
Second, our growth products are increasing AARPU in market penetration. For example, our broadband penetration reached 11.4% in the fourth quarter, up from 7.6% at the end of 2004; and compared to an industry average of 14.6%. In the fourth quarter we improved our long-distance penetration to 37%, compared to 33% a year ago and an industry average of 45%. Long-distance AARPU increased nearly 17% compared to the fourth quarter a year ago. As we continue to add high value customers. Also, we believe, we have a $500 million revenue growth opportunity in achieving industry benchmark metrics on our growth product while we work to hold our access line stable. We are focused on localized marketing initiatives expanding our distribution channels and broadening our base and our product suite for bundle. The key point is that this is our model and strategy going forward. We believe we can increase market penetration and AARPU to industry benchmark level on our portfolio of growth products thereby driving modest growth. I talked about cost reduction, let me expand on that. Our strategy is to optimize and balance a competitive cost structure, achieved through both cost reduction and improved productivity. At the same time, we continue our appropriate and disciplined investments to maintain in an nth our existing assets. Progress continues on both cost reduction and productivity improvement the result of which will ensure that we drive EBITA margin gains in the near term and that we have a competitive cost structure over the longer term. You know we’ve delivered $1.5 billion in cost savings since 2003, while at the same time improving service and increasing our revenue per employee by 16%. We have achieved this primarily by balancing force and load and optimizing our long haul network.
Looking ahead, we believe still have an opportunity to take costs out of this business, including improvements on our long haul network, even after the impact of somewhat higher wages, higher benefits, expensing of stock options and other (inaudible). When you review the progress we have made in reducing our costs over the last two years, it becomes very clear that a modest increase in revenue, coupled with continuing cost reduction can have a significant impact on our EBIDA and overall profitability.
Which brings me to our third value driver to improve EBIDA margins to an industry level. For some time now we have been targeting a goal of EBIDA margins in the mid 30% range, to be achieved through a combination of modest revenue growth, lower costs and leveraging existing assets in play. We believe this is a competitive and a realistic target for a blended (inaudible) business model we probably won’t use that expression any more since that’s the standard now in our industry. As I mentioned earlier, I believe we have the opportunity to achieve an EBIDA margin in the low 30% range in the near term and our mid-30% goal over the longer term. The force value driver for us is reaching sustainable profitability. The tender offer accelerated the operating momentum that was already under way and we reached break even EPS in the fourth quarter, excluding special items. This is a significant milestone for Qwest. We now believe we have the opportunity to be profitable in 2006. And as you know, if we earn income in future periods, we will generally not pay income taxes because of our prior tax losses. We understand that we must increase revenue, continue to lower costs and be more efficient in our operation. We must make the right assessment to support growth and good customer service and we will use our cash flow in the most value creative way.
Finally our last driver is growth and free cash flow. We generated $904 million in free cash flow in 2005 up from $428 million in 2004, both before one-time payments. With much of the improvement driven by operating performance, we expect to continue to increase free cash flow in 2006 with improved operating performance driving the gain, enhanced by lower interest expense resulting from our recent elimination of high coupon debt. We are growing cash flow while investing in disciplined and competitive levels of CAPX. Much of it is focused on broadband. In 2006 we estimate CAPX to be slightly more than 2005’s level with more than 30% of our wireline CAPX invested in broadband and taking our existing availability to higher speeds. Currently 77% of our footprint is DSL enabled with 50% of those locations eligible for 3-5 megabit service and some locations, 7 megabit service. Our strategy is to deliver just in time (inaudible) with applications layered on top. Our priorities for free cash flow are to invest in growth and then use the remainder in the most value creative way for our stakeholders. In the meantime, you should know that we are focused on our strategy on providing our customers with industry leading growth products and services they want as well as continuing to improve our performance and financial flexibility.
Now, let me ask Oren to make a few comments and go into more detail. Oren.
Oren Shaffer, Vice Chairman and CFO
Thanks, Dick. Good morning everyone. We are very pleased with the progress we made in the fourth quarter as well as the full year. We met all of our objectives for ’05 and in many cases exceeded them. Above all is to continue these favorable trends and operating momentum into 2006. Revenue totaled $3.5 billion for the quarter compared to $3.4 billion in the fourth quarter a year ago. For the year, revenue grew to $13.9 billion. This marks the first full year of revenue improvement since 2001 with growth driven by revenue increases in both of our retail channel, mass markets and business. And in a demonstration that our wireless strategy is beginning to take hold, we posted year over year wireless revenue growth for the first time in three years. In the wholesale channel, we held revenues steady despite continued industry pressures in a local reseller market. Looking specifically at wire line revenues, year over year trends improved again this quarter. We continue to benefit from Qwest growth products including high speed internet, advanced data products, long distance and bundle. Mass market revenue, which includes both consumer and small business, grew by 1 ½% in the fourth quarter and nearly 2% year over year. We look for continued success in increasing our penetration with key products and improving this rate of growth. Mass market revenue growth was evident in key product categories. Data and internet revenue increased 3% sequentially and 28% year over year. High speed internet subscribers grew an impressive 10% sequentially on the heels of a quarter with 13% sequential growth. Consumer demand for our high speed internet continues with nearly 90% of our new subscribers choosing the higher speed, Qwest Choice DSL Premiere or Deluxe service. And DSL penetration increased to 11.4% from 7.6% a year ago. As Dick mentioned, we expanded our network availability for high speed internet, broadband enabling grew to 7.2 million available households in our market. And we exceeded our year end target finishing the year at 77% of our total households compared with 67% a year ago. We plan to advance our broadband network capabilities in 2006 with increased speed and additional network enablement. Last market long distance revenue grew 5.2% sequentially and 11% year over year. We saw an 8 ½% sequential increase in ARPU. Long distance remains an important area of focus and significant revenue opportunities for us in 2006 as we close the gap between ours and our peers penetration.
Some of the initiatives we implemented to help drive both penetration and ARPU in the first quarter, include the expansion of our bundle eligible unlimited long distance plan as well as some modest pricing modification. Alliance, our direct TV alliance has been an exciting addition to the product suite. We posted another strong quarter of TV subscriber growth and now have nearly 130,000 customers on this service. Our strategic alliance with DIRECTV allows us to offer digital video satellite services to residential customers across the western United States and include this service on their Qwest bill. Evidence of the success of our bundling initiative is the growth in consumer connection, connections which include consumer and small business primary and secondary lines, high speed internet subscribers and video customers grew to 12.3 million in the fourth quarter. This marks the second sequential quarterly increase and an addition of nearly 200,000 connections since our new bundling and localized sales initiative began in May 2005. The Business Channel grew 1.2 % year over year as our data products continue to gain attraction and offset pressures from access line trends in the business market. We benefited from strong growth in private line and ATM as well as continued growth in long distance. Also encouraging are the demands for next generation services, including voice and IQ networking. Also revenue improved slightly in the quarter as pressures in local resale were essentially offset by growth in wholesale long distance revenue. Importantly, our continued pricing diligence that we began over a year ago drove improved revenue quality and increased our average revenue per minute. In the quarter, wireless revenue grew 5.3 % sequentially and over 11 % year over year, a turn from several years of revenue decline. This was the third consecutive quarter of subscriber increases as the base grew to 770,000, benefiting in part from flush roust service and (inaudible) offerings and also a more than 50 % data service take rate by new subscribers.
ARPU remains strong at $51 a month, up $5 or 11¢ on support quarter of 2004. Our wireless margin continued to improve as start up and migration costs are behind us. Importantly, the revenue trend in the quarter reflect the result of focused initiatives begun nearly a year ago which we believe are sustainable. These revenue trends are driven by success in our growth product as well as improved ARPU’s and bundle penetration. We also continue to take cost out of the business which along with stable revenue, grow another quarter of margin expansion. Adjusted EBIDA with $1.53 billion in the quarter after adjusting for $74 million of realignment excess. And after allowing for about $33 million of non reoccurring benefits, our run rate EBIDA is $1.20 billion as we exit the year. This marks the third consecutive quarter of improved margins, moves us even closer to EBDA margins of 30 %, that’s up 24 % just two years ago and advances us toward our mid-30’s margin (inaudible).
We continue to benefit from progress in our cost reduction efforts, diligent pricing initiatives and improving revenues while setting a margin impact of local line loss. Cost reduction and productivity improvement continue to be a key part of our strategy in driving further improvements in EBIDA and to improve overall profitability for Qwest. We remain focused on achieving cost saving goals and identifying new opportunities to improve productivity. Plus fourth quarter operating expenses total $3.3 billion, a decline of 1 % compared to the fourth quarter of 2004. While sales and SA&G declined $75 million sequentially, adjusting for restructuring and realignment expenses in both quarters, we continue to benefit from productivity improvements and continue the cross containment effort. For the year, operating and expense declined over $1 billion or 7.4 %. Cost of sales and SA&G declined nearly $900 million. The prior year includes expense associated with the legal reserve of $550 million. The expense decline was driven by continued productivity gain and the reduction of fixed and variable cost as a result of our facilities cost optimization effort. This was partially offset by wireless facility costs and volume increases. Overall headcount, declined by 2,050 units or about 5 % during 2005. Our long haul cost reduction and optimization effort have eliminated nearly $800 million in wireline facilities cost since the initiatives began in late 2003. And to reiterate a key point, both our fixed and variable unit costs have decreased reflecting a progress and on-going sustainability of our efforts. We successfully settled and eliminated our last underutilized purchase obligation with KMC, including all payments and liability. We believe there is significant opportunity to reduce costs and improve efficiency while we maintain a focus on our long haul network and continue to drive network optimization. Workforce levels will continue to be balanced with our natural attrition rate.
Turning to the balance sheet, financial flexibility was significantly improved in the fourth quarter by our successfully tendering and/or retiring $3 billion of our high coupon legacy debt. This was a significant step function in the company’s financial transformation and the $300 million plus reduction in interestic strength accelerates our path to profitability. Qwest net debt now stands at $14.5 billion, down over $11 billion from the peak of nearly $26 billion in 2002. Cash and short term investments totaled nearly $950 million at the end of the quarter. We continue to have a disciplined focus on our capital spending to balance our existing infrastructure with continuing support for our growth initiatives and service quality. CAPX in the fourth quarter totaled $503 million, this compared with $372 million in a year ago quarter. For the year CAPX totaled $1.6 million and we expect CAPX in 2006 to be slightly more than 2005. Free cash flow for the fourth quarter was $426 million, that’s before $204 million in one-time payments which consisted of our second and final payment of $125 million to the SEC and the $79 million settlement payment to KMC. As I said, this terminates the KMC relationship, including all obligations and the previously disclosed lawsuit. A 2005 free cash flow before the one-time payments was $904 million, largely exceeding our goal of $600-$800 million. We continue to expect free cash flow to increase by $450-$600 million in 2006 also before one-time payments from both the benefit of operational improvement and interest savings with potential variability due to other balance sheet changes. Keep in mind that this Company does have quarter to quarter fluctuation in our free cash flow.
In closing, we are pleased with the fourth quarter and the four year result. We advanced revenue, increased the penetration of our key growth products and drove higher ARPU. We made substantial progress in our EBIDA margin, bringing us closer to the goal of mid 30 %. We reduced future interest expense, reached earnings per share break even, including special items, and exceeded expectations for free cash flow. We have the opportunity for further meaningful improvement in 2006. With that, I’ll turn it back to Dick.
Thanks Oren. Our goals for ’06 are to drive modest organic revenue growth, improve EBIDA margins, especially for optimization and productivity initiatives and to increase our free cash flow. We will continue to review the opportunities that arise, especially with recent merger activities. But as we have demonstrated, these strategies must make sense for Qwest strategically, operationally, and financially. We’re disciplined in our acquisition strategy as we must be in all aspects of our business.
In summary, let me hit a few points. First, we have a valuable unique and increasingly profitable combination of local and long haul assets which we believe we can further leverage. Second, Qwest is uniquely positioned for growth as we drive penetration and ARPU on our key products with a $500 million revenue opportunity as we move toward average industry metrics for benchmarks. Third, we continue to pursue our EBIDA margin goal in the mid 30 % range assuming modest revenue growth. We believe this is a very competitive margin for a combined ILEC IXC operating model. Fourth, the elimination of our high cost legacy debt completes a significant step in a balance sheet restructuring we started in 2003, and facilitates growth and value for all of our constituents. Fifth, we will continue to deploy discipline just in time CAPX, balanced between returns and growth at a rate slightly higher than ’05. Sixth, free cash flow for us, we have successfully settled as Oren has pointed out, and paid off our last remaining unutilized UPL. We expect free cash flow growth in 2006 which increases our options for the future use of cash, including the opportunity to return capital to shareowners. And lastly, we believe we have the opportunity to be profitable in 2006 and then, with sustainable profitability begin to use our significant tax losses from prior years.
In closing our strategies, they are working. Our progress is demonstrable. We have momentum that is tangible. And we have a positive outlook for the future. We believe Qwest has the opportunity through our significant customer base, strong market position and product portfolio, the assets including our state of the art long haul fiber optic network the strategies and commitment to deliver growth and shareholder returns over the next few years. Now, we’d be happy to take a few questions this morning. So, operator if you would give us the first question.
Yes. At this time if you would like to ask a question, please press star and 1 on your touchtone phone. If your question has been answered and you’d like to withdraw from the question queue, you may do so by pressing the pound key. Once again, at this time, press star 1 to ask a question.
We’ll take our first questions from David Varden with Bank of America, go ahead please.
Good morning guys. Maybe two questions. A little picture and a big picture question. On earnings, maybe Oren, could you talk a little bit about what the $33 million in non recurring benefits were in the quarter and then as you look towards the recurring net income profile, earning profile into ’06, could you talk about the impact of stock options and pension expenses looking ahead to ’06 and from a bigger picture, Dick, I guess you’re the only CEO of a Bell Company that hasn’t been on the cover of a major news publication commenting on the issue of net neutrality so far so could you kind of give us your thoughts on the issue, kind of what your position is on it, what do you think the opportunity to monetize the network is, and you know when you think that this could really unfold to a profit generator? Thanks.
Do you want me to go ahead and go first Dick with the (inaudible) Good morning, on the earnings questions, the $33 million was largely some property tax settlements that we garnered in the fourth quarter and they were positive to us and that’s why we included them, although we will continue to work the property tax issue, we’re not in a position today to project whether it will be successful or not, or more successful in ’06, so we just considered them as non recurrent. On the stock option cost, we would expect our options although the Board hasn’t met and blessed everybody with their this year’s option, we would expect that the cost is about $20 million next year. On the pension expense, you know, our pension fund continues to be fully funded so we’re actually just accruing less credit pension expense and I think, and I’d have to check and get back to you but I think the differential year over year is something less than $30 million. I’ll check and see if that’s not right I’ll get back to you with it. And net neutralities that’s something we support, we’ve always supported it, we’ve always had the ability from the customer’s end on that last mile to provide different speeds and grades of services, I mean, I’ve been at this 37 years, started doing this years ago with condition lines, now we do it with variable speeds that you can purchase on a high speed internet connection, on our backbone, the same thing is true, we do have the ability to sell to business customers, B to B, different grades of service and customers have been buying this for some time so whether or not a wholesale customer buys that or not, that’s a decision they will make. Whether they continue to ride on the network. We aren’t going to be in the process of doing any blocking if that’s the question. But customers do have the ability to buy different levels of service and we’ll continue that. You know just as everybody else, we’re talking to lots of people and we’ll continue to discuss that, but one of the things that no one has pointed out is that if you reach an agreement with someone there’s usually a very strong non-disclosure statement and we will continue to respect that with those customers, wholesale and retail that we do business with.
Thank you. We’ll take our next question from Jeff Halpern with Sanford C. Bernstein, go ahead, please.
Good morning guys.
Good morning, Jeff
A couple of questions. Also a centering on a similar theme, I guess the first one is, as you look at in the wake of closing of SEC closing the AT&T deal, Verizon closing the MCI deal, are you seeing any changes in the process the RFP process for enterprise and government contracts. Secondly, you mentioned Dick, something you mentioned in the past which is you continue to look at different options associated with divestitures, associated with recent mergers and I guess I’d love for you to try to prioritize for us if you could potential you know, hypothetically if things came available whether it’s Verizon access lines or something else, would you, you know, how would you prioritize that vis a vis returning some of the excess cash flow to shareholders over time?
Well you got that third one in on there on the cash flow, Jeff. Let me just comment first of all on the RFP on the contracts, we really haven’t seen a lot of change, we have seen some degree in the enterprise space of price stability, on the federal government on networks, I think there’s an effort underway to accelerate that or get it back on schedule, that’s just an impression I have from talking with the government. So, it’s too soon to say we’re seeing something. We also think we have an opportunity a window here as customers start to realize that maybe they have a chance to renegotiate some contracts for what they’ve been paying the value proposition hasn’t been as good as it could have been. So I think we’ve got opportunity there. On mergers and acquisitions, you know, we’re very disciplined in this area and I guess we’ve shown that over the last couple of years. We will look at what’s strategically complementary to what we do, that means duplicate assets, or assets that we could optimize such as POPS or different legs or different rings, etc., you know strategically complementary is only half of the question, the other question is what’s the price for it. And we would have to be able to sit down and put pen to paper and show it to our owners and say that this is payback period and this is how it works and how we get the cost synergies accomplished. So I think we’ll continue to look at that, as far as access to clients, you know it’s like anything else, would you buy or sell, it all depends on the price and where those assets are located. And so again, I’ll just repeat it because I don’t want anybody to misinterpret. We have a $500 opportunity within our own business organically, we can attain this by just getting up to the average of our peer group, the benchmark that we talked about in our opening statement. That’s a great opportunity. It improves EBIDA, cash flow with no premium. So that’s something we’re totally focused on. If something else became available on a merger and acquisition, that was as I said strategically complementary at the right price point, we would consider it. Lastly, on the utilization of cash, as we accumulate more cash from operational success that we’re, the momentum that we have, we will make a decision later this year as to what is the most optimum way to use that cash in order to reward our constituents, our equity owners and you know there are only a few choices there. Everybody knows what they are, just as they were when we were reducing our debt and our Board will make that decision as we get further into the year. I think it would be premature for us to kind of speculate as to what path we might take because it will depend on the market at mid-year.
Great, thank you.
Thanks for the question.
Thank you. We’ll now take our next question from John Hojeleck with UBS, go ahead please.
Thanks, good morning. Hey Dick. Could you talk a little bit about the network (chaz) you going forward? You talked a little bit about the increasing CAPX we’re going to see next year, could you talk about you know how modest that is going to be and does it relate to some build out of fiber closer to the customer premises and secondly, just an update on your thinking of terrestrial video strategy?
On the CAPX what we said was it would be slightly above ’05 levels. I think Oren and I and the team would look at this and say you know that could be in the ’04, ’05 range if you looked at our CAPX, so slightly up is exactly what we said. Slightly up, it will depend upon the success investments. I mean if we have growth and opportunities, we’re going to deploy. We do not have any artificial restriction on CAPX. It’s all tied to getting a return on capital. So success based. Fiber, we have been doing fiber to the prim in new development, I think the number unless the engineers have changed it was 2,350 homes, in a new development Greenfield starts, we’ve been doing that for quite some time. We have been pushing out to our RT’s fiber where we need that to improve the band and get the higher speeds out. As I said, we’ve already got over half of our customers that have DSL available have 3-5 meg and outside of Denver and the Highlands area, Highlands Ranch area, and down in Phoenix you can get 7 megs, we’ve been there for sometime. We will continue to do that as customers need the higher levels of bandwidth, think of it as just in time inventory control. And we’re trying to manage that for the bandwidth there and the customers pay for it if they want it, the value proposition and then we get a return on capital. As far as the IP, I think you were talking about terrestrial we’ve got two cable, pardon me, three cable systems already up and running in the sense of DBSL deployments in Phoenix and Denver area. We also have our system in Omaha, Nebraska, we are having success in signing up new customers. We will follow with great interest the deployment of IP TV and what customers want and how it plays out being a follower is not a bad thing. And we’ll continue to watch this with great interest.
Thank you. We’ll take our next question now from Jonathan Chaplain with JP Morgan, go ahead please.
Thanks for taking the question. Two quick questions if I may? Firstly, just on the free cash flow point of clarity, I think you’re guiding to $1.2 - $1.5 billion in free cash flow for 2006, I just wanted to make sure of that. And then, secondly, if I could just follow up on Jeff’s question on uses of free cash flow. If you could just give us some indication of how much cash you feel comfortable with maintaining on the balance sheet, on a go forward basis, that would be great. And then secondly, if there’s any kind of color you can wrap around your thoughts on share repurchases versus dividends and the potential impact on equity value. I think that would be very useful. Thank you.
Oren, while you’re doing the math, let me do the last question first. We will look as I said earlier, look later in the year at the best way to reward and distribute the value we’ve created for our equity holders, to all our stakeholders. You know there’s stock buybacks, there’s dividend, there’s return of capital, of course there is some debt repurchase you can do. The question is which one creates the greatest value for the equity holder and that I think as I said earlier premature for us to speculate as which one of those courses we would take. But again, it’s not rocket science, there are only a few options there and as we accumulate the cash we’re not going to hold it, we’re going to find a way to deploy it in the most value creative way we can.
Jonathan, good morning. Your math and addition arithmetic if you will is correct. If we take the cash flow for ’05 and add the $450 to $600, which we believe we can improve, it does come out to $1.3 to $1.5 billion. On the second part of the question or the second question you had is, how much cash we would feel comfortable with on the balance sheet, we ended the year with just slightly more than $900 million on the balance sheet, and we have an interesting problem on our hands here is that we successfully pushed out most of our debt securities to where as you probably know very well, our total repayment obligation should we choose to repay the debt is under $500 million for ’06. So as we begin to make the decisions Dick was talking about earlier as to what we might do with free cash, it will drive us a little bit as to how much cash we accumulate on the balance sheet, but I believe that the Company should have $1 billion to you know $1.5 billion of cash on call on the balance sheet simply to smooth over some of the lumpiness we have in our quarter to quarter cash flows. I think as the operation stabilizes a little bit and a cash flow generation continues to improve as it does, you probably need less than that, but I think going through at least over the next little horizon we should think about those kind of free cash amounts on the balance sheet.
Thank you very much.
You’re very welcome.
Operator, we’ll take two more questions.
Okay, great. We’ll take our next question from Frank Loethan with Raymond James, go ahead please.
Good morning. Just real quick on the wholesale side. What are you seeing as far as high capacity circuits? You guys able, been able to keep the special access pricing up and what are you seeing on the wholesale pricing trends. And then, any headcount reductions in the plans this year. What is your current plans as far as your force levels?
On wholesale pricing, I think strategically changing the price point so our margins are positive and improved and we commented on that in our opening statement. And I think we’ve been successful at that. We’ve seen, I think a desire on the part of the entire sectors to have more rational pricing and so while our minutes are down, our revenues are up and our margins have improved. And I think we’ll continue to see that type of approach be successful. We have seen with the mergers some minutes pulled back from those companies. The long haul networks and we’ve had to listen up in places and be very creative in a wholesale group in bringing minutes and different circuits on but I don’t expect a lot of change, again, over the coming months, I just think the opportunity is there for us. On the second question you asked, on force levels, I would just point out that if you look at what Qwest has been doing, I made a comment earlier in my remarks about the revenue per employee and if you take I think it’s probably publicly available documents or filings, currently our revenue for employee is the highest relative to Bell South to key into Verizon, we expect as we said, with modest revenue growth, that we will continue to match portion load and deal with competitive losses and keep that level of efficiency that we’ve got. So, and one last comment. Over the last years at least since this team’s been here, we don’t make announcements about layoffs or things. We work with our union and the fact that we balance portion load, I mean it’s really a matter of customer’s equal work and work equals jobs and we’ll continue right down that path. I wouldn’t expect, you shouldn’t expect us to make any announcements or pronouncements about force level. We’re pretty proud of the revenue per employee. We look at the number of or expense per employee and where we are there and I think we’re in the range. Or leading the peer group.
Okay. And just to follow up on the wholesale side, what are you seeing out there generally in the market. Are you seeing any price firming on the wholesale market just in general? Or are you still seeing general price declines?
I think we’re seeing price stability. And we’ve seen price stability for the last few months. You know we obviously hope that continues.
Great, thank you.
Thank you. We’ll now take our final question from Blake Bath with Lehman Brothers, go ahead please.
Good morning guys.
Two questions. On the M&A question, just a follow up. Could you prioritize improving the profitability in the long haul asset versus a strategically adding access lines to your footprint? The second question is the goal of mid 30’s EBITDA margins, is that a 2-year goal, or a 5-year goal, since I’m the last question, I’ll throw in a third. The shares outstanding increased 2 ½ %, what was that? And what should we think about for the next year or two?
I’ll take the first two and leave the share question to Oren. On the merger acquisition side we started an approach of putting out aggregation points in our network which will save us millions and millions of dollars. We’ve got several hundred of those, we’ve already deployed and will continue to deploy those, they don’t require capital. We do those aggregation points in concert with our current supplier and Dan Willis of our group is working this issue for us and we have high expectation on that. So we’ve got work to do internally. As far as looking at long haul versus access lines, it really comes back to strategically complement means what kind of cost can you take out of the business. In other words if you have overlapping assets as we would have had with the recent attempt we made to do an acquisition, then you can look at a very short payback and the shareholders really benefit from it. It doesn’t matter whether it’s an access line or a long haul, that’s the question. And that’s strategically complementary. The second point is that it maybe very complementary, we may be able to save a significant amount of money merging two sets of assets or acquiring assets, but then what’s the price point. If the price point negates the ability to attain the cost synergy then you know it’s not on the table for us. And I’ll go back to the $500 million opportunity we got, we’re making progress, but there’s no premium in that, so that works out fine. Obviously there’s more opportunity in long haul because you’ve probably got more complementary assets than you do in access lines because they’re usually just the ST&A part that you can get your hands on. On the margin over the next two to three years, we’ve been very careful not to and will continue to be this way, very disciplined in not saying when we expect to attain the mid-30, we have said that during the coming year, ’06, we would expect to be in the low 30 range and I think if you look at the progress made in the December quarter, with the adjustments that we talked about, we’ve made steady progress towards that and are very close to that already. So we would expect over the coming year to attain that 30 % low 30 % range in EBIDA margin and the other is just a longer term goal and we will after we attain the first goal then we’ll talk about the second goal. Oren you want to talk about the shares?
Good morning, Blake. The roughly 40-45 million shares that we issued between December 31 ’04 and December 31 ’05 all related to an opportunistic debt retirement. And as you recall, we’ve been doing this really since I think ’02 where we had debt issues in the market that have a discount that we can use equity to capture the discount and actually works out, the math works out to where we issue equity at a pretty substantial premium to the market. And this was just more of that activity in ’05.
So we shouldn’t expect any of that going forward in the next two years?
Well the good news is and the bad news is, the good news is that our debt is trading at it’s face value almost now so we have little opportunity to capture discount and that’s also the bad news is we’ll be unable to do it as we go forward. I probably would rather have the debt trading at no discount than have the opportunity to retire, so I think we’re kind of where we need to be.
The other think is Blake, as Oren said earlier, with the work that his team has done spreading the maturity, you know, it’s smoothed out pretty good over the next five years or ten years or so. I mean if the debt maturities are really smoothed out.
I’d like to thank everybody for being on the call. I’d like to thank you for your support and we’ll continue to take advantage of the opportunity that our company has in the coming year. Thank you.
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