Qwest Communications International, Inc. Q1 2008 Earnings Call Transcript

May. 6.08 | About: CenturyLink, Inc. (CTL)

Qwest Communications International Inc. (NYSE:Q)

Q1 2008 Earnings Call

May 6, 2008 9:00 am ET

Executives

Rahn Porter - SVP, IR

Ed Mueller - Chairman and CEO

John Richardson - EVP Finance, CFO

Analysts

John Steen - Bank of America

Frank Louthan - Raymond James

Tom Seitz - Lehman Brothers

Jonathan Chaplin - JP Morgan Securities

Daniel Gaviria - Morgan Stanley

Brad Korch - Credit Suisse

Jason Armstrong - Goldman Sachs

John Hodulik - UBS

Michael McCormack - Bear Stearns

Peter Rhamey - BMO Capital Markets

Donna Jaegers - Janco Partners

Operator

Good morning. My name is Starlet, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Qwest first quarter 2008 Earnings Call. (Operator Instructions)

Mr. Porter, you may begin your conference

Rahn Porter

Thank you, Starlet. Hello, everyone, and welcome to our call. With us on the call this morning are Ed Mueller, our Chairman and CEO, and John Richardson, our Executive Vice President of Finance and CFO.

Before I turn the call over to Ed, I'd like to remind everyone that we'll be making forward-looking statements. These statements contain risks and uncertainties, which could cause actual results to differ materially from those expressed or implied here on the call. Those risks and uncertainties are on file with the SEC. Additionally, we do not adopt analyst estimates nor do we necessarily commit to updating the forward-looking statements that we have made 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 EBITDA, free cash flow and net debt. A full reconciliation of non-GAAP measures is included in the quarterly earnings section of our web site.

With that, I'd like to turn the call over to Ed.

Ed Mueller

Thank you, Ron. Good morning, everyone, and thank you for joining us today. I’d like to spend some time this morning updating you on our progress in implementing our five core strategies.

But, before I do that I would like to highlight the key takeaways from our first quarter results. Revenue totaled $3.4 billion. Importantly, revenue per data, Internet and video products grew 9% in the first quarter year-over-year. These growth products are an increasingly significant portion of our business and will help drive our growth of the industry shares from legacy to next generation products and services. In fact, revenue from data, Internet and video now represents nearly 40% of our total revenues. This compares to 32% of total revenue just two years ago.

Total revenue for the quarter was down sequentially compared to the previous year’s results. While underlying trends in our core business were favorable during the quarter, such as our year-over-year growth in recurring revenue in our business segment, equipment revenue anticipated wholesale industry dynamics and, preferably, revenue items have secured these trends in our results.

I think it is also important to note that our focus on profitability limited the margin impact of revenue declines. On the expense side, we continue to improve efficiencies and productivity reduced cost. While I am proud of what we have accomplished regarding focus and discipline, we see additional opportunity for cost reductions through our other initiatives, including the voluntary separation program in our Networx organization which I will talk about in a minute.

Adjusted EBITDA totaled $1.14 billion for the first quarter, down $30 million from the year ago first quarter; however, adjusted EBITDA margins improved sequentially from the fourth quarter and the full year to 33.6%. As productivity from our expanded sales force increases and our brand development efforts mature, we expect to continue towards our goal of mid-30% margins.

We are pursuing every available lever in all of our business segments to expand margins across the board, reflecting our expectation of sustainable profitability going forward and our earnings for the quarter including an effective tax rate for the first time in seven years. John will expand on this in a moment.

As you know, we are changing our segment reporting from wireline, wireless, and other to our three market based segments; business markets, mass markets, and wholesale markets. We believe this change will provide better visibility and the fact of the matter is it reflects the way we are now managing our business with greater effectiveness, efficiency, and accountability.

Let me now turn to our segment results. Positive trends in our business market segment continued in the first quarter of 2008 as our customers continued to transition from legacy platforms to strategic data products. We believe our investment in sales and marketing for this segment is contributing towards growth. This was our fourth consecutive quarter of year-of-year recurring revenue growth for our business market segment and we believe we still have a considerable opportunity ahead. This opportunity includes selling into the Networx’s program which will enable continuing growth in market share gains.

Lower segment income year-over-year reflects our investment in an expanded sales force with room for productivity improvement in the months ahead. In our mass market segment, first quarter revenue was flat sequentially and down slightly year-over-year. Growth in broadband and video subscribers, ARPU increases, and higher bundle penetration was offset by continuing access line losses. Segment income was down slightly year-over-year, but improved sequentially and with expenses also lower, year-over-year margins were comparable to the previous year. These results occurred in spite of continued intense competition and other economic pressures on our business. For wholesale markets, we continue to see the impact of industry consolidation in the first quarter as we focused on data and Internet services which represent close to half of segment revenue.

I am pleased to say, however, that we have improved our margins and are ahead of our plans for 2008. We continue to focus on our five strategies, and we've achieved a lot since the beginning of the year.

First, we have made significant progress in developing an infrastructure that can deliver simplified integrated solutions to customers. We have built a pipeline of new Mass Market products and services, some of them we have developed internally and others through partnerships, including the Verizon Wireless deal we announced yesterday.

In business markets, we continue to have success with our Office Connect product bundles where we grew revenue 12% sequentially. We also launched several upgrades to our iQ Networking products suites and integrated new features into the service.

In our wholesale markets, we launched new end office pricing plans to improve profitability. As you can see, we review simplified integrated solutions as an overarching fame that crosses all channels and customers. The goal is to make life easier for our customers and we've been working hard to build a pipeline of products and services and we will do exactly that.

This is what our spirit of service means and what employees of Qwest deliver to our customers' everyday. We will have more news along these lines in the coming weeks and months.

As to our second strategy to deepen in current partnerships and forge new ones, we made progress on both fronts. Yesterday, we announced a new five-year partnership with Verizon Wireless to sell Verizon Wireless services to Qwest's consumer, business and government customers.

We look to our current partnership with DIRECTV as an example if our both partners can benefit from the right committed relationship.

Speaking of DIRECTV, we continued our success and attracting subscribers while preparing for the natural synergies between their video on demand product to launch this year and our investment in broadband capabilities, which brings me to our third strategy to continue increase broadband capacities to our customers.

As you know, we have accelerated our investments in fiber-to-the-node. We plan to cover 1.5 million additional homes in 23 markets in 2008 and I am happy to say we are ahead of schedule with this rollout.

In April, we had two new fiber optic internet services for mass market customers. Qwest Connect Titanium, which provides connection speeds up to 12 Mbps and Qwest Quantum which provides connection speeds up to 20 Mbps and we are implementing this strategy to a balance written driven capital investment approach.

Our fourth strategy increased productivity and cost efficiency continues to yield positive result as reflected in our sequential EBITDA margin. An example of this was our voluntary separation program, which resulted in over 700 network employees taking early retirement.

We are helping to enable each of these strategies by impart escalating our mass markets, marketing efforts with new advertising launching in June. In addition, we are improving our ability to collect and analyze market intelligence, so we can be aligned as closely as possible with customer demands.

Also, we are implementing a localization effort where we have expanded the authority of our regional managers to enable them to be more responsive to competitors on a market-by-market basis.

Lastly, our commitment to balance investment in profitable growth with return to shareholders remains a key part of our strategy. We have to be disciplined in how we best deploy capital for growth and continue to reward our shareholders. Our current share buyback, coupled with the reinstatement of the dividend are excellent examples of our balanced approach, with our dividend payment in February and the continued progress on our share repurchase, Qwest has returned $370 million to shareholders this year alone and a total of $1.75 billion since the program began in 2006.

In summary, we are doing what we said we would. We are excited about the opportunities ahead to server customers. The work we did to rethink and build our strategies for success, the metrics and discipline, we bring to balancing investments with returns, and greater accountability across the business have caused our team to look at every aspect of our operations with a clear vision of how we can succeed.

Now, I’ll turn the call over to John for more details on the first quarter financial results.

John Richardson

Thanks Ed and good morning everyone. It was a very productive quarter for Qwest as Ed has outlined. And we are excited with the progress we’ve made on our strategic initiatives. Our new segment reporting will allow shareholder to track progress both, during this quarter and into the future, as those initiatives contribute to the bottom line. I will discuss segment reporting in a moment, but I would like to start by reviewing total company results for revenue, expense, and EBITDA.

Qwest reported total revenue for the quarter of $3.4 billion. The quarter’s results reflect growing demand for faster, more robust broadband services, which drove data internet and video revenue up 9% from a year ago to $1.3 billion. Deployment of fiber-to-the-node and other broadband investments during the quarter will help position us to continue meeting customer demand for data services. Offsetting this growth was continued competitive pressures on voice service revenue and a challenging year-over-year comparison due to industry consolidation in wholesale.

As a result, total revenue was down 1.4% year-over-year and sequentially total revenue was down slightly due to lower business market’s data integration revenue and changes in universal service funds surcharges and other items. Total operating expenses for the quarter were $2.9 billion. Looking at the components of operating expense, cost of sales was down year-over-year excluding the impact of severance charges as productivity initiatives and lower network volumes led to reductions in network and facilities cost.

These reductions were offset by the impact of severance expenses of $40 million associated with the voluntary separation programs we announced with the communication workers of America in March. Through this program we proactively matched workforce to workload and we will reduce our expense run rate starting in the second quarter. This program will yield annualized savings of approximately $54 million.

On a sequential basis, cost of sales declined after normalized interest severance charges largely due to equipment revenue. Investments in our business market sales force and brand awareness contributed to higher selling expenses year-over-year totaling $545 million for the quarter.

General and administrative expenses were lower due to charges in the first quarter of 2007 associated with our securities litigation. Adjusting pro litigation charges G&A expenses were flat sequentially and year-over-year. Finally depreciation and amortization was down sequentially and year-over-year as result of our continued discipline around capital spending. After netting out one-time impacts in both 2007 and 2008, total operating expenses declined by $53 million year-over-year. Adjusted EBITDA was $1.14 billion for the quarter. As a result of declining expenses, adjusted EBITDA margins expanded sequentially to 33.6% versus 33.1% in the fourth quarter of 2007. On a year-over-year basis, adjusted EBITDA was down on lower revenue and higher selling cost.

This quarter we changed our segment reporting to reflect the way we now manage the business and the opportunities that Qwest is pursuing in the marketplace. Let me take a moment to describe our new segment reporting structures. Now, we are reporting three segments - business markets, mass markets, and wholesale markets. Reporting for each segment includes both revenue and expense directly assignable to the segment. Unassigned revenue and expense such as universal service funds, surcharges, and certain G&A are reported only in total company results.

Looking at the performance of the segments during the quarter, business markets reported accelerated year-over-year revenue growth at 3.1% in line with our annual guidance. Total revenues were $995 million for the quarter. These results demonstrate the benefits of expanding our sales force for this segment. The total segment income was down 4.1% year-over-year as expenses increased $46 million to support the expanded sales force and the revenue growth.

Sequentially, revenue declined $13 million as procurement cycle impacted equipment which is typically strongest in the fourth quarter. However, recurring posted its fourth quarter consecutive quarter of sequential growth. Expenses declined by $29 million over the same period, primarily due to the lower equipment revenue, resulting in sequential segment income growth of 4.4%. Segment margin was 38.1% on total segment income of $379 million.

Revenue in Mass Markets was flat sequentially and down slightly year-over-year. These results were in line with expectations and our full year guidance, even with the challenging macro economic environment. Data, Internet and video revenue grew more than 20% year-over-year and continue to offset declines in wireline and wireless voice service revenue. These results reflect the dynamics of our subscriber base, including 90,000 net additions for our broadband Internet service during the quarter, including 13,000 new fiber-to-the-node subscribers for year-over-year growth of 17.2%.

Continued success in our video partnerships with DIRECTV generating 50,000 net additions for the quarter, maintaining Qwest's industry leading penetration rate for video subscribers, and an 8.3% declined year-over-year in Mass Markets access lines due to continued technology substitution to VoIP and wireless alternatives.

Lower spending in our promotional activity improved segment income by $21 million relative to the fourth quarter of 2007. On a year-over-year basis, segment income declined by 1% mostly from lower revenues to $717 million. Segment margin was flat compared to the first quarter of 2007.

Pressures in wholesale long-distance weighed on year-over-year revenue comparisons in wholesale consistent with our guidance for 2008 and revenue declined 7% year-over-year to $841 million.

Data and internet revenue increased by 3% over the same period and now represents more than 44% of total wholesale market revenue, as we continue to focus on new market opportunities.

Revenue from alternative sources such as cable improved significantly compared to the prior year. Sequentially, trends showed a leveling out of declines with revenues flat compared to the fourth quarter of 2007.

Facilities, network and other expenses were primarily responsible for a $53 million decline in segment expenses year-over-year. With low margin revenue driving the top line declines segment income was largely unaffected declining only 2% to $493 million allowing us to meet our objective of maximizing wholesale margins as revenues declined. As a result segment margins improved to 58.6%.

Sequentially, segment expenses were up $23 million almost entirely as a result of the favorable regulatory settlement during the fourth quarter.

Net income for the quarter was $157 million or $0.09 per share diluted. For the first time since 2001, Qwest is recording income tax expense at normal effective tax rates as a result of our decision in 2007 to reverse the valuation allowance previously taken again deferred tax assets. As a result, our net income result will not be comparable to 2007 throughout 2008. However, income before income taxes was up 5.8% since the first quarter of 2007 demonstrating Qwest financial progress.

Adjusted free cash flow for the quarter was $56 million, down $94 million from the same period in 2007. This result could be entirely attributed to the year-over-year increase in capital expenditures of $98 million. Capital expenditures were higher compared to the previous year partially to support our investment in fiber-to-the-node build out. Overall, broadband related investments across the company were 59% of total capital investments in the quarter, up from 50% for all of 2007.

Finally, turning to the balance sheet, net debt increased to $13.5 billion, as a result of lower cash and investment balances at the end of the quarter, reflecting typical seasonal flows of cash through our business. Cash and investment of $800 million remained within our targeted range.

During the quarter, Qwest rewarded shareholders with a $142 million in common stock dividends, combined with the $232 million in share repurchase since the beginning of the year, total cash returned to our shareholders in 2008 was over $370 million as of May 1st. The company remains committed to completing the remaining 20% of this current $2 billion share repurchase program this year.

As it relates to our guidance for 2008 financial results released in February we continue to believe revenues will be flat to slightly down over 2007 results. This excludes the revenue impact from transitioning from gross to net accounting for our wireless business, which will reduce both revenue and expense depending on the course and speed of customer migration. We continue to believe that Qwest will report full year 2008 results inline with our prior guidance on adjusted EBITDA, capital expenditures, and free cash flow.

In closing, our financial performance this quarter reflects the results of the company as it executes up against its strategies. Our new segment reporting structure is designed to illustrate Qwest progress and executing on its broadband and business market opportunities, while striving to optimize performance in all areas of our business through the introduction of new products and services and continued focus on productivity, efficiency, and disciplined capital spending resulting in benefits for all our stake holders.

With that, we’ll be happy to answer any questions you may have.

Question-and-Answer-Session

Operator

(Operator Instructions) Your first question comes from the line of David Barden with Bank of America.

John [Steen] - Bank of America

Hi, this is actually John [Steen] sitting in for David Barden. Good morning guys, thanks for taking my question.

Ed Mueller

Good morning John.

John Steen - Bank of America

Just following up on it's comments from the analyst day. Can you give us an update on the take rates of the high-speed fiber trials and ARPU and penetration?

Ed Mueller

Good morning, John. I will let John take that question but overall we are ahead of schedule on our field. We are ahead of schedule on the higher speed and we are ahead of schedule on upgrades of our current customers. So, John, if you want to go ahead?

John Richardson

Sure. Yeah, John. Good morning, John. As we indicated in the prepared remarks, of the 90,000 the net addition we had for high-speed, the subscribers, 13,000 of them were related to our fiber-to-the-node build-out that we have done last year and in the beginning of this year. I think we are making good progress here. The early returns suggest that customers are demanding the higher speed and with that we believe that our projects are going to prove out successfully as we go through 2008.

John Steen - Bank of America

That’s great. And we have heard other carriers talk about price hikes in coming quarters for core services as well as video and so, what's your posture here?

Ed Mueller

We will do price increases, that is our plan. We believe there is room in the market for the prices and where we can we are taking them.

John Steen - Bank of America

Alright. Thanks guys.

John Richardson

Thank you, John.

Operator

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

John Richardson

Good morning, Frank.

Frank Louthan - Raymond James

Good morning. Can you give us a little more detail on the broad and wireless agreements? A couple of thoughts there; one, can you give us more details on how you think that is going to positively impact your government business and is this going to be anyway related to rise in open access policies they put in place. Will you be willing to take advantage of their open access of the network with maybe some unique handsets or other offerings that you'd be offering to your customers or will it be just straight resale of similar offerings from Verizon?

Ed Mueller

Okay. Good morning Frank. Let me handle that one. First, the details of Verizon. We are really excited. Let me take the open access one, first. That was part of our desire to get a carrier like Verizon. We want access to the 4G technology. That's a big deal to us.

We will take advantage of any open access. We will take advantage of handsets or devices. Any partnerships we have with other businesses that drive that network we will take advantage. We are really excited about that. We like their technology. So, I think that's really good for us.

On the government front, it was a big deal to us to have Tom Richards and his team be able to sell, particularly in the Networx segment, where a bid requires a wireless customer. Tom, will have a great advantage to do that. That is really good news, as well as to rest of our Business segment.

We like the attitude of Verizon. We like their openness. We like their go-to-market strategy with us. We like the improved economics that we have with Verizon Wireless. Then we have access to all their technology, including the Fixed Mobile Convergence and we do think that the stickiness of Verizon with our DIRECTV with our new products on our access line surge here to stop the bleeding as much as we can on access line. This is just one more good thing for Qwest.

Frank Louthan - Raymond James

So what is the strategy with the current wireless systems that you have. Are you going to migrate them over as the contracts come up or just let them churn off? What are the thoughts there? How long will you be running those parallel? And can you give us any comments on maybe on a percentage basis or a ballpark how much better the economics are?

Ed Mueller

Well, we won't give you the economics, but I will assure you they're much, much better. You have seen our income statements in the past, so I will leave that there, because we won't divulge the actual content of the agreement.

Frank Louthan - Raymond James

I had to ask.

Ed Mueller

Yes, I know you did. It's a good try, but thanks. Keep asking. On the migration, we have contract ends with Sprint in '09 as we said at our analysts' day. We will move our customers or let our customers actually move with us with Verizon. We are excited about that. I think Verizon is also excited about that into a degree that we move them, I think will be good for us and we're very optimistic on that front.

Frank Louthan - Raymond James

Great, thank you.

Operator

Your next question comes from the line of Tom Seitz with Lehman Brothers.

Tom Seitz - Lehman Brothers

Ed, you've talked about monetizing the higher speeds that you're deploying. And I was wondering first if you could update us as to any initiatives or partnerships that you might be undertaking. Any sort of update there would be helpful.

And then secondly, I know it's only one month and it's probably a small data point, but you talked earlier about how customers really want higher speeds. And I was wondering if you saw any impact at all in Minneapolis-Saint Paul from the Comcast offering of, I think it's 50 megabits. Just any color there would be great? Thanks.

Ed Mueller

Okay, thanks, Tom. On the Minneapolis, its too early to call on that, I have to say that our customers, because we have a free pipe, when I say free we are not encumbered with any other video that we are pumping down rather than what we are hopeful to take advantages of video-on-demand with our DIRECTV, but our pipe at 12 and 20 is really getting good reaction and I think that matches up very well with the Comcast product line. We will watch that. They are a formidable competitor, but it is way too early to tell on that one.

Our partnerships on high-speed Internet, we will take them where its profitable and I think that early return on the video-on-demand broadband combination with DIRECTV is very exciting for us. And we really think that puts stickiness, also helps the financials for us as we go forward with our DIRECTV.

And I would say, that it’s truly, as we said before, that’s the blueprint of how we are going to do our 4G wireless with Verizon, and I'm really comfortable there.

Tom Seitz - Lehman Brothers

Great, thank you.

Operator

Your next questions come from the line of Jonathan Chaplin with JP Morgan Securities.

Jonathan Chaplin - JPMorgan Securities

It was encouraging to see wholesale revenue relatively flat sequentially despite the pressures you talked about. AT&T mentioned on their call that they've taken a bunch of BellSouth. They took a charge this quarter for a bunch of BellSouth data traffic that was taken onto their network. Was that revenue that came off of your network? And if so, is it something you grew through in the first quarter, or does the pressure show up in the second quarter?

I am wondering if you can just comment beyond that whether you should be able to maintain wholesale revenues flat on a sequential basis from here? Thank you.

Ed Mueller

Good morning, Jonathan. We are encouraged about wholesale. As we told you in the fall, we had to work through tough compares in the first six months. Our wholesale team has really done a good job of moving through this. And the margin is coming like we wanted it to.

I think it's a little too early to be say we are going to be flat the rest of the year, but I will say to you that we're ahead of schedule. The BellSouth obviously was an impact on us. I don't know much about that. I can't comment on their charge. But I like the way our team is going. We've stabilized our pricing plan. I mentioned in my prepared remarks that the End Office really helps our profitability.

Our teams are focused on operating contribution. You will see that in the segment results. You already see it, but you will see it even more as we move through the next three quarters. So Jonathan, I really believe this is really cooking well.

Jonathan Chaplin - JPMorgan Securities

Thanks, Ed. So did the BellSouth traffic come off this quarter, or was it something that shows up next quarter?

Ed Mueller

I can't answer that, Jonathan. I am not that deep into it. I think it probably comes off kind of steady over time. I don't know what they put back on. But our results are showing good overall, so you know, I would be remiss to tell you those exact numbers.

John Richardson

I think the important thing, Jonathan, for us, and Ed has alluded to it, is that we basically are doing what we said we were going to do. With top-line declines we were going to minimize the margin loss, and it's really evident in these results where the revenues declined 7% year-over-year and the margins declined $10 million at 2%, and the actual margin percentage went up 300 basis points.

So we're really encouraged about the progress that our wholesale team has made.

Jonathan Chaplin - JPMorgan Securities

Great, thanks. Thanks, guys. I appreciate that.

John Richardson

Have a good day Jonathan

Operator

Your next questions come from the line of Daniel Gaviria with Morgan Stanley.

Daniel Gaviria - Morgan Stanley

I've got a question on business lines. You posted disconnections in small business lines; and as well in the business segment your line loss increased by 70 basis points sequentially. I wanted to hear your view on business trends in the footprint and if you had seen any, if you had witnessed any increase in business closures? Thank you.

John Richardson

Thank you. This is John Richardson. Yeah, we don't post small business line changes. It’s part of our total mass markets connections. As it relates to our business lines, we do post that. It was a 3.3% decline. That is pretty much in line with what we have had in prior quarters.

And with the increased sales force that we have in our business markets space, and it's really starting to pay some dividends for us, I think as evidenced by the 3.1% growth that we have had in our business revenues, this year.

Daniel Gaviria - Morgan Stanley

Okay, thank you.

Operator

Your next question comes from the line of Chris Larsen with Credit Suisse.

Brad Korch - Credit Suisse

Hi, this is Brad Korch sitting in for Chris. Just two quick questions. One, would you consider accelerating your fiber build if the customer acceptance is better on the higher speeds, especially to capture share now while there are some more voice subs left?

And then secondly, could you update us at all on your CFO search?

Ed Mueller

Okay, let me talk about the high-speed. We are early in the process. We're ahead of schedule. We are going to stick to our CapEx, as well as our free cash flow in 2008 and we don't think that minimizes our market impact at all. Where we could mine more money out, as you see we're really moving money to our broadband at all and at the expense of some of the other CapEx programs that we may have had in the past.

And so we are sticking to it. I think we're in a good runway. If that changed in six, eight months or whatever, we would certainly give you new data. But I don't think we need to do that, and I think we are on a good trajectory there. The CFO search is progressing ahead, and that is all I would say on that.

Brad Korch - Credit Suisse

Okay, thank you.

Ed Mueller

You’re welcome.

Operator

Your next questions come from the line of Jason Armstrong with Goldman Sachs.

Jason Armstrong - Goldman Sachs

Thanks. Good morning. Just a couple questions. First on the guidance, you're sure sticking with revenues flat to down for the year. If we look at margins in the quarter, they were done a bit year-over-year, sort of 1Q this year versus 1Q last year. The extension is the mechanics of this don't point to the sort of zero to 2% EBITDA growth you pointed to.

So can you just sort of make some comments on how this fits together? And then maybe the early retirement you talked about, is that sort of what gets you there on the cost-cutting side?

And then maybe some comments on macro. You sort of mentioned challenging economic backdrop. It's consistent with what others have said. How is that playing a role here? Are you seeing that tick up at all on the enterprise side or maybe the consumer side in terms of involuntary disconnects, bad churn, etc.? Thanks.

John Richardson

Okay, good morning, Jason. Thanks for the questions. First of all, on our annual guidance, we are comfortable with our annual guidance. And year-over-year we did have some declines in EBITDA margin and in EBITDA. However, we do believe that we have the momentum to pick that up through the year with the cost cutting initiatives. And of course, as you have rightly pointed out, the one that we did the in the first quarter where we had 700 people leave as a result of our voluntary separation program really starts to pay benefits for us as we move through the year. We indicated in our prepared remarks that that was $54 million annually.

Also, as we continue our fiber-to-the-node build out and we continue to gain productivity from our sales force in the Business Markets space, and we continue to focus on margins in wholesale, we believe that we have the opportunity on EBITDA to hold EBITDA flat to a 2% growth in 2008.

And your other question, Jason?

Jason Armstrong - Goldman Sachs

It was on the macro. You just sort of talked about obviously pressure from the economy. If you can give us some more data points across enterprise and consumer, that would be great.

John Richardson

Well, our goal here is to work our way through the challenging economic environment that we have and, of course, that exists nationwide. And we are comfortable with our guidance even with that challenging environment that we operate in.

As it relates to evidence of effects on our business, one of the questions that was brought up in the fourth-quarter call was around bad debt. In mass markets as an example, our bad debt write-offs are largely in line with what they were in the fourth quarter and the third quarter. So we aren't seeing any real strong evidence that the economic pressures are having a huge effect on us in that area.

Jason Armstrong - Goldman Sachs

Okay. On the line loss side, ticked up on consumer at all. None of that is really tied to economy, whether it's housing starts or involuntary disconnects? You're not seeing any of that?

John Richardson

It could be tied to a lot of things. Actually, when you take a look at the consumer line loss I think that even though the rate is a little higher from a percentage standpoint, it's actually a little bit lower than what it was in the second quarter of 2007, and clearly things like housing starts are going to have an effect on our expense line loss. But again, our goal is to manage through that with offering new products and services that make the expense line relevant to our customer base.

Jason Armstrong - Goldman Sachs

Great. Thanks John.

John Richardson

Sure Jason.

Operator

Your next question comes from the line of John Hodulik with UBS.

John Hodulik - UBS

Good morning. Just a couple of quick follows-ups. Actually getting back to Jason's question. John, do you get meaningful margin improvement in the second half of the year due to the change in the wireless contract whether from Sprint or Verizon?

And then back to the mass market, Comcast in particular was more aggressive than they have been in the past in terms of promotion, advertising and pricing around both voice and data services, is that the biggest driver would you say in terms of the delta there in access line losses, because you seem to be suggesting its not as may be a economic as it might be in terms of economic related. So just some commentary on what kind of pressure you are seeing from cable would be great?

John Richardson

Got you. Thanks, John and good morning. As it relates to Verizon contract as I mentioned that we believe that our EBITDA is going to be inline with our guidance versus flat to slightly up. So, depended upon the courses and speed of migration that we have, we’re going to have migration cost as well as, I mentioned the change in our revenues. However, with those, we believe that we can operate within the guidance that we have.

As Ed mentioned, going forward we believe that, one of the reasons why we’ve done this is, is the improved economics around the Verizon deal and we’re encouraged by what we think that we could do there going forward. As it relates to Comcast and aggressive marketing and pricing that we think that there is a lot of room to grow on high speed Internet and in the market place we believe that overall penetration should top out at around 70% going into the future. So we think that there is room for growth. We have evidenced the growth in the quarter with our 90,000 net additions, 13,000 related to in our fiber-to-the-node footprint with higher speed offerings so we think that we have a great product particularly with the new products that we announced in April with the connection speeds up to 12 megabit and 20 megabit and we believe that we are going to be able to compete effectively and capture our rights from those market share in the broadband space.

John Hodulik - UBS

Okay, great thanks.

John Richardson

Thanks John.

Operator

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

Michael McCormack - Bear Stearns

Hi, just one on the consumer side a couple of your peers has begun to identify sort of how valuable the cost structure is in the consumer business. Maybe you guys could give us a few hints on it for you. And secondly, on DSL, I know you’ve got a focus now in going to those fibers in the neighborhood areas, but the number of DSL as in the quarter was the weakest we have seen in a couple of years and yet we are talking about the potential to raise pricing. Can you give us a sense for what’s going on in the dynamic there? We’ve got higher penetration and what gives you the comfort on the price increases? Thanks.

Ed Mueller

Let me start, Mike, on the DSL. The DSL broadband penetration we have two pushes there. We still think there is room to for total market growth on broadband whether it’s us or a competitor but that is moving up. We said in February analyst day we believed it to be 70% of households, I think that's true. So, the ceiling is on it. We are under penetrated, I believe, in our market shares. So, we are going to take market share from there with the ARPU increases with the 12 and 20 meg and the add-on services to come later.

The video-on-demand is one example of that that's near term and other services as well as the 4G technology on our wireless that will pull it all together. So, I am confident in the total growth as we get momentum in our fiber node. We are early into that. We ramp significantly in the second, really the third and fourth quarters of our 1.5 million households. So, we are very confident and John already talked about. We are confident enough to keep the guidance where we had at before in mind through this.

So, the variability on the consumer side, there definitely is some variability. We have fixed cost as you know, but I would say we are reacting to the cost structure just as we took 700 people out. And I think you see that that is how we react to it and we believe our margins will increase in all segments and, of course, John has already talked about, over time obviously just the way the map works, the structure we have with Verizon does improve our margins. We will call that out as we go forward because that's just a structural change in the agreement, difference between Sprint and Verizon.

Michael McCormack - Bear Stearns

Alright. Thanks guys.

Operator

Your next question comes from the line of Peter Rhamey with BMO Capital Markets.

Peter Rhamey - BMO Capital Markets

Good morning and thank you for taking the question. Just on that, you ended up, Ed, commenting on the migration. That contract with Sprint terminated, I believe in the first quarter of 2009. So presumably 800,000 customers would be migrated at that point, please confirm that.

And second of all, more of this would be for John, you bought back about 30 million shares in the quarter. It looks like the average price came in around $7 per share if my numbers are anywhere near correct. I was wondering what opportunity did you have to buyback shares this quarter that might have prevent you from being more aggressive and given where your stock is today. How do you look out going forward? Thank you.

Ed Mueller

Okay. Good morning, Peter. On the migration, we will work through the end of the contract. I think, we have plenty of runway, plenty of room, plenty of time to have that completed and in addition to what other customers which I think there will be many that we don't have today. We have been relatively flat.

In the consumer segment, I think we are going to gain Verizon customers that we don't even have today. So the starting point is the 800,000. I encourage there. I think it should be noted that that this is in our Business Markets Group. I think a tool that they have not had and will be good for us, particularly in the federal government as we do our Networx contract. So more to come on that, but I am very confident we will get where we need to go. John why don’t you handle the next part of the question.

John Richardson

Yeah, the share repurchases. Yeah, Peter thanks for the question. As we indicated in our prepared remarks, we are committed to doing what we said we were going to do in February, which was to pay our dividend and to continue to purchase shares in the marketplace and finish this $2 billion share repurchase program that we started in the fourth quarter 2006 and in 2008.With that program and when we complete it, with the dividend, we will have returned approximately $2.3 billion worth of cash to our shareholders.

As it relates to the average purchase price, I think that I'm not sure where your math is coming from, and maybe we can have Rahn and his team sort through that with you after the call. But we look like we average out at around $5.60 per share in the first quarter.

Peter Rhamey - BMO Capital Markets

Okay, my mistake on the math, no doubt. But just any restrictions on windows this quarter? And how do the windows look into Q2?

John Richardson

Well, our windows will open up with normal schedules.

Peter Rhamey - BMO Capital Markets

So you weren't constrained with the Verizon Wireless deal from buying back shares during the quarter?

John Richardson

We had certain programs in place that allowed us to complete our share buyback program in line with the schedule that we put out for ourselves at the beginning of the year.

Peter Rhamey - BMO Capital Markets

Perfect. Thank you very much, John.

Operator

And you final questions comes from the line of Donna Jaegers with Janco Partners.

Donna Jaegers - Janco Partners

Thanks for taking my question. Quick question, or maybe not so quick. I know in Colorado you guys were trying to get legislation approved to increase your basic rates. Can you inform us of any other state activities that you have going to try to get pricing to be moved up on the basic package?

Ed Mueller

Good morning, Donna. How are you today?

Donna Jaegers - Janco Partners

Good.

Ed Mueller

On Colorado, what we have is we're trying to get freedom and let the commission deal with our rates as opposed to legislative. So that is what we're about in Colorado. And then we will deal with that as we go forward.

In the other states, it depends on the regulations we have and what we have freedom for primarily one 1FR rate is probably fixed and we have made agreements in certain states, but we have plenty of room on bundles, on additional services that sit on top of that and as we take advantage of and I am really happy with where we can go with that.

Donna Jaegers - Janco Partners

And then just one other quick follow-up on the Networx contract, obviously everyone been disappointed by how slow the ramp has been in bidding on Networx contract. So do you have any other visibility that would lead you believe that there will be more activity later this year?

Ed Mueller

We do, that’s a great question. We think the log-jam is finally broke loose. We said at our analyst conference, we are working hard. Obviously, we are not the only carrier working hard on that, but we see that momentum gaining and like we saw in FTS 2000 some of us did back in the last time they did this much of the momentum breaks and people move. All the agencies and this government contracts really rolled fast. We have more in our hands today than we had in February and I am very encouraged about where we are going with this. Obviously, it will be an ’09 story for our business team and beyond as far as the revenue and the sales, but we are really encouraged as now breaking loose.

Donna Jaegers - Janco Partners

Great. Thanks Ed.

Ed Mueller

Let me close with a couple of comments here. First, I think we’ve talked about our five strategies, but two of the three segments I am really happy with our wholesale segment is moving in the direction we want it to as we talked about on the earlier in one of the questions. If the flatness continues that is very encouraging for our side, plus the profitability there.

Our business markets group has continued to perform with the Networx contract coming online. There is a good ramp for that group and I am really encouraged about the productivity of our sales teams.

On the residential or mass markets front, you all have called out and we agree that stemming the access line loss and how we would do that is paramount to us. And we have a full-court press on that with new products, but as well as our high-speed Internet. Really our goal here is to capture market, ARPU, and wallet per household. And we have, I think, great opportunity for that as we go forward, as we are kind of in the mid-50s range as we serve households today percent-wise. So I really, am encouraged there. Our early returns on fiber-to-the-node are going to do us really good.

We do have initiatives in place we are following, and our five strategies. We're continuing our focus on our Spirit of Service, which really helps us in the marketplace, and we are confident that we will continue to improve our market position over time.

With that, we appreciate your time and questions, and thank you, and have a great day.

Operator

Thank you. This concludes today's Qwest conference call. You may now disconnect.

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