Verizon Communications Inc. (VZ) Q1 2011 Earnings Report, Transcript and Summary

Good morning, and welcome to the Verizon First Quarter 2011 Earnings Conference Call. [Operator Instructions] It is now my pleasure to turn the call over to your host, Mr. John Doherty, Senior Vice President, Investor Relations for Verizon.

Thanks, Brad. Good morning, and welcome to our First Quarter 2011 Earnings Conference Call. Thanks for joining us this morning. I'm John Doherty. With me this morning is Fran Shammo, our Chief Financial Officer. Before we get started, let me remind you that our earnings release, financial and operating information, the investor quarterly and the presentation slides are available on our Investor Relations website. This call is being webcast. If you would like to listen to a replay, you can do so from our website. I would also like to draw your attention to our Safe Harbor statement. Information in this presentation contains statements about expected future events and financial results that are forward-looking, and subject to risks and uncertainties. Discussion of factors that may affect future results is contained in Verizon's filings with the SEC, which are available on our website. This presentation also contains certain non-GAAP financial measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are also on our website. Before we get started, I'd like to draw your attention to a newly formatted financial and operating information file that we've made available to you on our website. In addition to providing two years and eight quarters of historical financial information, we've added some new customer and connection metrics in Wireless and Wireline, which better reflect the trends in our business. With that, I will now turn the call over to Fran Shammo.

Thank you, John, and good morning, everyone. At our investor meeting in late January, we talked about our 2011 priorities, our strong focus on business plan execution and translating revenue opportunities into profitable growth and shareowner value. In looking at our first quarter results, I'd say we are off to a very strong start. Our Wireless business performed extremely well, further solidifying our leadership position in the industry. Our 4G LTE network deployment is going very well, and our network performance has exceeded even our own very high expectations. In one independent test after another, our network's ability to deliver video and data, with exceptional speed and performance, has been unmatched. Possibly even more impressive is the speed with which products and services are being developed for LTE. Through our LTE rollout, we have positioned ourselves on the leading edge of a whole new phase of Wireless market development. Our first quarter Wireless results once again demonstrate our ability to effectively manage growth and sustain profitability. We had a very strong quarter of device sales, with 906,000 retail postpaid customer net additions. In a period of less than eight weeks, we activated 2.2 million iPhones and in two weeks, we activated more than 260,000 of our first 4G LTE smartphone, the HTC ThunderBolt, at the premium price of $249.99. In addition, we added about 250,000 4G Internet devices to our retail postpaid base in the quarter, and quickly sold out iPad 2 tablets in early March. So we built good momentum throughout the quarter. Our Wireless service EBITDA margin of 43.7% is a solid result, once again demonstrates our ability to effectively manage the customer acquisition and retention costs associated with gaining market share and increasing smartphone penetration, while sustaining our industry-leading profitable growth profile going forward. In Wireline, our…

Thanks, Fran. Brad, let's open it up for questions, please.

[Operator Instructions] Your first question comes from Jason Armstrong of Goldman Sachs.

Great. Thanks. Good morning. First, on postpaid ARPU. Fran, you gave some helpful commentary on the exit rates at 2.8% in March. I guess what that implies, though, is that the entry rates in January were probably roughly 1.5% growth, which is a step down from the fourth quarter rates, and it seemed to imply to me that the 4G laptop cards you launched in December, I guess it’s logical that you would've over indexed sales here early in the quarter, which generally carry a little bit lower ARPU, and I'm wondering if you can offer granularity. Is that what happened? Just trying to put a finer point on sort of this progress through the quarter you had on ARPU. And the second question on Wireless margins. You talked about lumpiness in margins attached to handset launches, obviously, two big launches in the quarter with iPhone and ThunderBolt, but it was only a partial quarter for both. So does that mean that in 2Q, you'd expect a bit of incremental margin dilution, as we get a full quarter of those devices? Thanks.

Thank you, Jason. Okay, so let's address the ARPU first. So if you look at what we did, we came out of December at 2.5%, as I said in the previous comment. We had a very soft January. We continued to maintain our upgrades. If you recall, when we launched the iPhone initially, we had a week of just upgrades to our current base, which we felt was important to show our loyalty to our customers, who stayed with us, even though we didn't have the iPhone. And then we launched the iPhone, and we had people who were waiting for that device. So again, the first half of the quarter was soft. There was really no incremental ARPU, if you will, in that first half, given that sales were low and upgrades continued. But as we launched the iPhone, and if you think about it, it was only a half a quarter, but it's also important to realize that when we launched the iPhone, initially, we only launched it through our direct channel, and a couple major retailers. And then in the beginning of March, we launched it to the rest of our national retailers, and some of our regional retailers, and we really weren't 100% out there with the distribution until mid-March. The second piece is, is that we only had two weeks of sales worth on the LTE device on smartphones. And then finally, we just launched the 4G device at the last day of the month. So I think if you look at all of this and you look at the pro rata of access on these devices, that's why we only generated 2.2% of growth, but we accelerated to 2.8%. And as we said, we think that this will just continue to accelerate as the year goes on, as we launch these initial devices. Now getting into your margin comment, no, I don't think that you'll see a decline in the second quarter. The fluctuation, I believe, will come when a new device from Apple is launched, whenever that may be, and that we will be, on the first time, in equal footing with our competitors on a new phone hitting the market, which will also be a global device. So I think there will be some fluctuations when that happens, but we don't anticipate any fluctuation in the second quarter.

That's helpful. Thanks, Fran.

Thank you, Jason.

Thanks, Brad.

Our next question will come from John Hodulik of UBS.

Okay, Thanks, guys. Quick question on the Wireless, is 50% smartphone penetration still the target? Because I think it implies some accelerating penetration gains, which would also support your view on the improvements in ARPU. And then secondly on the Wireline side, you showed some progress there, and I guess you'll show some more progress when you lap the changes in the wholesale pricing. Is it possible that we see some Wireline growth by the end of the year in Wireline?

Thanks, John. So first off, on the 50% penetration, yes, we still are very confident in the 50%. And let me just be clear here because at the end of December, we labeled that we were at 26% penetration, but we changed the way we were calculating our penetration. So I want to make sure everybody's clear. We were kind of -- we were doing a different calculation than the rest of the industry, so we changed to equal the rest of the industry, so that we had an apples-to-apples comparison. So if you look at the 26% we disclosed in December, it really was 28%. Now we ended this quarter at 32%. This, I believe, is going to accelerate as we continue to launch, and have a full month of Apple on the decks. Also, with the LTE launches, as you know, we only had two weeks of our first HTC handset. We are coming out with our Samsung handset very shortly here, and then LG will be following. So we will have up to three devices launched by the second quarter. So again, that's going to accelerate the growth. And yes, we are very confident that we'll hit the 50% penetration. And then on the Wireline side of the house, I think as we continue here, we are confident that we can continue to expand the EBITDA margin in Wireline. Obviously, there is a lot of cost reduction that has to take place. We continue to work out and look at the entire logistics ecosystem. We are continuing to reduce real estate. Last year, we reduced over $7 million, and our target is equal for this year. We have a whole garage study being taking place, and we are closing garages and consolidating on that. So as you look at that continued margin, I think that's one piece of it. But as you mentioned, as we work ourselves out of the International Voice decline year-over-year, and I think that will happen entering into the third quarter. If the economy starts to stimulate a bit, and we continue to obviously penetrate on the FiOS side, I think there is a good point where we could actually see some top line growth out of the Wireline segment.

Okay. Thanks, Fran.

Thanks, John.

Our next question will come from Simon Flannery of Morgan Stanley.

Thanks very much. You talked about closing the Terremark transaction, Fran. Are you able to give us any color on sort of headline trends for Q1 for Terremark? And then I think in the past, in March, you talked about unlimited pricing, reviewing that on your new devices in the summer timeframe. Perhaps, you could give us an update on that? Thanks.

Thank you, Simon. So on Terremark, we closed the transaction on April 11. We'll have our first full quarter here in the second quarter. Terremark continued to grow at their steady pace of 20% through the first quarter. We believe that, that will continue into the second quarter and obviously, Bob Toohey and his team on the business side, have a lot of integration activity going on with Manny and his team, and we're going to hit the streets strong with an offer here, a collaborative offer between the former Verizon business and the Terremark assets. So I think we're off to a good start there. On the unlimited pricing, we are going to be going to a tier pricing in midsummer this year. That is a definite, and you will hear more of that as we get there. But yes, we will be going to a tiered pricing for both 3G and 4G devices.

Great. Thank you.

Thanks, Simon.

Our next question will come from Michael Rollins of Citi Investment Research.

Thanks. One question and just a couple of housekeeping things. On the question, can you talk a little bit more about the business markets, particularly, what you're seeing in the small and medium end of the market? And are you seeing any more competition in cable there? And then from a housekeeping perspective, can you just give us the Wireless replacement rates, device replacement rates during the quarter for postpaid, and where the Wireless business ended on a net debt basis for the quarter? Thanks.

Okay. Thanks, Mike. So on the -- first off, on the SMB, I think what we'll see is, first, if you look at on the Wireline side of the house and the overlap that we have there, obviously, we are at a disadvantage when you think about the DSL and the Voice strategy that we have on the former copper plant. We're at a disadvantage to cable in that area. But if you look at our FiOS and where we have passed the PRAM [Parallel Random Access Machine] and actually connected to PRAM in small business, our growth rate there is 37% year-over-year. So there is a difference between what market on the overlap of the Wireline assets we're talking about. So I think that's important to note. But from an overall perspective, I think we're flat. We've made some improvement year-over-year, but I will tell you, I'm not happy with the progress in the small-business arena, and Bobbie Mudge and his team are attacking that. But even within the Bob Toohey organization and Verizon business outside of the Wireline footprint, with the Terremark acquisition, I think we have some unique offers that we can now make to the small business arena around cloud, and I think that will help some of the offset of the former MCI mass markets, which continues to decline. From a housekeeping perspective, on net debt from an overall perspective on net debt, we ended the quarter, as I said, at $47.2 billion, and Wireless ended at about around $12 billion.

Great. Thanks. And then just the Wireless device replacement rate for postpaid, if you have that for the quarter, that would be great too.

Now Michael, just to clarify, when you say replacements rate, you mean upgrades?

Yes.

Okay. So just a couple things around that. The other one point I want to make on the debt side of the house is that we have about, as I said, we have a $4 billion dollars maturity coming up here in May that will come out of Wireless. So there's a maturity of about $4 billion. So that will take the net debt down on the Wireless side as well. Then on the upgrade side of the house, as we said, that 60% of our sales were smartphones altogether. And as I said before, in January, I thought there was a major opportunity for us because our featured base as part of our postpaid base was significantly higher, and this was an area where we thought that we could make some good inroads into upgrading our feature phone base into a smartphone. This quarter, 56% of our upgrades in total, and as you see from our release, we did about 3% a quarter so -- 3% a month, so it was about 9% for the quarter. So 56% of them were upgrades of feature phones or multimedia phones to our smartphones. So when you think about that, if you look at a feature phone, which has no data plan today, that's an incremental $30 of ARPU, and on our multimedia, they had a $10 feature plan, which now we get an incremental $20 of ARPU. So I think from that perspective, I do believe that we still have some very good inroads here from our feature phone perspective going forward. We still have 62% of our base that are still on feature phones. And then on the 4G side of the house, if you look at the adds that we did, 35% of them were new to category. And when I say that, they were also feature phones who upgraded into that. Now that's part of the 56% that I talked before. But just specifically, on the 4G device, 35% of them were upgrades.

Thanks very much.

Our next question will come from Brett Feldman of Deutsche Bank.

Thanks for taking the question, and I really appreciate all the color around the iPhone, the ThunderBolt. So I'm just going to ask for a bit more. If we just assume that you had a very strong launch around the iPhone, particularly to the existing customers, it kind of looks like as you exited the quarter, both devices might have been selling at about the same pace, so I'm wondering if that's a reasonable conclusion here. And then you had mentioned how the iPhone didn't launch with full distribution, but that's expanded. Is that the same approach you're taking with your LTE devices, or are you actually putting them in all of your channels on day one?

Yes, so Brett, let me address a couple of that. So on the iPhone launch, we were cautious because we were not sure, obviously, of the demand that was there for the phone, and we wanted to monitor the supply and the demand so that we did not run into a backlog situation. From an HTC perspective, we are launching that across the board. So it is not a similar effect there. Now if you look at the iPhone, 78% of the iPhone were upgrades, and 22% of those iPhones were new to our base. So if you do the math there, you can look at -- the iPhone dropped right down into our net adds for the quarter. And then if you look at 4G and you add that in, 54% of our net adds were consistent with both the iPhone launch and the HTC launch. So 54% of our net adds came from those two devices alone. So I think that from a pace perspective, we are very, very pleased with the HTC handset launch. You have seen, probably, some of the articles I have seen, where people have tested it. This is a true 4G device. You can put as much lipstick on 3 to make it a 4, but this is truly a 4G device, with the speeds of 4G, and I think people are impressed, and people will make their decisions. So out of the gate, we're very happy with the volume, and I think that this will just continue as we continue to launch more 4G smartphone devices coming here in the next few weeks.

So just one quick follow-up here, I mean, you're now selling the most popular 3G smartphone on the market in the iPhone. You're selling the most popular 4G smartphone on the market. I know it's early days, but are you seeing anything meaningfully different in the way people are using the devices?

Not really. I think that with the 4G speeds, obviously, people are consuming more data. That will be expected, given the video speeds and some of the TV download speeds. But keep in mind, though, that the 4G network is so much more efficient than the 3G network, so even with that incremental usage on 4G, that even at the same price of 3G, the profitability is higher. So it behooves us to move as many people to 4G as we possibly can, and you will see us doing that proactively in certain markets. So from a different standpoint, yes, they're consuming more on 4G than they are in 3G, but we expected that.

All right. Thanks, Brett.

Our next question will come from Phil Cusick of JPMC. Philip Cusick - JP Morgan Chase & Co: Thank you for taking my call. So first, I want to see if you can give a little more detail on some of these things. You talked about the smartphone mix picking up from 60%. Can you give us what the March smartphone mix might've been as you saw that ARPU acceleration?

Phil, I don't have that detail. I just had it for the quarter. Philip Cusick - JP Morgan Chase & Co: Okay. And then just following up on Brett's as well, the 4G data usage, you said, is higher. Can you give us an idea of what that is? Are you disclosing [ph] at this time?

At this point, we're not going to disclose the usage on 4G. It's really way too early to deal with that because as you know, as people get a initial handset, they initially download a lot of applications, so usage tends to be higher than the normal average. And we've only been at this HTC handset for 2 weeks, so I think it's premature to release anything like that. Philip Cusick - JP Morgan Chase & Co: Okay. I'll try one more swing, and then maybe I'll be out. So you talked about the iPhone being a global device. When that launches, do you anticipate that being a 4G device and sort of being at par in terms of speeds with your other 4G?

Yes, I can't answer for Apple's product launch, to be honest with you. All I know is it will be a global device. At that point, I think we'll have to go to Apple to find out exactly what that device will have.

Nice try, Phil. Philip Cusick - JP Morgan Chase & Co: All right. I tried. Thanks a lot, Fran.

All right. Thanks, Phil.

Our next question will come from Mike McCormack of Nomura Securities. [Technical Difficulty]

Our next question will come from David Barden, Bank of America Merrill Lynch. [Technical Difficulty]

Mike McCormack, Nomura Securities.

Yes, just a couple of quick questions. First, not to beat the ARPU thing to death here, but you guys have identified, obviously, some back-end loading of the smartphones, and that's -- I think that's good color. But thinking about ARPU growth, can you sort of identify the offsets, which might be coming in the form of voice pressure from family share roaming. And then how should we think about data devices like tablets and sticks and cards and stuff like that, that may carry a lower overall ARPU, which could sort of have an impact on the growth rate, but obviously, driving some decent adds. And then secondly, and it might be premature, but thinking about the iPhone guidance for the year based on 11 million, the 2.2 million tracking a bit lower, not surprising given a partial quarter, but it's also the launch quarter. So just trying to figure out what's your thought processes there? You, obviously, were anticipating a refresh at some point during the year that obviously could boost that as well, but just some thoughts around that would be great.

Yes, sure. Thanks, Mike. So from an ARPU's perspective, from a Voice ARPU perspective, we are, obviously, seeing a decline there, but it is a slowing decline year-over-year. So yes, that is putting pressure on us, but it is putting a pressure on us at a slower rate, and we view that as that will continue into the future. Also, from a Voice ARPU perspective, as we launch the iPhone, I guess I would be remiss to say that the call quality on the iPhone has been spectacular on the 3G CDMA network. And obviously, we think that our Voice will continue to slow as we add more iPhones, and people realize the quality of the voice network and the data network there. So I think that'll be fine. From a tablet and a broadband access device perspective, there is some small dilution going on from the old price plans to the new price plans, but we don't see that as being a drag to the overall ARPU, as we continue to penetrate into the tablet scenario, into the 4G MiFi devices, and the usage that the MiFi devices will bring, and the tiered pricing that we already have related to our data products. So I don't see that as being a major issue going forward. And as far as the 2.2 million in the first quarter and the 11 million, overall, we're sticking with our 11 million view for our guidance purposes.

Great. Thanks, Fran. I appreciate it.

Thank you, Mike.

Thanks, Mike.

Our next question will come from David Barden of Bank of America Merrill Lynch.

Thanks, guys, for taking the question. Just two, if I could, maybe, Fran, just starting with the debt raise recently this past quarter, and kind of bulking up on the balance sheet, both kind of $9 billion-or-so, with $7 billion going into cash. Obviously, we've got the Terremark deal cash going out the door, but is this cash that we put on the balance sheet really about trying to avoid the necessity of upstreaming dividends or maintaining leverage at the Verizon Wireless business? Because I did notice that you guys kind of called out that specifically in the call today, that you didn't want to have to do anything on the dividend until next year. But because you're not, you had to go into the markets and raise this money and put cash on the balance sheet. I'm just wondering if you could kind of talk for your thinking there. And I think the second question, if I could, is just maybe more strategically, thinking about the industry consolidation. I think you guys have come out as fairly neutral on AT&T's prospective acquisition of T-Mobile. With the caveat, as long as it doesn't lead towards incremental regulation of the industry, could you talk a little bit about what kinds of regulations you think would be the kinds of regulations that would get you up off the bench to kind of come in and oppose this deal? Thanks.

Okay. Thank you, David. So first, on the debt side of the house, yes, we actually went out into the market, because we have some debt maturities, both within corporate and Wireline this year, that needed to be refinanced, and we initially did it. The interest rates were so well, we took advantage of the interest rates, and raised it to $6.25 billion. We have about $2 billion worth of maturities coming in the back half of the year. We had a $500 million refinancing that took place in the first quarter. We also wanted to re [indiscernible] finance some of our CP paper, commercial paper, so we did that as well. And due to the lucrativeness of the interest rates we had, we also decided to pre-fund our pension plan of $400 million, both to take effect of the interest rate and the arbitrage on that, compared to the return that, that $400 million we'd get in the pension plan, that would help us alleviate some of our future cash flow obligations into the plan. So this really was all-around just the refinancing and rebalancing of our balance sheet, and just for general other observations. And as you said, to pay for the Terremark, and also to refinance the Terremark debt. And then from an AT&T and a T-Mobile merger perspective, I guess the comment I would have is we have to let that go through due process with the federal government. And we'll sit and wait and see. Obviously, we will then take a view of -- if it's a market-based condition merger, we will be fine with that. If it's a regulatory merger, then we'll have a harder time with it. Now as far as what may have been a little bit off here is, I'm not going to go into what types of things we may object to but obviously, we are very strong on where we stand with net neutrality. We are very strong where we stand with data roaming, and the positions that the FCC have recently taken there, and we will not stand by if there are certain regulations put on us that we have to deliver certain things at a fixed price that's set by a regulatory arm that has no authority over that regulation of price. So we'll sit back, let it go through its due process, and then we'll see what happens.

All right, guys. Thanks.

Thank you, David.

Our next question will come from Tim Horan of Oppenheimer. Timothy Horan - Oppenheimer & Co. Inc.: Thanks, guys. Two broader questions. Fran, on the Managed Services front, I know it's early in the process here, but do you find yourself bumping up against more some of the traditional IT outsourcers in that market? And do you have the capabilities you need in managed services to at this point, or do you need more acquisitions? And then secondly, on the smartphone side, could you talk about, ultimately, what you'd like to see in terms of number of suppliers on the different platforms and maybe, market share platform? And related to this, the subsidies for handsets, do you think we're at peak run rates here, and they can start to decline, or do you think we'll see handset subsidies on the smartphones increase for awhile? Thanks.

Okay. Thanks, Tim. So on the Managed Services side, I think that we have the portfolio of assets that we need to be very successful in this piece of the business, and I think we've shown that with some of the wins that we have publicly stated here in the past. And you're absolutely right, we are actually entering into a market where we're competing with many different players, depending upon where you are in the globe. Especially here in the U.S., we go up against all of the integrators, and some of the other service providers. But outside the globe, we hit on a bunch of different players like Tata and InfoSystems, and people like that. So it depends where you are in the globe, but we think we’re very well-positioned with our portfolio. And we've shown this with our strategic services growth of 12.8%. Some of the growth this quarter and the reason it jumped up was driven by our Managed Services business. So I think we're starting to really gain new ground here. We have proven ourselves with some of the major undertakings that we've taken with some of our announced deals with Matsui and JetBlue, and others. So I think we've got a good stance, and I don't think we need to do any more major acquisitions in this portfolio. As far as the smartphone side of the house and subsidies, I think, first, we're charging a premium on the 4G smartphone, so the subsidy, obviously, there is less than others, but we'll have to see how the market goes. And I would assume that this market will mature this similar that the feature phone market matured over the years, where as more players become into the marketplace, and we have new entrants, like maybe a Huawei, down the road, there will be put pressure on the other manufacturers to get more efficient and reduce price, and then that will help our subsidy go. So I think the maturity of the market and the ecosystem will eventually take care of itself.

Thanks, Tim.

Our final question will come from Jonathan Chaplin of Credit Suisse.

Thanks for taking the question. So one question, AT&T gave us one or two of the justifications for the deal, getting access to a lot more spectrum, and increasing their cell site density quickly. I think up to this transaction, they're going to have significant -- 50 megahertz or so more spectrum than you, and a cell site density, which is 25% to 35% more dense than yours as well. Can you talk about how you see your spectrum needs evolving over the course of the next three-to-five years? And what do you think you need to do from a cell site density perspective to keep up with the rapidly growing data demand you're seeing? Thanks.

Sure. Thanks, Jonathan. So as we’ve said before, we think we're in a very good spectrum position. We think we have the spectrum we need, and we're in a good position until about the year 2015 at this point. And we will continue to keep our eyes open to see where we need to buy spectrum or secure spectrum. But right now, we're in a very, very good position. I'm not going to speak to the competitor. You can ask those questions as to why they did this, and why they needed the spectrum, but I think we're in a very good position.

Thanks, Fran. Thanks to all of the participants that joined us this morning. And with that, Brad, let me hand it back to you to conclude the call.

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