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MarketWatch
May 2, 2006 Tuesday 10:13 AM EST
By Jeffry Bartash
From Lexis Nexis

WASHINGTON (MarketWatch) — Verizon Communications on Tuesday reported a lower first-quarter profit after the cost of upgrading its network and integrating the recently acquired MCI business, but the phone company added 541,000 high-speed Internet customers and 1.7 million wireless subscribers.

The nation’s second-largest phone carrier said profit fell to $1.6 billion, or 56 cents a share, from $1.8 billion, or 63 cents, in the first three months of 2005.

Revenue rose 25% to $22.7 billion from $18.2 billion a year ago, boosted by the inclusion of sales from the MCI long-distance business, the acquisition of which was completed Jan. 6. Without the contribution from MCI, revenue rose a lesser 3.1%.

Adjusted for one-time items, the local phone giant recorded quarterly income of $1.75 billion, or 60 cents a share, compared with a year-ago profit of $1.76 billion, or 63 cents a share. New York-based Verizon had been expected to earn 59 cents a share on an adjusted basis, on revenue of $22.8 billion, according to the consensus of analysts surveyed by Thomson First Call.

Also on an adjusted basis, operating margins widened to 17.2% from 15.6%.

Verizon said the cost of expanding its fiber network reduced earnings by 6 cents a share in the first quarter. The company’s spending billions of dollars to create a superfast fiber network in order to offer pay-television services and the fastest Internet connections in the nation. Network expenses are supposed to make their biggest dent on earnings in 2006 and become a smaller drag on profit in years after, Verizon executives have said.

Although some investors have questioned the strategy, the executives say they need the fiber network to handle the surging increase in Internet traffic and to combat a growing threat from the cable-TV industry, which is rapidly moving into the phone business.

Yet so far, Verizon has little to show amid difficulties in getting the thousands of franchise licenses required to offer its pay-TV service. The company has lobbied Congress for a national-franchising law to speed up the process, but it’s unclear whether a bill will pass this year.

Also during the quarter, Verizon took charges totaling 4 cents a share related to the integration of MCI, expenses to relocate employees, early retirement of debt and the adoption of new accounting rules.

In recent Tuesday trades, shares of Verizon (VZ) gained 1% in value. The stock is a component of the Dow industrials.

Segment breakdown

The wireless segment accounted for $8.8 billion in Verizon’s quarterly sales, up nearly 19% from a year earlier. Data revenue totaled $872 million, nearly 11.5% of total wireless sales.

The wireless unit, a joint venture with U.K.-based Vodafone Group (VOD) , gained 1.7 million net new customers to end the quarter with 53 million, trailing only Cingular Wireless. Wall Street had been expecting Verizon Wireless to gain around 1.5 million net wireless subscribers.

It was the eighth straight quarter in which Verizon added at least 1.5 million net suscribers.

Churn — the industry statistic measuring the rate at which customers leave — ended at an industry-low 1.18%. Average monthly revenue per user totaled $48.67 for the March quarter, down less than 1% from a year ago.

The company’s wireline segment, which includes MCI’s long-distance business, generated $12.5 billion in revenue, including $3.9 billion from data services such as high-speed access. Verizon added 514,000 DSL high-speed Internet customers to end the quarter with 5.7 million.

The number of access lines in service fell again, as expected, this time by 6.9% to 48 million from 51.5 million in first quarter of 2005. That was a slightly bigger loss than Wall Street expected. For the second straight quarter, however, the gain in DSL customers more than offset the loss of local phone lines.

During the quarter, Verizon generated $6.1 billion in operating cash flow, compared with $3.9 billion a year earlier. The company said it paid less in divestiture-related taxes, contributed a smaller sum to its pension fund and owed less money to wireless partner Vodafone.

Capital expenditures rose to $4.1 billion in the first quarter from $3.6 billion a year earlier, primarily to incorporate MCI’s operations into Verizon’s own business. The carrier bought back 11.6 million shares in the first three months of the year, spending $400 million.

Verizon reported $43.1 billion in long-term debt, up from $39 billion at the end of 2005, mostly owing to the MCI acquisition.