updated 5/2/2006 6:31:09 PM ET 2006-05-02T22:31:09

Verizon Communications Inc., racing to connect homes with fiber-optic lines to offset a decline in its traditional phone business, Tuesday reported a 7.1 percent drop in first-quarter earnings due to special items.

Verizon, the country’s largest telecommunications company by revenue, earned $1.632 billion, or 56 cents a share, compared with $1.757 billion, or 63 cents a share, in the same quarter last year.

The New York-based company had revenue of $22.7 billion, up 25 percent from $18.2 billion in last year’s first quarter due to the acquisition of MCI Inc., which closed in January this year.

Excluding special items, earnings were 60 cents a share, topping by a penny the average estimate of analysts surveyed by Thomson Financial. Net income including special items was down just 0.2 percent from last year, despite a higher income tax provision.

Among the special items was the cost of rebranding MCI services, a change in accounting to expense option-like grants to Verizon Wireless employees, and the continued movement of New Jersey employees to AT&T’s old headquarters in Basking Ridge.

Shares of Verizon fell 15 cents to close at $32.64 in afternoon trading on the New York Stock Exchange. After declining through most of last year, the stock is up 10 percent so far this year.

Verizon is the only major U.S. telecommunications company to bet on connecting homes directly with fiber optics — the others are focusing on sending broadband over phone lines using digital subscriber line technology, or DSL.

“Our investment dollars are focused on this initiative,” Doreen Toben, the company’s chief financial officer, said on a conference call.

Investors have been leery of the project, as shown by Verizon’s stock decline last year.

“We see little change in investor sentiment regarding this deployment of capital over the next several quarters, even though we believe it will provide long-term benefits to the company,” Stifel Nicolaus analyst Christopher King wrote in a research report.

The cost of the 15-state FiOS buildout reduced first-quarter earnings by 6 cents a share, excluding capital expenditures.

Verizon said it’s ahead of schedule in making FiOS available — 3.6 million homes are eligible to be connected — but connection costs are running higher than the target of $717 per home, Toben said.

In areas where FiOS has been available for a year, 17 percent of homes have signed up for broadband, the company said. It has also started competing with cable companies by selling video over FiOS in areas where it has been able to secure local video franchises. It didn’t provide the number of video subscribers it has, but said adoption rates were promising.

In another positive sign, Verizon said that for the second quarter in a row, it added more broadband subscribers, including DSL, than it lost phone lines.

In the wireline segment as whole, revenue grew 33 percent to $12.5 billion due to the addition of MCI’s business, the bulk of which served large corporate customers. Toben said Verizon has no intention of retaining MCI long-distance customers outside its local-phone service area.

Verizon said the integration of MCI was going according to plan, and had resulted in more than 1,200 job cuts. It said results should improve through the year, as it cuts more costs by moving traffic from MCI’s to its own network.

Verizon Wireless added 1.7 million customers in the quarter for a total of 53 million, just behind Cingular Wireless LLC with 55.8 million.

Verizon Wireless is a joint venture with Vodafone Group PLC, which Verizon wants to buy out. Britain-based Vodafone has so far demurred.

Revenue at Verizon Wireless was $8.8 billion, up 19 percent from a year ago.

Verizon’s largest competitor, AT&T Inc., has announced a $67 billion deal to take over BellSouth Corp., which would make AT&T far larger than Verizon.

Verizon chief executive Ivan Seidenberg said the deal would give AT&T the opportunity to cut costs, but said Verizon was well positioned to compete in growth areas like wireless and data.

“I think we have significant opportunity on the growth side. On the cost side, we’ll just have to make the critical mass we have — which is pretty significant — work better,” he said.

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