AT&T Inc. (T) Q2 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to AT&T’s Second Quarter 2012 Earnings Release. For the conference, all the participants are in a listen-only mode. There will be an opportunity for your questions, and instructions will be given at that time. (Operator instructions) As a reminder, today's call is being recorded. With that being said, I'll turn the conference over to Susan Johnson. Please go ahead.

Thank you, John. Good morning, everyone, and welcome to our second quarter conference call. It's great to have you with us this morning. I’m Susan Johnson, Head of Investor Relations for AT&T. Joining me on the call today is John Stephens, AT&T’s Chief Financial Officer. John will provide an update with perspective on the quarter, then we’ll take your questions. Let me remind you, our earnings material is available on the Investor Relations page of the AT&T website, at www.att.com/investor.relations. Okay, I also need to cover our Safe Harbor statement, which is on Slide 2. This presentation and comments may contain forward-looking statements. They're subject to risks. Results may differ materially. Details are on our SEC filings, and on AT&T’s website. Before I turn the call over to John, let me quickly cover our consolidated financial summary, which is on Slide 3. As a reminder, we completed the sale of AT&T’s Advertising Solutions, and AT&T Interactive business on May 8. Our reported results for this quarter and prior period still include Ad Solutions’ results, which are not treated as discontinued operations, given our 47% continuing equity ownership in YP Holdings. Reported EPS for the quarter was $0.66, a 10% increase both sequentially and year-over-year. The fundamental trends in our business continue to be solid. When you exclude the Advertising Solutions business, consolidated revenues were up 2% year-over-year. Thanks to strong mobile data growth, gains in U-verse, and advanced wireline business offering. We had our best consolidated margin in four years, with operating income expansion in wireless and wireline, both sequentially and year-over-year, and cash flow continues to be strong. Cash from operating activities for the quarter totaled $9.7 billion. Free cash flow was $5.1 billion. And our share repurchase program continued in the second quarter. In the quarter, we bought back almost 76 million shares for $2.5 billion. With that quick overview, I'll now turn the call over to AT&T’s Chief Financial Officer, John Stephens. John?

Thank you, Susan, and good morning, everyone. It's great to have you with us on this call. As you’ve seen, we had a very good quarter, and it was very straight forward, all about executing our strategy and growing the business. In wireless, you can clearly see the benefits of our mobile Internet strategy. This has resulted in strong wireless data revenue growth, almost 19%, record high service margins with our EBITDA service margins hitting 45%, and our lowest churn ever, postpaid, prepaid in total. In wireline, the transformation from legacy voice and data products to advanced data services continues at a solid pace. U-verse video and broadband continue to scale, while driving the strongest consumer revenue growth that we’ve seen in years. And we kept margins steady and improved wireline operating income, both sequentially and year-over-year even with few signs of a business recovery. This performance drove solid financial results. We grew revenue, expanded margins and increased earnings, and cash flow was very strong. We also took steps to make our balance sheet even stronger, recall debt and reduce future interest cost by refinancing at favorable rates. And as Susan mentioned, we continued our share buyback program, we’ve returned more than $5 billion to shareholders through share repurchases and dividends in the second quarter, and close to $10 billion year-to-date. All in all, a very positive quarter, which puts us in a great position heading into the second half of the year. With that as background, let’s now take a look at detailed results starting with the consolidated revenues on Slide 5. As you know, the sale of our Advertising Solutions business was completed in early May, so this second quarter did not have a full impact of Ad Solutions revenues. And because we retained an equity interest in…

Thank you, John. John, I think we are ready to open it up for questions and answers.

(Operator Instructions) And first, we'll go to line of John Hodulik with UBS. Please go ahead.

Great, thanks. Two quick ones. First, John, just on your comments on the business market, you turned positive on the enterprise side, do you expect that to remain positive going forward and as the slight changes, some incremental weakness on the sort of low end SME side? And then on the buyback, I’d say you guys have made a lot of progress there, do you expect to be substantially complete with the buyback by year-end? Thanks.

Morning, John. Thanks for joining the call. Let me take the second question first. With regard to the buyback, two things, we do expect to continue in the marketplace participating in buyback. That will be impacted by market conditions, continued strong cash flows, and the other factors that we spelled out. We have not guided towards when or how much we’ll buyback in any of the future quarters. But I think, as we said at the beginning of the year and on the January call, we are in a position with the cash on the balance sheet with the beginning of the year, and strong cash flows this year that we have an ability to buyback a large part of the [authorized] share repurchase, and we'll continue to monitor that and continue to pursue those opportunities. On the business side, we do have continued growth in strategic services, and that growth is encouraging to us, but we are seeing business has to be very careful, seems like whether they are hesitant about the elections, about tax law changes, about the federal deficit, they have abilities to spent or encouraged by that, but they are being very careful, we are seeing a lot of no decisions. So we're certainly hopeful to be able to continue our positive enterprise revenue story, but we'll have to prove that as well everybody else. We're still optimistic about our wireline business and believe particularly our business revenues are going to be positive going forward. It just may take as a little bit longer than we would have expressed to you in January.

Gotcha. Thanks.

Our next question from Simon Flannery with Morgan Stanley. Please go ahead.

Thank you very much. Good morning. John, I wonder if you could update us on the status of the review of the rural lines, and also churn investment this quarter, you went through some of the factors driving that. How should we think about churn going forward from here, you had a pretty substantial drop – is there more room for year-over-year improvements in that or if this is as good as you think you can get to? Thanks.

Morning, Simon. Thank you. First, on question with regard to kind of our strategic initiatives, you’ve seen in the directory sale and the completion of that, we've seen the continued movement on spectrum in 12 acquisitions of smaller acquisitions, why should we close a number of deals that are sitting before the SEC. And I think you’ve seen on – from the strategy side, our filing was serious where we’re jointly going there to clear up some and improve some usability for some of the WCS spectrum we owned. So, those are parts of the strategy. We’re continuing our review on the other pieces of our business. And as soon as we have something for sharing, we will, but we are going through that process and we will continue to go through that process. Just want to be careful to make sure we complete that analysis and have a full story for you when we’re ready to share it, Simon.

Okay, because there was some talk of (inaudible) and so forth, but that’s still an option rather than a choice at this stage, is that right?

Everything quite frankly at this stage is an option and we are looking at our whole host of different opportunities or different alternatives as you might expect, our shareholders would expect from us.

Okay. On the churn?

On the churn side, it was very encouraging. It was not only encouraging on the postpaid, but it was encouraging that it was across the board, we saw improved churn. We are optimistic about our ability to hold onto those kinds of levels and continue to improve it. We will see as we go through some of the seasonality in the business in the second half of the year, how that impacted. But this is a process that’s been going on for a long time making significant investments over a number of years and improving the quality of our network. And our wireless team, including our business wireless team has put a lot of effort to improving the customer experience. So, yes, our networks getting better but the customer experience is getting a whole lot better, and so we are optimistic that we will be able to move forward building from this positive base. But as we go on to the second half of the year and a part of the wireless business here that is much more seasonal, we’ll have to work through that and see if we can meet our goals.

Thank you.

Our next question is from Phil Cusick with JPMorgan. Please go ahead.

Hi, guys, can you hear me?

Sure, can.

Great, thank John. So let’s just talk about ARPU for a second. Can you tell us if you guys expect any change in trajectory given the new price environment in the third or fourth quarters? And then also do you anticipate change in the reporting methodology over time as tablets dilute revenue per device? Thanks.

Thanks Phil. First and foremost, we think our guidance’s out there, that we get 2% ARPU growth this year. We’re sticking with that. We’re encouraged by – where we are at on the 1.7% so far this year including all the impacts of high margin, high profit, but lower ARPU data in ten devices and tablets. As we mentioned in the call, our phone-only ARPU was 2% this quarter. Why we’re optimistic is because of the pricing changes we’ve done with regard to our tier data plans. We’re also encouraged because of what we’ve done with regard to drawing the smartphone base by 9 million subscribers, converting those lower ARPU subscribers that we had last year to smartphones, and generally more ARPU. So we’re encouraged by that. And we’re also encouraged by the fact that there is a lot more usage going on in that structure of tier data customers. We get better additional revenue, people pay for what they use. So we’re sticking with that. With regard to any shared data plans, we need not expect those to be – we expect those to be accretive over time. We think the conversion of those is going to be measured over time, part of that is because we’re doing like customer friendly, we believe in the old plans available to our customers and we are not forcing anyone off unlimited or any other plans. So we’re expecting it to transition in, but over time we expect it to be accretive because it will allow, if you will our customers the more they share, the more they are going to save. And I think that will be good for both us and them. With regard to our reporting activities, right now we're going to stick with our customer based ARPU. We’ll continue to evaluate all of our customer matrix, and all of our financial reporting and we’ll update that starting with next year as we always do. We are having a robust discussion about what’s the best way to provide the information to analysts, to the readers of our financial statement, to our owners, and so that’s ongoing. But at this time we do not expect to change, if we do, it likely will be with the New Year.

Thanks John.

Our next question is from Jonathan Chaplin of Credit Suisse. Please go ahead.

Thanks, couple of quick ones, if I could. So firstly, it looks like your smartphone sales this year are trending well below where they were at this point last year. I'm wondering if that means we are on track to do even less than the 25 million smartphone sales that you expected for the year or if you are just expecting a blockbuster fourth-quarter with the new iPhone launch? And then I'm just wondering if you could give us some context around what to expect for EBITDA margins? Given that trend, it seems like we should see an even lower upgrade rate next quarter, so sort of a seasonally up quarter for upgrades and with the iPhone launch you should be even low next quarter, but expect margins to be even higher? And then I'm wondering what they could potentially be in the fourth quarter as well? Thank you.

Okay, Jonathan, good to hear it from you. a couple of things, one on the smartphone upgrades and sales, a couple of things, one, we are seeing our policy kick in, change in our policy we told you about last year, we told you we’re going to grandfather our customers in and that’s now taking hold, and I think you’re seeing some effects of that. Quite frankly, I think in the first six months, our outsourcing effects of what would be considered a very healthy upgrade cycle fourth quarter of last year, particularly when the old upgrade policy of the shorter timeframe was still in place. So I think we’re seeing, we’re getting some of the benefits of what was upgraded in the fourth quarter last year is – helping lower or slow some of the upgrades in the first and second quarter of this year. We're not going to give guidance on specific EBITDA margins or upgrade cycles for the second half of the year. we are going to – we are sticking with our upgrade cycles being flat year-over-year. I openly recognized the fact that the map of the upgrade process is that we are running at a rate, trend rate for the first two quarters below that. but as we get these devices and have the seasonality of the holiday selling season, we will see an uptick and we’re comfortable with sticking with that guidance that’s out there.

Thanks, John.

As far as EBITDA margins, team did great – feel we’re good about where they are at and about all the items that the actions that the team took to get there and there I feel we’re comfortable about the fact that their – on solid business focused, customer focused strategies, things that we can do at the end, but we’re going to stick with our margin guidance that we’re going to grow EBITDA service margins year-over-year and that we expect that to be greater than 40%, and I understand how the comparisons look today, but we’re going to stick with the guidance we’ve done out there.

John, one point of clarification quickly, when you say sticking with guidance on smartphones, do you mean, you’re still sticking to 25 million smartphone sales for the year. The upgrade rate has to be down year-over-year right?

Yeah, so John, you make a great point. I appreciate the clarification. I think it will be – the year would be flat year-over-year at 25 million.

Got it.

So your comment is correct.

Got it. Thank you so much.

Thank you.

And next, we’ll go to Jason Armstrong with Goldman Sachs. Please go ahead.

Great, thanks, good morning. Maybe just a follow-up, there is obviously you’re getting a lot of questions on sort of the upgrade cycle out there, and John you just gave a lot of good data points. I think people probably still wrestle with, is this the result of policy changes versus is this just new handset availability or lack thereof, maybe another way of attacking this is, are you seeing notable changes in the percent of subscribers that are eligible for an upgrade at this point, but are postponing decisions? Maybe that would be helpful as sort of gauge to what to expect of the next several of quarters. And then just second quick question, the union deal you recently signed, I’m just wondering if you talk us through benefits from that deal and how they may change the cost structure? Thanks.

So with regard to the new – the change in the trend for upgrades, let me deal with it this way. First of all, we’re into one full quarter here with regard to – this is the first quarter where the upgrade policy change has really impacted us. And as I mentioned before, the fourth quarter last year was unusually high, so there is some impact I think on the first and second quarter from that. So it’s early in this process, but clearly, we believe that the upgrade policy is impacting – the new upgrade policy is impacting upgrade cycles and it’s helping us control that process and improve margins. Secondly, there maybe some impact quite frankly of the change in upgrade fee. It was a small change, but we – it was an increase of $18. I can’t suggest you that we can measure that. Third, there maybe some impact from customers deciding to wait until the new device comes out. I can’t speak to that, it’s too early at this time. I assume we’ll know that they will have some better insight in that after the device may come out. So I guess the key for us, (inaudible) walk away with this is, it appears our policy is working, it appears our plans are working, we need to continue down this path. But when you look at the upgrade numbers and then tie in the churn, I feel really good about the policies are [working] in a customer appreciative or a customer friendly way. So with regard to our recently announced tentative agreement with both the Midwest and our legacy T employees, I’d just suggest you that we’re appreciative of their leaderships bargaining in good faith, we are appreciative of the efforts that both teams made in…

Okay, thanks John.

Our next question is from David Barden with Bank of America/Merrill Lynch. Please go ahead.

Hey guys, thanks for taking the questions. John, maybe just a follow-up on the labor point. I was surprised to see that the headcount was down a little over 4% in the quarter that’s one of the bigger headcount changes we've seen in a few years, and I guess, if you could elaborate a little bit about what the – where that – where that was going on, and what the game plan behind the headcount is, both this past quarter and maybe for the rest of the year. And then just second, we’ve talked a lot about – and potential have a benefit down the road for an AT&T. Are you guys able to share any statistics right now about for instance what percentage of the base would actually, could actually generate over hedge either now or in the near future, the next year or two. I guess one of the questions everyone has is, we hear about the averages being large, but a lot of those people are still on a limited plan. If your average customer is only using 300 megabits, 400 megabits or 500 megabits a month and that’s growing 30%, 40% for the next few years, it could be many, many years before these tier plans kind of generate profits. Could you help kind of clear that issue up for us? Thanks.

Okay. First and foremost, on the employee count information if we could, we’d like to make sure we’re – if you will doing comparative numbers here. We did pull out the Ad Solutions employees from our employee base because of the transaction. And I think that maybe the biggest – if we’re talking about a 4% change, it would have to be that, that explains the difference and that was probably – we’re probably be close 3% of that 4% change.

Okay.

So, I am not sure of which – if anybody think that really the impact of what we’re talking about. With regard to tier data, understanding your question, I guess a couple of points. One, we’ve gone from zero to 27 million in two years. So, we’re pleased and it appears our customers are pleased with it. Two, customers are choosing the higher tier plans, whether that would be the 3 gig or the 5 gig plans with – and a clip of more than 70%. And so we’re doing well and they are choosing to have that usage available to them without additional charges. That’s all happening in this churn environment. So once again, it appears that’s all going well. We don’t give usage base and we’re not going to give breakage information out. But I can tell you, we’re also comfortable with this because of our recent changes to the buckets where we increase the available amount of data to them with a slight increase in price. And the fact that that’s been taken into account with low churn, is just another encouraging piece that we can serve customers well and still get ourselves set up for revenues that are going to be tied to usage, which will then be tied to our capital requirements and a really profitable situation. On the unlimited, I really think the unlimited is a kind of issue that we’ve really handled. And specifically, we’ve handled it because of our bit rate management program. And so those extraordinary consumers have been addressed and the process is in place for more than a few months now. And quite frankly, once again, I look to churn as a indicator of how that’s being accepted and how that’s impacting our customer base, and we feel good about the progress we’ve made there.

Okay. Thanks, John. Yeah, I think that that change in the employees was going to be the difference – the directory, so I appreciate your help. Thanks, John.

No problem.

And next, we’ll go to line of Tim Horan with Oppenheimer. Please go ahead.

Thanks. Good morning, guys. John, I seem to beat a dead horse here, but on smartphones the $25 million in sales maybe a touch more color on the outlook. Do you think, you can continue to control that over the next couple of years and at the same type of pace and I guess the latest of that with the upgrade fees and what you’re seeing around churn? Do you think, you can possibly still raise prices there maybe up to around the $50 price point or so? And then lastly on the handsets, it does seem like the – all the subsidy is coming down I guess for the non-iPhone devices the average selling prices seem to be coming down for Android devices. I’m wondering if you are seeing any benefit from that? Thanks.

Yeah. So Tim, I guess just probably more generally than you prefer, I mean the handset as the smartphones and the subsidy issue is day-in and day-out management issue, management intention and focus. So we’re looking at all kinds of things. I would suggest to you that we believe that this is just the first quarter of the upgrade policy change being fully in effect. and so we are optimistic about our ability to continue to manage it, to measure it, to provide customers, not only to enforce it but also to provide customers the opportunity to buyout, if they want to upgrade before their cycle times. and we are in place to do that. So we’re optimistic about the ability to do that. now, we’ll have to do that for ourselves, for our shareholders, for the analysts. But we believe we’re on track to do that. secondly, with regard to the environment as new handsets come out, as things get more competitive, we believe there will be more rationale pricing in those – in that market and we’ll be able to either through our own disciplined actions of pricing [tags] or our own disciplined actions of seeking out more cost advantageous devices. We need to continue to focus on lowering the costs or managing the costs of those subsidies. At the same time, we have some very good customers who are willing and who desire, who want handsets, and are willing to entering the contracts and work with us and provide us good monthly ARPUs that we’re going to be more than happy to continue work with them and continue to hold on to that customer base. So it’s a day in, day out focus of management. But it’s going to be one that we’re going to play out in quarters to come, just to prove to you that we can continue this good progress we’ve made this year, and specifically this quarter.

Thank you.

Our next question is from Michael Rollins with Citi Investment Research. Please go ahead.

Hi, good morning. Thanks for taking the question. I was curious if you could talk a bit more about, how do you think about the first half of free cash flow performance relative to the guidance of $15 billion to $16 billion for the year? And within that context maybe you could discuss directionally how you are seeing capital spending for wireline and wireless, the implications for cash taxes going into next year? And then last and not least is, just pension contributions and given the new laws, should we be thinking any differently about the way you’re going to be approaching the pension? Thanks.

Thanks, Michael. We’re going to stick with our $15 billion to $16 billion of free cash flow guidance or the run rate ahead of that, that’s evident from our numbers, and we’re pleased with the fact with where we are at. But as we’ve mentioned, we’re going to stick also with our CapEx guidance. And so we do expect trending up in CapEx to second half of the year. That’s not a – that’s only because in the first half of the year, our team and network team and others that use CapEx were real efficient and real careful. And if you will, spent the money like it was their own to be careful in managing it, and so they’ve spent a little bit less, but they still got their work done. And now that we’ve got that efficiency, we’re probably going to return more to a kind of normal spin, which will not only have a tick up in CapEx, but we’ll have some – will also impact free cash flow. Our cash tax situation isn’t something we talk about on a quarter-by-quarter basis, I would suggest you, I think the situation for us is a little different over the long-term than others. First and foremost, most depreciation has gone away, but that impact will be spread over three years for us, because of the way to estimate favorables where. Secondly, for this year, we’ve got some kind of the unique benefits that we are going to get. The contract termination payments in the transfer spectrum we made and the pension funding we did in the fourth quarter of last year, we’ll get the cash tax benefits of that this year. Probably more importantly tough is, if you think back to our – an IRS settlement we entered into…

Thanks John, it’s really helpful.

Thanks Mike.

And next we go to Brett Feldman with Deutsche Bank. Please go ahead.

Thanks for taking the question. I just want to follow-up a little bit on CapEx, it does seem like we’re going to see a step up in the second half. Could you provide a little color around, maybe where we’re going to see that? It seems that it would likely be on the wireless side in light of your LTE build out plan, but there are some wireline investments you need to make, that will be helpful color. And then just bigger picture, correct me if I am wrong, but I believe you’re doing a fairly dense initial deployment of LTE, many are hitting quite a few sites or most of your sites with that build out. So how do we think about capital intensity in the wireless business after that initial deployment is complete. Could we see CapEx tick down or are you relatively comfortable with the level of investment in the business and you would redirect this dollars and to say capacity deployment?

Great, let me try to (inaudible) so one at a time, first of all we do a tick up in there, a step up in span of the second half of the year in CapEx, yes – we expect that fits with our – sticking with our guidance of about $20 billion. Secondly, I think the – while we don’t give specific predictions of the break down quarter-by-quarter, I think it’s fair to assume that in the first half of the year we spent about 60% or so, close to 60% of our CapEx in wireless and you could expect that that will continue. I don’t want to give any guidance that would move you from that. I think the logical pieces there, things like the U-verse build and the fact that we really are, don’t have any extensive new living units coming new that is in that area, the consumer is for success phased outs, it’s not as much build, explains why some of the wireline maybe moderating, and the LTE build and accomplish that process. And the importance of that too is, it shows, may give you some insights of the why CapEx on the wireless side maybe increasing. We are doing a very dense bill, we think that’s the way to give the best quality service to our LTE customers, and we think in the long-term that’s going to really help in all aspects. So we believe that’s the right strategy, we stuck with that, and we’re going to stick with it, and I believe the customers are going to win, because that we decided to make that our strategy. With regard to so to speak next year and future years, when you think about the fact that the LTE build is well on its way, I think we mentioned 90%, we’re almost 90% of our data traffic is on enhanced backhaul already. As we roll it out, yes there is a logical thought that maybe you can lower CapEx and you just going forward. But we are sticking with our guidance of mid-teens as a percentage of revenue, and that’s really because we’ve got a lot of great opportunities in this business, we believe in the business, both in the wireline and the wireless business. And so, we want to make sure, we guided that – we believe we’ll find good opportunities for that investment, I already discussed this specifics, but I think we’re going to stick with the guidance. I understand your reason, and I think it’s logical that you would think there might be a step down, we’re not guiding in that direction.

Thank you, Brad, and John I think we’ve got time for just one more question.

And that would be from James Ratcliffe with Barclays. Please go ahead.

Good morning, thanks for taking the question. If we just look at wireline for a second, and do you can help us unpack how much of a role international had in the result of this quarter, and what the [recurrency] was a drag year-on-year? Thanks.

Quite frankly James, I think you’re probably well aware that our international exposure is really based on a U.S.-based companies going international, and it’s really not significant, the biggest international exposure we have quite frankly, is in our equity income from our investments in Central and South America through our holdings and (inaudible) that probably is the biggest Forex impact. I will tell you on the business services revenue, there was an impact from foreign exchange, but I would suggest you that I don’t think it changes the story for us, on that business services revenue. And I don’t want to hold that out as the story changer. I think it’s just much more about our businesses being careful and a little hesitant because of the uncertainties of budget deficits, tax laws and other things, and maybe that’s our conjunction, that’s what we believe. So it’s more of that than necessarily a foreign exchange hitting our business services revenue line.

All right. Thank you.

Thanks, and let me close up here. First and foremost, I want to thank you all for being with us this morning. We delivered a strong financial quarter with record-setting performances in wireless and another strong showing with U-verse. This just only goes to build our confidence as we head into the second half of the year. I should note with you that next quarter, we will report our results on October 21 – excuse me, on 24, October 24. Our earnings call that day will begin at 9 AM Eastern or 8 AM Central, little bit earlier. Once again, thank you for being on the call. And as always, thank you very much for you interest in AT&T. Have a good day.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T’s Executive TeleConference. You may now disconnect.