AT&T (T) Q3 2014 Results – Earnings Call Transcript

And additional information is available on the investor relations page of AT&T’s website. I also want to remind you that we are in the quite period for FCC Spectrum Auction 97 and AWS-3 Auction so we cannot address any questions about Spectrum today. So with that overview, I now turn the call over to AT&Ts Chief Financial Officer, John Stephens, John?

John Stephens

Thank you, Mike. And hello everyone. Thank you for joining us today and we always appreciate your interest in AT&T. Before we report out on our quarterly results, I’d like to update you on Project VIP in the longer term view of our business transformation.

We’ve been focused on building ultra fast, video centric networks and providing mobile connectivity to any device, anywhere our customers needed. I am pleased to say we have made great progress. It’s been nearly two years since we first announced our VIP initiatives and our plans to transition to IP networks. Basically, we are doing everything we said we are going to do and more.

We reached our 4G LTE build target in the third quarter four months ahead of schedule. The nation’s most reliable LTE network now covers more than 300 million people. We continue to improve our self identity and add capacity to help keep our network best-in-class. We are also on pace with our wireline network goals. Our high-speed IT broadband network now reaches 57 million customer locations. About two thirds of our U-verse video footprint now has access to 45 megabit per second speeds.

We also continue to make progress on expanding our U-verse video footprint and we committed to deploy ultra fast AT&T GigaPower service in 17 markets. Our fiber to the business expansion also is going strong. We now pass more than 600,000 new business customer locations with fiber, well on our way to our one million goal.

The transformation of our customer base also continued in the quarter. Two years ago when we first introduced Project VIP less than half of our broadband customers had high speed IP broadband. Now a significant part of that transition is complete with nearly three quarters of our base on high speed U-verse broadband. And our strategic business services are on track to be nearly 30% total wireline business revenues by the end of this year.

The transition in wireless is just as dramatic. There has been a steady shift of our subscribers to usage based plans; more than 80% of our smartphone base is now on usage-based plans. At the same time, mobile share value has helped move customers off the traditional subsidy model. We also have launched new business opportunities that will leverage our investment in a high speed networks.

The connected car is ready to take off. In the third quarter alone we added more than 500,000 connected cars as the 2015 model start to roll off the assembly lines. Digital Life, the first all-digital all-IP home security and automation platform has launched in 82 markets and has about a 140,000 subscribers. And AT&T has completed a Network On Demand trial in Austin that will enable companies to easily order, add or change services on their own in mere real time. A commercial roll out of Network On Demand enabled Ethernet services is expected in Austin by the end of this year.

Our financial strength allows us to invest while still returning substantial value to shareholders; in fact since 2012 we have returned more than $50 billion to shareholders through dividends and share buybacks. Cash flows are strong and we have been aggressive in monetizing non-strategic assets. Including the sale of our Connecticut wireline property we have generated about 16 billion in cash proceeds from asset sales.

This has helped us average nearly $20 billion a year in free cash flow and asset sales over the last two years and we expect to do the same this year in 2014. At the same time we’ve kept our financial house in order by funding a pension plan, making significant working capital improvements and taking advantage of historically low interest rates.

This is the heavy lifting our employees are doing everyday that you don’t always notice in the quarterly numbers. We are just managing for the short term or managing and investing for the long term. Now with that view, let’s take a look at third quarter results starting with our financial summary on slide four.

Consolidated revenue grew to $33 billion up $800 million or 2.5% year-over-year. This was driven by continued wireless growth as we repositioned our business model, solid consumer wireline growth, once again led by U-verse and continued growth in strategic business services.

Reported EPS for the quarter was $0.58. In the quarter we had $0.03 of cost associated with merger and integration related expenses. We also redeemed some debt early in the quarter to take advantage of low interest rates; both reductions in cost had a $0.02 impact on the quarter. When you exclude these items earnings per share were $0.63 compared to an adjusted $0.66 a year earlier.

Cash from operations continued at a strong rate and we also continue to find ways to monetize assets. Together, that has generated $32 billion in cash year-to-date. With year-to-date capital spending of $17 billion and about $7 billion paid in dividends so far this year. With all of that our cash position remains strong even as we continue to return substantial value to shareholders.

Now let’s turn to our operational highlights on Slide five. The third quarter was another solid step forward in the transformation of our business. This includes strong subscriber metrics in both wireless and wireline and continued growth in strategic business services. In wireless, we saw good in fact great trends in a challenging environment including more than 2 million net adds that included adding twice as many postpaid subscribers as we did in the year ago third quarter. Record low third quarter post paid churn, solid wireless revenue growth and improving adjusted service margins even with record third quarter smartphone gross adds and upgrades.

We also saw the continued transition of our customer base to AT&T Next and Mobile Share Value plans while also realizing sequential ARPU phone growth. In wireline, U-verse hit some important subscriber milestones. We now have more than 12 million high speed broadband subscribers. The transition phase of moving our broadband base to IP is nearing completion with about 75% of our total broadband base on our higher speed service. And we also reached more than 6 million U-verse video subs that helped drive strong U-verse revenue growth and continued wire line consumer gains.

U-verse is now a $15 billion annualized revenue stream growing at nearly 24%. In wireline business, strategic services growth continued at a strong pace. It’s now a $10 billion annualized revenue stream growing at more than 14%. With those highlights, let’s now drill down and take a look at our operating results starting with wireless.

We had a great net add quarter. That’s a trend we’ve been seeing throughout the year. Overall we added more than 2 million total subscribers led by postpaid and connected devices. We added nearly 800,000 new postpaid subscribers that’s twice as many as the year ago quarter, about 450,000 of those were tablets and computing devices with the remaining net adds, phone and some digital life.

And year-to-date we’ve added more than 2.4 million postpaid subscribers which also doubled last year’s pace. Another key point with our postpaid net adds is that we are adding these customers while maintaining high credit standards. These are rock solid high quality, new subscribers. These net adds exclude any migrations from our prepaid segment.

Connected devices also had a strong quarter as we started to see significant impact of the connected car with nearly 1.3 million connected devices were added in the quarter including more than half a million cars.

Churn turned in another strong quarter, in fact it was our best ever third quarter postpaid churn that follows our best ever churn in the second quarter and churn from Mobile Share Value and AT&T Next customers is even lower.

Total Churn for the quarter was up slightly to 1.3%, 1.36% reflecting a larger prepaid base with the March acquisition of Cricket. These are solid results in a challenging environment. We saw our competitive intensity pickup in an iPhone launch quarter with all major carriers now offering the iPhone and we expect that to continue as we move into the holiday sales period in the fourth quarter.

But we believe strongly in the quality of our network, our award winning customer service and the value proposition we offer customers. Our results so far this year show we are on the right track and we are looking to finish the year strong.

Now let’s look at revenue and ARPU on slide seven. We continue to see a shift in wireless revenues as customers sign up for Mobile Share Value plans and away from the traditional subsidy model. Total wireless revenues for the quarter were up nearly 5%, service revenues were stable year-over-year and equivalent revenues were up more than 40%. A take rate for AT&T Next was about the same as last quarter, about half of gross adds and upgrades. We also saw an increasing number of subscribers bringing their own device to our network, about 460,000 or 7% of smartphone gross adds were bring your own device or BYOD. That’s more than four times what we saw in the year ago third quarter and more than 1 million BYODs customers year-to-date.

We continue to have a large base of customers on discounted Mobile Share Value plans who have yet to migrate to Next. About 20% of our smartphone base is on Next, but about 52% of smartphone subscribers are on the non subsidy pricing. This means that there are about 20 million potential Next customers we expect to upgrade, that’s up from 17 million at the end of the second quarter.

Next take rates continue to be strong in company-owned stores nearly all are more than 90% of our Mobile Share Value customers with pre Next pricing or choosing AT&T Next when they upgrade in company owned stores. They all come without a customer choice, customers can choose the plan that is best for them and that’s great for us, and right now most customers are choosing to go off the subsidy mile when they upgrade or add a new line.

Also in the quarter, we continue to see customer’s buy up larger data plans and more interested in device insurance. This is helping drive revenue. Now let’s look at postpaid ARPUs. The expected trends we talked about last quarter are happening as more customers take AT&T Next. Phone-only service ARPU is down year-over-year but up sequentially. When you add a Next doings you get a better view of what an average customer pays us each month.

Phone-only ARPU with Next billings improved sequentially by 2%. The average monthly Next billings were about $29 per month driving our ARPU with Next higher. As the Next base grows, so does the impact on billings. We also continue to see strong growth in data billings, those details are on slide eight.

Wireless data billings increased by nearly 24% in the quarter. This was due to the increasing number of devices on the network and customers choosing 10 gigabit plans or larger. More than half of all Mobile Share accounts are on these plans. During the quarter, we added more than 2 million Mobile Share accounts giving us 16.7 million in total, that’s three times as many as we had a year ago. And we averaged about three connections per Mobile Share accounts or nearly 47 million connections in total. That’s roughly 60% of our overall postpaid base.

Smartphone sales continue to be strong; in fact, we had 6.9 million smartphone gross adds and upgrades. That’s a third quarter record. And it would have been even higher without inventory constraints.

We added $1.2 million subscribers to our smartphone base including about including 500,000 smartphone net adds. Most our sales continue to be smartphones, about 91% of the flow share.

About two-thirds of our postpaid smartphone base use LTE phones. As you know, LTE devices provide the best customer experience, while also being the most efficient on our networks.

Let’s now look at our wireline results, starting with consumer on slide nine. U-verse hit two subscriber milestones in a quarter. First, we now have more than 12 million high-speed broadband subscribers, after adding more than 600,000 in the quarter.

U-verse broadband is now 73% of our total broadband base and 75% in the consumer broadband base, that’s up 70% in the last two years, that’s help to drive total postpaid – that help drive total positive broadband net adds in the quarter.

We also continue to deploy our ultra high-speed GigaPower service. We now offer 1 gigabit speeds in Austin and have turned up the service in Dallas and Fort Worth. We’ve also committed to deploy GigaPower in 14 additional markets including Houston, Miami and Atlanta.

We also passed the 6 million mark with U-verse TV subscribers and in 216,000 in the quarter, and bundles continue to play a big role in our growth. More than 97% or virtually all of our video customers have some kind of bundle with us, most often broadband and video. And nearly two-thirds of U-verse TV subscribers take three or four services with us.

ARPU for U-verse triple play customers continues to be more than $179 that helps drive revenue growth while reducing churn. In fact triple-play bundled customers have significantly lower churn than standalone customers. All this help drive 3% revenue growth in consumer, total U-verse revenues are now more than $15 billion annualized revenue stream and our continued growth at nearly 25% year-over-year. U-verse now represents 64% or nearly two-thirds of our consumer revenues. That compares to 54% just the year ago.

Now let me take you to our wireline business results on slide 10. We also reached another significant milestone in the wireline business. Strategic business services, those are growth services such as VPN, Ethernet, hosting and other advanced IP services are nearly a $10 billion annualized revenue stream for us now.

The services backup more than 28% of business wireline revenue and grew by more than 14% in the third quarter. At our current growth rate strategic business services should be about 39% of business wireline revenues by the end of the year. Overall business revenues decline by 2% in the quarter. Service revenues were also down 2% year-over-year.

The shift to IP data and away from legacy services, as well as the economy is the story in wireline business. But within the business there are some differences. Our retail service revenues actually grew year-over-year.

Those are service revenues from an enterprise and small business. Enterprise revenues were up 1.7%, that it’s best performance in years and the six consecutive quarter of service revenue growth.

Small business trends also improve as even with a lack of new business formations. On the other hand, wholesale is again challenged by network grooming issue. We also make a strategic decision to refocus the wholesale business.

That reduce wholesale revenue is about $50 million in the quarter and we expect that amount to increase in the fourth and thereafter. The positive trends in retail service revenues are encouraging, and as is the transition IP services from legacy product.

But the economy and fewer business starts continue to make for a challenging environment and clearly call for the government to move toward actual form legislation. Now let’s look at consolidated and wireline margins on slide 11. For the quarter, our adjusted consolidated margin was 17.2% compared to 18.5% a year ago quarter. Wireless margins were pressured by strong adoption of mobile share value plans, solid customer growth, promotional activities and the leap acquisition.

However, when compared to the year ago third quarter, adjusted wireless EBITDA service margins actually expanded to 4 to 3.1. As the solid performance given our strong postpaid and smartphones that adds, as well as record third quarter gross adds and upgrade.

Wireline margins were pressured by increasing content costs and transformation expenses, lower legacy revenues also contributed to the pressure. But this pressure was partially offset by growth in consumer revenues, gains and strategic business services and solid execution or in cost initiatives.

Now let’s move to cash flow, our summaries on slide 12. In the first nine months of the year cash from operation totaled $25.6 billion and $8.7 for the quarter. Capital expenditures were 17 billion and $5.2 for the quarter.

And free cash flow before dividends is $8.6 billion and $3.5 billion for the quarter. We did monetize about $500 million of Next receivables in the quarter as there continues to be great interest from financial institutions and additional tranches in the future are possible.

Net dept to adjusted EBITDA was 1.7 and our credit rating continues to be among the best in the industry. In terms of uses of the cash, dividend payments year-to-date totaled $7.2 billion and we continue to be opportunistic with our share buyback program.

Our asset sales strengthened our balance sheet and cash position, when you will include the $1.9 billion in short term investments, we had $4.3 billion of cash at the end of the third quarter. We also to expect to close the sale of our wireline asset in Connecticut and the Frontier this Friday, which will enhance our cash position with $2 billion in proceeds.

Let me close with the quick summary of the quarter on slide 13. We continue to make progress with our business transformation in this quarter throughout this year. That includes the repositioning of our postpaid base of the subsidy model.

Total share counts continue to grow and of our 57% of our gross adds and upgrades to the quarter were either AT&T next or BYOD. At the same time we continue to see strong total and postpaid net adds with low postpaid churn in a very challenging environment.

We also continue to rationalize our business portfolio. This includes completing the sales of the América Móvil equity interest, closing Connecticut wirelines property transactions two months earlier than we had expected, and exiting select low margin wireline wholesale businesses.

This rationalization as well the impact of more BYOD devices than we had expected and fewer net AT&T net gross adds and upgrades will impact revenues. The company now expects full year consolidated revenue growth in the 3% to 4% range.

Even with this change we expect that Next rates will increase for the rest of the year and continued strong BYOD will help with margins even with traditional fourth quarter holiday pressure.

So overall we continue to have confidence in our strategy and our ability to compete in this challenging environment.

With that Tony, let’s go at and take some questions.

Question-and-Answer Session

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