AT&T's Management Discusses Q1 2014 Results - Earnings Call Transcript

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AT&T Inc. (T) Q1 2014 Earnings Conference Call April 22, 2014 4:30 PM ET

Executives

Susan Johnson – Senior Vice President, Investor Relations

John J. Stephens – Senior Executive Vice President and Chief Financial Officer

Analysts

Simon Flannery – Morgan Stanley & Co. LLC

Mike L. McCormack – Jefferies LLC

John C. Hodulik – UBS Securities LLC

Joseph A. Mastrogiovanni – Credit Suisse Securities LLC

Philip A. Cusick – JPMorgan Securities LLC

Tim K. Horan – Oppenheimer & Co., Inc.

Frank G. Louthan – Raymond James & Associates, Inc.

David Barden – Bank of America Merrill Lynch

Operator

Ladies and gentlemen, thank you for standing by and welcome to the AT&T’s First Quarter Earnings Release 2014. At this time, all lines are in a listen-only mode. Later, there will be an opportunity for your questions and instructions will be given at that time. (Operator Instructions) And as a reminder, this conference is being recorded.

I will now turn the conference over to Susan Johnson, Senior Vice President, Investor Relations. Please go ahead.

Susan Johnson

Thank you, Cathy. Good afternoon, everyone, and welcome. It’s great to have you with us today. I am 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 overview with perspective on the quarter. Then we will follow up with questions and answers.

Let me remind you, our earnings material is available on the Investor Relations page of the AT&T website, that’s www.att.com/investor.relations.

Now, before I turn the call over to John let me quickly cover our consolidated financial summary, which is on Slide 3. We had our best consolidated revenue growth in more than two years up 3.6% driven by strong wireless growth, our best consumer wireline growth since the introduction of U-verse in 2006 and rapid growth in strategic business services.

EPS for the quarter was $0.71 when adjusting for some transactional expense associated with the Leap acquisition. When compared on an adjusted basis that’s up nearly 11% over last year’s first quarter. Consolidated margins were up year-over-year due to wireless expansion margin expansion offsetting wireline pressure.

Cash flow started the year strong. In fact cash from operating activities for the quarter was the highest it’s been since 2007 $8.8 billion. Our solid cash flow allowed us to make significant investments in Project VIP and the growth drivers of our business. Capital spending was $5.8 billion and that gave us free cash flow of $3.0 billion for the quarter. We also continued to be opportunistic in buying back shares as part of our repurchase program. In the first quarter, we bought back about 37 million shares for $1.2 billion.

Now with that overview I’ll turn the call over to AT&T’s Chief Financial Officer, John Stephens. John?

John J. Stephens

Thanks, Susan and hello everyone, and thanks for joining us today and for your interest in AT&T. Before I get to our operational highlights, let me take a moment and give you a broader view of our business strategy beginning with slide 3. As you know, we have been working very deliberately on multi-year plan to transform our business.

In the first quarter, we really began to see the benefits of this transformation effort. You’ve seen us transform our networks from the legacy services to an all IP platform and a best in class network. Project VIP is accelerating that transformation through our LTE deployment, U-verse expansion and fiber build to businesses. We also reached a significant milestone in the quarter with our domain 2.0 initiative. We named two leading companies, Amdocs and Juniper Networks, as primary vendors that will help us achieve our vision of a user-defined network cloud of modern cloud-based architecture.

We also make significant strides in transforming the wireless customer value proposition. This transformation began with the move from feature phones to smartphones. These smartphones soon became the remote control of our lives and drove significant data usage. In recent years we began the transition to usage based pricing and away from device subsidies.

In the first quarter, we accelerated that transformation, thanks to the transparency and simplicity of our Mobile Share and Next plans. At the same time, we transformed our wireline business from legacy services, such as DSL to IP networks and IP services. In the first quarter this transformation helped drive our strongest consumer wireline growth in years. And in business our strategic business services continued its steady growth. And our transformation is not slowing down.

Yesterday, you saw us announced plans that strategically target 21 new markets to expand our ultra-fast fiber networks to deliver U-verse with GigaPower. Moves such as this are one more indicator of our ongoing transformation. Behind all this is the strength of our balance sheet, our strong cash from operations allows us to return substantial value to shareholders through dividends and share buybacks, while still having the ability to invest in our future.

Now let’s get to our highlights for the quarter which begin on Slide five. We had an impressive start to the year. Let me begin with a quick overview of the quarter. We made major moves in wireless that are reshaping the way we do business. We completed our Leap transaction and have begun the integration process. This will accelerate our prepaid initiative as we launched a new Cricket brand in the second quarter. And we have reached a critical point in our wireline business where we can clearly see that our Project VIP plans are working and transforming the business. These efforts results in our strongest consolidated revenue growth in more than two years while also driving double-digit adjusted EPS gains. And we did this while still dealing with a very weak economy.

To start wireless execution was superb in the quarter. We had our best postpaid net adds first-quarter in five years and revenue growth was strong. We also made massive strides in changing the subsidy model giving customers greater choice and a more transparent way of choosing their wireless equipment and service plan.

AT&T Next take rates were strong as more and more customers chose the installment plan method of purchasing handsets. And the shift to Mobile Share plans was nothing short of incredible. The number of new Mobile Share counts and connections tripled year-over-year with nearly half of our accounts now on 10 gigabyte or larger plans.

At the same time, U-verse continued its steady march of transforming our wireline business. In fact we had our best consumer wireline revenue growth since the introduction of U-verse about eight years ago. And the outlook for U-verse continues to be solid, as we expand the U-verse footprint and look to increase penetration.

Transformation also continues in business wireline, strategic business services revenues were up more than 16% in the quarter. So, a very solid start with excellent momentum. Now let me provide more details starting with our business our wireline, our wireless business on slide 6. Perhaps the biggest story in the quarter was the strong growth in total and postpaid subscribers, we added more than 600,000 postpaid subscribers in the quarter with smartphones and tablets leading the way, that’s more than twice as many as the year ago and the best first quarter in five years.

Overall, we had more than a million net ads in the quarter, as we showed year-over-year improvement in every customer category. In prepaid, we continue to make progress in adding smartphone subscribers. In the first quarter alone we added 255,000 prepaid smartphone subscribers to our network, this help drive year-over-year prepaid revenue growth. Also during the quarter, we took a major step in transforming prepaid with the close of our lead transaction, adding 4.5 million prepaid customers of which nearly 70% are using smartphones. We are really excited about this new opportunity. Churn continues to be a solid story for us. Total churn was stable for the quarter with postpaid churn down sequentially and up slightly year-over-year. That is a great achievement and what is definitely a noisy competitive environment.

We believe Mobile Share will have a positive long-term impact on churn. In fact, postpaid churn got progressively better throughout the quarter. As the transition of our customer base to usage-based plans accelerates, so does the shipping of our handset sales to AT&T Next. Those details as well as revenue breakouts are on Slide 7.

The transformation of our customer base can be clearly seen in this quarter. The combination of AT&T Next to Mobile Share value plans has annual level of transparency in the smartphone buying model that customers haven’t seen before. This new model lets customers choose, what plan best suites their need, and many customers have been choosing to move after subsidy model for simpler pricing and for a large number of our customers that means AT&T Next. More than 40% of smartphone gross add and upgrade to the quarter were on AT&T Next, that’s up from 15% in the fourth quarter. We shipped away from the subsidy of subsidy model as major implications.

First, when we shift two equipment and service as customer signed up for the next contracts you. You see that in our strong equipment growth to the quarter with slower service revenue growth. Second, AT&T Next accelerates the move to LTE capable devices. About 57% of smartphones on our network are LTE capable providing a superior customer experience on a best-in-class network that also means the honorable sufficient network? And third we see this as an investment in our high quality customer base and in customer choice.

It peels back the layers of the subsidy model and allows customers to make clear choices. It also helps build a stronger bond with our postpaid base in a noisy competitive environment. And we believe we are well positioned to use working capital in this way. With our strong balance sheet, we believe we can do this prudently and effectively.

Another important aspect of Next, is that these are highest credit quality customers, that’s Next was designed for and that’s who is selecting Next. I talked earlier about our transformation, it leads us to a different set of metrics, than what we have used in the past. Next in a shift to equipment revenue changes the way we look at ARPU. Phone-only ARPU a metric we have shared for sometime and which includes only service revenue increased by 0.4% in the quarter.

However, phone-only ARPU plus Next monthly billings increased by 2% year-over-year. This move to Mobile Share plans in the quarter was incredible, more details is on slide 8. During the quarter, we introduced several new Mobile Share value pricing plans for both families and individuals to help customers move out to subsidy model. First, we introduced new attractive pricing for the 10 gig or larger plans for customers who purchase a phone with AT&T Next or bring their own device.

Second, we rolled out similar value pricing for one and two gigabyte plans. At the same time, we made it easier for subscribers to move off the traditional subsidy model by allowing them to take advantage of these attractive new Mobile Share value pricing options in advance of upgrading to Next. We see this as another investment in our customer base. The cumulative impact of these changes was significant.

First, the number of Mobile Share accounts and connections rose sharply in the quarter, increasing by more than 50% since year-end and tripling year-over-year. Second, there was a major migration of subscribers to Mobile Share plans up 10 gigs or higher. Customers bought up more than two-thirds of Mobile Share account activity with the gigabytes or higher plans in the quarter driving overall penetration to almost 50%, that’s up from just 27% in the fourth quarter of 2013.

And third, these new offerings prompted about 1 million postpaid subscribers who were on unlimited plans to elect to shift to Mobile Share pricing. This helped drive the overall number of smartphones subscribers on tiered data pricing to 81% that’s a full six percent point increase in just one quarter. At the same time, we added more than $1 million new postpaid smartphone customers that includes customers who are staying with us and upgrading from feature phones. Our postpaid smartphone sales continue to run in the 90% plus range and our total postpaid smartphone base is at 78%.

Now let’s look at margins on Slide 9. In the first quarter, wireless EBITDA service margins were 45.4% that’s a 220 basis point increase from year ago levels. Even though we had a significant increase in postpaid gross add year-over-year. The margin expansion was driven by several factors, such as the move to the 24 months upgrade, network efficiencies, and operational improvements. Next also had a positive impact on margins.

All these activities more than offset the pressures we saw in the quarter. Cause of strong net adds both postpaid and total customer growth, additional promotional activity relating to our transformation, additional customer care costs related to Mobile Share and Next, and increased start-up investment in prepaid and digital life.

Our actions to improve margins also help to ease the pressure from about 1.1 million accelerated smartphone upgrades that occurred in the quarter. These are customers who took advantage of new pricing and move to Mobile Share plans and upgraded early. Without this boost, Next take rate would have been closer to 35%. In total, we had 2.9 million AT&T Next sales in the quarter. And now more than a quarter of our postpaid smartphone base is on a Mobile Share value non-subsidy pricing, and is no longer tied to the subsidy model.

Another margin comparison to total wireless EBITDA margin that was stable year-over-year even with all the growth in investment activities we had underway in the quarter. There is a lot of moving pieces in our wireless business last quarter. The huge shift to Mobile Share plans, the tremendous popularity of AT&T Next, the increase in total and postpaid net adds, and the transitional way for the subsidy model. But it all comes down to customer choice. We are making the buying process as open and transparent as possible and then letting customers manage the process. We believe this is not only best for our customers, but best for our share holders.

Now, let me turn to our wireline story starting on slide 10. The wireline story continues to be one of the transformation. That transformation began first in consumer when we introduced U-verse, since that time we have flipped the revenue model. But once with the declining revenue stream at a 4.3% growth in the first quarter accelerating from 2% a year ago.

Total U-verse revenues are now at nearly $14 billion annualized revenue stream and still growing at almost 30%. And U-verse now represents almost 60% of consumer revenues. We also see the transformation in our broadband results. More than two-thirds of our total broadband base are about a 11 million subscribers are now on U-verse broadband, highest speed and highest quality product. These gains drove total positive broadband net adds in the quarter. And we are positioned to continue that growth as our U-verse footprint expense and penetration improves.

It also helps drive total broadband ARPU which was up 9% in the quarter. U-verse TV continues to be popular as we added more than 200,000 subscribers churn continues to be low as penetration is growing. And U-verse voice, our voice-over-IP product just passed 4 million customers. We also announced that important initiative in the over the top space with the churn in group.

We are excited about the new venture and believe the combination of our two skill sets can create something truly impressive. We hope to start rolling out an offering later this year. Now let’s move to business wireline which is on slide 11. While wireline consumer was the first out of the gates with this move to IP, wireline business started the process a little later, but you can still see the transformation going on there as well.

The clearest way to see it is in the steady consisting growth of strategic business services. These are services such as VPN, Ethernet, hosting and other advanced IP services. Those services now make up more than 26% of total business wireline revenue and growth is up more than 16% year-over-year.

Overall revenues were down year-over-year inline with the slow economy and recent trend, but there are positive signs. In enterprise, our global business services we actually showed slight service revenue growth year-over-year, given recent headwinds that seemed as very positive. The biggest drag on the quarter was wholesale. It was challenged by network grooming, as wireless carriers aggressively decommissioned the legacy circuit.

However, if you look at our retail business by itself, enterprise, and small and medium size businesses total revenue was down only slightly in the quarter. And when you look at what business customers’ pay us for their total AT&T bill, both wireline and wireless total retail revenue actually grew year-over-year. We expect our transformational IP will continue to make headway in the business space. At the same time we continue to look for the signs that the economy will improve and provide us with additional lift.

Now, let’s look at consolidated wireline margins on Slide 12. You see the impacts from our transformation on these consolidated margins. For the quarter our consolidated margin was 19.3% up 40 basis points year-over-year. Wireless margin improvement help to offset wireline pressure from the trailing expenses tied to Project VIP. Wireline margins were down from a year ago, but essentially flat with fourth quarter. Declines in legacy services, and content, and retransmission price increases pressured our results.

And this pressure was partially offset by relative consumer revenues and gains and strategic business services. At the same time Project Agile is gaining steam. Project Agile’s are new initiatives that is improving efficiency and how the company organizes and operates to deliver best-in-class customer experience as in all IP, all mobile and all cloud services company. We are taking our initial cost savings from Agile and reinvesting in the Project. We expect one rate savings in the $3 billion range by 2017.

Now let’s move to cash flows our summary is on Slide 13. Our ability to generate cash continues to be strong, in the first quarter cash from operations totaled $8.8 billion or about $1.70 a share, that’s the highest cash from ops in seven years and almost four times our quarterly dividend commitment.

Capital expenditures were $5.8 billion as we took the strong cash flows and invested in Project VIP. And free cash flow before dividends was $3 billion on track with our full year guidance even as AT&T Next changes the subsidy model.

In terms of uses of cash, dividend payments for the quarter totaled about $2.4 billion and we repurchased about $37 million shares for another $1.2 billion. Our board of directors has also approved a $308 million share buyback as we continue to be opportunistic in buying back shares. Since we begin buying back shares about two years ago, we have bought back about 13% of the outstanding shares of the company and save more than a billion dollars in cash from eased divided requirements.

We also continue to look for opportunities to monetize some of our assets. This included more than $400 million in sales of América Móvil shares and real estate in the first quarter. We continue to move forward on our brands to sell our Connecticut wireline properties to Frontier for $2 billion and we expect that transaction to close by the end of the year.

During the first quarter we also closed our Leap acquisition. A high level look at that strategy and integration of Leap assets is on Slide 14. First and foremost the acquisition of Leap has clear and immediate benefits and value creation. The value of the spectrum what we see was significant about $3 billion in value. At the same time we will be able to get significant value from Leap’s $3 billion tax net operating loss and turn that into real cash for shareholders. And finally, we immediately refinance about 90% of Leap’s debt which will save us $500 million in interest expense or just the remaining term of that debt.

When you add these synergies together, the value of just these items was greater than the total purchase price of Leap. From a strategic perspective, the acquisition of the Cricket brand accelerates our move into the prepaid space. We planned to launch the new Cricket brand in the second quarter combining with AT&T’s existing prepaid operations to create the new cricket with the national presence and more than 3,000 distribution points across the country. The focus will be on simple plans with affordable devices helping customers take advantage of this thing, of the smart new choice in no contract wireless and all this is not a best-in-class network.

We are also integrating Leap customers and its networks. The customer transition is expected to take about 18 months as we move customers off of the outdated CDMA network on to AT&T’s GSM network. We will start deploying unutilized spectrum immediately, continuing our efforts into 2015. Integration costs are expected to be about $1.2 billion over a two year period with about half of that expected in 2014.

CapEx will be in a $1 billion range, but significantly offset by efficiencies with other wireless bill plans and with the majority of the spend targeted in 2015. Leap operational pressure will drive $0.05 of dilution in EPS this year with most of it in the second half of 2014.

We are very excited about this new growth opportunity and expected to really kick start our new prepaid strategy. We are also updating our outlook for the full year after Leap acquisition. Those details are on slide 15. We now expect consolidated revenue growth of 4% or greater for the year as we hold in Leap and see continued strength in wireless and wireline consumer. We continue to expect stable consolidated margins, which includes Leap operational pressure. So we expect EPS growth in the mid single-digit even with the dilution from the Leap operations and continue to investment in growth initiatives.

We still expect capital spending to be in the $21 billion range that we gave you in January with most of Leap’s integration impact in 2015. We also expect free cash flow in $11 billion range at even with expected strong Next sales and Leap cost. And you can expect us to continue to invest in our business transformation and growth opportunities.

And now I will turn it back to Susan for quick summary of the quarter and then we can get to your questions.

Susan Johnson

Thank you, John. Our recap of a very solid quarter is on slide 16, we definitely saw the impact of our business transformation in the first quarter. Revenue growth was strong that includes the best consolidated revenue growth in more than two years and the strongest consumer revenue growth since we launched U-verse. That help drive double-digit adjusted EPS growth for the quarter, wireless was led by the best first quarter postpaid growth we’ve seen in five years and AT&T Next and Mobile Share are transforming the customer value proposition, and put a large dent in this subsidy model while accelerating the growth of larger tiered data plan.

In wireline we are seeing the impact of our investments in IP. U-verse continues its robust growth and business continues to transform with growth and strategic business services. I will now close out the call with a quick review of our Safe Harbor statement and then we are going to open it up for question-and-answers.

Our Safe Harbor statement is shown on slide 2. This presentation and the comments we are going through make contain forward-looking statements that are subject to risks. Results may differ materially, details on our SEC filings and on AT&T’s website.

And now Cathy let’s go ahead and we will open up the call to take your questions.

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