AT&T Inc. (T) Q3 2013 Earnings Call October 23, 2013 4:30 PM ET
Susan Johnson - Senior Vice President of Investor Relations
John Stephens - Chief Financial Officer, Senior Executive Vice President
Phil Cusick - JPMorgan
Simon Flannery - Morgan Stanley
John Hodulik - UBS
David Barden - Bank of America Merrill Lynch
Joe Mastrogiovanni - Credit Suisse
Jason Armstrong - Goldman Sachs
Michael Rollins - Citi Investment
Brett Feldman - Deutsche Bank
Jennifer Fritzsche - Wells Fargo
Amir Rozwadowski - Barclays
Ladies and gentlemen, thank you for standing by and welcome to AT&T's third quarter earnings release 2013 conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions). Also as a reminder, this teleconference is being recorded.
And at this time, I will turn the conference call over to your host, Senior Vice President of Investor Relations, Ms. Susan Johnson. Please go ahead.
Thank you, Tony. 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 update with perspective on the quarter, then we will follow with Q&A.
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. I also need to cover our Safe Harbor statement, which is on slide two. This presentation and comments may contain forward-looking statements that are 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 cover our consolidated financial summary which is on slide three. Consolidated revenue was $32.2 billion, up 2.2% driven by continued wireless growth, impressive U-verse gains and rapid growth in strategic business services. Reported EPS for the quarter was $0.72. That's up more than 14% over last year's third quarter. This includes $0.03 from the previously disclosed transfer of spectrum and $0.03 from income tax items. When you exclude these items, earnings per share was $0.66, an increase of almost 6.5% year-over-year.
Cash flow continues to be strong. Cash from operating activities for the quarter totaled $9.2 billion and free cash flow was $3.2 billion and more than $11 billion, year-to-date. Also in the third quarter, we bought back about 55 million shares for $1.9 billion and year-to-date, we have returned more than $18 billion to shareholders through dividends and buybacks.
With that overview, I will now turn the call over to AT&T's chief Financial Officer, John Stephens. John?
Thank you, Susan, and good afternoon, everyone, and as always, thank you for your interest in AT&T. Let me start with an overview on slide four. There is a lot we really like about the quarter. we grew revenues and EPS and cash generation continues to be robust.
But when you look at what's driving the business, the one thing that stands out is Project Velocity IP or Project VIP. As you recall, we announced this plan just about a year ago. We said we would invest aggressively to expand our 4G LTE footprint, that we would expand U-verse broadband reach and that we take fiber connectivity to a million new business locations. Thanks to the great work of our network organization, we have made terrific progress on all of these fronts, including having the nation's fastest and most reliable 4G LTE network. And you can see the positive results in our third results.
Our total Wireless subscribers increased by nearly 1 million and our mobile data revenues grew nearly 18%. Revenues from our strategic business services, including VPN, Ethernet, hosting and other advanced IP services posted strong growth of nearly 16%, and the one thing that has been the most excited is the outstanding performance and future potential of U-verse, we reach 10 million total U-verse subscribers this quarter. Thanks to our best TV net gain in nearly five years and a record third quarter broadband sales. That's quite an achievement in this tough economy.
This helped drive our first $1 billion U-verse revenue month ever and that's growing at 28% year-over-year. This has been an incredible seven years since we first introduced the service, but project VIP has allowed us to take this platform to a whole new level and we are obviously excited about the road ahead as we build on the VIP platform to create a network that is increasingly software-defined and video-centric.
With that in mind, let me give you a quick update on the progress of project VIP, starting on Slide 5. Our project VIP initiative, focused on expanding the growth platforms of our business. These include expanding our 4G LTE to 300 million POPs by the end of 2014, executing on our spectrum and network quality initiatives, expanding our highly successful U-verse services to 8.5 million new customer locations with high-speed broadband going to 57 million or approximately 75% of our wireline customer locations while also bringing faster speeds and brining fiber to 1 million additional customer locations. We are going to get this done, but at the same time, we are going to move to enhance our spectrum portfolio to meet the massive growth needs of our wireless data business today and into the future.
Un-drawing all of this, we are strengthening our financial structure and our balance sheet to give us the ability to invest and maintain financial flexibility. Even though it hasn't been a full year since we first laid out our plans, we are on track or ahead of schedule with each of these initiatives.
To give you a build update our wireless progress on Slide Six. Our 4G LTE build continues to exceed our original expectations. We now reached nearly 250 million pops. The performance of our network has been outstanding. We have the nation's most reliable 4G LTE network according to our analysis of data from Nielsen, a well-known and leading global information and measurement company.
PC World and PC Magazine also said our speeds are the fastest and RootMetrics, who study national network performance in 125 cities, said overall call, data and text networks ranks first or tied for first in 56 of the 78 cities studied today in the second half of this year. At the same time, we have also made significant progress in our spectrum position.
Last November, we laid out a carefully planned spectrum strategy that would help us meet our mid-term needs, I am pleased to say, we have successfully executed those plans. That includes the purchase of WCS spectrum, 700 megahertz B Block and other recently closed deals and we have already placed into services substantial part of the acquired 700 B Block spectrum. Along with other pending transactions, this gives us a strong runway for our LTE expansion as we look ahead to future SEC auctions to address longer term spectrum needs.
Our U-verse deployment is also well underway. Those details are on Slide 7. We had increased our U-verse broadband customer locations by about 2.5 million this year, with about 1 million of those being video capable. Ultimately, our 8.5 million customer locations will be video enabled.
In the third quarter, we also increased U-verse broadband speeds up to 45 megabits per second. We continue to rollout new markets but we already offer those speeds in every region to almost two-thirds of our U-verse base. And we are moving forward plans for speeds of 75 megabits per second and faster.
We have also begun deployment of 100% fiber broadband network in Austin, Texas that will deliver speeds up to one gigabit per second. So while this will help drive a strong U-verse sales in the third quarter, almost all our gross adds of the third quarter came from non-Project VIP areas. This means that there is even more room for growth. More opportunity as we go forward with our VIP footprint.
On the business side, our fiber build to multitenant buildings now reaches about 200,000 new customer locations. That's well on our way to reach our year-end target and our one million locations target by 2015. We have also made tremendous progress with our financial objectives.
Let's turn to slide eight for those details. We committed to optimize our capital structure while investing aggressively in our networks. I am pleased to report that we are on target across the board. First, we have moved to equalize our pension plan assets and liabilities for essentially fully funded pension plan. The Department of Labor has published a proposed exemption for our voluntary contribution of a preferred equity interest in our wireless business and this, along with an expected increase in discount rates, would move us to essentially fully funded status with our pension plan by the end of this year. We are very proud that we are one of the few companies that still provide a pension benefit and with these moves our employees and retirees can have the confidence in knowing that these benefits are very well funded.
At the same time, we have also taken steps to help manage our healthcare costs, both for employees and retirees and continuing to move toward low-premium, high value consumer driven plans. We have also been focusing on finding efficiencies in financing our debt. And even though our total debt is up, year-over-year, our interest expense this year is down. Our average effective interest rate is down more than 60 basis points per year, while the weighted average time of the majority of our portfolio has basically remained unchanged. We have also been active in monetizing asset which improves our cash position, the recent tower sale adds to our financial strength and adds to the flexibility provided by earlier transactions. These moves help support our A credit rating, the highest credit rating among U.S. based telecom companies and the foundation for all of this, cash flow continues to be strong.
On top of our capital investment, we have continued our share repurchase program. To-date we have bought back 684 million shares with annualized future dividend savings of more than $1.2 billion per year. Combining share buybacks with our dividend, we have already returned more than $18 billion to shareowners this year. More than $40 billion returned since the beginning of 2012 and we are doing this while maintaining a best-in-class credit rating. A significant achievement at a time of increased capital investment. That's a quick update on Project VIP.
Now let's turn to our operational performance, starting with wireless on slide nine. Data revenue continues to drive wireless revenue growth. Data is now at $22 billion annualized revenue stream and it's growing at nearly 18%. It has a lot of runway as customers continue to increase their data bundles. That helped drive 3.7% service revenue growth this quarter. And total wireless revenues were up more than 5% in the quarter.
Postpaid ARPU continues to be industry leading for the 19th consecutive quarter. We saw the total postpaid ARPU growth. That's a record unmatched in the industry and our phone-only ARPU, again, increased by more than 3%. Our phone-only ARPU includes smartphones, but also includes our lower and feature phones and wireless home phones as well, which makes the growth even more impressive.
We also had a very strong net add quarter. Those details are on Slide 10. In fact, we had close to a 1 million total subs. Versus the third quarter a year ago, our postpaid net adds more than doubled. Our 363,000 postpaid gain in this quarter, included 178,000 new smartphone net adds, they are part of our overall 1.2 million new smartphone customers which will I will walk you through on the next slide.
This was accomplished even though we did see some impact from handset supply constraints. We also lead the industry in postpaid tablet gains. Tablets continue to be strong growth opportunity for us, with strong margins and much lower subsidies and the vast majority of tablet added in the quarter were LTE devices.
While we are positive on smartphone net adds, we are seeing some pressure with our more price-sensitive subscribers on low-end 2G feature phones. We continue to be excited about our pending acquisition of Leap Wireless that allow us to better compete in the prepaid space and we are continuing to move forward to an expected first quarter 2014 close.
Speaking of prepaid, it had its best performance in two years. As many of you know, the migration of tablets to postpaid plans has pressured this part of the business and we are still seeing that, but the introduction of LTE-capable go phones and new pricing plans that helps for growth at the higher end of the prepaid space for customers interested in usage-based pricing.
When you add up the acquisitions on top of our organic growth, we added more than 1 million retail postpaid and prepaid subscribers in the quarter. Connected devices are also doing well as more businesses turn to us for productivity, through machine-to-machine solutions.
Reseller revenues increased year-over-year, however resell had a net loss of 285,000 subscribers, primarily due to losses in the low revenue 2G subscriber accounts. We are also seeing solid results in churn. Postpaid churn was down slightly year-over-year and total churn both, sequentially and year-over-year. Both are notable achievements in this noisy competitive environment.
Let's now talk about our smartphone growth, which I mentioned earlier. Details are on Slide 11. We continue to grow our smartphone subscriber base, both from new customers and some current feature phone subscribers upgrading to smartphones, a record 89% of our postpaid phone sales were smartphones and we now have 75% of our postpaid phone base on smartphones. We expect that percentage to keep growing. These are the premium subscribers in our business. They have twice the ARPU of non-smartphone subscribers and much lower churn and the average usage on smartphones is continuing to grow at a rate more than 50% year-over-year.
Smartphone set another third quarter sales record of $6.7 million and we added 1.2 million new smartphone subscribers in the quarter. We also continue to subscribers moving to the usage-based data plans. Overall, 72% of our smartphone base has selected these plans and a growing number are choosing mobile share plans. We added more than 1 million new mobile share accounts for the quarter to reach 5.3 million. These accounts include more than 16 million devices on mobile share keeping us on a pace of about three subscribers per account.
We continue to see strong take rate on high-end data plans for both mobile share and tiered data customers. In the last year, take rates have grown from 9% to 22%. With 58% of the remaining on medium-size data plans. So we have got a strong base but we still have room to grow. We have announced earlier this month that all new customers will now be on mobile share plans. Mobile share plans have already been popular with new customers and we offer several different plans that will best meet their needs.
Now let's take a look at margins on slide 12. Our wireless EBITDA service margin was 42%. That's does not include the impact on the gains from the transfer of spectrum. We sold 600,000 more smartphones in the third quarter than a year ago and we had a third quarter record number of postpaid tablets as well. But even with this growth, our wireless EBITDA service margins expanded 40 basis points year-over-year. Upgrades were far ahead of last year's pace and flat sequentially and our upgrade rate for the quarter was 7.3%. The upgrades continue to solidify our high-value customer base and move them to more efficient LTE phones.
So with a high level of upgrades, we have increased the number of subscribers under contract in the quarter. These subscribers continue to bring long-term value including our higher ARPU, lower churn and strong data growth. And increasing the number of LTE devices on our network is driving greater network efficiency as well as increasing data usage. It is also moving customers offer our 2G network, which eventually will allow us to repurpose that spectrum for other uses. More than 40% of smartphone subscribers are now on 4G LTE devices.
These efficiencies were offset somewhat by costs associated with new product offerings such as Digital Life and expanding our prepaid wireless offerings. We now offer Digital Life in more than 50 markets. Looking ahead, we expect lower year-over-year upgrades in the fourth quarter as we start seeing the benefits from our new 24 month upgrade model. Customers are also responding well to AT&T Next as sales increased through the quarter and we have continued to expand the program to additional channels. The strength of our network has become a real selling factor for our wireless business. We are seeing outstanding speed and reliability performance and greater efficiencies as more and more customers upgrade to LTE devices. Our accelerated Project VIP, LTE build and improved coverage add to this momentum.
Now let me turn to U-verse. And I would simply say, that I don't think there is a better wireline growth story in the industry than U-verse. Turn to slide 13 for those details. Strong revenue growth and record net adds are a compelling combination. And when you add in expansion of our platform to millions of more customer locations, it's pretty easy to see the runway for U-verse is very long. We have several important U-verse milestones in the quarter.
First, we reached 10 million total U-verse subscribers. More than doubling the number we had just two years ago. That includes high-speed broadband subscribers where we added third quarter record 655,000 customers. Almost 60% of our broadband subscribers are now on the U-verse platform. We also had a second-best U-verse TV net adds ever and the most in almost five years, which keep us as the fastest growing pay-TV provider in the country. In fact, we now have more pay-TV subscribers than any other telco. U-verse revenue growth has been just as in process and is the fastest growing part of our business. We had our first $1 billion U-verse revenue mom in the third quarter and this seven-year-old startup is now a $12 billion annualized revenue stream, growing at more than 28%. U-verse now represents 54% of total consumer revenues, which grew 2.4% in the quarter. The record of success gives us even more confidence in project VIP and U-verse build that goes with it.
Now, let's move to wireline business, which you can see on Slide 14. The broad outline for our wireline business trends continue what we have seen in recent quarters. Obviously, there's a challenging economic environment for business services. At the same time, we are seeing growth in productivity services, like advanced data, the cloud and the mobility. In fact, as I mentioned earlier, revenues from strategic business services, were up almost 16% in the quarter and have grown to almost a quarter of business wireline revenue.
Our U-verse broadband is definitely making noise in the small business space with record gains up nearly 100,000 new high speed broadband customers in the third quarter. That's quite an achievement in this tough economy. As our integrated solutions that take advantage of our global network and mobility strengths, we had several key wins recently. For example, GE announced that it will connect its machines through AT&T network and cloud, creating the first highly secure wireless communications network for GE's industrial Internet.
Another recent win Delta Air Lines will put over 19,000 mobile devices in the hands of flight personnel to help personalize the in-flight experience for Delta's passengers. These contracts highlight the importance of mobility and integrated IP network. The majority of our large business customers also purchased wireless services from us. We think the integration of wireless and wireline services for our business customers will be a big advantage going forward.
Now, let's look at consolidated and wireline margins on Slide 15. For the quarter, our reported quarter consolidated operating margin was 19.2%. This includes a 70-basis point benefit from the previously disclosed transfer spectrum. On and adjusted basis, year-over-year margins were down. Margin pressure was largely due to record smartphone sales and expenses related to project VIP investments. We told you a year ago that there would be pressure on wireline margins with project VIP, we are seeing that this quarter, including success-based U-verse customer addition costs and trailing expenses from our capital spending. This pressure was partially offset by growth in consumer revenues, operational improvements in network sales and support functions and a solid execution of cost initiatives.
Now, let's move to cash flow. Summary is on Slide 16. In the first nine months of the year, cash from operations totaled $26.9 billion, capital expenditures were $15.8 billion as project VIP investing rose and free cash flow before dividends was more than $11 billion.
We continue to look for opportunities to improve our business. We are working with regulators on our proposed acquisition Leap Wireless, and we continue to expect that deal will close in the first quarter of 2014, and we expect to close our recently announced tower transaction before the end of the year.
As I mentioned earlier, keep a strong financial foundation is a priority for us. Our balance sheet is sound, our debt metrics are solid and our strong cash flow gives us the flexibility to invest in growth initiatives while returning substantial value to shareowners.
Now before we take questions, let me close with a quick recap of the highlights for the quarter. Those are on slide 17. Project VIP network initiatives continue to move ahead of schedule. Revenue growth was solid.
Consolidated wireless and consumer wireline. Consolidated wireless margins were stable. Even with pressure from strong smartphone sales and Project VIP expenses. And EPS continues to grow. A solid wireless quarter was complimented by a tremendous performance by U-verse. And when you add in strong strategic business service results, our confidence in Project VIP growth platforms gets even stronger. Looking forward to finishing the year strong and building momentum as we move ahead.
With that, Susan, let's go ahead and take some questions.
Thank you, John. Tony, I think we are now ready to open it up for some questions.
Earnings Call Part 2: