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AT&T Inc. (NYSE:T)

Q1 2010 Earnings Call

April 21, 2010 10:00 am ET

Executives

Brooks McCorcle – Senior Vice President, Investor Relations

Richard Lindner – Chief Financial Officer

Analysts

John Hodulik - UBS

Jason Armstrong - Goldman Sachs

Simon Flannery - Morgan Stanley

Christopher Larsen - Piper Jaffray

David Barden - BofA Merrill Lynch

Jonathan Chaplin - Credit Suisse

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the AT&T first quarterly earnings release 2010 conference call. (Operator Instructions) I would now like to turn the conference over to our host, Senior Vice President of Investor Relations for AT&T, Brooks McCorcle. Please go ahead.

Brooks McCorcle

Thank you Rich. Good morning everyone. Welcome to AT&T’s first quarter conference call. As Rich said this is Brooks McCorcle, head of Investor Relations for AT&T. And on behalf of everyone at our company we appreciate your interest and it’s really great to have you with us this morning.

Joining me on the call today is Rick Lindner, AT&T’s Chief Financial Officer. Rick will provide an update with a perspective on the quarter and then we’ll take your questions.

Let me remind you that our release, investor briefing, supplementary information and the presentation slides that accompany this call are all available on the Investor Relations page of the AT&T website. That’s www.att.com/investor.relations.

I also need to cover our Safe Harbor statement which is on Slide 2, and that says that information set forth in this presentation contains financial estimates and other forward-looking statements that are subject to risks and uncertainties, and actual results may differ materially. A discussion of factors that may affect future results is contained in AT&T’s filings with the Securities and Exchange Commission. AT&T disclaims any obligation to update or revise statements contained in this presentation based on new information or otherwise.

This presentation may contain certain non-GAAP financial measures. Reconciliations between the non-GAAP financial measures and the GAAP financial measures are also available on our website at www.att.com/investor.relations.

Before I turn the call over to Rick, let me quickly call your attention to Slide 3, which provides a consolidated financial summary. Before a previously disclosed non-cash charge, relating to the taxability of retiree healthcare subsidies, first quarter EPS was $0.59, which was up 11.3%. First quarter consolidated revenues grew year-over-year to $30.6 billion. That was supported by a double digit increase in wireless service revenues, continued mid-teens growth in strategic business products, and further AT&T U-verse gains. Consolidated margins improved both sequentially and year-over-year. We had substantial margin expansion in wireless, and wireline operating income margins were stable sequentially, reflecting solid execution in terms of our cost initiatives.

Finally, although down slightly from the first quarter a year ago, cash flow continues to be strong with cash from operating activities totaling $7.3 billion and free cash flow at $3.9 billion for the quarter.

With that quick overview, I’ll now turn the call over to AT&T’s Chief Financial Officer, Rick Lindner. Rick?

Richard Lindner

Thanks Brooks and good morning everyone. It’s good to have you with us this morning. Before we cover detailed results as we typically do, I’d like to start with a few comments on the quarter overall. The highlights are on Slide 4.

First of all, I’m pleased to be able to say that we had a terrific start to the year. Earnings per share before the non-cash charge was up double digits; consolidated revenues were up; margins expanded; cash flow was strong, and I think all of these reflect good execution on the plans that we outlined for you in January. Our wireless business continues to perform at a high level. We had 1.9 million net adds with continued strength in smart phones and connected devices. Wireless service revenues were up double digits; churn improved to best ever levels; postpaid ARPU grew again for the fifth consecutive quarter. And most important, even with continued strong iPhone activations we delivered substantial service wireless margin expansion to 44.5%.

The other area where we gained traction is in wireline consumer. In fact, we achieved our first sequential improvement in consumer revenues in several years. Our U-verse platform continues to scale and we had a nice rebound in broadband net adds. As a result, consumer IP revenues, that’s U-verse and broadband combined were up better than 32%.

In our business markets we’ve begun to see some early signs of improvement in the economy. Revenue and volume trends have begun to stabilize and sales of our most advanced services continued to be strong. Across the operations, we also continued to execute well on the cost side and that has helped us deliver strong margins and cash flow. So on a number of fronts, a positive quarter and a good start to the year.

Regarding the broader economic environment, in January we said that as we looked at 2010, we modeled a continuing but generally slow recovery. And while the economy has begun to show some encouraging signs, we continue to operate with that as a general framework. So that means we’re running the business in a way that allows us to deliver solid results that are not dependent on a quick economic upturn. And because we focused on cost improvement and margins, we believe we’re well positioned with good leverage when we do start to see meaningful improvement in the macro economy.

So with that as background, let’s get into the detailed results, starting with consolidated revenues on Slide 5. Consolidated revenue trends have stabilized over the past few quarters and as Brooks mentioned, in the first quarter they totaled $30.6 billion, up $78 million versus first quarter a year ago. The key drivers are first, wireless results that continue to be very strong; second, AT&T U-verse growth has driven steady improvement in our consumer trends; and third, business revenue comparisons are improving and we’re seeing signs that economic impacts may be moderating. Our overall revenue mix continues to undergo a substantial transformation, increasingly weighted to wireless, to wireline data and managed services.

In the first quarter, 69% of revenues came from these categories, and that was up 900 basis points over the past two years. And taken together in the first quarter, these revenues grew 7%. This shift in mix reflects broader industry and technology changes, but also the fact that we’ve moved aggressively to position our business out front in key areas, like mobile broadband, as well as advanced business products and IP based services.

So let’s move to wireless. Our wireless results start on Slide 6, and I’m pleased to say that our mobility business delivered another strong quarter. Wireless service revenues were up 10.3% to $12.8 billion. That was driven by continued strong subscriber gains, with 1.9 million net adds, our best ever first quarter total. It was led by an increase in connected device subscribers of more than 1 million, which we’ve broken out for you starting this quarter. Things like e-readers, alarm monitoring and a host of other emerging products. As you know, some time ago we created an organization devoted to growth in the emerging device space. And as you see in our results, those efforts are starting to pay off. While ARPUs and connected devices are typically low, the churn and margin characteristics are quite attractive. And it’s an important growth area. We believe the range of devices that will be connected wirelessly in the future will be both broad and deep.

Postpaid net adds for the quarter totaled 512,000 and with continued migration of the base to integrated devices. Our churn levels also continued their steady trend of improvement. Total churn was down 26 basis points year-over-year to 1.3%, and postpaid churn improved to 1.07%. Both of those are at best ever levels for us.

Customers are choosing AT&T and equally, if not more important, more customers are choosing to stay with AT&T than ever before. Beyond subscriber gains, the other major driver of wireless revenue growth is ARPU expansion. We lead the industry in postpaid ARPU, which was up again this quarter by 3.9%. This was our fifth consecutive quarter with year-over-year growth in postpaid ARPU. The growth in postpaid ARPUs been powered by mobile data. The details are on Slide 7.

In the first quarter, postpaid data ARPU increased nearly 22%. Wireless data revenues were up $947 million over the last year to now more than $4 billion for the quarter. Mobile data is a $16 billion plus annualized revenue stream for us, a run rate that’s doubled in just over two years. To drive this kind of growth, you need three things. First, a great data network. We carry about half of all the wireless data traffic in the United States today, and as we’ll discuss in a minute data throughputs have stepped up significantly with our HSPA platform. Second, you need a broad data capable device lineup. We have that today, and you should expect to see us continue rolling out terrific devices as we go through this year. We have twice the number of smart phones on our network as any of our competitors. And third, you need rich access to applications, again an area where we lead.

In the first quarter, data adoption was strong. We added 3.3 million 3G postpaid integrated devices to our network to reach 26.8 million in service. This included 2.7 million iPhone activations, more than a third of them new to AT&T. Customers with data plans grew nicely as well, up 2 million in the quarter and 8 million over the past year. And in both of these areas we still have a lot of running room. Only half of our postpaid subscribers have integrated devices and our inflow continues to expand, running above 70%. Our integrated device customers are high quality customers. ARPU for integrated devices is 1.7 times versus other devices. Roughly 60% of our integrated devices are on family plans, and another third are on business related plans. So they’re very sticky, with churn levels well below our averages.

Data usage trends also continue to expand. In the first quarter, text messages were up 52% to more than $140 billion. And multi-media messages more than doubled over the past year. Mobile broadband continues to be in the industry’s number one growth driver, and it’s an area where we’re very well positioned.

Now let me give you a quick progress report on our major wireless network initiatives. The details are on Slide 8. In our last earnings call in January, John Stankey, our President and CEO for Operations, shared with you our network plan and provided a look at key performance metrics over the previous 90 days. We’ve continued to make good progress through the first quarter, the first steps in an aggressive program for the year; adding an additional radio network carrier, adding cell phone towers, building and upgrading high capacity antenna systems, and building our fibre backhaul. All in, capital spending to support wireless was up over 30% year-over-year. As we’ve explained, implementing these network enhancements does cause some variations in performance at particular locations day-to-day, so the lines on some of the charts are not smooth, but the trends are clear.

First, with HSPA 7.2 software turned up nationwide in January and with our backhaul deployment taking shape, we’re seeing a significant step up in data speeds. Company wide, our 3G data download speeds are up 25% versus a year ago based on internal data and up 14% in just the past 90 days. In areas where we’ve completed the backhaul in support of HSPA 7.2, internal data is showing speed improvements in the 32% to 47% range, and that’s very encouraging.

On the voice side, we continue to have very high levels of call retainability nationwide based on independent tests, and we’re seeing improvement in voice metrics in New York where we have both very high data volumes and a high concentration of data users. Over the past 90 days internal data shows that 3G dropped call performance has improved in Manhattan and in the larger metro area. We’ve added third carriers for mid-town and downtown, supporting increased capacity in these high traffic areas. Our 3G voice composite quality index, an internal metric which measures both connectivity and retainability, moved up 10% in the quarter in the New York metro area overall, and in Manhattan that index moved up 47% quarter over quarter. In terms of download speeds, in Manhattan we’re seeing average speeds that are close to our nationwide average.

Looking ahead, we continue to execute our network plan, adding additional third carriers, adding fibre backhaul and Ethernet to cell sites in support of HSPA 7.2, as well as our migration to LTE. Deploying and building in venue solutions where appropriate. Plus we’re doing more with WiFi. In fact, our WiFi customer connections were up more than 5 times year-over-year. With our GSM technology foundation, a seamless path through HSPA to LTE, we’ve got a terrific technology path going forward for customers, and we believe the best path forward to capture the next wave of wireless growth.

Now in addition to subscriber and top line growth and the progress we’re seeing on our network initiatives, wireless margins also expanded this quarter. Slide 9 provides an overview. Our first quarter wireless service EBITDA margin was 44.5%. That’s up 380 basis points sequentially and up 200 basis points from the year earlier quarter. This reflects strong revenue growth, the high quality of our subscriber base, reduced churn, as well as cost improvements that we made in the network and support functions for wireless.

As we announced a couple of weeks ago, starting with this quarter we changed how we account for certain inter-company transactions as part of our effort to manage the business from an external customer perspective. This did have an impact on segment margins, increasing wireless EBITDA margins by 160 to 190 basis points in most periods. But it did not change the margin trends. And the comparisons on this Slide, as well as the comparisons we provided to you as part of our earlier disclosure, are all restated for this change. Longer term, with continued growth in service revenues and ongoing cost initiatives, there is additional opportunity to continue to expand wireless margins.

Now I’d like to turn and cover our wireline results, starting with consumer trends which are on Slide 10. Again this quarter we’re seeing clear evidence that U-verse is driving a steady transformation of our consumer business, and it’s helping us deliver our first sequential growth in wireline consumer revenues in quite some time. Our U-verse customer base continues to scale with 231,000 U-verse TV adds in the quarter to 2.3 million, and roughly 1 million over the past year. Broadband and U-verse voice over IP attach rates remain very high. More than three-quarters of U-verse subscribers have a triple or quad play bundle with us. And U-verse revenues continue to grow with more than a $3 billion annualized run rate, and based on current trends we should exit the year with annualized U-verse revenues exceeding $4 billion.

Today we offer 120 HD channels, more than our cable competitors in all markets where we compete, and we continue to innovate. Innovate with enhancements like our recently announced 24 megabit downstream Internet service in every U-verse market. And U-verse mobile remote access, which lets customers use their wireless handset to navigate the program guide and manage DVR recordings. In the first quarter, wireline IP revenues, that’s U-verse services plus non-U-verse broadband, grew better than 32%. These products now represent 37% of total consumer wireline revenues, up 960 basis points over the past year. As a result, we delivered our ninth consecutive quarter of year-over-year growth in revenues per household, and our fourth consecutive quarter of improved year-over-year consumer revenue comparisons.

We’re now more than three-quarters of the way through our U-verse build and we’re on track with our plan to reach 30 million living units. And as U-verse scales, we’re starting to see meaningful directional changes in our overall consumer business.

Next, let me provide a quick update on wireline business trends, which are on Slide 11. In the first quarter we saw continued improvement in business revenue trends, and that reflects good sales performance and some early signs of stabilization in business markets overall. Key economic metrics, like industrial production and net business formations, have begun to improve. We also see early signs of improvement in our own metrics. We had our first sequential growth in enterprise LD revenues in six quarters. We’re seeing lower, company managed wireless disconnects, and better business access line trends. We posted our best ever year-over-year business revenue comparisons in four quarters. And enterprise business revenues, taking out equipment, were nearly flat sequentially. All of these trends are encouraging. That said, I would caution that it’s still early in terms of talking about a recovery in business revenues, and too soon to gauge the timing and the shape of the improvement to come.

We continue, however, to drive solid growth in our most advanced business products. Revenues from strategic business products like Ethernet, virtual private networks, application services were up nearly 15%. Plus we continued to do well selling wireless in the business space. Looking ahead it’s clear that the ability to build unified solutions for business customers that include wireless, mobile broadband in particular, will increasingly be a key differentiator for customers across all business categories, and I think that’s a big positive for AT&T.

Our priorities in the business space have not changed. We continue to invest to expand our network reach and to strengthen our product portfolio. We have been disciplined on costs to maintain stable business margins, and both of these things will provide leverage as the economy recovers.

Now I’d like to take a look at margins and cash flow for the quarter, and the margin comparisons are on Slide 12. We told you in January that we expected to deliver stable to improved consolidated margins this year, with further wireless margin expansion and a disciplined focus on cost initiatives across the business. In the first quarter I think it’s fair to say that we delivered what we said we would. Our consolidated operating income margin was 19.6%. That’s up 80 basis points versus first quarter last year, and a 390 basis point improvement sequentially. This reflects solid performance across the company. Wireline operating expenses were down 2.8%, with major cost initiatives on track, including continuing consolidation of operations as we make changes to improve processes.

In wireless, we made good progress in areas such as billing, customer care and network operations. And across the business bad debt expense continues to trend favorably and total force was down by more than 6,000 in the quarter. Company wide we have a commitment to operate as One AT&T, which first means delivering a single, seamless experience to customers for all of our wireless and wireline products. And as we consolidate and integrate operations to do that, we also have continuing opportunities for cost efficiencies.

Along with solid margins, we also continue to deliver strong free cash flow. Our cash summary is on Slide 13. In the first quarter, cash from operations totaled $7.3 billion. Capital expenditures were $3.3 billion, including a 34% year-over-year increase in wireless capital. As we outlined for you in January, we continue to expect full year capital investment in the $18 to $19 billion range. Free cash flow before dividends was $3.9 billion, and dividend payments totaled $2.5 billion. In terms of other uses of cash, our debt is down almost $5 billion over the past 12 months and we have the flexibility to retire additional debt as it comes due while continuing to invest in the business and returning substantial value to shareowners through dividends.

I’d like to close with a quick recap on Slide 14. When you look at our business and when you look at the opportunities ahead, we believe there are a number of things that set AT&T apart in this industry. First, we have a strong wireless business that is setting the pace in terms of ARPU growth, revenue growth and margin expansion. Wireless service revenues were up double digits, churn reached best ever levels, and we delivered a substantial step up in margins with further margin expansion opportunity ahead. Most important, we’re well positioned to capture the next wave of wireless growth. We lead in integrated devices. We’ve established ourselves as the leader in connected devices, a significant growth area for us. And we have a terrific opportunity as we continue rolling out the backhaul to deliver significant speed increases for our wireless customers. We’re seeing excellent throughputs already and we’re aggressively investing for the next generation of growth in mobile broadband.

Our U-verse platform is gaining scale and is positively impacting our consumer trends. We expect continued solid U-verse growth throughout this year. We have the industry’s premier business capabilities and we’re hopeful that we’re seeing the early signs of stabilization in business markets. We have substantial opportunities ahead on the cost side of our business with continuing cost improvement opportunities that will both support margins and drive strong cash flow. And we have a proud history of returning substantial value and cash to our shareowners. So we’re off to a great start this year with excellent first quarter financial results and we continue to have a positive long-term outlook for the business.

With that, Brooks, that concludes our prepared remarks. I think we’re ready for some Q&A.

Brooks McCorcle

Okay. Rich, I think we can open up the queue.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from John Hodulik – UBS.

John Hodulik - UBS

Just a quick question on the wireless margins. Obviously it’s a really strong quarter and given the guidance was in the low 40s and you sort of touched on it a little bit today saying that, you know, it seemed to be more in the medium turn, there could be some upside to this, but I guess the question is is this the high water mark for the year as it relates to wireless margins? Or how do you expect the rest of the year to trend, especially with the potential iPhone refresh hitting in mid year as it has the last few years?

Richard Lindner

Sure John. We had not changed our overall guidance for wireless margins although the accounting changed that we talked about will drive an increase in those margins as we report the wireless segment by somewhere around 160 to 180 basis points or so. And so our outlook for the business hasn’t changed, that 160 to 180 basis points will ride on top of that. But as we look at it, you know, our expectation is for this year still to be in the lower and characterize it as the lower 40% range. In other words it’ll be higher with the accounting change but probably still in the same general vicinity that we guided toward, and the same thing going forward. We see improvement beyond 2010, certainly up into the mid 40s and again will be more toward the upper end of that range with the accounting change we talked about.

Going forward, you know first quarter, the last couple of years at least has been a little higher in wireless margins just because you tend to have following the holiday season you tend to have a little bit lower level of gross adds and upgrades in the postpaid space. And as we go forward in the rest of this year we will have some new product launches that we’re very excited about. We’ll have some product refreshes that we’re excited about. And those will most likely drive some higher upgrades and hopefully drive some higher gross add activity as well, so that may impact margins a bit. But we’re still in margins, both in wireless and wireline, we’re still executing as we talked about a lot of plans as we integrate our operations under the One AT&T initiatives, and so we’ll see benefits from that in both of our segments as we go forward in the year. And you saw some of that in the first quarter as we mentioned, force both announced reductions that we had made as well as just normal attrition came down about 6,000.

Operator

Your next question comes from Jason Armstrong - Goldman Sachs.

Jason Armstrong - Goldman Sachs

A couple of questions, maybe first just on the balance sheet. Rick, you’re closing in on the one-and-a-half times leverage targets. What are your thoughts from here around buyback timing and potential levels? And then second question just related to the wireless business, as we think about postpaid versus prepaid I think as we look at the net industry forecast for this quarter your results included, there’s sort of an expectation that we’re going to show a significant shift towards prepaid in terms of where the growth is coming from. I’m wondering along those lines are you comfortable with your positioning right now in prepaid or should we expect you to engage to a greater extent in the second?

Richard Lindner

Good morning Jason. Good questions. I think first of all on the balance sheet side, you know our view hasn’t changed at all. We are making good progress in bringing leverage back down into our targeted levels and we’re getting close. However, we’re also hopeful that we’re getting close to approval for the acquisition of the former Alltel properties from Verizon. That’s been pending for some time, regulatory approval. So that will push the metrics back up a little bit. But all that being said, the plan is still the same. We want to drive the credit metrics back within our target ranges and then we’ll take a look at where we are and the opportunities and determine what we want to do from a buyback perspective. So nothing really changed there.

In terms of wireless, you know what you’re seeing I think in this quarter, and its consistent with to a degree I think what people were expecting as we go into this year, is some shifting in the wireless business in terms of where revenue growth is coming from. And certainly our expectations for this year is that postpaid customer growth, postpaid net adds, will come down from prior levels but we’re seeing a continued shift then and revenue growth being driven by wireless data revenues, by penetration of integrated devices, and we’re seeing just kind of the tip of the iceberg I think with the opportunity on connected devices. And so as a result, what you see in this quarter is even with postpaid net adds being down, we’re delivering a wireless service revenue growth that’s above 10% for all of the reasons that I mentioned.

On top of it, in the prepaid part of the business we have over the last year been making some changes and tweaks to our prepaid offerings. We’ve also made some changes and tweaks to offerings within our reseller category that are primarily prepaid in nature. And as a result, what you saw this quarter is continued growth in the reseller category, but also small but positive growth in prepaid. And when you look at the prepaid trend over the past several quarters, churn has come down dramatically and the net add trend there has improved. So we’ll continue to tweak those offers in the marketplace and continue to work to drive some growth in those categories.

A couple of things that we won’t do is we won’t chase growth that we feel is not profitable and we won’t do things that could bring a significant impact or a negative impact to our postpaid business. And that’s still to a large degree where our focus is. And there’s still a lot of opportunity there. You know we’ve reached a point where about 50% penetrated with integrated devices in the postpaid base, but when you step back and you look at the sales for the quarter and by sales I mean looking at what customers are buying both in gross adds and in upgrades, we’re at or above 75% in terms of the sales activity there in integrated devices. So still a lot of opportunity there.

Operator

Your next question comes from Simon Flannery - Morgan Stanley.

Simon Flannery - Morgan Stanley

If we could turn over to the fixed side for a minute, you posted some good numbers on the DSL side relative to expectations, a turnaround from some of the recent trends that we’ve seen. Can you just talk a little about was there anything specific that you were doing there? And then talk more about the economics. What’s going on with broadband ARPUs generally and profitability on the U-verse side as this reaches scale?

Richard Lindner

Sure Simon. Good morning. First of all, in broadband in total we had a nice rebound this quarter and that reflects certainly continued growth in the U-verse platform and it reflects some first quarter seasonality that if you look at the last several years that you see. But what it also reflects is the fact that across our broadband product set, churn rates are down. And we did have better performance in DSL and I think to a large degree that reflects the fact that we’re offering a very good set of options for customers these days across our footprint. So customers, no matter where they are, they have the option with broadband to bundle a video product, either U-verse or Direct TV. They’ve got the option to bundle a voice product. And we on top of that give them the opportunity to bundle with broadband, either wired or wireless voice or both. We’re seeing good traction in voiceover IP in our U-verse footprint. And we’re also increasing speeds in broadband, so this quarter for example we implemented across our U-verse footprint a 24 megabit download speed in our broadband product. And outside of the U-verse footprint, in many areas we are offering DSL speeds that are at the 6 and 10 megabit levels.

And so when you put all of those together, I think we’ve just got a good overall product set that appeals to a broad range of consumer customers out there. Beyond that I would tell you there wasn’t anything specific in terms of what we did in broadband this quarter.

Simon Flannery - Morgan Stanley

And on the ARPU and profitability?

Richard Lindner

Oh, on ARPU and profitability we are seeing increases in broadband ARPU in consumer, particularly. And that simply reflects the fact that customers are continuing to migrate up in speed. So we’re currently at about 59% I believe of our consumer base that are buying 3 megabit speeds and above from us. And we expect that to continue. We expect as applications and customer demand and needs continues to increase that we’ll see customers migrating up in speeds, and so there’s ARPU opportunity there. And as you would expect, particularly in that kind of product as you drive higher speed higher ARPU, you’re also improving profitability.

On the U-verse side of things, you know one of the things I’ve started looking at in the last quarter or two is when you look at our U-verse customers in total and the products that they’re buying, and when you step back and you look at the recurring margins in those customers, the recurring revenues and expenses, we’re driving profitability levels at an EBITDA basis that really is equal to or better than our overall wireline margin levels. And obviously what creates in U-verse some dilution to margin and earnings then is the acquisition and the installation costs associated with those customers. But you know the plan going forward is we’re not going to slow down with U-verse. We’re going to continue to try to drive good growth in the U-verse platform in video but also in broadband and voiceover IP, and we’ll continue to do that throughout this year.

But over time as those installation costs just naturally become a smaller piece of the overall U-verse revenue stream, we’ll start to see then the lift in improvement and profitability there. But I have been encouraged by the fact that when I look at those recurring revenues and margins, that they’re at a reasonable level today and when you look at the trend they’ve been growing pretty nicely over the last few quarters.

Operator

Your next question comes from Christopher Larsen - Piper Jaffray.

Christopher Larsen - Piper Jaffray

Actually two follow on questions. First to follow up to Jason’s question on the balance sheet, how do you think about dividend increases versus share repurchases given the tax change that sounds very likely this year? And then on the cost side you gave great detail on the U-verse, I mean should we expect continued wireline margin improvement from this point, both as revenue trends begin to improve and you start to hit that inflection point on the U-verse? And then a last question of my own I guess, can you tell a little about your thoughts on the 3G footprint, what sort of percent of pops do you feel like you want to cover with full 3G versus edge?

Richard Lindner

Chris, good questions. Let me address the dividend question first. As you know we contemplate dividend increases as we get toward the end of the year. And so as part of that we certainly look at projections for the business in terms of cash flows supporting that dividend and we consider changes in the environment like tax law changes. But frankly, we’ll wait until we get closer to that timeframe and kind of see how everything in the environment shakes out before we make any determinations there.

Putting any tax issues aside, though, what I would tell you is that we do believe that a strong and a growing dividend is a key element of how we provide returns to shareowners. So in terms of use of cash that has traditionally been a much higher priority for us and share repurchase has been a tool and a vehicle we’ve used in cases where we’ve gone through periods where we have excess cash and we’re at, you know, comfortable levels in terms of our balance sheet leverage. And so it was a way to adjust and modify our capital structure. But having said that, as we get through the rest of this year and as we see how environment changes and how it might impact our shareowner base, we’ll consider all of those options.

Wireline margins, you know, is a balancing act right now in all honesty, because we have products that are legacy products like wireline voice that are declining, but they’re very mature products with not a lot of burden from installation or acquisition costs, so they have high margins. And the products that are the future of the business are growth products generally in the area of IP base service and managed services. There are more acquisition costs certainly associated with some of them like U-verse, but over time as those products scale they will grow in margin.

So we’re going through this transition and to balance it through this transition, that’s why we’ve been very proactive and very aggressive on the cost side of our business, and very proactive in trying to consolidate our operations that underlie and support both wireless and wireline, this set of One AT&T initiatives that we talk about. We’ve been very proactive in taking costs out of the business there and very proactive in taking costs out of the business in areas where we’re supporting services that are declining. And we’ll continue to do that.

I do believe we’ve got an opportunity to keep margins by a combination of all of those things, keep margins in wireline at a fairly stable level as we go forward in the following quarters in the wireline business and longer term, and I do think of this as longer term, I think if we get some lift in revenues and lift from the economy there is some upside to that.

And I’m sorry, I forgot the last question.

Brooks McCorcle

3G.

Richard Lindner

Oh, the 3G footprint is, you know we’re continuing to expand that footprint and you know we’ll have 3G coverage in virtually all areas that we serve at the same time as we’re moving into expanding the 3G capability through HSPA 7.2. And then beginning to trial and plan and move towards LTE. It’ll follow the normal network progression we’ve had with upgrades to the data network. I don’t have a specific pop number for you at this point.

Operator

Your next question comes from David Barden - BofA Merrill Lynch.

David Barden - BofA Merrill Lynch

Two questions if I could, guys. Rick on CapEx last quarter you predicated the guidance for an increase in spending on kind of a regulatory and an investment climate that was supportive of investment. It looks like CapEx this year in the first quarter was flat to slightly down. Could you talk a little bit about your perspectives now on whether the climate is supportive of making those investments and when you think they’ll come? And the second question was just on the wireline business generally, sequentially revenues were down about $180 million and the EBITDA level was also down about $180 million, so we saw almost all the revenue decline hit the margin line. And I was wondering if you could talk a little bit more about how we should think about that cost dynamic versus revenue as we start to see the economy kind of come back as you seem to be suggesting.

Richard Lindner

Sure David. Well first of all on the CapEx front, overall capital expenditures as you said were about flat with first quarter last year. We were up in wireless, down a bit in wireline and the reductions there had more to do with kind of demand level for services, services like high capacity circuits and so forth. We also had in the first quarter I would tell you a couple of areas where we had some supply chain and vendor issues that impacted some network components, not huge numbers but impacted the total numbers a little bit. And first quarter is always a little lower for us because of, you know, certainly a large portion of our cap spend, our portfolio capital projects, new portfolio capital projects which get approved and get into the pipeline kind of late in the prior year always take a bit of time to ramp up. So you’ve got all of those factors.

At this point our outlook for the year in terms of CapEx is the same as we gave you in January, a kind of $18 to $19 billion range, a little rebalance in the portfolio with a couple of billion dollars more spend supporting the wireless business offset by some reductions in spend in wireline. No change there.

On the regulatory front, I think we continue to have good I think positive productive dialog with regulators. They obviously have laid out some objectives and plans that they will move forward on and it will create a number of different notices and proposed rule makings and activities on the regulatory front. We’ll continue to work with them on all of those. At the end of the day, I do believe at the end of the day they understand and agree that in order to achieve their objectives it’s going to require an environment that supports capital investment and the ability for carrier to earn a return on that investment. So I think in that respect we’re hopeful.

You know on the wireline margin front, I wouldn’t get too concerned overall I guess with quarter-to-quarter changes in wireline margins, even in the range and magnitude you spoke of because there is always some quarter-to-quarter seasonality, and frankly as large as that business is, you know, there are just some issues and adjustments that occur from quarter-to-quarter that can impact those comparisons. But as I said earlier I think overall in the levels that we operated in around the first quarter, I think we will be able to maintain wireline margins throughout the year at a fairly stable way kind of in those ranges. And then longer term, again we’ll work to increase profitability in the growth services which will then further solidify and hopefully give us some upside with some revenue growth on margins and wireline.

Brooks McCorcle

Rich, I think we have time for one more question.

Operator

Your last question comes from Jonathan Chaplin - Credit Suisse.

Jonathan Chaplin - Credit Suisse

So just one follow up on wireless margins to kick it off. It sounds like you know the discussion, Rick, earlier was a little bit unclear. It sounds like our expectations for margin should be 160 to 180 basis points higher than they were before, so does that mean if you know you were guiding to sort of low 40s before, somewhere around 42 for argument’s sake, we should now be looking at 44? And if we were sort of focused on 45% before for where it should be longer term, we’re now focused on 47. Are those the right kind of ranges to think about? And then as we sort of start thinking about earnings trends now that we’re a quarter in to the year, your guidance was sort of a very wide range of flat to an improvement in earnings. Can you give us a little bit of more context around what earnings trends could be now that you’ve seen sort of a little bit of improvement in the economy and an upswing in enterprise? And then finally, Randall made a comment a few weeks ago about the industry moving towards tiered data pricing. Can you tell us what you’re doing internally to make the move towards tier data pricing, what has to happen for that to occur?

Richard Lindner

Sure Jonathan. Yes. First of all on wireless margins I hope I didn’t confuse everybody with the comments made earlier. Very simply our outlook hasn’t changed. So whatever you have modeled for wireless margins, with this accounting change it’s going to be 160, 170, 180 basis points higher than that. And it’s just a mechanical change. What I was trying to say is that moves the margin levels up probably still at least in the ranges that I would define as towards the lower 40s in 2010 and the mid 40s beyond that, although 160 to 180 basis points higher than what you had before.

On earnings per share I think our guidance has been to stable to improving earnings per share in 2010. Not changing that guidance clearly the first quarter and being up excluding the tax charge, being up 11% gives us confidence that you know we’re going to be able to provide some growth in earnings per share. And at the end of the day, put the guidance aside, that’s our objective. We want to grow the business. We want to grow top line revenues again. We had some top line revenue growth this quarter. That’s something that we shouldn’t just put aside. We want to continue that trend and to do that we need strong wireless growth, we need continuing improvement in both our consumer and business wireline categories.

And then we want to grow obviously earnings per share with that and with some margin expansion and hopefully grow it at faster rates than revenues. So that’s what we’re setting out to do and we’re off to a good start in this year.

On tier data pricing or pricing of any product, I won’t get into you know thoughts and strategies about making potential changes in the future on pricing for any products, but I think your question is a good one. And its one not just for AT&T but its one for the industry overall, because we’re dealing with a few factors that you have to step back and just think about. One, in wireless you’re dealing with some real limitations both from a technology standpoint and more importantly from a spectrum standpoint on capacity. And secondly, you’re dealing with an overall trend of devices and applications and services moving to a wireless environment. So that’s creating a tremendous amount of demand, particularly in wireless data. And the third factor in the environment is you’re dealing with a situation where when you look at your customer base, even customers that are using similar devices, there’s huge disparity in the amount of data that they use and the amount of capacity they consume. And so when you look at all of those things as an industry I think it will influence how in the future the pricing models develop.

And as an industry what the industry has to do is develop models that are understandable by customers, that customers you know can understand and live with, and at the same time is fair to customers in terms of the amount of a somewhat limited resource that they’re consuming. And so that’s kind of the whole thing on data pricing and it will I suspect evolve as we go forward in the industry and it’ll evolve as applications and devices continue to evolve and data traffic continues to grow.

Jonathan Chaplin - Credit Suisse

Thanks Rick.

Richard Lindner

Before we close, folks, I’d like to add just a couple of quick closing comments. In January we outlined a plan for you and I believe what you’ve seen in our results today is that we delivered what we said we would and hopefully what you see is that we delivered a little more than we said we would in this first quarter. We had a terrific start to the year. Wireless growth was excellent. Best ever churn, best ever postpaid ARPU, best ever first quarter net adds, strong data growth, and I think even more importantly we have a terrific technology path going forward to continue to deliver wireless growth. And we’re already seeing solid improvements in data download speeds and we’ve got a lot more to come there.

At the same time, U-verse and our U-verse platform continues to scale and its improved and its changing the revenue trajectory of our wireline consumer business. We have what we believe are the industry’s premier business capabilities and which we also continue to expand. And we’re seeing early encouraging signs in the business markets.

In total, as I said something not to be overlooked, our consolidated revenues were up. Our cost initiatives are on track and as a result margins expanded and cash flow continues to be strong. So it was a strong start to the year and our fundamental outlook on the business is positive. And now our job, very simply, is to continue to execute with the same kind of intensity and focus in the quarters ahead.

Before I sign off this morning I want to take just a minute to recognize someone. Gerald Ross is a person who has been on our Investor Relations team now for many years and for investors and analysts out there, you may now have met Gerald but I guarantee you you’ve seen his work because he’s the one that has written all of our press releases, our earnings releases. He’s written our earnings release presentations, our investor briefings and our presentations of a financial nature in all of our analysts meetings. He’s a real pro. He’s done a great job for us and the good news is he’s moving up. He’s moving to a new position supporting our Chairman and I just wanted to take a moment to thank Gerald for all of his efforts and his contributions over the years and wish him well.

And also I want to thank all of you for being on the call with us this morning. We appreciate you being with us and as always I want to thank you for your interest in AT&T.

Brooks McCorcle

Thank you everyone. Thanks Rich.

Operator

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.

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Source: AT&T Inc. Q1 2010 Earnings Call Transcript
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