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AT&T Inc. (NYSE:T)

Q1 2007 Earnings Call

April 24, 2007 10:00 am ET

Executives

Rick Lindner - CFO

Rich Dietz - IR

Analysts

Simon Flannery - Morgan Stanley

David Barden - Banc of America Securities

John Hodulik - UBS

Michael Rollins - Citigroup

Jason Armstrong - Goldman Sachs

Presentation

Operator

Good morning, ladies and gentlemen and welcome to the AT&T first quarter earnings release 2007 conference call. (Operator Instructions) I would now like to turn the call over to Mr. Rich Dietz. Mr. Dietz, you may begin.

Rich Dietz

Thank you and good morning, everyone. I'm Rich Dietz, and it is great to have you with us today on our first quarter 2007 earnings call. Also on the call this morning is Rick Lindner, AT&T's Chief Financial Officer. Rick will cover our first quarter results and then we will have a Q&A session.

Our release, the investor briefing, and supplementary information were issued earlier today, and as always, they are available on the investor relations page of the AT&T website. The presentation slides we will speak to on this call are also available on that same web page, www.att.com/investor.relations/.

Before we get started I need to cover our Safe Harbor statement, which is on slide 3 of our presentation. 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 these presentations, based on new information or otherwise. This presentation may contain certain non-GAAP financial measures. Reconciliation between the non-GAAP financial measures and the GAAP financial measures are available at our AT&T website.

With that as a background, let me cover our first quarter EPS comparisons, which are on slide 4. Adjusted EPS for the first quarter was $0.65. That is shown in the first column of this slide. Starting at the top and working down, reported EPS was $0.45. We reduced that by $0.04 for a gain we realized on a previously announced wireless asset transaction with T-Mobile. We add back $0.20 of merger costs associated with the BellSouth, AT&T and AWE/Cingular mergers. We also add back $0.03 associated with the effect of purchase accounting on advertising and publishing's deferred revenues and expenses.

As we outlined for you last quarter, in accordance with purchase accounting rules, the former BellSouth's deferred revenues and expenses for all directories delivered prior to the close of the merger have been eliminated. In 2007, this results in a reduction in consolidated revenues, expenses and net income, but does not affect cash from operations.

Factoring in all three items, the result is an adjusted EPS of $0.65. The EPS walk down for the year-ago quarter is in the right-hand column. In the first quarter of 2006, reported EPS was $0.37. We add back $0.15 of merger costs associated with the AT&T and AWE/Cingular mergers, resulting in an adjusted EPS of $0.52. So our reported EPS in the first quarter this year was $0.45, up 22% versus the year earlier quarter. Our adjusted EPS was $0.65; that is up 25%. Further details on the adjustments can be found on the investor relations page on the AT&T website.

With that, I will now turn it over to AT&T's Senior Executive Vice President and CFO, Rick Lindner.

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Rick Lindner

Thanks, Rich and good morning, everyone. As you have seen, I think we had a very strong first quarter. Before I cover the slides with you, let me make a couple of general comments. First as you know, this was the first full quarter of operations following our acquisition of BellSouth, with 100% ownership and consolidation of our wireless business. So it was an important three months for us in terms of transition and getting a good start on the integration work. I feel good about how we started the year. Our merger integration is on track. We had great results in wireless and earnings growth was strong. As a result, based on what we have seen in the market and what we achieved in the first quarter, I am optimistic and confident about our ability to deliver on the outlook that we shared with you in January.

Let's start with some first quarter highlights; and those highlights are on slide 6. First, our merger integration work, combined with good execution across the business, drove substantial margin expansion in both wireline and wireless.

Second, in line with our outlook, we grew total revenues versus pro forma results for 2006 and growth rates have improved every quarter over the past three quarters. That obviously reflects strong wireless results as well as improved performance in key parts of our wireline operations.

Third, broadband and video net adds were up this quarter, reflecting strong customer demand. Our merger synergies are on track, and from a timing perspective, slightly ahead of our outlook. We have ramped up our share repurchase activity. In the first quarter, we bought back $3 billion of our shares. That brings our total repurchases since the plan was announced to $5.7 billion. We now expect to complete the total planned $10 billion repurchase in the third quarter of this year. That is a quick overview.

Slide 7 shows you our earnings per share trajectory. As Rich mentioned, before merger-related items and the wireless transaction gain, first quarter EPS was $0.65. That is our eighth straight quarter of double-digit, year-over-year growth in adjusted EPS, as we continue to deliver on the multiyear outlook we reaffirmed in January.

Obviously, wireless is an important driver of this growth. Adjusted operating income from our wireless operations was up more than 80% year over year, with an adjusted EBITDA service margin of 38.9%. Strong execution of merger initiatives also drove margin expansion in our wireline results.

Slide 8 shows you our consolidated margins. Adjusted operating income margin in the first quarter was 23.7%. That is up 640 basis points versus the year-ago quarter and ahead of our target range for the year, which was 21% to 23%. Based on these results, we are raising our margin outlook for the full year to the 23% to 24% range.

There are a number of drivers behind this margin expansion. Obviously, BellSouth is included in our first quarter margins. Beyond that, our wireless business is a key driver, with improvements in revenue and ARPU as well as operating costs and churn. Finally, wireline operational initiatives and merger projects continue to yield benefits.

There has been no change to our outlook regarding financial impacts from Lightspeed this year, in that we continue to expect incremental dilution for the full year 2007 to be between $0.03 and $0.05 per share, consistent with what we told you in January. It will increase during the year as we ramp the service. At the same time, we expect to make continued progress on cost through the year as we execute merger initiatives in both wireless and wireline.

Slide 9 gives you an update on merger integration. As you see on this chart, last year, we achieved over $1 billion in savings from our SBC/AT&T integration. That is a combination of both expense and capital. It was about $300 million above our original outlook. This year, we expect that total to grow and we expect those synergies will continue to run at the high end of our original target ranges. At this point, our AT&T merger initiatives are more than half complete. This year, we have also begun to layer on savings from BellSouth. As we outlined for you in January, we expect synergies from both mergers to deliver more than $3 billion in savings this year, growing to more than $5 billion in 2008.

In the first quarter, our total cost synergies from the AT&T and BellSouth mergers totaled $900 million. Here is how that breaks out: first quarter synergies from AT&T were $600 million, about $450 million of expense and $150 million in capital. Obviously, we are still early in BellSouth execution; but in the first quarter we achieved $300 million in total cost synergies; about three-fourths of those savings were from capital, primarily due to eliminating some portfolio projects.

Leveraging our experience with the AT&T merger, we were able to quickly migrate 30% of the BellSouth mass market voice traffic in the first quarter. We expect to complete the migration of mass market voice traffic by the third quarter of this year.

It is important to note that as we are taking costs out of the business, we are also growing overall revenues consistent with the outlook we provided in January. The chart on slide 10 shows our trend line for total revenues versus pro forma results that combine AT&T, BellSouth and Cingular. This was our third consecutive quarter of overall revenue growth, with a clear ramp in growth rates. I think this demonstrates first of all, the power of our wireless results plus the consistent strength we are showing in regional business and the progress we have seen in enterprise trends; and the fact that our regional consumer revenues continue to be stable, contrary to what some may expect, driven by growth in broadband and bundling.

Slide 11 gives you an update on cash returned to shareowners. Our share repurchases in the first quarter totaled $3 billion and as I said, we now expect to complete our $10 billion buyback in the third quarter. First quarter share repurchases and dividends combined totaled $5.2 billion. For the full year, dividends plus the remainder of our share repurchase will take that total to $16 billion; more than double what we returned in 2006.

Looking at the first quarter, cash from operations totaled $4.6 billion, in line with our expectations. Capital expenditures were $3.3 billion. Our full year capital outlook is unchanged in the mid-teens as a percent of total revenues. Also, our full year outlook for free cash flow after dividends continues to be in the $4 billion to $5 billion range as we outlined in January. In addition, we continue to integrate operations and always look for opportunities to generate cash by monetizing excess assets. For example, we generated over $700 million last year and $180 million in this first quarter in real estate sales.

That is an overview of our consolidated results. What I would like to do now is turn to our operations and look at first quarter results in each of our three large segments: wireless, wireline, and advertising and publishing. Slide 12 provides a financial summary for wireless operations in the same format you are accustomed to seeing from Cingular in their quarterly conference calls. As an overview comment, I think it is clear our wireless operational and financial progress is not only continuing, it is accelerating. We reached $10 billion in total revenue for the quarter. Our wireless service revenues were up 13.5%; again, our third consecutive quarter of double-digit growth and our third consecutive quarter of improved year-over-year growth rates.

ARPU was up for the third straight quarter, driven by strong data growth. Churn continues to ratchet down. Our margins took a major step up. Our wireless EBITDA service margin expanded 450 basis points sequentially and 700 basis points year-over-year to 38.9%. Over the past 12 months, we have grown our wireless customer base by more than 6.4 million.

Slide 13 has more on our wireless margins. First-quarter margins are on the same basis as those reported to you before the acquisition of BellSouth and the consolidation of wireless in our financials. That means that any intra-company transactions have been market priced, and all wireless costs are properly booked to the wireless segment. What drove our wireless margins to new highs in this first quarter was the combination of a $1 billion increase year over year in revenues from customer growth, ARPU growth, and data growth and relatively flat cash expenses due to synergies and the leverage of the integrated GSM network.

The main drivers of cost reduction are lower churn and improvements in the network and support cost structure. During the quarter, we eliminated 36 of the 80 information technology systems that were planned for 2007. We completed the shutdown of two legacy prepaid platforms and we now have all of our prepaid customers on one go-forward platform that provides for a better customer experience at a lower cost.

We continue to migrate traffic and customers onto our network in California and Nevada as a result of the unwind of the T-Mobile joint venture. We now have 96% of our customers in those states on our network, giving them improved performance at a lower cost to AT&T.

Slide 14 shows our systems cost trends, driven by operational improvements following network integration. There are two factors here that are working together. First, we have rationalized the duplication in our network overlays, which has allowed us to decommission 4,300 cell sites over the past year. As a result, we have been able to terminate leases and T1 connections. In addition, our integration of the remaining GSM sites, plus a strong spectrum position, has provided us an efficient platform to handle future volume growth.

At the same time, as usage of our TDMA network has declined, we have started to groom that part of our network. The result, as this chart shows, is a decline in wireless cost of service as a percentage of wireless revenue from 29% a year ago to 25% in the first quarter. Going forward, we will realize additional cost improvements as TDMA sunsets and more traffic is moved to 3G, driving data growth at a lower cost.

The network is the foundation of everything we do in wireless. Network cost trends, as you see on this chart, are moving in the right direction. But at the same time, network performance has improved dramatically. Network quality and coverage drive lower churn, and slide 15 shows the details. Our postpaid churn dropped to 1.3% in the first quarter and that is down 30 basis points year-over-year and 20 basis points sequentially, to our lowest level ever. These churn improvements have comes despite continued pressure from TDMA migrations, which we estimate had about a 10 basis point impact on postpaid churn and 10 to 15 basis point impact on total churn levels this quarter.

We continue to make good progress migrating TDMA customers to our GSM network. At the end of 2006, we had 2.4 million subscribers on our TDMA network and three months later, at the end of this first quarter, that was down to 1.8 million and roughly half of those are wholesale customers. Total churn has also declined, although not quite as dramatically as postpaid. It reflects the impact of the prepaid segment, which typically has higher churn in the first quarter following the December holiday gift season. But churn is moving in the right direction, and we expect to see continuing improvement as we launch new products, as we further enhance the network, and as we move beyond our TDMA migration.

The wireless subscriber trends are on slide 16. First quarter net adds were 1.2 million. Over the past year, we have added 6.4 million customers, bringing our in-service total above 62 million. In addition to customer growth, the major trend reshaping wireless is data usage. As you see in this bar chart, the number of our active data users has grown substantially, up more than 30% over the past year from 25 million a year ago to more than 33 million. Data usage has grown even more dramatically, as entertainment options explode and data centric devices like the Blackberry 8800 which we launched in the first quarter continue to penetrate the base.

Data is a key element in our overall revenue growth as shown on slide 17. Our wireless service revenues grew 13.5% in the first quarter. Wireless data revenues grew 67%. Our wireless data ARPU was up 51% and it is now 16% of total ARPU. Postpaid data ARPU is over $9, an increase of approximately 55% year over year. Data growth, which has historically been driven by text messaging, is now seeing significant contributions from media bundles, email services, and data access.

Looking ahead, I think we are strongly positioned to be a leader in wireless data because of our 3G network, which will reach virtually all the top 100 US markets this year and because of our success in launching innovative and compelling products, some of which are shown on slide 18. We have launched a number of new 3G devices and we now have over 2.5 million UMTS users in our base. Our music strategy has been well received, as it gives customers the most alternatives in acquiring and accessing their favorite music.

We became the first wireless carrier in North America to launch the Blackberry 8800, which has a full QWERTY keyboard, built-ins GPS, a trackball navigation system, media player, and push-to-talk. We are also the first wireless carrier in the US to demonstrate a service that allows wireless phone users to easily share a live video as they talk. We expect this service to be commercially available later this year.

With our MediaFLO announcement, we are giving customers enhanced abilities to watch broadcast TV on their mobile devices. Of course, we were chosen to be the exclusive US carrier partner for Apple’s revolutionary iPhone. With new services such as these and more, along with the premier wireless network, we are confident AT&T has a terrific future in wireless.

Now let me turn now and talk about our wireline results, starting on slide 19. Wireline revenues in the first quarter totaled $18 billion. Versus pro forma results, that represents a decline of 3.2%, driven by expected reductions primarily in two categories. First in national mass markets, the old UNE-P and stand-alone long distance business where the former AT&T discontinued marketing a couple of years ago. Secondly, in wholesale where as expected, carriers are moving traffic to their own networks and UNE-P lines are declining.

Beyond these categories, our wireline revenue trends in the first quarter were consistent with and in some cases improved versus recent results. At the same time, wireline cost control and merger integration have been strong, and that has driven significant margin expansion. Bottom line on both the cost side and in terms of revenue trends for key categories, our wireline business is on target and continues to make good progress.

Now let's drill down on some of those customer categories, starting with regional business on slide 20. This has been an area of strength for us over several quarters, and in the first quarter growth moved up to 7%. The historical number shown here and throughout wireline are pro forma, combining AT&T and BellSouth results consistently in every quarter.

There are a couple things that stand out for us, I believe, in regional business. First, we continue to see strong growth in small and medium business. I think one of the keys here is that we are selling products from the AT&T enterprise portfolio. Customers like the network reliability, the security features and the bundled services we are now able to provide.

The second thing that stands out, and it may be somewhat surprising, is the fact that in regional business we continue to see good growth in both voice and data. On the voice side, access lines increased modestly in the quarter, as they have over the past several quarters, churn is low and ARPU is stable. Regional business data revenue growth came from solid advances in both transport and IP services, led by strength in managed Internet, virtual private networking, and DSL. Data makes up now about 30% of our regional business revenues.

We also continue to see encouraging trends in enterprise and the details are on slide 21. Demand is solid, data transport volumes are strong and enterprise IP services, which include virtual private networks, managed Internet services, and hosting, had strong double-digit growth as they have for several quarters. Our enterprise IP data revenues are now larger than traditional packet switch revenue, including frame and ATM. Data revenues in total our approaching 50% of total enterprise revenues and IP data revenues make up about 30% of enterprise data. That is up from 23% two years ago.

Best of all, we are winning contracts, including being awarded a place in the networks contract from the GSA and a landmark multiyear contract from General Motors worth nearly $1 billion. We have a premier global network for enterprise customers and we are expanding our capabilities with an emphasis on growth areas such as in international, wireless and managed hosting. By the end of 2007 we expect to have 38 Internet data centers deployed around the world and the AT&T global network will provide multinational companies with MPLS-based access from 155 countries via more than 2,000 service nodes.

In addition, we are beginning to integrate wireless. We have announced last week that wireless access has been added as a connectivity option for AT&T VP and business customers. We have launched a set of bundled offers that would give mid-size to large business the option of having a single monthly revenue commitment for their wireline and wireless services, and on-net pricing for wireline to wireless calling.

Another thing we did in enterprise in the first quarter is to tighten our focus regarding customer premise equipment sales, putting an emphasis on those sales that are part of higher margin service solutions. As a result, stand-alone CPE sales declined to their lowest levels in several quarters. That had an impact on reported enterprise revenues. But excluding CPE and revenues from acquired and sold assets, recurring service revenues for enterprise declined 3.4%, slightly better than a pro forma decline of 3.6% in the quarter before and declines of 5% three and four quarters ago.

As we have said before, the return to enterprise revenue growth is a process and we have taken some important first steps winning contracts, adding capabilities in key growth areas like hosting international and wireless. We are on a good path to achieve positive enterprise revenue growth during 2008.

Moving to slide 22, this slide shows our regional consumer trends and those are led by broadband. We had a terrific high speed Internet quarter, with 691,000 net adds, 90% of them consumer. Our high speed Internet connections are up 2.3 million over the past year, to reach 12.9 million in service. 42% of our DSL base takes speeds of 3 megabits or more. Our move to simplify pricing last fall has improved the product's financials. Churn is down, volume is up, and ARPU on new sales is up as well.

33.7% of our consumer primary lines also have broadband service with us and that is up from 26% a year ago. In California and Nevada, broadband penetration of primary consumer lines is now 42%. I think the best volume measure in our consumer business is revenue connections -- that is access lines, plus high-speed Internet, plus video. In the first quarter, total consumer connections increased by 402,000 as gains in video and Internet overcame declines in retail lines that were consistent with recent results. Primary consumer lines declined by 285,000 in the quarter. That compares with 331,000 in the preceding quarter and 251,000 in the year-ago quarter. Over the past year, our consumer connections are up 1.1%. Excluding a discontinued universal service fee on DSL that distorts year-over-year comparisons, consumer revenues were up slightly in the first quarter.

In addition to broadband, the next opportunity for us in our regional consumer business is video. Slide 23 gives you an update. In the first quarter, we added 187,000 video subscribers. That is bundled satellite combined with subscribers to our U-verse video service. We now have 1.7 million video subs, with 520,000 added over the past year. At the end of the first quarter, more than 5% of our consumer primary lines subscribed to a video solution from our company. I think this tells you that we can sell video.

We are working to build penetration for our U-verse service. Over the past few months we have ramped deployment and marketing. We recently expanded in both Houston and Dallas and last week we announced plans to launch in Los Angeles. At the end of the first quarter, we had 13,000 U-verse video subscribers. Our current number has grown to 20,000 up from 3,000 at the beginning of the year. U-verse installs per week ramped quickly in the first quarter, increasing from about 400 in January to about 2,000 currently. We expect that to ramp throughout the year, reaching 10,000 installs per week by the end of the year. Best of all, more than 80% of our U-verse subscribers are taking higher-end video packages and 65% are taking our highest-speed broadband service, both of which will drive revenues per customer.

Our third major segment is advertising and publishing, with highlights on slide 24. As you know, we have a large print directory business with 1,250 Yellow Page titles published annually. But also as a benefit that came from our BellSouth acquisition, we now have 100% ownership of yellowpages.com, the premier name in Internet directory services. This business is experiencing strong growth, with revenues up 56% in the first quarter versus last year.

Plus, we're pulling together a variety of local search options that begin to converge with our voice, broadband, and wireless services. Things like send-to-mobile, which lets Internet users send search results from yellowpages.com to their wireless phones as a text message. We also recently launched an optimized mobile browser interface available to subscribers of AT&T Wireless service. Last month, we launched YP411, bringing text message business search to consumer cell phones and PDA devices.

Our advertising and publishing operations produce margins approaching 50% with stable revenues and strong cash flow. They have great opportunities for innovation and integration with our other services. We believe they have a promising future.

Let me close with a quick recap on slide 25. In January, we reaffirmed our outlook. We said we would grow revenues this year, expand margins, and deliver double-digit adjusted EPS growth. Our first quarter results met that outlook or exceeded it on all counts. We posted our third straight quarter of pro forma revenue growth. Margins were up in both wireless and wireline. We posted our eighth quarter consecutively of double-digit adjusted EPS growth of 25%. We are on track with our AT&T merger integration plans and we are off to a good start with BellSouth. Best of all, we are encouraged by demand we see in the market for our products, with strong data and revenue growth in wireless, increased subscriber growth in broadband and video and steady improvement in our business segments. As always, there is more we can do and we have got a great deal of opportunity in front of us at AT&T. We look forward to delivering for you in the quarters ahead.

With that, Rich, I will turn it back to you . I think we are ready for some questions.

Rich Dietz

Okay, great. Thank you, Rick. Operator, we are ready for our Q&A session, so if you would begin the process.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Simon Flannery - Morgan Stanley.

Simon Flannery - Morgan Stanley

Good morning. Thanks very much. Can we spend a second on U-verse? It would be helpful to get some metrics around how many homes you have now built out the Lightspeed architecture to, how many you are marketing to, to get some penetration around there. How should we think about it for the rest of this year? Where are we in terms of thinking about the BellSouth build out, as well as any sort of per add or per home passed sort of metrics? Finally, any comment on franchising? Is that a limitation anywhere? Thanks a lot.

Rick Lindner

Thanks, Simon. Good morning. On U-verse, as you know, at the end of last year we had built out to a little over 2 million homes. That number is in the upper 2 million range approaching 3 million now. But as we told you, as we roll this product out and we launch markets, we are launching in a more confined area in each of the markets and then we are expanding those areas. I would estimate today, as an example, we may be marketing to 25%, 30% or so of those homes. Both of those numbers will expand as the year goes on. We will just continue to ramp, launching new markets. We expect to build out to around 8 million homes by the end of this year.

We will continue to grow the areas within the launched markets that we are selling to as we get more technicians on board and we get technicians trained, we will just continually ramp the service. As we said earlier, we expect to go from about 2,000 installs a week, which is where we are today, up to about 10,000 installs is our goal per week by the end of the year.

The franchising has not been an issue for us at this point in terms of the ramp. In fact, we continue to make good progress, particularly at the state levels. We have got the ability to launch video in roughly 50% of our states covering about 60% or so of our access lines today. We are making very good progress on the state level. In addition to that, we are working with key municipalities individually in a number of states. I don't see that as an issue that would slow the build or slow the ramp at this point.

Simon Flannery - Morgan Stanley

Anything on BellSouth, and also on the metrics of your cost per connection and so forth? Thanks.

Rick Lindner

In terms of BellSouth, we are working on plans and details for launching IP TV service in the BellSouth territory. Our goal is to get a market launched by the end of this year. We are working toward that. I would expect we will have more details on that, Simon, in the next couple of months. But that is the plan right now. We are looking at the technologies. We're looking at what they have deployed in their local plan, and how we can adapt that and use that in an IP TV infrastructure.

I think in terms of the metrics, there's not any surprises in what we are seeing. In some areas, we are doing a little bit more line conditioning than we originally expected. I think that will change over time as we continue to deploy the service. The installation time will come down. We are currently running at a little over seven hours per install, but that reflects a lot of new technicians who are very early on in the process. If you start looking at some of the technicians now that have been involved in installations for 90 days or more, their times are coming down. As we get further out and we begin to use an INID, an intelligent network interface device, that will reduce the installation times further.

I think the metrics we are seeing are generally consistent with what we expected in the project at this point. I think we are pleasantly surprised by the number of customers so far that are taking higher speed data and higher end video packages, which actually, I think, gives us some upside on the revenue and the ARPU side.

Simon Flannery - Morgan Stanley

That's very helpful. Thank you.

Operator

Your next question comes from David Barden – Banc of America Securities.

David Barden – Banc of America Securities

On the ARPU trends in wireless, Rick, now that data is 16% of total ARPU and we are still seeing growth in the low 50s, given that its momentum is continuing to grow, is there some reason to believe that we should not see some incremental element of acceleration in ARPU year over year? Pete earlier this year was talking about kind of flattish to slightly up, but starting at kind of the 1.4% level, it looks like things might get a little bit better from here on that front.

The second question was if you could do us a favor and recap the Telecom Italia situation and lay out what the international strategy is, so we aren't necessarily surprised the next time we see AT&T get involved in something.

Then the last would be just on networks. Is there any way to put a number around that being a tangible part of '08 enterprise revenues? Thanks a lot.

Rick Lindner

Thanks, David. On wireless ARPU, we are very pleased with the results we are seeing, and particularly on the data side. Total ARPU growth this quarter year over year was 1.4%, but when you start to look at our postpaid ARPU and start breaking it down into components, that 1.4% reflects some growth in the mix over the last year in resale. When you start looking at postpaid, for example, we are seeing year-over-year ARPU growth above 4%. That is very encouraging and it is being driven by data.

I think the other thing that is encouraging in data growth is the source of that growth. If you went back a year ago, I think we would have said data growth was almost entirely due to text messaging. What we are seeing today is increasingly data growth is coming from other sources. It is coming from customers buying media bundles. In other words, they are buying a bundled service that allows them a large number of text messages, multimedia messages and Internet browsing capabilities. It is coming from customers that are adopting email services, like Blackberry, on their mobile devices and it is coming from customers that are buying data-only packages for their laptops or data-only PDA devices. I would have said at one point in time data growth would expand to be maybe 20% of total ARPU. I am not certain that it won't expand beyond that based on the trends we are seeing.

I think with Telecom Italia, I would tell you that was an opportunity that we felt was worth looking at. For an equity investment there, there may have been an opportunity to work with a company that had not only a strong network presence in Italy but had network assets and presence throughout Europe. So that was basically our main interest in that asset. It was one that we felt we had opportunities to bring value to the company and we felt we had opportunities, potentially certainly to bring value to our shareowners and it was worth a look.

As we got into the transaction and we did some due diligence and got further into it, we decided it was in the right fit for us and wasn't the right thing for our shareowners, and so we have declined to move forward with it.

I think from the standpoint of our interest longer term, obviously we are interested in areas where we believe there are assets that would not just produce synergies, but would assist us in areas that provide future growth on the top line. So to the extent there were opportunities to strengthen our enterprise business and particularly to strengthen it internationally, we would certainly want to take a look at those. To the extent there are opportunities to strengthen our wireless business, which is a major source of growth, we will continue to look at opportunities there as well. I don't think there's anything more to it than that. We saw it as a somewhat unique opportunity that was worth spending some time doing some due diligence and taking a look.

You mentioned the networks contract. I think there are a couple things that we are very pleased with in terms of the future for us in enterprise. Let me mention one other first, and then talk a little bit about networks. The first is, as an example, our contract with General Motors. That is important to us because it is a large contract. It is a $1 billion contract over a five-year period with some incremental revenue growth associated with it. But it also gives us the opportunity to move into areas that we want to move in with our enterprise customers. It gives us an opportunity to work with a customer and help them to manage their networks on a global basis, migrate to an IP/MPLS-based infrastructure.

Likewise, with networks, it's a great opportunity for us, but it is difficult to quantify at this point, certainly with respect to trying to quantify a 2007 or a 2008 impact. As you know, the contract award there gives you the ability then to compete for a large volume of government contracts and spending. So, it puts us in a very good position on those contracts, but we have got to go still and win the business.

I think those two give us a lot of encouragement for what we are going to be able to do with the enterprise business going forward.

David Barden – Banc of America Securities

Thanks, Rick.

Operator

Your next question comes from John Hodulik - UBS.

John Hodulik - UBS

You have put together a nice set of numbers in terms of the accelerating revenue growth you have seen over the last year. I know you haven't given a lot of guidance on the top line, aside from the fact that there would be growth. But how should we expect that to trend over the next few quarters? It seems like a lot of the improvement has been from wireless. You have got wireless growing at an above-average trend now. But if you could talk a little bit about the gives and takes around your top line growth over the next year that would be great.

The CapEx number came in quite a bit lower than we thought. Can we get a wireline/wireless breakout? Is there any reason why it was lower than we had expected? Thanks.

Rick Lindner

Thanks, John. On the revenue growth side, our expectation is that we would like to continue that ramp up in the revenue growth. As you saw, we are seeing good trends in revenue and ARPU from wireless. That is certainly driving the positive revenue growth on a consolidated basis. But I think underneath that as well, is we have some good opportunities as we go forward in this year in both wireless and wireline. Certainly, we would expect to see continued improvements in our enterprise business as we go forward in this year.

I think we are going to see another quarter or two of revenue declines in wholesale because of the reasons we have talked about before. It is just a function of some UNE-P declines and it is a function of carriers consolidating traffic and moving traffic onto their own networks. But as we get later in this year, that will start to stabilize.

Then, we have got some exciting products coming out in both wireless and wireline. On the wireless side, obviously, the iPhone launching in June is a very interesting product for us. We're getting more and more excited about it as we get closer to launch. As I am sure you have seen, we have never had a product in 20-plus years in the wireless business that has had that much anticipation and that much buzz around it. So we are excited about that opportunity in the second half of the year for the wireless business. We are also excited about what we are seeing in video and the ability to begin to ramp now the U-verse service as we go throughout this year, which will start to give some lift to our consumer revenues.

On top of that, when you back off from our revenue growth, the thing that you have to keep in mind when you look at wireline, for example, is while we are seeing, I think, good cash flow and value from the national mass market base of legacy AT&T, it does and it has caused some reduction in our revenue growth rates as that base has attritioned out. But that base is getting smaller, and so the impacts from that will get smaller as we go forward.

Plus, we are working and will continue to work to migrate customers that are in region both on the consumer and business side into bundled services with us, so we can begin to migrate them into our retail base and begin to bundle more services with them. That is really where the future is from a wireline perspective.

A couple of interesting things we have seen in the last year related to bundling. When you look at consumer customers from a bundled standpoint, customers that are stand-alone voice customers have ARPUs in the low $40 range. As they begin to bundle and as we move them upwards to a full-quad bundle where they have got voice, data, video and wireless from us, all of a sudden that customer moves to a $250, $260 kind of monthly customer. At the same time, the churn rates are cut by two-thirds when you move from that stand-alone voice customer to a full-quad bundled customer. So those are the kinds of things and those are all things that you should expect and anticipate and we have talked about that will contribute to a ramp in revenue growth as we go forward over the next couple of years.

On CapEx, you mentioned the first quarter was a low CapEx quarter for us. That is not atypical of first quarter. But there are a couple of other things I think in the first quarter that, just from a timing perspective, caused a little bit of pause in capital spending.

One is in our wireless business there's a couple of things going on there. Number one, we have brought in Richard Burns from BellSouth to run the network organization there. As he has come into the organization it is just natural he wanted to take a review of the capital spend plan for the year and work through where he wanted to prioritize capital spending. So that has created probably a little bit of a pause in the timing of cap spend in the wireless business.

But on top of that, as we have talked about before, we have got a unique situation there as a result of the network integration. The network integration of the local networks that we completed in the latter part of last year has put us in a position where we have got a very good, dense cell site infrastructure combined with a good spectrum position, and some GSM equipment that was available after the consolidation of the networks that we can deploy. The net result of all that is it gives us the ability to grow traffic and volumes with very little capacity capital costs. I think those are the things you see in wireless.

On the wireline side, there may have been a little bit of a similar situation in the BellSouth region, where with the acquisition closing right at the end of the year, it took a little bit of time to get in and assess the capital program and get the capital program in place for the year. But in total, when you look across the business, I think we are comfortable with our guidance for the full year; and that remains mid-teens as a percent of revenues.

John Hodulik - UBS

Can you give us the split of wireline and wireless for the quarter?

Rick Lindner

Our total CapEx, as you know, was $3.3 billion. Wireless was right around $0.5 billion in the quarter.

John Hodulik - UBS

Thanks.

Operator

Your next question comes from Michael Rollins - Citigroup.

Michael Rollins - Citigroup

Just a couple of wireless questions. The first one is if you could talk about the 700 megahertz spectrum auctions, and just give us some perspective on how you look at your spectrum position, and how you think that auction should even develop, if you have a view going into it, with I think a vote coming up soon on how the auction is going to be shaped.

Secondly in terms of the competitive environment, how are you seeing rate plan price competition out there? How do you see the subprime market evolving as it affects your customer base? Thanks.

Rick Lindner

Thanks, Michael. On the 700 megahertz auctions, we are going to do our typical analysis and review in terms of a strategy and a plan for how we would participate. In terms of looking at it as spectrum that would be used in our wireless and our mobile wireless operations, there I would expect we would look at it the same way we did in the last spectrum auctions which is simply to look at a forecast of the business and the traffic, by market, with and without that spectrum and then determine how that impacts our capital expenditures that would be required to support various volume levels. That in effect determines the value that we place on that spectrum in the auction. So I would expect us to take there a similar approach. This spectrum, with its propagation characteristics, potentially could have some other applications but we are still early in the analysis of that.

On the rate plan side, I think pricing and rate plans overall have been fairly stable. We have seen a little bit of move in a couple of areas, carriers going to some bundled pricing that includes unlimited text messaging, for example. But for the most part, the rate plans have been relatively stable. We have seen beginning in the fourth quarter and going through the first quarter, I think we have seen a little more aggressive pricing environment in the market on devices and handsets. So we will have to see how that continues throughout this year because that obviously can have some impact on margins.

In terms us of the subprime market, I think some of the local carriers with unlimited products, the MetroPCSs, are gaining some share. I think their share gains tend to come out of prepaid and some low-end postpaid segments. But it really still is a niche product in terms of the network quality and the coverage and the segment of the customer base that they are going after.

Michael Rollins - Citigroup

Thanks very much.

Operator

Your final question comes from Jason Armstrong - Goldman Sachs.

Jason Armstrong - Goldman Sachs

A couple of final questions. Corporate free cash flow projections for the year. You have left the guidance where it was previously. You have got good momentum in the operating margins, where you raised guidance, obviously tight reins on the capital spending side. Can you provide some more color on what is preventing you from taking up the free cash flow guidance at the consolidated level?

A second question specifically on the wireless margins, a substantial step up, obviously, in the margins this quarter. In helping us think through the trajectory from here, you talked about a number of other initiatives on the cost side that could drive further improvements over the course of '07. So as we think about the further improvements, is this quarter the floor that we build off of or are there things specific to this quarter, maybe the lower gross add number or something else, that limit this as a starting point for the rest of '07? Thanks.

Rick Lindner

I think first of all on free cash flow, we will continue to evaluate guidance as we go through the year. The first quarter is always a very low free cash flow and a low operating cash flow quarter for us for a variety of reasons. But first quarter contains all of our annual employee incentive payments, annual bonuses, long-term compensation. It also includes typically a pretty significant reduction in accounts payable. A lot of things that in our business, maintenance contracts, and so forth that tend to be on an annual basis come up for renewal so those payments go out. In addition, this year, we had severance, change in control payments, and we had all of the costs associated with the BellSouth deal because it closed December 29, all of those cash payments went out first quarter.

I think as we go forward in the year, we will see how operating cash flow develops. We will see how the CapEx trends continue. I would like to get another quarter or so and see where the results are before we start making changes to guidance. As we have said before, at this point we expect our CapEx guidance to be unchanged. That we will beat that guidance for the year. Our operating cash flow in the first quarter was essentially on our expectation, so I didn't have a trigger at this point to change anything from a cash flow perspective.

In terms of wireless margins, we were really pleased with the step up in the wireless margins this quarter. I would tell you that roughly of the 700 basis point increase or so, 50% or more came from cost of service. So it came from network costs, access costs, moving traffic from the T-Mobile network back to our network in California, those kinds of things. 30% or so came from savings that continue to be merger-related in areas like IT and billing and customer care, G&A kinds of areas. Then there was some margin improvement as a result of having year over year a lower level of gross adds, particularly in postpaid, but that was a fairly minor part of it year-over-year.

I think going forward, we are going to continue to have some improvements in the network areas as we go through the year. We're going to continue to have some improvements in the G&A costs as we go forward this year. But I think really the next big step function improvement, particularly on the network side, comes when we sunset the TDMA network. I think what we will see going forward in this year then is probably more marginal improvements. But we have got the opportunity next year then for a bigger step function as we sunset TDMA.

The only other thing on wireless margins which is just add little bit of a wild card, we have to just see how it develops, is the comment I made earlier in terms of how the market develops for handset pricing, advertising promotions, the customer acquisition costs. If I see any potential pressure to the business going forward this year on margins, it is more on the acquisition cost side than it is on network or G&A.

Jason Armstrong - Goldman Sachs

Great, thanks, Rick.

Rich Dietz

That will conclude our Q&A session. I'd now like to turn it back to Rick for some closing comments.

Rick Lindner

Thanks, Rich and I would like to thank all of you for being on the call with us today. We do appreciate your interest. As we said, this quarter reflects our first three months of operations after BellSouth. I hope, as you have seen, we are off to a good start. The merger projects are on track. We had great margin expansion, including a major step-up in wireless margins. Wireless data, wireless ARPU, wireless revenues are all continuing to grow. Regional business revenues continue to be strong. Enterprise is on a solid path to growth. On top of that, we had a very good broadband quarter and we had a very good video quarter. Our U-verse video service is beginning to ramp. So as a result, we are encouraged.

As I said at the outset, we continue to be confident in our ability to deliver on the targets we laid out for you in January. Obviously, still a lot of work in front of us and a lot to do, but we do look forward to continuing our record of delivering for you in the quarters ahead.

So again, thanks for joining us and thanks for your interest in AT&T.

Rich Dietz

Thank you, Rick. That conclude our call this morning.

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Source: AT&T Q1 2007 Earnings Call Transcript
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