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AT&T Inc. (T)

Q2 2007 Earnings Call

July 24, 2007 10:00 am ET

Executives

Richard Dietz - Investor Relations

Richard G. Lindner - Chief Financial Officer and Senior Executive Vice President

Analysts

John Hodulik - UBS

Chris Larsen - Credit Suisse

Mike McCormack - Bear Stearns

Simon Flannery - Morgan Stanley

Jason Armstrong - Goldman Sachs

David Barden - Banc of America

Tom Seitz - Lehman Brothers

Frank Louthan - Raymond James

Presentation

Operator

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

Richard Dietz

Great and thank you. Good morning, everyone and welcome. It’s great to have you with us this morning for our second quarter earnings call. Joining me on the call this morning is Rick Lindner, AT&T's Chief Financial Officer, and Rick will cover our results, our outlook and then at the end of our presentation we’ll have a Q&A session.

Our release, investor briefing, the supplementary information and the presentation slides we will speak to on this call are all available on the investor relations page of the AT&T website -- that’s att.com/investor.relations.

Before we get started, I need to cover our Safe Harbor statement, which is on slide three of the 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. Reconciliations between the non-GAAP financial measures and the GAAP financial measures are available on our website and again that’s att.com/investor.relations.

Okay, I also want to quickly cover our EPS comparisons, which are on slide 4 of the presentation. Adjusted EPS for the second quarter was $0.70. Reported EPS this quarter was $0.47. We had $0.21 of merger costs and there was a $0.02 impact for the effect of purchase accounting on advertising and publishing’s deferred revenues and expenses from the BellSouth acquisition. You will note that 85% of our second quarter adjustments were non-cash. Adjusted EPS this quarter is up more than 20% from the $0.58 in the second quarter of 2006. This growth reflects strong operational progress in both wireless and wireline, including strong merger execution and further ramp in revenue growth. EPS this quarter also benefited about $0.01 from impacts related to tax settlements and state tax legislation and $0.01 from the monetization of non-strategic assets.

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

Richard G. Lindner

Thanks, Rich and good morning, everyone. Before I cover the details, let me begin with a couple of quick overview comments on the quarter and the major trends that I believe are providing much better visibility on the longer term potential of the business.

Looking at slide 6, I think item number one this quarter has to be the continued ramp in our top line revenue growth, building on improved trends over the past four quarters. Wireless growth is accelerating and the much-anticipated iPhone launch went very well. Regional results were solid.

We delivered a significant improvement in enterprise trends with a clear line of sight to positive revenue growth in this high potential area of our business. Our U-verse video product rollout began to ramp in the quarter and the results are encouraging.

In addition to top line progress, we continue to execute and deliver on merger synergies, and as a result margins were solid, free cash flow was strong. We completed our $10 billion share buy-back ahead of schedule in early July and we have good operational momentum heading into the second-half of the year.

So as a general overview, AT&T posted another strong quarter, we’re on a good trajectory for the second-half, with increased confidence about our opportunities beyond this year.

So with that as a perspective, now let’s get into some of the details. Slide 7 shows EPS growth and margin expansion. As Rich mentioned, before merger-related effects, our second quarter EPS was $0.70 and this is our ninth straight quarter of double-digit growth and adjusted EPS. Our adjusted consolidated operating income margin was 23.9%. That’s up substantially year over year and up 20 basis points sequentially with our wireline business driving the sequential expansion.

We continue to expect to operate at the top-end of the 23% to 24% margin range that we provided for 2007, as benefits from merger synergies and operational improvements outweigh costs from our U-verse rollout. And we expect to deliver continued double-digit growth in adjusted EPS this year and next.

Slide 8 provides a quick update on merger integration and synergy run rates. Last year, we achieved $1.1 billion in savings from our SBC AT&T integration. That’s a combination of both expense and capital savings and it was about $300 million above our previous outlook. And through the first-half of this year, as we layer on BellSouth integration, we realized approximately $1.9 billion in merger integration savings. Again, that’s combined capital and expense savings.

We are getting a lot of things done this year. Our support and staff consolidations are moving forward as planned. We have completed the migration of BellSouth mass market long distance traffic to the AT&T network, and our original target was the third quarter so we completed this project ahead of schedule. And rebranding efforts are on track and should largely be completed in the third quarter.

Even more important, we have a lot of headroom in terms of merger synergies. We continue to expect synergies above $3 billion this year, growing to over $5 billion next year.

Now, while the synergy execution is important, as I said I think the key news in our results this quarter is the progress we are delivering in top line revenue growth. The chart on slide 9 shows the revenue growth trajectory over the past five quarters. This total revenue versus pro forma results for 2006 and so it combines AT&T, BellSouth, and Cingular. You see a steady ramp in the growth rates and that ramp is driven by accelerating wireless growth, substantial improvements in enterprise, and solid regional results both in business and consumer, resulting in 2% year-over-year growth and 1.4% sequential growth.

This chart shows complete pro forma trends and it includes results from our national mass market business in all quarters. As you know, proactive marketing stopped in this business unit in 2004 and as a result, national mass market revenues have declined at a 20%-plus rate.

So to provide some perspective on revenue growth looking ahead as the national mass market revenue base gets smaller, our revenue growth in second quarter excluding this unit was 3.4%.

Now, the number one driver of revenues is accelerating growth in wireless shown on slide 10. In the second quarter, our wireless service revenue growth rate ran to 14.9%, double the rate we saw a year ago. We had strengthened subscriber growth with 1.5 million net adds, up 22% from the first quarter of this year and most of that increase came from post-paid net adds, which were up 34% from the first quarter. Over the past four quarters, we’ve increased wireless subscribers by $6.4 million and that’s better than 11% growth.

We’ve also had a strong upturn in wireless ARPU growth, boosted by explosive growth in data. Total ARPU grew 3.6% in the second quarter and that’s our strongest year-over-year increase in several years and our post-paid base had even stronger ARPU, up more than 6%.

As you know, on June 29th we launched the iPhone with Apple and the results have been terrific. We had just a day-and-a-half of iPhone sales and activations in the second quarter but in that short timeframe, we had 146,000 activations with over 40% of those being new customers.

The average rate plans for these subscribers is significantly above our current average ARPU and demand continues to be strong and we continue to see traffic levels in our stores above historical levels.

I think it may be an understatement to say that no device in the history of the wireless industry has come out with more fanfare than was the case with the iPhone. Expectations were certainly high but I am pleased to say that the iPhone has met them with a truly unique user interface, a great web browser, video iPod, and on top of it all a high-quality wireless phone.

Initial customer feedback has been off the charts and we look forward to continuing our relationship with Apple for years to come.

As I said, the number one driver behind ARPU growth and the overall wireless revenue ramp is very strong gains in wireless data. The highlights are on slide 11. Year over year, wireless data revenue growth was a robust 67%, taking us to $1.7 billion and our wireless data ARPU was up 52%. Data now accounts for 17% of total wireless service revenues and more than $10 of our post-paid ARPU.

And as strong as these numbers are, it is clear to us we are still early in the game and there is a huge amount of upside opportunity in wireless data services. Only about 60% of our wireless customers are active data users today so there’s plenty of headroom. Across our data customer base, while usage is growing there’s a lot of room for growth as applications and handsets are increasingly data-centric.

Historically, data growth has been driven by text messaging but we’re now seeing strong increases in both consumer and business data usage and we are seeing strong growth across all product categories, including e-mail, downloads, media bundles, Internet access, laptop connectivity, Smartphone connectivity, and enterprise vertical market solutions.

It is clear to us we are at the beginning of dramatic growth in wireless data and in fact, I believe one of the things we are seeing the iPhone do is broaden the appeal and dramatically ratchet up expectations for a data-rich wireless experience.

The iPhone is just one of a host of new data-rich products and services that we have recently launched, a few of the most notable are on slide 12. I think it is important to understand the advantages that we get from scale in developing these new products. Our coverage and distribution, combined with the scale opportunities of GSM as the world wireless standard, is a compelling combination for us as well as our strategic partners.

We just announced the national launch of Video Share across the country to nearly 160 3G markets. AT&T Video Share is a unique, groundbreaking 3G service that enables users to share live video over their wireless phones while simultaneously carrying on a voice call.

We’ve launched a number of new 3G devices, including the thin Samsung a717 and a727, both of which support our Video Share product. We also launched a North American exclusive with the BlackBerry Curve, the lightest and thinnest BlackBerry ever made with a full QWERTY keyboard and we now have more than 5 million customers with 3G handsets in the base. That’s double the total of last quarter.

In addition to increased revenues, our device lineup combined with excellent network coverage and quality have helped drive down churn. Slide 13 shows the trends. Post-paid churn dropped to 1.2% in the second quarter, down 30 basis points year over year and down 10 basis points sequentially to our lowest level ever. These churn improvements have come despite continued pressure from TDMA migrations, which we estimate had about a 5 to 10 basis point impact on post-paid churn.

We continue to make good progress migrating TDMA post-paid customers to GSM. At the end of the second quarter, we had approximately 1.3 million subscribers remaining on TDMA and that’s down from 2.4 million six months earlier. More than half of our remaining TDMA subscribers are wholesale.

So churn is moving in the right direction. We expect to see continuing improvements as we launch new products, further enhance the network, and move beyond our TDMA migration.

As we’ve accelerated revenue growth and lowered churn, we’ve also expanded wireless margins and grown wireless income. The details are on slide 14. Versus the year-ago quarter, second quarter adjusted wireless operating income was up 70% and adjusted service EBITDA was up 32%. The table on this slide also shows sequential margin changes and the decline from first quarter levels was primarily due to two factors.

One, preparation for the iPhone launch, including staffing, training, store prep and advertising accounted for about one-third of the decline and the remainder reflects increased customer acquisition costs, including handsets, particularly with a higher mix of more advanced data-centric devices being sold.

The benefits of stronger subscriber growth and increased customer adoption of data-rich handsets are clearly a positive for us going forward and our outlook for wireless margins has not changed. We expect full-year average EBITDA margins to be in the low 40% range next year with clear opportunities for further expansion beyond 2008.

In addition to wireless, I think the other big news in this quarter results is the improvement we are achieving in enterprise trends and the details are on slide 15. The chart shown here is the same one we provided in the past few quarters. It shows trends in total enterprise revenues excluding CPE sales and M&A impacts. As you see a year ago, we posted a year-over-year decline of 5.1%. The past three quarters, that moved into the 3% to mid-3% range.

We said the path to revenue growth would be a step function, not linear and this quarter, we took a major step up with a decline of less than 1%. Sequentially, recurring enterprise revenues were up 1.9% over the first quarter and as I said at the outset, we have a clear line of sight to positive enterprise revenue growth.

There are a number of drivers. Demand continues to be solid, data transport volumes are strong, IP services, including virtual private networks, managed Internet service and hosting, grew more than 18% in the quarter. IP Services now make up a third of our total enterprise data revenues.

Our customers continue to respond to good network reliability and advanced product sets and we are winning contracts. We have a premier global network for enterprise customers and we are expanding our capabilities in key growth areas like hosting, international, and wireless.

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 multi-national companies with MPLS based access from 155 countries via more than 2,000 service nodes.

Again, this is an area of our business that has great potential and we are on track to do what we set out to do, and that’s return to sustainable positive enterprise revenue growth.

While we improved trends in enterprise, we’ve also sustained good growth in regional business, including the small and medium business space. Slide 16 has the details.

Our regional business revenues grew by 4.5%, driven by both voice and data services. Data, which grew more than 7%, is now approaching 30% of total revenues. Data growth was led by strength in managed Internet, virtual private networking, and DSL. These IP-based services make up more than 40% of the regional business data revenues and they are growing at a mid-teens rate.

Voice revenues also continue to grow in regional business. Access lines increased in the quarter as they have over the past several quarters, churn remains stable and low, and ARPU has grown steadily over several quarters as customers add more features.

Revenues from small and medium-sized businesses in this category grew even faster, at more than 6%, just as they did last quarter. So the small and medium space continues to be very solid for us.

Slide 17 shows regional consumer trends where, despite increasing cable competition, we continue to deliver stable revenues, up four-tenths of a percent year over year and 1.1% sequentially. The drivers again are bundling and broadband, but with an increasing role for video. The volume measure that correlates most consistently with our consumer growth rates continues to be revenue connections -- that’s access lines plus high-speed Internet plus video.

And over the past year, we’ve had a net gain in regional consumer connections of 946,000, as gains in high-speed Internet and video have more than offset net declines in traditional access lines.

Our high-speed Internet connections are up 2.2 million over the past year to reach 13.3 million in service. 35% of our consumer primary lines also have broadband service, up from 28% a year ago and in California and Nevada, broadband penetration of primary lines is now at 43%. 46% of our DSL base takes speed tiers of 3-megabits or more. That’s up from 34% from a year ago and overall DSL churn rates remain low.

Our consumer primary lines declined by 193,000 in the second quarter, down substantially from a pro forma decline of 528,000 for the year earlier quarter, but these totals in part reflect migrations from wholesale and when you exclude these migrations, the change in total consumer switched access lines was generally consistent, pretty flat, with year earlier results despite a nearly 30% increase year over year in competitive footprint by cable companies in our regions.

The emerging opportunity for us in regional consumer is video and slide 18 provides an update. In the second quarter, we added 200,000 total video subscribers. That includes bundled satellite combined with subscribers to our U-verse video service. This 200,000 net gain was the best ever total, nearly double the pro forma total in the year-ago second quarter, and it’s also up from results in the first quarter of this year.

We now have 1.9 million total bundled video subscribers with more than 600,000 added over the past year and at the end of the second quarter, nearly 6% of consumer primary lines subscribed to a video solution from us.

So the bottom line is we are selling video and consumers increasingly are coming to expect AT&T to be a provider of innovative, high-quality television.

I think it is particularly gratifying to see the positive customer response and the accelerated ramp in our AT&T U-verse IP video service. Slide 19 has the highlights. Six months ago, we had 3,000 U-verse video subscribers. At the end of the first quarter, we had 13,000 and at the end of June, we were at 51,000. So as you can see, we ramped installation significantly. We are now up and selling in portions of 23 metropolitan areas and we expect to continue to expand deployment and continue our ramp with a target of reaching more than 10,000 installs per week in the fourth quarter.

More than 80% of our U-verse subscribers are taking higher end video packages and 65% are taking our highest speed broadband services, both of which drives revenue per customer. Our confidence in the technology and the service quality is being confirmed by customer feedback and we have a very positive outlook for AT&T U-verse video.

We are working on detailed plans for the Southeast region and will include a complete update at our analyst conference in December but in broad terms, we anticipate capital costs per household passed in the Southeast to come in about 10% to 15% less than in our 13 states, due to the ability to leverage super hub offices and infrastructure investments, including billing and customer support systems.

We will build out to approximately the same portion of the Southeast footprint as we are in the 13 states, around 50% to 55%. Our Southeast plans do not change our capital guidance for 2007 and 8 of mid-teens as a percent of revenue, and we’ll begin deployment of U-verse in our first Southeast market by year-end.

Before I close, let me provide an update on free cash flow and value return to shareowners. The details are on slide 20. We had a strong cash flow quarter and through the first-half of the year, cash from operations totaled $15 billion. Free cash flow after CapEx and dividends totaled $3.1 billion and we now expect free cash flow after dividends for the full year to come in between $5 billion and $6 billion, up from our previous guidance of between $4 billion and $5 billion.

I think I will pause there for a minute because many of you that I’ve talked to over the last six months probably want to stop and collectively say I told you so, because many of you told me that you expected free cash flow to be higher, and so you are correct. We are confident in the free cash flow numbers for the year being in the $5 billion to $6 billion range.

But in addition to cash from operations, we also generated in the first-half of 2007 more than $500 million from the sale of non-strategic assets, including real estate. And this cash generation gives us both the flexibility to invest in the future of the business and return substantial cash to shareowners.

As you saw in our press release, we completed the $10 billion share repurchase that we began in 2006 and completed it ahead of schedule in early July. And in the first-half of this year, through dividends and share repurchase, we’ve returned more than $11 billion of cash to shareowners.

We now have 125 million shares remaining in our current share repurchase authorization that was approved by our board. We expect to continue with repurchases under this authorization over the remainder of 2007.

So let me close with a quick recap, which is on slide 21. As I said at the outset, the company continues to execute and perform well. We have a strong record of delivering on our targets and that continued in the second quarter and we’ve got good momentum heading into the second-half.

And more to the point, we are seeing positive trends that are encouraging as we look ahead to the longer term potential of the business. Our merger synergy run-rates are growing. Revenue growth rates continue to accelerate with a strong ramp in wireless and substantial improvements in enterprise. At the same time, margins are solid. Adjusted earnings growth is on track with our double-digit outlook, and cash flow was strong with expected free cash flow after dividends now in the $5 billion to $6 billion range.

So in summary, a lot to be positive about as we look to the second-half and as we look to the years ahead. We are confident in the long-term potential of this business.

With that, Rich, I think we’ll stop here and we’ll open it up for questions.

Richard Dietz

Great, thank you, Rick. We’re now ready to start the Q&A session, please.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from John Hodulik with UBS. Please go ahead.

John Hodulik - UBS

Thanks. Good morning. A couple of questions; first, on the CapEx, it came in a little lighter than we expected. Can you give us the breakout between wireline and wireless? And then, is there any chance I can get you to update your ’08 outlook for free cash flow?

Richard G. Lindner

John, first of all on CapEx, we are running in total a little bit light of our plan and our guidance expectations for the year through the first-half. We are running a little bit light there primarily on the wireless side. Some of that reflects frankly the fact that as we talked about in the past, we are in a very good position in terms of the cell site density of the network, the spectrum that we have, the availability we have as a result of our network integration of existing GSM and edge equipment, so that has I think held down capital expenditures in the first-half of the year.

In addition to that in the second quarter there were some vendor credits that are just part of our ongoing agreements with some vendors that reduced CapEx a little bit further. But we do expect CapEx to be a little higher in the second-half of this year and a little higher in particular on the wireless side.

Part of that will reflect frankly additional CapEx as we continue to expand and grow the 3G network. In fact, most of our expenditures these days in CapEx that are network related in wireless are 3G.

2008, we are a little premature in terms of expanding guidance on cash flow in 2008. We are in the early stages of developing those business plans now but we will be in a position to lay that out for you I think in pretty good detail in our analyst conference in December.

John Hodulik - UBS

Okay, thanks, Rick.

Operator

Thank you. Our next question comes from Chris Larsen from Credit Suisse. Please go ahead.

Chris Larsen - Credit Suisse

Thanks. Two areas of big improvement, enterprise and continued strength in small business. On the enterprise side, can you give us an idea of is that share, is that price, is it usage what’s driving the step function that we saw this quarter?

Secondly, on the small business, we’ve seen a decline in competition over the last several years. Can you give us an idea of what the level of competition in small/medium business is today and what you might be seeing or what you might expect to see out of the cable guys who have announced intentions to get into that business? Thanks.

Richard G. Lindner

Sure, Chris. First, on the enterprise side, as I mentioned earlier really demand across the business there continues to be strong. Even in the voice side in enterprise, we are seeing some year-over-year growth in just plain old voice long-distance traffic, as an example, so we are seeing good volumes there. We continue to see very good demand in transport, although there continues to be I think a little more price pressure on the transport side because historically we had some price reductions in transport that led to a greater gap between the embedded contract pricing and the point of sale pricing.

And then we are seeing very good growth in IP-based services, particularly in VPN, managed Internet services and hosting services.

When you step back from the numbers, I think a couple of things that are important in the trends. First, in terms of point of sale pricing, we continue to see some flattening in point of sale pricing and we’re seeing it frankly right now in both the voice and data side, both voice LD pricing as well as some transport pricing, so I think that’s encouraging.

On the voice side in enterprise this quarter, we had a voice revenue year-over-year decline of about 4.5%. That’s the smallest decline we’ve had in a long, long time and that’s a function of some flattening in point of sale pricing along with a little bit of growth in minutes, so I think that helped out.

And then of course, our focus and our emphasis in this business continues to be on the data side and particularly with IP services, and so seeing 18% to 19% growth in IP-based services is a terrific sign for enterprise.

I don’t have good data to share with you relative to market share but I think we can, as we are looking at transactions, I think we are certainly competitive in the marketplace. We’ve got a great set of products and capabilities and so we are doing very well from a share perspective.

In small and medium business, the situation there really in the last several quarters in terms of the results and the trends we’re seeing hasn’t changed dramatically. We are continuing to see growth in both voice and data in small and medium business and in our regional business overall. We are continuing to see access line gains and we are seeing relatively low churn rates for both access lines and broadband services.

Where we do have competitive losses and maybe a good way to say this would be if you look at our access line disconnects in the regional business space, most of them are related to technology migration. Only about 30% of access line disconnects are competitive disconnects. In terms of cable competition up to this point of that 30%, the disconnects that are cable related are very small, four to five percentage points of that 30. So we are not seeing a lot in the market at this point, other than probably from Cox who has been in the market for some time. But I do expect over this next year we’ll see more activity as Comcast and Time Warner both begin to roll out their plans.

Again, I think where we will see them will tend to be more in the lower end of the small/medium business space, kind of 10 lines and under, maybe even four lines and under.

Again, so far we are not seeing much impact there. In fact, our small/medium business revenue growth was in the mid 6% range this quarter, about the same as last quarter.

Chris Larsen - Credit Suisse

Thanks a lot.

Operator

Thank you. Our next question comes from Mike McCormack from Bear Stearns. Please go ahead.

Mike McCormack - Bear Stearns

Thanks, guys. A couple of questions; first on wireless margins, obviously some pressure this quarter. You identified the iPhone piece of that, which obviously should abate and the benefit from the TDMA subset next year but maybe your sense on how you see the competitive landscape changing. Obviously you are spending money on handset subsidies and advertising. Does that come down over time or should we expect that to get worse?

And then on wireless ARPU, maybe just a sense on the growth drivers there. Are the aircards having an impact yet or what is driving that higher? Thanks.

Richard G. Lindner

Sure, Mike. On wireless margins I think, as we’ve said, there were two primary factors there. We had -- one way to look at it is adjusted EBITDA margins were down in the second quarter about 140 basis points from the first quarter, and roughly one-third of that change was related to essentially our preparations for the iPhone. We worked with Apple and jointly did some advertising so we had some costs associated with that in preparation for the launch. We also hired additional people for our stores, put them through training. We had the cost to develop a new activation process for the product and then of course the testing we went through in the product.

So all of those things contributed some costs into the second quarter related to the launch.

But the bigger factor and two-thirds of it really is related to additional acquisition costs, some advertising, more in handset subsidies just related to our ongoing business and primarily our post-paid business.

As we said in the first quarter, if there was one thing we felt we wanted to improve on going forward during the year is to increase our share in post-paid gross adds and net adds, and we had gotten I think a little bit out of the market in our handset pricing, particularly for some of the higher-end data devices and so we did get a little more aggressive there. We’ve met competitors generally in the pricing that’s out there and we’ll see how the market develops over the rest of the year. Those things tend to kind of ebb and flow in the marketplace but I’m very pleased with the results we have.

Mike McCormack - Bear Stearns

And presumably the cost-saves that you are talking about would offset the continued pressure on the handset subsidy side for the balance of the year though I would imagine.

Richard G. Lindner

Yes, absolutely and in fact, we would expect -- that’s why I said we’re not changing any guidance related to our margins. We’ll be in the upper 30s for all of this year and we still expect to be in the lower 40s for next year and you should see a ramp in margins between now and through the end of next year as we go through that process and as we take our TDMA network out of service in the first part of next year.

So no changes to the guidance and in fact, if anything, I was not just supportive but encouraging our wireless business unit to be a little more aggressive and get the momentum that we are seeing right now behind the business and grow sales and particularly in post-paid.

And we had a nice ramp that occurred not just between first and second quarter but a nice ramp that occurred throughout the second quarter as some of the things we were doing took effect, so we are pleased with it and as you look ahead, in particular when you see what is driving the business and kind of going to the second part of your question, what is driving wireless ARPU, it is on the data side and it is increasingly customers buying packages of data services for their devices, so as we begin to get more devices into the base, more smartphones into the base, more 3G devices into the base, then you start to migrate customers from simply buying a package of text messages to customers that are buying media bundles. In fact, year over year if you look at the growth in our data services, the biggest single component of it was the growth in customers buying media bundles, which gives them a package of text messages, multimedia messages and Internet access.

Mike McCormack - Bear Stearns

So are you seeing any traction in the enterprise segment with aircards yet or is it too early to tell?

Richard G. Lindner

No, we are continuing to see traction there. I think that will also be a growing portion of wireless data revenues. We are seeing it across both business and consumer. We are seeing it with aircards. We are also seeing it with Internet access and e-mail connectivity across a variety of devices.

Mike McCormack - Bear Stearns

Great. Thanks for the time, guys.

Operator

Thank you. Our next question comes from Simon Flannery from Morgan Stanley. Please go ahead.

Simon Flannery - Morgan Stanley

Thank you. Good morning. Can you just help us a little bit more on the U-verse side of things? The ads are starting to ramp now. Can you give us a little bit more clarity around things like homes passed and what sort of penetration rates? You’ve talked about 10% after six months. How is that all tracking versus expectations as well as the costs to install?

And then, if you have any updated thoughts on the 700-megahertz auction, I would appreciate that as well. Thanks.

Richard G. Lindner

U-verse is ramping now very nicely. I think relative to our plans for the year, it’s really right on target for the year in terms of both the construction side as well as the sales and installation pace.

We really have moved into more of a blocking/tackling phase of this product rollout so it’s about continuing to build and increase the number of homes passed and we are up in I think the -- right at 4 million so we’re right at the halfway point of the year. We’re about halfway to our target of 8 million homes passed for the year and we’re expanding marketing efforts across, steadily across the homes that we are passing and increasing the number of homes we’re marketing to in existing markets, and then of course rolling out additional markets.

We’re in, as I said, about 23 metropolitan areas now. That continues to increase each month, as do the number of homes we are marketing to. We are seeing I think very good sales rates and our installation results are improving. We are seeing good flow-through of orders in our systems. That statistic continues to improve each month.

Our installation times are still up in the 7 to 7-plus hour range on average, but that’s to a large degree, that’s a function of bringing a lot of new technicians on board and getting them up the learning curve.

I was on a U-verse installation last week and this is a technician who is one of our more experienced technicians in San Antonio and it was an installation done basically in four hours. So on the installation side of things, I would tell you there’s probably two primary variables on a case-by-case basis. It has to do with number one, the amount of experience of the technician and secondly with the condition of the wiring inside the home. And in some cases where we get into longer install times it’s because we are having to do more rewiring inside the house.

But all of the metrics in terms of installation and costs are really going according to plan at this point. I think actually on the upside on the revenue side, it continues to be better than we expected in terms of customer adoption of higher-end video packages. It continues to be higher than we expected on HD, about nearly half of new customers are taking and buying HD from us. And it continues to be higher on the data speeds that customers are buying, so all of those things I think are good signs from an ARPU perspective.

Simon Flannery - Morgan Stanley

And on the 700-megahertz?

Richard G. Lindner

The 700-megahertz, Simon, we have a group internally that is studying the 700-megahertz auction and our potential need for that spectrum and different uses for certain bands of that spectrum. And this is a similar approach to what we’ve taken in past auctions but it’s -- I think it is premature at this point to talk about strategy related to the auction. In fact, we won’t do that prior to the auctions.

Simon Flannery - Morgan Stanley

Okay. Thank you.

Operator

Thank you. Our next question comes from Jason Armstrong from Goldman Sachs. Please go ahead.

Jason Armstrong - Goldman Sachs

Great, thanks. Good morning, Rick. A couple of questions, first on wireless margins, maybe just sort of a longer term question; you are talking about low 40s as the opportunity for ’08, which matches what you’ve been saying for a while but the industry backdrop here has changed a little bit. You’ve still got strong revenue growth accelerating every quarter but there is much more of a balance now between volume growth and price growth, rather than revenue growth just purely being driven by volume. So this would seem to set a backdrop which would support much higher long-term margins, so I’m just wondering if you can give your perspective on that.

And then double-digit EPS growth, again I guess a longer term question; if you think about the revenue trajectory you are on, the operating leverage in the business and the ability to buy back 4% to 5% of your shares every year, what stops you from talking about this as a business that can grow earnings double-digit longer term -- in other words, beyond the 2008 timeframe you’ve talked about? Thanks.

Richard G. Lindner

Good questions, Jason. First on wireless margins, I think there could be some upside. We have to see how the business continues to develop but I think the surprise for many people this year is the fact that going into the year, there was a lot of question, concern, focus about penetration in the market and will that begin to top out. What we are seeing is now continued pretty good customer growth but on top of it, we are really ramping up ARPUs and a lot of that again is data related. And so the upside as we go forward in the future may be in that ARPU equation related to data.

I think it’s -- certainly we feel very comfortable with upper 30s EBITDA margins this year. We feel very comfortable with moving that into the lower 40s overall for 2008 but as I mentioned earlier, I would expect us to ramp pretty steadily over this next 18 months or so and we will get benefits throughout next year as we take the TDMA network out of service and as we are able to take costs out and trim and manage the network post bringing TDMA down. So that combined with if we continue on a very good ARPU trajectory could drive margins even harder in this business.

As we’ve said, our expectation beyond 2008 would be certainly with the trends we are seeing today would be to continue to grow those margin levels.

On the earnings growth, we’re obviously very comfortable and confident in the guidance that we’ve provided, which is double-digit growth for this year, double-digit growth for next year. We are looking at the same issues that you mentioned in your question in terms of the opportunities to ramp top line revenues and in particular, when you look across our business and just look at the major segments, we are seeing very good growth in wireless service revenues and actually some increasing ramp there. We are seeing very good trends in enterprise. I think it gives us more confidence about returning and not just returning but getting back to a sustainable top line growth situation in enterprise.

In regional, regional business continues to be very solid and we’ve got some opportunities on the consumer side as we ramp video, so that takes you back then to two areas of the business that have been declining and actually dampening our growth rate somewhat. One of those is wholesale and there have just been a lot of changes in the business in terms of consolidation of companies and networks, as well as some reductions in UNI-P lines that are impacting the wholesale business. But at the end of the day, that’s still a very good business for us and I think we are in the next couple of quarters, you’ll see that business, which is about a $3.5 billion a quarter business, may decline a little bit more yet due to some of the consolidation in UNI-P pressures, but then we’ll start to flatten out and then we’ll actually have some opportunities I think in the future to begin to grow there.

And then the national mass market business is one that’s actually been very good to us in terms of cash and value and as that declines, that will have less of a drag. So you start to see the ability to continue to ramp top line to continue to drive costs out of our business not just through merger synergies but as we get more scale, particularly in IP-based services, the ability to begin to ramp margins there and begin to move margins more in the direction of legacy services on the IP side is important to us as well.

And then, as you said with the cash flow we are producing and the ability to continue to repurchase some shares, I think it gives us a good opportunity for good earnings growth. And that’s one of the things we’re looking at right now on a longer term basis and again, I think we’ll be able to give you more definitive guidance when we get together in December.

Jason Armstrong - Goldman Sachs

Okay, thanks.

Operator

Thank you. Our next question comes from David Barden from Banc of America. Please go ahead.

David Barden - Banc of America

Thanks, guys, for taking the question. A couple of housekeeping items and then just one more question. Rick, were your comments on the buy-back intended to indicate that you are going to hope to complete the 125 million share buy-back in the second-half or just pursue it in the second-half?

You also gave us on the BellSouth parameters, 10% or 15% discount to cost per home passed for the U-verse project. Could you give us what that homes passed cost is now?

And then I guess just the last question is on DSL; still growth there but penetration rates are starting to slow down. I was wondering if you could give us some color around what the outlook here for DSL penetration is. Is it you think saturation of the market or is it a market share battle with cable at the margin, as your users continue to move up market in the speed category? Thank you very much.

Richard G. Lindner

Sure, David. First of all on the buy-back, we will, as I said, we’ve got 125 million shares remaining under the authorization and we’ll continue to buy under that authorization. I wouldn’t tell you that we’ll complete that authorization this year. We’ll continue to buy under it and the amounts that we buy will be dependent on the cash flow that we generate in the second-half of the year and it will be dependent on market conditions, obviously.

But I think we’ll continue, particularly at current price levels, frankly, we’ll continue to be very active in share repurchase.

On U-verse, in our 13 states we have a cost, a capital cost per home passed and this is all inclusive, so it includes the video serving infrastructure as well as the construction in the local loop and it includes development of the software and OCS systems that support these customers, so everything combined is about $330 roughly per home passed in the 13 states.

As we move into the Southeast, as I said we’ll leverage some of the work that we’ve done in the 13 states. We will benefit from the fact that the Southeast has fiber deployed a little deeper into their network and offsetting some of that though the Southeast in terms of density is a little, tends to be a little less dense than in our 13 states, so when you put all that together again I think we’ll be at a cost that’s probably 10% to 15% per home less than what we’ve seen in the 13 states, primarily by leveraging some of the work that we’ve already done.

In DSL, kind of an interesting thing. First of all, when we look at DSL we are really looking at broadband in total so we look across it, including the customers that we are bringing in with U-verse and some customers with satellite and so forth, so we did overall about 400,000 broadband net adds in the quarter. And that was down -- it’s down sequentially just due to normal seasonality and end-of-school disconnects but it was also down somewhat from second quarter of last year.

When you break the numbers apart though, what we find is that we actually increased gross adds and gross sales of broadband products second quarter this year versus second quarter last year, so we saw good activity in sales and we saw churn rates that were down slightly. On a percentage basis of the base, the churn was down slightly. The reason the number has come down, and this is just as you continue to build a larger and larger base, it is the churn number is kind of a bigger challenge to overcome each quarter.

But underlying the business in both churn and in gross sales, we’re seeing good activity and certainly when you look at the fact that while we’ve made good progress in penetrating our base, still at just 35% on average of penetration of our primary access lines, we feel like there is still substantial room to grow broadband.

Two other things happening in broadband that I think are important. One is, and we’ll see how this quarter turns out when everyone reports. I don’t think it will be any different but when we look over the last four quarters, the broadband share of spend in the marketplace has been split pretty evenly in our territory. To us, as we look at everyone’s numbers, it looks like we are getting about 50% of broadband share.

But secondly, we are also seeing in the DSL revenues, we are seeing the pricing and some of this is a result of the price changes we implemented in the second-half of last year in broadband but we are seeing our ARPU start to stabilize. It’s actually increasing a little bit in the business side and it’s flattening out pretty well in consumer, and that’s a function of the standard pricing we put in and it’s a function of customers upgrading service to higher data speeds.

I guess the last thing I would mention on DSL is that there’s always concerns and issues around that people talk about related to the broadband speeds in the local loop and the truth is there, particularly with our Lightspeed and U-verse deployment, we are going to continue to have substantial upside to move customers in the future up to higher broadband speeds, which I think will help to continue to keep churn levels low, will help competitively and it will also improve ARPU.

But even today with all the movement we’ve had in the base, we still have less than 10% of our customers that are buying at 6-megabit speeds, so we have substantial room to upgrade customers as their needs increase or as the demand is there for higher speeds in the local loop.

David Barden - Banc of America

Great. Thanks for the color, Rick.

Operator

Thank you. Our next question comes from Tom Seitz of Lehman Brothers. Please go ahead.

Tom Seitz - Lehman Brothers

Thanks for taking the question. Rick, you talked a little bit about wholesale and the fact that visibility is improving a little bit. Can you maybe flush that out a little bit? That’s sort of the third leg of the stool on business and once that turns, you are home free.

And then maybe could we get a comment perhaps about Verizon’s settlement with Broadcom, maybe what your exposure is with next generation devices and if you can comment as to whether or not you are looking at a similar settlement? Thanks.

Richard G. Lindner

Sure, Tom. First of all, I’m not going to comment on the Verizon settlement at this point. This is still an issue where we are looking at a number of options and haven’t reached any resolution yet so it would be premature for me to comment related to this.

But on the wholesale side, wholesale for us is a combination of products and it’s really -- you can break it down into three pretty good sized pieces. One is UNI-P lines and resale lines and revenues from those lines, which have been declining but those are starting to get down into a level where I think that they will start to stabilize somewhat. And the pricing there over the past year or so has moved up and the pricing now is staying I think pretty stable and the pricing is at reasonable rates there.

Secondly then there’s carrying primarily voice traffic and long-distance traffic on the wholesale network and that’s the element of the business that there have been some moving pieces because of industry consolidation and even some pieces where frankly we have moved revenues or moved traffic to our own network but in doing so, we no longer then recognize some termination revenues, some access revenues that we did recognize in the past under the old Will-Tel agreement. So that’s one. It’s kind of interesting where it has impacted negatively our wholesale revenues but obviously we get all the cost savings on the access side of things and from a net margin perspective, it’s been positive to us.

But we are working through that transition. We are working through transitions with other carriers and to some degree as other carriers migrate some traffic off, it has given us some capacity that we are being able to use by putting our own traffic on the network, so again it has some negative impact on revenues in the short-term. It has some positive impacts on margin and bottom line and I think that all starts to settle out over the next two to three quarters.

So having said that, then the third area of revenue there and some opportunity for us is in the transport side in wholesale, which has been pretty stable and I think actually going forward, I think we have some opportunities to grow that business.

When you put it together, it’s a $3.5 billion a quarter revenue stream. We have a little bit of consolidation to go through yet so that may drop somewhat but as we get into next year, I think then you’ve got a pretty stable revenue stream that stays in the $3.3 billion, $3.4 billion kind of range, with some opportunities to grow on the data side.

Tom Seitz - Lehman Brothers

Thanks very much for the color.

Richard Dietz

This next question will have to be our last question for this morning.

Operator

Thank you. Our last question comes from Frank Louthan from Raymond James. Please go ahead.

Frank Louthan - Raymond James

Thank you. Just back on the enterprise side, can you give us an idea of where you are seeing managed services, contracts coming into RFPs and how much that is moving the needle? And then, you are looking at the SME part of the business, seeing some traction there. Can you give us an idea of sort of the size of customers that you are target with your sales force, what is the range of monthly billings, kind of the low-end and the medium-end of where your sales force is targeting on the SME side as far as monthly billings? Thanks.

Richard G. Lindner

Frank, on the small medium business side, in our various very small segments -- I mean, the truth is we go after in the marketplace customers from the very smallest customers, four line and under type size ranges up to some medium business customers. And in our regional operations, some regional government medical education kinds of businesses that are a pretty good size. So we are across the entire range there.

We approach that market a little differently depending upon size. In some cases it is an active sales force on the street but at the low end of the range, it tends to be more call center driven in terms of the sales efforts, but as I said the encouraging thing there I think is that we are seeing both growth in voice and data. We’re seeing growth in access lines. We benefited I think from a pretty good economy. We’ll see how that plays out as we go forward, but that’s certainly helped in that space and we are increasingly -- I think the opportunity for us as we start to package some products around Internet access, broadband, voice, wireless, and some products on, for example, the security side that we’ve developed for larger enterprise customers, we are starting to package those and bring those down market. I think that creates a good opportunity for us and that reflects some of the growth you see in that segment.

On the data side in small medium business, we are seeing very good growth in managed Internet service, in DSL. We’re seeing good growth in the larger end of the segment in some VPN kinds of services.

I don’t know if that entirely answers your question but we are covering that entire market. We cover it a little differently depending on the size of the customer but again, just like in other aspects of our business, I think the ability to bundle wireless, data, traditional voice and to bundle that, put that together in some interesting packages is particularly attractive for small medium business customers.

Frank Louthan - Raymond James

Is that business growing faster at the smaller end than some other areas of the enterprise, and are you ramping up the sales force to go after those customers?

Richard G. Lindner

It is growing. It has tended to grow -- over the last couple of years it has grown more in the small medium category, but it’s not been as much about a volume or demand factor as it hasn’t had some of the same impacts from technology migration and from some of the pricing pressures that you’ve seen certainly in the enterprise space and even down into some of the larger regional customers.

Frank Louthan - Raymond James

Great, thanks. Very helpful.

Richard Dietz

That concludes our Q&A session. Rick, I believe you have a few closing comments for us this morning.

Richard G. Lindner

Thanks, Rich and let me close and just underscore a couple of points. First, I think you know at AT&T we take pride in our ability to deliver on targets and to do the things that we say we are going to do. I think the results we reported this morning continue a strong, consistent record in this regard. Again, it was our ninth straight quarter of double-digit adjusted EPS growth, margins continue to be strong and improving in both wireless and wireline. We had very good cash flow performance and raised our full-year target range for cash flow after dividends.

Beyond these achievements though I think the most encouraging part of the quarter from my perspective is the ramp we are seeing in revenue growth and that’s the element that really gives us confidence as we look at this business into 2008 and beyond 2008. again, we are seeing wireless growth accelerate. The iPhone launch went very well and the iPhone is going to provide a boost to those wireless revenues going forward.

Enterprise revenue growth, as we’ve seen, is approaching an inflection point. We continue to have very solid regional results with revenue growth this quarter in both business and consumer, and then we’ve got the opportunities in front of us with the ramp of our U-verse video product.

So these trends are all obviously positive for the business. We have good operating momentum heading into the second-half and we’re gaining increased visibility and confidence in the trajectory of the business beyond that.

We’re excited about the opportunities in front of us. We are confident in our ability to execute and confident in our ability to deliver for you, our shareowners.

Again, thanks for joining us and thank you for your interest in AT&T.

Richard Dietz

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

Operator

Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may all disconnect.

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