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Cingular Wireless LLC (NYSE:T)

Q1 2006 Earnings Conference Call

April 19, 2006, 10:00 a.m. EST

Executives

Kent Evans - IR

Pete Ritcher - CFO

Ralph de la Vega - COO

Analysts

Scott Goldman - Bear Stearns

Jason Armstrong - Goldman Sachs

David Barden - Banc of America Securities

Michael Rollins - Citigroup

Raena Smith - Morgan Stanley

David Janazzo - Merrill Lynch

John Hodulik - UBS

Jonathan Chaplin - JP Morgan

Frank Louthan - Raymond James

Chris Larsen - CSFB

Rick Prentiss - Raymond James

John Aiken - RBC Capital Markets

Michael Bowen - FBR

Qaisar Hasan - Buckingham Research

Will Power - Robert Baird

Presentation

Operator

Good morning, ladies and gentlemen, and welcome to the first quarter 2006 earnings conference call. (Operator Instructions). I would now like to turn the call over to Mr. Kent Evans. Mr. Evans, you may begin.

Kent Evans

Thank you, Marcella and good morning. We are pleased you could join us for Cingular Wireless' first quarter earnings call. In the room with me are Pete Ritcher, our Chief Financial Officer; and Ralph de la Vega, our Chief Operating Officer. As in prior quarters, Pete will start in a minute with a summary of the financial results for the quarter, followed by Ralph with an updated on operations performance.

First I have a couple of comments to make. The first is to remind you that our financial results were released this morning, and they are all posted on the Investor Relations pages of Cingular's website at www.Cingular.com, as well as the websites of BellSouth and AT&T. The webcast and the presentation that we will be speaking to are also available on all three websites. I will also remind you of the Safe Harbor statement that is on page 3 of the presentation covering forward-looking statements and financial estimates, as well as certain non-GAAP financial measures. Now I would like to introduce Pete Ritcher, Chief Financial Officer of Cingular Wireless. Pete.

Pete Ritcher

Thanks, Kent. I'm pleased to be here this morning and have the opportunity to discuss our first quarter results and Cingular's continued financial and operational progress. Earlier this year we gave you our financial outlook for 2006, which included revenue growth in the high single digits, continued churn reduction and continued margin improvement. As you can see in the financial results we have released this morning and as I go through the details on this earnings call, we are right on track.

You will also note that in the operational and financial metrics discussed today our momentum continues, and in many areas is getting stronger. The summary of key financial metrics on slide 5 identifies some of these results. As you can also see from this slide, we no longer need to make reference to pro forma results in our year-over-year comparisons, as we now have 12 months of reported post-merger data.

The results shown demonstrate the year-over-year and sequential improvements we have achieved this quarter. It is easy to see that our momentum is continuing, and in one of the most important metrics -- churn -- this momentum is taking us to levels never before achieved by Cingular and expectations that it will only get better.

Our service revenue of over $8 billion was up 7.9% from last year and total revenue growth exceeded 9% for the second straight quarter. Our normalized OIBDA margin expansion was also strong at 640 basis points year-over-year and 90 basis points sequentially to 31.9%. This is even more impressive considering the 1.7 million customers added during the quarter exceeded all external expectations; and, that our largest cost synergy source, which is the network, is still largely to come.

Operating margin growth has equally been impressive with a 700 basis point increase over last year and a 120 basis point improvement sequentially. Our ARPU trends continue the improvement we saw last quarter, even in light of the recent higher mix of wholesale customers.

As I mentioned before, churn is at record lows. Network quality is the single most important reason a customer churns from a carrier, and Ralph and his team have been extremely successful in the integration of Cingular and the old AT&T Wireless networks. As Ralph will show you later, we are well on our way to achieving all of our network goals.

Slide 6 locks OIBDA and operating income from reported to normalized results. Reported OIBDA of nearly $2.5 billion included $64 million of merger integration costs during the quarter. OIBDA normalized for these merger and integration costs is $2.55 billion for a 31.9% margin.

In addition to the $64 million in OIBDA impacting expenses during the quarter, we also had accelerated depreciation of $170 million associated with our network rationalization efforts and $359 million of non-cash intangible amortization costs. Operating income is $1.4 billion after normalizing for these issues with operating margins of 15.6%.

One of the telling successes of the integration and network quality initiatives at Cingular is the reduction in customer churn as you can see on slide 7. Our total churn declined by 20 basis points sequentially and 30 basis points year-over-year to 1.9%, the lowest ever achieved by Cingular. Postpaid churn was even lower at a record 1.6%, down 30 basis points both sequentially and year-over-year.

This reduction in churn is a testament of the success we are experiencing in our integration process and the benefits that it brings to our customers. The record low churn rates are even more impressive considering that we are not only deep into the network integration process, but also moving former AT&T Wireless customers to Cingular billing systems through migrations as well as billing conversions. Over 2.3 million customers were moved from what we call blue systems to in-state billing systems during the quarter.

In addition to AT&T Wireless and the Cingular systems migrations, we continue to move both Cingular and old AT&T Wireless TDMA customers to GSM and UMTS networks. We now have 89% of our customers GSM-enabled, and 97% of the minutes are generated on our GSM networks.

Over 7% of our customer base upgraded their handsets during the quarter, which is consistent with the level achieved last quarter. These upgrades not only to put customers back on contract, they put them into fewer handsets, which tend to drive higher data usage.

More customers have chosen Cingular in the past as we had been the historical leader in gross additions. More customers are now choosing to stay with Cingular because of network quality, enhanced customer service and our compelling products and services. We believe we have the best assets in the industry, and we continue to have success in integrating these assets to improve both the customer experience and our bottom-line.

Our OIBDA margin expansion is shown on slide 8. First quarter OIBDA of $2.55 billion is $657 million higher than the same quarter last year, and the 31.9% OIBDA is 640 basis points higher than the prior year quarter.

We continue to extract synergies. The biggest driver of synergies is the network, and the bulk of financial benefits from it as well as IT systems integrations are still to come. Our improved revenue growth will continue to drive higher margins, and the lower churn rate allows us to grow the customer base faster with lower acquisition costs.

Our store rationalization is complete, and the operational and cost benefits associated with that are just starting to kick in. Benefits from our reduced churn and distribution rationalization will continue to pay dividends going forward.

Cingular continues to manage the unwind of our California and Nevada joint venture with T-Mobile. We now have over 71% of our customers on the Cingular network in those markets. Our OIBDA cost will continue to decline as more and more of our customers' traffic is carried on our own network.

I'm pleased with the margin progress that we have made this quarter. It is in line with our expectations, and we expect to accelerate improvement throughout this year and next.

Solid subscriber growth is helping to fuel our margin success. Slide 9 shows the benefit that lower churn has on growing the business. Cingular gross additions were flat year-over-year, yet net customer additions were 23% higher this quarter. We are the largest wireless carrier in the United States, with nearly 56 million customers. Any incremental improvement in churn can significantly improve our growth rates. We expect our 4.7 million gross additions should be at or near the industry lead again this quarter, which speaks well for our distribution capabilities, as we have rationalized hundreds of company-owned stores and thousands of agent locations since the merger.

RadioShack was added to our distribution on January 1st, and we are pleased with the sales performance of this channel coming out of the box, along with the quality of the customers that have been added.

Cingular's postpaid mix improved during the first quarter with 900,000 net subscriber additions, an increase of over 41% from our fourth quarter results. Prepaid success continues with a net of 147,000 new customers as the GoPhone Pick Your Plan and Pay As You Go plans are bringing us higher ARPU and lower churn than our embedded prepaid base.

The decline in our total ARPU is moderating as shown on slide 10. ARPU of $48.48 for the quarter is down 2.3% year-over-year. This is the second quarter in a row where year-over-year ARPU declines were in the low 2% range, significantly less than the 5% ranges that were prevalent in previous quarters. This moderation of ARPU decline is a result of continued price discipline by Cingular and maturation of some of the drivers of decline, such as the migration of customers to rollover plans, to regional and national plans and from older AT&T Wireless Cingular Plans.

The primary driver of our ARPU decline this quarter was the growth in our reseller base. As many of you know, a significant portion of our growth last quarter was made up of reseller customers, and this growth continued into the first quarter, albeit at much lower levels. Approximately 9% of our customer base is now made up of various resellers with TracFone being our largest. While resellers provide good margins to Cingular, their ARPUs are relatively low, typically under $10 per month.

Cingular ARPU, excluding the impact of the growth in these resellers, actually improved year-over-year and sequentially as higher data ARPU more than offset the voice pressure. Data ARPU continues to climb as our $5.22 ARPU increased $0.51 this quarter. Data revenue, which grew 53% year-over-year, now represents 11% of our total ARPU.

Continued growth in traditional products such as messaging and corporate email is being supported by adoption and use in Media Net bundles and Internet access. With the additional speeds and applications available with UMTS/HSDPA, we expect our data ARPU will continue its rapid growth.

Strong customer growth and stabilizing ARPUs continue to push our annual revenue growth to very high single-digit levels as shown on slide 11. The 9.1% annual revenue growth is the second consecutive quarter over 9%. The momentum in subscriber growth and data adoption will continue to drive this improvement in the future.

Before I hand this over to Ralph, I would like to wrap up with slide 12. Our financial and operational results are gaining momentum. The strengths of combining the assets, employees and customers of Cingular and the old AT&T Wireless are beginning to assert themselves and producing results that we have never before achieved. Our planning and hard work is paying off for both our customers and our bottom line. We still have a lot of hard work in front of us to be where we want to be relative to the marketplace and our financial results, but we are getting there and we are showing progress each and every quarter.

Lowering churn is the key to getting us there, and as you can see, we are making significant progress in that area. Other carriers' customers are recognizing the benefits of Cingular in terms of network performance and products, and even more importantly, more of our own customers are seeing this value and staying with Cingular.

Postpaid net customer additions rebounded this quarter with a 41% improvement over fourth quarter levels. Our revenues and our margins continue to grow. We are right in line with our internal plans and expectations, and we expect to see accelerated improvement in our margins as we progress through the rest of the year.

Our merger/integration activities are on schedule and driving our anticipated results. Now I want to hand the call over to Ralph de la Vega who will give you an operational update for the quarter. Ralph.

Ralph de la Vega

Thank you, Pete and good morning to everyone on the call. As Peter outlined, we had a strong first quarter with lower churn, strong revenue growth, and improved margins both sequentially and year-over-year. I'm going to focus on our integration progress and talk you through key operational areas that are driving our improvement.

So let's begin by looking at chart 14. On chart 14 you can see how far we have come on integration in 18 months. Overall we are on schedule for all key integration activities. I will talk in more detail on several of these items in just a few minutes, but here is a consolidated view of where we stand on integrating and modernizing our networks, improving our IT systems, melding our customer services teams and realigning our stores.

Our strategy from the start has been to focus on delivering benefits to our customers as our first priority, then to achieve our cost savings. We are seeing this in everything we have done so far, from launching the common service experience and opening up mobile to mobile across Legacy, AT&T Wireless and Cingular Wireless customers to building the network with the fewest dropped calls.

We are very focused on our customers, and like Pete touched on earlier, we are seeing the results in reduced churn. We are executing well and the cost savings are there, but we will have a lot of work ahead of us, as you will see, when we review our integration initiatives.

So let's start with the biggest area for customer benefits and synergies, the network. Our network integration work is on track and is delivering the results we anticipated. We completed our TDMA network rationalization in 2005, and while the Legacy networks have now been integrated, some work like lease terminations and T1 disconnects lag the actual network integration work. So we will see additional margin improvement this year as these costs are eliminated.

Our GSM integration is on schedule and scheduled to wrap up in the third quarter of this year, and I will give you more details about that in just a minute. Before I move on, let me give you a quick update on our T-Mobile joint venture unwind. I'm pleased to report that we now have 71% of customers in California and Nevada on Cingular's network. As we move minutes onto Cingular's network, our customers will benefit from being on our gold network, and we will see additional margin improvement from lower system costs.

Now let's take another key area for synergy. Let's take a look at IT consolidation. We are making progress on our billing system conversions and overall system consolidations. We spent much of 2005 building and testing programs to convert the remaining Legacy AT&T customers onto our in-state billing systems, and we are now converting those customers and expecting to complete GSM customer conversions by the end of 2006. The remaining CDMA customers will be converted by early 2007.

So far we have also made significant progress reducing the number of IT systems we use in our business. Once we decommission the Legacy billing systems, we will then be able to remove all the associated systems that are working with them. This is when we really will see significant cost savings in the IT area.

Of course, our work in IT is closely related to reshaping our customer service. Although we have made steady progress in integrating our customer service operations in 2005, we will not be completely done until we finish our billing conversions and reduce the number of systems our reps use to service our customers. This will drive additional costs out of the business and will make it easier for us to provide consistent, high quality service to our customers. We believe we're on the right track here, and our month-over-month improvement over the last five quarters in customer care metrics demonstrates that.

Finally, last quarter we completed our company-owned store rationalization. We closed 620 underperforming and/or overlapping stores, while building 130 new, more productive stores. We ended 2005 with almost 500 fewer stores and with more sales than we had in 2004.

Also, on January 1 we launched Cingular in nearly 5,000 RadioShack locations. We're pleased with the strong gross adds and high quality customers from this channel. We are especially pleased to see a solid performance when this is the first quarter of selling Cingular for most of the RadioShack salespeople.

Now let's take a closer look at our network initiatives starting on the next chart, chart 15. Cingular is on a mission to build the best network. Internally we call it the gold network. We have a lot of moving pieces in our network and our network plan, but it is easy to see how all of our efforts contributed to building the best network. The work and investment we are putting into TDMA and GSM rationalization, the T-Mobile joint venture unwind, new site build outs and our third generation deployment are making a noticeable difference to our customers and adding to our bottom line. The best network maximizes our assets by providing expanded coverage, more reliability and enhanced capabilities while reducing costs.

The next chart focuses on our GSM integration, chart 17. On chart 17 you can see that we are on schedule and are making solid progress with our GSM integration. We now have completed integrating 51% of overlapping cell sites, and we now have about 31% of the sites in our network left to integrate. As we continue to execute our plan over the next two quarters, our GSM integration efforts will significantly contribute to margin improvements as we drive cost out of the business.

Just as with TDMA rationalization, much of the work will lag the actual network integration activities, so most of these savings will fall in the second half of 2006. That means that we still have a lot of cost reductions ahead of us.

In addition to driving cost savings, our GSM integration efforts are yielding significant service quality improvements for our customers, as you will see on our next chart. Chart 17 shows you some of the improvements that we're seeing so far. Based on results from our first fully integrated markets, we're driving considerable performance improvements by integrating the orange and blue networks.

Our first integrated markets saw dropped calls down 35% and blocked calls down 45%. This is even more impressive when you consider that we started off with some pretty good metrics. This quarter, based on data from Telefia, we learned just how big an impact our network investments are having, as we can now claim that Cingular has the fewest dropped calls of any national wireless carrier, and this is just the beginning. As we complete our network integration, our customers will experience a significant improvement in quality.

In addition to integrating our Legacy networks, we are also modernizing our network with 3G deployment. Chart 18 gives you an update on our 3G UMTS/HSDPA deployment. Last quarter we launched our third generation network with our Broadband Connect product in 16 markets covering over 30 million people in 2005. We're on track and will have most of the nation's top markets launched by the end of 2006. A majority of these markets will launch in the second half of this year.

Our 3G deployment significantly improves data speeds from our current nationwide EDGE network. UMTS with HSDPA enables us to provide industry-leading data throughputs with average data speeds of 400 kbps to 700 kbps. The speed of our 3G network paves the way for new products like Cingular Video that we launched this quarter. I will talk a little bit more about Cingular Video later.

Before I move on, I wanted to remind you that the real advantage of our third generation technology is that it supports simultaneous voice and data. This enables us to leverage our network investment for incremental voice capacity at a significantly lower cost. As we get customers on our third generation network, we will begin to see the cost benefits of this greater efficiency.

We plan to introduce more products leveraging our third generation technology for consumers and business customers later this year. These new products will help to fuel additional revenue growth.

Now let's take a look at the next chart where we look at our progress with IT systems network integration. We are focused on systems consolidations to improve business processes and eliminate redundancies caused by the merger. Last year we completed most of the back office systems consolidations work, and this year we are focused on executing billing conversions. After the merger, we had three billing systems in most markets. This added complexity to the business and made it difficult to provide consistent, high-quality service to our customers.

Our goal is to have a single billing system in each market, and we are well on our way to achieving this goal. Through migrations and conversions, we now have 88% of customers on in-state billing systems. We plan to complete GSM customer billing conversions in 2006, and the remaining TDMA subscribers will be converted in early 2007. As we continue billing system conversions, we will see additional improvements in productivity and in customer service.

We have reduced the number of IT systems we support by 25%, and much of the remaining systems consolidation work and the associated cost savings will happen as we decommission the legacy billing systems and the systems that tie to them. We still have much work to do in these areas in 2006 and expect to see improvements in margins and quality of service as we continue to drive complexities out of our business processes.

One area where we are already starting to see the benefits is customer service. The charts on slide 20 show the progress that we are making in customer service. Our work to simplify the business is paying off. We're eliminating the reasons for customers to call, while simultaneously increasing the number of issues resolved on the customer's first call. We plan to get even better as we move more customers into in-state billing systems, complete our network integration and make it easier to provide a consistent quality customer experience.

So what does all this integration work lead to? It leads to lower churn as you will see in the next chart. As our IT systems are consolidated, as our customer services get better, as our distribution improves, and as our network goes to the next level and as we launch new products and services, our churn continues to improve.

How much does it go down? Well, you can see the improvement on chart 21. Our churn, both prepaid and postpaid, is at the lowest levels in our history, and we look forward to breaking even more records as the year progresses. As we reduce churn, we make it easier to grow customers.

The next chart is similar to the one that we shared over the past year, showing the growth of our GSM subscriber base. The importance of this increase is twofold. First, by moving to one technology, we give ourselves a solid foundation on a global standard for the newest products and services. Second, it provides a simpler business with less duplication which directly leads to higher operating margins.

We ended the first quarter with over 89% of our subscriber base and 97% of the minutes now on GSM. This means that we have added 5.5 million new customers over the last year, and we have migrated another 8.2 customers to GSM. This works out to 13.7 million new customers on our GSM network over the last year and well over 20 million since the merger. That is like adding the entire base of T-Mobile to Cingular's GSM network in 18 months.

It illustrates the magnitude of the network integration and build out effort, and it also shows improved potential for our data business. GSM technology is the foundation for our data services. The more customers on GSM, the more potential to drive increases in data revenues. Let's take a closer look at data growth on the next chart.

Our data business has grown significantly in the last year. The chart on the left shows our data percent of service revenue increasing quarter-over-quarter with a 320 basis point increase year-over-year. Data revenues themselves have increased 53% in the last year.

The chart on the right shows that we now have over 25 million data customers. As we continue to move customers to GSM, we expect the number of customers using data applications to increase. Data customers generated 6.75 billion text messages in the first quarter. So far this year we have seen text messages from American Idol up 55% over the last season. Our customers in the first quarter sent 91 million MMS messages, and these accomplishments drive further increases in data usage as we continue to aggressively pursue new products and services.

The next slide shows you just a few examples of the products that we have launched this quarter. The sliver on the upper left is another Cingular exclusive with iTunes. It is a great design and proving very popular with our customers. The 8125 with the Windows Mobile 5.0 Pocket PC operating system is getting great reviews, and it is a great device to drive an increase in the use of wireless data applications.

The Option PC card even goes a step further. It is the first 3G card for both domestic and international use. It has quad band GSM capability and tri-band UMTS/HSDPA capability.

Finally, there is Cingular Video, which is as easy to use as it is to enjoy. With personalization capabilities like Media Net 3.0, it has the quickest access to a customer's specific content. In the months ahead, you will see us launching even more products and services designed to make wireless data easy to use.

Now let's summarize Cingular's very solid first quarter. Integration activities are on schedule and are starting to deliver the margin improvements we have planned. The majority of our cost savings will fall into the latter half of 2006 and the beginning of 2007 as we complete GSM integration and begin to sunset legacy billing systems. Network quality is up, and we will continue to improve as GSM integration work is completed. We now have the fewest dropped calls of any national carrier. Customer satisfaction is up and will continue to improve. Our integration efforts thus far have contributed to the lowest churn in Company history, and we have maintained strong growth while we have executed all of these integration activities.

The bottom line is that Cingular Wireless is getting better everyday. Everyday, as we integrate our GSM network, our service gets better, and customers experience fewer dropped calls and fewer blocked calls. Every day that we add a new cell site as part of our build out, our network coverage gets better. Every day we move a customer from TDMA to GSM that customer gets better coverage and we get better data revenues . We also get a day closer to being able to sunset TDMA billing systems and achieve better margins. Every day we put our customer on our 3G network, we can provide a customer with better services, get better data revenues and utilize lower-cost structures.

Finally, everyday that we move a customer from our joint venture with T-Mobile to Cingular's best network, our customers experience better service and we experience lower costs.

I'm convinced that we have the right strategy and the right plans and that we are executing exactly as promised, and we are still at the very beginning of what this new Company will be able to deliver. So I look forward to even better results as the year goes on. Now I will turn it back over to Kent, and we will open it up for questions.

Kent Evans

Marcella, we are now ready for questions. As we have many participants on the call today, I would like to ask each one of those asking questions to limit the number of multi-part questions so we have more of an opportunity to spread the questions around. Marcella.

Question-and-Answer Session

Thank you. (Operator Instructions) Our first question comes from Mike McCormack, Bear Stearns.

Scott Goldman - Bear Stearns

Good morning. This is Scott Goldman in for Mike McCormack. I had a quick question on RadioShack. We got conflicting reports from what you guys are saying today and what RadioShack may have said back earlier in the quarter.

I am wondering if you could talk about the impact RadioShack had on your gross adds and whether you saw any change as the quarter progressed? Thanks.

Ralph de la Vega

Yes, we have our own forecast for what our expectations were from RadioShack, and they have delivered against those expectations on the basis of gross adds. We anticipated a ramp in their sales, which is what has happened, and so we feel both good about the number of gross adds they have delivered, as well as the quality of their gross adds. They are actually right where we expected them to be, actually slightly better.

If you want to get more insight as far as their view, you are going to have to get details from them. But what they have delivered for us has met all of our expectations.

Scott Goldman - Bear Stearns

Great. And would you expect that gross add number to ramp up as we go in further throughout the year?

Ralph de la Vega

Yes, we expect the gross adds to ramp up as they continue to get more familiar with our products and we get better productivity out of them. So I'm pretty confident that that will happen.

Scott Goldman - Bear Stearns

Thank you.

Operator

Our next question comes from Jason Armstrong, Goldman Sachs.

Jason Armstrong - Goldman Sachs

Good morning. A question on margins with two parts, if Kent will allow that. The first part is, you mentioned network and IT savings still largely to come, so a substantial upside there. If you think about more near-term quarter in, quarter out trends, one of the big drivers here obviously is equipment subsidies. It looks like equipment subsidies picked up this quarter. By my calculations they cut into margins by about 100 basis points sequentially. What was the driver of this this quarter? Can you talk about the expected trajectory of subsidies from here?

Then the second part on margins, Pete, you said relative to this quarter you expect to accelerate margin improvement throughout this year and next. I'm wondering if you can put this in a bit more context. Are you saying that the 90 basis points of sequential improvement seen here should accelerate? Or are you referencing more of the year-over-year 640 basis points change which should accelerate? What exactly are you referring to?

Ralph de la Vega

Yes, let me try to address the first part, Jason. We have had actually great success in the first quarter with some of the promotions that we have put on board. Some of those promotions end up to be the higher price handsets. So you have seen some of the subsidies reflect that. The promotions specifically with the black RAZR or the pink RAZR and the silver RAZR have been huge hits. They have driven up our postpaid business and have had the impact that you talked about, in terms of equipment margins.

We expect that probably there will be less of that in the future, but the true proof of that will be what the market brings in the second, third and fourth quarters. But we're very pleased with the results, especially in the postpaid area.

Pete Ritcher

Jason, on my comment regarding accelerated margins, it is being driven by all the information that Ralph took you through regarding all of the integration efforts that we have going on and the expenses that come from those. After we get a few months past a lot of that activity and actually get into taking the costs out of the business; when the assets are no longer there or the activities are no longer there.

When I walk accelerated, I'm talking about we fully anticipate to see a greater percentage of those costs come out in the second half of the year than what we saw here in the first quarter. Yes, if you think about improvement, I think you should think of it on a sequential basis not on a year-over-year.

As you saw, we had significant year-over-year margin improvement for about the last four quarters. You probably won't see those same year-over-year reductions, but we do expect to see a pickup in the sequential improvements, especially as we move to the latter half of the year.

Jason Armstrong - Goldman Sachs

Thanks.

Operator

Our next question comes from David Barden, Banc of America Securities.

David Barden - Banc of America Securities

I'm going to ask a multi-part if I could. Just a follow-up and a question. Just on the quarter-over-quarter improvement in postpaid subscriber growth, can you guys try to pinpoint for us, what was the driver of that? Was it the bigger subsidies on high-end handsets added to the RadioShack channel, added to some other thing? Maybe just talk about the puts and takes. I'm trying to get a sense as to what the compromises are going to be in terms of subscriber growth over the rest of the year.

Then a question on usage. Obviously year-over-year usage in terms of minutes of use growth was good. Starting in the second quarter of last year; third, fourth and this quarter, there seems to have been kind of a flattening out of usage. It might be related to the prepaid evolution of the base. Could you speak to the flattening out of usage in your subscriber base? Thanks.

Ralph de la Vega

What we have seen in the first quarter, quite frankly, is a combination of all the things that we have been saying we are going to do come to fruition. We have done a great job in building the best network. We have seen network quality have a significant impact on our churn, and that has been one of the key drivers of growth in the first quarter.

As Pete mentioned, the gross adds were kind of flat when you compared it to the prior quarter in his analysis. So a big driver of this is just the fact that we have lower churn. We have tried to be competitive in the marketplace in terms of our handsets subsidies.

The real driver is the combination of having great capability in our network and the customers are beginning to see that big time. Having RadioShack kick off exactly as we planned has helped. Churn is getting better. We also launched some pretty compelling new products, so we are getting great success out of the Motorola SLVR. It is still the only product out there of its kind with iTunes. We are getting a very good take on the 8125 that I showed on my chart, and our customer service has never been better.

So it is really a combination of all of those things, not any one single thing. But what you are seeing is us having great execution on the things that we told you we were going to do, and they are delivering the results as we expected them.

Pete Ritcher

Yes and I would agree with that. The big driver, I think your point was primarily on what the large rebound we saw in postpaid and sort of net adds for the quarter; it was churn. I know all of you, along with us, may have been a little concerned about that mix last quarter.

As we explained at that point, we were going through a lot of distribution rationalization and that, but we had RadioShack coming on in the next quarter. We also had continuing improvements in churn, and that is exactly what we're planning on doing.

On the second issue on usage trends, I think you've got a couple of things. One you have pointed out. Our mix on the reseller and prepaid obviously has an effect on that math. But the other large driver I think that we are seeing, as we had mentioned before in our ARPU discussions, we have seen a maturation in a lot of the activity there on migration from TDMA to GSM and percentage of our customers that are on rollover plans; the percentage of our customers that are on some national rate plans. All of those issues we know were driving ARPU issues and usage issues for us. You are seeing somewhat of a maturation there too on the usage side.

David Barden - Banc of America Securities

Thanks, guys.

Operator

Thank you. Our next question comes from Michael Rollins, Citigroup.

Michael Rollins - Citigroup

Good morning.

Pete Ritcher

Good morning, Michael.

Michael Rollins - Citigroup

Just a question on the family plan. It is becoming a substantially larger part of your business. Can you talk about how the family plan economics have evolved over the last couple of years? Are the families spending more per handset now versus two years ago? Is the churn a reflection of just getting past a hurdle on the percent of family plans within your base? As that base of customers matures, it is just maybe a gravity effect on churn? Thanks.

Pete Ritcher

Let me take a stab at that. I will tell you that the family plan economics are pretty consistent over the last couple of years. I would tell you that they are up somewhat as I think we see increased penetration of data usage, and we fully expected that. As we have data usage and data penetration rates increasing across our whole base, we obviously are also seeing that here in our family plans. That really helps, as you know, in getting that ARPU up.

Then on the churn side, yes, I mean one of the big economic benefits of offering the family talk plan at the rates at which we and our competitors offer them, are the churn benefits that it produces for you, and we are seeing that. I don't think we're seeing any different trends than what we were seeing in the past. We still believe and everything we look at here shows that our primary reason for our churn improvements here are related to the improvements that we are doing in our network quality and our overall customer experience. So churn rates are good on family talk plans, and that is what they need to be to drive the kind of economics you need on those. But that is not the driver of our churn improvement here on a year-over-year basis.

Michael Rollins - Citigroup

Thank you.

Operator

Our next question comes from Simon Flannery, Morgan Stanley.

Raena Smith - Morgan Stanley

This is Raena Smith for Simon. I was hoping you could give us a little bit more detail on your plans for the 3G rollout? You mentioned that that was going to be more of a second-half focused rollout, and also the new products that you're planning there.

Ralph de la Vega

Yes. The majority of the nation's top markets will be rolled out in the second half of the year. Just so that you understand, the planning that we have done from day one has been to do it in a smart sequence. So you saw us rationalize TDMA. Rationalizing TDMA creates space and capability on our cell sites that allow the GSM integration to take place. As we get GSM integrated, that creates additional capability in our cell sites. Then finally, kind of the topping on the cake, if you will, is to finally overlay that with our UMTS capability.

So it is a logical flow in terms of how you roll out the technology and how you do it in a way that makes it easy to do, and so that once you are done with a particular market, you've finished in that market. So expect to see our coverage cover most of the nation's top markets by the end of this year.

I think you will see some interesting applications. Rather than give away our product launches on this call, I think we're going to have to wait a few more months. I think you're going to see some pretty exciting applications that are not in the marketplace today that we have tested in focus groups and are getting some very, very good reviews. So I don't want to give all that yet this early on to our competitors, but I think you will see us doing some very nice things in about another quarter to a quarter-and-a-half.

Operator

Our next question comes from David Janazzo, Merrill Lynch.

David Janazzo - Merrill Lynch

Pete, you had mentioned reseller ARPU was less than $10. How do you think about the profitability of the reseller customers, whether it is the cost, the lifetime or other factors?

Pete Ritcher

Yes, the profitability, as I mentioned, is fine. We are comfortable with the profitability that we have on those customers. But, at the same time, I will be upfront with you those kind of ARPUs don't move the needle much on our overall profitability. But there is no issue there that we have on the reseller or the wholesale arrangements that we have gotten into to where we have any issue or concerns around the profitability.

We say no to a lot of arrangements that we don't feel comfortable with the profitability on, and I don't think you should expect to see us as being a big and a large wholesaler of our network. That is not our business plan. But we are comfortable with the profitability of the resell customers that we have. At the same time, it is a small part of our overall business.

Operator

Our next question comes from John Hodulik, UBS.

John Hodulik - UBS

Thanks, good morning, guys. Ralph, just a follow-up to your comments on the handset subsidy issue. You said that you expected that trend to improve. If you could just give us some color on how that should improve; do you expect the phones to get cheaper as they continue to scale up, or is the replacement rate going to go down? I think that sounds like that was the big delta in our numbers for the quarter and the margins. I would just like a little bit more color on how you expect that to play out or that situation to improve.

Ralph de la Vega

I think that my comments are based on what I see as the product roadmap for the next few quarters, John. And so it is based on the mix that I see and the fact that we should be seeing less subsidy on the handsets that we will be rolling out in the quarters to come.

John Hodulik - UBS

It is not necessarily a mix of the phones, but there will be less promotion or less subsidy of the phones as they roll out?

Ralph de la Vega

I think it will be a combination of the two. The mix will be slightly different. As we roll out in coming quarters UMTS devices, you will see a different mix, a different mix with prepaid as well. So the whole combination should be -- unless the market dictates some other actions -- you should see a reduction in that.

Pete Ritcher

John, the only thing I will add too is that I think, as you have seen from our churn improvements this quarter and then the activities we still have underway and the expectation we have for churn improvements going forward for the rest of the year, we have a lot of room to grow the business here by continuing to reduce our churn. You should expect to see us to balance those metrics or whatever there around our growth and our operating margins.

So obviously to the extent that we are hanging onto our customers at a lot better rate than we were before, it puts less pressure on us to have to go out and chase new customers. We will be in the market. We will be competitive, but we with these churn improvements that we have, we have a real ability to grow at rates comparable to what we did in the past or greater than what we did in the past but not have to chase it with acquisition costs.

So you should expect to see us balance across both of those metrics as we move through the year.

John Hodulik - UBS

Great and just a quick question for Pete. The CapEx was a little bit below what we thought. I imagine you're keeping to the $7 billion to $7.5 billion for the year?

Pete Ritcher

Yes, we are. As you know, we were really hot in the fourth quarter. We have maintained that momentum. I know it is a little below where your consensus was, but it is still higher than what we spent in the first quarter of last year and what we traditionally spend in the first quarter. That is associated with all the activities that we have underway.

As Ralph was taking you through, though, we're very satisfied with where our progress is on those, and we don't anticipate any issues that would take us out of that previously issued guidance.

Operator

Our next question is from Jonathan Chaplin, JP Morgan.

Jonathan Chaplin - JP Morgan

Thanks for taking the question. Actually I had two very quick ones. Firstly, there seems to be a little bit of investor angst about the upcoming Spectrum auctions. It seems like you guys have just about the best Spectrum position out there, at least in the top 100 markets. I'm wondering if there are markets outside of the top 100 markets where you feel like you need to augment your Spectrum position? Just basically what your propensity to participate in the auctions is going to be.

Then secondly just looking at your data revenue per data customer, it seems to have gone up about 8% sequentially. I'm wondering how much of that is driven by the HSDPA rollouts at the end of last year? I'm wondering if you could give us some sense for what the ARPU is on an HSDPA customer relative to a normal data customer? Thanks.

Pete Ritcher

I will take those, Jonathan. First off, on the Spectrum auction, we have not announced whether we will be participating in an auction or not yet. We are still assessing what our potential needs may be there, so I don't have anything I could add at this time.

On data ARPUs -- and Ralph, feel free to jump in here -- but I would tell you that we are happy with our progress on the 16 markets that we launched last year, but that did not have any significant effect on our data ARPU increase from quarter to quarter. With 16 markets and the ramp up you have in growth rates there and primarily being data cards as we started to roll out, that is not the big driver for our data ARPU increase.

Sequentially we are obviously counting on it for being a big driver of our data ARPU as we move throughout end of 2007 and beyond. But that was not the big driver for our increase this last quarter.

Ralph de la Vega

Yes, what we are seeing, Jonathan, in those markets where we have launched is a nice uptake on the data cards, a nice increase in data usage. But, as Pete mentioned, that impact to our bottom line is still yet to come. So that is why we feel bullish on the future. Just to reiterate, our Spectrum position in the top markets is outstanding. So a bit too early to call on what we will do in those auctions yet.

Operator

Our next question comes from Frank Louthan, Raymond James.

Frank Louthan, Raymond James

Great. A slightly different topic. If you could comment a little bit on looking forward as you continue to expand data growth, can you give us an idea of what you're spending on backhaul and to what extent going forward do you expect that to grow? Are you expanding the possibility of using some microwave backhaul or something like that going forward, as you're potentially having some large increases in that expense as you expand your data products?

Ralph de la Vega

We are looking at every technological option available to us to reduce that cost and are looking at a combination of microwave, putting in national networks that have IP capability, and trying to maximize the assets that we have. So I think it is not one thing; it is a combination of things, and they vary by region depending on the situations of the geography that we are talking about.

You will see us continue to try to have more efficient backhaul, which is capable of doing the things that you mentioned.

Frank Louthan, Raymond James

Any ballpark on what your percentage of your costs are going to backhaul currently?

Ralph de la Vega

I don't have a number that I can share with you. Pete, any -- --?

Pete Ritcher

We have not released any of that data.

Frank Louthan, Raymond James

Great, thank you.

Operator

Our next question comes from Chris Larsen, Credit Suisse First Boston.

Chris Larsen, Credit Suisse First Boston

Actually just a couple of quick questions. First, on the first quarter subscriber additions, can you give us a sense for what percentage were wholesale, prepaid and Add-a-Phone or family plans? Then, what percent of the base now is prepaid?

Secondly, how do you account for data customers if they say get a RIM or some sort of PDA and they get both the voice and the data subscription on that device? Are they one customer with $80 of ARPU or two with $40 of ARPU?

Pete Ritcher

This is Pete Ritcher. The breakdown in the first quarter of our net adds: 900,000 were postpaid, 147,000 were prepaid and a little over 600,000 were wholesale or resale customers.

I don't have a percentage of what that is on our base right now for prepaid. But feel free to contact our IR group and we can fill you in on those details. I'm sorry, the last part of your question?

Chris Larsen, Credit Suisse First Boston

The accounting treatment for multiple service devices like a RIM or a PDA that has both a data service and then a voice service?

Pete Ritcher

Yes, it is all based on, there is one SIM card there in that unit, that is counted as one customer.

Operator

Our next question comes from Rick Prentiss, Raymond James.

Rick Prentiss - Raymond James

Actually I want to follow up a little bit on Chris' question there. On your $5.22 of data ARPU, is that impacted at all by the wholesale customer base, or is that data revenue just from that 25 million data customers?

Pete Ritcher

Rick, it is over all of our subscribers, so nearly 56 million of them. It is an apples-to-apples comparison. Obviously it is higher per data user -- significantly higher -- and it is higher per postpaid user. But that is an apples-to-apples with the way in which we report our ARPU subscriber base.

Ralph de la Vega

That is a good clarifying question, Rick. Not every subscriber publishes like we do. So if you do it on the base of postpaid, it is much higher.

Rick Prentiss - Raymond James

Yes, because I think you said wholesale is like 9% of your base now, if I heard earlier, right?

Pete Ritcher

Correct.

Rick Prentiss - Raymond James

Then a second question is, as far as GSM out there in the white space, if you will, how happy are you with the availability of GSM out there? What are your thoughts as far as -- since you will have UMTS in the major markets by the second half of this year, when do you want to see UMTS out in the greenfield areas?

Ralph de la Vega

First, let me say that we are very pleased with the partners that we have that are taking out GSM to the white spaces. We are very pleased with the expansion that we have seen and the partners that we have.

In terms of UMTS, that will go out at a slower pace, but we are working with partners not only nationally, but I think what is really exciting is what is happening internationally. We are seeing a very significant growth in UMTS and people beginning to take up HSDPA, and in fact, some providers are actually switching from CDMA to UMTS-based technologies that will give us even greater worldwide capability to leverage the scale of the technology that we are deploying.

So some very, very encouraging signs of people taking UMTS and following our lead on HSDPA both at 1900, 2100, as well as 800 and 900. So the rest of the world at this point has latched onto our strategy, and that is a real good confirmation for us that we did the right thing.

Rick Prentiss - Raymond James

Great. Good luck, guys.

Operator

Our next question comes from John Aiken, RBC Capital Markets.

John Aiken - RBC Capital Markets

My question is about new voice products. Push-to-Talk recently introduced and then perhaps in the future, devices that combine Wi-Fi and GSM into a single unit. What type of contribution have you been seeing from Push-to-Talk, and what are your expectations for some of the dual mode Wi-Fi GSM devices going forward?

Ralph de la Vega

Yes, we have seen a pretty healthy uptake on Push-to-Talk, where we are not releasing those figures yet. What you are going to see from us is a significantly greater number of devices with Push-to-Talk capability. Throughout most of the first quarter, we have actually been selling only two devices. Now we have got devices that will be coming out that will be a significantly greater number both at the consumer level, as well as the PDA level, and it is very exciting what you're going to see in the upcoming quarters.

It is not appropriate for me to give you more details than that for competitive reasons. But suffice it to say, that you're going to see a much more robust portfolio of handsets and PDAs that have Push-to-Talk that will significantly expand the reach of our Push-to-Talk products in the coming quarters.

John Aiken - RBC Capital Markets

Okay and then on the Wi-Fi/GSM?

Ralph de la Vega

Yes, we will have several products that have Wi-Fi/GSM capable handsets. We have some that will be coming out in the next quarter or so that will add to the portfolio of that Wi-Fi capability.

Operator

Our next question comes from Michael Bowen, FBR.

Michael Bowen - FBR

Good morning. Thanks for taking the question. A two-parter here, unrelated; with RadioShack can you give us some idea as to possibly for '06 what you expect RadioShack to be adding incrementally to the net subscriber base?

Second question is, anecdotally as I travel around the country and I talk to investors -- and I also have a Cingular device and a Verizon device -- in some of the major markets there still seems to be, what I'm hearing, complaints about the coverage. I would like to understand from a network standpoint what you are doing with regard to either towers or the technology on the towers to improve your coverage? While you're doing a nice job improving your margins, the coverage is still lagging behind Verizon. I would love to hear a little bit of detail on that. Thanks.

Ralph de la Vega

Michael, let's begin with that one first. First, I don't know which markets you traveled, but when we measure our progress, we have drive tests that are done by third-parties. I have looked at our drive tests in the first quarter, and I'm smiling ear-to-ear with the results that we are seeing not only on coverage but on dropped calls and blocked calls. We are just having the best results that we have seen in many, many places, beating every other competitor.

The way that we are doing these drive tests, just to give you some sense of how we're going about it, is after we get through with an area that is integrated the first thing we immediately do is we drive test it. Number one, to make sure we have optimized the RF to the best that we can, but also to compare it to our competitors. The results so far after integration have just been outstanding, in addition to the benefits that we are getting from the integration activity, so we are not stopping the network build out.

You are seeing us build anywhere from 3,000 to 3,600 new network sites this year, and we have seen some very good progress made in the first quarter as well. So if you're going into the markets that perhaps are not integrated, I could see where you may be seeing a difference, but I would there say in almost every market that we have integrated that I have looked at we have got the best network claim that we can make. So you should continue to see us getting better.

As I mentioned in my opening comments, we are building sites everyday in our network, and everyday we are integrating new sites that just make the coverage that much better for our customers.

Michael Bowen - FBR

When you do your drive tests, are you able to isolate by device? I mean obviously there are a lot of phones and devices out there. Can you isolate that and check to see whether it is a particular device may not be getting as good a service, or is it just a general test?

Ralph de la Vega

Yes, there are certain devices that are used with the drive test devices that we know have reasonable RF reception capabilities, but reception varies by device clearly. So depending on which device you carry, you may have slightly better or slightly worse RF, and the device clearly, clearly makes a difference. But you should be seeing what I'm seeing when I get the actual facts put in front of us with hard data, that everywhere throughout this country our network is getting better.

The best testament of that is what our customers are telling us by their lower churn numbers. So we feel pretty good. But if you have not seen it where you travel, I can almost tell you that you will as we get through with the network improvement that I have been talking about.

Michael Bowen - FBR

Okay. Thanks. And RadioShack?

Ralph de la Vega

RadioShack, we are not providing projections for '06 on RadioShack.

Michael Bowen - FBR

Okay, thank you.

Operator

Our next question comes from Qaisar Hasan, Buckingham Research.

Qaisar Hasan - Buckingham Research

Clarification on your cash flows, specifically working capital. If I look at your prepaid expenses and your accounts payable, there seems to be an outflow about slightly more than $1 billion on a sequential basis. I was just wondering if you could just shed some light as to what is driving those outflows and what we can expect on the working capital side as we go through the rest of the year?

Pete Ritcher

Fourth quarter CapEx is what drove it. As you know, we had another $3 billion worth of CapEx in the fourth quarter, and you have accounts payable on your books, and you have got to pay those principally in the first quarter. We have given guidance out there regarding our cash flow of around $2 billion range for the year, and we still feel comfortable with that guidance.

Operator

Our next question comes from Will Power, Robert Baird.

Will Power - Robert Baird

You all have had strong wholesale subscriber growth both in Q4 and Q1. I know there's an element of seasonality there associated with TracFone and prepaid. I wonder if you have already started to see that taper off, or I guess generally what your expectations are to the balance of the year on the wholesale side? As part of that, as you look at 2% year-over-year ARPU declines for total ARPU, is that a reasonable expectation or barometer to use going into the balance of the year as well?

Pete Ritcher

Well, I will tell you that I don't have a specific forecast to give you on reseller. I think I could just point to the things you have already alluded to in that we tend to see some seasonality there in the first quarter. We've talked about last quarter what we saw during the holidays and how we are being driven a lot by a lot more gift giving and prepaid and reseller products under the Christmas tree. So I don't think we have any information here that would lead us to believe that those trends will change any. But I don't have any specific forecast or whatever to be able to give you. I'm sorry, the second part of your question?

Will Power - Robert Baird

Yes, I'm trying to get some additional color on the ARPU front, how we should think about that going forward? It looks like ARPU is down about 2% year-over-year, total ARPU in Q1. Is that a good benchmark to kind of use over the balance of the year?

Pete Ritcher

I think our expectations are we should see that or better. As we pointed out here, the real reduction that we saw year-over-year was driven by the reseller growth. If it does moderate and we continue to have the improvements that we are having here in both our churn and then the trends that we have seen on an actual year-over-year increase on the retail side of our business, is that we should expect to see those year-over-year ARPU trends continue to moderate. My way of saying that I think you should see them get better on a year-over-year basis.

Operator

Mr. Evans, the allowed time for questions and answers has expired.

Kent Evans

Well, thank you very much for joining us on our call today, and if you have any questions, please contact us or the Investor Relations departments of BellSouth and AT&T. Thank you very much.

Operator

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating, and you may all disconnect.

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Source: Cingular Wireless LLC Q1 2006 Earnings Conference Call Transcript (T)
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