AT&T Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. Amounts are in millions of dollars unless otherwise noted. The interim statements are unaudited.
Business context
AT&T provides wireless, wireline communications, broadband and video services in the U.S. and internationally. It completed its acquisition of DIRECTV on July 24, 2015; reported 2015 results include DIRECTV for 68 days, so comparisons with 2014 are not on a like-for-like basis. AT&T also acquired Mexican wireless businesses in 2015 and reorganized its reporting into four segments.
Key financial metrics
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Operating revenue | $39,091 | $32,957 | $104,682 | $98,008 |
| Operating income | $5,923 | $5,607 | $17,253 | $17,681 |
| Net income attributable to AT&T | $2,994 | $3,130 | $9,339 | $10,441 |
| Diluted EPS | $0.50 | $0.60 | $1.71 | $2.00 |
| Operating cash flow | Not separately stated | Not separately stated | $26,695 | $25,593 |
| Capital expenditures | Not separately stated | Not separately stated | $13,356 | $16,829 |
- Q3 revenue rose 18.6%, mainly reflecting DIRECTV and Mexican operations; nine-month revenue rose 6.8%. Q3 operating income increased 5.6%, but nine-month operating income declined 2.4%.
- AT&T’s operating margin was 15.2% in Q3 versus 17.0% a year earlier, and 16.5% for the nine months versus 18.0%. Management cited higher acquisition-related charges among the factors affecting margins.
- For the nine months, cash used in investing activities was $43,047, including $17,703 for spectrum licenses, $13,356 of capital expenditures and $12,991 for acquisitions. Cash provided by financing activities was $13,951.
- Cash and cash equivalents were $6,202 at September 30, 2015, down from $8,603 at December 31, 2014; short-term investments were $400. Current assets were $34,951 and current liabilities $47,938.
- Total debt, including debt maturing within one year, was approximately $126,930 ($7,535 current and $119,395 long-term), compared with approximately $82,067 at year-end 2014. The reported debt ratio was 50.8%; net debt ratio was 48.3% in selected data (48.2% in MD&A). Management said free cash flow after dividends would be prioritized for debt reduction.
- Dividends declared were $0.47 per share in Q3 and $1.41 for the nine months. Nine-month dividends paid were $7,311.
Material changes and operating trends
- DIRECTV drove much of the reported growth in video revenue and expanded the Entertainment and Internet Services segment. That segment reported Q3 revenue of $10,858 and operating income of $1,019, versus a prior-year operating loss of $337; acquisition-period effects limit comparability.
- Business Solutions revenue increased 1.2% in Q3 and segment contribution rose 11.3%. Fixed strategic services grew, while legacy voice and data revenue declined 8.7%.
- Consumer Mobility revenue fell 4.6% in Q3, but segment contribution rose 8.6% as operating expenses declined. Postpaid service revenue pressure reflected lower-priced Mobile Share Value plans and subscriber migrations to Business Solutions; postpaid churn increased.
- International, including the acquired Latin American video and Mexican wireless operations, recorded a Q3 operating loss of $83. Mexico wireless lost 231,000 subscribers and Latin American video lost 113,000 connections during the quarter.
- Operating expenses rose 21.3% in Q3, including higher broadcast and programming costs, acquisition-related amortization and integration costs. Nine-month interest expense rose 8.0%, primarily due to higher average debt.
Outlook, risks and unusual items
- Management expected 2015 capital expenditures to be around $21 billion and capital expenditures at 15% of service revenue or lower from 2016 through 2018. No specific earnings or revenue guidance is provided in the supplied filing text.
- Management cited expected DIRECTV synergies and bundled video, broadband and mobile offerings, while acknowledging execution, integration, cost and timing risks. It intends to use free cash flow after dividends to reduce debt.
- The DIRECTV acquisition consideration was valued at $47,404, including $14,378 cash and $32,727 of AT&T stock; 954.4 million shares were issued, giving former DIRECTV shareholders approximately 16% of the combined company. Preliminary purchase-price allocations included $35,343 of goodwill and $20,500 of assumed long-term debt and may be adjusted.
- AT&T changed its accounting for customer setup and installation costs to capitalize and amortize them over an expected customer relationship of about four years. The change increased nine-month 2015 net income by $148 and diluted EPS by $0.03 versus the historical method; it did not affect operating cash flow.
- Acquisition-related items reduced operating income by $3,128 for the first nine months, including $1,689 of merger and integration charges and $1,439 of acquired-intangible amortization. A $98 Q3 gain from repurchasing previously sold equipment installment receivables was recorded in SG&A.
- Other notable exposures include the FTC’s unlimited-data-plan litigation, an FCC notice proposing a $100 penalty over disclosures for that plan, and lawsuits alleging antitrust violations involving DIRECTV’s NFL Sunday Ticket. AT&T disputes the allegations. The filing also identifies spectrum capacity constraints, regulation and net-neutrality proceedings, foreign exchange and Latin American political and economic uncertainty, and acquisition integration as risks.
- FCC conditions on the DIRECTV transaction include fiber deployment, discounted broadband for qualifying low-income households, broadband usage-practice and interconnection disclosures, and compliance reporting; the conditions generally apply for four years.
Investor verification priorities
- Separate organic performance from the 68-day DIRECTV contribution and the effects of the Mexican acquisitions; check the filing’s pro forma DIRECTV results and assumptions.
- Track debt reduction, interest expense, liquidity and dividend funding following the acquisition, including the stated capital-spending plans.
- Assess whether DIRECTV integration, cost savings and subscriber trends support management’s expected synergies, and monitor subscriber losses in Mexico and Latin America.
- Review customer fulfillment-cost accounting and acquisition-related charges when comparing earnings, margins and cash generation across periods.
- Monitor outcomes and potential financial exposure from the FTC, FCC and NFL Sunday Ticket matters, as well as FCC merger commitments and wireless spectrum constraints.