AT&T Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Amounts below are in U.S. dollars; financial statement amounts are in millions unless noted. AT&T operates in telecommunications, media and technology. The quarter includes Time Warner (WarnerMedia) results only from June 15–30, 2018.
Financial performance and liquidity
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Operating revenue | $38,986 | $39,837 | $77,024 | $79,202 |
| Operating income | $6,466 | $6,526 | $12,667 | $12,882 |
| Net income attributable to AT&T | $5,132 | $3,915 | $9,794 | $7,384 |
| Diluted EPS | $0.81 | $0.63 | $1.56 | $1.19 |
| Operating margin | 16.6% | 16.4% | 16.4% | 16.3% |
- Cash flow: Six-month operating cash flow was $19.176 billion, versus $17.670 billion a year earlier. Investing cash outflow was $52.635 billion, including $40.715 billion for acquisitions and $10.959 billion for property and equipment purchases. Financing cash outflow was $3.720 billion. Cash and restricted cash ended the period at $13.753 billion; cash and cash equivalents alone were $13.523 billion.
- Capital investment and dividends: Management expected 2018 capital investment of approximately $25 billion, or $22 billion net of expected FirstNet reimbursements and vendor financing. First-half dividends paid were $6.144 billion; dividends declared were $1.00 per share.
- Debt and liquidity: Debt totaled $190.167 billion, including $21.672 billion maturing within one year and $168.495 billion of long-term debt. Cash and cash equivalents were $13.523 billion. The debt ratio was 50.8% and net debt ratio 47.2%. AT&T reported compliance with credit-facility covenants, including a maximum net debt-to-EBITDA ratio of 3.5-to-1.
- Interest and taxes: Q2 interest expense was $2.023 billion, up 45% year over year; first-half expense was $3.794 billion, up 41.1%. The effective tax rate was 22.6% for Q2 and the first half, versus 33.9% and 33.7%, respectively, in 2017.
Material changes versus the prior comparable period
- Reported revenue fell 2.1% in Q2 and 2.7% in the first half. Service revenue declined 7.6% in both periods, while equipment revenue rose 23.7% in Q2 and 36.5% in the first half. AT&T attributed much of the service/equipment mix shift and reported revenue decline to adoption of ASC 606, including net presentation of certain regulatory fees and changed allocation of bundled-contract revenue. Legacy wireline and video declines also contributed.
- Net income attributable to AT&T increased 31.1% in Q2 and 32.6% in the first half, while operating income declined modestly. Higher reported net income reflected lower tax expense and substantial actuarial gains recorded in other income; it was not solely an improvement in operating performance.
- ASC 606 was adopted prospectively for prior-period comparisons using the modified retrospective method. AT&T disclosed that Q2 2018 revenue and diluted EPS under the prior accounting method would have been $39.909 billion and $0.74, versus reported $38.986 billion and $0.81. For the first half, the historical-method figures would have been $78.839 billion and $1.42, versus reported $77.024 billion and $1.56. Comparisons across periods therefore require care.
- Segment performance was mixed: Consumer Mobility contribution increased to $4.978 billion in Q2 from $4.739 billion; Business Solutions fell to $1.961 billion from $2.131 billion; Entertainment Group fell to $1.432 billion from $1.630 billion; and International contribution was a loss of $150 million versus a loss of $32 million. WarnerMedia contributed $445 million for its 16-day period and has no comparable 2017 result.
- Operational trends included 146.9 million domestic wireless subscribers, up 7.9% year over year, and 1.809 million DIRECTV NOW video subscribers versus 491,000. Domestic satellite video subscribers declined to 19.984 million from 20.856 million; legacy voice and data connections continued to fall.
Outlook, commentary, risks and unusual items
- Outlook: Management expected a 2018 effective tax rate of approximately 23% and capital investment of approximately $25 billion. It said Consumer Mobility service revenue on a comparable basis should increase during the rest of 2018 as the prior-year launch of unlimited plans rolls out of comparisons. The filing provides no specific full-year revenue or EPS guidance.
- Time Warner acquisition: Completed June 14 for total consideration of $79.114 billion, comprising approximately $42.1 billion cash and $36.6 billion of AT&T stock; former Time Warner shareholders received about 16% of the combined company. Purchase-price allocations were preliminary and could change materially. AT&T acquired $22.846 billion of debt at fair value and reported $18.876 billion of that debt at face value remaining at quarter-end. The Department of Justice appealed the merger judgment on July 12; AT&T said it would defend the transaction. Integration, synergies, additional interest expense and dilution are identified risks.
- Unusual earnings items: Pension and postretirement remeasurements generated actuarial gains of $1.796 billion in Q2 and $2.726 billion in the first half, materially boosting other income. A change in the estimated customer relationship life reduced Q2 costs and increased net income by $126 million, or $0.02 per diluted share. The 2017 U.S. tax reform reduced the federal corporate rate to 21%; management noted future tax-accounting adjustments could still be material.
- Other commitments and contingencies: AT&T agreed to sell 31 data centers for $1.1 billion, with closing expected within six to eight months subject to conditions. The filing describes ongoing DIRECTV NFL SUNDAY TICKET and FTC litigation, an FTC case concerning AT&T Mobility’s legacy data-throttling program, and appeals and labor negotiations. Potential damages or outcomes are not quantified clearly in the filing text.
- Business and regulatory risks: The filing highlights intense wireless, broadband and video competition; continuing declines in legacy services and linear video; foreign exchange and regulatory exposure; costs and execution risks in network investment and 5G deployment; privacy and net-neutrality regulatory uncertainty; litigation; and the DOJ appeal and integration of WarnerMedia.
Key facts for investors to verify
- How much of reported revenue and EPS growth reflects tax effects, pension actuarial gains and ASC 606 presentation rather than recurring operating trends.
- WarnerMedia’s post-acquisition operating performance, final purchase-price allocation, integration costs, realized synergies and effect on leverage and interest expense.
- Progress on debt reduction, refinancing of near-term maturities, cash generation and the ability to fund capital investment and dividends.
- Wireless service revenue, subscriber additions and churn, alongside continued video, legacy wireline and International segment weakness.
- Developments in the DOJ appeal and other litigation, including any material change in exposure; also the completion and proceeds of the data-center sale.