AT&T INC. quarterly report, Q3 FY2014

AT&T Inc. — Q3 2014 Form 10-Q

Reporting period: Three and nine months ended September 30, 2014. Financial statements are unaudited; amounts are in millions of dollars except per-share data. AT&T provides wireless and wireline communications services. The 2014 results include Leap Wireless from its March 13 acquisition date.

Financial performance and position

Metric	Q3 2014	Q3 2013	Nine months 2014	Nine months 2013
Operating revenue	$32,957	$32,158	$98,008	$95,589
Operating income	$5,402	$6,188	$17,296	$18,241
Net income attributable to AT&T	$3,002	$3,814	$10,201	$11,336
Diluted EPS	$0.58	$0.72	$1.95	$2.09

Q3 revenue rose 2.5%, while operating income fell 12.7% and AT&T-attributable net income fell 21.3%. For the nine months, revenue rose 2.5%, operating income declined 5.2%, and attributable net income declined 10.0%.
Operating margin was approximately 16.4% in Q3 versus 19.2% a year earlier (calculated from reported revenue and operating income). Wireless segment margin declined to 24.6% from 26.4%; Wireline declined to 8.8% from 10.6%.
Cash flow, nine months: Operating cash flow was $25,593, down from $26,879. Capital expenditures were $16,829, up from $15,565. Investing cash use was $14,980; financing cash use was $11,494. Period-end cash and cash equivalents were $2,458, versus $3,339 at year-end 2013; short-term investments were another $1,890.
Debt and liquidity: Current debt was $5,109 and long-term debt $70,516 at September 30, 2014, or $75,625 combined. The reported debt ratio was 44.8%, versus 45.0% at December 31, 2013. AT&T had no borrowings under its $8 billion revolving credit facilities and reported covenant compliance.
Quarterly dividends declared were $0.46 per share, compared with $0.45 in Q3 2013. The nine-month declared dividend was $1.38 per share.

Material changes versus prior periods

Wireless equipment revenue rose 44.3% in Q3 and 46.8% year to date, largely reflecting AT&T Next installment-plan device sales. Service revenue was nearly flat; management said no-subsidy plans reduce monthly service revenue while shifting revenue toward equipment.
Wireless subscribers totaled 118.65 million, up 8.4% year over year, including Leap subscribers. Postpaid churn improved to 0.99% from 1.07% in Q3, while total churn increased to 1.36% from 1.31%, partly due to prepaid pressure following Leap’s acquisition.
Wireline revenue declined 0.4% in Q3 and 0.6% for the nine months. Legacy voice and traditional data declines continued; growth in U-verse and strategic business services partly offset them. Switched access lines fell 16.4% year over year, while U-verse video connections grew 15.2%.
Operating expense grew faster than revenue: total expenses increased 6.1% in Q3 and 4.3% year to date. Cost of services and sales rose with device sales, higher-priced handsets, insurance costs, network expense, and U-verse content costs.
Interest expense increased 22.6% in Q3 and 11.1% year to date, reflecting early debt-redemption charges, tower-transaction interest, and higher debt balances.
Nine-month other income included a $1,243 pretax gain on the sale of the América Móvil investment. The sale also contributed to a higher nine-month effective tax rate of 35.6%, versus 30.5% in 2013, because expected foreign tax credits were no longer available.

Outlook, commentary, risks, and unusual items

Management expects continued growth in wireless and wireline IP-based services, alongside ongoing declines in legacy voice and basic wireline data. It expects wireless service revenue pressure as customers migrate to Mobile Share and no-subsidy plans, with equipment revenue increasing as AT&T Next adoption grows.
Management expects 2014 capital expenditures of approximately $21 billion and 2015 capital expenditures of approximately $18 billion for existing businesses. It described 2014 as the peak investment year for Project VIP and said the goal of reaching about 57 million customer locations with IP broadband had been achieved in Q3.
AT&T expects lower 2014 operating cash flow as AT&T Next installment financing expands and Leap integration and DIRECTV merger costs are incurred. Receivable sales provide some cash-flow support; the company had sold $2,276 of net installment receivables in the first nine months and recorded a $901 deferred purchase-price receivable.
The pending DIRECTV acquisition is valued at approximately $48.5 billion and was expected to close in the first half of 2015, subject to FCC, Department of Justice, foreign-government approvals, and other conditions. AT&T cited integration, financing, added debt and shares, regulatory approval, and realization of synergies as risks. It also committed to specified broadband deployment, pricing, and open-Internet conditions after closing.
AT&T agreed in November 2014 to acquire Mexican wireless company GSF Telecom for $2.5 billion less net debt, subject to regulatory approval; it expected closing in Q1 2015. The Connecticut wireline sale for approximately $2 billion closed October 24, 2014.
On October 28, 2014, the FTC sued AT&T Mobility concerning its data-speed management program for some unlimited-plan customers; AT&T disputed the allegations. The filing also describes spectrum constraints, regulatory uncertainty, competition, legacy-service declines, pension costs, and potential network and technology risks.
A change in estimated useful lives for capitalized software increased net income by $198, or $0.04 per diluted share, in Q3 and by $330, or $0.06 per diluted share, for the first nine months. Fourth-quarter results were expected to include pension settlement accounting. No full-year revenue or EPS guidance is stated in the supplied filing text.

Important facts for investors to verify

Whether operating margins stabilize as equipment revenue mix, device financing, promotional activity, and U-verse content costs evolve.
Cash generation after capital spending, dividends, acquisition-related costs, and continued AT&T Next installment financing.
DIRECTV and GSF Telecom approvals, closing terms, financing needs, integration costs, and achievable synergies.
Debt and liquidity effects of planned transactions and spectrum spending, including the $5.1 billion of debt maturing within one year.
Progress in offsetting continued legacy wireline declines with U-verse, broadband, and strategic business services, and the impact of regulatory or litigation outcomes.
The degree to which Q3 and year-to-date earnings benefited from the software-life estimate change and the América Móvil disposal gain.