AT&T Inc (T) — Q2 2019 Earnings Call Transcript

Thank you, and good morning, everyone, and welcome to our second quarter conference call. I’m Mike Viola, Head of Investor Relations for AT&T. And joining me on the call today is Randall Stephenson, AT&T’s Chairman and CEO; and John Stephens, AT&T’s Chief Financial Officer. Randall will provide an update on our key 2019 initiatives, and John will cover our operating results. We will follow that up with a Q&A session. Before we begin, I want to call your attention to our Safe Harbor statement, which notes that some of our comments today may be forward-looking. As such, they’re subject to risks and uncertainties, results may differ materially and additional information is available on the Investor Relations website. I also want to remind you that we’re in the quiet period for the FCC Spectrum Auction 103, so we can’t address any questions about that today. As always, our earnings materials are available on the Investor Relations page of the AT&T website, including our news release, investor briefing, 8-K, and associated schedules. One more item before I turn it over to Randall, we’ve scheduled our WarnerMedia Day for the afternoon of October 29 at Warner Bros. Studios in Burbank, California. We will discuss more details on the new streaming service, HBO Max, and more details will come, but go ahead and mark your calendars. And so, with that, I’d like to turn the call over to Randall Stephenson.

Thanks, Mike. Good morning. The headline of the second quarter and the first half of the year is we’re hitting each of our commitments we made for 2019, as you can see on Slide 3. I’ll start with our new leveraging plans, which are right on track. Since we closed the merger last June, net debt is down $18 billion. We expect to further reduce net debt by another $12 billion in the second half of the year, which should get us to a 2.5 times net debt to adjusted EBITDA range by year-end. And to the extent that we can overachieve on that objective, you can expect we’ll take a hard look at allocating capital to share buybacks in the back half of the year. Wireless is about half of our overall EBITDA, and it continues to fire on all cylinders. Last quarter, we grew revenues, EBITDA, and phone subscribers both postpaid and prepaid. Wireless service revenues were up 2.4% in the second quarter and we’re continuing to see the payoff on our investments with our world-class network. Our wireless network has been named the fastest, the best, and the most reliable by independent testing services. FirstNet continues to drive our network performance as well as our 5G leadership. At the end of the quarter, we were about 60% complete with our FirstNet coverage, ahead of plan. We are now targeting 70% completion by year-end. Our FirstNet build is accelerating our 5G deployment. As we deploy FirstNet, we’re installing hardware that can be upgraded to 5G with a simple software release. As a result, we’re on track for nationwide 5G coverage by the first half of 2020. Turning to WarnerMedia, there was another strong quarter. Merger synergies remain on track, and we had solid operating income growth across all three business units. This was a record year with 191 Primetime Emmy nominations for WarnerMedia, and HBO alone scored 137 nominations, which is the most in its history. Consequently, we had very strong HBO digital subscriber growth in the quarter, and we’re set up really well for the second half of the year. Bottom line, HBO’s stepped-up investment in content is working. This will be critical as we launch HBO Max next spring. As Mike mentioned, we look forward to sharing more about HBO Max in October. Our Entertainment Group continues to make solid progress; we didn’t just stabilize EBITDA, we actually grew it by 1.1% in the quarter. Later this summer, we’ll beta launch AT&T TV in a few markets, which is our live TV service over broadband. We have high expectations for this product, and we’ll learn from the pilot before we expand to more cities as we move through the year. IP broadband revenue growth remains strong. We continue to see solid growth in our AT&T Fiber product. That product now reaches about 14 million customer locations or 22 million when you include businesses. Overall, we’re making solid and steady progress against the commitments we made coming into the year. We are even more confident that we’re going to meet or exceed those commitments for the full year. In fact, this morning, we raised our free cash flow guidance for 2019 to the $28 billion range, which is up $2 billion, and we’ve reaffirmed all of our other guidance for the year. Now for more detail on the quarter, I’m going to turn it over to John, and he’ll take you through the results. So, John?

Thank you, Randall, and good morning, everyone. Let me begin with our financial summary on Slide 5. As Randall mentioned, we’re on track with all our financial targets, and in many areas, we’re ahead of plan. Adjusted EPS was $0.89 in the quarter, including a $0.02 impact from a higher effective tax rate. We continue to expect low single-digit growth for the full year, as we are set up for solid performance in the second half of the year. We grew revenue both on a reported and pro forma basis in the quarter. In fact, all segments are growing on a constant currency basis. Adjusted operating margin was up 90 basis points due to the addition of WarnerMedia, strong growth in Mobility, and continued improvement in our Entertainment Group. Our cash flows were very strong this quarter. Let’s look at this on Slide 6. Cash from operations came in strong at $14.3 billion, which is up 40%, and free cash flow was a record $8.8 billion. The addition of WarnerMedia operations made an impact, as did adding their receivables to our securitization efforts. The securitization lifted free cash flow by $2.6 billion. Our ability to generate cash continues to be impressive. Over the last 12 months, we’ve generated $29 billion in free cash flow or about $4 a share. Thanks to our securitization efforts, we have confidence to raise our free cash flow guidance for the full year to the $28 billion range. Our strong cash position also allows us to continue to invest at industry-leading levels. CapEx was $5.5 billion, and total capital investment was $6.5 billion when you include the $1 billion of payments for prior vendor financing activity. We reduced net debt by $6.8 billion in the quarter. Let me speak more to deleveraging on Slide 7. We have paid off $18 billion in debt since we closed the merger, and we ended the quarter with our adjusted net debt to EBITDA ratio at just under 2.7 times. This is down from 3 times leverage ratio when we closed the deal. We’re squarely on track to hit our year-end target of being in the 2.5 times range. Year-to-date, we’ve reduced net debt by nearly $9 billion, which includes about $7 billion from free cash flow and nearly $4 billion in asset monetizations, offset by about $2 billion of vendor payments and other purchases of assets. These sales have come from assets that contribute no EBITDA. Looking at the remainder of the year, we’re confident that we’ll hit our year-end leverage target. To the extent we can overachieve on that target, you can expect we will take a hard look at allocating capital to share buybacks in the back half of the year. Let’s now look at our segment operating results starting with our Communications segment on Slide 8. The story of our Communications segments this quarter is stable revenue growth, EBITDA, and margin growth, while adding phone subscribers. Our Entertainment Group is delivering EBITDA growth, and Business Wireline revenue trends improved in the quarter, thanks to strength in strategic and managed services and about $125 million from IP licensing. But even without those licensing proceeds, Business Wireline revenue trends were the best we’ve seen in years. When you factor in strong Business Wireless performance, our Business Solutions revenue grew 2.3%. On the cost side, our team is doing great work in controlling content promotions and other operating costs. Solid cost management was evident throughout the business, especially in our Entertainment and Business Wireline units. Let me give you more details starting with Mobility on Slide 9. Our Mobility business continues to perform very well. Service revenues grew by 2.4%, EBITDA growth was even higher at 3.1%, and EBITDA margins expanded by 80 basis points with service margins of 56.1%. We had a strong quarter with 355,000 phone net adds, including 72,000 postpaid and 283,000 prepaid. We also added 388,000 smartphones in the quarter, further strengthening our customer base. Postpaid phone trend was up slightly to 0.86%, but was down sequentially. Meanwhile, our prepaid business, especially Cricket, continues to perform at strong consistent levels. Prepaid revenues were up nearly 10%, and we had our 18th consecutive quarter of phone growth, with churn hitting an all-time low at both Cricket and AT&T prepaid. With the network leadership and FirstNet expansion that Randall discussed earlier, we’re confident our wireless business will get even stronger as we evolve to 5G. In summary, our network investments, particularly our spectrum deployment, are paying off, and we’re far from finished.

Now let’s go on to our Entertainment Group results on Slide 10. Our focus on long-term customer value is impacting our Entertainment Group positively. EBITDA grew both year-over-year and sequentially, marking the second consecutive quarter of EBITDA growth. Year-to-date EBITDA was up about 4%. Expense reductions outpaced revenue declines, setting the stage for EBITDA growth. Broadband revenue growth helped us alongside continued growth in video ARPUs. The number of premium TV customers on the two-year price lock declined by more than 600,000 in the quarter. Video subscriber numbers were in line with our expectations. Premium declined by 778,000, and DIRECTV NOW declined by 168,000. As Randall mentioned earlier, later this summer, we’ll begin piloting AT&T TV, our thin client broadband TV product. This is an important milestone with our fiber deployment reaching 14 million customer locations, satisfying our fiber build commitments. This will be a significant driver of growth going forward. In fact, we had more than 300,000 AT&T fiber net adds in the quarter, and IP broadband revenue grew by 6.5%. We expect AT&T fiber penetration to grow as the service matures. Overall, we remain confident that we’ll meet or exceed our Entertainment Group EBITDA target for the full year, and we’re laying the groundwork for continued stability beyond 2019. Let’s move to WarnerMedia’s results, which are on Slide 11. WarnerMedia continues to be free cash flow accretive. Our expense management alongside merger-related synergies is on track, and we expect to hit a $700 million run rate by the end of this year. HBO Max is set to launch next spring. Overall, WarnerMedia had another strong quarter with 5.5% revenue growth and solid operating income growth. HBO revenues grew, thanks to strong content sales driven by home entertainment and international licensing. Turner revenues were up about 2% on subscription revenue growth, which includes the advertising impact of not having the NCAA Men’s Final Four championship this year. It’ll return to Turner next year. At Warner Bros., theatrical revenues increased due to home entertainment games and a highly successful release of Mortal Kombat 11, which drove game revenues. With that, Mike, we’re now ready to take questions.

Operator, we’re ready for the Q&A instructions.

Great. Thank you. Maybe some questions on the Entertainment segment, specifically on the video subscribers. John, you mentioned you’ve got about another 1 million subscribers left on the promotions. When did those promotions expire? And could you comment a bit on the programming disputes you’re having with CBS and Nexstar? Is this expectation for resolution driving some of the belief in continued growth in EBITDA in that segment? And then, how do you expect that to impact the subscriber trends as we look into the second half of the year? Thanks.

Hi, John. It’s Randall. I’ll take the carriage disputes with CBS and Nexstar first, and then hand it to John to reconcile the subscriber numbers for you. As everyone probably knows, CBS has pulled their signal off DIRECTV, and so has Nexstar. These are two very different situations. On CBS, it’s an interesting scenario. The bid asked is not that wide. We sent a reasonable fair offer over five days ago, and we haven’t received a response yet. It’s somewhat interesting that we’re still in this position without interaction with CBS. I’m guessing they’re likely distracted with other negotiations currently. For Nexstar, the situation is very different. Their product is broadcast; they’ve pulled their signal off, and their opening bid was for a 100% increase on negotiations for broadcast channels that are essentially free-over-the-air content. We just won’t impose those kinds of price increases on our customers. Our customers in this streaming era are finding other ways to access this content, and there’s technology in place that flows right into the programming guide in our DIRECTV lineup. So, that situation could take longer. As for CBS, I’m optimistic we just return to the table and resolve this.

John, taking that forward, we’ve got about 1 million customers left on these price locks; those price locks expire in the fourth quarter. This will happen ratably throughout the second half of the year, but we expect to see the impacts of our long-term customer value approach on those customers. We anticipate seeing some of the same trends we’ve seen. Additionally, we’ve seen EBITDA growth and stable performance. We believe that our long-term customer value approach is working. So, we will continue to review this as we progress through the remainder of the year, particularly as we launch AT&T TV. Moving into 2020, we feel more optimistic as we’ll have been through a full year of focusing on long-term value-based customer approaches and potential improvements in 2020.

Most importantly, what John just highlighted is that as we come out of 2019, the customer base will be ideally suited for HBO Max. We had a strong second quarter with HBO, and we are gaining more confidence that this DIRECTV base, as we transition out of 2019, will drive HBO and HBO Max penetration as we launch next year.

Thanks a lot, gentlemen.

Thanks for the question, John. We’ll take the next question, operator.

Hey, guys. Thanks. Follow-up on the seasonality in video losses in 2Q versus 1Q, it came through around that 100,000. How do you think about typical video losses in 3Q versus 2Q? And should we expect a continued subdued level of promotion in video until you get to the wider AT&T TV launch?

Yeah, Phil. You should expect a subdued or long-term value-focused promotional activity. We have some normal summer activity with video, but I wouldn’t expect a significant change in that pattern. Given the number of customers transitioning off these two-year price locks, we expect the level of losses will continue through this period. However, there is positive momentum in our early insights with AT&T TV; we’re optimistic about rolling it out and the impact on customer acquisition in 2020.

Thank you very much. Can you help us think about balancing buybacks versus continued deleveraging once you reach the 2.5 target? How will you divide your free cash flow between the two? And could you update us on the $6 billion to $8 billion of net asset sales? You’ve sold almost $4 billion already. Where do you see that trending at this point?

Simon, I want to take the asset sales first. We feel good about where we’re at. We’ve sold about $4 billion in that number. We’ve got substantial efforts underway to sell additional assets, including cell towers and other real estate. We expect these asset sales to continue, and remain confident in meeting our $6 billion to $8 billion target. This is on a net basis, including the investments we’re making as we enter the auctions. I’ll remind you, we expect to potentially recapitalize and return value to shareholders through buybacks after achieving our debt targets. We maintain a focus on cash flow generation and prudent balance sheet management.

Thanks, Simon.

Hey, guys. Thanks for taking the questions. On the Business Wireline side, is there something structural or competitively that evolved here indicating this might be the first data point in a new trend? Or is it more of an anomaly?

David, let me first address the cash flow guide. The increase in free cash flow guidance primarily results from strong operational performance and cash generation through securitization efforts. We're at $26 billion, and that’s looking good. We can push that up to $28 billion through effective traffic management and operational efficiencies.

On the Business Wireline front, U.S. business is performing very well. The last six quarters have shown robust fixed investment growth for businesses. There are several new IP services that have also been doing well, and pricing has remained rational across the industry.

We’re relatively positive about the revenue side, continuing growth, and seeing better retention efforts in Business Wireline.

And the deals announced with Microsoft and IBM have important implications that will help manage our costs more effectively. We're seeing increased demand for cloud solutions. We see strong potential moving forward in business initiatives and improving overall operational efficiencies.

Thanks, David.

We’ll take the next question.

Thanks for taking the question. Over the last few quarters, we’ve seen steady execution in the wireless business, notably without FirstNet and 5G fully deployed. As these initiatives roll out, can you talk about how you think about the go-to-market strategy in Mobility?

Brett, we feel confident in how we are executing on our network strategy and FirstNet strategy. Our growth potential is significant, especially as we expand to new markets with FirstNet. We're beginning to see penetration in areas we haven't reached before, where competition is limited.

We expect substantial opportunities in that initial first responder community, and also in the larger secondary first responder market. Access to these groups opens the door for significant growth opportunities for us.

And particularly in the enterprise segment, we're seeing strong demand for solutions and applications tailored for 5G. We're focused on business-driven growth as we ramp up coverage and handsets into the market.

Thanks, Brett.

Thanks. Randall, as you think about the industry and potential new entrants coming into wireless, how will that impact AT&T's strategy?

The evolving structure of the industry, through mergers or new competitors, serves to reinforce our strategy rather than modify it. Our approach must remain focused on FirstNet and 5G deployment as key elements of our operations moving forward. Our strategy is resilient and focused appropriately on areas where we excel.

We’ve noticed strong health in our U.S. business, and I believe businesses are more resilient than ever.

So overall, we see economic opportunities for continued profitable growth in that area.

Can you discuss the importance of content exclusivities in relation to sports rights and how they will influence AT&T's future?

NFL SUNDAY TICKET has served DIRECTV well over the years, but it's currently tied to our satellite product. It remains an important retention tool as we enter the fall. We're focused on leveraging our content in a more multi-platform situation. Our growing relationship with live content will bolster our HBO Max platform and help us grow subscriber numbers across various distribution platforms.

We believe exclusive content is vital for our competitive advantage, and we’ll continue to leverage opportunities within WarnerMedia for added value.

Overall, exclusivity remains a key strategic asset in engaging consumers effectively.

Given the current performance of the Entertainment Business with revenue and EBITDA growth despite subscriber losses, how are you approaching new product launches and future customer engagement?

Exactly. Subscribers declining while margins increase illustrates the value of our existing subscriber base. The DIRECTV product will continue to exist alongside the new AT&T TV, which significantly reduces customer acquisition costs. We're focused on managing costs while maintaining value for customers.

This dual product strategy best supports customer retention while simultaneously pursuing new acquisition strategies.

As we expand marketing for AT&T TV, we’re seeing promising opportunities that align with our existing HBO subscriber base.

Thanks, Kannan.

I’ll hand it over for closing comments.

Overall, we had strong revenue growth, stable EBITDA, and we continue to invest wisely in both content and network. It was an excellent quarter, and we remain optimistic going forward.

We are meeting our commitments from last year, with a strong focus on the financial health of our company. The cash flows are positive, and our outlook remains bullish as we move ahead. We look forward to WarnerMedia Day in October, and we appreciate everyone’s participation in this call. Thank you.

Okay. So long, everyone.