AT&T (T) has announced first-quarter 2010 results, with adjusted earnings per share (EPS) of 59 cents beating the Zacks Consensus Estimate of 55 cents and the year-ago quarter EPS of 53 cents. “Ma Bell” has posted a 6% positive earnings surprise in 3 of the previous 4 quarters.

Adjusted earnings exclude a $995 million non-cash charge associated with the recent federal health care overhaul, which eliminated a tax break that AT&T enjoyed for having covered the cost of prescription drugs for retired employees. Net income (attributable to AT&T) for the quarter fell 20.8% year-over-year to $2.5 billion (42 cents a share) on account of the hefty heath care-related charges.

The largest US telecom carrier posted consolidated revenues of $30.6 billion (up 0.3% year-over-year) for the quarter, marginally below the Zacks Consensus Estimate of $30.7 billion. Revenues were boosted by continued growth momentum in its wireless business.

AT&T’s shares fell 30 cents (or 1.13%) to $26.36 in early trading on April 21, 2010.

Result by Key Segments

Wireless: iPhone Leads the Way

AT&T registered a net gain of 1.9 million wireless subscribers in the quarter to reach 87 million total subscribers in service, up 11.2% year-over-year, driven by increased smartphone penetration (especially iPhone) and healthy adoption of connected devices. This represents the largest first-quarter net addition in the company’s history.

Postpaid net additions for the quarter totaled 512,000 (27% of total net additions), down 43% year-over-year, impacted by the maturing domestic wireless market.

The momentum for iPhone continues with strong new activations of 2.7 million (more than a third represented by new customers). Postpaid 3G wireless devices also registered solid net additions with 3.3 million new activations in the quarter. Connected devices (including e-readers and GPS devices) increased 1.1 million in the quarter reaching 5.8 million in service.

Total wireless revenue for the quarter increased 8.2% to $13.9 billion. Wireless data revenue increased by 29.8% year-over-year to $4.1 billion, driven by strong handset sales and associated data access, e-mail and messaging services.

Total churn (customer switch) of 1.30% (down from 1.56% a year ago) was the lowest ever, while postpaid churn of 1.07% is also a record-low. Postpaid ARPU (average revenue per user) increased 3.9% year-over-year to $61.89, driven by healthy data growth.

Wireline: U-Verse Gains Offset Voice Losses

Consistent gains from U-verse video services continue to help AT&T counter increasing competition in the traditional wireline business. Total U-verse TV subscribers reached 2.3 million with a net addition of 231,000 customers. U-verse TV footprint passed 24 million homes at the end of the quarter.

Driven by U-verse broadband service, AT&T gained 278,000 broadband customers in the quarter, taking the total broadband customer base to 17.5 million. Healthy broadband growth has boosted wireline consumer IP data revenues that grew 32.5% year-over-year.

AT&T remains challenged by the precipitous decline in its traditional fixed-line business. Wireline voice access lines continue to decline as reflected by a sequential decrease of approximately 1.3 million lines in the quarter to 48.08 million. Total wireline sales declined 4.6% to $15.4 billion as wireline voice revenue fell 12% year-over-year to $7.5 billion. The ongoing substitution of landline calls with wireless services, coupled with cable competition in overlapping markets, largely contributed to this decline.

Dividend & Cash Flow

AT&T generated $7.3 billion cash from operations in the quarter and spent $3.3 billion in capital expenditure, resulting in a free cash flow (cash from operations minus capital expenditures) of $4 billion. The company declared a first-quarter dividend of 42 cents per share, representing an increase from 41 cents a year-ago.

Outlook

AT&T has not released any financial forecast for the second quarter. For 2010, it envisages stable revenue and stable-to-improved earnings and operating margins. The forecast takes into account the dilutive impact of roughly 5 cents to 6 cents associated with the carrier’s impending acquisition of specific wireless assets from archrival Verizon (VZ). However, AT&T does not expect pension retiree benefit costs to drag the bottom-line in 2010.

Moreover, AT&T expects strong free cash flow in 2010 despite an incremental investment in wireless, Ethernet backhaul and U-verse. Total capital expenditures for the year have been projected in the range of $18 billion to $19 billion, an increase from $17.3 billion in 2009. The company aims to achieve a wireless OIBDA service margin in the low-40% range in 2010 with a long-term target in the mid-40% range.  

Moving forward, we expect that the iPhone, which has been the lifeblood for AT&T’s wireless business, will continue to perform in line with expectations and boost data revenues. Other positive aspects are represented by higher dividend payouts and opportunities for margin expansion.

However, we maintain a cautious approach due to the weakening demand for wireline voice services and the ongoing price and promotional war with Verizon. Moreover, AT&T may lose its iPhone exclusivity in 2010, and there is mounting speculation about Verizon selling the device. We currently have a Neutral recommendation on AT&T.
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