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  • Ladies and gentlemen, thank you for standing by.

  • Welcome to the AT&T Second Quarter 2018 Earnings Call.

  • At this time, all of your participant phone lines are in a listen-only mode.

  • Later, we'll conduct a question-and-answer session, instructions will be given at that

  • time.

  • (Operator Instructions) I would now like to turn the conference over

  • to our host, Michael Viola, Senior VP, IR.

  • Please go ahead.

  • Okay, thanks for Lori and good afternoon, everyone.

  • Welcome to the second quarter conference call.

  • As Lori said, I'm Mike Viola, Head of IR, for AT&T.

  • This is our first call, first earnings call, after we closed our acquisition of Time Warner

  • and we're broadcasting this call from WarnerMedia headquarters in New York.

  • So we told you earlier, we are going to use this call not only to discuss the quarter

  • but we're also going to provide more details on our strategy and to do that, we've brought

  • together the CEO, CFO and four business leaders of our business units.

  • Today's agenda is going to begin with John Stephens who will cover AT&T and Time Warner's

  • second quarter financial results as well as update our outlook and guidance.

  • Randall will provide our strategic perspective of the business and then each of the business

  • unit leaders will take (inaudible) will about their second quarter results and give a perspective

  • of their businesses going forward.

  • After that, the entire team will be available to participate in the Q&A session.

  • I'd like to mention one save the date item.

  • We plan to host sell-side meeting on the evening of November 29 and followed by a buy-side

  • meeting that next morning on the 30, both will be here in New York and all the folks

  • on this call will join us for those meeting.

  • So please mark the calendars and more details to come.

  • Now before I turn the call over to John, I need to call your attention to our safe harbor

  • statement.

  • It says that some of the comments today will be forward looking and as such is subject

  • to risks, uncertainties.

  • Results may differ materially.

  • In addition, information is available on the Investor Relations website.

  • I will also need to remind you that we're in the quiet period for the FCC CAF-II auction.

  • 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 that includes the new release, 8-K, investor briefing, other associated schedules.

  • And available on our website are materials on WarnerMedia's full second quarter that

  • includes trading schedules and other important documents.

  • And so now I'd like to turn the call over to AT&T's CFO, John Stephens.

  • Thanks, Mike and hello everyone and thanks for being on the call today.

  • Let me begin with our financial summary, which is on slide five.

  • I think most of you know that FASB has been very very busy this past year, implementing

  • a number of accounting standards five of which have direct impact on AT&T.

  • Those includes standards that deal with revenue recognition, pension reporting, impacts on

  • cash flow reporting.

  • These changes impact our income statements and cash flows at the same time the Company

  • made a policy decision to record Universal Service Fees net as an offset to our regulatory

  • fees.

  • We are working hard to help you understand these changes.

  • So in addition to the GAAP financial information, we're providing comparable historical results

  • to help you better understand the impact on financials from revenue recognition and the

  • policy decisions as well as Time Warner's second quarter results on a historical basis.

  • We will be referring to these historical results in our comparisons during this call.

  • Now, let's start with EPS.

  • We continued to show strong adjusted EPS growth, up more than 15% for both the quarter and

  • year-to-date.

  • Tax reform continues to have a positive impact on EPS as does the adoption of revenue recognition.

  • We also had about $0.02 of help from the 16 days we owned Time Warner, which we have renamed

  • on WarnerMedia.

  • The WarnerMedia earnings contribution was slightly more than what you might expect for

  • such a short period.

  • But if you know, financial results can be uneven and we saw that in the second quarter.

  • Consolidated revenue came in at $39 billion, down slightly from a year ago, but that includes

  • about $900 million of pressure from how we are now accounting for USF fees on a net basis.

  • When you look on a comparable basis, revenues were up slightly.

  • That's mostly due to 2 weeks of Time Warner revenues, but also helped by gains in wireless

  • and AdWorks.

  • We continue to use our tax reform savings to invest in and grow our customer base.

  • As John Donovan will discuss these investments help drive postpaid phone growth and significant

  • year-over-year improvement in prepaid phone net adds, continued growth in consumer broadband

  • customers even in a seasonally challenging quarter and solid subscriber growth in total

  • video customers.

  • Adjusted consolidated operating margins in the quarter were up year-over-year on a reported

  • basis, but down on a comparable one.

  • Solid smartphone sales drove some of the pressured margins.

  • But the biggest factor continues to be customer transition to over-the-top video.

  • Let's have a look at free cash flow.

  • It was a strong $5.1 billion for the quarter, up substantially both year-over-year and sequentially.

  • Year-to-date, our cash from operations and free cash flow is up about $1.5 billion which

  • makes us very comfortable with our free cash flow guidance for the full year.

  • Our cash flows also reflect the timing differences between spending 4% and the reimbursements

  • we received from the organization.

  • This usually trails spending by several months.

  • Year-to-date, that comes to more than $100 million of free cash flow pressure.

  • Capital spending for the quarter was $5.1 billion or $5.4 billion before the $300 million

  • of FirstNet reimbursements we did receive in the quarter.

  • Let's now cover financial results from operations beginning on slide 6.

  • AT&T domestic mobility operations are divided between the business solutions and consumer

  • wireless segments.

  • For comparison purposes, we're providing supplemental information for our total US wireless operations.

  • Our wireless business turned in very good results.

  • Year-over-year service revenue turned positive.

  • Margins remained strong.

  • And we had phone growth in both postpaid and prepaid.

  • Total revenues were up year-over-year, thanks to gains in both service and equipment revenues.

  • Also service revenues were up almost 2% sequentially.

  • Strong sales and BYOD supported that growth.

  • Our upgrade rate was down year-over-year, but our equipment revenues were up reflecting

  • customers' purchasing habit and their choice of more expensive devices.

  • But even with these strong sales, margins were very good with service margins coming

  • in over 50% on a comparable basis.

  • Looking ahead, we expect positive service revenue growth for the full year on a comparable

  • basis.

  • Turning to our Entertainment Group, we continue to see the impact of the video transition

  • in our revenues and margins.

  • This will take a while to work through and we expect it to continue for the rest of the

  • year.

  • But we are seeing some sequential stability in both revenues and margins.

  • We're making changes to drive revenues and effectively manage the transition.

  • We are getting through some promotional pricing that impacted revenues in the past and we

  • now have some new features on our next generation platform that will drive additional revenue

  • opportunities, such as cloud DVR, a more robust VOD experience with new pay-per-view options

  • and an additional stream capability.

  • John Donovan is going to walk you through those plans in a few minutes.

  • Also helping is AdWorks which continues to grow at a double-digit rate and is now an

  • annualized revenue stream of over $1.8 billion.

  • Moving to our Business Solutions group, revenues were down as gains in wireless and strategic

  • business services helped to offset declines in legacy services.

  • Business wireless had strong growth, up more than 4%, this is driven by both equipment

  • and service revenues.

  • Wireline revenues were down more than 4% year-over-year.

  • We still expect tax reform to produce a lift in communications spend but we just haven't

  • seen it yet.

  • Wireline EBITDA margins were up slightly on a comparable basis.

  • Cost efficiencies continue to offset pressure from legacy products and our investments in

  • FirstNet.

  • In our international business solid customer performance helped to offset currency pressures.

  • Revenues were stable year-over-year, while margins were pressured by World Cup expenses

  • as well as foreign exchange.

  • Now let's look at Time Warner second quarter financials on slide seven.

  • Time Warner had strong growth at all operating divisions on a comparable basis.

  • This includes strong subscription revenue growth at both Turner and HBO.

  • Turner also showed solid advertising revenue growth of 3%.

  • Adjusted operating income was $1.8 billion driven by increases at Warner and HBO.

  • Now, for some housekeeping items.

  • With recent FASB accounting rules, the Time Warner merger and purchase price accounting

  • rules there is going to be a lot of new information included in our results.

  • We're going to do our best to make that easy for you to understand.

  • First, we'll file pro formas with the SEC in August.

  • Second, we have posted the full second quarter results for Time Warner on our Investor Relations

  • website.

  • This includes the Time Warner historical results, trending schedules, all the information you

  • are accustomed to seeing.

  • Finally as you're updating your models keep in mind the following.

  • Results will continue to be reported at the divisional level but there are certain things

  • that will be eliminated in the corporate and other segment, including about $3 billion

  • of annual inter-company contract revenues and purchase accounting impact on customer

  • base and deferred production costs.

  • We're very excited at Time Warner is part of the AT&T family and the WarnerMedia is

  • part of the AT&T family and John Stankey is going to provide more insights and highlights

  • in a few minutes.

  • Now let's look at our 2018 outlook with Time Warner included.

  • We're raising adjusted earnings per share growth to the upper end of the $3.50 range

  • with WarnerMedia included.

  • Year-to-date, we're already seeing 15% growth.

  • In fact, the tax reform, improving wireless service and advertising revenues as well as

  • the addition of Time Warner supports strong adjusted EPS growth even with the additional

  • shares issued as part of the deal.

  • Looking at free cash flow, our free cash flow guidance at the beginning of the year was

  • stand-alone.

  • We expect most of the benefit of the Time Warner free cash flow for last half of the

  • year about $2 billion will be absorbed by integration and deal costs, including severance

  • cost, retention centers, legal fees, bankers cost and interest expense prior to close.

  • When you consider those items, and slightly lower cash capital spending we're raising

  • expected free cash flow to be upper end of $21 billion range with dividend coverage in

  • the low 60% range and that's even with the additional shares and dividend responsibility

  • from the merger with Time Warner.

  • Now then we are halfway through the year, we also have a better view of CapEx.

  • Capital investment is expected to be in $25 billion range, but that'll be $22 billion

  • of CapEx on our cash flow statements after you net out our FirstNet reimbursements and

  • some of the vendor financing opportunities that our team has pursued.

  • A primary focus for us this year and the next few years is deleveraging the business.

  • We have a strong business that generates a ton of cash and EBITDA and we are very confident

  • in the deleveraging targets that we have given you.

  • Let me recap them now.

  • Net debt to EBITDA is projected in the 2.9 times range by the end of this year and in

  • 2.5 range by the end of next year.

  • To reach that target, we expect EBITDA growth.

  • We use excess cash to pay down debt and as always, we'll continue to look for ways that

  • monetize down strategic assets.

  • You've seen that recently with the data center deal and our pending sale of broadcast 600

  • spectrum.

  • We expect to return to historic debt levels in 1.8x range by the end of 2022.

  • That's the financial summary.

  • Now I'll turn it over to Randall.

  • Randall?

  • Thanks, John, and it was an exciting quarter.

  • After 600 days of reviews and litigation, we did finally complete the acquisition of

  • Time Warner and then just a few days later, we announced our agreement to acquire AppNexus.

  • And if you're not familiar with AppNexus, it's one of the top ad technology companies

  • around.

  • And as John mentioned, we renamed Time Warner to WarnerMedia, so we'll be referring to that

  • as WarnerMedia from here forward.

  • And as John Stankey will cover later, they had a really strong second quarter.

  • We couldn't be pleased -- more pleased with the condition Jeff left the Company with this.

  • We've now assembled the key elements of a modern media company and it all begins with

  • owning a wide array of premium content because we are absolutely convinced that there is

  • nothing that drives customer engagement like high quality premium content.

  • And whether it's Netflix, Amazon, Google, Disney or Comcast, everybody is now pursuing

  • the same thing.

  • How do you deliver great media and entertainment experiences to our customers.

  • And I think the recent valuations of media companies are reinforcing this point.

  • But we couldn't be any happier with the range and quality of brands that we now own.

  • For live programming, it doesn't get any better than CNN for news and for sports, we have

  • the NBA, March Madness, NFL Sunday Ticket, Major League Baseball and PGA.

  • And for original premium subscription content, there is nobody better than HBO or cable networks

  • and Turner are among the best and they are performance well.

  • And for content creation, our production studio at Warner Brothers is the gold standard and

  • they possess one of the deepest IP libraries around.

  • And when you talk about digital content, we now own the CNN.com digital brads and these

  • are the most visited websites in the world.

  • And I am pleased to report we are media properties and we have what we think are a terrific set

  • of digital assets and bottom line we absolutely love this portfolio.

  • But just owning great content is no longer sufficient.

  • The modern media company must develop extensive direct to consumer relationships.

  • And we think pure a wholesale business models for media companies will be really tough to

  • sustain over time.

  • And when you look across our wireless, pay TV and our broadband businesses, we now have

  • more than 170 million direct to consumer relationships.

  • And these relationships are critical as we begin developing new media experiences for

  • all kinds of different audiences.

  • And the 170 million relationships provides invaluable insights for new advertising models.

  • And that's exactly what's behind our investment in ad technology.

  • Today we use our data insights and we deliver ads on DIRECTV and when we do this, our advertising

  • yields improve by 3 to 5x.

  • And as you are going to hear from Brian Lesser shortly that business grew 16% in the second

  • quarter.

  • Now Turner has an ad inventory that's three times the size of our DIRECTV inventory.

  • And as we acquired the same data to that inventory, we expect a significant lift and AppNexus,

  • that acquisition is all about improving our capabilities and reducing our time to market

  • here.

  • So you take these three elements, premium content, 170 million direct to consumer relationships

  • and great ad technology and then you combine those with our high speed networks and we

  • think all of this is a game changer.

  • Bringing these four elements together has