AT&T Inc (T) 2012 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to AT&T's second-quarter 2012 earnings release. For the conference, all the participants are in a listen-only mode. There will be an opportunity for your questions and instructions will be given at that time. (Operator Instructions). As a reminder, today's call is being recorded. With that being said, I will turn the conference over to Susan Johnson. Please go ahead.

Thank you, John. Good morning, everyone and welcome to our second-quarter conference call. It is great to have you with us this morning. I am Susan Johnson, Head of Investor Relations for AT&T. Joining me on the call today is John Stephens, AT&T's Chief Financial Officer. John will provide an update with perspective on the quarter, then we will take your questions.

Let me remind you our earnings material is available on the Investor Relations page of the AT&T website. That is www.ATT.com/investor.relations.

Okay, I also need to cover our Safe Harbor statement, which is on slide 2. This presentation and comments may contain forward-looking statements. They are subject to risks. Results may differ materially. Details are on our SEC filings and on AT&T's website.

Before I turn the call over to John, let me quickly cover our consolidated financial summary, which is on slide 3. As a reminder, we completed the sale of AT&T's Advertising Solutions, an AT&T interactive business, on May 8. Our reported results for this quarter and prior periods still include Ad Solutions' results, which are not treated as discontinued operations given our 47% continuing equity ownership in YP Holdings.

Reported EPS for the quarter was $0.66, a 10% increase both sequentially and year over year. The fundamental trends in our business continue to be solid. When you exclude the Advertising Solutions business, consolidated revenues were up 2% year over year thanks to strong mobile data growth, gains in U-verse and advanced wireline business offerings.

We had our best consolidated margin in four years with operating income expansion in wireless and wireline both sequentially and year over year. And cash flow continues to be strong. Cash from operating activities for the quarter totaled $9.7 billion. Free cash flow was $5.1 billion. And our share repurchase program continued in the second quarter. In the quarter, we bought back almost 76 million shares for $2.5 billion. With that quick overview, I will now turn the call over to AT&T's Chief Financial Officer, John Stephens. John?

Thank you, Susan and good morning, everyone. It is great to have you with us on this call. As you have seen, we had a very good quarter and it was very straightforward, all about executing our strategy and growing the business. In wireless, you can clearly see the benefits of our mobile Internet strategy. This has resulted in strong wireless data revenue growth, almost 19%, record high service margins with our EBITDA service margins hitting 45% and our lowest churn ever -- postpaid, prepaid and total.

In wireline, the transformation from legacy voice and data products to advanced data services continues at a solid pace. U-verse video and broadband continue to scale while driving the strongest consumer revenue growth that we have seen in years and we kept margins steady and improved wireline operating income both sequentially and year over year even with few signs of a business recovery.

This performance drove solid financial results. We grew revenue, expanded margins and increased earnings and cash flow was very strong. We also took steps to make our balance sheet even stronger. We called debt and reduced future interest costs by refinancing at favorable rates. And as Susan mentioned, we continued our share buyback program. We returned more than $5 billion to shareholders through share repurchases and dividends in the second quarter and close to $10 billion year-to-date. All in all, a very positive quarter, which puts us in a great position heading into the second half of the year.

With that as background, let's now take a look at detailed results starting with the consolidated revenues on slide 5. As you know, the sale of our Advertising Solutions business was completed in early May, so this second quarter did not have a full impact of Ad Solution revenues and because we retained an equity interest in the business, we could not restate past quarters. Even so, on a reported basis, consolidated revenues increased year over year and if you exclude Ad Solutions from all periods, they were up $600 million, or 2%.

The drivers are strong mobile Internet growth, U-verse revenue growth of more than 38% and continued growth in strategic business services. When excluding Ad Solutions, 80% of our revenue came from wireless, wireline data and managed services in the second quarter. That is up from 77% a year ago and 74% two years ago. Revenues from these growth areas, these next-generation products and services, were up about $1.3 billion, or more than 5% in the quarter. We made remarkable progress in transforming our business the last few years and we expect this mix shift to continue.

Now let's look at wireless starting on slide 6. We have confidence in our mobile Internet strategy, our network and the ability of our team to execute and compete. After our second-quarter performance, that confidence has only been reinforced. Margins were at record levels. As you have seen, our service EBITDA margin for the quarter was 45% and churn was at record lows. Revenue growth was solid thanks to gains in data revenues. This drove our 14th consecutive quarter of postpaid ARPU growth and phone-only ARPU was up more than 2%, growing off a much higher ARPU base than anyone else. We now have more than 43 million smartphone subscribers on our network or about 62% of our postpaid base and smartphone sales continue to be strong.

We also continue to bring more subscribers onto our network with usage-based data plans. It has been two years since we introduced these tiered plans and we now have 27 million or about two-thirds of all smartphone subscribers on these plans with most choosing the higher-priced plans.

Let's talk more about churn and net ads. Details are on slide 7. Postpaid churn hit an all-time low, dropping below 1% for the first time ever. We also had our best ever total and prepaid churn. There are a number of reasons for this -- the quality and depth of our network, an improved customer experience, our focus on customer-friendly plans, and the fact that we have 88% of our subscribers on family talk or business plans. For all these reasons, customers are choosing to stay with AT&T.

We also continue to add new customers, 1.3 million in the quarter. That includes gains in every customer category. Postpaid net adds were 320,000, an increase from the first quarter. Prepaid added 92,000 subscribers. A solid reseller quarter netted us 472,000 new subscribers and we have 382,000 connected device net adds as well. These results are tied directly to the performance of our network and the quality of the customer experience. We now cover 275 million POPs with our 4G network with more than a third of our postpaid smartphone subscribers using a 4G device and almost 90% of our data traffic is on enhanced backhaul. This drives higher speeds for our customers and greater efficiency in our network.

Our 4G LTE build continues on track and we now have LTE in 47 markets, record low churn and strong sales tell the story of our wireless business. New customers are choosing AT&T and existing ones continue to stay with us in record numbers.

You can also see the strong performance in our wireless data results and in our smartphone and branded computing sales, which are on slide 8. Data revenues were $6.4 billion, up $1 billion year over year. Data revenues are now a $25 billion annualized revenue stream, growing at almost 19%. Smartphone sales were solid and we continue to build our subscriber base with 5.1 million smartphones sold in the quarter.

Smartphone subscribers now number 43 million and make up 62% of our total postpaid base, but smartphones accounted for 77% of postpaid sales during the quarter, showing continuing opportunity for growth. And when you look at our total smartphone base, we have added 9 million high-value smartphone customers in just the last 12 months.

We also continue to activate more iPhones than any other carrier. We had 3.7 million this quarter with about 22% of those subscribers new to AT&T. These customers are choosing AT&T for a reason. We provide the best mobile Internet experience on the nation's largest 4G network.

Branded computing sales also drive data growth. Sales continued to be strong in the second quarter. We had 496,000 net adds in the quarter. We now have 6.3 million branded computing subscribers, tablets and tethering plans on the network and that is up more than 50% in the past year. Last week, we announced our new shared data plans. We believe this will drive even more branded computing subscribers onto our network.

But perhaps the best story this quarter is our wireless margins. Details are on slide 9. We have done a lot of work to improve our service margin and that work is paying off. We have had our best wireless EBITDA service margin ever, 45%. Let's put that in context. Two years ago, our margins were about 200 basis points lower and this quarter, we sold 1.2 million more smartphones than we did then. That helped show the value of our smartphone base whose ARPU is twice that of non-smartphone devices. Plus smartphone subscribers have lower churn and strong data growth.

We have also taken several other steps that have a positive impact on margins. This includes our new upgrade policy. It has been more than a year since we implemented the changes and we are now seeing the impact. Our new data pricing plans we announced earlier this year also help drive revenues while offering customers more data and our continued focus on overall cost management.

All this helps explain the strong growth we saw this quarter with our operating income, almost 18% year over year and 13% sequentially. We are pleased with our wireless results this quarter. Our entire team had another outstanding wireless performance.

Now let's move to wireline starting with business, which you can see on slide 10. Business wireline revenue was down 1.5% this quarter. That compares favorably to a decline of 4.1% in the year-ago second quarter. This business continues to be a multifaceted story that is playing out in a cautious economic environment. Customers that can continue to invest are doing so. But others are holding off decisions because they are more hesitant to spend in uncertain economic times and small-business formations continue to lag even below last year's numbers. You can see this in our results.

Large businesses or enterprise customers continue to invest in advanced data services. This has led to improving revenues even without any lift from the economy. In fact, we had our first enterprise revenue growth in more than four years. The growth was small, but still a positive trend.

At the other end of the spectrum, our small-business revenue growth was down slightly sequentially, once again challenged by the lack of new business starts. And our wholesale and government sector saw revenue pressure as some customers reduced legacy data connections.

We continue to see strong growth in strategic business services as products such as Ethernet, VPNs and application services, which were up 13.5% for the quarter. This would have been even higher without the impact of foreign exchange. And IP data revenues were up more than 5% year over year as well. This shows that businesses continue to invest in efficiency and advanced data services even in this tough economic climate.

We also held business wireline margins steady by doing a good job of keeping expenses in check. The positive growth in enterprise revenues is an encouraging sign, but we are facing continuing economic headwinds. There is a great opportunity in this business, especially as we continue to transition to advanced data services. But based on the current business environment, the return to growth in revenues may take longer than we originally anticipated.

You can also see the transformation to IP data in our consumer results. Details are on slide of 11. We had another strong quarter with our U-verse services. So strong in fact that we are seeing our best growth in consumer wireline revenues in more than four years, 1.7%. U-verse has transformed wireline consumer. We now have 6.8 million total U-verse subscribers. That is both video and high-speed Internet. That includes 4.1 million video subscribers with 155,000 added in the second quarter and we added more than 0.5 million U-verse broadband subs in the quarter as well. This includes new high-speed broadband small-business subscribers. And U-verse revenue growth has been amazing. It is now a $9 billion annualized revenue stream, growing at about 38% year over year. And we believe there is a lot of room for further growth. Overall video penetration is at 17% and continues to grow.

Now let's look at margins on slide 12. For the second quarter, consolidated margins were up both sequentially and year over year, on track with the expectations we set out in January. Our consolidated operating margin was 21.6%. That is up thanks to strong performance in wireless and consumer wireline revenues, our continued focus on improving the customer experience. That is everything from giving the customers more choices or ways to interact with us and doing business in a way that the customer prefers.

Wireline operating income margins also expanded both sequentially and year over year at 13.8%. That is in line with our guidance of stabile wireline margins for the year. Helping offset declines in legacy services were growth in U-verse and advanced data, solid cost management and execution of One AT&T initiatives. We continue to keep a sharp eye on cost efficiencies and see more opportunity as we move ahead.

Along with solid margins, we continue to have strong cash flows and we have taken several steps to improve our capital structure. Our summary is on slide 13. In the first half of the year, cash from operations totaled $17.5 billion. Capital expenditures were at $8.9 billion with more than half of that invested in the wireless business. Free cash flow before dividends was $8.6 billion and dividend payments totaled $5.2 billion.

In terms of uses of cash, total debt is down $1.2 billion in the quarter with a debt to capital ratio of 38.4% and a net debt to EBITDA ratio of 1.42. We have been very active in the debt market taking advantage of favorable interest rates and our strong cash flows. We have paid off some debt early. We have called $7 billion in debt so far this year. We now have no debt due for the remainder of this year and only $3.5 billion due in 2013.

At the same time, we've continued to pursue share buybacks. In the second quarter, we repurchased almost 76 million shares. So far, we have bought back more than 143 million shares or about half of our 300 million share authorization. That totals $4.6 billion of stock.

When you look at both dividends and the stock buyback, we returned nearly $10 billion to our shareholders in the last six months. As always, any shares we purchase could include open market purchases, structured programs such as accelerated share repurchase and other programs, including 10b5-1 plans where appropriate.

The quarter's performance demonstrates the strength of our capital structure. Our strong cash flow gives us the flexibility to both invest and retire debt. Our balance sheet is sound, our debt metrics solid and we continue to return value to shareholders.

Now before we get to your questions, let me recap the quarter on slide 14. Our key growth drivers -- wireless, data, managed services -- now account for 80% of our revenue, growing at a more than 5% rate year over year. Our mobile Internet strategy continues to click with strong smartphone sales, record low postpaid churn and the best service margins we have ever seen.

U-verse continues to power wireline consumer transforming the business with solid growth and record revenues. We also saw positive enterprise revenue growth even with no lift from the economy and we continue to strengthen our balance sheet while returning substantial value to our shareholders from dividends and share buybacks. The transformation of our business took a major step in the quarter with the sale of our Advertising Solutions business and we continue to add to our wireless portfolio through spectrum acquisitions.

Put it all together and we had a very strong quarter with continued confidence as we move into the second half of the year. Susan, that concludes our prepared remarks. I think we are ready for Q&A.

Thank you, John. John, I think we are ready to open it up for questions and answers.

(Operator Instructions). John Hodulik, UBS.

Thanks. Two quick ones. First, John, just based on your comments on the business market, you turned positive on the enterprise side. Do you expect that to remain positive going forward and is the slight change just some incremental weakness on the sort of low-end SME side? And then on the buyback, obviously, you guys have made a lot of progress there. Do you expect to be substantially complete with the buyback by year-end? Thanks.

Good morning, John. Thanks for joining the call. Let me take the second question first. With regard to the buyback, two things. We do expect to continue in the marketplace and participating in buyback. That will be impacted by market conditions, continued strong cash flows and the other factors that we spelled out. We have not guided towards when or how much we will buy back in any of the future quarters, but I think, as we said at the beginning of the year and on the January call, we are in a position with the cash on the balance sheet at the beginning of the year and strong cash flows in this year that we have an ability to buy back a large part of the authorized share repurchase and we will continue to monitor that and continue to pursue those opportunities.

On the business side, we do have continued growth in strategic services and that growth is encouraging to us, but we are seeing businesses be very careful. It seems like whether they are hesitant about the elections, about tax law changes, about the federal deficit, they have abilities to spend, so we are encouraged by that, but they are being very careful. We are seeing a lot of no decisions, so we are certainly hopeful to be able to continue our positive enterprise revenue story, but we will have to prove that as will everybody else.

We are still optimistic about our wireline business and believe particularly our business revenues are going to be positive going forward. It just may take us a little bit longer than we would have expressed to you in January.

Got you. Thanks.

Simon Flannery, Morgan Stanley.

Thank you very much. Good morning. John, I wonder if you could update us on the status of the review of the rural lines and also churn was excellent this quarter. You went through some of the factors driving that. How should we think about churn going forward from here? You had a pretty substantial drop. Is there more room in your view for improvements in that or is this as good as you think it can get to? Thanks.

Good morning, Simon. Thank you. First, on the question with regard to kind of our strategic initiatives, you have seen the directory sale and the completion of that. We have seen the continued movement on spectrum in the 12 acquisitions -- smaller acquisitions of spectrum we closed and a number of deals that are sitting before the FCC. And I think you have seen for the strategy side our filing with Sirius where we are jointly going there to clear up some -- improve some usability of some of the WCS spectrum we own. So those are parts of the strategy.

We are continuing our review on the other pieces of our business and as soon as we have something worth sharing, we will. But we are going through that process and we will continue to go through that process. I just want to be careful to make sure we complete that analysis and have a full story for you when we are ready to share it, Simon.

Okay, because there was some talk of the IPT [slams] and so forth, but that is still an option rather than a choice at this stage, is that right?

Everything quite frankly at this stage is an option and we are looking at a whole host of different opportunities or different alternatives, as you might expect, our shareholders would expect from us.

Okay. On the churn?

On the churn side, it was very encouraging. It was not only encouraging on the postpaid, but it was encouraging that it was across the board we saw improved churn. We are optimistic about our ability to hold onto those kinds of levels and continue to improve it. We will see as we go through some of the seasonality in the business in the second half of the year how that impacted, but this is a process that is going on for a long time. We have been making significant investments over a number of years improving the quality of our network. And our wireless team, including our business wireless team, has put a lot of effort into improving the customer experience.

So yes, our numbers could be better, but the customer experience is getting a whole lot better and so we are optimistic that we will be able to move forward building from this positive base. But as we go into the second half of the year, and a part of the wireless business year that is much more seasonal, we will have to work through that and see if we can meet our goals.

Thank you.

Phil Cusick, JPMorgan.

Hi, guys. Can you hear me?

Sure can.

Great, thanks, John. So let's just talk about ARPU for a second. Can you tell us if you expect any change in trajectory given the new pricing environment from the third or fourth quarters? And then also do you anticipate changing your reporting methodology over time as tablets dilute revenue per device? Thanks.

Thanks, Phil. First and foremost, I think our guidance is out there that we get 2% ARPU growth this year. We are sticking with that. We are encouraged by where we are at on the 1.7% so far this year, including all the impacts of high margin, high profit, but lower ARPU data and data devices and tablets. As we mentioned in the call, our phone-only ARPU was 2% this quarter.

Why are we optimistic is because of the pricing changes we have done with regard to our tiered data plans. We are also encouraged because of what we have done with regard to growing the smartphone base by 9 million subscribers, converting those lower ARPU subscribers that we had last year to smartphones and generating more ARPU. So we are encouraged by that and we are also encouraged by the fact that there is a lot more usage going on. And in that structure of tiered data customers, we get that additional revenue. People pay for what they use. So we are sticking with that.

With regard to any shared data plans, we do not expect those to be -- we expect those to be accretive over time. We think the conversion of those is going to be measured over time. Part of that is because we are doing it in a customer-friendly way. We are leaving the old plans available to our customers and we are not forcing anyone off of unlimited or any other plans. So we are expecting it to transition in, but, over time, we expect it to be accretive because it will allow, if you will, our customers, the more they share, the more they are going to save and I think that will be good for both us and them.

With regard to our reporting activities, right now, we are going to stick with our customer-based ARPU. We will continue to evaluate all of our customer metrics and all of our financial reporting and we will update that starting with next year as we always do. We are having a robust discussion about what is the best way to provide the information to analysts, to the readers of our financial statements, to our owners and so that is ongoing. But at this time, do not expect to change. If we do, it likely will be with the new year.

Good, thanks, John.

Jonathan Chaplin, Credit Suisse.

Thanks. A couple of quick ones if I could. So firstly, it looks like your smartphone sales this year are trending well below where they were at this point last year. I am wondering if that means we are on track to do even less than the 25 million smartphone sales that you expected for the year or if you are just expecting a blockbuster fourth quarter with the new iPhone launch?

And then I am just wondering if you could sort of give us some context around what to expect for EBITDA margins given that trend. It seems like we should see an even lower upgrade rate next quarter. This is sort of the seasonally up quarter for upgrades and with the iPhone launch it should be even lower next quarter. So I would expect margins to be even higher. And then I'm wondering what they could potentially be in the fourth quarter as well. Thank you.

Okay, Jonathan, good hearing from you. A couple of things. One, on the smartphone upgrade in sales, a couple of things. One, we are seeing our policy kick in, our change in our policy. We told you about it last year. Told you we were going to grandfather our customers in and that's now taking hold and I think you're seeing some effects of that.

Quite frankly, I think in the first six months, you're also seeing effects of what would be considered a very healthy upgrade cycle fourth quarter of last year, particularly when the old upgrade policy of a shorter timeframe was still in place. So I think we're seeing -- we're getting some of the benefits of what was upgraded in the fourth quarter last year is helping lower or slow some of the upgrades in the first and second quarter this year.

We're not going to give the guidance on specific EBITDA margins or upgrade cycles for the second half of the year. We are sticking with our upgrade cycles being flat year-over-year. I openly recognize the fact that the math of the upgrade process is that we are running at a rate, a trend rate for the first two quarters below that. But as we get new devices and have the seasonality of the holiday selling season, we will see an uptick and we're comfortable with sticking with that guidance that is out there.

As far as EBITDA margins, the team did great, feel real good about where they are at and all the items that are -- he actions that the team took to get there and I feel real comfortable about the fact that they are solid, business-focused, customer-focused strategies, things that we can do again. But we are going to stick with our margin guidance that we are going to grow EBITDA service margins year over year and that we expect that to be greater than 40%. And I understand how the comparisons look today, but we are going to stick with the guidance we have got out there.

John, one point of clarification quickly. When you say sticking with guidance on smartphones, you mean still sticking to 25 million smartphone sales for the year? The upgrade rate has to be down year over year, right?

Yes, so, John, you make a great point and I appreciate the clarification. I think what we said at the beginning of the year is it would be flat year over year at 25 million. So your comment is correct.

Got it. Thank you so much.

Jason Armstrong, Goldman Sachs.

Great, thanks, good morning. Maybe just a follow-up. There is obviously I think a lot of questions on sort of the upgrade cycle out there and John, you just gave a lot of good data points. I think people probably still wrestle with is this a result of policy changes versus is this just new handset availability or lack thereof.

Maybe another way of attacking this is are you seeing notable changes in the percent of subscribers that are eligible for an upgrade at this point, but are postponing decisions, maybe that would be helpful as sort of a gauge of what to expect over the next couple quarters. And then just second quick question, the union deal you recently signed, just wondering if you can talk us through benefits from that deal and how that may change the cost structure. Thanks.

So with regard to the change in the trend for upgrades, let me deal with it this way. First of all, we are into one quarter, one full quarter here with regard to -- this is the first quarter where the upgrade policy change has really impacted us. And as I mentioned before, the fourth quarter last year was unusually high, so there is some impact I think on the first and second quarter from that. So it is early in this process. But clearly we believe that the upgrade policy is impacting -- the new upgrade policy is impacting upgrade cycles and is helping us control that process and improve margins.

Secondly, there may be some impact quite frankly of the change in upgrade fee. It was a small change, but it was an increase of $18. I can't suggest to you that we can measure that.

Third, there may be some impact from customers deciding to wait until the new device comes out. I can't speak to that; it is too early at this time. I assume we will know that or have some better insight in that after a device may come out.

So I guess the key for us and Jason, the thing I would have you walk away with is it appears our policy is working. It appears our plans are working. We need to continue down this path, but when you look at the upgrade numbers and then tie in the churn, I feel really good about the policies are working in a customer-appreciative or a customer-friendly way.

So with regard to our recently announced tentative agreement with both the Midwest and our legacy T employees, I would just suggest to you that we are appreciative of their leaderships bargaining in good faith. We are appreciative of the effort that both teams made in coming to a resolution and quite friendly, I want to point out the resolution in these contracts is right about the same week that we resolved these contracts three years ago. So it is really good to have a quality working relationship with your employees and their representatives.

We will let the details come out from the union and we will let them go through the process of ratification with the employees, which we are very optimistic about. But needless to say, we think it is a fair deal for some valued employees, but we also think it continues to make rational progress in not only the wage structure, but the benefit and the cost structure. So we feel it is a good fair deal and gets our employees' interests and our shareholders' interests aligned. More details to come out and hopefully we will have an announcement on ratification coming soon. We are hopeful for that.

One other thing I want to add is if we are fortunate enough to get these, which we expect, if we are fortunate to get these contracts ratified, between these two contracts and the IBEW extension we signed a few weeks ago, that would bring 25,000 or more than 25,000 of our employees whose contract terms are coming due this year under new contracts. So we are really making good progress on that front. And we look forward to working with the representatives from the West and the East and quite frankly the Southeast in coming to resolutions on contracts with them. We are positive about this. We have a lot of good people here and we're looking forward to keeping them working.

Thanks, John.

David Barden, Bank of America-Merrill Lynch.

Hey, guys. Thanks for taking the questions. John, maybe just a follow-up on the labor point. I was surprised to see that the headcount was down a little over 4% in the quarter. That is one of the bigger headcount changes we have seen in a few years. And I guess if you could elaborate a little bit about where that was going on and what the game plan behind the headcount is both this past quarter and maybe for the rest of the year.

And then just second, we have talked a lot about the (technical difficulty) and the potential to have a benefit down the road for an AT&T. Are you guys able to share any statistics right now about, for instance, what percentage of the base would actually, could actually generate overage either now or in the near future the next year or two?

I guess one of the questions everyone has is we hear about the averages being large, but a lot of those people are still on unlimited plans. If your average customer is only using 300, 400 or 500 megabytes a month and that is growing 30%, 40% for the next few years, it could be many, many years before these tiered plans kind of generate profits. Could you help kind of clear that issue up for us? Thanks.

Okay, first and foremost, on the employee count information, if we could, I would like to make sure we are, if you will, doing comparative numbers here. We did pull out the Ad Solutions employees from our employee base because the transaction, and I think that may be the biggest -- if we are talking about a 4% change, it would have to be that that explains the difference. So that would probably be close to 3% of that 4% change. So I am not sure what you have in front of you, but I think that is really the impact of what we are talking about.

With regard to tiered data, I understand your question. I guess a couple of points. One, we have gone from zero to 27 million in two years, so we are pleased and it appears our customers are pleased with it. Two, customers are choosing the higher tiered plans, whether that be the 3 gig or the 5 gig plans and so at a clip of more than 70%. And so we are doing well and they are choosing to have that usage available to them without additional charges.

That is all happening in this churn environment, so once again it appears it is all going well. We don't give usage base and we are not going to give breakage information out, but I can tell you we are also comfortable with this because of our recent changes to the buckets where we increase the available amount of data to that with a slight increase in price and the fact that that has been taken into account with low churn is just another encouraging piece that we can serve customers well and still get ourselves set up for revenues that are going to be tied to usage, which will then be tied to our capital requirements and a really profitable situation.

On the unlimited, I really think the unlimited is a kind of issue that we have really handled and specifically we have handled it because of our bid rate management program. And so those extraordinary consumers have been addressed and that process has been in place for more than a few months now. And quite frankly, once again, I look to churn as an indicator of how that is being accepted and how that is impacting our customer base and we feel good about the progress we have made there.

Okay, thanks, John. Yes, I think that the change in the employees was going to be the difference in the directory. So that clears it up. I appreciate the help. Thanks, John.

No problem.

Tim Horan, Oppenheimer.

Thanks, good morning, guys. John, I hate to beat a dead horse here, but on the smartphones, the 25 million in sales, maybe a touch more color on the outlook. Do you think you can continue to control that over the next couple of years and at the same type of pace? And I guess related to that, with the upgrade fees and what you have seen here on churn, do you think you can possibly still raise prices there, maybe up to around the $50 price point or so?

And then lastly on the handsets, it does seem like the -- are the subsidies coming down I guess for the non-iPhone devices? The average selling prices seem to be coming down for Android devices. I am wondering if you are seeing any benefit from that. Thanks.

So Tim, I guess just probably more generally than you would prefer, I mean the handset and the smartphones and the subsidy issue is a day in/day out management issue, management attention and focus. So we are looking at all kinds of things.

I would suggest to you that we believe that this is just the first quarter of the upgrade policy change being fully in effect and so we are optimistic about our ability to continue to manage it, to measure it, to provide customers not only to enforce it, but also to provide customers the opportunity to buy up if they want to upgrade before their cycle times. And we have processes in place to do that. So we are optimistic about the ability to do that. Now we will have to do that for ourselves, for our shareholders, for the analysts, but we believe we are on track to do that.

Secondly, with regard to the environment, as new handsets come out, as things get more competitive, we believe there will be more rational pricing in that market and we will be able to, either through our own disciplined actions of pricing acts or our own disciplined actions of seeking out more cost advantageous devices, we need to continue to focus on lowering the costs or managing the costs of those subsidies.

At the same time, we have some very good customers who are willing and who desire, who want handsets and are willing to enter into contracts and work with us and provide us good monthly ARPUs that we are going to be more than happy to continue to work with them and continue to hold onto that customer base.

So it is a day in/day out focus of management, but it is going to be one that we are going to play out in quarters to come just to prove to you that we can continue this good progress we have made this year and specifically this quarter.

Thank you.

Michael Rollins, Citi Investment Research.

Hi, good morning. Thanks for taking the question. I was curious if you could talk a bit more about how to think about the first half of free cash flow performance relative to the guidance of $15 billion to $16 billion for the year. And within that context, maybe you could discuss directionally how you are seeing capital spending for wireline and wireless, the implications for cash taxes going into next year. And then last and not least is just pension contributions and given the new law, should we be thinking any differently about the way you're going to be approaching the pension? Thanks.

Thanks, Michael. We are going to stick with our $15 billion to $16 billion of free cash flow guidance. We are at a run rate ahead of that. We have -- that is evident from our numbers and we are pleased with the fact of where we are at. But as we mentioned, we are going to stick also with our CapEx guidance. And so we do expect a trending up in CapEx the second half of the year. That is not a -- that is only because, in the first half of the year, our team -- our network team and others that use CapEx were real efficient and real careful and, if you will, spent the money like it was their own. You have to be careful in managing it. And so they spent a little bit less, but they still got their work done and now that we have got that efficiency, we are probably going to return more to a normal spend, which will not only have a tick-up in CapEx, but we will have some -- will also impact free cash flow.

Our cash tax situation isn't something we talk about on a year-to-year or on a quarter-by-quarter basis. I would suggest to you I think the situation for us is a little different over the long term than others. First and foremost, bonus depreciation has gone away, but that impact will be spread over three years for us because of the way the estimated payment rules work.

Secondly, for this year, we have got some kind of unique benefits that we are going to get. The contract termination payments and the transfer spectrum we made and the pension funding we did in the fourth quarter of last year, we will get the cash tax benefit of that this year.

Probably more importantly though is if you think back to our IRS settlement we entered into in September of 2010 for about $8 billion, if you are familiar with that, you realize that there is about $600 million a year of cash tax benefits that are coming out of that settlement and that will give you every year through the year I think 2022. So that settlement provides cash benefits for the future.

And then lastly, if you have seen the spectrum purchases we made going all the way back to the auction process back in the '08 timeframe and all the spectrum purchases since, we don't deduct or amortize those for book purposes, but they are deductible and amortizable for tax. So we have got a lot of things going on that are going to allow us to manage cash taxes. And we put a lot of focus on that.

With regard to the pension funding and the highway bill/pension funding law change, we don't have any mandatory contributions to our pension plan this year. So for 2012, it doesn't affect us. For 2013 going forward, certainly it could affect us, but it is too early to talk about that. We are going to have to see how our return on assets do this year. We are going to have to see how our liabilities work out.

I will tell you our focus on the pension plan is really to make sure our employees know that it is secure and that it is funded and that we are efficient in doing it and that is as much a focus as the change in the highway bill pension laws.

Thanks, John. It's really helpful.

Brett Feldman, Deutsche Bank.

Thanks for taking the question. I just want to follow up a little bit on CapEx. Since it does seem like we're going to see a step-up in the second half, could you provide a little color around maybe where we are going to see that? It seems it would likely be on the wireless side in light of your LTE buildout plan, but if there is some wireline investments you need to make, that would be helpful color.

And then just bigger picture, correct me if I am wrong, but I believe you're doing a fairly dense initial deployment of LTE. Meaning you are hitting quite a few sites or most of your sites with that buildout. How do we think about capital intensity in the wireless business after that initial deployment is complete? Could we see CapEx tick down or are you relatively comfortable with the level of investment in the business and you would redirect those dollars into say capacity deployments?

Great, let me try to knock them off one at a time. First of all, with regard to step-up in spend in the second half of the year in CapEx, yes, we expect (technical difficulty) sticking with our guidance of about $20 billion.

Secondly, I think while we don't give specific predictions of the breakdown quarter by quarter, I think it is fair to assume that -- in the first half of the year, we spent about 60% or so or close to 60% of our CapEx on wireless and you could expect that that will continue. I don't want to give any guidance that would move you from that.

I think the logical pieces there are things like the U-verse build and the fact that we really don't have any extensive new living units coming due, that in that area the consumer is more success-based now. It is not as much build. Explains why some of the wireline may be moderating and the LTE build and the completion of that process and the importance of that to us shows -- may give you some insights into why CapEx on the wireless side might be increasing.

We are doing a very dense bill. We think that is the way to give the best quality service to our LTE customers and we think in the long term that is going to really help in all aspects. So we believe that that is the right strategy. We have stuck with that and we are going to stick with it and believe that the customers are going to win because we decided to make that our strategy.

With regard to, so to speak, next year and future years, when you think about the fact that the LTE build is well on its way. I think we mentioned 90% or almost 90% of our data traffic is on enhanced backhaul already. As we roll it out, yes, there is a logical thought that maybe you could lower CapEx in years going forward, but we are sticking with our guidance of mid-teens as a percentage of revenue and that is really because we have a lot of great opportunities in this business. We believe in the business both in the wireline and the wireless business and so we want to make sure we guided that we believe we will find good opportunities for that investment. We are not ready to discuss the specifics, but I think we are going to stick with the guidance. I understand your reason and I think it is logical that you would think there might be a step down. We are not guiding in that direction.

Thank you, Brett and John, I think we have got time for just one more question.

James Ratcliffe, Barclays.

Good morning. Thanks for taking the question. If we could just look at wireline for a second and you can help us unpack how much of a role international had in the results this quarter and whether currency was a drag year on year. Thanks.

Quite frankly, James, I think you are probably well aware that our international exposure is really based on our US-based companies going international and it is really not significant. The biggest international exposure we have quite frankly is in our equity income from our investments in Central and South America through our holdings in America Movil. That probably had the biggest ForEx impact.

I will tell you, on the business services revenue, there was some impact from foreign exchange, but I would suggest to you that I don't think it changes the story for us on that business services revenue and I don't want to hold that out as the story changer. I think it is just much more about businesses being careful. I am a little hesitant because the uncertainties of budget deficits, tax laws and other things and maybe that is our conjecture, but that is what we believe. So it is more that than necessarily foreign exchange hitting our business services revenue line.

Great, thank you.

Thanks and let me close it up here. First and foremost, I want to thank you all for being with us this morning. We delivered a strong financial quarter with record-setting performances in wireless and another strong showing with U-verse. This just only goes to build our confidence as we head into the second half of the year.

I should note with you that next quarter we will report our results on October 24. Our earnings call that day will begin at 9 a.m. Eastern or 8 a.m. Central, a little bit earlier. Once again, thank you for being on the call and as always, thank you very much for your interest in AT&T. Have a good day.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T's executive teleconference. You may now disconnect.