AT&T Gets a Boost From Increased Smartphone Use

By THOMAS GRYTA

AT&T Inc.'s T -2.12% second-quarter profit rose 8.7%, as the company's wireless division reported its most profitable quarter ever, benefiting from the increased use of smartphones.

Like rival Verizon Wireless, AT&T said a majority of its wireless customers under contract now own a smartphone. This trend has led to higher revenue from data usage and stickier mobile customers for the carriers, which are now changing the plans price structures to better leverage profits from users of mobile devices.

In the second quarter, AT&T said its wireless service margins rose to 30.3% from 26.9% a year ago; its revenue from wireless data increased 19% to $6.4 billion; and the rate at which customers leave its network, a measurement known as churn, fell to 0.97% from 1.15% last year.

"Almost all the upside in their earnings was driven by the wireless division," said Deutsche Bank analyst Brett Feldman, who cited the drop in phone upgrades. "They are doing a better job of selling smartphones to customers where they are going to benefit from that sale."

Overall, the company reported a profit of $3.9 billion, or 66 cents a share, up from $3.59 billion, or 60 cents, a year earlier. Revenue edged up 0.3% to $31.58 billion; wireless revenue rose 4.8% to $16.35 billion.

Analysts polled by Thomson Reuters had forecast earnings of 63 cents a share on total revenue of $31.7 billion.

"All in all, it was a very positive quarter which puts us in a great position heading into the second half of the year," Chief Financial Officer John Stephens said in a conference call Tuesday.

AT&T shares, which have been trading near multiyear highs, recently dropped 2.3% to $34.56.

In the latest period, AT&T added 320,000 customers who signed long-term service contracts, compared with 331,000 additions a year earlier. The increase was better than analysts expected--which was a rise of 224,000, according to Deutsche Bank—and reflected the company's improvement in keeping customers. AT&T noted that 88% of customers are on either family or business plans, something that can make it more burdensome for customers to switch carriers.

The wireless division's highest-ever margins was driven by lower costs, fewer costly phone upgrades and the growing base of smartphones. AT&T said 62% of postpaid subscribers owning one at the end of the quarter, up from 50% a year ago.

AT&T also noted that a record low 6% of postpaid customers upgraded their phone in the quarter, something that helps profitability as smartphones are heavily subsidized by carriers.

In an interview, Mr. Stephens cited stricter upgrade policies, put in place earlier this year, as being responsible but conceded that customers may be waiting for purchases later this year. Apple Inc's new iPhone is expected to be released in the fall.

Despite losing its exclusive status as iPhone selling, AT&T still depends on the device. In the quarter, AT&T activated 3.7 million iPhones, or about 73% of its total smartphones.

Indeed, Mr. Stephens noted that the company still expects to sell 25 million smartphones for 2012. Based on the 10.6 million sold in the first half, overall sales of the devices should accelerate and iPhone launches often provide a boost for the company. In the fourth quarter of last year, the company sold 9.4 million smartphones.

But there is more competition as Verizon Wireless and Sprint Nextel Corp. now both offer the iPhone. Despite AT&T activating more than 9 million iPhones in the second half of 2010—with two-year contacts—Mr. Stephens contends that "many" of those customers have already upgraded and renewed their contracts.

Mr. Stephens said the company will continue to evaluate share repurchases after spending $4.6 billion this year, putting the company about halfway through its authorization for buybacks.

He said that AT&T is watching the regulatory review of Verizon Wireless' effort to buy unused wireless spectrum from a group of cable companies for $3.9 billion. As part of that deal, Verizon would sell a block of spectrum and analysts largely expect AT&T to bid aggressively.

"If it is good spectrum and we can use (it), I'm sure we would be interested," Mr. Stephens said.

He said that an ongoing review of several of AT&T's businesses, including its rural access line unit, is continuing. Chief Executive Randall Stephenson hinted earlier this year that selling the unit would prove complex because of myriad of regulatory clearances needed.

AT&T's revenue in the traditional wireline business dropped 0.8% to $14.9 billion.

In May, AT&T sold a majority stake in its Yellow Pages business to private-equity firm Cerberus Capital Management LP for $950 million. The partial-quarter inclusion of the operations created a drag; excluding the business, total revenue in the second-quarter revenue rose 2%.

—Melodie Warner contributed to this article.

Write to Thomas Gryta at thomas.gryta@dowjones.com