Why did operating income fall 25% in 2003 when revenues fell only 5.3%?

The filing attributes the decline primarily to a $1.92 billion increase in combined net pension and postretirement cost, which reflects net investment losses, a lower assumed long-term return on plan assets (from 9.5% to 8.5%), a lower discount rate and higher medical claims. Continued loss of retail access lines to below-cost UNE-P wholesale lines also contributed.

Is the 2003 net income of $8.51 billion a good measure of underlying performance?

Not on its own. Net income includes a $2.54 billion net benefit from cumulative effects of accounting changes, mainly a $3.68 billion gain from adopting FAS 143 less a $1.14 billion directory accounting charge. Income before extraordinary item and cumulative effect was $5.97 billion, or $1.80 per diluted share, down from $7.47 billion in 2002.

What is the status of the Cingular and AT&T Wireless transaction?

Cingular announced the agreement on February 17, 2004 to acquire AT&T Wireless for about $41 billion in cash. It is subject to approval by AT&T Wireless shareholders and federal regulators. SBC expects to provide about $25 billion, primarily from debt, cash on hand, operating cash flow and asset sales, and expects an initial decrease in net income from integration costs and higher financing costs. The agreement may be terminated if closing conditions are not met by December 31, 2004, subject to extension to June 30, 2005.

How is the wireline business performing?

Wireline voice revenue fell 10.7% to $22.08 billion as retail access lines declined, while data revenue rose 5.3% to $10.15 billion, mainly on DSL growth. Total switched access lines fell 4.2% to 54.7 million, and wholesale lines rose 23.3%, which the company says pressures wireline operating margins because wholesale revenue is lower than the cost of service.

What regulatory developments could affect SBC's results?

On March 2, 2004, the D.C. Circuit overturned significant portions of the FCC's Triennial Review Order, including rules on mass-market unbundled switching (and therefore UNE-P) and high-capacity transport, while upholding the decision not to unbundle broadband investment. The effect on UNE-P availability in SBC's 13-state area is unclear. The FCC's broadband review and VoIP rulemaking are also pending, and the company says the effects cannot be determined at this time.

AT&T INC. 10-K FY2003 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 11, 2004. Cited figures are marked; the original filing is the authoritative source.

SBC Communications Inc. (now AT&T Inc.) reported 2003 operating revenues of $40.84 billion^a, down 5.3% from $43.14 billion in 2002, and operating income of $6.47 billion, down 25.0% from $8.62 billion.

Net income rose to $8.51 billion^b ($2.56 per diluted share) from $5.65 billion, but this was driven by a $2.54 billion net benefit from accounting changes (a $3.68 billion gain from adopting FAS 143, partly offset by a $1.14 billion directory accounting charge). Income before extraordinary item and cumulative effect of accounting changes was $5.97 billion ($1.80 per diluted share), down from $7.47 billion. The filing attributes the operating decline mainly to a $1.92 billion increase in combined net pension and postretirement cost and the continuing loss of retail access lines to UNE-P wholesale lines.

Net income also benefited from a $1.57 billion^c gain on the sale of the Cegetel interest. The wireline segment, which provides about 65% of 2003 revenues, faces continued pressure: total switched access lines fell 4.2% to 54.7 million, while DSL lines grew to about 3.5 million. Management expects a 2004 capital budget of $5.0 to $5.5 billion and combined pension and postretirement cost of $1.0 to $1.4 billion.

Regulatory uncertainty is significant, as the D.C. Circuit's March 2, 2004 decision overturned portions of the FCC's Triennial Review Order, including mass-market switching and UNE-P, with the effect still unclear. The most significant subsequent event is Cingular's February 17, 2004 agreement to acquire AT&T Wireless for about $41 billion^d in cash.

SBC expects to contribute about $25 billion, funded primarily with debt, cash on hand, operating cash flow and asset sales. The filing notes this may initially reduce net income through integration costs and higher financing costs, and that the transaction requires shareholder and federal regulatory approval.

02—Key points

Key Highlights

Operating revenues fell 5.3% to $40.84 billion in 2003, and operating income fell 25.0% to $6.47 billion, driven mainly by a $1.92 billion increase in combined net pension and postretirement cost.
Reported net income of $8.51 billion ($2.56 per diluted share) included a $2.54 billion net benefit from cumulative effects of accounting changes; income before those items was $5.97 billion ($1.80 per diluted share).
Retail access lines declined to 47.1 million, while wholesale UNE-P lines rose to 6.7 million from 5.0 million, pressuring wireline margins (segment operating margin 11.1% vs. 15.5% in 2002).
DSL lines reached approximately 3.5 million at December 31, 2003, up from 2.2 million a year earlier, and the company expects DSL availability to reach nearly 80% of wireline customer locations in early 2004.
Cash from operations was $13.52 billion, and the company paid $4.54 billion in dividends; the 2003 dividend totaled $1.41 per share, and the quarterly rate was raised to $0.3125 in December 2003.
The Cingular acquisition of AT&T Wireless (approximately $41 billion) is expected to require about $25 billion of SBC funding and could initially reduce net income; a $1.4 billion termination fee is payable to SBC and BellSouth in certain circumstances.
The 2004 capital expenditure target is $5.0 to $5.5 billion, and SBC is considering a voluntary pension and postretirement plan contribution of $2 billion or more in 2004.

03—Questions

Frequently Asked Questions

Why did operating income fall 25% in 2003 when revenues fell only 5.3%?
The filing attributes the decline primarily to a $1.92 billion increase in combined net pension and postretirement cost, which reflects net investment losses, a lower assumed long-term return on plan assets (from 9.5% to 8.5%), a lower discount rate and higher medical claims. Continued loss of retail access lines to below-cost UNE-P wholesale lines also contributed.
Is the 2003 net income of $8.51 billion a good measure of underlying performance?
Not on its own. Net income includes a $2.54 billion net benefit from cumulative effects of accounting changes, mainly a $3.68 billion gain from adopting FAS 143 less a $1.14 billion directory accounting charge. Income before extraordinary item and cumulative effect was $5.97 billion, or $1.80 per diluted share, down from $7.47 billion in 2002.
What is the status of the Cingular and AT&T Wireless transaction?
Cingular announced the agreement on February 17, 2004 to acquire AT&T Wireless for about $41 billion in cash. It is subject to approval by AT&T Wireless shareholders and federal regulators. SBC expects to provide about $25 billion, primarily from debt, cash on hand, operating cash flow and asset sales, and expects an initial decrease in net income from integration costs and higher financing costs. The agreement may be terminated if closing conditions are not met by December 31, 2004, subject to extension to June 30, 2005.
How is the wireline business performing?
Wireline voice revenue fell 10.7% to $22.08 billion as retail access lines declined, while data revenue rose 5.3% to $10.15 billion, mainly on DSL growth. Total switched access lines fell 4.2% to 54.7 million, and wholesale lines rose 23.3%, which the company says pressures wireline operating margins because wholesale revenue is lower than the cost of service.
What regulatory developments could affect SBC's results?
On March 2, 2004, the D.C. Circuit overturned significant portions of the FCC's Triennial Review Order, including rules on mass-market unbundled switching (and therefore UNE-P) and high-capacity transport, while upholding the decision not to unbundle broadband investment. The effect on UNE-P availability in SBC's 13-state area is unclear. The FCC's broadband review and VoIP rulemaking are also pending, and the company says the effects cannot be determined at this time.

04—Continue

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