Why did net income fall in 2005 even though revenue grew?

Net income fell 18.7% to $4.8 billion because 2004 included large one-time gains, including a $908 million gain from discontinued operations and $922 million in other income, while 2005 other income was only $14 million. Equity income from international holdings also dropped by about $417 million. Operating income rose 4.5%, and the tax benefit from the IRS settlement partially offset these declines.

How much of 2005 results reflect the AT&T Corp. acquisition?

Only 43 days of AT&T Corp. results (November 18 to December 31, 2005) are included in consolidated results. These contributed about $2.9 billion in segment revenue and $118 million in operating income. Pro forma 2005 revenue including the full year of AT&T Corp. would be substantially higher, so 2006 reported revenue is expected to increase significantly.

Is the wireline business in decline, and what is management doing about it?

Voice revenue fell 4.3% to $19.9 billion as access lines declined 5.6%, driven by wireless, cable, and VoIP substitution and the end of mass-market UNE-P access. Management is offsetting this with growth in DSL, long-distance, bundled service offerings, and Project Lightspeed. The company expects retail access line trends to improve, but also expects wholesale line declines to continue and the margin pressure from competition to persist.

What are the key risks to the investment case?

Key risks include ongoing access-line erosion, uncertain regulatory outcomes for IP video and Project Lightspeed (including possible state and local franchise fees), integration of AT&T Corp. (which carries pricing pressure and possible synergy shortfalls), pension and postretirement costs of $1.7-1.8 billion in 2006, and litigation including the AT&T Wireless securities class action with damages claimed above $2.1 billion. Cingular's competitive position and its dependence on joint management with BellSouth are also risks.

AT&T INC. 10-K FY2005 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 1, 2006. Cited figures are marked; the original filing is the authoritative source.

AT&T Inc. (formerly SBC Communications) closed its acquisition of AT&T Corp. (ATTC) on November 18, 2005, roughly doubling its scale in business and data services.

Consolidated 2005 operating revenues grew 7.5% to $43.9 billion^a, but only 43 days of ATTC results are included, and net income fell 18.7% to $4.8 billion ($1.42 per diluted share, from $1.77). The decline was driven by lower equity income from international holdings, lower other income, and a sharp drop in the effective tax rate to 16.3%, which was helped by a $902 million one-time IRS settlement benefit. Operating income rose 4.5% to $6.2 billion, but the operating margin slipped to 14.1% from 14.5%, pressured by merger costs and a charge to terminate WilTel agreements.

The core wireline business remains under structural pressure. Total switched access lines fell 5.6%^b to 49.4 million as customers shifted to wireless, cable, and VoIP, and the FCC's UNE-P rule changes continue to erode wholesale revenue. Growth came from data (up 18% to about 30% of consolidated revenue, with 6.9 million DSL lines) and long-distance.

Cingular, the 60%-owned wireless joint venture, ended 2005 with 54.1 million customers and is now the largest U.S. wireless provider, though its results are reported only through equity income. Management guides to higher 2006 capital spending of $8.0^c-8.5 billion, about $4.4 billion of it for Project Lightspeed IP video and broadband, and expects pension and postretirement costs of $1.7-1.8 billion. For investors, the filing shows a company in transition with strong cash generation (operating cash flow of $13.0 billion) and a dividend of $1.30 per share, raised to $0.3325 quarterly.

Debt rose to about $30 billion^d after assuming $8.3 billion of ATTC debt, and the debt ratio fell to 35.9%. The key questions are whether Project Lightspeed and merger synergies can offset access-line losses, and whether the expected workforce reductions and integration of ATTC deliver the planned savings.

02—Key points

Key Highlights

Revenue grew 7.5% to $43.9 billion, but this includes only 43 days of AT&T Corp. results following the November 18, 2005 acquisition.
Net income declined 18.7% to $4.8 billion ($1.42 diluted EPS vs. $1.77), partly offset by a $902 million one-time IRS settlement benefit that lowered the effective tax rate to 16.3%.
Wireline switched access lines fell 5.6% to 49.4 million, while DSL lines grew 36% to 6.9 million and data revenue rose 18%.
Cingular (60% owned) reached 54.1 million wireless customers, the largest U.S. wireless provider, but its results flow through equity income rather than revenue.
2006 capex guidance rises to $8.0-8.5 billion, including about $4.4 billion for Project Lightspeed IP video and broadband deployment reaching 18 million households by 2008.
Total debt rose to about $30 billion after assuming $8.3 billion of AT&T Corp. debt, while the debt ratio improved to 35.9% from 40.0%; the company repurchased 76 million shares for $1.8 billion and quarterly dividend was raised 3.1% to $0.3325.

03—Questions

Frequently Asked Questions

Why did net income fall in 2005 even though revenue grew?
Net income fell 18.7% to $4.8 billion because 2004 included large one-time gains, including a $908 million gain from discontinued operations and $922 million in other income, while 2005 other income was only $14 million. Equity income from international holdings also dropped by about $417 million. Operating income rose 4.5%, and the tax benefit from the IRS settlement partially offset these declines.
How much of 2005 results reflect the AT&T Corp. acquisition?
Only 43 days of AT&T Corp. results (November 18 to December 31, 2005) are included in consolidated results. These contributed about $2.9 billion in segment revenue and $118 million in operating income. Pro forma 2005 revenue including the full year of AT&T Corp. would be substantially higher, so 2006 reported revenue is expected to increase significantly.
Is the wireline business in decline, and what is management doing about it?
Voice revenue fell 4.3% to $19.9 billion as access lines declined 5.6%, driven by wireless, cable, and VoIP substitution and the end of mass-market UNE-P access. Management is offsetting this with growth in DSL, long-distance, bundled service offerings, and Project Lightspeed. The company expects retail access line trends to improve, but also expects wholesale line declines to continue and the margin pressure from competition to persist.
What are the key risks to the investment case?
Key risks include ongoing access-line erosion, uncertain regulatory outcomes for IP video and Project Lightspeed (including possible state and local franchise fees), integration of AT&T Corp. (which carries pricing pressure and possible synergy shortfalls), pension and postretirement costs of $1.7-1.8 billion in 2006, and litigation including the AT&T Wireless securities class action with damages claimed above $2.1 billion. Cingular's competitive position and its dependence on joint management with BellSouth are also risks.

04—Continue

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