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AT&T: Blame the economy, not the iPhone

Telecommunications giant is hit by the slumping economy, but sees growth in wireless and its new U-verse service for broadband and TV.

Updated at 9:18 a.m. PDT: Analysis added about AT&T's iPhone subsidy and its labor costs. Comments also added from the company's conference call.

AT&T is pinning the more than 9 percent dip in profits for the first quarter on the slumping economy and expenses related to its retirement plan--and not on hefty subsidies associated with the popular iPhone.

AT&T said Wednesday it earned $3.1 billion, or 53 cents per share, in the first quarter. This figure is down from $3.5 billion, or 57 cents per share, during the same quarter last year. Revenue fell about 0.6 percent to $30.6 billion.

Despite the loss, results actually exceeded Wall Street expectations. And much of the good news from the quarter came from the company's wireless business, which was driven by big sales of Apple's iPhone 3G. Specifically, AT&T gained a total of 1.2 million new subscribers to reach a total of 78.2 million.

The company activated more than 1.6 million iPhone 3G devices during the first quarter. And its overall wireless data revenue increased 38.6 percent to $3.2 billion. Growth was driven mostly by messaging, Internet access, e-mail, access to applications, and related services.

"I think the 1.6 million sales of the iPhone in this environment was very strong," Randall Stephenson, AT&T's CEO, said during the conference call. "Despite economic pressures, we had a solid first quarter."

Sales of Apple's iPhone, which AT&T sells exclusively in the U.S., provided the biggest boost to AT&T's wireless business during the quarter. More than 40 percent of the 1.6 million new iPhone subscribers that AT&T activated during the quarter were new to the company. AT&T said these customers tend to spend about 1.6 times more on wireless data services than other AT&T customers. What's more, the churn rate, or the rate at which customers dump the service, is much lower for iPhone users than for other AT&T customers, the company said.

The high ARPU or average revenue per user gained on iPhone sales helped AT&T boost its overall profit margins on wireless data services to more than 40 percent. And Stephenson said the company expects to continue to maintain these margins throughout the year.

Still, AT&T is spending a great deal of money upfront on subsidies to attract these new subscribers. AT&T sells the 8GB version of the device for $199 with a two-year contract and the 16GB version for $299 with a two-year contract. But the devices themselves unsubsidized cost $599 for the 8GB version and $699 for the 16GB models.

AT&T hopes that it can make up the difference in cost by charging at least $70 a month for a voice and data plan that goes with the iPhone, but the company still must pay the upfront cost of the phone. Stephenson said that the dilution experienced from these costs improved dramatically for the company. And he noted that the iPhone has provided a tremendous amount of growth for the company and has helped AT&T acquire some of the industry's highest value customers.

AT&T also saw strong sales from integrated devices, which are non-cell phone devices, like monitoring devices, that operate on AT&T's wireless network. The company said it improved sales of these services by 60 percent compare to a year ago.

Additionally, AT&T's wireline broadband service performed well during the quarter. For its U-verse service, AT&T added 284,000 new TV subscribers in the quarter for a total of 1.3 million.

Even though AT&T saw strong growth in its new businesses, the company was still dragged down by its traditional phone business. AT&T has suffered from consumers migration away from landline phones toward cell phones and other services offered from competitors, like the cable companies.

The slumping economy has accelerated this trend somewhat. Stephenson said during the call that the troubled economy affected the company's declining traditional landline business the most. He said he didn't see any drastic change in business or economic conditions during the first quarter of this year compared to the fourth quarter of 2008. And he noted that the positive momentum the company saw in wireless and its U-verse business had more to do with the products than any momentum from the economy.

And even though the company did relatively well in these growth markets during the quarter, he also said the company was feeling some pressure from the ailing economy.

"As employment is reduced at large business customer, we've seen some reduction in the company-paid wireless devices, which typically have higher ARPU," he said. "And we see consumers try to manage their spend better."

As a result, he said a lot of consumers are migrating from pay-per-use data plans to unlimited packages, which has helped some customers reduce their bills. But in other cases, he noted that some customers are reducing their data usage altogether.

"We are looking at things we can do from a pricing standpoint to deal with this," he said. "We would like to see them continue to move to data packages and not reduce or block their data usage."

The economy wasn't the only drag on AT&T's earnings. The company is also feeling the weight of expensive retiree benefits. The company counted more than $400 million in retiree expenses during the quarter. This expense shaved off about 5 cents per share from its earnings, the company said. AT&T is currently in labor negotiations with its biggest union, the Communications Workers of America . And health care benefits for retirees is one of several issues the two sides are trying to hammer out. AT&T's union workers have been without a contract since April 5.