By Sinead Carew
NEW YORK (Reuters) - AT&T Inc reported a higher-than-expected quarterly profit on Tuesday, sending its stock up as much as 4 percent, as a decline in iPhone sales reduced the amount of cash it had to pay Apple Inc and boosted its margins.
Apple shares fell almost 2 percent after AT&T also said its numbers should improve further in coming quarters when it expects recent upgrade policy changes to temper smartphone sales further.
Wireless operators have long paid hefty subsidies for smartphones like the iPhone with an aim to attracting new customers and keeping existing customers happy. But AT&T and rival Verizon Wireless have recently been tightening their policies to temper upgrades after they were both hurt by hefty iPhone subsidies in the fourth quarter, when the latest model hit stores.
While fewer iPhone sales meant weaker subscriber growth in the quarter, it did help the company's wireless profit.
Piper Jaffray analyst Christopher Larsen said AT&T's mobile service margin of 41.6 percent had beaten his expectation for 39.7 percent. The margin, based on earnings before interest, tax, depreciation and amortization, was 28.7 percent in the fourth quarter and 39 percent in the year-ago quarter.
"One of the big things is they didn't have such a big iPhone refresh," Larsen said, adding that AT&T results were "pretty good" across the entire company.
AT&T noted that its margin was also helped by the fact that the percentage of its customers using smartphones increased from the first quarter of the previous year.
The more often AT&T customers upgrade to a new iPhone, the more it hurts AT&T margins, because an existing customer does not necessarily increase his or her spending, while a new customer will automatically boost revenue.
AT&T said it had activated 4.3 million iPhones in the quarter, down from 7.6 million in the fourth quarter. In comparison, larger rival Verizon Wireless, a joint venture between Verizon Communications Inc and Vodafone Group PLC, sold 3.2 million iPhones in the latest quarter.
GOOD FOR AT&T, BAD FOR APPLE
Chief Financial Officer John Stephens told analysts on a conference call that he expects a recent increase in upgrade fees to start boosting revenue and delaying upgrades starting this quarter. And in the second half of the year he sees a another decline in smartphone upgrades because of a policy change announced last year that aims to make customer upgrades less frequent. This will start to take effect this year.
Analysts said there was some risk the new policies will start to send customers to other operators but Stephens noted that AT&T is not any stricter than its rivals.
The policy change will not have a big impact on customer defections "because it's the norm," Stephens told Reuters.
The percentage of AT&T subscribers upgrading their handsets fell to 7 percent in the quarter from 12 percent the fourth quarter and 8.9 percent in the first quarter the year before.
Pacific Crest analyst Steve Clement said that while the carrier policy change was bad news for handset makers including Apple, the risk of customers leaving AT&T because of the new policy appears to be mitigated by the fact Verizon Wireless and Sprint Nextel also allow less frequent upgrades.
"It will be interesting to see how folks react around the next iPhone refresh," Clement said, but added: "When it's a quasi coordinated move it definitely helps. It decreases the competitive risk."
AT&T's net income rose to $3.58 billion, or 60 cents per share, from $3.4 billion, or 57 cents per share, a year earlier. Analysts on average had expected 57 cents per share, according to Thomson Reuters I/B/E/S.
Consolidated revenue rose nearly 2 percent to $31.8 billion from $31.25 billion.
The No. 2 U.S. mobile provider added 187,000 subscribers in the quarter, which was roughly in line with expectations for 193,000 from six analysts surveyed by Reuters. This was much fewer than Verizon Wireless, which reported 501,000 net additions last week.
AT&T shares were up $1.18 or 3.9 percent at $31.79 in afternoon trading on the New York Stock Exchange. Apple shares were down $11.28 or 2 percent at $560.42 on Nasdaq.
(Reporting by Sinead Carew in New York and Sayantani Ghosh in Bangalore; Editing by Dave Zimmerman, Lisa Von Ahn and Alden Bentley)