attq3_10q07.htm

FORM 10-Q


United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 
(Mark One)
   

 
x
Quarterly Report Pursuant to Section 13 or 15(d) of the
 
   
Securities Exchange Act of 1934
 
       
   
For the quarterly period ended September 30, 2007
 
       
   
or
 
       
 
o
Transition Report Pursuant to Section 13 or 15(d) of the
 
   
Securities Exchange Act of 1934
 
 
For the transition period from       to     

Commission File Number 1-8610

AT&T INC.

Incorporated under the laws of the State of Delaware
I.R.S. Employer Identification Number 43-1301883

175 E. Houston, San Antonio, Texas 78205
Telephone Number:  (210) 821-4105

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X]   No [   ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. Large accelerated filer [X]   Accelerated filer [   ]   Non-accelerated filer [   ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [   ]   No [X]

At October 29, 2007, common shares outstanding were 6,064,758,808.



PART I - FINANCIAL INFORMATION
 
Item 1. Financial Statements
 
   
AT&T INC.
 
CONSOLIDATED STATEMENTS OF INCOME
 
Dollars in millions except per share amounts
 
(Unaudited)
 
   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2007
   
2006
   
2007
   
2006
 
Operating Revenues
                       
Voice
  $
10,164
    $
8,400
    $
30,997
    $
25,524
 
Data
   
5,880
     
4,598
     
17,281
     
13,633
 
Wireless service
   
9,834
     
8
     
28,417
     
24
 
Directory
   
1,240
     
906
     
3,417
     
2,716
 
Other
   
3,014
     
1,726
     
8,467
     
5,267
 
Total operating revenues
   
30,132
     
15,638
     
88,579
     
47,164
 
Operating Expenses
                               
Cost of sales (exclusive of depreciation and
                               
amortization shown separately below)
   
11,591
     
6,923
     
34,321
     
21,450
 
Selling, general and administrative
   
7,915
     
3,361
     
22,992
     
10,587
 
Depreciation and amortization
   
5,322
     
2,437
     
16,354
     
7,415
 
Total operating expenses
   
24,828
     
12,721
     
73,667
     
39,452
 
Operating Income
   
5,304
     
2,917
     
14,912
     
7,712
 
Other Income (Expense)
                               
Interest expense
    (887 )     (442 )     (2,639 )     (1,378 )
Equity in net income of affiliates
   
162
     
649
     
545
     
1,438
 
Other income (expense) – net
    (17 )    
109
     
614
     
315
 
Total other income (expense)
    (742 )    
316
      (1,480 )    
375
 
Income Before Income Taxes
   
4,562
     
3,233
     
13,432
     
8,087
 
Income taxes
   
1,499
     
1,068
     
4,617
     
2,669
 
Net Income
  $
3,063
    $
2,165
    $
8,815
    $
5,418
 
Earnings Per Common Share
                               
Net Income
  $
0.50
    $
0.56
    $
1.43
    $
1.40
 
Earnings Per Common Share - Assuming Dilution
                               
Net Income
  $
0.50
    $
0.56
    $
1.42
    $
1.39
 
Weighted Average Number of Common
                               
Shares Outstanding – Basic (in millions)
   
6,088
     
3,873
     
6,152
     
3,880
 
Dividends Declared Per Common Share
  $
0.3550
    $
0.3325
    $
1.065
    $
0.9975
 
See Notes to Consolidated Financial Statements.

2

 
AT&T INC.
 
CONSOLIDATED BALANCE SHEETS
 
Dollars in millions except per share amounts
           
   
September 30,
   
December 31,
 
   
2007
   
2006
 
Assets
 
(Unaudited)
       
Current Assets
           
Cash and cash equivalents
  $
2,714
    $
2,418
 
Accounts receivable – net of allowances for
               
uncollectibles of $1,362 and $1,276
   
16,305
     
16,194
 
Prepaid expenses
   
1,900
     
1,477
 
Deferred income taxes
   
2,433
     
3,034
 
Other current assets
   
2,191
     
2,430
 
Total current assets
   
25,543
     
25,553
 
Property, plant and equipment
   
206,818
     
202,149
 
Less: accumulated depreciation and amortization
   
112,372
     
107,553
 
Property, Plant and Equipment – Net
   
94,446
     
94,596
 
Goodwill
   
66,847
     
67,657
 
Licenses
   
35,687
     
34,252
 
Customer Lists and Relationships – Net
   
15,361
     
18,922
 
Other Intangible Assets – Net
   
6,001
     
6,566
 
Investments in Equity Affiliates
   
2,403
     
1,995
 
Postemployment Benefit
   
14,779
     
14,228
 
Other Assets
   
6,901
     
6,865
 
Total Assets
  $
267,968
    $
270,634
 
                 
Liabilities and Stockholders’ Equity
               
Current Liabilities
               
Debt maturing within one year
  $
6,026
    $
9,733
 
Accounts payable and accrued liabilities
   
20,239
     
22,106
 
Advanced billing and customer deposits
   
3,471
     
3,402
 
Accrued taxes
   
6,282
     
3,026
 
Dividends payable
   
2,156
     
2,215
 
Total current liabilities
   
38,174
     
40,482
 
Long-Term Debt
   
54,585
     
50,063
 
Deferred Credits and Other Noncurrent Liabilities
               
Deferred income taxes
   
22,595
     
27,406
 
Postemployment benefit obligation
   
28,756
     
28,901
 
Unamortized investment tax credits
   
158
     
181
 
Other noncurrent liabilities
   
12,526
     
8,061
 
Total deferred credits and other noncurrent liabilities
   
64,035
     
64,549
 
                 
Stockholders’ Equity
               
Common shares issued ($1 par value)
   
6,495
     
6,495
 
Capital in excess of par value
   
91,534
     
91,352
 
Retained earnings
   
32,606
     
30,375
 
Treasury shares (at cost)
    (14,411 )     (7,368 )
Accumulated other comprehensive income
    (5,050 )     (5,314 )
Total stockholders’ equity
   
111,174
     
115,540
 
Total Liabilities and Stockholders’ Equity
  $
267,968
    $
270,634
 
See Notes to Consolidated Financial Statements.
3

 
AT&T INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Dollars in millions, increase (decrease) in cash and cash equivalents
 
(Unaudited)
 
   
Nine months ended
 
   
September 30,
 
   
2007
   
2006
 
Operating Activities
           
Net income
  $
8,815
    $
5,418
 
Adjustments to reconcile net income to net cash
               
provided by operating activities:
               
Depreciation and amortization
   
16,354
     
7,415
 
Undistributed earnings from investments in equity affiliates
    (434 )     (1,359 )
Provision for uncollectible accounts
   
1,142
     
450
 
Amortization of investment tax credits
    (23 )     (21 )
Deferred income tax (benefit) expense
   
486
      (269 )
Net gain on sales of investments
    (29 )     (10 )
 Gain on license exchange
    (409 )    
-
 
 Changes in operating assets and liabilities:
               
Accounts receivable
    (1,253 )    
249
 
Other current assets
    (661 )    
42
 
Accounts payable and accrued liabilities
    (46 )     (1,819 )
Stock-based compensation tax benefit
    (149 )     (10 )
Other - net
   
427
     
507
 
Total adjustments
   
15,405
     
5,175
 
Net Cash Provided by Operating Activities
   
24,220
     
10,593
 
Investing Activities
               
Construction and capital expenditures
    (12,124 )     (6,158 )
Net investments in affiliates
   
-
      (633 )
Dispositions
   
993
     
72
 
Acquisitions, net of cash acquired
    (233 )     (115 )
Proceeds from sale of marketable securities
   
471
     
-
 
Proceeds from sale of debt and equity securities
   
414
     
-
 
Investments in debt and equity securities
    (301 )    
-
 
Other
   
28
     
8
 
Net Cash Used in Investing Activities
    (10,752 )     (6,826 )
Financing Activities
               
Net change in short-term borrowings with original
               
maturities of three months or less
    (4,279 )    
2,336
 
Issuance of long-term debt
   
7,898
     
1,491
 
Repayment of long-term debt
    (3,008 )     (2,882 )
Purchase of treasury shares
    (8,912 )     (1,359 )
Issuance of treasury shares
   
1,736
     
463
 
Dividends paid
    (6,584 )     (3,873 )
Stock-based compensation tax benefit
   
149
     
10
 
Other
    (172 )    
74
 
Net Cash Used in Financing Activities
    (13,172 )     (3,740 )
Net increase in cash and cash equivalents
   
296
     
27
 
Cash and cash equivalents beginning of year
   
2,418
     
1,224
 
Cash and Cash Equivalents End of Period
  $
2,714
    $
1,251
 
                 
Cash paid during the nine months ended September 30 for:
               
Interest
  $
2,518
    $
1,503
 
Income taxes, net of refunds
  $
2,028
    $
2,249
 

See Notes to Consolidated Financial Statements.
4


AT&T INC.
     
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
     
Dollars and shares in millions, except per share amounts
     
(Unaudited)
     
   
Nine months ended
 
   
September 30, 2007
 
   
Shares
   
Amount
 
Common Stock
           
Balance at beginning of year
   
6,495
    $
6,495
 
Balance at end of period
   
6,495
    $
6,495
 
                 
Capital in Excess of Par Value
               
Balance at beginning of year
          $
91,352
 
Issuance of shares
           
134
 
Stock based compensation
           
48
 
Balance at end of period
          $
91,534
 
                 
Retained Earnings
               
Balance at beginning of year
          $
30,375
 
Net income ($1.42 per diluted share)
           
8,815
 
Dividends to stockholders ($1.065 per share)
            (6,525 )
Adoption of FIN 48
            (50 )
Other
            (9 )
Balance at end of period
          $
32,606
 
                 
Treasury Shares
               
Balance at beginning of year
    (256 )   $ (7,368 )
Purchase of shares
    (230 )     (8,912 )
Issuance of shares
   
63
     
1,869
 
Balance at end of period
    (423 )   $ (14,411 )
                 
Accumulated Other Comprehensive Income, net of tax
               
Balance at beginning of year
          $ (5,314 )
Purchase accounting adjustment to apply FAS 158, net of tax
           
46
 
Other comprehensive income (loss) (see Note 3)
           
218
 
Balance at end of period
          $ (5,050 )
 See Notes to Consolidated Financial Statements  
.
 

 
5

      
 AT&T INC.  
 SEPTEMBER 30, 2007            
        
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)                    
 Dollars in millions except per share amounts

NOTE 1. PREPARATION OF INTERIM FINANCIAL STATEMENTS

Basis of Presentation Throughout this document, AT&T Inc. is referred to as “AT&T,” “we” or the “Company.” The consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) that permit reduced disclosure for interim periods. We believe that these consolidated financial statements include all adjustments (consisting only of normal recurring accruals) necessary to present fairly the results for the interim periods shown. The results for the interim periods are not necessarily indicative of results for the full year. You should read this document in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2006 and our Forms 10-Q for interim periods.

The consolidated financial statements include the accounts of the Company and our majority-owned subsidiaries and affiliates. Our subsidiaries and affiliates operate in the communications services industry both domestically and internationally providing wireless and wireline communications services and equipment, managed networking, wholesale services and directory advertising and publishing services.

All significant intercompany transactions are eliminated in the consolidation process. Investments in partnerships and less than majority-owned subsidiaries where we have significant influence are accounted for under the equity method. Prior to the closing of the BellSouth Corporation (BellSouth) acquisition on December 29, 2006, we accounted for our joint ventures with BellSouth under the equity method since we shared control equally. Thus, for 2006 we recorded as equity income our proportionate share of economic ownership in these joint ventures, namely, 60% of AT&T Mobility LLC (AT&T Mobility), formerly Cingular Wireless LLC and 66% of YELLOWPAGES.COM (YPC). AT&T Mobility and YPC became wholly-owned subsidiaries of AT&T on December 29, 2006. Earnings from certain foreign equity investments accounted for using the equity method are included for periods ended within up to one month of our period end.

The preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes, including estimates of probable losses and expenses. Actual results could differ from those estimates. We have reclassified certain amounts in prior-period financial statements to conform to the current period’s presentation.

Employee Separations In accordance with Statement of Financial Accounting Standards No. 112, “Employers’ Accounting for Postemployment Benefits,” (FAS 112) we establish obligations for expected termination benefits provided under existing plans to former or inactive employees after employment but before retirement. These benefits include severance payments, workers’ compensation, disability, medical continuation coverage and other benefits. At September 30, 2007, we had severance accruals under FAS 112 of $156, of which $132 was established as merger-related severance accruals. At December 31, 2006, we had severance accruals of $263.

New Accounting Standards
FIN 48 We adopted Financial Accounting Standards Board (FASB) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48) on January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes.” The Interpretation prescribes a threshold for the financial statement recognition and measurement of a tax position taken or expected to be taken within an income tax return. For each tax position, the enterprise must determine whether it is more likely than not that the position will be sustained upon examination based on the technical merits of the position, including resolution of any related appeals or litigation. A tax position that meets the more likely than not recognition threshold is then measured to determine the amount of benefit to recognize within the financial statements. No benefits may be recognized for tax positions that do not meet the more likely than not threshold. As required by FIN 48, we reclassified deferred income tax liabilities of $6,225 from our “Deferred income taxes” for unrecognized tax benefits, of which $6,100 was included in “Other noncurrent liabilities” and $175 was included in “Accrued taxes” on our Consolidated Balance Sheets and the remaining $50 was recorded as a reduction to the beginning of year retained earnings to reflect the cumulative effect of adoption of FIN 48 in the first quarter. In May 2007, the FASB issued further guidance on whether a tax position is effectively settled, the adoption of which did not have a material impact.
 
 
6

      
AT&T INC.  
SEPTEMBER 30, 2007            
        
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued                   
Dollars in millions except per share amounts
 
The total amount of unrecognized tax benefits including interest and penalties at January 1, 2007 was $6,275, of which $1,913 would favorably affect income tax expense in future periods. The $1,913 is net of related deferred tax assets. During the third quarter, we reduced our unrecognized tax benefits by $390. The significant components of the reduction were a decrease of $261 as a result of settlement of an Internal Revenue Service (IRS) audit, a decrease of $229 due to a change in management’s measurement of benefits related to capital losses claimed on our 2002 tax return, and an increase of $116 due to interest accruals and current period unrecognized tax benefits. The total amount of unrecognized tax benefits including interest and penalties at September 30, 2007 was $5,791, of which $4,136 was included in “Other noncurrent liabilities” and $1,655 was included in “Accrued taxes” on our Consolidated Balance Sheets. Of our total unrecognized tax benefits balance of $5,791, we expect to pay $1,655 within one year. We cannot reasonably estimate the timing or amounts of additional cash payments, if any, at this time. Of the September 30, 2007 balance, $1,909 represents the amount of unrecognized tax benefits that, if recognized, would favorably affect income tax expense in future periods. This amount is net of related deferred tax assets.

We record interest and penalties related to federal, state and foreign unrecognized tax benefits in income tax expense. Accrued interest and penalties included in unrecognized tax benefits were $1,380 and $1,364 as of January 1, 2007 and September 30, 2007, respectively.

The Company and our subsidiaries file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. Our income tax returns are regularly audited and reviewed by the IRS as well as state and foreign taxing authorities.

The IRS has completed field examinations of AT&T’s tax returns through 2002 and all audit periods prior to 1998 are closed for federal purposes. We were unable to reach agreement with the IRS on one issue related to our 1998 and 1999 tax returns and, as a result, we have filed a refund suit in U.S. District Court. We have withdrawn from the IRS “Expedited Resolution of Uncertain Tax Positions Initiative” with regard to capital losses claimed on our 2002 tax returns and have requested that this issue be included in the IRS Appeals Division (Appeals) settlement meetings regarding our 2000-2002 returns. We may reach a resolution of this examination cycle during the next twelve months but, at this time, we are not able to determine the impact that resolution may have on our unrecognized tax benefits. The IRS is currently examining the AT&T 2003-2005 tax returns, and we expect their fieldwork to be completed during 2008.

The IRS has completed the examination of all acquired entity tax returns through 2003 (AT&T Corp. through 2004) and, with the exception of BellSouth, all years through 2001 are closed. We expect to settle the AT&T Corp. 2005 examination within the next twelve months with an immaterial impact on our unrecognized tax benefits. Appeals has issued BellSouth an assessment for years 1999-2001 which was paid during the second quarter, and we are reviewing our options with this case.

FAS 159 In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (FAS 159). FAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value, providing the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. FAS 159 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact FAS 159 will have on our financial position and results of operations.

EITF 06-11 In June 2007, the Emerging Issues Task Force (EITF) ratified the consensus on EITF 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards”. EITF 06-11 provides that a realized income tax benefit from dividends or dividend equivalents that are charged to retained earnings and are paid to employees for nonvested equity-classified share-based awards and equity-classified outstanding share options should be recognized as an increase to additional paid-in capital rather than a reduction of income tax expense. EITF 06-11 applies prospectively to the income tax benefits that result from dividends on equity-classified employee share-based payment awards that are declared in fiscal periods beginning after December 15, 2007. We are currently evaluating the impact EITF 06-11 will have on our financial position and results of operations.
 
7

 
      
AT&T INC.  
SEPTEMBER 30, 2007            
        
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued                   
Dollars in millions except per share amounts

NOTE 2. ACQUISITIONS, DISPOSITIONS, VALUATION AND OTHER ADJUSTMENTS
 
Acquisitions
BellSouth Corporation In December 2006, we acquired BellSouth in a transaction accounted for under  Statement of Financial Accounting Standards No. 141, “Business Combinations” (FAS 141), issuing 2.4 billion shares. BellSouth was the leading communications service provider in the southeastern U.S., providing wireline communications services, including local exchange, network access, long-distance services and Internet services to substantial portions of the population across nine states. BellSouth also provided long-distance services to enterprise customers throughout the country.

We and BellSouth jointly owned AT&T Mobility and the Internet-based publisher YPC. In the AT&T Mobility joint venture, we held a 60% economic interest and BellSouth held a 40% economic interest and in the YPC joint venture, we held a 66% economic interest and BellSouth held a 34% economic interest. For each joint venture, control was shared equally. We and BellSouth each accounted for the joint ventures under the equity method of accounting, recording the proportional share of AT&T Mobility’s and YPC’s income as equity in net income of affiliates on the respective consolidated statements of income and reporting the ownership percentage of AT&T Mobility’s net assets as “Investments in and Advances to AT&T Mobility” and the ownership percentage of YPC’s net assets as “Investments in Equity Affiliates” on the respective consolidated balance sheets. After the BellSouth acquisition, BellSouth, AT&T Mobility and YPC became wholly-owned subsidiaries of AT&T, and the operational results of these companies have been included in our consolidated financial statements since the December 29, 2006 acquisition date.

Under the purchase method of accounting, the transaction was valued, for accounting purposes, at approximately $66,800. The assets and liabilities of BellSouth and AT&T Mobility have been preliminarily appraised, based on third-party valuations, for inclusion in the balance sheet, adjusting 100% of BellSouth’s and 40% of AT&T Mobility’s values. Long-lived assets such as property, plant and equipment reflect a value of replacing the assets, which takes into account changes in technology, usage, and relative obsolescence and depreciation of the assets, sometimes referred to as a “Greenfield approach.” This approach often results in differences, sometimes material, from recorded book values even if, absent the acquisition, the assets would not be impaired. In addition, assets and liabilities that would not normally be recorded in ordinary operations (i.e. customer relationships) will be recorded at their acquisition values. Debt instruments and investments are valued in relation to current market conditions and other assets and liabilities are valued based on the acquiring company’s estimates. After all values have been assigned to assets and liabilities, the remainder of the purchase price is recorded as goodwill. These values are subject to adjustment for one year after the close of the transaction as additional information is obtained, and those adjustments could be material.

8

      
AT&T INC.  
SEPTEMBER 30, 2007            
        
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued                   
Dollars in millions except per share amounts

The following table summarizes the preliminary estimated fair values of the BellSouth assets acquired and liabilities assumed and related deferred income taxes as of the acquisition date and adjustments made thereto during the first nine months of 2007.

   
BellSouth Purchase Price Allocation
 
   
As of
         
As of
 
   
12/31/06
   
Adjustments
   
9/30/07
 
Assets acquired
                 
Current assets
  $
4,875
    $
42
    $
4,917
 
Property, plant and equipment
   
18,498
     
249
     
18,747
 
Intangible assets not subject to amortization:
                       
Trademark/name
   
330
     
-
     
330
 
Licenses
   
214
     
100
     
314
 
Intangible assets subject to amortization:
                       
Customer lists and relationships
   
9,230
     
145
     
9,375
 
Patents
   
100
     
-
     
100
 
Trademark/name
   
211
     
-
     
211
 
Investments in AT&T Mobility
   
32,759
     
-
     
32,759
 
Other investments
   
2,446
      (3 )    
2,443
 
Other assets
   
11,211
      (97 )    
11,114
 
Goodwill
   
26,467
      (92 )    
26,375
 
Total assets acquired
   
106,341
     
344
     
106,685
 
                         
Liabilities assumed
                       
Current liabilities, excluding
current portion of long-term debt
   
5,288
      (528 )    
4,760
 
Long-term debt
   
15,628
      (4 )    
15,624
 
Deferred income taxes
   
10,318
     
797
     
11,115
 
Postemployment benefit obligation
   
7,086
      (70 )    
7,016
 
Other noncurrent liabilities
   
1,223
     
128
     
1,351
 
Total liabilities assumed
   
39,543
     
323
     
39,866
 
Net assets acquired
  $
66,798
    $
21
    $
66,819
 

Adjustments were primarily related to finalization of participant count estimates used in the opening balance sheet valuation for the pension and postretirement plans, a gain on a contingency related to an insurance claim recovery for Hurricane Katrina damages, tax impacts related to AT&T Mobility’s purchase accounting adjustments, the valuation of certain licenses and a decrease in the estimate of relative obsolescence of property, plant and equipment resulting in an increase in value and longer average remaining economic life. Deferred tax adjustments are associated with the above-mentioned items.


9

      
AT&T INC.  
SEPTEMBER 30, 2007            
        
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued                   
Dollars in millions except per share amounts

BellSouth’s 40% economic ownership of AT&T Mobility has been recorded above as “Investment in AT&T Mobility,” and has been eliminated in our Consolidated Balance Sheets. We have recorded the consolidation of AT&T Mobility as a step acquisition, retaining 60% of AT&T Mobility’s prior book value and adjusting the remaining 40% to fair value. The following table summarizes the preliminary estimated fair values (40%) and historical book values (60%) of the AT&T Mobility assets acquired and liabilities assumed and related deferred income taxes as of the acquisition date and adjustments made thereto during the first nine months of 2007.

   
Fair Value Adjustments
AT&T Mobility
 
   
As of
         
As of
 
   
12/31/06
   
Adjustments
   
9/30/07
 
Assets acquired
                 
Current assets
  $
6,988
    $
3
    $
6,991
 
Property, plant and equipment
   
19,687
      (411 )    
19,276
 
Intangible assets not subject to amortization:
                       
Licenses
   
33,979
     
887
     
34,866
 
Intangible assets subject to amortization:
                       
Customer lists and relationships
   
7,583
     
479
     
8,062
 
Trademark/names
   
343
      (127 )    
216
 
Other
   
176
      (44 )    
132
 
Other assets
   
1,086
     
2
     
1,088
 
Goodwill
   
27,429
      (377 )    
27,052
 
Total assets acquired
   
97,271
     
412
     
97,683
 
                         
Liabilities assumed
                       
Current liabilities, excluding
current portion of long-term debt
   
7,014
     
384
     
7,398
 
Intercompany debt
   
9,043
     
-
     
9,043
 
Long-term debt
   
12,559
     
-
     
12,559
 
Deferred income taxes
   
5,459
     
71
     
5,530
 
Postemployment benefit obligation
   
301
     
93
     
394
 
Other noncurrent liabilities
   
2,007
      (92 )    
1,915
 
Total liabilities assumed
   
36,383
     
456
     
36,839
 
Net assets acquired
  $
60,888
    $ (44 )   $
60,844
 

Adjustments were primarily related to valuation estimates that, due to the proximity of the merger to year-end, were based on data from periods prior to the close of the December 29, 2006 acquisition. Using the December 29, 2006 data, purchase price allocations decreased the opening balance sheet values of property, plant and equipment, trademark/names and other intangibles, offset by an increased value of licenses and customer lists and relationships acquired. Deferred tax adjustments are associated with the above-mentioned items.

We continue to evaluate the overall integration and operation of our networks resulting from the acquisition. This may result in additional revisions during the purchase price allocation period and adjustments could be material.


10

      
AT&T INC.  
SEPTEMBER 30, 2007            
        
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued                   
Dollars in millions except per share amounts

Valuation and Other Adjustments
As AT&T Corp. (ATTC) and BellSouth stock options that were converted at the time of the respective mergers are exercised, the tax effect on those options may further reduce goodwill. As of September 30, 2007, we had recorded $8 in related goodwill reductions for ATTC and $28 for BellSouth.

Included in the current liabilities reported on our Consolidated Balance Sheet are accruals established under EITF Issue No. 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination” (EITF 95-3). The liabilities include accruals for severance, lease terminations and equipment removal costs associated with our acquisitions of ATTC and BellSouth.

Included in the liabilities assumed for the December 2006 acquisition of BellSouth was accrued severance of $535 for BellSouth employees and $44 for AT&T Mobility employees, all of which will be paid from company cash. In addition to the severance accruals, we also maintained the accruals that were established by AT&T Mobility associated with their acquisition of AT&T Wireless, Inc. (AWE). The AWE-related accruals are for plans affecting the integration of retail stores, administrative space and networks acquired in AT&T Mobility’s acquisition of AWE. During 2007, we recorded additional accruals for severance, lease terminations and equipment removal costs at AT&T Mobility. We will continue to evaluate these accruals through the end of the allocation period.

Following is a summary of the accruals recorded at December 31, 2006, cash payments made during the first nine months of 2007 and the purchase accounting adjustments thereto, for the acquisitions of ATTC and BellSouth.

   
12/31/06
   
Cash
   
Additional
         
9/30/07
 
   
Balance
   
Payments
   
Accruals
   
Adj.
   
Balance
 
Severance accruals paid from:
                             
Company funds
  $
986
    $ (348 )   $
16
    $ (72 )   $
582
 
Pension and postemployment
benefit plans
   
183
      (39 )    
-
     
-
     
144
 
Lease terminations
   
146
      (72 )    
220
     
24
     
318
 
Equipment removal and other related costs
   
117
      (110 )    
152
      (28 )    
131
 
Total
  $
1,432
    $ (569 )   $
388
    $ (76 )   $
1,175
 


11

      
AT&T INC.  
SEPTEMBER 30, 2007            
        
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued                   
Dollars in millions except per share amounts

NOTE 3. COMPREHENSIVE INCOME

The components of our comprehensive income for the three and nine months ended September 30, 2007 and 2006 include net income, adjustments to stockholders’ equity for the foreign currency translation adjustment, net unrealized gain (loss) on available-for-sale securities and net unrealized gain (loss) on cash flow hedges and defined benefit postretirement plans. The foreign currency translation adjustment was due to exchange rate fluctuations in our foreign affiliates’ local currencies, and the reclassification adjustment on cash flow hedges was due to the amortization of losses from our interest rate forward contracts.

Following is our comprehensive income:

   
Three months ended
   
Nine months ended   
 
   
September 30,
   
September 30,
 
   
2007
   
2006
   
2007
   
2006
 
Net income
  $
3,063
    $
2,165
    $
8,815
    $
5,418
 
Other comprehensive income, net of tax:
                               
   Foreign currency translation adjustment
    (14 )    
29
     
4
      (16 )
   Net unrealized gains (losses) on securities:
                               
    Unrealized gains (losses)
    (15 )     (17 )    
134
     
17
 
    Reclassification adjustment for gains realized in net income
   
3
     
-
      (37 )     (8 )
   Net unrealized gains (losses) on cash flow hedges:
        Unrealized gains (losses)
    (15 )    
-
      (51 )    
2
 
        Reclassification adjustment for losses realized in net income
   
5
     
4
     
13
     
12
 
   Defined benefit postretirement plans:
                               
       Amortization of net actuarial loss included in net income
   
87
     
-
     
262
     
-
 
       Amortization of prior service benefit included in net income
    (35 )    
-
      (106 )    
-
 
   Other
   
-
     
-
      (1 )    
1
 
Other comprehensive income
   
16
     
16
     
218
     
8
 
Total Comprehensive Income 
  $
3,079
    $
2,181
    $
9,033
    $
5,426
 


12

      
AT&T INC.  
SEPTEMBER 30, 2007            
        
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued                   
Dollars in millions except per share amounts

NOTE 4. EARNINGS PER SHARE

A reconciliation of the numerators and denominators of basic earnings per share and diluted earnings per share for net income for the three and nine months ended September 30, 2007 and 2006 is shown in the table below:

   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2007
   
2006
   
2007
   
2006
 
Numerators
                       
Numerator for basic earnings per share:
                       
Income from continuing operations
  $
3,063
    $
2,165
    $
8,815
    $
5,418
 
Dilutive potential common shares:
                               
Other stock-based compensation
   
2
     
2
     
6
     
5
 
Numerator for diluted earnings per share
  $
3,065
    $
2,167
    $
8,821
    $
5,423
 
Denominators (000,000)
                               
Denominator for basic earnings per share:
                               
Weighted-average number of common
                               
shares outstanding
   
6,088
     
3,873
     
6,152
     
3,880
 
Dilutive potential common shares:
                               
Stock options
   
26
     
5
     
25
     
4
 
Other stock-based compensation
   
15
     
14
     
19
     
16
 
Denominator for diluted earnings per share
   
6,129
     
3,892
     
6,196
     
3,900
 
Basic earnings per share
                               
Net income
  $
0.50
    $
0.56
    $
1.43
    $
1.40
 
Diluted earnings per share
                               
Net income
  $
0.50
    $
0.56
    $
1.42
    $
1.39
 


At September 30, 2007, we had issued and outstanding options to purchase approximately 241 million shares of AT&T common stock. The exercise prices of options to purchase a weighted average of 73 million shares in the third quarter and 100 million for the first nine months exceeded the average market price of AT&T stock. Accordingly, we did not include these amounts in determining the dilutive potential common shares for the respective periods.

At September 30, 2006, we had issued and outstanding options to purchase 234 million shares of AT&T common stock. The exercise prices of options to purchase a weighted average of 189 million shares in the third quarter and 212 million for the first nine months exceeded the average market price of AT&T stock. Accordingly, we did not include these amounts in determining the dilutive potential common shares for the respective periods.

At September 30, 2007, the exercise price of 169 million share options was below market price.
 
13

AT&T INC.  
SEPTEMBER 30, 2007            
        
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued                   
Dollars in millions except per share amounts

NOTE 5. SEGMENT INFORMATION

Our segments are strategic business units that offer different products and services and are managed accordingly. We analyze our various operating segments based on segment income before income taxes. Interest expense, interest income and other income (expense) – net are managed only on a total company basis and are, accordingly, reflected only in consolidated results. Therefore, these items are not included in the calculation of each segment’s percentage of our consolidated results. As a result of the December 29, 2006 acquisition of BellSouth, we have revised our segment reporting to represent how we now manage our business, restating prior periods to conform to the current segments. We have four reportable segments: (1) wireline, (2) wireless, (3) advertising & publishing and (4) other.

The wireline segment provides both retail and wholesale landline communications services, including local and long-distance voice, switched access, Internet protocol and Internet access data, messaging services, managed networking to business customers, AT&T U-versesm TV service (U-verse) and satellite television services through our agency agreements with EchoStar Communications Corp. and the DIRECTV Group, Inc.

The wireless segment provides voice, data and other wireless communications services, and includes 100% of the results of AT&T Mobility, which was our wireless joint venture with BellSouth prior to the December 29, 2006 acquisition and is now a wholly-owned subsidiary of AT&T. In 2006, although we analyzed AT&T Mobility’s revenues and expenses under the wireless segment, we eliminated the wireless segment in our consolidated financial statements. In our 2006 consolidated financial statements we reported our 60% proportionate share of AT&T Mobility’s results as equity in net income of affiliates.

The advertising & publishing segment includes our directory operations, which publish Yellow and White Pages directories and sell directory and Internet-based advertising. This segment also includes the results of YPC, which was a joint venture with BellSouth prior to the December 29, 2006 acquisition and is now a wholly-owned subsidiary of AT&T. For segment reporting disclosure, we have carried forward the deferred revenue and deferred cost balances for BellSouth at the acquisition date in order to reflect how the segment is managed. This is different for consolidated reporting purposes as under FAS 141, BellSouth deferred revenue and expenses from directories published during the twelve-month period ending with the December 29, 2006 acquisition date are not recognized and therefore were not included in the opening balance sheet. For management reporting purposes, we continue to amortize these balances over the life of the directory. Thus, our advertising & publishing segment results include revenue of $196 in the third quarter and $911 for the first nine months and expenses of $64 in the third quarter and $291 for the first nine months of 2007, related to directories published in the Southeast region during 2006, prior to our acquisition of BellSouth. These amounts are eliminated in the consolidations and eliminations column in the reconciliation below.

The other segment includes results from Sterling Commerce Inc., customer information services and all corporate and other operations. This segment includes our portion of the results from our international equity investments. Prior to December 29, 2006, this segment also included our results from AT&T Mobility as equity in net income of affiliates, as discussed above.

In the following tables, we show how our segment results are reconciled to our consolidated results reported in accordance with GAAP. The Wireline, Wireless, Advertising & Publishing and Other columns represent the segment results of each such operating segment. The Consolidation and Elimination column adds in those line items that we manage on a consolidated basis only: interest expense, interest income and other income (expense) – net. This column also eliminates any intercompany transactions included in each segment’s results as well as the advertising & publishing revenue and expenses in 2007 related to directories published in the Southeast region during 2006, mentioned previously. In 2006, since our 60% share of the results from AT&T Mobility is already included in the Other column, the Wireless Elimination column removes the non-consolidated results shown in the wireless segment.


14

      
AT&T INC.      
SEPTEMBER 30, 2007            
        
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued              
Dollars in millions except per share amounts     

For the three months ended September 30, 2007             
     
               
 
         
Consolidation
   
 
 
   
Wireline
   
Wireless
   
Advertising &
Publishing
   
Other
   
and Elimination
   
Consolidated
Results
 
Revenues from external customers
  $
17,471
    $
10,911
    $
1,436
    $
510
    $ (196 )   $
30,132
 
Intersegment revenues
   
469
     
26
     
21
     
52
      (568 )    
-
 
Total segment operating revenues
   
17,940
     
10,937
     
1,457
     
562
      (764 )    
30,132
 
Operations and support expenses
   
11,725
     
7,262
     
755
     
399
      (635 )    
19,506
 
Depreciation and amortization expenses
   
3,333
     
1,709
     
238
     
41
     
1
     
5,322
 
Total segment operating expenses
   
15,058
     
8,971
     
993
     
440
      (634 )    
24,828
 
Segment operating income
   
2,882
     
1,966
     
464
     
122
      (130 )    
5,304
 
Interest expense
   
-
     
-
     
-
     
-
     
887
     
887
 
Equity in net income (loss) of affiliates 1
   
-
      (40 )    
-
     
159
     
43
     
162
 
Other income (expense) – net
   
-
     
-
     
-
     
-
      (17 )     (17 )
Segment income before income taxes
  $
2,882
    $
1,926
    $
464
    $
281
    $ (991 )   $
4,562
 
1 The Wireless column includes minority interest recorded as Other Income (Expense) – Net on the Consolidated Statements of Income

At September 30, 2007 or for the nine months ended             
     
               
 
         
Consolidation
   
 
 
   
Wireline
   
Wireless
   
Advertising &
Publishing
   
Other
   
and Elimination
   
Consolidated
Results
 
Revenues from external customers
  $
52,425
    $
31,254
    $
4,328
    $
1,483
    $ (911 )   $
88,579
 
Intersegment revenues
   
1,494
     
75
     
50
     
181
      (1,800 )    
-
 
Total segment operating revenues
   
53,919
     
31,329
     
4,378
     
1,664
      (2,711 )    
88,579
 
Operations and support expenses
   
34,958
     
20,826
     
2,281
     
1,340
      (2,092 )    
57,313
 
Depreciation and amortization expenses
   
10,073
     
5,410
     
743
     
128
     
-
     
16,354
 
Total segment operating expenses
   
45,031
     
26,236
     
3,024
     
1,468
      (2,092 )    
73,667
 
Segment operating income
   
8,888
     
5,093
     
1,354
     
196
      (619 )    
14,912
 
Interest expense
   
-
     
-
     
-
     
-
     
2,639
     
2,639
 
Equity in net income (loss) of affiliates 1
   
-
      (131 )    
-
     
533
     
143
     
545
 
Other income (expense) – net
   
-
     
-
     
-
     
-
     
614
     
614
 
Segment income before income taxes
  $
8,888
    $
4,962
    $
1,354
    $
729
    $ (2,501 )   $
13,432
 
                                                 
Segment Assets
  $
170,477
    $
96,158
    $
9,508
    $
172,455
    $ (180,630 )   $
267,968
 
1 The Wireless column includes minority interest recorded as Other Income (Expense) – Net on the Consolidated Statements of Income



      
AT&T INC.      
SEPTEMBER 30, 2007            
        
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued              
Dollars in millions except per share amounts    


For the three months ended September 30, 2006               
       
               
 
         
Consolidation
   
 
     
   
Wireline
   
Wireless
   
Advertising &
Publishing
   
Other
   
and Elimination
   
Wireless
Elimination
   
Consolidated
Results
 
Revenues from external customers
  $
14,305
    $
9,561
    $
907
    $
418
    $
-
    $ (9,553 )   $
15,638
 
Intersegment revenues
   
1
     
-
     
6
     
51
      (58 )    
-
     
-
 
Total segment operating revenues
   
14,306
     
9,561
     
913
     
469
      (58 )     (9,553 )    
15,638
 
Operations and support expenses
   
9,563
     
6,561
     
431
     
349
      (59 )     (6,561 )    
10,284
 
Depreciation and amortization expenses
   
2,387
     
1,582
     
1
     
42
     
2
      (1,577 )    
2,437
 
Total segment operating expenses
   
11,950
     
8,143
     
432
     
391
      (57 )     (8,138 )    
12,721
 
Segment operating income
   
2,356
     
1,418
     
481
     
78
      (1 )     (1,415 )    
2,917
 
Interest expense
   
-
     
-
     
-
     
-
     
442
     
-
     
442
 
Equity in net income (loss) of affiliates 1
   
-
      (36 )     (2 )    
644
     
1
     
42
     
649
 
Other income (expense) – net
   
-
     
-
     
-
     
-
     
109
     
-
     
109
 
Segment income before income taxes
  $
2,356
    $
1,382
    $
479
    $
722
    $ (333 )   $ (1,373 )   $
3,233
 
1 The Wireless column includes minority interest recorded as Other Income (Expense) – Net on the Consolidated Statements of Income

For the nine months ended September 30, 2006                
     
               
 
         
Consolidation
   
 
   
 
 
   
Wireline
   
Wireless
   
Advertising &
Publishing
   
Other
   
and Elimination
   
Wireless
Elimination
   
Consolidated
Results
 
Revenues from external customers
  $
43,161
    $
27,774
    $
2,716
    $
1,263
    $
-
    $ (27,750 )   $
47,164
 
Intersegment revenues
   
2
     
-
     
30
     
127
      (159 )    
-
     
-
 
Total segment operating revenues
   
43,163
     
27,774
     
2,746
     
1,390
      (159 )     (27,750 )    
47,164
 
Operations and support expenses
   
29,888
     
19,657
     
1,298
     
1,010
      (159 )     (19,657 )    
32,037
 
Depreciation and amortization expenses
   
7,266
     
4,874
     
2
     
127
     
-
      (4,854 )    
7,415
 
Total segment operating expenses
   
37,154
     
24,531
     
1,300
     
1,137
      (159 )     (24,511 )    
39,452
 
Segment operating income
   
6,009
     
3,243
     
1,446
     
253
     
-
      (3,239 )    
7,712
 
Interest expense
   
-
     
-
     
-
     
-
     
1,378
     
-
     
1,378
 
Equity in net income (loss) of affiliates 1
   
-
      (99 )     (13 )    
1,421
     
2
     
127
     
1,438
 
Other income (expense) – net
   
-
     
-
     
-
     
-
     
315
     
-
     
315
 
Segment income before income taxes
  $
6,009
    $
3,144
    $
1,433
    $
1,674
    $ (1,061 )   $ (3,112 )   $
8,087
 
1 The Wireless column includes minority interest recorded as Other Income (Expense) – Net on the Consolidated Statements of Income
 
 
16

      
AT&T INC.      
SEPTEMBER 30, 2007            
        
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued              
Dollars in millions except per share amounts    

NOTE 6. PENSION AND POSTRETIREMENT BENEFITS

Substantially all of our employees are covered by one of various noncontributory pension and death benefit plans. We also provide certain medical, dental and life insurance benefits to substantially all retired employees under various plans and accrue actuarially determined postretirement benefit costs as active employees earn these benefits. Our objective in funding these plans, in combination with the standards of the Employee Retirement Income Security Act of 1974, as amended (ERISA), is to accumulate assets sufficient to meet the plans’ obligations to provide benefits to employees upon their retirement. No significant cash contributions are required under ERISA regulations during 2007.

The following details pension and postretirement benefit costs included in operating expenses (in cost of sales and selling, general and administrative expenses) in the accompanying Consolidated Statements of Income. We account for these costs in accordance with Statement of Financial Accounting Standards No. 87, “Employers’ Accounting for Pensions” and Statement of Financial Accounting Standards No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” In accordance with GAAP, combined pension and postretirement cost for 2007 includes costs for BellSouth and AT&T Mobility employees, whereas 2006 does not. In the following table, gains are denoted with parentheses and losses are not.

   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2007
   
2006
   
2007
   
2006
 
Pension cost:
                       
Service cost – benefits earned during the period
  $
314
    $
262
    $
943
    $
787
 
Interest cost on projected benefit obligation
   
803
     
627
     
2,411
     
1,881
 
Expected return on assets
    (1,367 )     (1,008 )     (4,101 )     (2,992 )
Amortization of prior service cost
   
36
     
37
     
107
     
112
 
  Recognized actuarial loss
   
61
     
91
     
181
     
271
 
Net pension cost (benefit)
  $ (153 )   $
9
    $ (459 )   $
59
 
                                 
Postretirement benefit cost: