Edgar Filing: AT&T INC.

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.

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.

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.

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	.

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.

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.

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.

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.

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.

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

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

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.

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-verse^sm 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.

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

(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

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

Equity in net income (loss) of affiliates ¹

(40

)

159

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

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

Equity in net income (loss) of affiliates ¹

(131

)

533

143

545

Other income (expense) – net

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

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