10-Q 1 att3q0910q.htm AT&T INC. THIRD QUARTER FORM 10-Q att3q0910q.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-Q
 

 
(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, 2009
 
       
   
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
 
208 S. Akard St., Dallas, Texas 75202
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes [X]   No [   ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer
[X]
 
Accelerated filer
[   ]
Non-accelerated filer
[   ]
(Do not check if a smaller reporting company)
Smaller reporting company
[   ]

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 31, 2009, there were 5,901 million common shares outstanding.

 
 

 

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,
   
2009
   
2008
   
2009
   
2008
 
Operating Revenues
                       
Wireless service
  $ 12,372     $ 11,227     $ 35,978     $ 32,726  
Voice
    7,940       9,313       24,702       28,525  
Data
    6,424       6,144       18,981       18,170  
Directory
    1,162       1,333       3,622       4,114  
Other
    2,957       3,325       8,877       9,417  
Total operating revenues
    30,855       31,342       92,160       92,952  
Operating Expenses
                               
Cost of sales (exclusive of depreciation and amortization shown separately below)
    12,885       13,022       37,605       36,914  
Selling, general and administrative
    7,672       7,724       23,225       23,034  
Depreciation and amortization
    4,910       4,978       14,699       14,839  
Total operating expenses
    25,467       25,724       75,529       74,787  
Operating Income
    5,388       5,618       16,631       18,165  
Other Income (Expense)
                               
Interest expense
    (853 )     (858 )     (2,581 )     (2,577 )
Equity in net income of affiliates
    181       257       549       712  
Other income (expense) – net
    27       (23 )     43       97  
Total other income (expense)
    (645 )     (624 )     (1,989 )     (1,768 )
Income Before Income Taxes
    4,743       4,994       14,642       16,397  
Income taxes
    1,468       1,705       4,890       5,746  
Net Income
    3,275       3,289       9,752       10,651  
Less: Net Income Attributable to Noncontrolling Interest
    (83 )     (59 )     (236 )     (188 )
Net Income Attributable to AT&T
  $ 3,192     $ 3,230     $ 9,516     $ 10,463  
                                 
Basic Earnings Per Share Attributable to AT&T
  $ 0.54     $ 0.55     $ 1.61     $ 1.76  
Diluted Earnings Per Share Attributable to AT&T
  $ 0.54     $ 0.55     $ 1.61     $ 1.75  
Weighted Average Number of Common
Shares Outstanding Basic (in millions)
    5,901       5,893       5,899       5,938  
Dividends Declared Per Common Share
  $ 0.410     $ 0.400     $ 1.230     $ 1.200  
See Notes to Consolidated Financial Statements.

 

 

AT&T INC.
 
CONSOLIDATED BALANCE SHEETS
 
Dollars in millions except per share amounts
           
   
September 30,
   
December 31,
 
   
2009
   
2008
 
Assets
 
(Unaudited)
       
Current Assets
           
Cash and cash equivalents
  $ 6,167     $ 1,792  
Accounts receivable – net of allowances for
               
uncollectibles of $1,345 and $1,270
    14,796       16,047  
Prepaid expenses
    1,791       1,538  
Deferred income taxes
    991       1,014  
Other current assets
    2,176       2,165  
Total current assets
    25,921       22,556  
Property, plant and equipment
    225,669       218,579  
Less: accumulated depreciation and amortization
    (127,348 )     (119,491 )
Property, Plant and Equipment – Net
    98,321       99,088  
Goodwill
    71,727       71,829  
Licenses
    47,946       47,306  
Customer Lists and Relationships – Net
    7,814       10,582  
Other Intangible Assets – Net
    5,656       5,824  
Investments in Equity Affiliates
    2,813       2,332  
Other Assets
    6,370       5,728  
Total Assets
  $ 266,568     $ 265,245  
                 
Liabilities and Stockholders’ Equity
               
Current Liabilities
               
Debt maturing within one year
  $ 6,755     $ 14,119  
Accounts payable and accrued liabilities
    18,093       20,032  
Advanced billing and customer deposits
    4,036       3,849  
Accrued taxes
    1,965       1,874  
Dividends payable
    2,419       2,416  
Total current liabilities
    33,268       42,290  
Long-Term Debt
    65,909       60,872  
Deferred Credits and Other Noncurrent Liabilities
               
Deferred income taxes
    22,279       19,196  
Postemployment benefit obligation
    31,750       31,930  
Other noncurrent liabilities
    13,361       14,207  
Total deferred credits and other noncurrent liabilities
    67,390       65,333  
                 
Stockholders’ Equity
               
Common shares issued ($1 par value)
    6,495       6,495  
Capital in excess of par value
    91,678       91,728  
Retained earnings
    38,841       36,591  
Treasury shares (at cost)
    (21,280 )     (21,410 )
Accumulated other comprehensive loss
    (16,161 )     (17,057 )
Noncontrolling interest
    428       403  
Total stockholders’ equity
    100,001       96,750  
Total Liabilities and Stockholders’ Equity
  $ 266,568     $ 265,245  
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,
   
2009
   
2008
 
Operating Activities
           
Net income
  $ 9,752     $ 10,651  
Adjustments to reconcile net income to
               
net cash provided by operating activities:
               
Depreciation and amortization
    14,699       14,839  
Provision for uncollectible accounts
    1,384       1,297  
Deferred income tax expense
    2,574       4,063  
Net (gain) loss from impairment on sale of investments
    89       (2 )
Changes in operating assets and liabilities:
               
Accounts receivable
    (133 )     (1,597 )
Other current assets
    (288 )     616  
Accounts payable and accrued liabilities
    (361 )     (5,958 )
Stock-based compensation tax benefit
    -       (15 )
Other - net
    (2,235 )     (1,121 )
Total adjustments
    15,729       12,122  
Net Cash Provided by Operating Activities
    25,481       22,773  
                 
Investing Activities
               
Construction and capital expenditures
               
Capital expenditures
    (11,067 )     (14,388 )
Interest during construction
    (553 )     (455 )
Acquisitions, net of cash acquired
    (184 )     (10,086 )
Dispositions
    205       1,444  
Investments in securities, net of sales
    (14 )     (103 )
Sale of other investments
    -       436  
Other
    44       33  
Net Cash Used in Investing Activities
    (11,569 )     (23,119 )
                 
Financing Activities
               
Net change in short-term borrowings with
               
original maturities of three months or less
    (3,918 )     5,188  
Issuance of long-term debt
    8,161       10,924  
Repayment of long-term debt
    (6,170 )     (3,143 )
Purchase of treasury shares
    -       (6,077 )
Issuance of treasury shares
    8       317  
Dividends paid
    (7,252 )     (7,150 )
Stock-based compensation tax benefit
    -       15  
Other
    (366 )     (104 )
Net Cash Used in Financing Activities
    (9,537 )     (30 )
Net increase (decrease) in cash and cash equivalents
    4,375       (376 )
Cash and cash equivalents beginning of year
    1,792       1,970  
Cash and Cash Equivalents End of Period
  $ 6,167     $ 1,594  
                 
Cash paid during the nine months ended September 30 for:
               
Interest
  $ 3,307     $ 3,068  
Income taxes, net of refunds
  $ 2,535     $ 5,217  
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, 2009
 
   
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
          $ 91,728  
Issuance of shares
            26  
Share-based payments
            (76 )
Balance at end of period
          $ 91,678  
                 
Retained Earnings
               
Balance at beginning of year
          $ 36,591  
Net income attributable to AT&T ($1.61 per diluted share)
            9,516  
Dividends to stockholders ($1.23 per share)
            (7,255 )
Other
            (11 )
Balance at end of period
          $ 38,841  
                 
Treasury Shares
               
Balance at beginning of year
    (602 )   $ (21,410 )
Issuance of shares
    7       130  
Balance at end of period
    (595 )   $ (21,280 )
                 
Accumulated Other Comprehensive Income (Loss), net of tax
               
Balance at beginning of year
          $ (17,057 )
Other comprehensive income (see Note 2)
            896  
Balance at end of period
          $ (16,161 )
                 
Noncontrolling Interest
               
Balance at beginning of year
          $ 403  
Net income
            236  
Distributions
            (209 )
Translation adjustments
            (2 )
Balance at end of period
          $ 428  
                 
Total stockholders’ equity as of December 31, 2008
          $ 96,750  
Changes attributable to AT&T stockholders
            3,226  
Changes attributable to noncontrolling interest
            25  
Total stockholders’ equity as of September 30, 2009
          $ 100,001  
See Notes to Consolidated Financial Statements.
 



 

 
AT&T INC.
SEPTEMBER 30, 2009

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 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, 2008.

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 advertising solutions.

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. 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.

For interim periods, we calculate income taxes by determining an expected annual effective tax rate and applying that rate to pre-tax income for the period. The resulting tax expense is then adjusted for the impact of significant events or issues that arise during the period, such as enactment of tax legislation or resolution of tax controversies. During the third quarter of 2009, we recorded a benefit related to the favorable resolution of federal and state audit issues, which resulted in a decrease to our effective tax rate for the period.

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.
 
Valuation and Other Adjustments  In accordance with GAAP, we established 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, 2009, we had severance accruals of $516. At December 31, 2008, we had severance accruals of $752.

Included in the current liabilities reported on our consolidated balance sheets are accruals established prior to 2009. These liabilities include accruals for severance, lease terminations and equipment removal costs associated with our acquisitions of AT&T Corp., BellSouth Corporation and Dobson Communications Corporation. Following is a summary of the accruals recorded at December 31, 2008, cash payments made during 2009, and the adjustments thereto.

   
12/31/08
   
Cash
   
Adjustments
   
9/30/09
 
   
Balance
   
Payments
   
and Accruals
   
Balance
 
Severance accruals paid from:
                       
Company funds
  $ 140     $ (105 )   $ (23 )   $ 12  
Pension and postemployment
benefit plans
    103       (4 )     -       99  
Lease terminations
    387       (54 )     (16 )     317  
Equipment removal and other related costs
    88       (38 )     (6 )     44  
Total
  $ 718     $ (201 )   $ (45 )   $ 472  
 

 

 
AT&T INC.
SEPTEMBER 30, 2009

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts

Recent Accounting Standards

Accounting Standards Codification  In June 2009, the FASB issued standards that established the FASB Accounting Standards Codification (ASC or Codification) as the source of authoritative GAAP by the FASB for nongovernmental entities. The ASC supersedes all non-SEC accounting and reporting standards that existed at the ASC’s effective date. The FASB uses Accounting Standards Updates (ASU) to amend the ASC. These standards are effective for interim and annual periods ending after September 15, 2009 (i.e., the quarterly period ended September 30, 2009, for us).

Subsequent Events  In May 2009, the FASB issued a standard that established general standards of accounting for and disclosing events that occur after the balance sheet date but before financial statements are issued or are available for issuance. They were effective for interim and annual periods ending after June 15, 2009 (i.e., the quarterly period ended June 30, 2009, for us). In preparing the accompanying unaudited consolidated financial statements, we have reviewed all known events that have occurred after September 30, 2009, and through the filing on November 5, 2009, for inclusion in the financial statements and footnotes.

Noncontrolling Interests Reporting  In December 2007, the FASB issued a standard that requires noncontrolling interests held by parties other than the parent in subsidiaries to be clearly identified, labeled, and presented in the consolidated statements of financial position within equity, but separate from the parent’s equity. For us, the new standard became effective January 1, 2009, with restatement of prior financial statements and had no material impact on our financial position and results of operations.

Fair Value Measurement and Disclosures  In April 2009, the FASB issued staff positions that require enhanced disclosures, including interim disclosures, on financial instruments, determination of fair value in turbulent markets, and recognition and presentation of other-than-temporary impairments. These staff positions were effective for interim and annual reporting periods beginning in our second quarter of 2009, and they have increased quarterly disclosures but have not had an impact on our financial position and results of operations (see Note 6).

In August 2009, the FASB issued ASU 2009-5, “Measuring Liabilities at Fair Value” (ASU 2009-5), which amends existing GAAP for fair value measurement guidance by clarifying the fair value measurement requirements for liabilities that lack a quoted price in an active market. Per the Codification, a valuation technique based on a quoted market price for the identical or similar liability when traded as an asset or another valuation technique (e.g., an income or market approach) that is consistent with the underlying principles of GAAP for fair value measurements would be appropriate. ASU 2009-5 was effective August 2009, the issuance date, and had no material impact on our financial position or results of operations.

In September 2009, the FASB issued ASU 2009-12, “Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)” (ASU 2009-12), which provides guidance for an investor on using the net asset value per share provided by an investee to estimate the fair value of an alternative investment when the fair value for the primary investment is not readily determinable. It affects certain investments that are required or permitted by GAAP to be measured or disclosed at fair value on a recurring or nonrecurring basis. It requires disclosures by major category of investment about certain attributes (e.g., applicable redemption restrictions, unfunded commitments to the issuer of the investments, and the investment strategies of that issuer). ASU 2009-12 will be effective for interim and annual periods ending on or after December 15, 2009 (i.e., the year ending December 31, 2009, for us). Fair value standards apply not only to the investments we hold but also to investments held by our benefit plans. We are currently evaluating the impact on our financial position and results of operations.

Variable Interest Entities  In June 2009, the FASB issued a standard that requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity. This standard is effective for both interim and annual periods as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009 (i.e., January 1, 2010, for us), and we are currently evaluating its impact on our financial position and results of operations.

 

 
AT&T INC.
SEPTEMBER 30, 2009

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts

Revenue Arrangements with Multiple Deliverables  In October 2009, the FASB issued ASU 2009-13, “Multiple-Deliverable Revenue Arrangements” (ASU 2009-13), which addresses how revenues should be allocated among all products and services included in our sales arrangements. It establishes a selling price hierarchy for determining the selling price of each product or service, with vendor-specific objective evidence (VSOE) at the highest level, third-party evidence of VSOE at the intermediate level, and a best estimate at the lowest level. It replaces “fair value” with “selling price” in revenue allocation guidance. It also significantly expands the disclosure requirements for such arrangements. ASU 2009-13 will be effective prospectively for sales entered into or materially modified in fiscal years beginning on or after June 15, 2010 (i.e., the year beginning January 1, 2011, for us). The FASB permits early adoption of ASU 2009-13, applied retrospectively, to the beginning of the year of adoption. We are currently evaluating the impact on our financial position and results of operations.

Software  In October 2009, the FASB issued ASU 2009-14, “Certain Revenue Arrangements That Include Software Elements” (ASU 2009-14), which clarifies the guidance for allocating and measuring revenue, including how to identify software that is out of the scope. ASU 2009-14 amends accounting and reporting guidance for revenue arrangements involving both tangible products and software that is “more than incidental to the tangible product as a whole” and the hardware components will also be outside of the scope of software revenue guidance and may result in more revenue recognized at the time of the hardware sale. Additional disclosures will discuss allocation of revenue to products and services and the significant judgments applied in the revenue allocation method, including impacts on the timing and amount of revenue recognition. ASU 2009-14 will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 (i.e., the year beginning January 1, 2011, for us). ASU 2009-14 has the same effective date, including early adoption provisions, as ASU 2009-13. Companies must adopt ASU 2009-14 and ASU 2009-13 at the same time. We are currently evaluating the impact on our financial position and results of operations.


 

 
AT&T INC.
SEPTEMBER 30, 2009

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts

NOTE 2. COMPREHENSIVE INCOME

The components of our comprehensive income for the three and nine months ended September 30, 2009 and 2008 include net income, adjustments to stockholders’ equity for the foreign currency translation adjustment, net unrealized gain (loss) on available-for-sale securities, 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 locks.

Following is our comprehensive income with the respective tax impacts for the three months and nine months periods ending September 30, 2009 and 2008:

   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Net income
  $ 3,275     $ 3,289     $ 9,752     $ 10,651  
Other comprehensive income, net of tax:
                               
Foreign currency translation adjustment (includes $6, $3, $(2) and $8 attributable to noncontrolling interest), net of taxes of $1, $(75), $45 and $(15)
    2       (139 )     86       (29 )
Net unrealized gains (losses) on securities:
                               
Unrealized gains (losses), net of taxes of $115, $(118), $130 and $(153)
    229       (220 )     258       (284 )
Less reclassification adjustment realized in net income, net of taxes of $(17), $(6), $24 and $(15)
    (34 )     (12 )     43       (28 )
Net unrealized gains (losses) on cash flow hedges:
                               
Unrealized gains (losses) on cross currency swaps, net of taxes of $(26), $24, $169 and $(28)
    (52 )     44       316       (52 )
Unrealized gain (loss) on interest rate locks, net of taxes of $(30), $0, $(1) and $(2)
    (60 )     -       (10 )     (3 )
Reclassification adjustment for losses on cash flow hedges included in net income, net of taxes of $2, $2, $6 and $6
    4       4       11       13  
Defined benefit postretirement plans:
                               
Amortization of net actuarial (gain) loss and prior service benefit included in net income,
    net of taxes of $32, $(17), $99 and $(50)
    64       (31 )     190       (90 )
Other
    -       (1 )     -       (1 )
Other comprehensive income (loss)
    153       (355 )     894       (474 )
Less: Total comprehensive income attributable to the noncontrolling interest
    (89 )     (62 )     (234 )     (196 )
Total Comprehensive IncomeAttributable to AT&T
  $ 3,339     $ 2,872     $ 10,412     $ 9,981  

 

 

 
AT&T INC.
SEPTEMBER 30, 2009

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts

NOTE 3. 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, 2009 and 2008 are shown in the table below:

   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Numerators
                       
Numerator for basic earnings per share:
                       
Net income attributable to AT&T
  $ 3,192     $ 3,230     $ 9,516     $ 10,463  
Dilutive potential common shares:
                               
Other stock-based compensation
    2       2       7       7  
Numerator for diluted earnings per share
  $ 3,194     $ 3,232     $ 9,523     $ 10,470  
Denominators (000,000)
                               
Denominator for basic earnings per share:
                               
Weighted-average number of common
                               
shares outstanding
    5,901       5,893       5,899       5,938  
Dilutive potential common shares:
                               
Stock options
    3       6       3       12  
Other stock-based compensation
    18       22       20       21  
Denominator for diluted earnings per share
    5,922       5,921       5,922       5,971  
Basic earnings per share
  $ 0.54     $ 0.55     $ 1.61     $ 1.76  
Diluted earnings per share
  $ 0.54     $ 0.55     $ 1.61     $ 1.75  

At September 30, 2009, we had issued and outstanding options to purchase approximately 180 million shares of AT&T common stock. The exercise prices of options to purchase a weighted average of 158 million shares in the third quarter and 165 million for the first nine months were above 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 period. At September 30, 2009, the exercise price of 19 million share options was below market price.

At September 30, 2008, we had issued and outstanding options to purchase approximately 206 million shares of AT&T common stock. The exercise prices of options to purchase a weighted average of 173 million shares in the third quarter and 131 million for the first nine months were above 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 period. At September 30, 2008, the exercise price of 34 million share options was below market price.


10 
 

 
AT&T INC.
SEPTEMBER 30, 2009

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts

NOTE 4. SEGMENT INFORMATION

Our segments are strategic business units that offer different products and services over various technology platforms and are managed accordingly. We analyze our various operating segments based on segment income before income taxes, reviewing operating revenues, operating expenses (depreciation and non-depreciation) and equity income for each segment. We make our capital allocations decisions primarily based on the network (wireless or wireline) providing services. Interest expense 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. We have four reportable segments: (1) wireless, (2) wireline, (3) advertising solutions and (4) other.

The wireless segment uses our nationwide network to provide consumer and business customers with wireless voice and advanced data communications services.

The wireline segment uses our regional, national and global network to provide consumer and business customers with landline voice and data communications services, AT&T U-verseSM TV, high-speed broadband and voice services (U-verse) and managed networking to business customers. Additionally, we offer satellite television services through our agency arrangements.

The advertising solutions segment publishes Yellow and White Pages directories and sells advertising in various media, including directory and Internet-based advertising, and local search.

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. Also included in the other segment are impacts of management decisions affecting the company for which management does not evaluate the individual operating segments.

In the following tables, we show how our segment results are reconciled to our consolidated results. The Wireless, Wireline, Advertising Solutions and Other columns represent the segment results of each operating segment. The Consolidation and Elimination column adds in those line items that we manage on a consolidated basis only: interest expense and other income (expense) – net. This column also eliminates any intersegment transactions included in each segment’s results.

Segment assets at September 30, 2009 were materially unchanged from the year ended December 31, 2008 with the exception of other segment assets. Our other segment assets totaled $14,078, which increased $5,376, or 61.8%, primarily due to an increase in cash.


11 
 

 
AT&T INC.
SEPTEMBER 30, 2009

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts

For the three months ended September 30, 2009
                               
               
Advertising
       
Consolidation
 
Consolidated
   
Wireless
 
Wireline
 
Solutions
 
Other
 
and Elimination
 
Results
Revenues from external customers
  $ 13,627     $ 15,706     $ 1,161     $ 360     $ 1     $ 30,855  
Intersegment revenues
    27       598       19       67       (711 )     -  
Total segment operating revenues
    13,654       16,304       1,180       427       (710 )     30,855  
Operations and support expenses
    8,877       11,097       721       571       (709 )     20,557  
Depreciation and amortization expenses
    1,418       3,289       158       45       -       4,910  
Total segment operating expenses
    10,295       14,386       879       616       (709 )     25,467  
Segment operating income (loss)
    3,359       1,918       301       (189 )     (1 )     5,388  
Interest expense
    -       -       -       -       853       853  
Equity in net income of affiliates
    -       9       -       172       -       181  
Other income (expense) – net
    -       -       -       -       27       27  
Segment income (loss) before income taxes
  $ 3,359     $ 1,927     $ 301     $ (17 )   $ (827 )   $ 4,743  

For the nine months ended September 30, 2009
                               
               
Advertising
       
Consolidation
 
Consolidated
   
Wireless
 
Wireline
 
Solutions
 
Other
 
and Elimination
 
Results
Revenues from external customers
  $ 39,687     $ 47,765     $ 3,621     $ 1,086     $ 1     $ 92,160  
Intersegment revenues
    72       1,743       59       202       (2,076 )     -  
Total segment operating revenues
    39,759       49,508       3,680       1,288       (2,075 )     92,160  
Operations and support expenses
    25,620       33,659       2,221       1,404       (2,074 )     60,830  
Depreciation and amortization expenses
    4,288       9,787       500       124       -       14,699  
Total segment operating expenses
    29,908       43,446       2,721       1,528       (2,074 )     75,529  
Segment operating income (loss)
    9,851       6,062       959       (240 )     (1 )     16,631  
Interest expense
    -       -       -       -       2,581       2,581  
Equity in net income of affiliates
    -       17       -       531       1       549  
Other income (expense) – net
    -       -       -       -       43       43  
Segment income (loss) before income taxes
  $ 9,851     $ 6,079     $ 959     $ 291     $ (2,538 )   $ 14,642  


12 
 

 
AT&T INC.
SEPTEMBER 30, 2009

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts


For the three months ended September 30, 2008
                               
               
Advertising
       
Consolidation
 
Consolidated
   
Wireless
 
Wireline
 
Solutions
 
Other
 
and Elimination
 
Results
Revenues from external customers
  $ 12,571     $ 17,003     $ 1,333     $ 435     $ -     $ 31,342  
Intersegment revenues
    47       547       17       66       (677 )     -  
Total segment operating revenues
    12,618       17,550       1,350       501       (677 )     31,342  
Operations and support expenses
    8,838       11,456       735       396       (679 )     20,746  
Depreciation and amortization expenses
    1,401       3,352       194       29       2       4,978  
Total segment operating expenses
    10,239       14,808       929       425       (677 )     25,724  
Segment operating income (loss)
    2,379       2,742       421       76       -       5,618  
Interest expense
    -       -       -       -       858       858  
Equity in net income of affiliates
    -       9       -       248       -       257  
Other income (expense) – net
    -       -       -       -       (23 )     (23 )
Segment income before income taxes
  $ 2,379     $ 2,751     $ 421     $ 324     $ (881 )   $ 4,994  

For the nine months ended September 30, 2008
                               
               
Advertising
       
Consolidation
 
Consolidated
   
Wireless
 
Wireline
 
Solutions
 
Other
 
and Elimination
 
Results
Revenues from external customers
  $ 36,333     $ 51,149     $ 4,114     $ 1,356     $ -     $ 92,952  
Intersegment revenues
    143       1,633       60       201       (2,037 )     -  
Total segment operating revenues
    36,476       52,782       4,174       1,557       (2,037 )     92,952  
Operations and support expenses
    23,750       34,141       2,293       1,802       (2,038 )     59,948  
Depreciation and amortization expenses
    4,327       9,814       609       88       1       14,839  
Total segment operating expenses
    28,077       43,955       2,902       1,890       (2,037 )     74,787  
Segment operating income (loss)
    8,399       8,827       1,272       (333 )     -       18,165  
Interest expense
    -       -       -       -       2,577       2,577  
Equity in net income of affiliates
    5       18       -       689       -       712  
Other income (expense) – net
    -       -       -       -       97       97  
Segment income before income taxes
  $ 8,404     $ 8,845     $ 1,272     $ 356     $ (2,480 )   $ 16,397  




13 
 

 
AT&T INC.
SEPTEMBER 30, 2009

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts

NOTE 5. 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 2009.

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 GAAP standards for employers’ accounting for pensions and other postretirement benefits. In the following table, gains are denoted with parentheses and losses are not. A portion of these expenses is effectively capitalized as part of the benefit load on internal construction and capital expenditures, historically averaging approximately 10%.

   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Pension (benefit) cost:
                       
Service cost – benefits earned during the period
  $ 265     $ 294     $ 808     $ 880  
Interest cost on projected benefit obligation
    835       830       2,525       2,489  
Expected return on assets
    (1,140 )     (1,400 )     (3,421 )     (4,201 )
Amortization of prior service cost
    6       34       62       100  
Recognized actuarial loss
    163       1       495       7  
Net pension (benefit) cost
  $ 129     $ (241 )   $ 469     $ (725 )
                                 
Postretirement (benefit) cost:
                               
Service cost – benefits earned during the period
  $ 81     $ 108     $ 257     $ 322  
Interest cost on accumulated postretirement
                               
benefit obligation
    595       637       1,856       1,912  
Expected return on assets
    (239 )     (331 )     (716 )     (995 )
Amortization of prior service benefit
    (134 )     (92 )     (313 )     (271 )
Recognized actuarial loss (gain)
    -       -       (1 )     -  
Postretirement cost
  $ 303     $ 322     $ 1,083     $ 968  
                                 
Combined net pension and postretirement cost
  $ 432     $ 81     $ 1,552     $ 243  

Our combined net pension and postretirement cost increased $351 in the third quarter and $1,309 for the first nine months of 2009. The increase was due to lower expected return on assets and an increase in amortization of actuarial losses, both primarily from investment losses in 2008. As allowed under GAAP, we use a method in which gains and losses are amortized only when the net gains or losses exceed 10 percent of the greater of the projected benefit obligation or the market-related value of assets (MRVA). Under GAAP, the expected long-term rate of return is calculated on the MRVA. GAAP requires that actual gains and losses on pension and postretirement plan assets be recognized in the MRVA equally over a period of up to five years. However, we use a methodology, allowed under GAAP, under which we hold the MRVA to within 20% of the actual fair value of plan assets, which can have the effect of accelerating the recognition of excess actual gains and losses in the MRVA in less than five years. The use of this policy increased pre-capitalization pension and postretirement cost by approximately $400 in the third quarter and $1,200 for the first nine months of 2009. This methodology did not have a significant effect on our 2008 combined net pension and postretirement benefits.

In August 2009, non-management retirees were informed of medical and drug coverage changes. In addition, we adopted changes to our pension plans consistent with the Pension Protection Act. Because of these modifications of retiree benefits, our amortization of prior service (benefit) cost also changed, reducing costs by $128 for the third quarter of 2009. We anticipate the fourth quarter will show cost reductions consistent with the reductions that began in August.

14
 

 
AT&T INC.
SEPTEMBER 30, 2009

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts

We have varying types of pension programs providing benefits for substantially all of certain non-U.S. operations. In addition to the pension and postretirement costs above, we recorded net pension (benefit) cost for non-U.S. plans of ($2) in the third quarter and ($4) for the first nine months of 2009 and $4 in the third quarter and $11 for the first nine months of 2008.

We also provide senior- and middle-management employees with nonqualified, unfunded supplemental retirement and savings plans. Net supplemental retirement pension cost, which is not included in the table above, was $42 in the third quarter, $35 of which was interest cost, and $125 for the first nine months of 2009, $105 of which was interest cost. Net supplemental retirement pension benefits cost was $45 in the third quarter, $35 of which was interest cost, and $136 for the first nine months of 2008, $106 of which was interest cost.

NOTE 6. FINANCIAL INSTRUMENTS

The carrying amounts and estimated fair values of our long-term debt, including current maturities, and other financial instruments, are summarized as follows at September 30, 2009:

 
2009
 
 
Carrying
 
Fair
 
 
Amount
 
Value
 
Notes and debentures
  $ 72,471     $ 76,588  
Commercial paper
    -       -  
Bank borrowings
    25       25  
Available-for-sale securities
    1,952       1,952  

GAAP standards require disclosures for financial assets and liabilities that are remeasured at fair value at least annually. GAAP standards establish a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. Substantially all of our available-for-sale securities are valued using quoted market prices (referred to as Level 1). Adjustments to fair value are recorded in accumulated other comprehensive income (OCI) until the investment is sold or experiences an other-than-temporary decline in fair value (see Note 2). All of our derivatives are Level 2.

The fair values of our notes and debentures were estimated based on quoted market prices, where available, or on the net present value method of expected future cash flows using current interest rates. The carrying value of debt with an original maturity of less than one year approximates market value.

Our available-for-sale securities are carried at fair value, and realized gains and losses on these securities were included in “Other income (expense) – net” in the consolidated statements of income. The fair value of our available-for-sale securities was principally determined based on quoted market prices, and the carrying amount of the remaining securities approximates fair value. These securities include $1,566 of equities, $303 in government fixed income bonds and $83 of other securities.

Our short-term investments, other short-term and long-term held-to-maturity investments and customer deposits are recorded at amortized cost, and the respective carrying amounts approximate fair values.

Derivatives  We use interest rate swaps, interest rate locks and foreign currency exchange contracts to manage our market risk to changes in interest rates and foreign exchange rates. We do not use financial instruments for trading or speculative purposes. Virtually all of our derivatives are designated as fair value hedges or cash flow hedges.

15 
 

 
AT&T INC.
SEPTEMBER 30, 2009

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts

Fair Value Hedging We designate our fixed-to-floating interest rates swaps as fair value hedges. The purpose of these swaps is to manage interest rate risk by managing our mix of fixed-rate and floating-rate debt. Unrealized gains or losses on interest rate swaps are recorded at fair market value as assets or liabilities, respectively. Changes in the fair value of the interest rate swaps offset changes in the fair value of the fixed-rate notes payable they hedge due to changes in the designated benchmark interest rate and are recognized in interest expense. These swaps involve the receipt of fixed rate amounts for floating interest rate payments over the life of the swaps without exchange of the underlying principal amount.

Cash Flow Hedging Unrealized gains or losses on derivatives designated as cash flow hedges are recorded at fair value as assets or liabilities respectively for the period they are outstanding. For derivative instruments designated as cash flow hedges, the effective portion is reported as a component of OCI until reclassified into interest expense in the same period the hedged transaction affects earnings. The gain or loss on the ineffective portion is recognized in income from continuing operations in each current period.

We designate our combined interest rate foreign currency swap agreements (cross-currency swaps) as cash flow hedges. We have entered into multiple cross-currency swaps to hedge our exposure to variability in expected future cash flows that are attributable to foreign currency risk generated from the issuance of our Euro- and British pound sterling-denominated debt. These agreements include initial and final exchanges of principal from fixed foreign denominations to fixed U.S.-denominated amounts, to be exchanged at a specified rate, which was determined by the market spot rate upon issuance. They also include an interest rate swap of a fixed foreign-denominated rate to a fixed U.S.-denominated interest rate. We evaluate the effectiveness of our cross-currency swaps each period. In the period ending September 30, 2009, no material ineffectiveness was measured.

Periodically, we enter into and designate interest rate locks to partially hedge the risk of changes in interest payments attributable to increases in the benchmark interest rate during the period leading up to the probable issuance of fixed-rate debt. We designate our interest rate locks as cash flow hedges. Gains and losses at the time we settle our interest rate locks are amortized into income over the life of the related debt, except where a material amount is deemed to be ineffective, which would be immediately reclassified to income. In the nine months ending September 30, 2009, no material ineffectiveness was measured. Over the next 12 months, we expect to reclassify $21 from OCI to interest expense due to the amortization of net losses on historical interest rate locks. Our unutilized interest rate locks carry mandatory early terminations, the latest occurring in April 2011.

We enter into foreign exchange contracts with third parties to manage our exposure to changes in currency exchange rates related to foreign currency-denominated transactions. Some of these instruments are designated as cash flow hedges while others are not, largely based on size and duration. Gains and losses at the time we settle or take delivery on our designated foreign exchange contracts are amortized into income over the next few months as the hedged funds are spent by our foreign subsidiaries, except where a material amount is deemed to be ineffective, which would be immediately reclassified to income. In the nine months ended September 30, 2009, no material ineffectiveness was measured.

The balance of the derivative loss in accumulated other comprehensive loss was $166 at September 30, 2009, and $483 at December 31, 2008.

Collateral and Credit-Risk Contingency We have entered into agreements with most of our derivative counterparties establishing collateral thresholds based on respective credit ratings and netting agreements. At September 30, 2009, we held $247 of counterparty collateral (a receipt liability). Under the agreements, if our credit rating had been downgraded one rating level, we would have been required to post collateral of $23 (a deposit asset). We do not offset the fair value of collateral, whether the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable), against the fair value of the derivative instruments.

16 
 

 
AT&T INC.
SEPTEMBER 30, 2009

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts

Following is the size of our outstanding derivative positions:

Volume of Derivative Activity
 
September 30,
 
 
2009
 
 
Notional
Value
 
       
Interest rate swaps
  $ 9,000  
Cross-currency swaps
    7,502  
Interest rate locks
    2,800  
Foreign exchange contracts
    139  

Following are our derivative instruments and their related hedged items affecting our financial position and performance:

Fair Value of Derivatives in the Consolidated Balance Sheet
Derivatives designated as hedging instruments and reflected as other assets, other liabilities and, for a portion of interest rate swaps, accounts receivable.

   
September 30,
 
Asset Derivatives
 
2009
 
       
Interest rate swaps
  $ 436  
Cross-currency swaps
    471  
Interest rate locks
    19  
Foreign exchange contracts
    -  
Total
  $ 926  

   
September 30,
 
Liability Derivatives
 
2009
 
       
Cross-currency swaps
  $ (449 )
Interest rate locks
    (92 )
Foreign exchange contracts
    -  
Total
  $ (541 )


17 
 

 
AT&T INC.
SEPTEMBER 30, 2009

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts

Effect of Derivatives on the Consolidated Income Statement
   
Three months ended
   
Nine months ended
 
Fair Value Hedge Relationships
 
September 30, 2009
   
September 30, 2009
 
             
Interest rate swaps (Interest expense):
           
Gain/(Loss) on swap
  $ 79     $ (141 )
Gain/(Loss) on long-term debt
    (79 )     141  
In addition, the net swap settlements that accrued and settled in the three and nine months ended September 30, 2009 were also reported as reductions of interest expense.
 
                 
Cash Flow Hedge Relationships
               
                 
Cross-currency swaps:
               
Gain/(Loss) recognized in OCI
  $ (78 )   $ 485  
Other income (expense) reclassified from OCI into income
    -       -  
                 
Interest rate locks:
               
Gain/(Loss) recognized in OCI
    (90 )     (11 )
Interest income (expense) reclassified from OCI into income
    (6 )     (17 )
                 
Non-designated Hedging Instruments
               
                 
Foreign exchange contracts (Other income)
  $ -     $ 1  


18
 

 
AT&T INC.
SEPTEMBER 30, 2009

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts

 
RESULTS OF OPERATIONS

For ease of reading, AT&T Inc. is referred to as “we,” “AT&T,” or the “Company” throughout this document and the names of the particular subsidiaries and affiliates providing the services generally have been omitted. AT&T is a holding company whose subsidiaries and affiliates operate in the communications services industry in both the United States and internationally providing telecommunications services and equipment as well as advertising services. You should read this discussion in conjunction with the consolidated financial statements, accompanying notes and management’s discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the year ended December 31, 2008. In the tables throughout this section, percentage increases and decreases that are not considered meaningful are denoted with a dash.

Consolidated Results  Our financial results in the third quarter and for the first nine months of 2009 and 2008 are summarized as follows:

   
Third Quarter
   
Nine-Month Period
 
   
2009
   
2008
   
Percent
Change
 
2009
   
2008
   
Percent
Change
 
Operating Revenues
  $ 30,855     $ 31,342       (1.6 )%   $ 92,160     $ 92,952       (0.9 )%
Operating expenses
                                               
Cost of sales
    12,885       13,022       (1.1 )     37,605       36,914       1.9  
Selling, general and administrative
    7,672       7,724       (0.7 )     23,225       23,034       0.8  
Depreciation and amortization
    4,910       4,978       (1.4 )     14,699       14,839       (0.9 )
Total Operating Expenses
    25,467       25,724       (1.0 )     75,529       74,787       1.0  
Operating income
    5,388       5,618       (4.1 )     16,631       18,165       (8.4 )
Income before income taxes
    4,743       4,994       (5.0 )     14,642       16,397       (10.7 )
Net Income Attributable to AT&T
  $ 3,192     $ 3,230       (1.2 )%   $ 9,516     $ 10,463       (9.1 )%

Overview
Operating income  Our operating income decreased $230, or 4.1%, in the third quarter and $1,534, or 8.4%, for the first nine months of 2009, primarily due to the decline in voice revenues along with an increase in pension and other postemployment benefits (OPEB) expense, partially offset by continued growth in wireless service revenue and wireline data revenue and decreases in wireline expenses. Operating income also decreased in part due to higher cost of equipment sales in our wireless segment mainly attributed to the continued success of the Apple iPhone. These factors were the primary causes of our operating income margin decreasing from 17.9% to 17.5% in the third quarter and from 19.5% to 18.0% for the first nine months of 2009.

Operating revenues  Our operating revenues decreased $487, or 1.6%, in the third quarter and $792, or 0.9%, for the first nine months primarily due to the continuing decline in voice revenues and a decline in directory revenue driven by lower print revenue. These declines were partially offset by continued growth in wireless service revenue due to an increase in average customers of 9.1%, driven in part by the continued success of the Apple iPhone, and an increase in wireline data revenue largely due to Internet Protocol (IP) data growth, including U-verse and broadband growth. Consistent with our quarterly and year to date results, we expect our 2009 revenues to be slightly lower than our 2008 revenues.

The declines in our voice and advertising revenues reflect continuing economic pressures on our customers as well as increasing competition. Total retail consumer voice connections decreased 11.8%. Business customers also disconnected switched access lines, reduced usage-based services and reduced print advertising. Customers disconnecting access lines switched to wireless, Voice over Internet Protocol (VoIP) and cable offerings for voice and data or terminated service permanently as businesses closed or consumers left residences. While we lose the voice revenues, we have the opportunity to increase wireless service or wireline data revenues should the customer choose us as their wireless or VoIP provider. We also continue to expand our VoIP service for customers who have access to our U-verse video service.

Cost of sales expenses decreased $137, or 1.1%, in the third quarter and increased $691, or 1.9%, for the first nine months. The decrease in the third quarter was primarily due to reductions in wireline expenses partially offset by increases in pension/OPEB expenses as well as higher upgrade equipment costs driven by higher Apple iPhone sales. The increase in the first nine months was primarily due to higher upgrade costs and higher equipment costs related to the continued success of the Apple iPhone and other smartphones along with an increase in pension/OPEB expenses. Pension/OPEB expense increased due to lower expected return on assets and an increase in amortization of actuarial losses, both primarily from investment losses in 2008. Partially offsetting these nine-month increases were decreases in wireline expenses primarily driven by employee-related costs (excluding pension/OPEB) due to workforce reductions.

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AT&T INC.
SEPTEMBER 30, 2009

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued
Dollars in millions except per share amounts