Edgar Filing: AT&T INC.

att3q08.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, 2008

		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 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, 2008, there were 5,893 million common shares outstanding

Financial Data

AT&T Inc.

Consolidated Statements of Income
Dollars in millions except per share amounts
Unaudited	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2007			2008			2007
Operating Revenues
Wireless service	$	11,227		$	9,834		$	32,726		$	28,417
Voice		9,313			10,164			28,525			30,997
Data		6,144			5,880			18,170			17,281
Directory		1,333			1,240			4,114			3,417
Other		3,325			3,014			9,417			8,467
Total Operating Revenues		31,342			30,132			92,952			88,579

Operating Expenses
Cost of services and sales (exclusive of
depreciation and amortization shown separately below)		13,070			11,736			36,972			34,816
Selling, general and administrative		7,676			7,770			22,976			22,497
Depreciation and amortization		4,978			5,322			14,839			16,354
Total Operating Expenses		25,724			24,828			74,787			73,667
Operating Income		5,618			5,304			18,165			14,912
Interest Expense		858			887			2,577			2,639
Equity in Net Income of Affiliates		257			162			712			545
Other Income (Expense) - Net		(81	)		(17	)		(91	)		614
Income Before Income Taxes		4,936			4,562			16,209			13,432
Income Taxes		1,706			1,499			5,746			4,617
Net Income	$	3,230		$	3,063		$	10,463		$	8,815


Basic Earnings Per Share	$	0.55		$	0.50		$	1.76		$	1.43
Diluted Earnings Per Share	$	0.55		$	0.50		$	1.75		$	1.42
Weighted Average Number of Common
Shares Outstanding - Basic (in millions)		5,893			6,088			5,938			6,152
Dividends Declared Per Common Share	$	0.400		$	0.355		$	1.200		$	1.065
See Notes to Consolidated Financial Statements.

Financial Data

AT&T Inc.
Consolidated Balance Sheets
Dollars in millions except per share amounts
	September 30, 2008			December 31, 2007
	(Unaudited)
Assets
Current Assets
Cash and cash equivalents	$	1,594		$	1,970
Accounts receivable - net of allowances for
uncollectibles of $1,328 and $1,364		16,395			16,185
Prepaid expenses		1,657			1,524
Deferred income taxes		1,560			2,044
Other current assets		2,239			2,963
Total current assets		23,445			24,686
Property, Plant and Equipment		215,420			210,518
Less: accumulated depreciation and amortization		117,649			114,648
Property, Plant and Equipmant - Net		97,771			95,890
Goodwill		71,537			70,713
Licenses		46,931			37,985
Customer Lists and Relationships - Net		11,495			14,505
Other Intangible Assets - Net		5,816			5,912
Investments in Equity Affiliates		2,839			2,270
Postemployment Benefit		18,164			17,291
Other Assets		6,530			6,392
Total Assets	$	284,528		$	275,644

Liabilities and Stockholders' Equity
Current Liabilities
Debt maturing within one year	$	17,419		$	6,860
Accounts payable and accrued liabilities		18,690			21,399
Advanced billing and customer deposits		3,896			3,571
Accrued taxes		2,976			5,027
Dividends payable		2,357			2,417
Total current liabilities		45,338			39,274
Long-Term Debt		59,355			57,255
Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes		27,776			24,939
Postemployment benefit obligation		25,493			24,011
Other noncurrent liabilities		14,048			14,798
Total deferred credits and other noncurrent liabilities		67,317			63,748

Stockholders' Equity
Common shares issued ($1 par value)		6,495			6,495
Capital in excess of par value		91,684			91,638
Retained earnings		36,613			33,297
Treasury shares (at cost)		(21,412	)		(15,683	)
Accumulated other comprehensive income(loss)		(862	)		(380	)
Total stockholders' equity		112,518			115,367
Total Liabilities and Stockholders' Equity	$	284,528		$	275,644

See Notes to Consolidated Financial Statements.

Financial Data

AT&T Inc.
Consolidated Statements of Cash Flows
Dollars in millions increase (decrease) in cash and cash equivalents
Unaudited	Nine Months Ended September 30,
		2008		2007
Operating Activities
Net income	$	10,463		$	8,815
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization		14,839			16,354
Undistributed earnings from investments in equity affiliates		(572	)		(434	)
Provision for uncollectible accounts		1,297			1,142
Deferred income tax expense		4,063			486
Net gain on sales of investments		(2	)		(29	)
Gain on license exchange		-			(409	)
Changes in operating assets and liabilities:
Accounts receivable		(1,597	)		(1,253	)
Other current assets		616			(661	)
Accounts payable and accrued liabilities		(5,958	)		(46	)
Stock-based compensation tax benefit		(15	)		(149	)
Other - net		(361	)		529
Total adjustments		12,310			15,530
Net Cash Provided by Operating Activities		22,773			24,345

Investing Activities
Construction and capital expenditures
Capital expenditures		(14,388	)		(12,124	)
Interest during construction		(455	)		(125	)
Acquisitions, net of cash acquired		(10,086	)		(233	)
Dispositions		1,444			993
Proceeds from sale of securities, net of investments		(103	)		584
Sale of other investments		436			-
Other		33			28
Net Cash Used in Investing Activities		(23,119	)		(10,877	)

Financing Activities
Net change in short-term borrowings with
original maturities of three months or less		5,188			(4,279	)
Issuance of long-term debt		10,924			7,898
Repayment of long-term debt		(3,143	)		(3,008	)
Purchase of treasury shares		(6,077	)		(8,912	)
Issuance of treasury shares		317			1,736
Dividends paid		(7,150	)		(6,584	)
Stock-based compensation tax benefit		15			149
Other		(104	)		(172	)
Net Cash Used in Financing Activities		(30	)		(13,172	)
Net increase (decrease) in cash and cash equivalents		(376	)		296
Cash and cash equivalents beginning of year		1,970			2,418
Cash and Cash Equivalents End of Period	$	1,594		$	2,714

Cash paid during the nine months ended September 30 for:	$	3,068		$	2,518
Interest
Income taxes, net of refunds	$	5,217		$	2,028
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, 2008
	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				$	91,638
Issuance of shares					87
Stock based compensation					(41	)
Balance at end of period				$	91,684

Retained Earnings
Balance at beginning of year				$	33,297
Net income ($1.75 per diluted share)					10,463
Dividends to stockholders ($1.20 per share)					(7,090	)
Other					(57	)
Balance at end of period				$	36,613

Treasury Shares
Balance at beginning of year		(451	)	$	(15,683	)
Purchase of shares		(164	)		(6,077	)
Issuance of shares		13			348
Balance at end of period		(602	)	$	(21,412	)

Accumulated Other Comprehensive Income (Loss), net of tax
Balance at beginning of year				$	(380	)
Other comprehensive income (loss) (see Note 2)					(482	)
Balance at end of period				$	(862	)
See Notes to Consolidated Financial Statements.

AT&T INC.

SEPTEMBER 30, 2008

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, 2007.

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. Earnings from certain foreign equity investments accounted for using the equity method are included for periods ended within up to one month of our year end.

Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (FAS 157) requires disclosures for financial assets and liabilities that are remeasured at fair value at least annually. FAS 157 establishes 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 other comprehensive income until the investment is sold (see Note 2). The fair market value of these securities was $2,196 at September 30, 2008.

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 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, 2008, we had severance accruals under FAS 112 of $220, of which $23 were established as merger-related severance accruals. At December 31, 2007, we had severance accruals of $127.

Included in the current liabilities reported on our consolidated balance sheet are accruals established under Emerging Issues Task Force (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 AT&T Corp., BellSouth Corporation (BellSouth) and Dobson Communications Corporation. Following is a summary of the accruals recorded under EITF 95-3 at December 31, 2007, cash payments made during 2008 and the adjustments thereto.

AT&T INC.

SEPTEMBER 30, 2008

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

	12/31/07		Cash					9/30/08
	Balance		Payments			Adjustments		Balance
Severance accruals paid from:
Company funds	$	540	$	(201	)	$	8	$	347
Pension and postemployment benefit plans		129		(24	)		-		105
Lease terminations		425		(78	)		96		443
Equipment removal and other related costs		161		(52	)		4		113
Total	$	1,255	$	(355	)	$	108	$	1,008

New Accounting Standards

Split Dollar Life Insurance In 2007, the EITF ratified the consensus on EITF 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements” (EITF 06-4) and EITF 06-10 “Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements” (EITF 06-10). EITF 06-4 and EITF 06-10 cover split-dollar life insurance arrangements (where the company owns and controls the policy) and provides that an employer should recognize a liability for future benefits in accordance with Statement of Financial Accounting Standards No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions” (FAS 106). These are effective for fiscal years beginning after December 15, 2007. We adopted EITF 06-4 and EITF 06-10 on January 1, 2008, recording additional postretirement liabilities of $101 and a decrease to retained earnings of $63.

FSP 157-3 On October 10, 2008, the FASB issued FASB Staff Position 157-3, “Determining the Fair Value of a Financial Asset When the Market of that Asset is not Active” (FSP 157-3). FSP 157-3 provides an example that clarifies and reiterates certain provisions of the existing fair value standard, including basing fair value on orderly transactions and usage of management and broker inputs. FSP 157-3 is effective immediately but is not expected to have a material impact on our financial position or results of operations.

AT&T INC.

SEPTEMBER 30, 2008

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, 2008 and 2007 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 forward contracts.

Following is our comprehensive income:

	Three months ended						Nine months ended
	September 30,							September 30,
	2008			2007				2008			2007
Net income	$	3,230		$	3,063			$	10,463		$	8,815
Other comprehensive income, net of tax:
Foreign currency translation adjustment		(142	)		(14	)			(37	)		4
Net unrealized gains (losses) on securities:
Unrealized gains (losses)		(220	)		(15	)			(284	)		134
Less reclassification adjustment realized in net income		(12	)		3				(28	)		(37	)
Net unrealized gains (losses) on cash flow hedges:
Unrealized gains (losses)		44			(15	)			(55	)		(51	)
Reclassification adjustment for losses on cash flow hedges included in net income		4			5				13			13
Defined benefit postretirement plans:
Amortization of net actuarial (gain) loss and prior service benefit included in net income		(31	)		52				(90	)		156
Other		(1	)		-				(1	)		(1	)
Other comprehensive income (loss)		(358	)		16				(482	)		218
Total Comprehensive Income	$	2,872		$	3,079			$	9,981		$	9,033

AT&T INC.

SEPTEMBER 30, 2008

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

NOTE 3. EARNINGS PER SHARE

Reconciliations of the numerators and denominators of basic and diluted earnings per share for net income for the three and nine months ended September 30, 2008 and 2007 are shown in the table below:

	Three months ended				Nine months ended
	September 30,				September 30,
	2008		2007		2008		2007
Numerators
Numerator for basic earnings per share:
Net income	$	3,230	$	3,063	$	10,463	$	8,815
Dilutive potential common shares:
Other stock-based compensation		2		2		7		6
Numerator for diluted earnings per share	$	3,232	$	3,065	$	10,470	$	8,821
Denominators (000,000)
Denominator for basic earnings per share:
Weighted-average number of common
shares outstanding		5,893		6,088		5,938		6,152
Dilutive potential common shares:
Stock options		6		26		12		25
Other stock-based compensation		22		15		21		19
Denominator for diluted earnings per share		5,921		6,129		5,971		6,196
Basic earnings per share	$	0.55	$	0.50	$	1.76	$	1.43
Diluted earnings per share	$	0.55	$	0.50	$	1.75	$	1.42

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 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 period. At September 30, 2008, the exercise price of 34 million share options was below market price.

At September 30, 2007, we had issued and outstanding options to purchase 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 period.

AT&T INC.

SEPTEMBER 30, 2008

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. 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 & publishing and (4) other.

The wireless segment provides wireless voice and advanced data communications services.

The wireline segment provides landline voice and data communications services, managed networking to business customers, AT&T U-verseSM TV, high-speed broadband and voice services (U-verse) and satellite television services through our agency arrangements.

The advertising & publishing segment includes our directory operations, which publish Yellow and White Pages directories and sell directory and Internet-based advertising. Results for this segment are shown under the amortization method, which means that revenues and direct expenses are recognized ratably over the life of the directory title, typically 12 months. However, consolidated results for 2007 directory operations acquired in our BellSouth acquisition are treated differently in accordance with Statement of Financial Accounting Standards No. 141, “Business Combinations” (FAS 141).

Under FAS 141, BellSouth deferred revenue and expenses from directories published during the twelve-month period ending with the December 29, 2006 acquisition date were not recognized in 2007 consolidated results. Accordingly, our consolidated revenue and expenses in 2007 related to directory operations were lower. Because management assesses the performance of the segment including the revenue and expenses associated with those directories, for segment reporting purposes, our 2007 advertising & publishing segment results include revenue of $196 in the third quarter and $911 for the first nine months of 2007 and expenses of $64 in the third quarter and $291 for the first nine months of 2007. These amounts are eliminated in the consolidation and elimination 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. Also included in the other segment are impacts of management decisions affecting the entire 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 reported in accordance with GAAP. The Wireless, Wireline, Advertising & Publishing 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 intercompany transactions included in each segment’s results as well as the advertising & publishing revenue and expenses in the third quarter and for the first nine months of 2007 as noted above.

Segment assets for the nine months ended September 30, 2008 are materially unchanged from the year ended December 31, 2007 with the exception of the wireless and other segment assets. Our wireless segment assets totaled $126,563, which increased $20,610, or 19.5%, primarily due to the acquisition of wireless spectrum. Our other segment assets totaled $219,043, which increased $35,968, or 19.7%, primarily due to an increase in value of our investments in our subsidiaries.

AT&T INC.

SEPTEMBER 30, 2008

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

For the three months ended September 30, 2008
						Advertising &				Consolidation and			Consolidated
	Wireless			Wireline		Publishing		Other		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			11,482		735		369		(678	)		20,746
Depreciation and amortization expenses		1,401			3,331		194		51		1			4,978
Total segment operating expenses		10,239			14,813		929		420		(677	)		25,724
Segment operating income (loss)		2,379			2,737		421		81		-			5,618
Interest expense		-			-		-		-		858			858
Equity in net income of affiliates		-			-		-		257		-			257
Minority interest		(57	)		-		-		-		57			-
Other income (expense) – net		-			-		-		-		(81	)		(81	)
Segment income before income taxes	$	2,322		$	2,737	$	421	$	338	$	(882	)	$	4,936

For the nine months ended September 30, 2008
						Advertising &					Consolidation and			Consolidated
	Wireless			Wireline		Publishing		Other			Elimination			Results
Revenues from externa l 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			34,213		2,293		1,729			(2,037	)		59,948
Depreciation and amortization expenses		4,327			9,770		609		133			-			14,839
Total segment operating expenses		28,077			43,983		2,902		1,862			(2,037	)		74,787
Segment operating income (loss)		8,399			8,799		1,272		(305	)		-			18,165
Interest expense		-			-		-		-			2,577			2,577
Equity in net income of affiliates		5			-		-		707			-			712
Minority interest		(186	)		-		-		-			186			-
Other income (expense) – net		-			-		-		-			(91	)		(91	)
Segment income before income taxes	$	8,218		$	8,799	$	1,272	$	402		$	(2,482	)	$	16,209

AT&T INC.

SEPTEMBER 30, 2008

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

For the three months ended September 30, 2007
						Advertising &				Consolidation and			Consolidated
	Wireless			Wireline		Publishing		Other		Elimination			Results
Revenues from external customers	$	10,911		$	17,472	$	1,436	$	509	$	(196	)	$	30,132
Intersegment revenues		26			469		21		53		(569	)		-
Total segment operating revenues		10,937			17,941		1,457		562		(765	)		30,132
Operations and support expenses		7,262			11,646		755		478		(635	)		19,506
Depreciation and amortization expenses		1,709			3,334		238		40		1			5,322
Total segment operating expenses		8,971			14,980		993		518		(634	)		24,828
Segment operating income (loss)		1,966			2,961		464		44		(131	)		5,304
Interest expense		-			-		-		-		887			887
Equity in net income of affiliates		3			-		-		159		-			162
Minority interest		(43	)		-		-		-		43			-
Other income (expense) – net		-			-		-		-		(17	)		(17	)
Segment income before income taxes	$	1,926		$	2,961	$	464	$	203	$	(992	)	$	4,562

For the nine months ended September 30, 2007
						Advertising &					Consolidation and			Consolidated
	Wireless			Wireline		Publishing		Other			Elimination			Results
Revenues from external customers	$	31,254		$	52,432	$	4,328	$	1,476		$	(911	)	$	88,579
Intersegment revenues		75			1,494		50		182			(1,801	)		-
Total segment operating revenues		31,329			53,926		4,378		1,658			(2,712	)		88,579
Operations and support expenses		20,826			34,750		2,281		1,548			(2,092	)		57,313
Depreciation and amortization expenses		5,410			10,076		743		125			-			16,354
Total segment operating expenses		26,236			44,826		3,024		1,673			(2,092	)		73,667
Segment operating income (loss)		5,093			9,100		1,354		(15	)		(620	)		14,912
Interest expense		-			-		-		-			2,639			2,639
Equity in net income of affiliates		12			-		-		533			-			545
Minority interest		(143	)		-		-		-			143			-
Other income (expense) – net		-			-		-		-			614			614
Segment income before income taxes	$	4,962		$	9,100	$	1,354	$	518		$	(2,502	)	$	13,432

AT&T INC.

SEPTEMBER 30, 2008

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 retirees under various plans and accrue actuarially determined postretirement benefit costs as 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 2008.

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 FAS 106. In the following table, gains are denoted with parentheses and losses are not.

	Three months ended						Nine months ended
	September 30,						September 30,
	2008			2007			2008			2007
Pension (benefit) cost:
Service cost – benefits earned during the period	$	294		$	314		$	880		$	943
Interest cost on projected benefit obligation		830			803			2,489			2,411
Expected return on assets		(1,400	)		(1,367	)		(4,201	)		(4,101	)
Amortization of prior service cost		34			36			100			107
Recognized actuarial loss		1			61			7			181
Net pension benefit	$	(241	)	$	(153	)	$	(725	)	$	(459	)

Postretirement benefit cost:
Service cost – benefits earned during the period	$	108		$	127		$	322		$	381
Interest cost on accumulated postretirement
benefit obligation		637			644			1,912			1,931
Expected return on assets		(331	)		(336	)		(995	)		(1,010	)
Amortization of prior service benefit		(92	)		(90	)		(271	)		(270	)
Recognized actuarial loss		-			72			-			220
Postretirement benefit cost	$	322		$	417		$	968		$	1,252

Combined net pension and postretirement cost	$	81		$	264		$	243		$	793

Our combined net pension and postretirement cost decreased $183 in the third quarter and $550 for the first nine months of 2008. This decline was primarily due to the decrease in amortization of the unrecognized actuarial losses recorded under Statement of Financial Standards No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” in Other Comprehensive Income. As allowed under GAAP, we amortize gains and losses 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.

We have varying types of pension programs providing benefits for certain non-U.S. operations. In addition to the pension and postretirement costs above, we recorded net pension cost for non-U.S. plans of $4 in the third quarter and $11 for the first nine months of 2008 and $3 in the third quarter and $11 for the first nine months of 2007.

We also provide senior- and middle-management employees with nonqualified, unfunded supplemental retirement and savings plans. Net supplemental retirement pension benefits cost, which is not included in the table above was $45 in the third quarter and $136 for the first nine months of 2008, of which $35 and $106 was interest cost, respectively. Net supplemental retirement pension benefits cost was $50 in the third quarter and $146 for the first nine months of 2007, of which $37 and $109 was interest cost, respectively.

AT&T INC.

SEPTEMBER 30, 2008

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation

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 directory advertising and publishing 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, 2007. 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 2008 and 2007 are summarized as follows:

	Third Quarter							Nine-Month Period
					Percent							Percent
	2008		2007		Change			2008		2007		Change
Operating revenues	$	31,342	$	30,132		4.0	%	$	92,952	$	88,579		4.9	%
Operating expenses		25,724		24,828		3.6			74,787		73,667		1.5
Operating income		5,618		5,304		5.9			18,165		14,912		21.8
Income before income taxes		4,936		4,562		8.2			16,209		13,432		20.7
Net Income		3,230		3,063		5.5			10,463		8,815		18.7

Overview

Operating income Our operating income increased $314, or 5.9%, in the third quarter and $3,253, or 21.8%, for the first nine months of 2008, reflecting continued growth in wireless service and data revenues. Our operating income margin increased from 17.6% to 17.9% in the third quarter and from 16.8% to 19.5% for the first nine months. Reported results in 2008 include directory revenue and expenses from directories published by BellSouth Corporation (BellSouth) subsidiaries. In accordance with U.S. generally accepted accounting principles (GAAP), our reported results in 2007 did not include deferred 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 from BellSouth directories published during the 12-month period ending with the December 29, 2006 date we acquired BellSouth. Had our 2007 directory results included this deferred revenue and expenses, operating income would have increased $182 in the third quarter and $2,633 for the first nine months of 2008, as compared to 2007. See our “Advertising & Publishing Segment Results” section for discussion of this purchase accounting treatment.

Operating revenues Our operating revenues increased $1,210, or 4.0%, in the third quarter and $4,373, or 4.9%, for the first nine months primarily due to continuing growth in wireless subscribers. Revenues in the third quarter and for the first nine months also reflect an increase in data revenues, primarily related to Internet Protocol (IP) data, partially offset by the continued decline in voice revenues. As discussed above, purchase accounting treatment for directories published 12 months prior to the BellSouth acquisition also increased revenues in the third quarter and for the first nine months of 2008 when compared to 2007.

Our operating revenues also reflect the continued decline in our retail access lines due to increased competition, as customers disconnected both primary and additional lines and switched to competitors’ wireless, Voice over Internet Protocol (VoIP) and cable offerings for voice and data. The slower national economy also adversely affected the ability of our consumer wireline customers to purchase our services. While we lose the voice revenues, we have the opportunity to increase wireless service revenues should the customer choose us as their wireless provider.

AT&T INC.

SEPTEMBER 30, 2008

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation -Continued

Dollars in millions except per share amounts

Operating expenses Our operating expenses increased $896, or 3.6%, in the third quarter and increased $1,120, or 1.5%, for the first nine months. The increase in the third quarter was primarily due to an increase of $782 in equipment costs related to the successful launch of the iPhone 3G and increased sales of PDA devices. Also increasing expenses were higher commissions and residuals from the growth in wireless, as well as hurricane-related expenses affecting both the Wireless and Wireline segments. Partially offsetting these increases were merger integration costs recognized in 2007 and not in 2008, and lower amortization expense on intangible assets in 2008.

The increase for the first nine months was primarily due to increased wireless equipment sales, a $374 charge taken in the first quarter of 2008 for workforce reductions and the purchase accounting treatment of the BellSouth deferred directory expenses discussed above. Partially offsetting these increases were merger integration costs recognized in 2007 and not in 2008, and lower amortization expense on intangible assets in 2008.

Interest expense decreased $29, or 3.3%, in the third quarter and $62, or 2.3%, for the first nine months of 2008. Interest expense remained relatively unchanged with a decrease in our weighted average interest rate and changes in interest charged during construction offset by an increase in our average debt balances. Future interest expense will continue to reflect increased interest during construction related to preparing spectrum purchases for service.

Equity in net income of affiliates increased $95, or 58.6%, in the third quarter and $167, or 30.6%, for the first nine months of 2008. The increase is primarily due to improved results from our investment in América Móvil S.A. de C.V. (América Móvil), Telmex and Telmex Internacional.

Other income (expense) – net We had other expense of $81 in the third quarter and $91 for the first nine months of 2008, as compared to other expense of $17 in the third quarter and other income of $614 for the first nine months of 2007. Results in the third quarter of 2008 primarily included expenses of $59 related to minority interest expenses, $46 for the sale of administrative buildings and other non-strategic assets and $44 related to asset impairments, partially offset by $54 of interest and dividend income. Results in the third quarter of 2007 primarily included $43 in minority interest expenses and $24 from the loss on sale of cost investments, partially offset by interest income of $44.

Results for the first nine months of 2008 primarily included expenses of $188 related to minority interest expenses, $89 loss on the sale of land and other non-strategic assets and $75 related to asset impairments, partially offset by $177 of interest, dividend and leveraged lease income and $79 gain on sale of investments. Results for the first nine months of 2007 primarily included gains of $409 related to a wireless spectrum license exchange, $127 for the sale of administrative buildings and other non-strategic assets, $118 of interest income and $29 for the sale of cost investments. These gains were partially offset by $143 in minority interest expenses.

Income taxes increased $207, or 13.8%, in the third quarter and $1,129, or 24.5%, for the first nine months of 2008. The increase in income taxes in the third quarter and for the first nine months was primarily due to higher income before income taxes. Our effective tax rates were 34.6% in the third quarter of 2008 compared to 32.9% in the third quarter of 2007, and 35.4% for the first nine months of 2008 compared to 34.4% for the first nine months of 2007. The increase in our effective tax rates in 2008 was primarily due to an increase in income before income taxes. The effective tax rate for the third quarter of 2007 reflects a benefit related to adjustments to our unrecognized tax benefits partially offset by the impact of a state law change.

AT&T INC.

SEPTEMBER 30, 2008

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation - Continued

Dollars in millions except per share amounts

Selected Financial and Operating Data

	September 30,
	2008			2007
Wireless customers (000)		74,871			65,666
Consumer revenue connections (000) 1,2		47,548			49,598
Network access lines in service (000) 2		57,191			62,871
Broadband connections (000) 2,3		14,841			13,760
Video connections (000) 4		2,963			2,112
Debt ratio 5		40.6	%		35.3	%
Ratio of earnings to fixed charges 6		5.15			5.34
Number of AT&T employees		303,530			303,670

1	Consumer revenue connections includes retail access lines, U-verse voice over IP connections, broadband and video.
2	Represents services by AT&T’s local exchange companies (ILECs) and affiliates.
3	Broadband connections include DSL, U-verse high-speed Internet access and satellite broadband.
4	Video connections include customers that have satellite service under our agency arrangements and U-verse video connections of 781 in 2008 and 126 in 2007.
5	See our “Liquidity and Capital Resources” section for discussion.
6	See Exhibit 12.

Segment Results

Our segments represent strategic business units that offer different products and services over various technology platforms and are managed accordingly. Our operating segment results presented in Note 4 and discussed below for each segment follow our internal management reporting. We analyze our various operating segments based on segment income before income taxes. Interest expense and other income (expense) – net are managed only on a total company basis and are, accordingly, reflected only in consolidated results. We have four reportable segments: (1) wireless, (2) wireline, (3) advertising & publishing, and (4) other.

The wireless segment provides wireless voice and advanced data communications services.

The other segment includes results from Sterling Commerce Inc. (Sterling), customer information services and all corporate and other operations. The other 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 entire company for which management does not evaluate the individual operating segments.

AT&T INC.

SEPTEMBER 30, 2008

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation - Continued

Dollars in millions except per share amounts

The following tables show components of results of operations by segment. Significant segment results are discussed following each table. Capital expenditures for each segment are discussed in “Liquidity and Capital Resources.”

Wireless

Segment Results

	Third Quarter									Nine-Month Period
							Percent									Percent
	2008			2007			Change			2008			2007			Change
Segment operating revenues
Service revenues	$	11,273		$	9,860			14.3	%	$	32,869		$	28,492			15.4	%
Equipment revenues		1,345			1,077			24.9			3,607			2,837			27.1
Total Segment Operating Revenues		12,618			10,937			15.4			36,476			31,329			16.4
Segment operating expenses
Cost of services and equipment sales		4,989			4,079			22.3			13,261			11,690			13.4
Selling, general and administrative		3,849			3,183			20.9			10,489			9,136			14.8
Depreciation and amortization		1,401			1,709			(18.0	)		4,327			5,410			(20.0	)
Total Segment Operating Expenses		10,239			8,971			14.1			28,077			26,236			7.0
Segment Operating Income		2,379			1,966			21.0			8,399			5,093			64.9
Equity in Net Income of Affiliates		-			3			-			5			12			(58.3	)
Minority Interest 1		(57	)		(43	)		(32.6	)		(186	)		(143	)		(30.1	)
Segment Income	$	2,322		$	1,926