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AT&T 10-Q 2006

                                                                                                

 

FORM 10-Q

 

United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

(Mark One)

 

 

x

Quarterly Report Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

 

For the quarterly period ended September 30, 2006

 

or

 

 

o

Transition Report Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

 

For the transition period from       to     

 

Commission File Number 1-8610

 

AT&T INC.

 

Incorporated under the laws of the State of Delaware

I.R.S. Employer Identification Number 43-1301883

 

175 E. Houston, San Antonio, Texas 78205

Telephone Number: (210) 821-4105

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12-b2 of the Exchange Act. Large accelerated filer x Accelerated filer [ ] Non-accelerated filer [ ]

 

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

 

At October 31, 2006, common shares outstanding were 3,842,902,194.

 

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,

 

 

2006

 

2005

 

2006

 

2005

Operating Revenues

 

 

 

 

 

 

 

 

Voice

$

8,464

$

5,743

$

25,725

$

17,355

Data

 

4,546

 

2,514

 

13,465

 

7,343

Directory

 

906

 

917

 

2,716

 

2,723

Other

 

1,722

 

1,130

 

5,258

 

3,434

Total operating revenues

 

15,638

 

10,304

 

47,164

 

30,855

Operating Expenses

 

 

 

 

 

 

 

 

Cost of sales (exclusive of depreciation and

 

 

 

 

 

 

 

 

amortization shown separately below)

 

6,664

 

4,364

 

20,641

 

13,153

Selling, general and administrative

 

3,620

 

2,175

 

11,396

 

7,229

Depreciation and amortization

 

2,437

 

1,803

 

7,415

 

5,437

Total operating expenses

 

12,721

 

8,342

 

39,452

 

25,819

Operating Income

 

2,917

 

1,962

 

7,712

 

5,036

Other Income (Expense)

 

 

 

 

 

 

 

 

Interest expense

 

(442)

 

(349)

 

(1,378)

 

(1,051)

Interest income

 

98

 

82

 

278

 

291

Equity in net income of affiliates

 

649

 

219

 

1,438

 

342

Other income (expense) – net

 

11

 

(70)

 

37

 

11

Total other income (expense)

 

316

 

(118)

 

375

 

(407)

Income Before Income Taxes

 

3,233

 

1,844

 

8,087

 

4,629

Income taxes

 

1,068

 

598

 

2,669

 

1,498

Net Income

$

2,165

$

1,246

$

5,418

$

3,131

Earnings Per Common Share:

 

 

 

 

 

 

 

 

Net Income

$

0.56

$

0.38

$

1.40

$

0.95

Earnings Per Common Share - Assuming Dilution:

 

 

 

 

 

 

 

 

Net Income

$

0.56

$

0.38

$

1.39

$

0.95

Weighted Average Number of Common

 

 

 

 

 

 

 

 

Shares Outstanding – Basic (in millions)

 

3,873

 

3,296

 

3,880

 

3,300

Dividends Declared Per Common Share

$

0.3325

$

0.3225

$

0.9975

$

0.9675

See Notes to Consolidated Financial Statements.

 

2

 

AT&T INC.

CONSOLIDATED BALANCE SHEETS

Dollars in millions except per share amounts

 

 

 

 

 

 

 

September 30,

 

 

December 31,

 

 

2006

 

 

2005

Assets

 

(Unaudited)

 

 

 

Current Assets

 

 

 

 

 

Cash and cash equivalents

$

1,251

 

$

1,224

Accounts receivable – net of allowances for

 

 

 

 

 

uncollectibles of $936 and $1,176

 

8,668

 

 

9,351

Prepaid expenses

 

1,038

 

 

1,029

Deferred income taxes

 

1,598

 

 

2,011

Other current assets

 

957

 

 

1,039

Total current assets

 

13,512

 

 

14,654

Property, plant and equipment

 

152,573

 

 

149,238

Less: accumulated depreciation and amortization

 

94,922

 

 

90,511

Property, Plant and Equipment – Net

 

57,651

 

 

58,727

Goodwill

 

13,385

 

 

14,055

Intangible Assets – Net

 

7,728

 

 

8,503

Investments in Equity Affiliates

 

2,222

 

 

2,031

Investments in and Advances to Cingular Wireless

 

33,029

 

 

31,404

Other Assets

 

16,365

 

 

16,258

Total Assets

$

143,892

 

$

145,632

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current Liabilities

 

 

 

 

 

Debt maturing within one year

$

4,713

 

$

4,455

Accounts payable and accrued liabilities

 

14,789

 

 

17,088

Accrued taxes

 

3,122

 

 

2,586

Dividends payable

 

1,281

 

 

1,289

Total current liabilities

 

23,905

 

 

25,418

Long-Term Debt

 

26,799

 

 

26,115

Deferred Credits and Other Noncurrent Liabilities

 

 

 

 

 

Deferred income taxes

 

14,368

 

 

15,713

Postemployment benefit obligation

 

18,150

 

 

18,133

Unamortized investment tax credits

 

188

 

 

209

Other noncurrent liabilities

 

5,081

 

 

5,354

Total deferred credits and other noncurrent liabilities

 

37,787

 

 

39,409

 

 

 

 

 

 

Stockholders’ Equity

 

 

 

 

 

Common shares issued ($1 par value)

 

4,065

 

 

4,065

Capital in excess of par value

 

27,116

 

 

27,499

Retained earnings

 

30,653

 

 

29,106

Treasury shares (at cost)

 

(5,867)

 

 

(5,406)

Additional minimum pension liability adjustment

 

(218)

 

 

(218)

Accumulated other comprehensive income

 

(348)

 

 

(356)

Total stockholders’ equity

 

55,401

 

 

54,690

Total Liabilities and Stockholders’ Equity

$

143,892

 

$

145,632

See Notes to Consolidated Financial Statements.

 

3

 

AT&T INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Dollars in millions, increase (decrease) in cash and cash equivalents

(Unaudited)

 

Nine months ended

 

September 30,

 

 

2006

 

2005

Operating Activities

 

 

 

 

Net income

$

5,418

$

3,131

Adjustments to reconcile net income to net cash

 

 

 

 

provided by operating activities:

 

 

 

 

Depreciation and amortization

 

7,415

 

5,437

Undistributed earnings from investments in equity affiliates

 

(1,359)

 

(285)

Provision for uncollectible accounts

 

450

 

561

Amortization of investment tax credits

 

(21)

 

(17)

Deferred income tax expense (benefit)

 

(269)

 

(315)

Net gain on sales of investments

 

(10)

 

(104)

Changes in operating assets and liabilities:

 

 

 

 

Accounts receivable

 

249

 

(39)

Other current assets

 

42

 

(249)

Accounts payable and accrued liabilities

 

(1,819)

 

(242)

Stock-based compensation tax benefit

 

(10)

 

(3)

Other - net

 

507

 

508

Total adjustments

 

5,175

 

5,252

Net Cash Provided by Operating Activities

 

10,593

 

8,383

Investing Activities

 

 

 

 

Construction and capital expenditures

 

(6,158)

 

(3,743)

Receipts from (investments in) affiliates – net

 

(633)

 

2,603

Dispositions

 

72

 

126

Acquisitions

 

(115)

 

(169)

Maturities of held-to-maturity securities

 

3

 

98

Proceeds from note repayment

 

-

 

37

Other

 

5

 

-

Net Cash Used in Investing Activities

 

(6,826)

 

(1,048)

Financing Activities

 

 

 

 

Net change in short-term borrowings with original

 

 

 

 

maturities of three months or less

 

2,336

 

(1,656)

Repayment of other short-term borrowings

 

(3)

 

-

Issuance of long-term debt

 

1,491

 

-

Repayment of long-term debt

 

(2,882)

 

(2,123)

Purchase of treasury shares

 

(1,359)

 

(742)

Issuance of treasury shares

 

463

 

362

Dividends paid

 

(3,873)

 

(3,196)

Stock-based compensation tax benefit

 

10

 

3

Other

 

77

 

-

Net Cash Used in Financing Activities

 

(3,740)

 

(7,352)

Net increase (decrease) in cash and cash equivalents from continuing operations

 

27

 

(17)

Net Cash Used in Operating Activities from Discontinued Operations

 

-

 

(310)

Net increase (decrease) in cash and cash equivalents

 

27

 

(327)

Cash and cash equivalents beginning of year

 

1,224

 

760

Cash and Cash Equivalents End of Period

$

1,251

$

433

 

 

 

 

 

Cash paid during the nine months ended September 30 for:

 

 

 

 

Interest

$

1,503

$

1,198

Income taxes, net of refunds

$

2,249

$

1,535

See Notes to Consolidated Financial Statements.

 

4

 

AT&T INC.

 

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

 

 

Dollars and shares in millions, except per share amounts

 

 

(Unaudited)

 

 

 

Nine months ended

 

September 30, 2006

 

Shares

Amount

Common Stock

 

 

 

Balance at beginning of year

4,065

$

4,065

Balance at end of period

4,065

$

4,065

 

 

 

 

Capital in Excess of Par Value

 

 

 

Balance at beginning of year

 

$

27,499

Issuance of shares

 

 

(302)

Stock based compensation

 

 

(81)

Balance at end of period

 

$

27,116

 

 

 

 

Retained Earnings

 

 

 

Balance at beginning of year

 

$

29,106

Net income ($1.39 per diluted share)

 

 

5,418

Dividends to stockholders ($1.00 per share)

 

 

(3,865)

Other

 

 

(6)

Balance at end of period

 

$

30,653

 

 

 

 

Treasury Shares

 

 

 

Balance at beginning of year

(188)

$

(5,406)

Purchase of shares

(45)

 

(1,359)

Issuance of shares

21

 

898

Balance at end of period

(212)

$

(5,867)

 

 

 

 

Additional Minimum Pension Liability Adjustment

 

 

 

Balance at beginning of year

 

$

(218)

Balance at end of period

 

$

(218)

 

 

 

 

Accumulated Other Comprehensive Income, net of tax

 

 

 

Balance at beginning of year

 

$

(356)

Other comprehensive income (loss) (see Note 3)

 

 

8

Balance at end of period

 

$

(348)

See Notes to Consolidated Financial Statements.

 

 

5

AT&T INC.

SEPTEMBER 30, 2006

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Dollars in millions except per share amounts

 

NOTE 1. PREPARATION OF INTERIM FINANCIAL STATEMENTS

 

Basis of Presentation Throughout this document, AT&T Inc. is referred to as “AT&T,” “we” or the “Company.” The consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) that permit reduced disclosure for interim periods. We believe that these consolidated financial statements include all adjustments (consisting only of normal recurring accruals) necessary to present fairly the results for the interim periods shown. The results for the interim periods are not necessarily indicative of results for the full year. You should read this document in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2005.

 

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 wireline and wireless telecommunications services and equipment as well as directory advertising and publishing services.

 

All significant intercompany transactions are eliminated in the consolidation process. Investments in partnerships, joint ventures, including Cingular Wireless (Cingular), and less than majority-owned subsidiaries where we have significant influence are accounted for under the equity method. We account for our 60% economic interest in Cingular under the equity method since we share control equally (i.e., 50/50) with our 40% economic partner in the joint venture. We have equal voting rights and representation on the Board of Directors that controls Cingular. Earnings from certain foreign equity investments accounted for using the equity method are included for periods ended within up to three months of the date of our Consolidated Statements of Income.

 

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. As a result of our November 2005 acquisition of AT&T Corp. (ATTC), in 2006, we revised our segment reporting (see Note 5). In addition, we revised the product categories reported in operating revenue as follows: long-distance voice is now reported in voice revenue; the majority of customer premises equipment and integration services revenue, previously reported as voice and data revenue are now reported in other revenue; and directory revenues now reflect our traditional directory segment revenues. Additionally, in assessing fair value of contracts in conjunction with the acquisition of ATTC (see Note 2) we reduced revenues and operating expenses by $18 in the post-acquisition 2005 period and by $79 for the first six months of 2006 to reflect settlements with foreign carriers for transport/carrying calls at the contract incremental/cash settlement rates rather than contract swap rates. Operating Income remained unchanged.

 

FIN 48  In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48), an interpretation of Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (FAS 109). FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing a recognition threshold for tax positions taken or expected to be taken in a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the impact FIN 48 will have on our financial position and results of operations.

 

EITF 06-3 In June 2006, the Emerging Issues Task Force (EITF), a task force established to assist the FASB on significant emerging accounting issues, ratified the consensus on EITF 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement” (EITF 06-3). EITF 06-3 provides that taxes imposed by a governmental authority on a revenue producing transaction between a seller and a customer should be shown in the income statement on either a gross or a net basis, based on the entity’s accounting policy, which should be disclosed pursuant to Accounting Principles Board Opinion No. 22, “Disclosure of Accounting Policies.” Amounts that are allowed to be charged to customers as an offset to taxes

 

6

AT&T INC.

SEPTEMBER 30, 2006

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

owed by a company are not considered taxes collected and remitted. If such taxes are significant, and are presented on a gross basis, the amounts of those taxes should be disclosed. EITF 06-3 will be effective for interim and annual reporting periods beginning after December 15, 2006. We are currently evaluating the impact EITF 06-3 will have, but do not expect a material impact on our financial position and results of operations.

 

FAS 157 In September 2006, the FASB issued Statement of Financial Accounting Standard No. 157, “Fair Value Measurements” (FAS 157). FAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. FAS 157 applies under other accounting pronouncements that require or permit fair value measurement. FAS 157 does not require any new fair value measurements and we do not expect the application of this standard to change our current practice. FAS 157 requires prospective application for fiscal years ending after November 15, 2007.

 

FAS 158 In September 2006, the FASB issued Statement of Financial Accounting Standard No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (FAS 158), an amendment of Statement of Financial Accounting Standard No. 87 “Employers’ Accounting for Pensions” (FAS 87), Statement of Financial Accounting Standard No. 88 “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits,” Statement of Financial Accounting Standard No. 106 “Employers’ Account for Postretirement Benefits Other Than Pensions” (FAS 106) and Statement of Financial Accounting Standard No. 132(R) “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” FAS 158 will require us to recognize the funded status of defined benefit pension and postretirement plans as an asset or liability in our statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. This standard will have no effect on our expense or benefit recognition, nor will it affect the funding requirements imposed under the Employee Retirement Income Security Act of 1974, as amended (ERISA). FAS 158 requires prospective application for fiscal years ending after December 15, 2006. Had FAS 158 been in effect at December 31, 2005, we would have reduced our pension assets approximately $8,700 and increased our postretirement benefit obligation approximately $7,300. The after tax reduction to our stockholders’ equity would have been approximately $10,000. We will adopt FAS 158 in the fourth quarter of 2006.

 

Employee Separations In accordance with Statement of Financial Accounting Standards No. 112, “Employers’ Accounting for Postemployment Benefits,” we establish obligations for probable termination benefits provided 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, 2006, for employees not affected by the change-in-control provisions of the ATTC benefit plans, we had severance accruals of $276, of which $241 was established as merger-related severance accruals. In accordance with Statement of Financial Accounting Standards No. 141, “Business Combinations” (FAS 141), severance accruals recorded for ATTC employees were included in the preliminary purchase price allocation (see Note 2).

 

NOTE 2. ACQUISITIONS

 

AT&T Corp. In November 2005, we acquired ATTC in a transaction accounted for under FAS 141, issuing 632 million shares. ATTC was one of the nation’s largest business service communications providers, offering a variety of global communications services, including large domestic and multinational businesses, small and medium-sized businesses and government agencies, and operated one of the largest telecommunications networks in the U.S. ATTC also provided domestic and international long-distance and usage-based-communications services to consumer customers. ATTC is now a wholly owned subsidiary of AT&T and the results of ATTC’s operations have been included in our consolidated financial statements after the November 18, 2005 acquisition date.

 

Under the purchase method of accounting, the transaction was valued, for accounting purposes, at $15,517 and the assets and liabilities of ATTC were recorded at their respective fair values as of the date of the acquisition. At the time of the acquisition, we obtained preliminary third-party valuations of property, plant and equipment, intangible assets (including the AT&T trade name), debt

 

7

AT&T INC.

SEPTEMBER 30, 2006

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

and certain other assets and liabilities. Because of the proximity of this transaction to year-end, the values of certain assets and liabilities were based on preliminary valuations and were subject to adjustment as additional information was obtained. Such additional information includes, but is not limited to: valuations and physical counts of property, plant and equipment, valuation of investments and the involuntary termination of employees. As of September 30, 2006, we have obtained additional information on many of the outstanding issues relating to the preliminary valuation, resulting in the adjustment of certain assets and liabilities, offset by a change to goodwill. We have 12 months from the closing of the acquisition to finalize our valuations; any remaining adjustments will be reflected in the fourth quarter.

 

The following table summarizes the preliminary estimated fair values of the ATTC assets acquired and liabilities assumed and related deferred income taxes as of the acquisition date and adjustments made thereto during the first nine months of 2006.

 

 

 

Purchase Price Allocation

 

 

As of

 

 

 

As of

 

 

12/31/05

 

Adjustments

 

9/30/06

Assets acquired

 

 

 

 

 

 

Current assets

$

6,295

$

16

$

6,311

Property, plant and equipment

 

10,921

 

(662)

 

10,259

Intangible assets not subject to amortization:

 

 

 

 

 

 

Trade name

 

4,900

 

-

 

4,900

Licenses

 

40

 

-

 

40

Intangible assets subject to amortization:

 

 

 

 

 

 

Customer lists and relationships

 

3,050

 

-

 

3,050

Patents

 

150

 

-

 

150

Brand licensing agreements

 

70

 

-

 

70

Investments in unconsolidated subsidiaries

 

160

 

(90)

 

70

Other assets

 

4,247

 

165

 

4,412

Goodwill

 

12,343

 

(691)

 

11,652

Total assets acquired

 

42,176

 

(1,262)

 

40,914

 

 

 

 

 

 

 

Liabilities assumed

 

 

 

 

 

 

Current liabilities, excluding

current portion of long-term debt

 

6,740

 

63

 

6,803

Long-term debt

 

8,293

 

-

 

8,293

Deferred income taxes

 

531

 

(720)

 

(189)

Postemployment benefit obligation

 

8,807

 

(468)

 

8,339

Other noncurrent liabilities

 

2,288

 

(137)

 

2,151

Total liabilities assumed

 

26,659

 

(1,262)

 

25,397

Net assets acquired

$

15,517

$

-

$

15,517

 

Adjustments were primarily related to property, plant and equipment, head-count assumptions associated with payments for involuntary employee separations, pension asset valuations and the adjustment for certain tax items. Reductions in the value of property, plant and equipment primarily reflects the reduction of estimated real estate values of property in use as well as a more comprehensive look at our fixed asset portfolio. Included in our third-quarter 2006 operating results is a $71 reduction of depreciation expense related to the revaluation of these assets. The timing lag in valuation of certain pension assets (primarily real estate related) resulted in a $20 reduction of operating expense in the third quarter. In addition to the deferred tax impacts associated with valuation adjustments, a net reduction in deferred taxes was recorded as a result of modifications to various pre-merger tax estimates and the resolution of an ATTC Internal Revenue Service audit (an adjustment of $385 for the years 1997-2001). In total we recorded an increase of $97 in operating income, $70 of which related to periods prior to the third quarter of 2006.

 

8

AT&T INC.

SEPTEMBER 30, 2006

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

The completion of the final valuation of the assets and liabilities may result in further adjustments to goodwill. Additionally, as ATTC stock options that were converted at the time of the merger are exercised, the tax effect on those options may further reduce goodwill. As of September 30, 2006, we had recorded $11 in related reductions.

 

ATTC maintained change-in-control provisions with its employees that required enhanced severance and benefit payments be paid to employees of ATTC if a change-in-control occurred. Included in the liabilities assumed at acquisition, was $1,543 accrued for such enhanced severance and benefits. As part of the opening balance sheet adjustments, a revised number of expected employee separations that will result in payments resulted in a decline in the change-in-control severance and benefit accrual of $477. Following is a summary of the accrual recorded at December 31, 2005, cash payments made during the first nine months of 2006 and the purchase accounting adjustments thereto.  We will continue to evaluate this accrual through the end of the allocation period.

 

 

Balance at

12/31/05

Cash Payments for the Quarter Ended

 

Balance at

 

3/31/06

6/30/06

9/30/06

Adjustments

9/30/06

Paid out of:

 

 

 

 

 

 

 

 

 

 

 

 

Company funds

$

870

$

(46)

$

(59)

$

(86)

$

(97)

$

582

Pension and Postemployment
  benefit plans

 

673

 

(5)

 

(27)

 

(18)

 

(380)

 

243

Total

$

1,543

$

(51)

$

(86)

$

(104)

$

(477)

$

825

 

The following unaudited pro forma consolidated results of operations assume that the acquisition of ATTC was completed as of January 1, 2005.

 

 

For the Quarter Ended

 

For the Year Ended

 

 

3/31/05

 

6/30/05

 

9/30/05

 

12/31/05

 

2005

Revenues

$

16,619

$

16,554

$

16,414

$

16,202

$

65,789

 

Net Income

 

1,319

 

1,257

 

1,729

 

1,862

 

6,167

 

 

As part of the process of coordinating benefits, we changed our management vacation pay policy for legacy SBC employees so vacation is earned ratably throughout the year rather than at the end of the preceding year. As a result, we recognized a decrease in operating expenses of $246 in the third quarter of 2006. We anticipate the expense reduction for the fourth quarter of 2006 to be approximately $80.

 

9

AT&T INC.

SEPTEMBER 30, 2006

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

NOTE 3. COMPREHENSIVE INCOME

 

The components of our comprehensive income for the three and nine months ended September 30, 2006 and 2005 include net income, adjustments to stockholders’ equity for the foreign currency translation adjustment, net unrealized gain (loss) on available-for-sale securities and net unrealized gain (loss) on cash flow hedges. 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,

 

 

2006

 

2005

 

 

2006

 

2005

Net income

$

2,165

$

1,246

 

$

5,418

$

3,131

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

29

 

(2)

 

 

(16)

 

28

Net unrealized gains (losses) on securities:

 

 

 

 

 

 

 

 

 

Unrealized gains (losses)

 

(17)

 

2

 

 

17

 

(21)

Less reclassification adjustment realized

in net income

 

-

 

(4)

 

 

(8)

 

(37)

Net unrealized gains on cash flow hedges:

Unrealized gains, net of taxes

 

-

 

-

 

 

2

 

-

Reclassification adjustment for losses

 

 

 

 

 

 

 

 

 

on cash flow hedges included in net income

 

4

 

2

 

 

12

 

3

Other

 

-

 

(2)

 

 

1

 

(2)

Other comprehensive income (loss)

 

16

 

(4)

 

 

8

 

(29)

Total Comprehensive Income 

$

2,181

$

1,242

 

$

5,426

$

3,102

 

 

10

AT&T INC.

SEPTEMBER 30, 2006

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

NOTE 4. EARNINGS PER SHARE

 

A reconciliation of the numerators and denominators of basic earnings per share and diluted earnings per share for net income for the three and nine months ended September 30, 2006 and 2005 is shown in the table below:

 

 

Three months ended

 

Nine months ended

 

September 30,

 

September 30,

 

2006

2005

 

 

2006

 

2005

Numerators

 

 

 

 

 

 

 

 

 

Numerator for basic earnings per share:

 

 

 

 

 

 

 

 

 

Net income

$

2,165

$

1,246

 

$

5,418

$

3,131

Dilutive potential common shares:

 

 

 

 

 

 

 

 

 

Other stock-based compensation

 

2

 

5

 

 

5

 

8

Numerator for diluted earnings per share

$

2,167

$

1,251

 

$

5,423

$

3,139

Denominators (000,000)

 

 

 

 

 

 

 

 

 

Denominator for basic earnings per share:

 

 

 

 

 

 

 

 

 

Weighted-average number of common

 

 

 

 

 

 

 

 

 

shares outstanding

 

3,873

 

3,296

 

 

3,880

 

3,300

Dilutive potential common shares:

 

 

 

 

 

 

 

 

 

Stock options

 

5

 

-

 

 

4

 

1

Other stock-based compensation

 

14

 

10

 

 

16

 

10

Denominator for diluted earnings per share

 

3,892

 

3,306

 

 

3,900

 

3,311

Basic earnings per share

 

 

 

 

 

 

 

 

 

Net income

$

0.56

$

0.38

 

$

1.40

$

0.95

Diluted earnings per share

 

 

 

 

 

 

 

 

 

Net income

$

0.56

$

0.38

 

$

1.39

$

0.95

 

At September 30, 2006, we had issued and outstanding options to purchase approximately 234 million shares of AT&T common stock. The exercise prices of options to purchase a weighted average of 189 million shares in the third quarter and 212 million for the first nine months exceeded the average market price of AT&T stock. Accordingly, we did not include these amounts in determining the dilutive potential common shares for the respective periods. At September 30, 2006, the exercise price of 47 million share options were below market price, commonly referred to as “in the money.” Of these options, 11 million will expire by the end of 2007.

 

At September 30, 2005, we had issued and outstanding options to purchase 202 million shares of AT&T common stock. The exercise prices of options to purchase a weighted average of 191 million shares in the third quarter and 195 million for the first nine months exceeded the average market price of AT&T stock. Accordingly, we did not include these amounts in determining the dilutive potential common shares for the respective periods.

 

11

AT&T INC.

SEPTEMBER 30, 2006

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

NOTE 5. SEGMENT INFORMATION

 

Our segments are strategic business units that offer different products and services and are managed accordingly. We analyze our various operating segments based on segment income. Interest expense, interest income and other income (expense) – net are managed only on a total company basis and are, accordingly, reflected only in consolidated results. Therefore, these items are not included in the calculation of each segment’s percentage of our consolidated results. As a result of our November 18, 2005 acquisition of ATTC we have revised our segment reporting to represent how we now manage our business, restating prior periods to conform to the current segments. We have four reportable segments: (1) wireline, (2) Cingular, (3) directory and (4) other.

 

The wireline segment provides both retail and wholesale landline telecommunications services, including local and long-distance voice, switched access, internet protocol and internet access data, messaging services, managed networking to business customers, our U-versesm video service and satellite television services through our agreement with EchoStar Communications Corp.

 

The Cingular segment reflects 100% of the results reported by Cingular, our wireless joint venture. Although we analyze Cingular’s revenues and expenses under the Cingular segment, we eliminate the Cingular segment in our consolidated financial statements. In our consolidated financial statements, we report our 60% proportionate share of Cingular’s results as equity in net income of affiliates.

 

The directory segment includes our directory operations, which publish Yellow and White Pages directories and sell directory and internet-based advertising. Our portion of the results from YELLOWPAGES.COM (YPC), a joint venture with BellSouth Corporation (BellSouth), is recorded in this segment as equity in net income of affiliates.

 

The other segment includes results from Sterling Commerce Inc. and all corporate and other operations. This segment also includes our portion of the results from our international equity investments and from Cingular as equity in net income of affiliates, as discussed above.

 

In the following tables, we show how our segment results are reconciled to our consolidated results reported in accordance with GAAP. The Wireline, Cingular, Directory and Other columns represent the segment results of each such operating segment. The Wireline column includes revenues from services sold to Cingular (see Note 6). Since we account for Cingular using the equity method of accounting, these revenues are not eliminated upon consolidation and as such, remain in consolidated revenue. The Consolidation and Elimination column adds in those line items that we manage on a consolidated basis only: interest expense, interest income and other income (expense) – net. This column also eliminates any intercompany transactions included in each segment’s results. Since our 60% share of the results from Cingular is already included in the Other column, the Cingular Elimination column removes the results of Cingular shown in the Cingular segment.

 

 

12

AT&T INC.

SEPTEMBER 30, 2006

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

 

For the three months ended September 30, 2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Wireline

 

Cingular

 

Directory

 

Other

 

Consolidation
and Elimination

 

Cingular
Elimination

 

Consolidated
Results

Revenues from external customers

$

14,577

$

9,553

$

906

$

155

$

-

$

(9,553)

$

15,638

Intersegment revenues

 

9

 

-

 

15

 

49

 

(73)

 

-

 

-

Total segment operating revenues

 

14,586

 

9,553

 

921

 

204

 

(73)

 

(9,553)

 

15,638

Operations and support expenses

 

9,756

 

6,561

 

439

 

161

 

(72)

 

(6,561)

 

10,284

Depreciation and amortization expenses

 

2,376

 

1,576

 

1

 

60

 

-

 

(1,576)

 

2,437

Total segment operating expenses

 

12,132

 

8,137

 

440

 

221

 

(72)

 

(8,137)

 

12,721

Segment operating income

 

2,454

 

1,416

 

481

 

(17)

 

(1)

 

(1,416)

 

2,917

Interest expense

 

-

 

306

 

-

 

-

 

442

 

(306)

 

442

Interest income

 

-

 

6

 

-

 

-

 

98

 

(6)

 

98

Equity in net income (loss) of affiliates

 

-

 

-

 

(2)

 

651

 

-

 

-

 

649

Other income (expense) – net

 

-

 

(44)

 

-

 

-

 

11

 

44

 

11

Segment income before income taxes

$

2,454

$

1,072

$

479

$

634

$

(334)

$

(1,072)

$

3,233

 

 

 

At September 30, 2006 or for the nine months ended

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Wireline

 

Cingular

 

Directory

 

Other

 

Consolidation
and Elimination

 

Cingular
Elimination

 

Consolidated
Results

Revenues from external customers

$

43,970

$

27,751

$

2,716

$

478

$

-

$

(27,751)

$

47,164

Intersegment revenues

 

25

 

-

 

53

 

126

 

(204)

 

-

 

-

Total segment operating revenues

 

43,995

 

27,751

 

2,769

 

604

 

(204)

 

(27,751)

 

47,164

Operations and support expenses

 

30,422

 

19,657

 

1,321

 

497

 

(203)

 

(19,657)

 

32,037

Depreciation and amortization expenses

 

7,233

 

4,854

 

2

 

181

 

(1)

 

(4,854)

 

7,415

Total segment operating expenses

 

37,655

 

24,511

 

1,323

 

678

 

(204)

 

(24,511)

 

39,452

Segment operating income

 

6,340

 

3,240

 

1,446

 

(74)

 

-

 

(3,240)

 

7,712

Interest expense

 

-

 

901

 

-

 

-

 

1,378

 

(901)

 

1,378

Interest income

 

-

 

13

 

-

 

-

 

278

 

(13)

 

278

Equity in net income (loss) of affiliates

 

-

 

-

 

(13)

 

1,451

 

-

 

-

 

1,438

Other income (expense) – net

 

-

 

(120)

 

-

 

-

 

37

 

120

 

37

Segment income before income taxes

$

6,340

$

2,232

$

1,433

$

1,377

$

(1,063)

$

(2,232)

$

8,087

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Segment Assets

$

103,791

$

80,292

$

4,718

$

135,078

$

(99,695)

$

(80,292)

$

143,892

 

13

AT&T INC.

SEPTEMBER 30, 2006

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

 

For the three months ended September 30, 2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Wireline

 

Cingular

 

Directory

 

Other

 

Consolidation
and Elimination

 

Cingular
Elimination

 

Consolidated
Results

Revenues from external customers

$

9,222

$

8,746

$

917

$

165

$

-

$

(8,746)

$

10,304

Intersegment revenues

 

7

 

-

 

15

 

17

 

(39)

 

-

 

-

Total segment operating revenues

 

9,229

 

8,746

 

932

 

182

 

(39)

 

(8,746)

 

10,304

Operations and support expenses

 

5,987

 

6,548

 

425

 

168

 

(41)

 

(6,548)

 

6,539

Depreciation and amortization expenses

 

1,747

 

1,541

 

1

 

54

 

1

 

(1,541)

 

1,803

Total segment operating expenses

 

7,734

 

8,089

 

426

 

222

 

(40)

 

(8,089)

 

8,342

Segment operating income

 

1,495

 

657

 

506

 

(40)

 

1

 

(657)

 

1,962

Interest expense

 

-

 

304

 

-

 

-

 

349

 

(304)

 

349

Interest income

 

-

 

8

 

-

 

-

 

82

 

(8)

 

82

Equity in net income (loss) of affiliates

 

-

 

1

 

-

 

219

 

-

 

(1)

 

219

Other income (expense) – net

 

-

 

(36)

 

-

 

-

 

(70)

 

36

 

(70)

Segment income before income taxes

$

1,495

$

326

$

506

$

179

$

(336)

$

(326)

$

1,844

 

 

 

For the nine months ended September 30, 2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Wireline

 

Cingular

 

Directory

 

Other

 

Consolidation
and Elimination

 

Cingular
Elimination

 

Consolidated
Results

Revenues from external customers

$

27,645

$

25,584

$

2,723

$

487

$

-

$

(25,584)

$

30,855

Intersegment revenues

 

23

 

-

 

63

 

42

 

(128)

 

-

 

-

Total segment operating revenues

 

27,668

 

25,584

 

2,786

 

529

 

(128)

 

(25,584)

 

30,855

Operations and support expenses

 

18,733

 

19,464

 

1,301

 

475

 

(127)

 

(19,464)

 

20,382

Depreciation and amortization expenses

 

5,277

 

4,845

 

4

 

157

 

(1)

 

(4,845)

 

5,437

Total segment operating expenses

 

24,010

 

24,309

 

1,305

 

632

 

(128)

 

(24,309)

 

25,819

Segment operating income

 

3,658

 

1,275

 

1,481

 

(103)

 

-

 

(1,275)

 

5,036

Interest expense

 

-

 

968

 

-

 

-

 

1,051

 

(968)

 

1,051

Interest income

 

-

 

44

 

-

 

-

 

291

 

(44)

 

291

Equity in net income (loss) of affiliates

 

-

 

4

 

(1)

 

343

 

-

 

(4)

 

342

Other income (expense) – net

 

-

 

(76)

 

-

 

-

 

11

 

76

 

11

Segment income before income taxes

$

3,658

$

279

$

1,480

$

240

$

(749)

$

(279)

$

4,629

 

14

AT&T INC.

SEPTEMBER 30, 2006

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

NOTE 6. TRANSACTIONS WITH CINGULAR

 

We and BellSouth, the two owners of Cingular, have each made a subordinated loan to Cingular (shareholder loans). Our shareholder loan to Cingular totaled $4,108 at September 30, 2006 and December 31, 2005. This loan bears interest at an annual rate of 6.0% and matures in June 2008. We earned interest income on this loan of $62 in the third quarter and $184 for the first nine months of 2006 and $74 in the third quarter and $248 for the first nine months of 2005.

 

We and BellSouth agreed to finance Cingular’s capital and operating cash requirements to the extent Cingular requires funding above the level provided by operations. We and BellSouth also entered into a revolving credit agreement with Cingular to provide short-term financing for operations on a pro rata basis at an interest rate of LIBOR (London Interbank Offered Rate) plus 0.05%, which expires July 31, 2007. This agreement provides for the repayment of our and BellSouth’s shareholder loans made to Cingular in the event there are no outstanding amounts due under the revolving credit agreement and to the extent Cingular has excess cash, as defined by the agreement.

 

Under the revolving credit agreement we received net repayments from Cingular totaling $91 in the third quarter and had net advances of $624 for the first nine months of 2006. Our share of advances to Cingular under the revolving credit agreement is reflected in “Investments in and Advances to Cingular Wireless” on our Consolidated Balance Sheets and totaled $931 at September 30, 2006 and $307 at December 31, 2005.

 

We generated revenues of $359 in the third quarter and $1,106 for the first nine months of 2006 and $220 in the third quarter and $607 for the first nine months of 2005 for services sold to Cingular. These revenues were primarily from access and long-distance services sold to Cingular on a wholesale basis, and commissions revenue related to customers added through AT&T sales sources. The offsetting expense amounts are recorded by Cingular, and 60% of these expenses are included in our “Equity in net income of affiliates” line on our Consolidated Statements of Income when we report our 60% proportionate share of Cingular’s results.

 

15

AT&T INC.

SEPTEMBER 30, 2006

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

NOTE 7. 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 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 2006.

 

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 FAS 87 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,

 

2006

2005

 

 

2006

 

2005

Pension cost:

 

 

 

 

 

 

 

 

 

Service cost – benefits earned during the period

$

262

$

197

 

$

787

$

589

Interest cost on projected benefit obligation

 

627

 

403

 

 

1,881

 

1,210

Expected return on assets

 

(1,008)

 

(636)

 

 

(2,992)

 

(1,908)

Amortization of prior service cost and transition asset

 

37

 

47

 

 

112

 

140

Recognized actuarial loss

 

91

 

39

 

 

271

 

118

Net pension cost

$

9

$

50

 

$

59

$

149

 

 

 

 

 

 

 

 

 

 

Postretirement benefit cost:

 

 

 

 

 

 

 

 

 

Service cost – benefits earned during the period

$

108

$

95

 

$

326

$

290

Interest cost on accumulated postretirement

 

 

 

 

 

 

 

 

 

benefit obligation

 

485

 

355

 

 

1,457

 

1,077

Expected return on assets

 

(234)

 

(189)

 

 

(701)

 

(567)

Amortization of prior service benefit

 

(90)

 

(90)

 

 

(269)