Edgar Filing: AT&T INC.

att3q10.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, 2010

		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, 2010, there were 5,910 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,
	2010			2009			2010			2009
Operating Revenues
Wireless service	$	13,675		$	12,372		$	39,711		$	35,978
Voice		6,973			7,943			21,671			24,701
Data		6,928			6,448			20,407			19,053
Directory		961			1,162			3,009			3,622
Other		3,044			2,809			8,121			8,451
Total operating revenues		31,581			30,734			92,919			91,805
Operating Expenses
Cost of services and sales (exclusive of depreciation and amortization shown separately below)		13,519			12,907			38,235			37,665
Selling, general and administrative		7,707			7,574			22,570			22,914
Depreciation and amortization		4,891			4,881			14,529			14,614
Total operating expenses		26,117			25,362			75,334			75,193
Operating Income		5,464			5,372			17,585			16,612
Other Income (Expense)
Interest expense		(729	)		(851	)		(2,248	)		(2,573	)
Equity in net income of affiliates		217			181			629			549
Other income (expense) – net		125			29			825			44
Total other income (expense)		(387	)		(641	)		(794	)		(1,980	)
Income from Continuing Operations Before Income Taxes		5,077			4,731			16,791			14,632
Income tax (benefit) expense		(6,560	)		1,463			(1,512	)		4,886
Income from Continuing Operations		11,637			3,268			18,303			9,746
Income from Discontinued Operations, net of tax		780			7			777			6
Net Income		12,417			3,275			19,080			9,752
Less: Net Income Attributable to Noncontrolling Interest		(78	)		(83	)		(243	)		(236	)
Net Income Attributable to AT&T	$	12,339		$	3,192		$	18,837		$	9,516
Basic Earnings Per Share from Continuing Operations Attributable to AT&T	$	1.96		$	0.54		$	3.06		$	1.61
Basic Earnings Per Share from Discontinued Operations Attributable to AT&T		0.13			-			0.13			-
Basic Earnings Per Share Attributable to AT&T	$	2.09		$	0.54		$	3.19		$	1.61
Diluted Earnings Per Share from Continuing Operations Attributable to AT&T	$	1.95		$	0.54		$	3.04		$	1.61
Diluted Earnings Per Share from Discontinued Operations Attributable to AT&T		0.13			-			0.13			-
Diluted Earnings Per Share Attributable to AT&T	$	2.08		$	0.54		$	3.17		$	1.61
Weighted Average Number of Common Shares Outstanding – Basic (in millions)		5,909			5,901			5,908			5,899
Weighted Average Number of Common Shares Outstanding – with Dilution (in millions)		5,938			5,922			5,937			5,922
Dividends Declared Per Common Share	$	0.42		$	0.41		$	1.26		$	1.23

See Notes to Consolidated Financial Statements.

AT&T INC.
CONSOLIDATED BALANCE SHEETS
Dollars in millions except per share amounts
	September 30,			December 31,
	2010			2009
Assets	(Unaudited)
Current Assets
Cash and cash equivalents	$	3,246		$	3,741
Accounts receivable – net of allowances for doubtful accounts of $978 and $1,202		13,606			14,845
Prepaid expenses		1,686			1,562
Deferred income taxes		1,059			1,247
Other current assets		2,380			3,792
Total current assets		21,977			25,187
Property, plant and equipment		240,466			230,295
Less: accumulated depreciation and amortization		(138,991	)		(130,242	)
Property, Plant and Equipment – Net		101,475			100,053
Goodwill		73,447			72,782
Licenses		50,113			48,741
Customer Lists and Relationships – Net		5,369			7,393
Other Intangible Assets – Net		5,525			5,494
Investments in Equity Affiliates		4,544			2,921
Other Assets		6,802			6,275
Total Assets	$	269,252		$	268,846

Liabilities and Stockholders’ Equity
Current Liabilities
Debt maturing within one year	$	6,426		$	7,361
Accounts payable and accrued liabilities		18,417			21,260
Advanced billing and customer deposits		3,933			4,170
Accrued taxes		1,416			1,681
Dividends payable		2,482			2,479
Total current liabilities		32,674			36,951
Long-Term Debt		62,540			64,720
Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes		20,651			23,781
Postemployment benefit obligation		27,071			27,847
Other noncurrent liabilities		13,023			13,226
Total deferred credits and other noncurrent liabilities		60,745			64,854

Stockholders’ Equity
Common stock ($1 par value, 14,000,000,000 authorized at September 30, 2010 and December 31, 2009: issued 6,495,231,088 at September 30, 2010 and December 31, 2009)		6,495			6,495
Additional paid-in capital		91,748			91,707
Retained earnings		50,751			39,366
Treasury stock (585,370,749 at September 30, 2010 and 593,300,187 at December 31, 2009, at cost)		(21,112	)		(21,260	)
Accumulated other comprehensive loss		(14,888	)		(14,412	)
Noncontrolling interest		299			425
Total stockholders’ equity		113,293			102,321
Total Liabilities and Stockholders’ Equity	$	269,252		$	268,846

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,
	2010			2009
Operating Activities
Net income	$	19,080		$	9,752
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization		14,529			14,614
Undistributed earnings from investments in equity affiliates		(531	)		(430	)
Bad debt expense		973			1,383
Deferred income tax expense and noncurrent unrecognized tax benefits		(4,146	)		2,476
Net (gain) loss from impairment and sale of investments		(746	)		98
Income from discontinued operations		(777	)		(6	)
Changes in operating assets and liabilities:
Accounts receivable		266			(270	)
Other current assets		495			(269	)
Accounts payable and accrued liabilities		(2,861	)		(1,551	)
Net income attributable to noncontrolling interest		(243	)		(236	)
Other - net		(689	)		(117	)
Total adjustments		6,270			15,692
Net Cash Provided by Operating Activities		25,350			25,444

Investing Activities
Construction and capital expenditures
Capital expenditures		(13,170	)		(11,034	)
Interest during construction		(577	)		(553	)
Acquisitions, net of cash acquired		(2,615	)		(184	)
Dispositions		1,821			205
(Purchases) and sales of securities, net		(437	)		11
Other		22			19
Net Cash Used in Investing Activities		(14,956	)		(11,536	)

Financing Activities
Net change in short-term borrowings with original maturities of three months or less		(33	)		(3,918	)
Issuance of long-term debt		2,235			8,161
Repayment of long-term debt		(5,280	)		(6,169	)
Issuance of treasury stock		24			8
Dividends paid		(7,436	)		(7,252	)
Other		(399	)		(367	)
Net Cash Used in Financing Activities		(10,889	)		(9,537	)
Net increase (decrease) in cash and cash equivalents		(495	)		4,371
Cash and cash equivalents beginning of year		3,741			1,727
Cash and Cash Equivalents End of Period	$	3,246		$	6,098

Cash paid during the nine months ended September 30 for:
Interest	$	3,322		$	3,307
Income taxes, net of refunds	$	3,013		$	2,535

See Notes to Consolidated Financial Statements.

AT&T INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Dollars and shares in millions except per share amounts (Unaudited)
	September 30, 2010
	Shares			Amount
Common Stock
Balance at beginning of year		6,495		$	6,495
Balance at end of period		6,495		$	6,495

Additional Paid-In Capital
Balance at beginning of year				$	91,707
Issuance of treasury shares					184
Share-based payments					(161	)
Change related to acquisition of interests held by noncontrolling owners					18
Balance at end of period				$	91,748

Retained Earnings
Balance at beginning of year				$	39,366
Net income attributable to AT&T ($3.17 per diluted share)					18,837
Dividends to stockholders ($1.26 per share)					(7,444	)
Other					(8	)
Balance at end of period				$	50,751

Treasury Stock
Balance at beginning of year		(593	)	$	(21,260	)
Issuance of shares		8			148
Balance at end of period		(585	)	$	(21,112	)

Accumulated Other Comprehensive Income (Loss) Attributable to AT&T, net of tax:
Balance at beginning of year				$	(14,412	)
Other comprehensive income attributable to AT&T (see Note 2)					(476	)
Balance at end of period				$	(14,888	)

Noncontrolling Interest:
Balance at beginning of year				$	425
Net income attributable to noncontrolling interest					243
Distributions					(217	)
Acquisition of interests held by noncontrolling owners					(156	)
Translation adjustments applicable to noncontrolling interest, net of taxes					4
Balance at end of period				$	299

Total Stockholders’ Equity at beginning of year				$	102,321
Total Stockholders’ Equity at end of period				$	113,293
See Notes to Consolidated Financial Statements.

AT&T INC.

SEPTEMBER 30, 2010

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 Regulation S-X and other applicable rules of the Securities and Exchange Commission that permit reduced disclosures for interim reporting. We believe that these consolidated financial statements include all adjustments (consisting only of normal recurring accruals) necessary to present fairly the results for the presented interim periods. The results for the interim periods are not necessarily indicative of those 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, 2009.

In preparing the accompanying unaudited consolidated financial statements, we have reviewed all known events that have occurred after September 30, 2010, and through the date that our Form 10-Q was available for issuance for possible inclusion in this Form 10-Q.

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.

The preparation of financial statements in conformity with U.S. generally accepted accounting principles 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—see Note 4 for a discussion of our change in approach to intersegment activity, effective January 1, 2010, and see Note 7 for a discussion of changes in reporting related to discontinued operations.

Recent Accounting Standards

Fair Value Measurements and Disclosures In January 2010, the Financial Accounting Standards Board issued “Fair Value Measurements and Disclosures—Improving Disclosures about Fair Value Measurements” (Accounting Standards Update (ASU) 2010-06), which requires new disclosures and explanations for transfers of financial assets and liabilities between certain levels in the fair value hierarchy. ASU 2010-06 also clarifies that fair value measurement disclosures are required for each class of financial asset and liability, which may be a subset of a caption in the consolidated balance sheets, and those disclosures should include a discussion of inputs and valuation techniques. For financial assets and liabilities subject to lowest-level measurements, ASU 2010-06 further requires that we separately present purchases, sales, issuances and settlements instead of netting these changes. With respect to matters other than lowest-level measurements, we adopted ASU 2010-06 beginning with the quarter ended March 31, 2010, with the remaining disclosure requirements becoming effective for fiscal years and interim periods beginning on or after December 15, 2010 (i.e., the quarter ending March 31, 2011, for us). See Note 6 for fair value measurements and disclosures for our investment securities and derivatives.

AT&T INC.

SEPTEMBER 30, 2010

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-Continued

Dollars in millions except per share amounts

Valuation and Other Adjustments Included in the current liabilities reported on our consolidated balance sheets are acquisition-related accruals established prior to 2009. 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 (Dobson). Following is a summary of the accruals recorded at December 31, 2009, cash payments made during 2010, and the adjustments thereto:

	12/31/09		Cash			Adjustments			9/30/10
	Balance		Payments			and Accruals			Balance
Severance accruals paid from:
Company funds	$	6	$	(3	)	$	(2	)	$	1
Pension and postemployment benefit plans		98		(3	)		-			95
Lease terminations1		212		(28	)		(66	)		118
Equipment removal and other related costs1		23		(1	)		(21	)		1
Total	$	339	$	(35	)	$	(89	)	$	215

1The “Adjustments and Accruals” related to the BellSouth and Dobson acquisitions and resulted in goodwill reductions.

Employee Separations 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. We had severance accruals of $195 at September 30, 2010 and $669 at December 31, 2009. The decrease in balance was due to payments during the period.

Income Taxes

Healthcare Legislation In March 2010, the President of the United States signed into law comprehensive health care reform legislation under the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010, which included a change in the tax treatment related to Medicare Part D subsidies. We recorded a $995, or $0.17 per diluted share, charge to income tax expense in our consolidated statement of income during the first quarter of 2010 and increased our deferred income taxes liability balance to reflect the impact of this change.

Internal Revenue Service Settlement In September 2010, we reached a settlement with the Internal Revenue Service (IRS) on tax basis calculations related to a 2008 restructuring of our wireless operations. The IRS settlement resolves the uncertainty regarding the amount and timing of amortization deductions related to certain of our wireless assets. The allowed amortization deductions on these settlement-related assets and the related cash flow impacts are expected to be recognized over a 15-year period, which began in 2008. Pursuant to the settlement, we will pay approximately $300 to the IRS during the fourth quarter of 2010 as a result of the disallowance of a portion of the amortization deductions taken on our 2008 and 2009 income tax returns. We recorded an $8,300, or $1.40 per diluted share, reduction to income tax expense in our consolidated statement of income during the third quarter of 2010 and corresponding decreases of $6,760 to our net noncurrent deferred income tax liabilities and $1,540 to other net tax liabilities to reflect the tax benefits of the settlement. The IRS settlement resulted in a reduction to our unrecognized tax benefits for tax positions related to the current year of $348 and for tax positions related to prior years of $1,057, for a total of $1,405, which also reduces the total amount of unrecognized tax benefits that, if recognized, would impact the effective tax rate. Our effective tax rates were (129.2)% for the third quarter and (9.0)% for the first nine months of 2010, compared to 30.9% and 33.4% for the same periods in 2009. The decrease in our 2010 effective tax rates was primarily driven by the impacts of the IRS settlement, partially offset by the effects of the healthcare legislation.

AT&T INC.

SEPTEMBER 30, 2010

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, 2010 and 2009 include net income, foreign currency translation adjustments and net unrealized gains (losses) on available-for-sale securities, net unrealized gains (losses) on cash flow hedges and defined benefit postretirement plans.

Following is our comprehensive income with the respective tax impacts for the three months and nine months periods ended September 30, 2010 and 2009:

	Three months ended						Nine months ended
	September 30,						September 30,
	2010			2009			2010			2009
Net income	$	12,417		$	3,275		$	19,080		$	9,752
Other comprehensive income, net of tax:
Foreign currency translation adjustments (includes $6, $6, $4 and $(2) attributable to noncontrolling interest), net of taxes of $54, $1, $116 and $45		100			2			215			86
Net unrealized gains (losses) on securities:
Unrealized gains (losses), net of taxes of $31, $115, $17 and $130		58			229			33			258
Reclassification adjustment realized in net income, net of taxes of $(1), $(17), $(30) and $24		(1	)		(34	)		(56	)		43
Net unrealized gains (losses) on cash flow hedges:
Unrealized gains (losses) net of taxes of $(108), $(56), $(380) and $168		(205	)		(112	)		(706	)		306
Reclassification adjustment for losses included in net income, net of taxes of $5, $2, $11 and $6		4			4			9			11
Defined benefit postretirement plans:
Amortization of net actuarial gain and prior service cost included in net income, net of taxes of $9, $32, $20 and $99		14			64			33			190
Other comprehensive income (loss)		(30	)		153			(472	)		894
Total comprehensive income		12,387			3,428			18,608			10,646
Less: Total comprehensive income attributable to noncontrolling interest		(84	)		(89	)		(247	)		(234	)
Total Comprehensive Income Attributable to AT&T	$	12,303		$	3,339		$	18,361		$	10,412

AT&T INC.

SEPTEMBER 30, 2010

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 attributable to AT&T for the three and nine months ended September 30, 2010 and 2009, are shown in the table below:

	Three months ended						Nine months ended
	September 30,						September 30,
	2010			2009			2010			2009
Numerators
Numerator for basic earnings per share:
Income from continuing operations	$	11,637		$	3,268		$	18,303		$	9,746
Net income attributable to noncontrolling interest		(78	)		(83	)		(243	)		(236	)
Income from continuing operations attributable to AT&T		11,559			3,185			18,060			9,510
Dilutive potential common shares:
Other share-based payment		3			2			8			7
Numerator for diluted earnings per share	$	11,562		$	3,187		$	18,068		$	9,517
Denominators (000,000)
Denominator for basic earnings per share:
Weighted-average number of common shares outstanding		5,909			5,901			5,908			5,899
Dilutive potential common shares:
Stock options		3			3			3			3
Other share-based payment		26			18			26			20
Denominator for diluted earnings per share		5,938			5,922			5,937			5,922
Basic earnings per share from continuing operations attributable to AT&T	$	1.96		$	0.54		$	3.06		$	1.61
Basic earnings per share from discontinued operations attributable to AT&T		0.13			-			0.13			-
Basic earnings per share attributable to AT&T	$	2.09		$	0.54		$	3.19		$	1.61
Diluted earnings per share from continuing operations attributable to AT&T	$	1.95		$	0.54		$	3.04		$	1.61
Diluted earnings per share from discontinued operations attributable to AT&T		0.13			-			0.13			-
Diluted earnings per share attributable to AT&T	$	2.08		$	0.54		$	3.17		$	1.61

At September 30, 2010, we had issued and outstanding options to purchase approximately 136 million shares of AT&T common stock. The exercise prices of 109 million shares were above the market price of AT&T stock at September 30, 2010. Accordingly, we did not include these amounts in determining the dilutive potential common shares for the period. At September 30, 2010, the exercise prices of 22 million vested stock options were below market price.

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 158 million shares were above the market price of AT&T stock at September 30, 2009. Accordingly, we did not include these amounts in determining the dilutive potential common shares for the period. At September 30, 2009, the exercise prices of 19 million vested stock options were below market price.

AT&T INC.

SEPTEMBER 30, 2010

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. The customers and long-lived assets of our reportable segments are predominantly in the United States. 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 receive commissions on sales of satellite television services offered through our agency arrangements.

The Advertising Solutions segment includes our directory operations, which publish Yellow and White Pages directories and sell directory advertising and Internet-based advertising and local search.

The Other segment includes results from customer information services and all corporate and other operations. This segment also includes our portion of the results from our international equity investments. Also included in the Other segment are impacts of corporate-wide decisions for which the individual operating segments are not being evaluated.

Historically, intersegment activity had been reported as revenue in the billing segment and offsetting operating expense in the purchasing segment. Upon consolidation, the intersegment revenue and expense were eliminated with the consolidated results reflecting the cash operating and depreciation expense of providing the intersegment service. As part of AT&T’s ongoing initiatives to manage its business from an external customer perspective, we no longer report intersegment revenue and instead report the cash operating and depreciation expense related to intersegment activity in the purchasing segment, which provided services to the external customer. While this change did not impact AT&T’s total consolidated results, the impact to each operating segment varied. In particular, the Wireless segment, as a purchaser of network, IT and other services from the Wireline segment, experienced a reduction in cash operating expense partially offset by increased depreciation expense with the net result being increased operating margins. This change was effective with the reporting of operating results for the quarter ended March 31, 2010. We have restated prior-period segment information to conform to the current period’s presentation.

In May 2010, we announced the sale of Sterling Commerce Inc. (Sterling) which we closed in August 2010. The Other segment results for all periods shown have been restated to exclude the results of Sterling, which are now reflected in discontinued operations (see Note 7).

In the following tables, we show how our segment results are reconciled to our consolidated results reported. The Wireless, Wireline, Advertising Solutions and Other columns represent the segment results of each such operating segment. The consolidation column adds in those line items that we manage on a consolidated basis only: interest expense and other income (expense) – net.

AT&T INC.

SEPTEMBER 30, 2010

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

For the three months ended September 30, 2010
						Advertising								Consolidated
	Wireless			Wireline		Solutions		Other			Consolidations			Results
Total segment operating revenues	$	15,180		$	15,275	$	961	$	165		$	-		$	31,581
Operations and support expenses		10,040			10,318		640		228			-			21,226
Depreciation and amortization expenses		1,640			3,118		123		10			-			4,891
Total segment operating expenses		11,680			13,436		763		238			-			26,117
Segment operating income (loss)		3,500			1,839		198		(73	)		-			5,464
Interest expense		-			-		-		-			729			729
Equity in net income (loss) of affiliates		(6	)		2		-		221			-			217
Other income (expense) - net		-			-		-		-			125			125
Segment income before income taxes	$	3,494		$	1,841	$	198	$	148		$	(604	)	$	5,077

For the nine months ended September 30, 2010
					Advertising								Consolidated
	Wireless		Wireline		Solutions		Other			Consolidations			Results
Total segment operating revenues	$	43,319	$	46,092	$	3,009	$	499		$	-		$	92,919
Operations and support expenses		26,785		31,324		1,988		708			-			60,805
Depreciation and amortization expenses		4,776		9,337		393		23			-			14,529
Total segment operating expenses		31,561		40,661		2,381		731			-			75,334
Segment operating income (loss)		11,758		5,431		628		(232	)		-			17,585
Interest expense		-		-		-		-			2,248			2,248
Equity in net income of affiliates		14		7		-		608			-			629
Other income (expense) - net		-		-		-		-			825			825
Segment income before income taxes	$	11,772	$	5,438	$	628	$	376		$	(1,423	)	$	16,791

For the three months ended September 30, 2009
					Advertising								Consolidated
	Wireless		Wireline		Solutions		Other			Consolidations			Results
Total segment operating revenues	$	13,627	$	15,749	$	1,162	$	196		$	-		$	30,734
Operations and support expenses		8,645		10,762		686		388			-			20,481
Depreciation and amortization expenses		1,490		3,226		159		6			-			4,881
Total segment operating expenses		10,135		13,988		845		394			-			25,362
Segment operating income (loss)		3,492		1,761		317		(198	)		-			5,372
Interest expense		-		-		-		-			851			851
Equity in net income of affiliates		-		9		-		172			-			181
Other income (expense) - net		-		-		-		-			29			29
Segment income before income taxes	$	3,492	$	1,770	$	317	$	(26	)	$	(822	)	$	4,731

For the nine months ended September 30, 2009
					Advertising								Consolidated
	Wireless		Wireline		Solutions		Other			Consolidations			Results
Total segment operating revenues	$	39,687	$	47,900	$	3,622	$	596		$	-		$	91,805
Operations and support expenses		24,959		32,618		2,113		889			-			60,579
Depreciation and amortization expenses		4,493		9,594		501		26			-			14,614
Total segment operating expenses		29,452		42,212		2,614		915			-			75,193
Segment operating income (loss)		10,235		5,688		1,008		(319	)		-			16,612
Interest expense		-		-		-		-			2,573			2,573
Equity in net income of affiliates		-		16		-		532			1			549
Other income (expense) - net		-		-		-		-			44			44
Segment income before income taxes	$	10,235	$	5,704	$	1,008	$	213		$	(2,528	)	$	14,632

AT&T INC.

SEPTEMBER 30, 2010

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 2010.

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. In the following table, gains are denoted with parentheses. A portion of these expenses is 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,
	2010			2009			2010			2009
Pension cost:
Service cost – benefits earned during the period	$	269		$	264		$	807		$	808
Interest cost on projected benefit obligation		787			835			2,362			2,525
Expected return on assets		(1,143	)		(1,140	)		(3,429	)		(3,421	)
Amortization of prior service (benefit) cost		(4	)		7			(12	)		62
Recognized actuarial loss		171			163			513			495
Net pension cost	$	80		$	129		$	241		$	469

Postretirement cost:
Service cost – benefits earned during the period	$	87		$	81		$	261		$	257
Interest cost on accumulated postretirement benefit obligation		564			595			1,693			1,856
Expected return on assets		(284	)		(238	)		(853	)		(716	)
Amortization of prior service benefit		(156	)		(134	)		(469	)		(313	)
Recognized actuarial gain		(2	)		(1	)		(5	)		(1	)
Net postretirement cost	$	209		$	303		$	627		$	1,083

Combined net pension and postretirement cost	$	289		$	432		$	868		$	1,552

Our combined net pension and postretirement cost decreased $143 in the third quarter and $684 for the first nine months of 2010. The decrease was primarily related to lower interest costs due to a lower net obligation, as a result of retiree medical and drug coverage changes, partially offset by a change in the discount rate from 7% to 6.5%. An increase in amortization of prior service benefit, driven by the utilization of market interest rates for lump sum pension distributions, under the Pension Protection Act and changes in future retiree benefits, also contributed to the decrease in combined net pension and postretirement cost. When calculating the expected return on plan assets, we use a method in which gains and losses are amortized only when the net gains or losses exceed 10% of the greater of the projected benefit obligation or the market-related value of assets (MRVA). Actual gains and losses on pension and postretirement plan assets are generally recognized in the MRVA equally over a period of up to five years. However, we use a methodology 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. Due to investment losses on plan assets experienced in 2008, this methodology contributed $1,577 to our combined net pension and postretirement costs in 2009. This methodology did not have a material impact on our combined net pension and postretirement cost in 2010.

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 cost for non-U.S. plans of less than $1 in the third quarter and $1 for the first nine months of 2010 and $(1) in the third quarter and $(4) for the first nine months of 2009.

AT&T INC.

SEPTEMBER 30, 2010

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

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 $41 in the third quarter, of which $34 was interest cost and $125 for the first nine months of 2010, of which $101 was interest cost. In 2009, net supplemental retirement pension benefits cost was $42 in the third quarter, of which $35 was interest cost and $125 for the first nine months, of which $105 was interest cost.

NOTE 6. FAIR VALUE MEASUREMENTS AND DISCLOSURE

The Fair Value Measurement and Disclosure framework provides a three-tiered fair value hierarchy that gives highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:

Level 1	Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets that AT&T has the ability to access.

Level 2	Inputs to the valuation methodology include: · Quoted prices for similar assets and liabilities in active markets. · Quoted prices for identical or similar assets or liabilities in inactive markets. · Inputs other than quoted market prices that are observable for the asset or liability. · Inputs that are derived principally from or corroborated by observable market data by correlation or other means.

	If the asset or liability has a specified (contractual) term, the Level 2 input must be observable for substantially the full term of the asset or liability.

Level 3	Inputs to the valuation methodology are unobservable and significant to the fair value measurement. · Fair value is often based on internally developed models in which there are few, if any, external observations.

The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used should maximize the use of observable inputs and minimize the use of unobservable inputs.

The valuation methodologies described above may produce a fair value calculation that may not be indicative of future net realizable value or reflective of future fair values. AT&T believes its valuation methods are appropriate and consistent with other market participants. The use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date. There have been no changes in the methodologies used at September 30, 2010 and December 31, 2009.

Long-Term Debt and Other 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:

	September 30, 2010						December 31, 2009
	Carrying			Fair			Carrying			Fair
	Amount			Value			Amount			Value
Notes and debentures		$	68,680		$	76,366		$	71,811		$	75,212
Bank borrowings			32			32			33			33
Investment securities			2,233			2,233			1,885			1,885

AT&T INC.

SEPTEMBER 30, 2010

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

The fair values of our notes and debentures were estimated based on quoted market prices, where available. The carrying value of debt with an original maturity of less than one year approximates market value.

Investment Securities

Our investment securities consist of primarily available-for-sale instruments, which include equities, fixed income bonds and other securities. Substantially all the fair values of our available-for-sale securities were estimated based on quoted market prices. Investments in securities not traded on a national securities exchange are valued using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Realized gains and losses on securities are included in “Other income (expense) – net” in the consolidated statements of income using the specific identification method. Unrealized gains and losses, net of tax, on available-for-sale securities are recorded in accumulated other comprehensive income (accumulated OCI). Unrealized losses that are considered other than temporary are recorded in other income (expense) – net. Fixed income investments have maturities of $85 in 2010, $302 in 2011 and 2012, $83 in 2013 and 2014, and $224 for years thereafter.

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

Our investment securities maturing within one year are recorded in “Other current assets,” and instruments with maturities of more than one year are recorded in “Other Assets” on the consolidated balance sheets.

Following is the fair value leveling for available-for-sale securities and derivatives as of September 30, 2010 and December 31, 2009:

	September 30, 2010
	Level 1		Level 2			Level 3		Total
Available-for-Sale Securities
Domestic equities	$	955	$	-		$	-	$	955
International equities		482		-			-		482
Fixed income bonds		-		694			-		694
Asset Derivatives
Interest rate swaps		-		681			-		681
Cross-currency swaps		-		209			-		209
Foreign exchange contracts		-		8			-		8
Liability Derivatives
Cross-currency swaps		-		(706	)		-		(706	)
Interest rate locks		-		(506	)		-		(506	)
Foreign exchange contracts		-		(5	)		-		(5	)

AT&T INC.

SEPTEMBER 30, 2010

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

	December 31, 2009
	Level 1		Level 2			Level 3		Total
Available-for-Sale Securities
Domestic equities	$	1,047	$	-		$	-	$	1,047
International equities		412		-			-		412
Fixed income bonds		-		341			-		341
Asset Derivatives
Interest rate swaps		-		399			-		399
Cross-currency swaps		-		635			-		635
Interest rate locks		-		150			-		150
Foreign exchange contracts		-		2			-		2
Liability Derivatives
Cross-currency swaps		-		(390	)		-		(390	)
Interest rate locks		-		(6	)		-		(6	)
Foreign exchange contracts		-		(7	)		-		(7	)

Derivative Financial Instruments

We employ derivatives to manage certain market risks, primarily interest rate risk and foreign currency exchange risk. This includes the use of interest rate swaps, interest rate locks, foreign exchange forward contracts and combined interest rate foreign exchange contracts (cross-currency swaps). We do not use derivatives for trading or speculative purposes. We record derivatives on our consolidated balance sheets at fair value that is derived from observable market data, including yield curves and foreign exchange rates (all of our derivatives are Level 2). Cash flows associated with derivative instruments are presented in the same category on the consolidated statements of cash flows as the item being hedged.

The majority of our derivatives are designated either as a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedge), or as a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge).

Fair Value Hedging We designate our fixed-to-floating interest rate 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. 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. Accrued and realized gains or losses from interest rate swaps impact interest expense on the consolidated statements of income. Unrealized gains on interest rate swaps are recorded at fair market value as assets, and unrealized losses on interest rate swaps are recorded at fair market value as liabilities. 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, though they net to zero. Gains or losses realized upon early termination of our fair value hedges would be recognized in interest expense.

Cash Flow Hedging Unrealized gains on derivatives designated as cash flow hedges are recorded at fair value as assets, and unrealized losses on derivatives designated as cash flow hedges are recorded at fair value as liabilities, both for the period they are outstanding. For derivative instruments designated as cash flow hedges, the effective portion is reported as a component of accumulated 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 other income - expense in each period.

We designate our 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 quarter. In the nine months ended September 30, 2010 and September 30, 2009, no ineffectiveness was measured.

AT&T INC.

SEPTEMBER 30, 2010

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

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 when 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 second quarter, we settled $200 of notional rate locks without utilizing them in a debt issuance. The total impact to interest expense was $(5). We are confident our remaining rate locks will be utilized given our probable refinancing needs over the next two years. No other ineffectiveness was measured in the nine months ended September 30, 2010. Over the next 12 months, we expect to reclassify $15 from accumulated 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 2012.

We hedge a large portion of the exchange risk involved in anticipation of highly probable foreign currency-denominated transactions. In anticipation of these transactions, we often enter into foreign exchange contracts to provide currency at a fixed rate. Some of these instruments are designated as cash flow hedges while others remain non-designated, 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 an amount is deemed to be ineffective, which would be immediately reclassified to income. In the nine months ended September 30, 2010, and September 30, 2009, no ineffectiveness was measured.

Collateral and Credit-Risk Contingency We have entered into agreements with our derivative counterparties establishing collateral thresholds based on respective credit ratings and netting agreements. At September 30, 2010, we had posted collateral of $53 (a deposit asset) and held collateral of $52 (a receipt liability). Under the agreements, if our credit rating had been simultaneously downgraded one rating level by Moody’s, S&P and Fitch, we would have been required to post additional collateral of $173. At December 31, 2009, we held $222 of counterparty collateral. 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.

Following is the notional amount of our outstanding derivative positions:

	September 30,		December 31,
	2010		2009
Interest rate swaps	$	11,250	$	9,000
Cross-currency swaps		7,502		7,502
Interest rate locks		3,400		3,600
Foreign exchange contracts		233		293
Total	$	22,385	$	20,395

AT&T INC.

SEPTEMBER 30, 2010

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

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

Fair Value of Derivatives in the Consolidated Balance Sheets

Derivatives designated as hedging instruments are reflected as other assets, other liabilities and, for a portion of interest rate swaps, accounts receivable.

	September 30,		December 31,
Asset Derivatives	2010		2009
Interest rate swaps	$	681	$	399
Cross-currency swaps		209		635
Interest rate locks		-		150
Foreign exchange contracts		8		2
Total	$	898	$	1,186

	September 30,			December 31,
Liability Derivatives	2010			2009
Cross-currency swaps	$	(706	)	$	(390	)
Interest rate locks		(506	)		(6	)
Foreign exchange contracts		(5	)		(7	)
Total	$	(1,217	)	$	(403	)

Effect of Derivatives on the Consolidated Statements of Income

	Three months ended								Nine months ended
Fair Value Hedging Relationships	September 30, 2010				September 30, 2009				September 30, 2010				September 30, 2009
Interest rate swaps (Interest expense):
Gain (Loss) on interest rate swaps		$	100			$	79			$	294			$	(141	)
Gain (Loss) on long-term debt			(100	)			(79	)			(294	)			141

In addition, the net swap settlements that accrued and settled in the quarter ended September 30 were also reported as reductions of interest expense.

	Three months ended						Nine months ended
Cash Flow Hedging Relationships	September 30, 2010			September 30, 2009			September 30, 2010			September 30, 2009
Cross-currency swaps:
Gain (Loss) recognized in accumulated OCI	$	(119	)	$	(78	)	$	(443	)	$	485
Other income (expense) reclassified from accumulated OCI into income		1			-			-			-

Interest rate locks:
Gain (Loss) recognized in accumulated OCI		(217	)		(90	)		(650	)		(11	)
Interest income (expense) reclassified from accumulated OCI into income		(5	)		(6	)		(16	)		(17	)

Foreign exchange contracts:
Gain (Loss) recognized in accumulated OCI		23			-			7			-
Other income (expense) reclassified from accumulated OCI into income		(4	)		-			(4	)		-

The balance of the unrealized derivative gain (loss) in accumulated OCI was $(555) at September 30, 2010 and $142 at December 31, 2009.

AT&T INC.

SEPTEMBER 30, 2010

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

NOTE 7. ACQUISITIONS, DISPOSITIONS AND OTHER ADJUSTMENTS

Acquisitions

Wireless Properties Transaction In June 2010, we acquired certain wireless properties, including Federal Communications Commission (FCC) licenses and network assets, from Verizon Wireless for $2,372 in cash and increased goodwill by $937. The assets primarily represent former Alltel Wireless assets and served approximately 1.6 million subscribers in 79 service areas across 18 states. The preliminary fair value of the acquired net assets of $1,435 included $361 of property plant and equipment, $765 of FCC licenses, and $224 of customer lists and other intangible assets.

Dispositions

Sale of Sterling Operations In August 2010, we sold our Sterling subsidiary to International Business Machines Corporation (IBM) for approximately $1,400 in cash. Sterling provides business applications and integration solutions to approximately 18,000 customers worldwide. In conjunction with the sale, we divested of $649 of goodwill and other intangible assets. We also entered into a transition services agreement with IBM related to short-term support of Sterling’s operations after the sale, and an enterprise license agreement, under which we would purchase software from Sterling.

During the second quarter of 2010, we accounted for Sterling as a discontinued operation. We determined that the cash inflows under the transition services agreement and our cash outflows under the enterprise license agreement will not constitute significant continuing involvement with Sterling’s operations after the sale. We have reclassified Sterling’s operating results, for all historical periods, to net income from discontinued operations in the accompanying consolidated statements of income. We also applied held-for-sale treatment to Sterling’s assets and liabilities, and accordingly, included Sterling’s assets in other current assets and the related liabilities in accounts payable and accrued liabilities in our consolidated balance sheets as of December 31, 2009. Sterling’s assets and liabilities included the following as of December 31, 2009:

	December 31, 2009
Assets held for sale:
Current assets	$	333
Property, plant and equipment		40
Goodwill and other intangible assets		672
Other assets		47
Total assets	$	1,092

Liabilities related to assets held for sale:
Current liabilities	$	365
Other liabilities		126
Total liabilities	$	491

AT&T INC.

SEPTEMBER 30, 2010

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

The following table includes Sterling’s operating results, which we historically included in our Other segment, for the indicated periods:

	Three Months Ended				Nine Months Ended
	September 30, 2010		September 30, 2009		September 30, 2010		September 30, 2009
Operating revenues	$	81	$	137	$	349	$	396
Operating expenses		72		121		327		377
Operating income		9		16		22		19
Income before income taxes		8