All variances other than those specifically stated as being due to the ATTC acquisition are related to the operations of traditional SBC.
The increase in long-distance revenues were almost entirely driven by the increase in long-distance customers due to the acquisition of ATTC. Additionally, in-region retail long-distance revenues increased $99 in the first quarter of 2006, reflecting our higher long-distance penetration levels. Sales of combined long-distance and local calling fixed-fee offerings (referred to as “bundling”) also contributed to the increased long-distance revenues and customers. Long-distance revenues continued to increase in our traditional SBC Midwest, West and Southwest regions.
The increase in local voice revenues of $194 in the first quarter primarily reflects our acquisition of ATTC. Our local voice revenue growth will continue to be negatively impacted due to increased competition, including customers shifting to competitors’ wireless, VoIP technology and cable offerings for voice, and the disconnection of additional lines for DSL service and other reasons.
Local voice revenues were negatively impacted by declines in customer demand, calling features, inside wire and retail payphone revenues. The decline in customer demand decreased revenues $88. A decline in demand for calling features (e.g., Caller ID and voice mail), due primarily to the access line declines, decreased revenues approximately $47 in the first quarter of 2006. Lower demand for inside wire and retail payphone services decreased revenues approximately $38 in the first quarter of 2006. We expect payphone access lines and revenue to continue to decline in future periods. Voice revenue was also lower due to receiving a settlement of $32 from another carrier in the first quarter of 2005. We also expect mass-market consumer-based revenues acquired with ATTC to continue to decline on a sequential basis, but will positively contribute to results on a year-over-year basis. Partially offsetting these demand-related declines were revenue increases of $54 related to pricing increases for calling features in the first quarter of 2006.
Lower demand for wholesale services, primarily due to the decline in UNE-P lines provided to competitors, decreased revenue approximately $176 in the first quarter of 2006. Lines provided under the former UNE-P rules (which ended in March 2006) declined, as competitors moved to alternate arrangements to serve their customers or their customers chose an alternative technology. Competitors representing a majority of our UNE-P lines have signed commercial agreements with us and therefore remain our wholesale customers.
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
RESULTS OF OPERATIONS - Continued
For the remaining UNE-P lines, we believe, based on marketing research, that customers primarily switched to competitors using alternative technologies or their own networks as opposed to returning as our retail customers.
Datarevenues increased $2,051, or 85.8%, in the first quarter of 2006, with increases of $779 in Internet Protocol (IP) data, $666 in transport and $606 in packet switched services, which were almost entirely due to the acquisition of ATTC. Revenues from our traditional SBC regions increased approximately 9.0% compared to the first quarter of 2005 and 2.0% sequentially, while pro forma revenues from ATTC’s traditional enterprise categories declined slightly compared to the first quarter of 2005 and sequentially.
Included in IP data revenues are services for dedicated internet access, virtual private network and other hosting services. Contributing to the increase in IP data services was continued growth in DSL, our broadband internet-access service. DSL internet service increased data revenues approximately $103 in the first quarter reflecting an increase in DSL lines in service, which was partially driven by lower-priced promotional offerings and pricing responses to competitors. The number of DSL lines in service grew to approximately 7.4 million, a 32.5% increase from March 31, 2005.
Our transport services, which include DS1s and DS3s (types of dedicated high-capacity lines), and SONET (a dedicated high-speed solution for multi-site businesses), represented about 50% of total data revenues in the first quarter of 2006 and 65% of total data revenues in the first quarter of 2005.
Our packet switched services includes frame relay, asynchronous transfer mode (ATM) and managed packet services. As customers continue to shift from this traditional technology to IP-based technology, we expect these services to decline as a percentage of our overall data revenues.
Otheroperating revenues increased $636 in the first quarter of 2006, primarily due to incremental revenue of $601 from our acquisition of ATTC. The major items included in other operating revenues are integration services and customer premises equipment, outsourcing, directory and operator assistance services and government-related services. Our co-branded AT&T | DISH Network satellite TV service increased revenue $15 in 2006. Partially offsetting these revenue increases were reduced demand for directory and operator assistance, billing and collection services provided to other carriers, wholesale and other miscellaneous products and services, which decreased revenue $42 in 2006.
Cost of salesexpenses increased $2,733 in the first quarter of 2006, primarily related to the acquisition of ATTC, which increased expenses approximately $2,800. Cost of sales consists of costs we incur to provide our products and services, including costs of operating and maintaining our networks. Costs in this category include our repair technicians and repair services, certain network planning and engineering expenses, operator services, information technology, property taxes related to elements of our network, and payphone operations. Pension and postretirement costs, net of amounts capitalized as part of construction labor, are also included to the extent that they are allocated to our network labor force and other employees who perform the functions listed in this paragraph.
27
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
RESULTS OF OPERATIONS - Continued
Traffic compensation expense (for access to another carrier’s network) increased $113 in 2006, due primarily to growth in Yahoo! Inc. and long-distance service and as a result of decreased costs recorded in the first quarter of 2005 related to a carrier settlement. Benefit expenses, consisting primarily of our combined net pension and postretirement cost, increased $35 in 2006, primarily due to changes in our actuarial assumptions, which included the reduction of our discount rate from 6.00% to 5.75%, and net losses on plan assets in prior years. Salary and wage merit increases and other bonus accrual adjustments increased expense $31 in 2006.
Partially offsetting these increases were lower nonemployee-related expenses such as contract services, agent commissions and materials and supplies costs, which decreased $60 in the first quarter of 2006. Lower employee levels decreased expenses, primarily salary and wages, $39 in 2006.
Costs associated with equipment sales and related network integration services decreased $34 in 2006 primarily as a result of the September 2005 amendment of our agreement for our co-branded AT&T | DISH Network satellite TV service. Prior to restructuring our relationship with EchoStar in September 2005, our co-branded AT&T | DISH Network satellite TV service had relatively high initial acquisition costs. Costs associated with equipment for large-business customers (as well as DSL and, previously, video) typically are greater than costs associated with services that are provided over multiple years.
Expenses also decreased in 2006 resulting from repair costs of approximately $100 incurred in the first quarter of 2005 related to severe weather in our traditional SBC regions.
Selling, general and administrativeexpenses increased $1,531 in the first quarter of 2006, primarily due to the ATTC acquisition, which increased expenses approximately $1,250. Selling, general and administrative expenses consist of our provision for uncollectible accounts; advertising costs; sales and marketing functions, including our retail and wholesale customer service centers; centrally managed real estate costs, including maintenance and utilities on all owned and leased buildings; credit and collection functions, and; corporate overhead costs, such as finance, legal, human resources and external affairs. Pension and postretirement costs are also included to the extent they relate to employees who perform the functions listed in this paragraph.
Other wireline segment costs increased $274 in 2006, most of which was advertising related to promotion of the new AT&T name. In addition, advertising expense increased $25 in 2006 primarily driven by our promotion of the Home Turf campaign and sponsorship of the Winter Olympics. Salary and wage merit increases and other bonus accrual adjustments increased expenses $22 in 2006. Benefit expenses, consisting primarily of our combined net pension and postretirement cost, increased $19 in 2006 primarily due to changes in our actuarial assumptions, which included the reduction of our discount rate from 6.00% to 5.75% and net losses on plan assets in prior years. Nonemployee related expenses, such as contract services, agent commissions and materials and supplies costs, increased $30 in 2006.
28
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
RESULTS OF OPERATIONS - Continued
Partially offsetting these increases were lower employee levels, which decreased expenses, primarily salary and wages, $69 in the first quarter of 2006. Our provision for uncollectible accounts decreased $28 in 2006 as we experienced fewer losses from our retail customers and a decrease in bankruptcy filings by our wholesale customers.
Depreciation and amortizationexpenses increased $657 in 2006. Expenses increased $734 due to the acquisition of ATTC, of which $266 related to amortization of intangible assets, primarily customer lists and relationships, identified at the time of the merger. Expenses related to traditional SBC decreased $77 in the first quarter of 2006, due primarily to significantly lower capital expenditures since 2001.
Supplemental Information
Access Line Trends
Following is a summary of our in-region switched access lines at March 31, 2006 and 2005:
In-Region1 | | | |
Switched Access Lines | March 31, | |
| | | Increase |
(in 000’s) | 2006 | 2005 | (Decrease) |
| | | |
Retail Consumer | | | |
Primary | 22,630 | 23,222 | (592) |
Additional | 3,786 | 4,218 | (432) |
Retail Consumer Subtotal | 26,416 | 27,440 | (1,024) |
| | | |
Retail Business | 17,377 | 17,507 | (130) |
Retail Subtotal | 43,793 | 44,947 | (1,154) |
Percent of total switched access lines | 89.8% | 86.7% | |
| | | |
Sold to ATTC | 1,517 | 2,144 | (627) |
Sold to other CLECs2 | 3,150 | 4,359 | (1,209) |
Wholesale Subtotal | 4,667 | 6,503 | (1,836) |
Percent of total switched access lines | 9.6% | 12.5% | |
| | | |
Payphone (Retail and Wholesale) | 308 | 418 | (110) |
Percent of total switched access lines | 0.6% | 0.8% | |
| | | |
Total Switched Access Lines | 48,768 | 51,868 | (3,100) |
| | | |
DSL Lines in Service | 7,432 | 5,608 | 1,824 |
| | | | |
1 In-region represents access lines served by AT&T’s ILECs.
2Competitive local exchange carriers (CLECs)
29
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
RESULTS OF OPERATIONS - Continued
Total in-region switched access lines in service at March 31, 2006 declined 3,100, or 6.0%, from March 31, 2005 levels. Retail access lines, while declining 2.6% from 2005 levels, represent 89.8% of total in-region switched access lines at March 31, 2006, compared to 86.7% a year earlier. During this same period, wholesale lines decreased 28.2% and at March 31, 2006 represented 9.6% of total access lines, down from 12.5% a year earlier.
The decline in total access lines reflects many factors, including the disconnection of additional lines as our existing customers purchase our DSL broadband services and for other reasons, and the continued growth in alternative communication technologies such as wireless, cable and other internet-based systems. However, recently, declines in our retail business access lines have been partially offset by sales of our business internet-based systems (which are reported as data revenues). We do not currently offer a residential internet-based service except in limited areas served by ATTC prior to the acquisition. The decline in our wholesale lines reflects the end of the UNE-P rules in March 2006.
Cingular
Segment Results
| First Quarter | |
| | | | Percent |
| 2006 | 2005 | | Change |
Segment operating revenues | | | | | | | |
Service revenues | $ | 8,005 | $ | 7,419 | | 7.9% | |
Equipment revenues | | 975 | | 810 | | 20.4 | |
Total Segment Operating Revenues | | 8,980 | | 8,229 | | 9.1 | |
Segment operating expenses | | | | | | | |
Cost of services and equipment sales | | 3,647 | | 3,439 | | 6.0 | |
Selling, general and administrative | | 2,846 | | 3,001 | | (5.2) | |
Depreciation and amortization | | 1,680 | | 1,675 | | 0.3 | |
Total Segment Operating Expenses | | 8,173 | | 8,115 | | 0.7 | |
Segment Operating Income | | 807 | | 114 | | - | |
Interest Expense | | 297 | | 338 | | (12.1) | |
Equity in Net Income of Affiliates | | - | | 2 | | - | |
Other – net | | (32) | | 4 | | - | |
Segment Income (Loss) | $ | 478 | $ | (218) | | - | |
Accounting for Cingular
We account for our 60% economic interest in Cingular under the equity method of accounting in our consolidated financial statements since we share control equally (i.e., 50/50) with our 40% economic partner BellSouth Corporation (BellSouth) in the joint venture. We have equal voting rights and representation on the Board of Directors that controls Cingular. This means that our consolidated results include Cingular’s results in the “Equity in net income of affiliates” line. However, when analyzing our segment results, we evaluate Cingular’s results on a stand-alone basis using information provided by Cingular during the year. Accordingly, in our segment presentation, we present 100% of Cingular’s revenues and expenses under “Segment operating revenues” and “Segment operating expenses.” Including 100% of Cingular’s results in our segment operations (rather than 60% in equity in net income of affiliates) affects the presentation of this segment’s revenues, expenses, operating income, nonoperating items and segment income but does not affect our consolidated net income. We discuss Cingular’s liquidity and capital expenditures under the heading “Cingular” within “Liquidity and Capital Resources.”
30
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
RESULTS OF OPERATIONS - Continued
Cingular’s Customer and Operating Trends
As of March 31, 2006, Cingular served approximately 55.8 million cellular/PCS (wireless) customers, compared to 54.1 million at December 31, 2005 and 50.4 million at March 31, 2005. Cingular’s increase in customer gross additions in the first quarter of 2006 compared to the first quarter of 2005 was primarily driven by an increase in reseller and prepaid customer growth, combined with its larger distribution network, broad range of service offerings and advertising over the past year. Cingular’s recent customer activity is listed below:
Wireless Customer Activity
| | Three-Month Period Ended |
(in 000s) | | Mar 31, 2006 | Dec 31, 2005 | Sep 30, 2005 | Jun 30, 2005 | | Mar 31, 2005 | |
Gross additions | | 4,737 | 5,136 | 4,386 | 4,292 | | 4,672 | |
Net additions | | 1,679 | 1,820 | 867 | 952 | | 1,367 | |
Other adjustments1 | | (13) | 32 | (17) | 140 | | (149) | |
Net additions including other adjustments1 | | 1,666 | 1,852 | 850 | 1,092 | | 1,218 | |
| 1 | Other adjustments include customers gained or lost through property divestitures related to the AT&T Wireless Services Inc. (AT&T Wireless) acquisition and other adjustments. |
Competition and the slowing rate of new wireless users as the wireless market matures will continue to impact Cingular’s gross additions and revenue growth, expenses and put pressure on margins. Cingular expects that future revenue growth will become increasingly dependent on minimizing customer turnover (customer churn) and increasing average revenue per user/customer (ARPU).
Cingular’s ARPU has weakened over the past several years as it has offered a broader array of plans to expand its customer base and responded to increasing competition, resulting in pricing reductions. While Cingular’s ARPU has somewhat stabilized recently, Cingular expects continued pressure on ARPU notwithstanding increasing revenue from data services.
Cingular expects its cost of services to continue increasing due to higher network system usage, which includes the costs Cingular is now paying T-Mobile USA (T-Mobile) for the use of its network in California and Nevada, higher costs associated with integrating AT&T Wireless’ network and operations, and, to a lesser extent, increased expenses related to operating, maintaining and decommissioning Time Division Multiple Access (TDMA) networks that duplicated Global System for Mobile Communication (GSM) networks while integrating the networks acquired from AT&T Wireless. Cingular’s remaining purchase commitment to T-Mobile was approximately $409 at March 31, 2006. Operating costs will substantially increase in the event that Cingular’s network expansion in California and Nevada is not completed prior to fulfilling the purchase commitment with T-Mobile. However, this network expansion is proceeding on schedule and Cingular currently expects this network expansion to be completed on time, and as of March 31, 2006, approximately 70% of Cingular’s customers in California and Nevada are now on the Cingular network.
31
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
RESULTS OF OPERATIONS - Continued
ARPU declined 2.3% in the first quarter of 2006. The decline in ARPU was due to a decrease in local service, net roaming revenue and other revenue per customer partially offset by an increase in average data revenue per customer, which increased 41.1%. Local service revenue per customer declined primarily due to an increase in reseller customers which provide significantly lower ARPU than non-reseller customers, and customer shifts to all-inclusive rate plans that offer lower monthly charges, as well as Cingular’s free mobile-to-mobile plans, which allow Cingular customers to call other Cingular customers at no charge and to a lesser extent “rollover” minutes (which allow customers to carry over unused minutes from month to month for up to one year). An increase in customers on rollover plans tends to lower average monthly revenue per customer since unused minutes (and associated revenue) are deferred until subsequent months for up to one year.
The effective management of wireless customer churn is critical to Cingular’s ability to maximize revenue growth and maintain and improve margins. Cingular’s wireless customer churn rate is calculated by dividing the aggregate number of wireless customers (prepaid and postpaid) who cancel service during each month in a period by the total number of wireless customers at the beginning of each month in that period. Cingular’s churn rate was 1.9% in the first quarter of 2006, down from 2.2% in the first quarter of 2005.
The churn rate for Cingular’s postpaid customers was 1.6% in the first quarter of 2006, down from 1.9% in the first quarter of 2005. The decline in postpaid churn reflects benefits from the acquisition of AT&T Wireless, including more affordable rate plans, broader network coverage, higher network quality, exclusive devices and free mobile-to-mobile calling among Cingular’s 55.8 million customers.
Cingular’s Operating Results
Our Cingular segment operating income margin was 9.0% in the first quarter of 2006, which improved over margins of 6.2% in the fourth quarter of 2005 and 1.4% in the first quarter of 2005. The higher margin in the first quarter of 2006 compared to the first quarter of 2005 was primarily due to revenue growth of $751.
Servicerevenues are comprised of local voice and data services, roaming, long-distance and other revenue. Service revenues increased $586, or 7.9%, in the first quarter of 2006 and consisted of:
| • | Local voice revenues increased $339, or 5.5%, in the first quarter primarily due to a 10.5% increase in Cingular’s average number of wireless customers, partially offset by a decline in local service ARPU of 4.5%. |
| • | Data service revenues increased $303, or 53.2%, due to a 41.1% increase in average data revenue per customer and increased use of text messaging and internet access services. Data service revenues represented 9.7% of Cingular’s total revenues in the first quarter. |
| • | Roaming revenues from Cingular customers and other wireless carriers for use of Cingular’s network decreased $32, or 6.9%, in the first quarter. |
| • | Long-distance and other revenue decreased $24, or 11.8%, in the first quarter primarily as a result of a decline in property management revenues, which were partially offset by increased domestic long-distance revenue. |
32
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
RESULTS OF OPERATIONS - Continued
Equipmentrevenues increased $165, or 20.4%, in the first quarter of 2006 due to increased handset revenues primarily as a result of higher priced handsets, partially offset by a decline in gross prepaid customer additions.
Cost of services and equipment sales expenses increased $208, or 6.0%, in the first quarter of 2006 primarily due to increases in network usage and associated network system expansion.
Cost of services increased $176, or 8.2%, in the first quarter of 2006 primarily due to the following:
| • | Increases in network usage with an increase in minutes of use of 22.8% in the first quarter of 2006. |
| • | Higher roaming and long-distance cost, partially offset by declines in Universal Service Fund, regulatory fees and reseller expenses. The reseller decrease resulted from a 43% decrease in minutes of use on the T-Mobile network. |
Equipment sales expense increased slightly in the first quarter of 2006 by $32, or 2.5%, due to handset unit sales associated an increase in the average cost per unit sold of 13.3% due to sales of higher quality handsets for gross customer additions, including exclusive devices, partially offset by a decline in gross prepaid customer additions. Total equipment costs continue to be higher than equipment revenues due to Cingular’s sales of handsets below cost, through direct sales sources, to customers who committed to one-year or two-year contracts or in connection with other promotions, though this difference narrowed compared to the first quarter of 2005.
Selling, general and administrative expenses decreased $155, or 5.2%, in the first quarter of 2006 due to decreases in general and administrative expenses of $123, or 7.1%, and selling expenses of $32, or 2.5%. Selling, general and administrative expenses included integration costs of approximately $46 in the first quarter of 2006 and $102 in the first quarter of 2005, which included employee termination costs, re-branding and advertising of the Cingular and AT&T Wireless combination and customer service and systems integration costs.
Decreases in selling, general and administrative expenses were primarily due to the following:
| • | Other administrative expenses decreased $50 in the first quarter of 2006 primarily due to a decline in employee costs and employee-related benefits due to a decrease in headcount. |
| • | Customer service expenses decreased $46 in the first quarter of 2006 due to a decline in the number of call center outsourced professional services. |
| • | Selling expense decreased $32 mainly from declines of $28 in marketing and advertising and $13 in commissions expense, partially offset by an increase of $9 in sales expense. |
| • | Billing, bad debt and other customer maintenance expense decreased $27 in the first quarter primarily due to fewer account write-offs, cost savings related to transitioning to one billing system, partially offset by an increase in equipment maintenance expenses. |
33
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
RESULTS OF OPERATIONS - Continued
Depreciation and amortization expenses increased $5, or 0.3%, in the first quarter of 2006. Depreciation expense increased $146 in the first quarter of 2006 primarily due to depreciation associated with the property, plant and equipment related to Cingular’s ongoing capital spending associated with its GSM network. Additionally, depreciation expense increased due to accelerated depreciation on certain TDMA network assets based on Cingular’s projected transition of network traffic to GSM technology and accelerated depreciation on certain other network assets. Substantially all of Cingular’s TDMA assets are anticipated to be fully depreciated by the end of 2007.
Amortization expense decreased $141 in the first quarter of 2006 primarily due to the declining amortization of the AT&T Wireless customer contracts and other intangible assets acquired, which are amortized using the sum of the months digits method of amortization.
Directory
Segment Results
| First Quarter | |
| | | | Percent |
| 2006 | 2005 | | Change |
Total Segment Operating Revenues | $ | 923 | $ | 929 | | (0.6)% | |
Segment operating expenses | | | | | | | |
Cost of sales | | 288 | | 280 | | 2.9 | |
Selling, general and administrative | | 159 | | 164 | | (3.0) | |
Depreciation and amortization | | 1 | | 2 | | (50.0) | |
Total Segment Operating Expenses | | 448 | | 446 | | 0.4 | |
Segment Operating Income | | 475 | | 483 | | (1.7) | |
Equity in Net Income (Loss) of Affiliates | | (5) | | (1) | | - | |
Segment Income | $ | 470 | $ | 482 | | (2.5)% | |
Our directory operating income margin was 51.5% in the first quarter of 2006, compared to 52.0% in the first quarter of 2005. See further discussion of the details of our directory segment revenue and expense fluctuations below.
Operating revenues decreased $6, or 0.6%, in the first quarter of 2006. Revenues in 2006 decreased primarily as a result of decreased demand for local Yellow Pages advertising which was partially offset by increased internet advertising revenues. These results reflect the impact of competition from other publishers, other advertising media and continuing economic pressures on advertising customers.
34
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
RESULTS OF OPERATIONS - Continued
Cost of salesincreased $8, or 2.9%, in the first quarter of 2006. The increase was driven by higher costs for internet traffic, publishing and commissions.
Selling, general and administrative expenses decreased $5, or 3%, in the first quarter of 2006 primarily due to lower bad debt expense, partially offset by increased other directory segment costs, including benefits.
Other
Segment Results
| First Quarter |
| | | | Percent | |
| 2006 | 2005 | | Change | |
Total Segment Operating Revenues | $ | 203 | $ | 169 | | 20.1% |
Total Segment Operating Expenses | | 239 | | 212 | | 12.7 |
Segment Operating Income (Loss) | | (36) | | (43) | | 16.3 |
Equity in Net Income (Loss) of Affiliates | | 339 | | (58) | | - |
Segment Income (Loss) | $ | 303 | $ | (101) | | - |
| | | | | | | | | |
Our other segment operating results in the first quarter of 2006 and 2005 consist primarily of Sterling, corporate and other operations. Sterling provides business integration software and services.
Operating revenues increased $34 in the first quarter of 2006 primarily due to increased operating revenue at Sterling.
Operating expenses increased $27 in the first quarter of 2006 primarily due to increased corporate expenses (including) advertising costs and incremental ATTC corporate expenses) and increased operating expenses at Sterling, partially offset by management fees paid in 2005 that did not recur in 2006.
35
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
RESULTS OF OPERATIONS - Continued
Our other segment includes our equity investments in international companies, the income from which we report as equity in net income of affiliates. Our earnings from foreign affiliates are sensitive to exchange-rate changes in the value of the respective local currencies. Our foreign investments are recorded under GAAP, which include adjustments for the purchase method of accounting and exclude certain adjustments required for local reporting in specific countries. Our other segment also includes our 60% proportionate share of Cingular’s results as equity in net income of affiliates. Our equity in net income of affiliates by major investment is listed below:
| | First Quarter |
| | 2006 | | 2005 |
Cingular | $ | 213 | $ | (144) |
Telmex | | 61 | | 51 |
América Móvil | | 55 | | 27 |
Other | | 10 | | 8 |
Other Segment Equity in Net Income (Loss) of Affiliates | $ | 339 | $ | (58) |
Equity in net income of affiliates increased $397 in the first quarter of 2006. The increase was primarily due to an increase of $357 in our proportionate share of Cingular’s results. Also contributing to the increase was increased equity income of $38 from Telmex and América Móvil reflecting higher revenue levels at both companies including significant increases in wireless subscribers at América Móvil.
36
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
COMPETITIVE AND REGULATORY ENVIRONMENT
OverviewAT&T subsidiaries operating outside the U.S. are subject to the jurisdiction of national regulatory authorities in the market where service is provided, and regulation is generally limited to operational licensing authority for the provision of enterprise (i.e., large business) services. Subsidiaries operating within the U.S. are subject to federal and, to a lesser extent, state regulatory authorities. In the Telecommunications Act of 1996 (Telecom Act), Congress established a pro-competitive, deregulatory national policy framework to bring the benefits of competition and investment in advanced telecommunications facilities and services to all Americans by opening all telecommunications markets to competition and reducing or eliminating burdensome regulation. Since the Telecom Act was passed, the Federal Communications Commission (FCC) and some state regulatory commissions have maintained many of the extensive regulatory requirements applicable to our traditional wireline subsidiaries.
We are actively pursuing additional legislative and regulatory measures to reduce or eliminate regulatory requirements that inhibit our ability to provide the full range of services increasingly demanded by our customers. For example, we are supporting legislative efforts at both the state and federal levels, as well as proposed rules at the FCC, that would offer a streamlined process for new video service providers to compete with traditional cable television providers. During 2006, Indiana and Kansas passed legislation that enables new video entrants to acquire a state-wide franchise to offer video services, see “Video Legislation” below. In addition, we are supporting efforts to update regulatory treatment for retail services. Several bills are also pending before Congress that would both reform the Telecom Act and promote additional video competition. Passage of legislation is uncertain and depends on many factors, but we believe that the increasing pace of technological change and competition in our industry will encourage lawmakers to remove artificial barriers to competition.
Triennial Review Remand Order Effective March 11, 2005, the Triennial Review Remand Order (TRRO) eliminated our obligation to provide local switching and hence the UNE-P, for mass-market customers, subject to a 12-month transition period. Since this transition period started, our wholesale customers representing a majority of our UNE-P lines have signed commercial agreements with us. For the remaining UNE-P lines, we believe, based on marketing research, that customers primarily converted to competitors using alternative technologies or their own networks as opposed to returning as our retail customers. At the March 11, 2006 transition deadline we re-priced to market-based or resale-like rates any UNE-P lines that had not been converted, except in the state of Illinois where competitive local exchange carriers have the right under state law to retain the lines that are in service at UNE-P equivalent rates. We had less than 100,000 UNE-P lines in Illinois as of March 11, 2006.
Video LegislationIn March 2006, Indiana passed a state telecommunications deregulation bill that will make it easier for telecommunications companies to offer television service. The law prohibits the regulation of advanced services, broadband services, information services and retail IP enabled service, commercial mobile service and new services (any service not commercially available on March 28, 2006), and deregulates prices for basic telecommunications service after a three-year transition period. It also creates statewide video franchising to replace individual local agreements.
In April 2006, Kansas passed a state video franchise bill that will allow video providers to be granted statewide authorization and to avoid city-by-city franchise negotiations. The bill specifically lists wireline,
37
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in Millions except per share amounts
COMPETITIVE AND REGULATORY ENVIRONMENT – Continued
wireless, satellite or any other alternative technology as acceptable mediums for providing service to customers, and states that video providers will not be required to comply with mandatory facility build-out provisions nor provide video service to any customer using a specific technology.
Number Portability Since 1999, customers have been able to retain their numbers when switching their local service between wireline companies. The FCC allowed incumbent local exchange companies including SBC’s traditional wireline subsidiaries, to recover their carrier-specific costs of implementing wireline number portability through customer charges over a five-year term based on an estimated number of customers over that term. Because of the downturn in the telecommunications market since 1999, which led to fewer access lines, many companies, including the SBC subsidiaries, had fewer customers than were estimated and were therefore unable to fully recover their number portability implementation costs. Accordingly, in February 2005, we asked the FCC to waive the five-year limitation on recovery of number portability costs and, in March 2006, we asked the Commission, in the alternative, to allow us to include our remaining, unrecovered number portability costs through the existing End User Common Line charge. If our request is granted, we will be able to recover approximately $190 of those costs.
38
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
OTHER BUSINESS MATTERS
Pending Acquisition of BellSouthOn March 4, 2006, we agreed to acquire BellSouth in a transaction in which each share of BellSouth common stock will be exchanged for 1.325 shares of AT&T common stock. Based on the average closing price of AT&T shares for the two days prior to, including, and two days subsequent to the public announcement of the merger (March 5, 2006) of $27.32, the total transaction is valued, for purchase accounting purposes, at approximately $65,000. The transaction has been approved by the Board of Directors of each company and also must be approved by the stockholders of AT&T and BellSouth. The transaction is also subject to review by the U.S. Department of Justice (DOJ) and approval by the FCC and various other regulatory authorities. We currently expect the transaction to close by the end of 2006.
Project LightspeedIn June 2004, we announced key advances in developing a network capable of delivering a new generation of integrated digital television, high-speed broadband and VoIP services to our residential and small-business customers, referred to as Project Lightspeed. We have been building out this network in numerous locations and began providing services, including IP video, in one limited market, in late 2005. Our goal in this controlled market entry is to fully apply our new operating and back-office systems, gain information on customer preferences and, if needed, to fine-tune the service. To that end, we have restricted the number of customers and services offered to the necessary minimum. Subject to successful results from this controlled market entry and successful testing of our additional IP video services, we plan to enter 15 to 20 additional markets by the end of 2006. During that expansion, we expect to add additional features to our IP video service offering. We expect to have the capability to offer service to approximately 18 million households by the end of 2008, as part of our initial deployment, and expect to spend approximately $4,400 in network-related deployment costs and capital expenditures beginning in 2006 through 2008, as well as additional success-based customer activation capital expenditures.
With respect to our IP video service, we continue to work with our vendors to develop, in a timely manner, the requisite hardware and software technology. Our deployment plans could be delayed if we do not receive required equipment and software on schedule. We also continue to negotiate with programming owners (e.g., movie studios and cable networks) for permission to offer existing television programs and movies and, if applicable, other new interactive services that we could offer in the future using advances in the IP technology. Our ability to provide an attractive and profitable video offering will depend in large part on the results of these efforts. Also, as discussed in the “Competitive and Regulatory Environment” section, we are supporting legislation at both the federal and state levels that would streamline the regulatory process for new video competitors to enter the market.
We believe that Project Lightspeed is subject to federal oversight as a “video service” under the Federal Communications Act. However, some cable providers and municipalities have claimed that certain IP services should be treated as a traditional cable service and therefore subject to the applicable state and local regulation, which could include the requirement to pay fees to obtain local franchises for our IP video service. If the courts were to decide that state and local regulation were applicable to our Project Lightspeed services, it could have a material adverse effect on the cost, timing and extent of our deployment plans.
39
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
OTHER BUSINESS MATTERS - Continued
Antitrust LitigationIn 2002, two consumer class-action antitrust cases were filed in the United States District Court for the Southern District of New York (District Court) against SBC, Verizon Communications Inc., BellSouth and Qwest Communications International Inc. alleging that they have violated federal and state antitrust laws by agreeing not to compete with one another and acting together to impede competition for local telephone services (Twombly v. Bell Atlantic Corp., et al.). In October 2003, the District Court granted the joint defendants’ motion to dismiss and the plaintiffs appealed. In October 2005, the United States Court of Appeals for the Second Circuit Court (Second Circuit) reversed the District Court, thereby allowing the cases to proceed. The Second Circuit noted in its decision that its ruling was procedural in nature and did not address the merits of the cases. Motions for rehearing and rehearing en banc were denied on January 3, 2006, and the case has now been remanded to the District Court for further proceedings.On remand, we have moved for partial dismissal on alternative grounds. In addition, Defendants filed a Petition for Writ of Certiorari with the Supreme Court of the United States on March 6, 2006. We continue to believe that an adverse outcome having a material effect on our financial statements in these cases is unlikely but will continue to evaluate the potential impact of these suits on our financial results as they progress.
AT&T Wireless Litigation Several class-action lawsuits have been filed in the District Court against ATTC asserting claims under the federal securities laws in connection with the offering of AT&T Wireless tracking stock in April 2000 (In re AT&T Corp. Securities Litigation). The plaintiffs have demanded damages in excess of $2,100 related to the offering of AT&T Wireless tracking stock. In April 2006, the parties agreed to settle the litigation for $150, pending approval by the trial court. In connection with the split-off of AT&T Wireless, certain provisions of the separation agreement between AT&T Wireless and ATTC result in Cingular, due to its acquisition of AT&T Wireless, being allocated 70% of any liabilities arising out of these actions to the extent they relate to AT&T Wireless tracking stock, with the remaining liability being allocated equally between ATTC and Comcast Cable Communications, Inc. Accordingly, the settlement, if approved by the court, would not result in any additional expenses being accrued by Cingular or ATTC.
Retiree Phone Concession LitigationIn May 2005, we were served with a purported class action in U.S. District Court, Western District of Texas (Stoffels v. SBC Communications Inc.), in which the plaintiffs, who are retirees of Pacific Bell Telephone Company, Southwestern Bell, and Ameritech, contend that the telephone concession provided by the company is, in essence, a “defined benefit plan” within the meaning of the Employee Retirement Income Security Act of 1974 (ERISA). Plaintiffs seek to certify a class of persons that are either (1) retirees of an SBC company who were receiving a telephone concession after they retired from January 1, 2002 to the present and who lived outside the SBC service area; or (2) current or former employees of any SBC participating company with more than five years of service with an SBC participating company as of June 1, 2005 who were eligible or who might become eligible to receive an out-of-franchise telephone concession after they retired; or (3) members of the immediate family of any person in Group 1 or Group 2, including surviving spouses and the retiree dependents (and including registered domestic partners of Pacific Telesis employees and retirees) during the time that SBC had a policy to provide employees of such participating companies with a telephone concession after retirement. Plaintiffs seek reformation of the out-of-region phone concession offered under the postemployment benefits plan (the Plan) and the documents
40
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
OTHER BUSINESS MATTERS - Continued
governing it to comply with ERISA, an order requiring us to fund the Plan as reformed, the appointment of an independent fiduciary to administer the Plan, an order requiring the Plan to pay benefits to plaintiffs and other class members consistent with the terms of the plan, civil penalties and attorneys’ fees and costs pursuant to ERISA. We filed a Motion to Dismiss for failure to state a claim, which was denied by the U.S. District Court, Western District of Texas on February 3, 2006. The case has been set for trial on September 25, 2006. We believe that an adverse outcome having a material effect on our financial statements in this case is unlikely, but will continue to evaluate the potential impact of this suit on our financial results as it progresses.
Hepting LitigationPlaintiffs filed this purported class action in U.S. District Court in the Northern District of California on behalf of “all individuals in the United States that are current residential subscribers or customers of defendants’ telephone services or internet services, or that were residential telephone or internet subscribers or customers at any time after September 2001,”(Hepting, et al v. AT&T Corp., AT&T Inc. and Does 1-20). They allege that the defendants have provided and continue to provide the U.S. Government with direct access to databases containing its stored telephone and internet records, and have disclosed and are currently disclosing to the U.S. Government records concerning communications to which Plaintiffs and class members were a party. Plaintiffs seek damages, a declaratory judgment, and injunctive relief for violations of the First and Fourth Amendments to the United States Constitution, the Foreign Intelligence Surveillance Act, the Electronic Communications Privacy Act, and other federal and California statutes. In April 2006, we filed a Motion to Dismiss the complaint.
41
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
ACCOUNTING POLICIES AND STANDARDS
Pension and Other Postemployment Benefit PlansOn March 31, 2006, the Financial Accounting Standards Board (FASB) issued the exposure draft “Employers’ Accounting for Defined Benefit Pension and Other Postemployment Benefit Plans, an amendment of FASB Statements 87, 88, 106, and 132(R).” The exposure draft is phase one of the FASB’s stated intent to reform the pension and other postretirement accounting and reporting standards and, if adopted in its current form, would (1) require companies to recognize the current economic status on the balance sheet (whether over funded or under funded for GAAP purposes but not for ERISA purposes), (2) require plan obligations to be measured as of the date of the employer’s statement of financial position (which we currently do) and (3) require adoption for fiscal years ending after December 15, 2006, which would affect our year-end 2006 reporting. This exposure draft is subject to a public comment period ending May 31, 2006 and further review and amendment by the FASB; it is uncertain what the requirements of a final statement would be, when issued. However, had this exposure draft 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.
42
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
LIQUIDITY AND CAPITAL RESOURCES
We had $1,057 in cash and cash equivalents available at March 31, 2006. Cash and cash equivalents included cash of $611, money market funds of $335 and other cash equivalents of $111. Cash was used to meet the financing needs of the business including, but not limited to, payment of operating expenses, funding capital expenditures, dividends to stockholders, funding of Cingular’s capital and operating requirements in accordance with the terms of our agreement with Cingular and BellSouth, tax-related payments and debt repayments. We discuss many of these factors in detail below.
Cash Provided by Operating Activities
During the first quarter of 2006, our primary source of funds was cash from operating activities of $2,458 compared to $1,253 in the first quarter of 2005. Operating cash flows increased in the first quarter of 2006 compared to 2005 primarily due to lower tax payments in the first quarter of 2006 of approximately $573 and the additional cash from operations related to our acquisition of ATTC. Included in the lower tax payment amount is a refund received from the completion of the ATTC federal income tax audit covering 1997 – 2001. The 2005 and 2006 tax payments include amounts related to prior year accrued liabilities. The timing of cash payments for income taxes, which is governed by the Internal Revenue Service and other taxing jurisdictions, will differ from the timing of recording tax expense and deferred income taxes, which are reported in accordance with GAAP. We also made advance tax payments in 2005, which we consider to be a refundable deposit, to a certain state jurisdiction. These payments were made in order to avoid potentially onerous interest and penalties. The issues involved are in dispute and we intend to pursue all procedural options available to us in order to obtain refunds of the amounts deposited. We do not anticipate 2006 cash payments for income taxes to exceed reported income tax expense.
Cash Used in Investing Activities
In the first quarter of 2006, cash used for investing activities consisted of:
| • | $1,821 in construction and capital expenditures. |
| • | $699 of funding of Cingular’s capital and operating requirements in accordance with the terms of our agreement with Cingular and BellSouth. See our “Cingular” section below for details. |
| • | $62 related to an investment in 2Wire Inc., a privately held company that provides services related to Project Lightspeed. |
In the first quarter of 2006, cash provided by our investing activities of $27 was related to the sale of Covad shares and other assets.
To provide high-quality communications services to our customers, we must make significant investments in property, plant and equipment. The amount of capital investment is influenced by demand for services and products, continued growth and regulatory considerations. Our capital expenditures totaled $1,821 in the first quarter of 2006 and $1,050 in the first quarter of 2005. Capital expenditures in the wireline segment, which represented substantially all of our capital expenditures, increased 72.0% in the first quarter of 2006 compared to the first quarter of 2005 and was impacted by the acquisition of ATTC. Our first quarter capital expenditures were used primarily for our wireline subsidiaries’ networks (including ATTC), Project Lightspeed and support systems for our long-distance service.
43
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
LIQUIDITY AND CAPITAL RESOURCES – Continued
Because of opportunities made available by the continued changing regulatory environment and our acquisition of ATTC, we expect that our capital expenditures in 2006, which includes Project Lightspeed and excludes Cingular, will be in the target range of between $8,000 and $8,500. We expect to spend approximately $4,400 on our Project Lightspeed initiative for network related deployment costs and capital expenditures through 2008, as well as additional success-based customer activation capital expenditures. We expect that the business opportunities made available, specifically in the data/broadband area, will allow us to expand our products and services (see “Project Lightspeed” discussed in “Other Business Matters”).
We expect to fund 2006 capital expenditures for our wireline segment, which includes international operations, using cash from operations and incremental borrowings, depending on interest rate levels and overall market conditions. Substantially all of our capital spending in 2006 will relate to our wireline segment and will be used primarily for our subsidiaries’ networks, Project Lightspeed and merger-integration projects. The other segment capital expenditures were less than 2.0% of total capital expenditures in the first quarter of 2006. Included in the other segment are equity investments, which should be self-funding as they are not direct AT&T operations, as well as corporate and Sterling operations. We expect to fund any directory segment capital expenditures using cash from operations. We discuss our Cingular segment below.
Cash Used in Financing Activities
We plan to fund our 2006 financing activities primarily through cash from operations. We will continue to examine opportunities to fund our activities with cash from the disposition of certain assets and other investments as well as issuing debt at favorable rates in order to refinance some of our debt maturities in 2006.
We paid dividends of $1,289 in the first quarter of 2006 compared to $1,066 in the first quarter of 2005, reflecting the issuance of additional shares for the ATTC acquisition and a dividend increase. Dividends declared by our Board of Directors totaled $0.3325 per share in the first quarter of 2006 and $0.3225 per share in the first quarter of 2005. In December 2005, our Board of Directors approved a 3.1% increase in the regular quarterly dividend to $0.3325 per share. Our dividend policy considers both the expectations and requirements of stockholders, internal requirements of AT&T and long-term growth opportunities. It is our intent to provide the financial flexibility to allow our Board of Directors the opportunity to continue our historical approach to dividend growth. All dividends remain subject to approval by our Board of Directors.
Our Board of Directors authorized the repurchase of up to 400 million shares of our common stock; this authorization expires at the end of 2008. Under this repurchase program we expect to purchase approximately $2,000 of additional shares under our repurchase program in the remainder of 2006 and $8,000 during 2007. We did not repurchase any shares in the first quarter of 2006.
At March 31, 2006 we had $5,712 of debt maturing within one year, which includes $4,015 of long-term debt maturities during 2006, $1,627 of commercial paper borrowings and $70 of bank borrowings relating to foreign subsidiaries of ATTC. Included in our long-term debt maturities was the purchase accounting
44
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
LIQUIDITY AND CAPITAL RESOURCES – Continued
fair value debt adjustment applicable to the acquisition of ATTC. All of our commercial paper borrowings are due within 90 days. The bank borrowings availability is contingent on the level of cash held by some of our foreign subsidiaries. We continue to examine our mix of short- and long-term debt in light of interest rate trends.
During the first quarter of 2006, debt repayments totaled $261 and consisted of:
| • | $254 related to debt maturities with interest rates ranging from 5.875% to 6.96%. |
| • | $7 related to scheduled principal payments on other debt and short-term borrowings. |
At March 31, 2006, our debt ratio was 36.4% compared to our debt ratio of 40.2% at March 31, 2005. The decrease was primarily due to our acquisition of ATTC in the fourth quarter of 2005, which increased stockholders’ equity by more than $14,500 compared to the first quarter of 2005, partially offset by ATTC debt we now reflect on our balance sheet following the acquisition. Our debt ratio at December 31, 2005 was 35.9%. The increase in the debt ratio from year-end is due to a net increase in debt of more than $900 in the first quarter of 2006, including net advances to Cingular and refinancing of debt, which was partially offset by an increase in stockholders’ equity.
We have a 3-year credit agreement totaling $6,000 with a syndicate of banks, which expires on October 18, 2007. Advances under this agreement may be used for general corporate purposes, including support of commercial paper borrowings and other short-term borrowings. There is no material adverse change provision governing the drawdown of advances under this credit agreement. We are in compliance with all covenants under the agreement. We had no borrowings outstanding under committed lines of credit as of March 31, 2006.
Pending Acquisition of BellSouth
On March 4, 2006, we agreed to acquire BellSouth in a transaction in which each share of BellSouth common stock will be exchanged for 1.325 shares of AT&T common stock. Based on the average closing price of AT&T shares for the two days prior to, including, and two days subsequent to the public announcement of the merger (March 5, 2006) of $27.32, the total transaction is valued, for purchase accounting purposes, at approximately $65,000.
Cingular
The upgrade, integration and expansion of the Cingular and AT&T Wireless networks and the networks acquired in a transaction with Triton PCS Holdings, Inc. will continue to require substantial amounts of capital over the next several years. As of March 31, 2006, Cingular has spent $1,441 primarily for GSM/GPRS/EDGE network upgrades with cash from operations, dispositions and, as needed, advances under the revolving credit agreement mentioned below. Cingular expects to fund its capital requirements in 2006 from existing cash balances, cash generated from operations and, if necessary, drawing under the revolving credit agreement. In 2006, Cingular expects to spend within a target range of between $7,000 and $7,500 primarily for the upgrade, integration and expansion of its networks, the installation of UMTS/HSDPA technology in a number of markets and the construction and upgrade of network facilities in California and Nevada following the sale of duplicate facilities to T-Mobile upon the termination of Cingular’s GSMF network infrastructure joint venture.
45
AT&T INC.
MARCH 31, 2006
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
LIQUIDITY AND CAPITAL RESOURCES – Continued
Cingular’s cash requirements may increase if they participate in the upcoming FCC spectrum auction and are successful in bidding.
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 includes a provision 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. During the first quarter of 2006 we made net advances to Cingular of $699 under the revolving credit agreement. These amounts increased the outstanding amount of advances made to Cingular to a total of $1,006 at March 31, 2006 from $307 at December 31, 2005 and are reflected in “Investments in and Advances to Cingular Wireless” on our Consolidated Balance Sheets.
46
AT&T INC.
MARCH 31, 2006
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Dollars in millions
At March 31, 2006, we had interest rate swaps with a notional value of $4,250 and a fair value liability of approximately $70.
Item 4. Controls and Procedures
The registrant maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed by the registrant is recorded, processed, summarized, accumulated and communicated to its management, including its principal executive and principal financial officers, to allow timely decisions regarding required disclosure, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. The chief executive officer and chief financial officer have performed an evaluation of the effectiveness of the design and operation of the registrant’s disclosure controls and procedures as of March 31, 2006. Based on that evaluation, the chief executive officer and chief financial officer concluded that the registrant’s disclosure controls and procedures were effective as of March 31, 2006.
47
AT&T INC.
MARCH 31, 2006
CAUTIONARY LANGUAGE CONCERNING FORWARD-LOOKING STATEMENTS
Information set forth in this report contains forward-looking statements that are subject to risks and uncertainties, and actual results could differ materially. Many of the factors listed here are discussed in more detail in the “Risk Factors” section in our Annual Report on Form 10-K and updated in the “Risk Factors” section below. We claim the protection of the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995.
The following factors could cause our future results to differ materially from those expressed in the forward-looking statements:
• | Adverse economic changes in the markets served by us or in countries in which we have significant investments. |
• | Changes in available technology and the effects of such changes including product substitutions and deployment costs. |
• | Increases in our benefit plans’ costs including increases due to adverse changes in the U.S. securities markets, resulting in worse-than-assumed investment returns and discount rates, and adverse medical cost trends. |
• | The final outcome of Federal Communications Commission proceedings and reopenings of such proceedings and judicial review, if any, of such proceedings, including issues relating to access charges, broadband deployment, availability and pricing of unbundled network elements and platforms (UNE-Ps) and unbundled loop and transport elements. |
• | The final outcome of regulatory proceedings in the states in which we operate and reopenings of such proceedings, and judicial review, if any, of such proceedings, including proceedings relating to interconnection terms, access charges, universal service, UNE-Ps and resale and wholesale rates, broadband deployment including Project Lightspeed, performance measurement plans, service standards and traffic compensation. |
• | Enactment of additional state, federal and/or foreign regulatory and tax laws and regulations pertaining to our subsidiaries and foreign investments. |
• | Our ability to absorb revenue losses caused by increasing competition, including offerings using alternative technologies (e.g., cable, wireless and VoIP), and our ability to maintain capital expenditures. |
• | The extent of competition and the resulting pressure on access line totals and wireline and wireless operating margins. |
• | Our ability to develop attractive and profitable product/service offerings to offset increasing competition in our wireline and wireless markets. |
• | The ability of our competitors to offer product/service offerings at lower prices due to lower cost structures and regulatory and legislative actions adverse to us, including state regulatory proceedings relating to UNE-Ps and nonregulation of comparable alternative technologies (e.g., VoIP). |
• | The timing, extent and cost of deployment of our Project Lightspeed initiative; the development of attractive and profitable service offerings; the extent to which regulatory, franchise fees and build-out requirements apply to this initiative, and; the availability, cost and/or reliability of the various technologies and/or content required to provide such offerings. |
• | The issuance by the Financial Accounting Standards Board or other accounting oversight bodies of new accounting standards or changes to existing standards. |
• | The issuance by the Internal Revenue Service and/or state tax authorities of new tax regulations or changes to existing standards and actions by federal, state or local tax agencies and judicial authorities |
48
AT&T INC.
MARCH 31, 2006
CAUTIONARY LANGUAGE CONCERNING FORWARD-LOOKING STATEMENTS - Continued
with respect to applying applicable tax laws and regulations; and the resolution of disputes with any taxing jurisdictions.
• | The impact of the wireless joint venture with BellSouth, known as Cingular, including: marketing and product-development efforts; customer acquisition and retention costs; access to additional spectrum; network upgrades; technological advancements; industry consolidation, including the acquisition of AT&T Wireless, and; availability and cost of capital. |
• | Cingular’s failure to achieve, in the amounts and within the time frame expected, the capital and expense synergies and other benefits expected from its acquisition of AT&T Wireless. |
• | The impact of our pending acquisition of BellSouth, including our ability to obtain shareholder and governmental approvals of the acquisition on the proposed terms and schedule; the risk that the businesses will not be integrated successfully; the risk that the cost savings and any other synergies from the acquisition may take longer to realize than expected or may not be fully realized; and the disruption from the acquisition making it more difficult to maintain relationships with customers, employees or suppliers. |
• | The impact of our acquisition of ATTC, including the risk that the businesses will not be integrated successfully; the risk that the cost savings and any other synergies from the acquisition may not be fully realized or may take longer to realize than expected; disruption from the integration process making it more difficult to maintain relationships with customers, employees or suppliers; and competition and its effect on pricing, spending, third-party relationships and revenues. |
• | Changes in our corporate strategies, such as changing network requirements or acquisitions and dispositions, to respond to competition and regulatory, legislative and technological developments. |
Readers are cautioned that other factors discussed in this report, although not listed here, also could materially affect our future earnings.
49
AT&T INC.
MARCH 31, 2006
PART II - OTHER INFORMATION
Dollars in millions except per share amounts
Item 1A. Risk Factors
We discuss in our Annual Report on Form 10-K various risks that may materially affect our business. We use this section to update this discussion to reflect material developments since our Form 10-K was filed.
The impact of our pending acquisition of BellSouth, including our ability to obtain shareholder and governmental approvals of the acquisition on the proposed terms and schedule; the risk that the businesses will not be integrated successfully; the risk that the cost savings and any other synergies from the acquisition may take longer to realize than expected or may not be fully realized; and disruption from the acquisition making it more difficult to maintain relationships with customers, employees or suppliers.
We agreed to acquire BellSouth in order to streamline the ownership and operations of Cingular and combine the Cingular, BellSouth and AT&T IP networks into a single IP network; to speed the deployment, and at lower cost, of next-generation IP video and other services; to provide business customers with the benefits of combining AT&T’s national and international networks and services with BellSouth’s local exchange and broadband services; and to create potential cost savings, technological development and other benefits. Achieving these results will depend in part on successfully integrating three large corporations, which could involve significant management attention and create uncertainties for employees; additionally, we and Cingular are already in the process of integrating previous acquisitions. Uncertainty among employees could adversely affect the ability of AT&T, BellSouth and Cingular to attract and retain key employees. Diversion of attention from ongoing operations on the part of management and employees could adversely affect our customers, suppliers and other parties with whom we have relationships. While the merger is pending, customers and strategic partners may delay or defer decisions to use services of each of the three companies, which could adversely affect the revenues and earnings of each company as well as the market prices of AT&T and BellSouth common shares. We also expect to incur substantial expenses related to the integration of these companies. We must integrate a large number of systems, both operational and administrative. These integration expenses may result in our taking significant charges against earnings, both cash and non-cash, primarily from the amortization of intangibles. Delays in this process could have a material adverse effect on our revenues, expenses, operating results and financial condition. In addition, events outside of our control, including changes in state and federal regulation and laws as well as economic trends, also could adversely affect our ability to realize the expected benefits from this acquisition.
Item 2. Unregistered Sales of Securities and Use of Proceeds
(a) | During the first quarter of 2006, non-employee directors acquired from AT&T shares of common stock pursuant to AT&T’s Non-Employee Director Stock and Deferral Plan. Under the plan, a director may make an annual election to receive all or part of his or her: (1) annual retainer in the form of AT&T shares or deferred stock units (DSUs) and (2) fees in the form of DSUs. DSUs are convertible into AT&T shares. Also under the plan, each Director will receive an annual grant of DSUs during the second quarter. In the first quarter an aggregate of 13,551 AT&T shares and DSUs were acquired by non-employee directors at prices ranging from $25.95 to $27.59, in each case the fair market value of the shares on the date of acquisition. The issuances of shares and DSUs were exempt from registration pursuant to Section 4(2) of the Securities Act. |
50
AT&T INC.
MARCH 31, 2006
Item 6. Exhibits
Exhibits identified in parentheses below, on file with the Securities and Exchange Commission (SEC), are incorporated by reference as exhibits hereto. Unless otherwise indicated, all exhibits so incorporated are from File No. 1-8610.
2 | Agreement and Plan of Merger, dated as of March 4, 2006, among BellSouth Corporation, AT&T Inc. and ABC Consolidation Corp. (Exhibit 2.1 to Form 8-K dated March 4, 2006.) |
3-a | Restated Certificate of Incorporation, filed with the Secretary of State of Delaware on November 18, 2005. (Exhibit 3-a to Form 8-K dated November 18, 2005.) |
3-b | Certificate of Amendment to the Restated Certificate of Incorporation, filed with the state of Delaware on May 3, 2006. (Exhibit 3-b to Form 8-K dated April 28, 2006.) |
3-c | Bylaws amended May 3, 2006. (Exhibit 3-c to Form 8-K dated April 28, 2006.) |
10-cc | Stock Purchase and Deferral Plan. |
10-dd | Cash Deferral Plan. |
12 | Computation of Ratios of Earnings to Fixed Charges |
31 | Rule 13a-14(a)/15d-14(a) Certifications 31.1 Certification of Principal Executive Officer 31.2 Certification of Principal Financial Officer |
32 | Section 1350 Certifications |
51
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
May 5, 2006 | /s/Richard G. Lindner |
| Richard G. Lindner |
| Senior Executive Vice President |
and Chief Financial Officer
