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Executives

Brooks McCorcle - Senior Vice President of Investor Relations

Richard G. Lindner - Chief Financial Officer, Senior Executive Vice President

Ralph De La Vega - President and Chief Executive Officer - AT&T Mobility

Analysts

David Barden - Banc of America

John Hodulik - UBS

Simon Flannery - Morgan Stanley

Craig E. Moffett - Sanford C. Bernstein

Mike McCormack - J.P. Morgan

Tom Sykes - Barclays Capital

Michael Rollins - Citigroup

Timothy Horan - Oppenheimer

Jason Armstrong - Goldman Sachs

AT&T Inc. (T) Q3 2008 Earnings Call October 22, 2008 10:00 AM ET

Operator

Good morning, ladies and gentlemen, and welcome to the AT&T third quarter earnings release 2008 conference call. (Operator Instructions) I would now like to turn the call over to Ms. Brooks McCorcle. Ms. McCorcle, you may begin.

Brooks McCorcle

Thank you, Sandra. Good morning, everyone and welcome to our third quarter conference call. It’s really good to have you with us this morning. As Sandra mentioned, this is Brooks McCorcle. I run investor relations for AT&T, and joining me on the call this morning are Rick Lindner, AT&T's Chief Financial Officer; and Ralph De La Vega, AT&T's President and Chief Executive Officer for Mobility and Consumer Markets. .

As you know, we released third quarter results earlier this morning and as you’ve seen, our wireless results were a key driver, so we wanted to have Ralph on the call this morning to talk about the business and provide additional background.

Before we get underway, let me remind you that our release, investor briefing, supplementary information, and the presentation slides that accompany this call are all available on the investor relations page of the AT&T website -- that’s www.att.com/investor.relations.

I also need to cover our Safe Harbor statement, which is on slide 3, and that says that information set forth in this presentation contains financial estimates and other forward-looking statements that are subject to risks and uncertainties and that actual results may differ materially. A discussion of factors that may affect future results is contained in AT&T's filings with the Securities and Exchange Commission. AT&T disclaims any obligation to update or revise statements contained in these presentations based on new information or otherwise.

This presentation may contain certain non-GAAP financial measures. Reconciliations between the non-GAAP financial measures and the GAAP financial measures are also available on our website at www.att.com/investor.relations.

With that covered, let me take you through our EPS comparisons, which are on slide four. Reported EPS this was $0.55. We had $0.12 of non-cash merger costs and the result is adjusted EPS of $0.67. There are a couple of things that are not excluded from our adjusted results that I want to mention.

First, our third quarter reported and adjusted EPS does not exclude approximately $0.10 of pressure related to very strong results generated by our iPhone 3G initiative. As we’ve outlined previously, these are success-based costs. Obviously we are thrilled by the terrific response. Demand was greater than we anticipated. We are certainly winning customers at the high-end and as Ralph will cover in more detail, this is really great for our business long-term.

Also, third quarter reported and adjusted EPS does not exclude approximately $0.03 of pressure due to costs associated with hurricanes, including hurricanes Ike and Gustaf, which as you know struck the Gulf Coast in September. Restoration work is continuing and we expect additional storm impacts in our fourth quarter results.

With that background, I will now turn the call over to AT&T's Senior Executive Vice President and CFO, Rick Lindner. Rick.

Richard G. Lindner

Thanks, Brooks and good morning, everyone. It’s great to be with you again. Before I dive into the slides, I want to make just a few general comments. When I look at the quarter, I believe our results show that while no business is immune to the broader environment, our business mix is more resilient than most. Our revenue streams are predominantly subscription based. I believe we have the best assets in the telecom industry, along with terrific scale. And we are very sound financially, and we are executing with a great deal of discipline. Looking ahead, we have opportunities, both in terms of revenue initiatives as well as on the cost side of our business. We have a seasoned management team and we know how to adjust and drive operations.

As you may have read recently, we’ve begun a reorganization of our business to simplify operations and make sure our customer focus remains sharp, and that our business initiatives move forward as technology and our networks advance. Along with that, we’ll have opportunities to improve costs. Our planning is just getting underway and we’ll have more to report in the quarters ahead but this is just to reemphasize the point that while the macro environment is obviously not ideal, there are still opportunities to improve operations and that’s where we are focused.

Now if I may, let me start with slide five, which lays out our third quarter highlights. As Ralph will cover in more detail, we drove terrific growth this quarter in wireless -- 2 million net adds, 1.7 million of them post-paid, the best post-paid results for any quarter in our history; 2.4 million iPhone activations, roughly 40% of them for new AT&T customers; continued 50%-plus wireless data growth and continued mid-teens growth in total wireless revenues, up 15.4% this quarter.

In addition, our business trends continue to be stable. We had sequential growth in enterprise, wholesale, and regional business in all three areas. Our U-verse TV service continues to ramp and we are on track to exceed 1 million subscribers this year. And we continue to have a strong balance sheet. We reduced debt in the third quarter as we told you we would. We continue to have access to the credit markets and we have the financial strength to return value to shareowners and invest in the future of our business.

Turning to slide six, slide six shows our consolidated revenues. Total revenues for the quarter topped $31 billion. That’s up more than $1 billion, or 3.3% versus adjusted results for the year-ago quarter. And it’s up 1.5% sequentially. The major drivers are wireless, where as I said revenues grew 15.4%, and wireline IP data revenues, which were up 16.2%. This includes consumer U-verse services and broadband and on the business side, it includes services such as virtual private networking, managed Internet services, and hosting.

Our overall business trends continue to be quite stable. In enterprise, the economic effects we are seeing are primarily in voice usage and some data transport but deal flow continues to be good. And our wholesale business continued its major turnaround, reflecting solid demand and incremental revenue from our IBM relationship. These positives more than offset pressures from wireline consumer voice.

Now this is the point in the webcast where I normally drill down on each of these areas, starting with wireless, but I am pleased to say this quarter we have with us Ralph De La Vega, who heads up our wireless and consumer operations, so I’ll let Ralph take you through the next several slides and then I’ll be back with comments on wireline results, margins, and cash. Ralph.

Ralph De La Vega

Thanks, Rick and good morning to everyone on the call. I am very pleased to be here and what a great time to talk about our wireless business, not just because we have terrific subscriber numbers to report but even more important because I am confident we are on a very solid path for continued good growth.

In June, we outlined for you our plan to accelerate growth in a new era of wireless data services. The foundation for that plan is our 3G network, which is now deployed in 324 U.S. cities and performing very well. The catalyst for our plan was a breakthrough device, the iPhone 3G, which was launched as an AT&T exclusive on July 11th. The results are on slide seven but here are the key takeaways: number one, iPhone 3G activations have exceeded our expectations and they have brought a significant halo effect which has driven store traffic and helped sales of other devices; number two, the iPhone is delivering very high quality customers with great ARPU and churn -- in simple words, we are winning share at the high-end; number three, our wireless data revenue growth continues to be impressive, above 50% again this quarter, and we are still early in the game; and number four, AT&T is on a very sound wireless technology path which gives us incremental steps to further increase wireless speeds in a timely fashion on our way to 4G with seamless backwards compatibility for customers.

So my message this morning is as follows -- our iPhone 3G initiative is doing everything we had hoped for and more, and as for our business going forward, and we have a very strong technology and network roadmap which we believe offers tremendous opportunity for us.

Those are the headlines. Now let me talk about the detailed results, starting on slide eight. We launched the iPhone 3G on July 11th, so we had 82 selling days in the quarter and in those 82 days, we activated 2.4 million iPhone 3G units, 40% of them to customers who were new to AT&T. This was 2.4 times our pace with the original iPhone through September of last year. By comparison, with the first iPhone a year ago, it took us nine months to reach the 2.4 million mark.

The iPhone 3G helped drive 2 million total net adds in the quarter, 1.7 million of them post-paid, making this the best retail post-paid net add quarter in our company’s history. As a matter of fact, the third quarter of 2007 was the previous best post-paid net add quarter in our history. Our results this quarter beat that by 40%.

The iPhone’s halo is also impressive. Same-store traffic was up 15% versus the third quarter last year and this is a very important point -- two-thirds of our third quarter post-paid net adds chose integrated devices. That’s a device that has either a qwerty or touch-screen keyboard and ARPUs for customers with integrated devices are much higher -- in fact, much higher than the average for our base. We also had a very strong upgrade quarter, meaning our customers are staying with us and renewing contracts in increasing numbers and over 40% of those upgrades were for customers purchasing an Internet data plan for the first time.

Slide nine provides more background on the quality of customers we are winning with the iPhone 3G. On the average, the iPhone 3G generates subscriber ARPU that is more than 1.6 times the average of our post-paid base and as you may know, AT&T already has the industry’s highest post-paid ARPU.

Based on our experience with this iPhone and the earlier version, churn is significantly better than the average for our post-paid base and also better than the average for other integrated devices. As a result, the net present value, or the NPV of a iPhone subscriber, is more than 2X the NPV of our average post-paid subscriber. As I said, the iPhone 3G is helping us win at the high-end. This customer profile strongly supports the investment case for this initiative, which is to say that we are creating substantial long-term value for our company.

Our overall wireless data growth trends are on slide 10. The total wireless data revenues were up more than 50%, with strong gains in both consumer and business. Internet access revenues and multimedia messages volumes more than doubled a year-ago levels and while this is rapid growth, frankly we know we are in the early innings.

Here are a few key metrics -- the percentage of our post-paid subscribers who have an integrated device doubled over the past year, but at this point we are only at 22%. ARPU for customers with integrated devices are significantly better than the average of our post-paid base. The number of 3G devices in our base also has grown dramatically from around 7 million a year ago to more than 17 million at the end of the third quarter, but that is still a low percentage.

We are seeing even more dramatic growth in laptop cards. The third quarter was our best laptop connect quarter ever and we have more than doubled our 3G laptop connect base over the last year. Looking at wireless broadband connectivity in total, today we have nearly 5.9 million broadband speed laptop cards and integrated devices in service. That reflects a net gain of roughly 2.8 million in the third quarter alone.

We have a great growth record in wireless data and we have even greater potential. Part of the potential comes from the cutting edge devices that we are bringing to market. As you may have seen or you will see today, we are going to announce the launch of the BlackBerry Bold as an AT&T exclusive beginning on November the 4th. Not only do we have the 3G iPhone but now we also have the very best BlackBerry in our stores and customers are going to be thrilled with the new Bold. We expect it is going to do very well for us.

Beyond specific devices, I believe there’s even greater potential ahead as we begin to address the marketplace with more integrated devices as the traditional boundaries between wireline and wireless get replace by innovative services the delight customers in a seamless way -- that’s where our technology is headed. It’s a direction that customers are moving and it’s the thinking behind our decision to combine wireline consumer and wireless into a single organization.

The foundations for these innovations is a great network and slide 11 lays out our wireless network strategy. At AT&T, we have assembled a truly outstanding spectrum position. We have 700-megahertz spectrum that is unencumbered from a regulatory standpoint. It covers 100% of the top 200 markets and across the top 100 U.S. markets, we have a total average spectrum depth of 90-megahertz.

Today, we already have our premier wireless network with excellent speeds. AT&T is the only U.S. carrier to have HSPA in a broadly deployed 3G network and we have the nation’s fastest 3G network today -- that’s based on independent tests.

We have dramatically expanded 3G coverage. We currently cover 324 U.S. markets and we continue to grow our coverage and looking ahead, we have a lot of opportunity to further increase speeds on our way to 4G. In the 2009 timeframe, the next step in our evolution is HSPA release 7, which could deliver peak speeds exceeding 20-megabits per second and this will be largely achieved through a software upgrade. And beyond that, we will move into LTE, which will allow us for backward compatibility to our GSM and HSPA networks, a great benefit to customers who can move up the speed chain with us as their wireless data needs evolve.

We have a solid foundation in GSM and high quality spectrum and I feel very good about AT&T's wireless technology path. In fact, when you combine the quality and depth of our spectrum that have, our clear technology path, and our premiere device lineup, I believe it is clear that we are in the best position of all U.S. carriers to drive wireless data growth.

Slide 12 provides a look at wireless margins. Those of you who have followed our progress over the past few years know that our wireless growth initiatives work hand-in-hand with continuous improvements in our operating costs in network, in customer service and in billing, and those are ongoing efforts and we continue to deliver solid operational progress.

As you know, this quarter that progress is matched by the investment we’ve made in the successful iPhone initiative and to a lesser degree by storm costs. Our reported service OIBDA margin was 33.5%. Adding back iPhone launch and hurricane related costs would bring that up to approximately 42%.

Given the huge response to the iPhone, which we expect will continue in the fourth quarter, it is reasonable to anticipate our full year wireless EBITDA margin will be better than 37%. It is clear that as up-front iPhone impacts lessen and recurring service revenues build, margins will expand and the iPhone 3G will be a terrific investment for us.

First, it’s an investment in high value customers. The iPhone has helped us add share at the high-end and the customers we are adding, a high ARPU and low churn, the very best customers in the industry. And second, it’s an investment that we are confident is one of our great opportunities and the best growth area in telecom and that’s wireless data.

With that overview, Rick, I will turn it back to you.

Richard G. Lindner

Thanks, Ralph. And now let me turn to wireline, starting with business results on slide 13. Looking across our business markets, while we are obviously seeing some pressure from the macro economy, the trends overall are stable and all three parts of our business organization -- enterprise, regional, and wholesale -- delivered sequential growth this quarter. Enterprise revenues were up sequentially eight-tenths of a percent and year over year they were down 1.4%, reflecting some softness in voice volumes and some areas of data transport. We continue to deliver high-teens growth in enterprise IP data revenues. Sales flow was solid and a number of major contracts signed in recent months are beginning to ramp.

Regional business revenues were up 2.3%, slightly better than in the second quarter. Regional business data revenue grew 8.4% year over year, led by ethernet and IP data services, including managed Internet VPN hosting and related services. IP and ethernet together now make up nearly 54% of our regional business data revenues and in the third quarter they grew nearly 19%.

We are doing a number of things to differentiate our products for small and mid-sized business customers. We are offering attractive bundles and term contracts. We are helping these customers migrate to IP. We are doing much more with wireless, including offering family talk plans for small and mid-sized firms, and our U-verse platform for high speed Internet access is now available to small businesses in nearly 70 U.S. markets.

I would like to talk briefly about the turnaround we’ve seen in wholesale. The highlights are on slide 14. In 2007, we saw high-single-digit declines in wholesale revenues, as we absorbed the effects of industry consolidation, the decline in UNI-P wholesale lines industry wide, and merger concessions that affected pricing. Most of these impacts are behind us now and in this quarter, we return to year-over-year wholesale revenue growth. This was our third consecutive quarter of sequential growth in wholesale revenues.

Fundamental demand in the wholesale space is solid, driven by wireless carriers, Internet service providers, content providers, and others. Also last October, we formed an agreement with IBM that calls for AT&T to become its primary global network management services provider. We are steadily working our way through the operational steps to transfer network management and revenues and we expect a further ramp in revenues from our IBM agreement in the fourth quarter.

Slide 15 shows regional consumer trends, which have not changed dramatically from recent quarters. The consumer space is going through a fundamental transformation from a dependence on legacy voice to connections driven by broadband, video, and mobility. These areas are growing, offsetting in part revenue pressures from the economy and declines in voice lines.

Our consumer IP data revenues, that’s broadband plus U-verse services, were up 19%. Boosted by these services, overall revenues per consumer household continued to grow. Our U-verse base continues to scale and our U-verse broadband attach rate continues to be high, greater than 85%.

U-verse is also demonstrating that it has pull-through with voice. In areas where we’ve marketed U-verse for a period of time, we are seeing clear improvements in access line retention.

We are doing more with wireless in the consumer space, including selling more broadband wireless bundles. We are bundling wireline broadband with wireless laptop connect service, plus extensive WiFi availability. As Ralph mentioned earlier, these combinations are logical and attractive to more and more customers and that’s the thinking behind combining wireless and consumer markets, putting those customer-facing units into a single organization. It is a different way of looking at our business but it is closer to how customers actually view and look at their service options.

For example, if you take a unified look at broadband and combine wireline broadband connections with wireless 3G laptop cards and wireless broadband speed connections via integrated devices, we had a net increase in broadband connections of 2.9 million in the third quarter, 148,000 wired broadband connections plus 2.8 million additional wireless broadband connections.

The other key focus area for us in consumer, as you know, is to ramp U-verse and we continue to make good progress. Slide 16 has an update. Our U-verse network deployment now reaches 14 million living units and we have 781,000 subscribers in service and we are on track to exceed more than 1 million in service by year-end. Penetration is growing nicely and we are getting to more than 10% penetration in less than 12 months.

Customer satisfaction is high. As you may have seen a couple of weeks ago when the AT&T U-verse TV ranked highest in customer satisfaction among residential TV customers in the north central, south, and west regions in a J.D. Power study.

And we continue to add new services and features. Our migration to offering a second HD stream was completed in the third quarter. Every set-top box we install is HD capable, so we can cost-effectively growth without CPE costs or technician dispatches as our customers adopt more HD. And the rollout of our total home DVR service is progressing nicely. We expect that to be completed by the end of this year.

With that look at operational results, let me close with a look at margins and cash flow. Margin comparisons are on slide 17. As Ralph outlined earlier in the wireless discussion, the major impacts on our margins this quarter are straightforward. Expense pressure from the iPhone initiative was approximately $900 million and hurricane impacts totaled approximately $145 million. Savings from previously outlined synergy and operational cost reduction initiatives are on track to deliver according to plan this year and without the storm and iPhone impacts, consolidated margins would have been relatively flat with the second quarter this year.

Looking ahead to the remainder of the year, given stronger-than-expected iPhone sales and some further hurricane related costs, we anticipate a full-year adjusted consolidated operating margin of approximately 23%.

Slide 18 provides a quick cash summary. Cash from operations totaled $9.3 billion in the quarter, nearly $23 billion year-to-date. Capital expenditures are on track with our target range mid-teens as a percent of revenues, and we are on pace to deliver full-year free cash flow of approximately $14 billion. Our yields are attractive and our balance sheet is sound. Our debt metrics are solid and in the third quarter, we reduced debt by $3.4 billion. And for the balance of this year, we will use free cash flow after dividends to continue to reduce outstanding debt.

Moving to slide 19, I would sum up the quarter very simply -- while the macro environment presents challenges, our business is more resilient than most. We have great assets, we are growing revenues. We continue to have opportunities to reduce costs. Our management team is experienced and tested and our execution continues to produce good results.

Wireless subscriber growth and data growth are both very strong. The iPhone 3G is delivering even more than we expected, with a very attractive customer profile. Business trends continue to be stable and U-verse TV is ramping as planned.

We are strong financially and we have a great track record of returning value to shareowners.

I think with that, Brooks, I believe Ralph and I are ready to stop now and take some questions.

Brooks McCorcle

Okay, thanks, Rick, thanks, Ralph. Okay, Sandra, we’re ready to open up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question is from David Barden from Banc of America.

David Barden - Banc of America

I actually have two, if I could -- Rick, I definitely walked away from the second quarter conversation looking into the second half with a belief that the margin in wireline was a focus for the company. There was the renewed Yahoo! agreement, the launch of the Shell contract, the networks contract, the improvement of the IBM contract, the restructuring of the organization, the headcount reductions, and yet margins were down, even normalizing for the hurricane situation, somewhat sharply, more sharply than I expected them to be. And I guess it would be helpful if you can kind of talk about how that might look into the fourth quarter and how that rolls into your margin guidance for the year. And obviously with so many moving parts in the world these days, any color on ’09 would be very helpful.

The second question I had was on the iPhone -- you guys have obviously absorbed a lot of impact from the iPhone much more quickly than you thought. The original expectation was $0.10 to $0.12 in the second half, $0.10 to $0.12 in ’09, break-even in 2010. Now that you’ve kind of altered the initial part of that equation, could you give us your new look into how this changes into ’09 and ‘10? Thank you very much.

Richard G. Lindner

Sure, David, good questions. First on wireline margins, you know, when we started this year, we said our guidance for the year is that we expect wireline margins to be pretty stable in the mid-30% range, and in any quarter in this business, you will see a little bit of movement up or down but when you look across the first quarter, the second quarter, and the third quarter, we have stayed pretty stable in the 35% range and in fact, if you just adjust the wireline results for some of the hurricane costs in this quarter, we were at 35.1. So I think from a margin standpoint, wireline is meeting our expectations and when you step back from it, there are a lot of moving pieces in the wireline business, so for example, we do have some dilution from our ramp of U-verse and that dilution is a little higher in the third and fourth quarters of this year than in the first two quarters, simply because we are driving more volume and more customer acquisitions.

You have the impact of transitions in our business as we are moving from and seeing declines in voice revenues really across the portfolio from consumer customers as well as from the large enterprise customers and we are replacing those revenues with new IP based services, with broadband, U-verse, with VPN, and in some cases doing more managed services for large enterprise customers. Some of those agreements that you mentioned, the Shell agreements and the IBM agreements, for example, we’re in the early stages of those agreements where we are bringing business on and as part of that, we’re bringing costs on as well to manage those networks. Over time in those agreements, our margins will improve as we rationalize the cost and as we drive more incremental business with those customers.

So those are some of the moving parts that we see in the business but all in all, I think we are pleased with what we are seeing on wireline margins. Essentially what we are doing is we are moving through the transition of these services, we are maintaining margins, keeping a close eye on costs -- as you may have seen in this quarter, for example, we reduced force by 4,000 and that’s primarily in our wireline business. That is part of the consolidation, part of merger synergies, some of the reorganization impacts that we announced earlier this year.

Let me talk for a minute on iPhone dilution and clearly the volumes were more significant this quarter and so the amount of dilution exceeded our expectations. One thing to note, and I think this is very positive, when we looked at the third and fourth quarter when we were announcing the iPhone deal, we expected good iPhone volumes but we also expected volumes in some other devices potentially to be reduced as a result. That’s not what we saw this quarter. What we saw was stronger iPhone volumes than we expected, and then when you look at both gross adds for new customers as well as upgrades of existing customers on all other devices excluding the iPhone 3G, those volumes were flat to up in the third quarter. So we saw a nice halo effect as Ralph talked about with other devices.

As we go forward into the fourth quarter, I think this is very good news for us, particularly in this economic environment, we continue to see stronger store traffic than we typically would this time of year. Store traffic is up versus what it was last October, as an example, and I think volumes will continue to be good. It’s hard to predict the fourth quarter because so much of the volume in the fourth quarter frankly happens between Thanksgiving and the end of the year but I would tell you that our expectation is less dilution from the iPhone in the fourth quarter than the third, but probably a little more than we would have expected when we gave you guidance prior to the iPhone launch. And we’ll see where we end up with in this quarter in terms of volumes and so forth and then we’ll be able to give you better guidance as far as 2009 but clearly more customer growth up-front is better for us as we go into 2009 and 2010.

David Barden - Banc of America

Thanks, guys. Appreciate it.

Operator

The next question is from John Hodulik from UBS.

John Hodulik - UBS

Thanks. Good morning. A quick question on the wireline side -- it seemed like the economy slowed it seems fairly dramatically in September, maybe the latter part of September, and I think the enterprise numbers that you guys posted today were a little bit weaker than we thought in terms of the revenue growth. Did you see any sort of real change in the business in September, maybe into October, that would suggest that the overall trend is going to stay more negative than the -- or previous expectations that you were going to start to see some real growth in that business? And concurrent with that, you didn’t really see much of a change -- if anything, you saw some improvement in the end region business segment, so if you could just talk about how the economy is affecting those businesses and what the outlook is for that, that would be great, Rick.

Richard G. Lindner

Sure, John. I think first of all, I’d say overall as we said in the presentation, business revenues are pretty stable. When you put together wholesale regional business and enterprise business and put the three together and look at our total wireline business revenues, they were up year over year about 0.3%. And in this environment, overall I think that’s pretty good.

On the enterprise side, as I mentioned in our presentation, I think we are happy with what we are seeing in the marketplace in terms of deal flow, in terms of deals that we are winning and contracts we are retaining. What we did see in the third quarter and we saw a little bit of this in the second quarter as well is some softness in usage-based services, primarily in long distance and we saw somewhat in some softening of transport services. And in addition to that, there is one other factor I didn’t mention in the presentation but year over year, our CPE sales and our equipment sales in enterprise are down, which from my standpoint is not a big concern. We are selling CPE only really to the extent that it facilitates sales of network services and it tends to be a fairly low margin business but if you exclude CPE, then enterprise was still a little negative but only about 0.5%.

I think the difference between what our expectations would have been early this year and we are seeing now primarily has to do with a little bit of softness in long distance, a little bit of softness in transport volumes. We have -- as we went through the quarter, we have about mid-teens percent of our business in financial, in the financial industry and we probably saw a little bit of impact there. But as you mentioned, at the same time we are seeing a little better growth actually in small and medium business and in fact, what was interesting to me is we are seeing that primarily on the small end of our smaller regional customers. And I think that’s -- in this environment, I think that’s very encouraging, particularly with cable working to enter that space.

All in all though, as we go into the fourth quarter I would tell you that we would expect to see trends that look similar to what you’ve seen this quarter. I think pretty stable overall, probably a little bit better growth in wholesale as we continue to ramp our agreement with IBM. I think you will see probably similar trends in enterprise and regional.

John Hodulik - UBS

Great, thanks.

Operator

The next question is from Simon Flannery from Morgan Stanley.

Simon Flannery - Morgan Stanley

Thanks very much. Good morning. Rick, you made a comment earlier about an increasing dependence on subscription based revenues and that may be a little bit of a difference from the last downturn we experienced. Can you characterize across some of your major business units how much of your revenues are really monthly recurring charges, or sort of fixed price versus some of the usage-based models we’ve seen -- we saw the industry with in the past? And then if you can also talk about how you are thinking about free cash flow deleveraging versus dividends or buy-backs over the balance of the year. Thanks.

Richard G. Lindner

Sure, Simon. I don’t have exact numbers in terms of breaking down revenues by subscription based or usage based but if you think about the major categories of customers, starting with consumer it’s increasingly consumers are buying bundles of services from us. And those tend to be more fixed in nature, whether you are talking video, broadband, or even on the voice side, increasingly customers are buying a fixed access line cost plus a fixed long distance package.

When you move into wireless, certainly versus where we were five years ago, 10 years ago, the revenues are moving again much more towards subscription based services so on the voice side, voice overage minutes have been for several years now have been declining as a percent of ARPU and customers are tending to gravitate toward fixed price voice bundles that allow them to operate and not incur substantial overages.

And on the data side, if you think about where we are going, particularly with integrated devices, the very first thing that happens when someone buys an integrated device like an iPhone or a Blackjack or a BlackBerry is to move to generally an unlimited type of data plan, because they simply want to avoid the overages.

Where we do have a little more exposure on usage based is still in our -- some of our business customers and enterprise customers and wholesale, where it’s usage based on primarily voice minutes and long distance revenues.

I think in terms of free cash flow, you know, our plan right now for the rest of the year, as I mentioned in the presentation, is to continue to use available free cash flow to reduce debt. I have to tell you I would love to be in the market buying shares at this point and at these prices and at these values. However, given the environment we are operating in, I think it’s the prudent thing to do for us to manage cash very carefully and to use cash flow to pay down debt and pay down debt as it matures going forward in the near-term. I just think that’s the prudent way to operate the business in this environment.

Simon Flannery - Morgan Stanley

And then on dividends?

Richard G. Lindner

Dividends -- as you know, we go through a dividend discussion and decision with our board in December, so that’s coming up in the next 60 days or so. I don’t think it’s appropriate for me to comment on that at this point, given that we haven’t had those discussions with the board yet but I would just again offer and remind that we have got a very good track record in terms of good times and bad of supporting and growing the dividend and returning cash to shareowners and nothing has changed in that regard.

Simon Flannery - Morgan Stanley

Great. Thanks, Rick.

Operator

The next question is from Craig Moffett from Sanford Bernstein.

Craig E. Moffett - Sanford C. Bernstein

Good morning. The consumer electronics industry seems to have had a real downturn around mid-September, just judging by the data reported by MasterCard and Best Buy and others. Did you see any change in the flow in your stores for the iPhone and for smartphones in general starting around mid-September and into early October? As you look forward into the fourth quarter, what are the things you are looking for to help you sort of adjust as you prepare inventory levels and that sort of thing for the holiday season?

Ralph De La Vega

Let me give you some facts around that and these are very encouraging facts. Traditionally what happens in October in the wireless industry, at least from our perspective, is that you have a downturn in store traffic. Traffic begins to pick up in mid-November and it really goes strong in December.

What we are seeing in October of ’08 versus September of ’08 is an increase in traffic. Our same-store traffic is up 4% and total traffic is up 7% versus a month ago, and that’s just through half the month, so I have to caution that this is through about half the month of what we are seeing. If you compare our October traffic through the middle of the month to the same period last year, our same-store traffic is up 12% and our total store traffic is up 25%, which highlights the points that Rick was making, is that iPhone 3G is providing a good traffic driver into our stores and then once customers get into our stores, we have a great portfolio of products which just got better today after the announcement of the Bold, but we’ve also put in a great portfolio of low-end devices which in particular in today’s economy is a very key point. We announced earlier that we have four low-end texting devices, the Pantech Matrix, the Samsung Propel, the Pantech Slate, and the UTS Quickfire. All of those devices are less than $100 and the Pantech is $79, the Samsung is $79, and the Pantech Slate is $49, so we have choice for every customer that walks into our store. We have the very best keyboard that is a touch screen from the iPhone and now we have, if you really want a physical keyboard with a BlackBerry Bold, I think we have the very best device in the market today, a whole range of low-end texting devices, so that we can close the sale and believe it or not, our close rates are up this month compared to last month.

So despite the economy, I feel very confident that we have a great portfolio, a great marketing strategy, and a great distribution strategy that is going to lead us to see continued good growth despite the economic conditions, at least in wireless.

Craig E. Moffett - Sanford C. Bernstein

That’s good to hear, Ralph. Can you talk about your inventory levels and your inventory planning for the holidays?

Ralph De La Vega

We are very carefully looking at the inventory levels and of course ordering only what we think we can sell, and so we are being very careful but we have a great track record of being able to deliver the sales, make sure that we don’t run out but at the same time don’t end up with excess inventory. So we are paying a lot more attention to that and making sure we only have in inventory that which we are certain we are going to sell, and that’s just prudent management, given the economic situations that we have.

But the traffic in our stores, the close rates, and what we are seeing in the middle of October, at least, is encouraging, given the economic climate that we are facing.

Craig E. Moffett - Sanford C. Bernstein

Thank you.

Operator

The next question is from Mike McCormack from J.P. Morgan.

Mike McCormack - J.P. Morgan

First, I guess for Ralph on the wireless side, you talked about the customers coming in with integrated devices having much higher ARPU than the average of the base. Could you give us a sense for what the delta might be between the average integrated device versus an iPhone?

And secondly I guess for Rick on the CapEx side, or the free cash flow side, rather, how much of the delta in free cash flow guidance is related to just pure margin pressure from iPhone related pressures versus capital spending? Thanks, guys.

Ralph De La Vega

Mike, in terms of the actual integrated devices, I think when you average them all, they are comparable or slightly below the iPhone. It varies by device but both are significantly above just what we regularly call a feature phone. And what we are finding out is that as customers use the applications on these integrated devices, like Rick was saying, they want the assurance of not having overages and so we are seeing them sign up to data plans in record numbers and that is driving the 50% data revenue growth, despite everything else that we have seen. So both the iPhone and integrated devices are very comparable, with the iPhone in certain cases being a little bit higher.

Mike McCormack - J.P. Morgan

Ralph, just to follow-up on that, the non-iPhone integrated/laptop card breakdown for the quarter, there was I think 400,000 in total. Can you give us any sense for the breakdown between cars versus devices?

Ralph De La Vega

We are not providing that breakdown at this point, Mike, but if you look at the volume of data cards that we have sold, I mean, it’s on a ramp. We basically doubled the number of subscribers we’ve had on data cards and now that we have the what I call the dongles that just go into USB ports, those are flying. We saw a huge demand on those in the South Texas area after Hurricane Ike and that is how people were basically running their business and doing the insurance adjustments. They were -- I was at those stores and insurance adjustors are coming in and buying them up so they could communicate, so we think we have a lot of upside on the wireless data cards and we think it’s a growth opportunity for us way into the future.

Mike McCormack - J.P. Morgan

Thanks, Ralph.

Richard G. Lindner

Mike, on CapEx and free cash flow, you know, there’s been a number of changes since the beginning of this year. I think the most significant changes in terms of our plans as we’ve gone through the year from a free cash flow and CapEx perspective have been around wireless and the iPhone. You’ve seen the numbers from a dilution standpoint, which are essentially cash numbers. And then on top of that, as we went through the first half of this year, we made some conscious decisions and reinforced those actually when we launched the iPhone to ramp up the investment in our 3G network to provide more coverage. We are on track to be in about 350 metropolitan areas by the end of this year, 99 of the top 100 markets and so more coverage, as well as more capacity to handle the data traffic growth that we are seeing. And in addition to that, we made the step to spend some additional capital to improve the quality of that network by beginning to take 3G into our 850 spectrum. And so that has had some impact this year on CapEx.

In addition, the hurricane costs this quarter plus some additional costs we’ll see next quarter not just in the income statement but also some incremental capital expenditures for hurricane restoration will impact results. I think the capital piece of that probably will end up being in the $60 million to $70 million range.

Those are the major drivers in changes in free cash flow. Over and above that, I think we’ve done a pretty good job in terms of number one, any softness in wireline revenues, particularly in voice. We’ve done a pretty good job of taking costs out of the business to support that and so I think the two things, the iPhone and the hurricane, both the income impacts as well as additional capital expenditures are the primary difference. We are also working very hard right now scrubbing capital investment across the portfolio because I think it’s important at this time to be conservative with capital investment and so we are scrubbing that portfolio pretty hard to help fund these initiatives.

Still at the end of the day, I think it’s important to note that this year with the costs we’ve incurred for the iPhone launch, building the 3G network, some associated costs with the hurricanes, we are still going to be at 150% or so coverage of our dividend with free cash flow, so still very strong in terms of free cash flow and very strong financially.

Mike McCormack - J.P. Morgan

Great. Thanks for the detail, Rick.

Operator

The next question is from Tom Sykes from Barclays Capital.

Tom Sykes - Barclays Capital

Thanks for taking the question. You’ve got a lot of upward pressure on wireless ARPU from all the integrated devices but we didn’t see really any year-over-year improvement in ARPU or -- and I was just wondering if you could talk about the downward pressures that are occurring and how you sort of expect long-term trends for ARPU to play out. Thanks.

Ralph De La Vega

Let me talk to that -- first of all, the upward pressures that you are seeing are not fully manifested in the third quarter results because if you look at the average number of subscribers that we added with the iPhone 3G, there are not enough to impact the huge base of customers that we have. We anticipate that that aspect will get better and better and you will see more impact from the iPhone 3G.

On the regular base, what we are seeing are the same things on the wireless side but to a lesser extent that Rick talked about. We are seeing customers watch their bundles to make sure they don’t exceed their plans. We are seeing a little bit of a downturn on international roaming and long distance but those are the only two areas that we have seen really any ARPU weakness and it’s been more than offset by the growth in data and we anticipate that the iPhone 3G ARPU lift we’ll be seeing in the future quarters to come, and I think we have a lot of upside on that.

Tom Sykes - Barclays Capital

Great. Thank you very much.

Richard G. Lindner

Tom, one thing I would add to that is just remember in the numbers when you look at flat ARPU year over year, that’s across our entire base of customers and it’s impacted by the fact that our resale base has grown this past year, so it’s a mix issue. When you look at post-paid customers, post-paid ARPU is up 2.6%. That’s where we are seeing the strength in data. It’s partially offset by a little bit of softness in some of the roaming and LD revenues that Ralph talked about but still up 2.6% on post-paid I think is a good sign. And I think it will compare favorably to what you see across the industry.

Tom Sykes - Barclays Capital

Thanks for the color.

Operator

The next question is from Michael Rollins from Citigroup.

Michael Rollins - Citigroup

Good morning. Just a couple of follow-ups, first with regard to the comments about store traffic, I was curious if there was a way to think about that with respect to the new customers to AT&T that are coming into the store versus those that are coming into upgrade devices. And the second question I had was just going on to the wireline side of the business, or it may have actually even been the consolidated part of the business, where in the beginning of the year you outlined some significant cost-cutting opportunities in terms of I think a combination of systems and headcount reductions and you put some numbers around that. Can you give us an update in terms of where those cost-cutting initiatives are in terms of where you expected them to be? And can you give us some potential sizing for the ’09 cost-cutting opportunities? I know you are in a preliminary stage but some order of magnitude would be great. Thank you.

Ralph De La Vega

Let me try to take a stab at the first portion of that -- we don’t have data that we can share with you at this point on the mix of the traffic between new and upgrades but I can tell you, if you look at the third quarter and assume that that trend continues in the fourth, in the third we had not only record net adds but record gross adds and so we see a healthy traffic both on the new as well as the upgrades, and so I think it’s a combination of those two but we don’t have anything that we can break it out for you right now. I just took the stuff that we had through the middle of October just to give you an insight for what’s happening overall but we don’t have that further broken down between upgrades and new adds.

Richard G. Lindner

Mike, on cost-cutting, when we started this year we told you our expectation was that the combination of merger synergies and other cost initiatives would ramp up to an annual cost benefit of about $6 billion, and that was up from just under $4 billion last year, so an incremental roughly a little over $2 billion. And we are on track to hit that number. I think the merger initiatives are right on track, maybe a little ahead of schedule. I think the other cost initiatives are doing very well. We’ve got some pluses and minuses there but overall we are going to be in that $6 billion range.

As we look ahead to next year, our plan was to add an additional billion dollars through again further progress, really the completion, if you will, of the merger synergies from the three large transactions we did over the last few years and some additional work on just operational cost initiatives. And we are looking at a number of opportunities now, some associated with the reorganization we just announced, which I think will be additive to that number.

Michael Rollins - Citigroup

Thanks very much.

Operator

The next question is from Tim Horan from Oppenheimer.

Timothy Horan - Oppenheimer

Good morning. One question on the consumer front and one on business, maybe -- on consumer, are you seeing maybe any differences between lower credit quality subscribers and wireless wireline in terms of maybe of churn or just flow of traffic in incoming calls? And then on the business front, Rick, [why do you think the small business] is holding up and some of your peers are talking about some pricing pressure on the enterprise front. Just curious if you are seeing anything there. Thanks.

Richard G. Lindner

I’ll let Ralph comment in terms of what we may be seeing in wireless in terms of lower credit customers but I would tell you, Tim, overall first of all our customer base is a pretty solid base from a credit standpoint. We just went through -- we went through a pretty detailed review this quarter because of what was going on in the economy of our receivables and reserves across all the business units. And it didn’t result in any increase in reserves associated with bad debts. And in fact, kind of interestingly on the consumer side, our access line disconnects due to non-pay were down year over year about 4%, so I think that speaks to the fact that we have maintained pretty consistent credit standards.

Ralph, I don’t know if you have any color to add on the wireless.

Ralph De La Vega

Yeah, I do. Tim, you know, given all the volumes that we have seen and the traffic that has been running through our stores, we’ve kept a really close eye on what’s happening to credit, low credit customers and specifically to bad debt. The good news is that bad debt in October and how we looked at it from the third quarter is essentially flat and it’s actually improved year over year slightly, so we have pretty much held our credit standards throughout this crisis and that’s led to very good results. I am just pleased to tell you that our credit standards are holding up well, they are driving considerable volume but it’s absolutely the right volume and it’s not having an impact at all on bad debt levels, so I am very, very pleased.

Richard G. Lindner

I think, Tim, to your question on the regional business revenues and the small/medium businesses there in particular, we are pleased with the results, particularly in this environment and I think -- we’ve done a lot of things as we’ve talked about over this past year, including taking a little pain ourselves by going to that base, signing up customers on term contracts, making sure those customers are on the right product bundles and offering them some incentives to move to term contracts. And I think that -- while that produced some pain over the last year in terms of some declines in the rate of revenue growth, I think that’s positioned us pretty well going forward. And at the same time, I think we’ve got -- frankly, we’ve got the best, most comprehensive package and bundle of services for small/medium business customers and so I think that’s helped us maintain that growth rate. And the growth there is -- you know, voice this quarter is pretty flat but the growth there has been on the data side and particularly, and as we talked about in the presentation, ethernet and IP data revenues, which were up 19%.

On the enterprise side, you know, the pricing there I think is always aggressive in that environment, both wireless and wireline. I think anecdotally we saw a little more pricing pressure from some competitors on -- in EBS on the wireless front this quarter but overall, I think the environment there continues to be as it has been. I don’t see significant other changes there and as we said, the revenue results reflect a little bit of softness in some usage based revenues but it’s more that than it is pricing changes impacting it at this point.

Timothy Horan - Oppenheimer

Thank you.

Brooks McCorcle

Sandra, I think we have time for one more question.

Operator

Thank you. The last question is from Jason Armstrong from Goldman Sachs.

Jason Armstrong - Goldman Sachs

I’ll just keep it to one topic -- Rick, if we can just hit pensions, maybe an update on sort of planned performance to date, and then maybe an early look into EPS impacts next year, and then finally on this topic, just if you can talk about the overall funding position. Obviously you came into the year in a real position of strength with substantial over-funding. What we see is sort of an aggregate of a lot of different sort of state plans I guess that are going on, so I was just wondering if you could comment on any expectation of contributions you might have to make into ’09. Thanks.

Richard G. Lindner

Sure, Jason. It’s a timely topic. Our pension fund has incurred losses this year, just like virtually all other investors and all other funds have. Those losses in the fund will get, under generally accepted accounting principles, get recognized in the results over time and there will be some EPS impacts from pension costs or increased benefit costs as a result of the losses this year as we go into 2009.

I really can’t give you a range of magnitude at this point because the impact is relatively volatile as the results this year and the market results have been fairly volatile. So we will certainly move through the end of this year, hopefully get a little bit of lift in the markets between now and end of year, and then when we provide guidance, we’ll be able to give you definitive numbers in terms of the impacts. But you should expect some pressure in benefit costs from losses in the pension and OPEB funds. There will be some offset there most likely because discount rates at the same time are likely to be higher for next year if the interest rate environment stays in the range that it currently is.

In terms of funding, as you said we entered the year in a very, very strong funding position in our pension plan and again, we’ll have to see how results play out over the balance of this year but I don’t expect at this point that we’ll have any funding requirements in 2009. But obviously it will be dependent upon results through the balance of this year.

Jason Armstrong - Goldman Sachs

Great. Thanks, Rick.

Richard G. Lindner

Folks, before we end the call this morning, I would like to leave you today with just one final thought -- these are obviously challenging times and they are challenging for companies across all industries. And in this environment, we believe it is prudent to be conservative, to manage and reduce expenses, be disciplined with capital investment and to preserve cash.

At the same time, I think it is also important that we take advantage of clear growth opportunities when they present themselves and that we position the company for the future. And one of these for us, one of these clear opportunities is our exclusive with Apple to distribute the iPhone 3G. And I know some of you will be concerned with the dilution we experienced this quarter with the new iPhone launch but I believe our results will bear it out, that it is an important investment in our future. This investment funded the acquisition of nearly a million high-end iPhone customers that are new to AT&T and we will enjoy those customer relationships for years to come. It also allowed us to upgrade some 1.4 million existing customers to this device and virtually every one of them will increase their spend with AT&T. They will download applications, they will utilize capabilities provided by the iPhone combined with our 3G network, and they will be long-term AT&T customers.

The dilution from this investment will fall next quarter and again in the following quarter as the benefits of this customer base are realized and the returns and the margins will grow.

I know I speak for Ralph when I tell you that we are confident the investment made this quarter will produce terrific returns and generate significant value in the future. And devices like the iPhone, combined with AT&T's spectrum position and technology platform, position us to lead in the fastest growing segment of telecom, and that’s wireless data.

So again folks, I want to thank you for your attention this morning and as always, we thank you for your interest in AT&T.

Brooks McCorcle

Thank you, all. Have a great day. Thanks, Sandra.

Operator

Thank you. Ladies and gentlemen, this concludes today’s conference. Thank you for participating. You may all disconnect.

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