10-Q 1 q1_10q.htm AT&T 2013 FORM 10-Q q1_10q.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-Q
 

 
(Mark One)
   

 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
       
   
For the quarterly period ended March 31, 2013
 
       
   
or
 
       
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
       
For the transition period from       to     
 
Commission File Number 1-8610

AT&T INC.

Incorporated under the laws of the State of Delaware
I.R.S. Employer Identification Number 43-1301883
 
208 S. Akard St., Dallas, Texas 75202
Telephone Number:  (210) 821-4105


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes [X]   No [   ]
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes [X]   No [   ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer
[X]
 
Accelerated filer
[   ]
Non-accelerated filer
[   ]
(Do not check if a smaller reporting company)
Smaller reporting company
[   ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [   ]   No [X]
 
At April 30, 2013 there were 5,380 million common shares outstanding.
 

 
 

 

PART I - FINANCIAL INFORMATION
Item 1.  Financial Statements

AT&T INC.
 
CONSOLIDATED STATEMENTS OF INCOME
 
Dollars in millions except per share amounts
 
(Unaudited)
 
   
Three months ended
 
   
March 31,
 
   
2013
   
2012
 
Operating Revenues
  $ 31,356     $ 31,822  
                 
Operating Expenses
               
Cost of services and sales (exclusive of depreciation
               
   and amortization shown separately below)
    12,554       12,817  
Selling, general and administrative
    8,333       8,344  
Depreciation and amortization
    4,529       4,560  
Total operating expenses
    25,416       25,721  
Operating Income
    5,940       6,101  
Other Income (Expense)
               
Interest expense
    (827 )     (859 )
Equity in net income of affiliates
    185       223  
Other income (expense) – net
    32       52  
Total other income (expense)
    (610 )     (584 )
Income Before Income Taxes
    5,330       5,517  
Income tax expense
    1,557       1,865  
Net Income
    3,773       3,652  
Less: Net Income Attributable to Noncontrolling Interest
    (73 )     (68 )
Net Income Attributable to AT&T
  $ 3,700     $ 3,584  
Basic Earnings Per Share Attributable to AT&T
  $ 0.67     $ 0.60  
Diluted Earnings Per Share Attributable to AT&T
  $ 0.67     $ 0.60  
Weighted Average Number of Common Shares Outstanding Basic (in millions)
    5,513       5,918  
Weighted Average Number of Common Shares Outstanding with Dilution (in millions)
    5,530       5,940  
Dividends Declared Per Common Share
  $ 0.45     $ 0.44  
See Notes to Consolidated Financial Statements.
               

 

 

AT&T INC.
           
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
           
Dollars in millions
           
(Unaudited)
           
   
Three months ended
 
   
March 31,
 
   
2013
   
2012
 
Net income
  $ 3,773     $ 3,652  
Other comprehensive income, net of tax:
               
   Foreign currency translation adjustments (includes $0 and $1 attributable to
        noncontrolling interest), net of taxes of $62 and $131
    121       243  
   Available-for-sale securities:
               
        Net unrealized gains (losses), net of taxes of $40 and $54
    75       101  
        Reclassification adjustment included in net income, net of taxes of $(4) and $(3)
    (7 )     (6 )
   Cash flow hedges:
               
        Net unrealized gains (losses), net of taxes of $49 and $0
    90       -  
        Reclassification adjustment included in net income, net of taxes of $4 and $3
    7       6  
   Defined benefit postretirement plans:
               
       Amortization of net prior service credit included in net income, net of taxes of
           $(109) and $(84)
    (178 )     (137 )
Other comprehensive income
    108       207  
Total comprehensive income
    3,881       3,859  
Less: Total comprehensive income attributable to noncontrolling interest
    (73 )     (69 )
Total Comprehensive Income Attributable to AT&T
  $ 3,808     $ 3,790  
See Notes to Consolidated Financial Statements.
               

 

 

AT&T INC.
 
CONSOLIDATED BALANCE SHEETS
 
Dollars in millions except per share amounts
 
   
March 31,
   
December 31,
 
   
2013
   
2012
 
Assets
 
(Unaudited)
       
Current Assets
           
Cash and cash equivalents
  $ 3,875     $ 4,868  
Accounts receivable - net of allowances for doubtful accounts of $547 and $547
    12,100       12,657  
Prepaid expenses
    1,021       1,035  
Deferred income taxes
    980       1,036  
Other current assets
    2,396       3,110  
Total current assets
    20,372       22,706  
Property, plant and equipment
    274,035       270,907  
   Less: accumulated depreciation and amortization
    (164,333 )     (161,140 )
Property, Plant and Equipment – Net
    109,702       109,767  
Goodwill
    69,772       69,773  
Licenses
    53,507       52,352  
Customer Lists and Relationships – Net
    1,190       1,391  
Other Intangible Assets – Net
    5,022       5,032  
Investments in and Advances to Equity Affiliates
    4,998       4,581  
Other Assets
    6,431       6,713  
Total Assets
  $ 270,994     $ 272,315  
                 
Liabilities and Stockholders’ Equity
               
Current Liabilities
               
Debt maturing within one year
  $ 3,446     $ 3,486  
Accounts payable and accrued liabilities
    17,523       20,494  
Advanced billing and customer deposits
    4,167       4,225  
Accrued taxes
    2,210       1,026  
Dividends payable
    2,440       2,556  
Total current liabilities
    29,786       31,787  
Long-Term Debt
    70,686       66,358  
Deferred Credits and Other Noncurrent Liabilities
               
Deferred income taxes
    28,918       28,491  
Postemployment benefit obligation
    41,663       41,392  
Other noncurrent liabilities
    11,603       11,592  
Total deferred credits and other noncurrent liabilities
    82,184       81,475  
                 
Stockholders’ Equity
               
Common stock ($1 par value, 14,000,000,000 authorized at March 31, 2013 and
               
   December 31, 2012: issued 6,495,231,088 at March 31, 2013 and December 31, 2012)
    6,495       6,495  
Additional paid-in capital
    90,940       91,038  
Retained earnings
    23,787       22,481  
Treasury stock (1,072,424,764 at March 31, 2013 and 913,836,325
               
   at December 31, 2012, at cost)
    (38,568 )     (32,888 )
Accumulated other comprehensive income
    5,344       5,236  
Noncontrolling interest
    340       333  
Total stockholders’ equity
    88,338       92,695  
Total Liabilities and Stockholders’ Equity
  $ 270,994     $ 272,315  
See Notes to Consolidated Financial Statements.
               

 

 

AT&T INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Dollars in millions
 
(Unaudited)
 
   
Three months ended
 
   
March 31,
 
   
2013
   
2012
 
Operating Activities
           
Net income
  $ 3,773     $ 3,652  
Adjustments to reconcile net income to net cash provided by operating activities:
               
   Depreciation and amortization
    4,529       4,560  
   Undistributed earnings from investments in equity affiliates
    (185 )     (223 )
   Provision for uncollectible accounts
    262       328  
   Deferred income tax expense and noncurrent unrecognized tax benefits
    509       337  
   Net (gain) loss from sale of investments, net of impairments
    (11 )     (9 )
   Changes in operating assets and liabilities:
               
      Accounts receivable
    295       73  
      Other current assets
    864       1,120  
      Accounts payable and accrued liabilities
    (1,675 )     (1,655 )
   Other - net
    (162 )     (338 )
Total adjustments
    4,426       4,193  
Net Cash Provided by Operating Activities
    8,199       7,845  
                 
Investing Activities
               
Construction and capital expenditures:
               
   Capital expenditures
    (4,252 )     (4,261 )
   Interest during construction
    (66 )     (65 )
Acquisitions, net of cash acquired
    (1,045 )     (433 )
Dispositions
    5       16  
Sales (purchases) of securities, net
    -       5  
Other
    1       1  
Net Cash Used in Investing Activities
    (5,357 )     (4,737 )
                 
Financing Activities
               
Net change in short-term borrowings with original maturities of three months or less
    274       -  
Issuance of other short-term borrowings
    1,474       -  
Issuance of long-term debt
    4,875       2,986  
Repayment of long-term debt
    (1,791 )     (2,204 )
Purchase of treasury stock
    (5,911 )     (2,066 )
Issuance of treasury stock
    56       218  
Dividends paid
    (2,502 )     (2,606 )
Other
    (310 )     (130 )
Net Cash Used in Financing Activities
    (3,835 )     (3,802 )
Net decrease in cash and cash equivalents
    (993 )     (694 )
Cash and cash equivalents beginning of year
    4,868       3,045  
Cash and Cash Equivalents End of Period
  $ 3,875     $ 2,351  
                 
Cash paid during the three months ended March 31 for:
               
   Interest
  $ 1,081     $ 1,224  
   Income taxes, net of refunds
  $ (1,114 )   $ (712 )
See Notes to Consolidated Financial Statements.
               

 

 

AT&T INC.
 
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
 
Dollars and shares in millions except per share amounts
 
(Unaudited)
 
   
March 31, 2013
 
   
Shares
   
Amount
 
Common Stock
           
Balance at beginning of year
    6,495     $ 6,495  
Issuance of stock
    -       -  
Balance at end of period
    6,495     $ 6,495  
                 
Additional Paid-In Capital
               
Balance at beginning of year
          $ 91,038  
Issuance of treasury stock
            (10 )
Share-based payments
            (88 )
Balance at end of period
          $ 90,940  
                 
Retained Earnings
               
Balance at beginning of year
          $ 22,481  
Net income attributable to AT&T ($0.67 per diluted share)
            3,700  
Dividends to stockholders ($0.45 per share)
            (2,440 )
Other
            46  
Balance at end of period
          $ 23,787  
                 
Treasury Stock
               
Balance at beginning of year
    (914 )   $ (32,888 )
Repurchase of common stock
    (168 )     (5,911 )
Issuance of treasury stock
    10       231  
Balance at end of period
    (1,072 )   $ (38,568 )
                 
Accumulated Other Comprehensive Income Attributable to AT&T, net of tax:
               
Balance at beginning of year
          $ 5,236  
Other comprehensive income attributable to AT&T
            108  
Balance at end of period
          $ 5,344  
                 
Noncontrolling Interest:
               
Balance at beginning of year
          $ 333  
Net income attributable to noncontrolling interest
            73  
Distributions
            (66 )
Balance at end of period
          $ 340  
                 
Total Stockholders’ Equity at beginning of year
          $ 92,695  
Total Stockholders’ Equity at end of period
          $ 88,338  
See Notes to Consolidated Financial Statements.
               

 

 
AT&T INC.
MARCH 31, 2013

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Dollars in millions except per share amounts


NOTE 1. PREPARATION OF INTERIM FINANCIAL STATEMENTS

Basis of Presentation  Throughout this document, AT&T Inc. is referred to as “AT&T,” “we” or the “Company.” We believe that these consolidated financial statements include all adjustments, consisting only of normal recurring accruals, that are necessary to present fairly the results for the presented interim periods. The results for the interim periods are not necessarily indicative of those for the full year. You should read this document in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2012.

The consolidated financial statements include the accounts of the Company and our majority-owned subsidiaries and affiliates. Our subsidiaries and affiliates operate in the communications services industry both domestically and internationally, providing wireless communications services, traditional voice services, data/broadband and internet services, video services, telecommunications equipment, managed networking and wholesale services.

All significant intercompany transactions are eliminated in the consolidation process. Investments in partnerships and less than majority-owned subsidiaries where we have significant influence are accounted for under the equity method. Earnings from certain foreign equity investments accounted for using the equity method are included for periods ended within up to one month of our period end. We also record our proportionate share of our equity method investees’ other comprehensive income (OCI) items, including actuarial gains and losses on pension and other postretirement benefit obligations.

The preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes, including estimates of probable losses and expenses. Actual results could differ from those estimates. Certain amounts have been reclassified to conform to the current period’s presentation.

Stock Repurchase Program  During the first quarter of 2013, we repurchased 168 million shares for $5,911 under a repurchase authorization that was approved by our Board of Directors in July 2012. At March 31, 2013, we had 61 million shares remaining under that authorization. In March 2013, our Board of Directors authorized the repurchase of up to an additional 300 million shares of our common stock. The plan has no expiration date.
 
 

 
AT&T INC.
MARCH 31, 2013

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts

 
NOTE 2. EARNINGS PER SHARE

A reconciliation of the numerators and denominators of basic earnings per share and diluted earnings per share for net income attributable to AT&T for the three months ended March 31, 2013 and 2012, is shown in the table below:

 
Three months ended
 
March 31,
 
2013 
 
2012 
Numerators
         
Numerator for basic earnings per share:
         
   Net income
$
3,773 
 
$
3,652 
   Net income attributable to noncontrolling interest
 
(73)
   
(68)
   Net income attributable to AT&T
 
3,700 
   
3,584 
   Dilutive potential common shares:
         
      Other share-based payment
 
   
Numerator for diluted earnings per share
$
3,704 
 
$
3,587 
Denominators (000,000)
         
Denominator for basic earnings per share:
         
   Weighted average number of common shares outstanding
 
5,513 
   
5,918 
   Dilutive potential common shares:
         
      Share-based payment
 
17 
   
22 
Denominator for diluted earnings per share
 
5,530 
   
5,940 
Basic earnings per share attributable to AT&T
$
0.67 
 
$
0.60 
Diluted earnings per share attributable to AT&T
$
0.67 
 
$
0.60 

At March 31, 2013 and 2012, we had issued and outstanding options to purchase approximately 15 million and 28 million shares of AT&T common stock. For the quarter ended March 31, 2013 and 2012, the exercise prices of 4 million and 5 million shares were above the market price of AT&T stock for the respective periods. Accordingly, we did not include these amounts in determining the dilutive potential common shares. At March 31, 2013 and 2012, the exercise prices of 11 million and 22 million vested stock options were below market price.

 

 
AT&T INC.
MARCH 31, 2013

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts


NOTE 3. OTHER COMPREHENSIVE INCOME

Changes in the balances of each component of other comprehensive income (OCI) included in accumulated OCI for the three months ended March 31, 2013, are presented below. All amounts are net of tax and exclude noncontrolling interest.

At March 31, 2013 and for the period ended:
 
   
 
   
 
   
 
     
 
 
Foreign
Currency
Translation Adjustment
   
Net
Unrealized
Gain (Loss)
on Available-
for-Sale
Securities
   
Net
Unrealized
Gains
(Losses) on
Cash Flow
Hedges
   
Defined Benefit Postretirement
Plans
 
 
Accumulated Other Comprehensive Income
Balance as of January 1, 2013
$
 (284)
 
$
 272 
 
$
 (110)
 
$
 5,358 
 
$
 5,236 
Other comprehensive income
   before reclassifications
 
 121 
   
 75 
   
 90 
   
 - 
   
 286 
Amounts reclassified
   from accumulated OCI
 
 - 
   
 (7) 
1
 
 7  
2
 
 (178) 
3
 
 (178)
Net other comprehensive
   income (loss)
 
 121 
   
 68 
   
 97 
   
 (178)
   
 108 
Balance as of March 31, 2013
$
 (163)
 
$
 340 
 
$
 (13)
 
$
 5,180 
 
$
 5,344 
 1 
Pre-tax gains of $11 are included in Other income (expense) - net in the consolidated income statement.
 2 
(Gains) losses are included in interest expense on the consolidated income statement. See Note 6 for additional information.
 3 
Prior service credits associated with postretirement benefits, net of amounts capitalized as part of construction labor, are included in Cost of services and sales and Selling, general and administrative on the
 
consolidated income statement. See Note 5 for additional information.

NOTE 4. SEGMENT INFORMATION

Our segments are strategic business units that offer different products and services over various technology platforms and are managed accordingly. We analyze our various operating segments based on segment income before income taxes. We make our capital allocation decisions based on our strategic direction of the business, needs of the network (wireless or wireline) providing services and other assets needed to provide emerging services to our customers. Actuarial gains and losses from pension and other postretirement benefits, interest expense and other income (expense) – net, are managed only on a total company basis and are, accordingly, reflected only in consolidated results. Therefore, these items are not included in each segment’s reportable results. The customers and long-lived assets of our reportable segments are predominantly in the United States. We have three reportable segments: (1) Wireless, (2) Wireline and (3) Other. Our operating results prior to May 9, 2012, also included our Advertising Solutions segment, which was subsequently sold.

The Wireless segment uses our nationwide network to provide consumer and business customers with wireless data and voice communications services. This segment includes our portion of the results from our mobile payment joint venture marketed as the Isis Mobile WalletTM (ISIS), which is accounted for as an equity investment.

The Wireline segment uses our regional, national and global network to provide consumer and business customers with data and voice communications services, AT&T U-verse® high-speed broadband, video and voice services and managed networking to business customers. Additionally, we receive commissions on sales of satellite television services offered through our agency arrangements.

The Other segment includes our portion of the results from our international equity investments, our 47 percent equity interest in YP Holdings LLC (YP Holdings), and costs to support corporate-driven activities and operations. Also included in the Other segment are impacts of corporate-wide decisions for which the individual operating segments are not being evaluated, including interest costs and expected return on plan assets for our pension and postretirement benefit plans.
 
 

 
AT&T INC.
MARCH 31, 2013

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts


In the following tables, we show how our segment results are reconciled to our consolidated results reported.

For the three months ended March 31, 2013:
                               
   
Wireless
   
Wireline
    Advertising Solutions    
Other
   
Consolidations
   
Consolidated Results
 
Data
  $ 5,125     $ 8,162     $ -     $ -     $ -     $ 13,287  
Voice, text and other
    9,937       5,306        -       -       -       15,243  
Equipment and other
    1,629       1,187        -       10       -       2,826  
Total segment operating revenues
    16,691       14,655        -       10       -       31,356  
Operations and support expenses
    10,180       10,335        -       372       -       20,887  
Depreciation and amortization expenses
    1,835       2,688        -       6       -       4,529  
Total segment operating expenses
    12,015       13,023        -       378       -       25,416  
Segment operating income (loss)
    4,676       1,632        -       (368 )     -       5,940  
Interest expense
    -       -       -       -       827       827  
Equity in net income (loss) of affiliates
    (18 )     1       -       202       -       185  
Other income (expense) – net
    -       -        -       -       32       32  
Segment income (loss) before income taxes
  $ 4,658     $ 1,633     $ -     $ (166 )   $ (795 )   $ 5,330  
                                                 
For the three months ended March 31, 2012:
                                 
Consolidated Results
 
   
Wireless
   
Wireline
   
Advertising
Solutions
   
Other
   
Consolidations
 
Data
  $ 4,235     $ 7,800     $ -     $ -     $ -     $ 12,035  
Voice, text and other
    10,331       5,892        -       -       -       16,223  
Equipment and other
    1,570       1,237       744       13       -       3,564  
Total segment operating revenues
    16,136       14,929       744       13       -       31,822  
Operations and support expenses
    9,978       10,402        547       234       -       21,161  
Depreciation and amortization expenses
    1,666       2,808        77       9       -       4,560  
Total segment operating expenses
    11,644       13,210       624       243       -       25,721  
Segment operating income (loss)
    4,492       1,719        120       (230 )     -       6,101  
Interest expense
    -       -       -       -       859       859  
Equity in net income of affiliates
    (13 )     -       -       236       -       223  
Other income (expense) – net
    -       -       -       -       52       52  
Segment income (loss) before income taxes
  $ 4,479     $ 1,719     $ 120     $ 6     $ (807 )   $ 5,517  

NOTE 5. PENSION AND POSTRETIREMENT BENEFITS

Substantially all of our employees are covered by one of our noncontributory pension plans. We also provide certain medical, dental, life insurance, and death benefits to certain retired employees under various plans and accrue actuarially determined postretirement benefit costs as active employees earn these benefits. Our objective in funding these plans, in combination with the standards of the Employee Retirement Income Security Act of 1974, as amended (ERISA), is to accumulate assets sufficient to meet the plans’ obligations to provide benefits to employees upon their retirement. During 2013, we have a required contribution to our pension plans of approximately $175.

In October 2012, we filed an application with the U.S. Department of Labor for approval to make a voluntary contribution of a preferred equity interest in our Mobility business to the trust used to pay qualified pension benefits under plans sponsored by AT&T. At the time we filed the application, the interest had a fair market value of $9,500. We anticipate approval in 2013, and expect to make the contribution at that time. As currently proposed, the preferred equity interest will constitute a qualified plan asset for ERISA funding purposes, but will not be included in plan assets in our consolidated financial statements upon contribution. Final determination of whether it will qualify as a plan asset for financial reporting purposes is subject to the final terms of the preferred equity interest.
 
 
10 

 
AT&T INC.
MARCH 31, 2013

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts


The following table details pension and postretirement benefit costs included in operating expenses (in cost of services and sales, and selling, general and administrative expenses) in the accompanying consolidated statements of income. We recognize actuarial gains and losses from remeasuring our pension and postretirement plan obligations and assets in our operating results at our annual measurement date of December 31, unless earlier remeasurements are required.

In the following table, expense credits are denoted with parentheses. A portion of these expenses is capitalized as part of internal construction projects, providing a small reduction in the net expense recorded.

   
Three months ended
 
   
March 31,
 
   
2013
   
2012
 
Pension cost:
           
   Service cost – benefits earned during the period
  $ 330     $ 310  
   Interest cost on projected benefit obligation
    607       700  
   Expected return on assets
    (828 )     (880 )
   Amortization of prior service (credit)
    (23 )     (4 )
   Net pension cost
  $ 86     $ 126  
                 
Postretirement cost:
               
   Service cost – benefits earned during the period
  $ 95     $ 84  
   Interest cost on accumulated postretirement benefit obligation
    390       447  
   Expected return on assets
    (178 )     (200 )
   Amortization of prior service (credit)
    (263 )     (217 )
   Net postretirement cost
  $ 44     $ 114  
                 
   Combined net pension and postretirement cost
  $ 130     $ 240  

Our combined net pension and postretirement cost decreased $110 in the first quarter of 2013. The decrease reflects the prior year’s declining bond rates, which contribute to lower interest costs, and reflects higher amortization of prior service credits due to plan changes, including changes to retiree costs for continued healthcare coverage. This decrease is partially offset by lower expected long-term return on plan assets reflecting the continued uncertainty in the securities markets, the U.S. economy and plan’s asset mix.

We also provide senior- and middle-management employees with nonqualified, unfunded supplemental retirement and savings plans. Net supplemental retirement pension benefits cost, which is not included in the table above, was $27 in the first quarter of 2013, of which $25 was interest cost, and $31 for the first quarter of 2012, of which $29 was interest cost.
 
 
11 

 
AT&T INC.
MARCH 31, 2013

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts


NOTE 6. FAIR VALUE MEASUREMENTS AND DISCLOSURE

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

Level 1
Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets that we have the ability to access.

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

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

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

The valuation methodologies described above may produce a fair value calculation that may not be indicative of future net realizable value or reflective of future fair values. We believe our valuation methods are appropriate and consistent with other market participants. The use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date. There have been no changes in the methodologies used since December 31, 2012.

Long-Term Debt and Other Financial Instruments
The carrying amounts and estimated fair values of our long-term debt, including current maturities and other financial instruments, are summarized as follows:

 
March 31, 2013
 
December 31, 2012
 
 
Carrying
 
Fair
 
Carrying
 
Fair
 
 
Amount
 
Value
 
Amount
 
Value
 
Notes and debentures
  $ 72,120     $ 81,691     $ 69,578     $ 81,310  
Commercial paper
    1,748       1,748       -       -  
Bank borrowings
    1       1       1       1  
Investment securities
    2,359       2,359       2,218       2,218  

The carrying value of debt with an original maturity of less than one year approximates market value. The fair value measurements used for notes and debentures are considered Level 2.
 
 
12 

 
AT&T INC.
MARCH 31, 2013

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts


Investment Securities
Our investment securities include equities, fixed income bonds and other securities. A substantial portion of the fair values of our available-for-sale securities were estimated based on quoted market prices. Investments in securities not traded on a national securities exchange are valued using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Realized gains and losses on securities are included in “Other income (expense) – net” in the consolidated statements of income using the specific identification method. Unrealized gains and losses, net of tax, on available-for-sale securities are recorded in accumulated other comprehensive income (accumulated OCI). Unrealized losses that are considered other than temporary are recorded in “Other income (expense) – net” with the corresponding reduction to the carrying basis of the investment. Fixed income investments of $91 have maturities of less than one year, $294 within one to three years, $200 within three to five years, and $258 for five or more years, which approximate fair value.

Our short-term investments (including money market securities) and customer deposits are recorded at amortized cost, and the respective carrying amounts approximate fair values. Our investment securities are recorded in “Other Assets” on the consolidated balance sheets.

Following is the fair value leveling for available-for-sale securities and derivatives as of March 31, 2013 and December 31, 2012:

   
March 31, 2013
   
Level 1
 
Level 2
 
Level 3
 
Total
Available-for-Sale Securities
                     
   Domestic equities
$
 977 
 
$
 - 
 
$
 - 
 
$
 977 
   International equities
 
 493 
   
 - 
   
 - 
   
 493 
   Fixed income bonds
 
 - 
   
 843 
   
 - 
   
 843 
Asset Derivatives
                     
   Interest rate swaps
 
 - 
   
 262 
   
 - 
   
 262 
   Cross-currency swaps
 
 - 
   
 457 
   
 - 
   
 457 
Liability Derivatives
                     
   Cross-currency swaps
 
 - 
   
 (783)
   
 - 
   
 (783)
                         
   
December 31, 2012
   
Level 1
 
Level 2
 
Level 3
 
Total
Available-for-Sale Securities
                     
   Domestic equities
$
 873 
 
$
 - 
 
$
 - 
 
$
 873 
   International equities
 
 469 
   
 - 
   
 - 
   
 469 
   Fixed income bonds
 
 - 
   
 837 
   
 - 
   
 837 
Asset Derivatives
                     
   Interest rate swaps
 
 - 
   
 287 
   
 - 
   
 287 
   Cross-currency swaps
 
 - 
   
 752 
   
 - 
   
 752 
   Foreign exchange contracts
 
 - 
   
 1 
   
 - 
   
 1 
Liability Derivatives
                     
   Cross-currency swaps
 
 - 
   
 (672)
   
 - 
   
 (672)
 
 Derivatives designated as hedging instruments are reflected as Other assets, Other noncurrent liabilities and, for a portion of interest rate swaps, Other current assets.
 
 
13 

 
AT&T INC.
MARCH 31, 2013

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts


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

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

Fair Value Hedging We designate our fixed-to-floating interest rate swaps as fair value hedges. The purpose of these swaps is to manage interest rate risk by managing our mix of fixed-rate and floating-rate debt. These swaps involve the receipt of fixed-rate amounts for floating interest rate payments over the life of the swaps without exchange of the underlying principal amount. Accrued and realized gains or losses from interest rate swaps impact interest expense on the consolidated statements of income. Unrealized gains on interest rate swaps are recorded at fair market value as assets, and unrealized losses on interest rate swaps are recorded at fair market value as liabilities. Changes in the fair value of the interest rate swaps offset changes in the fair value of the fixed-rate notes payable they hedge due to changes in the designated benchmark interest rate and are recognized in interest expense. Gains or losses realized upon early termination of our fair value hedges are recognized in interest expense. In the three months ended March 31, 2013 and March 31, 2012, no ineffectiveness was measured.

Cash Flow Hedging Unrealized gains on derivatives designated as cash flow hedges are recorded at fair value as assets, and unrealized losses on derivatives designated as cash flow hedges are recorded at fair value as liabilities, both for the period they are outstanding. For derivative instruments designated as cash flow hedges, the effective portion is reported as a component of accumulated OCI until reclassified into interest expense in the same period the hedged transaction affects earnings. The gain or loss on the ineffective portion is recognized as other income or expense in each period.

We designate our cross-currency swaps as cash flow hedges. We have entered into multiple cross-currency swaps to hedge our exposure to variability in expected future cash flows that are attributable to foreign currency risk generated from the issuance of our Euro and British pound sterling denominated debt. These agreements include initial and final exchanges of principal from fixed foreign denominations to fixed U.S. denominated amounts, to be exchanged at a specified rate, which was determined by the market spot rate upon issuance. They also include an interest rate swap of a fixed foreign-denominated rate to a fixed U.S. denominated interest rate. We evaluate the effectiveness of our cross-currency swaps each quarter. In the three months ended March 31, 2013 and March 31, 2012, no ineffectiveness was measured.

Periodically, we enter into and designate interest rate locks to partially hedge the risk of changes in interest payments attributable to increases in the benchmark interest rate during the period leading up to the probable issuance of fixed-rate debt. We designate our interest rate locks as cash flow hedges. Gains and losses when we settle our interest rate locks are amortized into income over the life of the related debt, except where a material amount is deemed to be ineffective, which would be immediately reclassified to “Other income (expense) – net” in the consolidated statements of income. Over the next 12 months, we expect to reclassify $45 from accumulated OCI to interest expense due to the amortization of net losses on historical interest rate locks.

We hedge a portion of the exchange risk involved in anticipation of highly probable foreign currency-denominated transactions. In anticipation of these transactions, we often enter into foreign exchange contracts to provide currency at a fixed rate. Some of these instruments are designated as cash flow hedges while others remain nondesignated, largely based on size and duration. Gains and losses at the time we settle or take delivery on our designated foreign exchange contracts are amortized into income in the same period the hedged transaction affects earnings, except where an amount is deemed to be ineffective, which would be immediately reclassified to “Other income (expense) – net” in the consolidated statements of income. In the three months ended March 31, 2013 and March 31, 2012, no ineffectiveness was measured.
 
 
14 

 
AT&T INC.
MARCH 31, 2013

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts


Collateral and Credit-Risk Contingency  We have entered into agreements with our derivative counterparties establishing collateral thresholds based on respective credit ratings and netting agreements. At March 31, 2013, we had posted collateral of $139 (a deposit asset) and held collateral of $410 (a receipt liability). Under the agreements, if our credit rating had been downgraded one rating level by Moody’s Investors Service and Standards & Poor’s and two rating levels by Fitch, Inc., before the final collateral exchange in March, we would have been required to post additional collateral of $149. At December 31, 2012, we had posted collateral of $22 (a deposit asset) and held collateral of $543 (a receipt liability). We do not offset the fair value of collateral, whether the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable), against the fair value of the derivative instruments.
 
Following is the notional amount of our outstanding derivative positions:

   
March 31,
   
December 31,
 
   
2013
   
2012
 
Interest rate swaps
  $ 3,000     $ 3,000  
Cross-currency swaps
    12,576       12,071  
Foreign exchange contracts
    4       51  
Total
  $ 15,580     $ 15,122  

Following is the related hedged items affecting our financial position and performance:
 
             
Effect of Derivatives on the Consolidated Statements of Income
           
   
Three months ended
 
    March 31,     March 31,  
Fair Value Hedging Relationships   2013     2012  
Interest rate swaps (Interest expense):
           
Gain (Loss) on interest rate swaps
  $ (24)     $ (61)  
Gain (Loss) on long-term debt
    24        61   

In addition, the net swap settlements that accrued and settled in the quarter ended March 31 were offset against interest expense.

   
Three months ended
 
   
March 31,
   
March 31,
 
Cash Flow Hedging Relationships  
2013
   
2012
 
Cross-currency swaps:
           
Gain (Loss) recognized in accumulated OCI
  $ 141      $ (5)  
                 
Interest rate locks:
               
Interest income (expense) reclassified from accumulated OCI into income
    (11)       (9)  
                 
Foreign exchange contracts:
               
Gain (Loss) recognized in accumulated OCI
    (2)        

 
15 

 
AT&T INC.
MARCH 31, 2013

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts


RESULTS OF OPERATIONS

For ease of reading, AT&T Inc. is referred to as “we,” “AT&T” or the “Company” throughout this document, and the names of the particular subsidiaries and affiliates providing the services generally have been omitted. AT&T is a holding company whose subsidiaries and affiliates operate in the communications services industry in both the United States and internationally, providing wireless and wireline telecommunications services and equipment. You should read this discussion in conjunction with the consolidated financial statements, accompanying notes and management’s discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the year ended December 31, 2012. A reference to a “Note” in this section refers to the accompanying Notes to Consolidated Financial Statements. In the tables throughout this section, percentage increases and decreases that are not considered meaningful are denoted with a dash.

Consolidated Results  Our financial results in the first quarter of 2013 and 2012 are summarized as follows:

   
First Quarter
 
   
2013
   
2012
   
Percent
 Change
 
 
Operating Revenues
  $ 31,356     $ 31,822       (1.5)  %
Operating expenses
                       
   Cost of services and sales
    12,554       12,817       (2.1)  
   Selling, general and administrative
    8,333       8,344       (0.1)  
   Depreciation and amortization
    4,529       4,560       (0.7)  
Total Operating Expenses
    25,416       25,721       (1.2)  
Operating Income
    5,940       6,101       (2.6)  
Income Before Income Taxes
    5,330       5,517       (3.4)  
Net Income
    3,773       3,652       3.3   
Net Income Attributable to AT&T
  $ 3,700     $ 3,584       3.2  %

Overview
Operating income decreased $161, or 2.6%, in the first quarter of 2013 and our operating income margin decreased from 19.2% in 2012 to 18.9% in 2013. Both operating revenues and expenses in 2012 include results for our sold Advertising Solutions segment, which has a negative impact on the 2013 operating income. Operating income in the first quarter also reflects continued growth in wireless data and equipment revenues and wireline data revenues. Growth in wireless and wireline data revenues were offset by voice revenue declines and higher expenses primarily related to growth in U-verse subscribers and wireless handset costs. 

Operating revenues decreased $466, or 1.5%, in the first quarter of 2013. The sale of our Advertising Solutions segment reduced revenues $744. Also contributing to the decrease were the continued declines in wireline voice and wireless voice and text revenues. These decreases were offset by continued growth in wireless data and equipment revenues driven by growth in the subscriber base and the increasing percentage of smartphone customers, which contribute to higher wireless data revenues. The revenue decrease was also offset by higher wireline data revenues from U-verse services from consumer customers and strategic business services.

As the telecommunications industry continues to evolve from voice-oriented services into an industry driven by data-based services, technology, and efficiencies, our products, services and plans have also changed as we pursue the transition of traditional voice and basic data services to sophisticated, high-speed, IP-based alternatives. This transition of our offerings will result in continued growth in our wireless and wireline IP-based data revenues as we bundle and price plans with greater focus on the data services that our customers desire, provide new products and services, and transition customers from their current traditional services. We expect continued declines in voice revenues and our basic wireline data services as customers choose these next-generation services.

 
16 

 
AT&T INC.
MARCH 31, 2013

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations - Continued
Dollars in millions except per share amounts


Cost of services and sales expenses decreased $263, or 2.1%, in the first quarter of 2013. The sale of our Advertising Solutions segment reduced expenses $314 in the first quarter. The first-quarter decrease was also due to lower interconnect and Universal Service Fund (USF) fees, which are offset by lower revenue. These decreases were partially offset by increased wireline costs attributable to U-verse subscriber growth, higher wireless equipment costs related to upgrades and wireless network costs.

Selling, general and administrative expenses decreased $11, or 0.1%, in the first quarter of 2013. The sale of our Advertising Solutions segment reduced expenses $233 in the first quarter. The first-quarter decrease was also due to lower wireless commissions and lower financing-related costs associated with our pension and postretirement benefits (referred to as Pension/OPEB expenses), which were offset by increased wireless administrative costs and advertising expenses.

Depreciation and amortization expense decreased $31, or 0.7%, in the first quarter of 2013. The sale of our Advertising Solutions segment reduced depreciation and amortization expense $77 in the first quarter. Expenses also decreased due to lower amortization of intangibles for customer lists related to acquisitions offset by increased depreciation associated with ongoing capital spending for network upgrades and expansion.

Interest expense decreased $32, or 3.7%, in the first quarter of 2013. The decrease in interest expense was primarily due to lower average interest rates, partially offset by higher average debt balances.

Equity in net income of affiliates decreased $38, or 17.0%, in the first quarter of 2013 primarily due to lower equity income from América Móvil, S.A. de C.V. (América Móvil) resulting from foreign exchange impacts, and increased expenses in our mobile payment joint venture, marketed as the Isis Mobile WalletTM (ISIS). These decreases were partially offset by earnings from YP Holdings LLC (YP Holdings).

Other income (expense) – net We had other income of $32 in the first quarter of 2013, compared to other income of $52 in the first quarter of 2012. Results for first quarter 2013 included a $11 gain on the sale of investments, $5 of leveraged lease income and $17 of interest and dividend income. Results for first quarter 2012 included a $10 gain on the sale of investments, $33 of leveraged lease income and $15 of interest and dividend income.

Income taxes decreased $308, or 16.5%, in the first quarter of 2013. Our effective tax rate was 29.2% for the first quarter 2013, compared to 33.8% for first quarter 2012. The decrease in effective tax rate for the first quarter was primarily due to recognition of benefits related to tax audit settlements.

Selected Financial and Operating Data
           
     
March 31,
 
     
2013
   
2012
 
Wireless customers (000)
    107,251       103,940  
Network access lines in service (000)1
    28,043       32,764  
Total wireline broadband connections (000)
    16,514       16,530  
Debt ratio2
    45.6 %     38.4 %
Ratio of earnings to fixed charges3
    5.19       5.24  
Number of AT&T employees
    243,340       252,330  
 1 Prior-year amounts restated to conform to current-period reporting methodology.                
 2 Debt ratios are calculated by dividing total debt (debt maturing within one year plus long-term debt) by total capital (total debt plus total stockholders’ equity) and do not consider cash available to  
  pay down debt. See our “Liquidity and Capital Resources” section for discussion.  
 3 See Exhibit 12.                
                       
 
 
17 

 
AT&T INC.
MARCH 31, 2013

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations - Continued
Dollars in millions except per share amounts


Segment Results

Our segments are strategic business units that offer different products and services over various technology platforms and are managed accordingly. Our operating segment results presented in Note 4 and discussed below for each segment follow our internal management reporting. We analyze our operating segments based on segment income before income taxes. We make our capital allocation decisions based on our strategic direction of the business, needs of the network (wireless or wireline) providing services and other assets needed to provide emerging services to our customers. Actuarial gains and losses from pension and other postemployment benefits, interest expense and other income (expense) – net, are managed only on a total company basis and are, accordingly, reflected only in consolidated results. We have three reportable segments: (1) Wireless, (2) Wireline and (3) Other. Our operating results prior to May 9, 2012, also included Advertising Solutions, which was previously a reportable segment.

The Wireless segment uses our nationwide network to provide consumer and business customers with wireless data and voice communications services. This segment includes our portion of the results from our mobile payment joint venture ISIS, which is accounted for as an equity investment.

The Wireline segment uses our regional, national and global network to provide consumer and business customers with data and voice communications services, U-verse high-speed broadband, video, voice services, and managed networking to business customers. Additionally, we receive commissions on sales of satellite television services offered through our agency arrangements.

The Advertising Solutions segment included our directory operations, which published Yellow and White Pages directories and sold directory advertising, Internet-based advertising and local search through May 8, 2012.

The Other segment includes our portion of the results from our international equity investments, our 47 percent equity interest in YP Holdings, and costs to support corporate-driven activities and operations. Also included in the Other segment are impacts of corporate-wide decisions for which the individual operating segments are not being evaluated, including interest costs and expected return on plan assets for our pension and postretirement benefit plans.

The following sections discuss our operating results by segment. Operations and support expenses include certain network planning and engineering expenses; information technology; our repair technicians and repair services; property taxes; bad debt expense; advertising costs; sales and marketing functions, including customer service centers; real estate costs, including maintenance and utilities on all buildings; credit and collection functions; and corporate support costs, such as finance, legal, human resources and external affairs. Pension and postretirement service costs, net of amounts capitalized as part of construction labor, are also included to the extent that they are associated with these employees.

We discuss capital expenditures for each segment in “Liquidity and Capital Resources.”


 
18 

 
AT&T INC.
MARCH 31, 2013

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations - Continued
Dollars in millions except per share amounts

 
Wireless
                 
Segment Results
                 
   
First Quarter
 
   
2013
   
2012
   
Percent
Change
 
 
Segment operating revenues
                 
      Data
  $ 5,125      $ 4,235        21.0  %
      Voice, text and other service
    9,937        10,331        (3.8)  
      Equipment
    1,629        1,570        3.8   
Total Segment Operating Revenues
    16,691        16,136        3.4   
Segment operating expenses
                       
      Operations and support
    10,180        9,978        2.0   
      Depreciation and amortization
    1,835        1,666        10.1   
Total Segment Operating Expenses
    12,015        11,644        3.2   
Segment Operating Income
    4,676        4,492        4.1   
Equity in Net Loss of Affiliates
    (18)       (13)       (38.5)  
Segment Income
  $ 4,658      $ 4,479        4.0  %
 
The following table highlights other key measures of performance for the Wireless segment:
 
                     
     
First Quarter
 
     
2013
   
2012
   
Percent
Change
 
 
 
Wireless Subscribers (000)
    107,251        103,940       3.2  %
 
Gross Subscriber Additions (000)
    4,727        5,278       (10.4)  
 
Net Subscriber Additions (000)
    291        726       (59.9)  
 
Total Churn
    1.38%        1.47%    
(9) BP
 
                           
Postpaid Smartphone Subscribers (000)
    48,302        41,158       17.4  %
Postpaid Data-Centric Device and Other Phone Subscribers (000)
    22,447        28,245       (20.5)  
Total Postpaid Subscribers (000)
    70,749        69,403       1.9   
 
Net Postpaid Subscriber Additions (000)
    296        187       58.3   
 
Postpaid Churn
    1.04%        1.10%    
(6) BP
 
                           
Prepaid Subscribers (000)
    7,104        7,368       (3.6) %
 
Net Prepaid Subscriber Additions (000)
    (184)       125        -   
                           
Reseller Subscribers (000)
    14,702        13,869       6.0  %
 
Net Reseller Subscriber Additions (000)
    (252)       184        
                           
Connected Device Subscribers (000)
    14,696        13,300       10.5  %
 
Net Connected Device Subscriber Additions (000)
    431        230       87.4   
Represents 100% of AT&T Mobility wireless subscribers.
 
Excludes merger and acquisition-related additions during the period.
 
Calculated by dividing the aggregate number of wireless subscribers who canceled service during a period divided by the total number of wireless subscribers at the beginning of that period. The churn
 
 
rate for the period is equal to the average of the churn rate for each month of that period.
 
Includes devices such as eReaders, automobile monitoring systems, and fleet management--excludes tablet subscribers, which are split between prepaid and postpaid.
 
 
 
19 

 
AT&T INC.
MARCH 31, 2013

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations - Continued
Dollars in millions except per share amounts


Wireless Subscriber Relationships
As the wireless industry continues to mature, we believe that future wireless growth will increasingly depend on our ability to offer innovative services and devices and a wireless network that has sufficient spectrum and capacity to support these innovations and make them available to more subscribers. To attract and retain subscribers, we offer a broad handset line and a wide variety of service plans.

As technology evolves, rapid changes are occurring in the handset and device industry with the continual introduction of new models or significant revisions of existing models. We believe a broad offering of a wide variety of smartphones reduces dependence on any single operating system or manufacturer as these products continue to evolve in terms of technology and subscriber appeal. In the first quarter of 2013, we continued to see increasing use of smartphones by our postpaid subscribers. Of our total postpaid phone subscriber base, 71.6% (or 48.3 million subscribers) use smartphones, up from 61.2% (or 41.2 million subscribers) a year earlier. As is common in the industry, most of our subscribers’ phones are designed to work only with our wireless technology, requiring subscribers who desire to move to a new carrier with a different technology to purchase a new device. From time to time, we offer and have offered attractive handsets on an exclusive basis. As these exclusivity arrangements expire, we expect to continue to offer such handsets, and we believe our service plan offerings will help to retain our subscribers by providing incentives not to move to a new carrier. We do not expect exclusivity terminations to have a material impact on our Wireless segment income, consolidated operating margin or our cash flows from operations.

Our postpaid subscribers typically sign a two-year contract, which includes discounted handsets and early termination fees. About 90% of our postpaid smartphone subscribers are on FamilyTalk® Plans (family plans), Mobile Share plans or business discount plans (discount plans), which provide for service on multiple devices at discounted rates, and such subscribers tend to have higher retention and lower churn rates. We offer our Mobile to Any Mobile feature, which enables our subscribers on these and other qualifying plans to make unlimited mobile calls to any mobile number in the United States, subject to certain conditions. We also offer data plans at different price levels (usage-based data plans) to attract a wide variety of subscribers and to differentiate us from our competitors. Our postpaid subscribers on data plans increased 10.9% year over year. A growing percentage of our postpaid smartphone subscribers are on usage-based data plans, with 69.3% (or 33.5 million) on these plans as of March 31, 2013, up from 60.9% (or 25.1 million) as of March 31, 2012. Approximately 75% of subscribers on tiered data plans have chosen the higher-priced plans. We recently expanded our Mobile Share data plans (which allow postpaid subscribers to share data at discounted prices among devices covered by their plan) to include additional, larger usage levels. Participation in these plans continues to increase. Such offerings are intended to encourage existing subscribers to upgrade their current services and/or add connected devices, attract subscribers from other providers, and minimize subscriber churn.

As of March 31, 2013, about 60% of our postpaid smartphone subscribers use a 4G-capable device (i.e., a device that would operate on our HSPA+ or LTE network). Due to substantial increases in the demand for wireless service in the United States, AT&T is facing significant spectrum and capacity constraints on its wireless network in certain markets. We expect such constraints to increase and expand to additional markets in the coming years. While we are continuing to invest significant capital in expanding our network capacity, our capacity constraints could affect the quality of existing voice and data services and our ability to launch new, advanced wireless broadband services, unless we are able to obtain more spectrum. Any long-term spectrum solution will require that the Federal Communications Commission (FCC) make new or existing spectrum available to the wireless industry to meet the expanding needs of our subscribers. We will continue to attempt to address spectrum and capacity constraints on a market-by-market basis.

Wireless Metrics
Subscriber Additions As of March 31, 2013, we served 107.3 million wireless subscribers, an increase of 3.2%. Market saturation and competition in the wireless industry will continue to limit the rate of growth in the industry’s subscriber base, which has contributed to the 10.4% decrease in gross subscriber additions (gross additions) when compared to March 31, 2012 . Lower net subscriber additions (net additions) in the first quarter of 2013 were primarily attributable to resellers rationalizing their accounts due to low or no usage and the migration of prepaid tablet subscribers to our postpaid plans. The increase in net postpaid additions in the first quarter of 2013 reflected an increase in postpaid tablet subscribers of 365,000, as well as lower postpaid churn.
 
 
20 

 
AT&T INC.
MARCH 31, 2013

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations - Continued
Dollars in millions except per share amounts

 
Average service revenue per user (ARPU) – Postpaid increased 0.9% in the first quarter of 2013. Postpaid data services ARPU increased 18.0% in the first quarter of 2013, reflecting greater use of smartphones and data-centric devices by our subscribers.

The growth in postpaid data services ARPU in the first quarter of 2013 was partially offset by a 6.0% decrease in postpaid voice, text and other service ARPU in the first quarter. Voice, text and other service ARPU declined due to lower access and airtime charges, triggered in part by postpaid subscribers on our discount plans and lower roaming revenues.

ARPU – Total increased 0.1% in the first quarter of 2013, reflecting growth in data services as more subscribers are using smartphones and data-centric devices. Data services ARPU increased 17.1% in the first quarter of 2013. The increase was largely offset by the growth in connected device, tablet and reseller subscribers, which have lower-priced data-only plans. Voice, text and other service ARPU declined 6.9% in the first quarter of 2013 primarily due to voice access and usage trends and a shift toward a greater percentage of data-centric devices, as well as lower regulatory fees. We expect continued revenue growth from data services as more subscribers use smartphones and data-centric devices, and as we continue to expand our network, and expect continued pressure on voice, text and other service ARPU.

Churn  The effective management of subscriber churn is critical to our ability to maximize revenue growth and to maintain and improve margins. The total churn rates were lower in the first quarter of 2013, reflecting the popularity of our product offerings and network improvements. Postpaid churn rates were lower primarily due to our policy change in calculating churn for third party retailers; however, even without that change, churn rates were lower. Reseller subscribers have traditionally had the lowest churn rate among our wireless subscribers; however, the disconnection of low or no usage customers has partially offset other improvements in our total churn rate.

Operating Results
Our Wireless segment operating income margin in the first quarter increased from 27.8% in 2012 to 28.0% in 2013. Our Wireless segment operating income increased $184, or 4.1%, in the first quarter of 2013. The increase in operating margin and income reflected continuing data revenue growth and operating efficiencies, partially offset by high subsidies associated with growing smartphone sales. While we subsidize the sales prices of various smartphones, we expect to recover that cost over time from increased usage of the devices, especially data usage by the subscriber.

Voice, text and other service revenues decreased $394, or 3.8%, in the first quarter of 2013. While the number of wireless subscribers increased 3.2% in the first quarter of 2013, these revenues continue to decline due to voice access declines, as noted in the ARPU and subscriber relationships discussions above. In 2013, to better reflect our service pricing plans, we have chosen to combine text messaging revenue with voice and other services; we have adjusted previously reported voice, text and other, and data revenues to reflect this change.

Data service revenues increased $890, or 21.0%, in the first quarter of 2013. The increase was primarily due to the increased number of subscribers using smartphones and data-centric devices, such as eReaders, tablets, and mobile navigation devices. Data service revenues accounted for 34.0% of our wireless service revenues for the first quarter of 2013, compared to 29.1% last year.

Equipment revenues increased $59, or 3.8%, in the first quarter of 2013 due to a year-over-year increase in smartphone sales as a percentage of total device sales to postpaid subscribers and higher device upgrades.

Operations and support expenses increased $202, or 2.0%, in the first quarter of 2013. The first-quarter increase was primarily due to the following:
·  
Selling (other than commissions) and administrative expenses increased $198 due primarily to an $80 increase in information technology costs in conjunction with ongoing support systems development, a $77 increase in employee-related costs and a $68 increase in advertising costs, partially offset by a $55 decrease in bad debt expense due to lower write-offs.
·  
Equipment costs increased $130 reflecting an increase in upgrade activity and total device sales and the sales of the more expensive smartphones.
·  
Network system costs increased $89 due to higher network traffic and personnel-related network support costs and cell site related costs in conjunction with our network enhancement efforts.
 
 
21 

 
AT&T INC.
MARCH 31, 2013

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations - Continued
Dollars in millions except per share amounts


Partially offsetting these increases were the following:
·  
Interconnect and long-distance costs decreased $104 due to third-party credits and lower access costs in the current period.
·  
USF fees decreased $65 primarily due to federal rate decreases, which are offset by lower USF revenues.
·  
Commission expenses decreased $47 due the decline in gross additions, offset by a year-over-year increase in smartphone sales as a percentage of total device sales and higher upgrade activity.

Depreciation and amortization expenses increased $169, or 10.1%, in the first quarter of 2013. Depreciation expense increased $241, or 15.9%, in the first quarter primarily due to ongoing capital spending for network upgrades and expansion. Amortization expense decreased $72, or 48.0%, in the first quarter primarily due to lower amortization of intangibles for customer lists related to acquisitions.

Wireline
                 
Segment Results
                 
   
First Quarter
 
   
2013
   
2012
   
Percent
Change
 
 
Segment operating revenues
                 
   Data
  $ 8,162     $ 7,800       4.6   %
   Voice
    5,306       5,892       (9.9)  
   Other
    1,187       1,237       (4.0)  
Total Segment Operating Revenues
    14,655       14,929       (1.8)  
Segment operating expenses
                       
   Operations and support
    10,335       10,402       (0.6)  
   Depreciation and amortization
    2,688       2,808       (4.3)  
Total Segment Operating Expenses
    13,023       13,210       (1.4)  
Segment Operating Income
    1,632       1,719       (5.1)  
Equity in Net Income of Affiliates
    1       -        
Segment Income
  $ 1,633     $ 1,719       (5.0)  %

Operating Results
Our Wireline segment operating income margin in the first quarter decreased from 11.5% in 2012 to 11.1% in 2013. Our Wireline segment operating income decreased $87, or 5.1%, in the first quarter of 2013. The decrease in operating margin and income was driven primarily by lower voice revenue, partially offset by data revenue growth and lower depreciation and amortization expenses.
 
 
22 

 
AT&T INC.
MARCH 31, 2013

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations - Continued
Dollars in millions except per share amounts


Data revenues increased $362, or 4.6%, in the first quarter of 2013. Data revenues accounted for approximately 56% of wireline operating revenues in the first quarter of 2013 and 52% in the first quarter of 2012. Data revenue includes IP, strategic business and traditional data services.
·  
IP data revenue (excluding strategic business services below) increased $399, or 11.4%, in the first quarter primarily driven by higher U-verse penetration, customer additions, and migration from our legacy voice and DSL services. In the first quarter, U-verse revenue from consumers increased $327 for high speed Internet access, $246 for video and $48 for voice. These increases were partially offset by a decrease of $180 in DSL revenue as customers continue to shift to our strategic high speed Internet access offerings. We expect DSL revenue to continue to decline as a percentage of our overall data revenues.
·  
Strategic business service revenues, which include VPNs, Ethernet, hosting, IP conferencing, VoIP, Ethernet-access to Managed Internet Service (EaMIS), security services, and U-verse services provided to business customers, increased $192, or 10.8%, in the first quarter primarily driven by higher demand for these next generation services. In the first quarter, revenue from Ethernet increased $63, VPN increased $48, EaMIS increased $28 and U-verse services increased $25.
·  
Traditional data revenues, which include circuit-based and packet-switched data services, decreased $234, or 9.3%, in the first quarter. This decrease was primarily due to lower demand as customers continue to shift to our most advanced IP-based offerings such as Ethernet, VPN, U-verse High Speed Internet access and managed Internet services. We expect these traditional services to continue to decline as a percentage of our overall data revenues.

Voice revenues decreased $586, or 9.9%, in the first quarter of 2013 primarily due to declining demand for traditional voice services by our consumer and business customers. Included in voice revenues are revenue from local voice, long-distance (including international) and local wholesale services. Voice revenues do not include VoIP revenue, which is included in data revenues.
·  
Local voice revenues decreased $360, or 9.9%. The decrease was driven primarily by a 14.4% decline in total switched access lines. We expect our local voice revenue to continue to be negatively affected by competition from alternative technologies and continued declines in switched access lines.
·  
Long-distance revenues decreased $223, or 11.2%. Lower demand for long-distance service from global businesses and consumer customers decreased revenue $189 in the first quarter. Additionally, expected declines in the number of our national mass-market customers decreased revenue $35 in the first quarter.

Other operating revenues decreased $50, or 4.0%, in the first quarter of 2013. Major items included in other operating revenues are integration services and customer premises equipment, government-related services and outsourcing, which account for approximately 60% of total other revenue for both periods.

Operations and support expenses decreased $67, or 0.6%, in the first quarter of 2013. Operations and support expenses consist of costs incurred to provide our products and services, including costs of operating and maintaining our networks and personnel costs, such as compensation and benefits.

The first quarter decrease was primarily due to lower employee related expense of $93, reflecting ongoing workforce reduction initiatives; decreased USF fees of $75, which are offset by lower USF revenue; lower traffic compensation expense of $59; and decreased information technology costs of $53. These decreases were partially offset by increased cost of sales of $163, primarily related to U-verse related expenses, and increased advertising expense of $62.

Depreciation and amortization expenses decreased $120, or 4.3%, for the first quarter of 2013. Depreciation decreased $77, or 2.9%, primarily due to assets becoming fully depreciated. Amortization decreased $43, or 26.2%, primarily related to lower amortization of intangibles for the customer lists associated with acquisitions.
 
 
23 

 
AT&T INC.
MARCH 31, 2013

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations - Continued
Dollars in millions except per share amounts


Supplemental Information

Wireline Broadband, Telephone and Video Connections Summary
Our broadband, switched access lines and other services provided by our local exchange telephone subsidiaries at March 31, 2013 and 2012 are shown below and trends are addressed throughout this segment discussion.

   
March 31,
   
March 31,
   
Percent
 
(in 000s)
 
2013
   
2012
   
Change
 
U-verse High Speed Internet
    8,447       5,941       42.2   %
DSL and Other Broadband Connections
    8,067       10,589       (23.8)  
Total Wireline Broadband Connections1
    16,514       16,530       (0.1)  
                         
Total U-verse Video Connections
    4,768       3,991       19.5   
                         
Retail Consumer Switched Access Lines
    14,840       18,092       (18.0)  
U-verse Consumer VoIP Connections
    3,120       2,442       27.8   
Total Retail Consumer Voice Connections2
    17,960       20,534       (12.5)  
                         
Switched Access Lines
                       
Retail Consumer
    14,840       18,092       (18.0)  
Retail Business
    11,185       12,420       (9.9)  
Retail Subtotal
    26,025       30,512       (14.7)  
                         
Wholesale Subtotal
    1,725       1,902       (9.3)  
                         
Total Switched Access Lines2,3
    28,043       32,764       (14.4)  %
 1
 Total wireline broadband connections include DSL, U-verse High Speed Internet and satellite broadband.
 2
 Prior-period amounts restated to conform to current-period reporting methodology.
 3
 Total switched access lines include access lines provided to national mass markets and private payphone service providers of 293 at March 31, 2013 and 350 at March 31, 2012.

Advertising Solutions
                 
Segment Results
                 
 
First Quarter
 
 
2013
 
2012
   
Percent Change
 
Total Segment Operating Revenues
  $ -     $ 744       -  
Segment operating expenses
                       
   Operations and support
    -       547       -  
   Depreciation and amortization
    -       77       -  
Total Segment Operating Expenses
    -       624       -  
Segment Income
  $ -     $ 120       -  

On May 8, 2012, we completed the sale of our Advertising Solutions segment to an affiliate of Cerberus Capital Management, L.P. Following the sale, we are no longer recording operating results for this segment. We hold a 47 percent interest in the new entity, YP Holdings.

 
24 

 
AT&T INC.
MARCH 31, 2013

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations - Continued
Dollars in millions except per share amounts

 
Other
                 
Segment Results
                 
 
First Quarter
 
 
2013
 
2012
   
Percent Change
 
 
Total Segment Operating Revenues
  $ 10      $ 13        (23.1)  %
Total Segment Operating Expenses
    378        243        55.6   
Segment Operating Income (loss)
    (368)       (230)       (60.0)  
Equity in Net Income of Affiliates
    202        236        (14.4)  
Segment Income (loss)
  $ (166)