10-Q 1 q3_10q.htm AT&T 2014 FORM 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
                                                       
(Mark One)
 
 
 
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
 
 
 
 
For the quarterly period ended September 30, 2014
 
or
 
 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
       
For the transition period from          to

Commission File Number 1-8610

AT&T INC.

Incorporated under the laws of the State of Delaware
I.R.S. Employer Identification Number 43-1301883

208 S. Akard St., Dallas, Texas 75202
Telephone Number: (210) 821-4105


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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
                                                                                                                                                               Yes [X]   No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of "accelerated filer," "large accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
                                                                                                                                                                            Yes [   ]   No [X]
 
At October 31, 2014, there were 5,187 million common shares outstanding.
 

 
PART I - FINANCIAL INFORMATION
Item 1.  Financial Statements

AT&T INC.
 
CONSOLIDATED STATEMENTS OF INCOME
 
Dollars in millions except per share amounts
 
(Unaudited)
 
   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
Operating Revenues
 
$
32,957
   
$
32,158
   
$
98,008
   
$
95,589
 
Operating Expenses
                               
Cost of services and sales (exclusive of depreciation
                               
   and amortization shown separately below)
   
14,541
     
13,403
     
42,074
     
39,227
 
Selling, general and administrative
   
8,475
     
7,952
     
24,932
     
24,406
 
Depreciation and amortization
   
4,539
     
4,615
     
13,706
     
13,715
 
Total operating expenses
   
27,555
     
25,970
     
80,712
     
77,348
 
Operating Income
   
5,402
     
6,188
     
17,296
     
18,241
 
Other Income (Expense)
                               
Interest expense
   
(1,016
)
   
(829
)
   
(2,757
)
   
(2,481
)
Equity in net income (loss) of affiliates
   
(2
)
   
91
     
188
     
494
 
Other income (expense) – net
   
42
     
50
     
1,456
     
370
 
Total other income (expense)
   
(976
)
   
(688
)
   
(1,113
)
   
(1,617
)
Income Before Income Taxes
   
4,426
     
5,500
     
16,183
     
16,624
 
Income tax expense
   
1,367
     
1,595
     
5,769
     
5,066
 
Net Income
   
3,059
     
3,905
     
10,414
     
11,558
 
Less: Net Income Attributable to Noncontrolling Interest
   
(57
)
   
(91
)
   
(213
)
   
(222
)
Net Income Attributable to AT&T
 
$
3,002
   
$
3,814
   
$
10,201
   
$
11,336
 
Basic Earnings Per Share Attributable to AT&T
 
$
0.58
   
$
0.72
   
$
1.96
   
$
2.10
 
Diluted Earnings Per Share Attributable to AT&T
 
$
0.58
   
$
0.72
   
$
1.95
   
$
2.09
 
Weighted Average Number of Common Shares
                               
   Outstanding – Basic (in millions)
   
5,198
     
5,315
     
5,208
     
5,402
 
Weighted Average Number of Common Shares
                               
   Outstanding with Dilution (in millions)
   
5,214
     
5,331
     
5,224
     
5,419
 
Dividends Declared Per Common Share
 
$
0.46
   
$
0.45
   
$
1.38
   
$
1.35
 
See Notes to Consolidated Financial Statements.
                               
2
 
AT&T INC.
               
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
             
Dollars in millions
               
(Unaudited)
               
   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
Net income
 
$
3,059
   
$
3,905
   
$
10,414
   
$
11,558
 
Other comprehensive income, net of tax:
                               
    Foreign Currency:
                               
        Translation adjustments (includes $(1), $(1), $0
           and $(2) attributable to noncontrolling interest), net of taxes of
           $(22), $(21), $(17) and $(86)
   
(35
)
   
(37
)
   
(29
)
   
(155
)
        Reclassification adjustment included in net income,
            net of taxes of $0, $0, $224 and $19
   
-
     
-
     
416
     
34
 
    Available-for-sale securities:
                               
        Net unrealized gains (losses), net of taxes of $(15), $38,
           $19 and $84
   
(29
)
   
69
     
30
     
155
 
        Reclassification adjustment realized in net income, net of
           taxes of $(1), $(2), $(9) and $(7)
   
(1
)
   
(3
)
   
(15
)
   
(13
)
     Cash flow hedges:
                               
        Net unrealized gains, net of taxes of $201, $171,
           $148 and $286
   
370
     
316
     
272
     
526
 
        Reclassification adjustment included in net income,
           net of taxes of $3, $4, $14 and $12
   
8
     
7
     
29
     
22
 
     Defined benefit postretirement plans:
                               
        Reclassification adjustment included in net income, net of
           taxes $0, $0, $33 and $5
   
-
     
-
     
61
     
8
 
        Amortization of net prior service credit included in
           net income, net of taxes of $(146), $(109), $(435)
           and $(327)
   
(239
)
   
(178
)
   
(718
)
   
(533
)
Other comprehensive income
   
74
     
174
     
46
     
44
 
Total comprehensive income
   
3,133
     
4,079
     
10,460
     
11,602
 
Less: Total comprehensive income attributable to
     noncontrolling interest
   
(56
)
   
(90
)
   
(213
)
   
(220
)
Total Comprehensive Income Attributable to AT&T
 
$
3,077
   
$
3,989
   
$
10,247
   
$
11,382
 
See Notes to Consolidated Financial Statements.
                               
3

AT&T INC.
 
CONSOLIDATED BALANCE SHEETS
 
Dollars in millions except per share amounts
 
   
September 30,
   
December 31,
 
   
2014
   
2013
 
Assets
 
(Unaudited)
     
Current Assets
       
Cash and cash equivalents
 
$
2,458
   
$
3,339
 
Accounts receivable - net of allowances for doubtful accounts of $482 and $483
   
13,445
     
12,918
 
Prepaid expenses
   
869
     
960
 
Deferred income taxes
   
1,030
     
1,199
 
Other current assets
   
8,033
     
4,780
 
Total current assets
   
25,835
     
23,196
 
Property, plant and equipment
   
286,987
     
274,798
 
   Less: accumulated depreciation and amortization
   
(171,853
)
   
(163,830
)
Property, Plant and Equipment – Net
   
115,134
     
110,968
 
Goodwill
   
70,131
     
69,273
 
Licenses
   
60,784
     
56,433
 
Other Intangible Assets – Net
   
6,252
     
5,779
 
Investments in Equity Affiliates
   
166
     
3,860
 
Other Assets
   
9,637
     
8,278
 
Total Assets
 
$
287,939
   
$
277,787
 
                 
Liabilities and Stockholders' Equity
               
Current Liabilities
               
Debt maturing within one year
 
$
5,109
   
$
5,498
 
Accounts payable and accrued liabilities
   
24,119
     
21,107
 
Advanced billing and customer deposits
   
4,038
     
4,212
 
Accrued taxes
   
4,328
     
1,774
 
Dividends payable
   
2,385
     
2,404
 
Total current liabilities
   
39,979
     
34,995
 
Long-Term Debt
   
70,516
     
69,290
 
Deferred Credits and Other Noncurrent Liabilities
               
Deferred income taxes
   
37,393
     
36,308
 
Postemployment benefit obligation
   
29,918
     
29,946
 
Other noncurrent liabilities
   
17,014
     
15,766
 
Total deferred credits and other noncurrent liabilities
   
84,325
     
82,020
 
                 
Stockholders' Equity
               
Common stock ($1 par value, 14,000,000,000 authorized at September 30, 2014 and
               
   December 31, 2013: issued 6,495,231,088 at September 30, 2014 and December 31, 2013)
   
6,495
     
6,495
 
Additional paid-in capital
   
91,064
     
91,091
 
Retained earnings
   
34,165
     
31,141
 
Treasury stock (1,310,226,392 at September 30, 2014 and 1,268,914,913
               
   at December 31, 2013, at cost)
   
(47,037
)
   
(45,619
)
Accumulated other comprehensive income
   
7,926
     
7,880
 
Noncontrolling interest
   
506
     
494
 
Total stockholders' equity
   
93,119
     
91,482
 
Total Liabilities and Stockholders' Equity
 
$
287,939
   
$
277,787
 
See Notes to Consolidated Financial Statements.
               
4

AT&T INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Dollars in millions
 
(Unaudited)
 
   
Nine months ended
 
   
September 30,
 
   
2014
   
2013
 
Operating Activities
       
Net income
 
$
10,414
   
$
11,558
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
   Depreciation and amortization
   
13,706
     
13,715
 
   Undistributed earnings from investments in equity affiliates
   
(45
)
   
(232
)
   Provision for uncollectible accounts
   
692
     
653
 
   Deferred income tax expense
   
1,304
     
2,505
 
   Net gain from sale of investments, net of impairments
   
(1,374
)
   
(272
)
   Changes in operating assets and liabilities:
               
      Accounts receivable
   
(1,269
)
   
(440
)
      Other current assets
   
(813
)
   
520
 
      Accounts payable and accrued liabilities
   
4,763
     
(420
)
   Retirement benefit funding
   
(420
)
   
(175
)
   Other - net
   
(1,365
)
   
(533
)
Total adjustments
   
15,179
     
15,321
 
Net Cash Provided by Operating Activities
   
25,593
     
26,879
 
                 
Investing Activities
               
Construction and capital expenditures:
               
   Capital expenditures
   
(16,829
)
   
(15,565
)
   Interest during construction
   
(178
)
   
(213
)
Acquisitions, net of cash acquired
   
(2,053
)
   
(4,025
)
Dispositions
   
6,074
     
846
 
Purchases of securities
   
(1,996
)
   
-
 
Return of advances to and investments in equity affiliates
   
3
     
301
 
Other
   
(1
)
   
(4
)
Net Cash Used in Investing Activities
   
(14,980
)
   
(18,660
)
                 
Financing Activities
               
Net change in short-term borrowings with original maturities of three months or less
   
(16
)
   
1,851
 
Issuance of other short-term borrowings
   
-
     
1,476
 
Repayment of other short-term borrowings
   
-
     
(1,476
)
Issuance of long-term debt
   
8,564
     
6,416
 
Repayment of long-term debt
   
(10,376
)
   
(2,131
)
Purchase of treasury stock
   
(1,617
)
   
(11,134
)
Issuance of treasury stock
   
34
     
108
 
Dividends paid
   
(7,170
)
   
(7,325
)
Other
   
(913
)
   
499
 
Net Cash Used in Financing Activities
   
(11,494
)
   
(11,716
)
Net decrease in cash and cash equivalents
   
(881
)
   
(3,497
)
Cash and cash equivalents beginning of year
   
3,339
     
4,868
 
Cash and Cash Equivalents End of Period
 
$
2,458
   
$
1,371
 
Cash paid during the nine months ended September 30 for:
               
   Interest
 
$
3,351
   
$
2,980
 
   Income taxes, net of refunds
 
$
1,337
   
$
1,573
 
See Notes to Consolidated Financial Statements.
 
5

AT&T INC.
 
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
 
Dollars and shares in millions except per share amounts
 
(Unaudited)
 
   
September 30, 2014
 
   
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
         
$
91,091
 
Issuance of treasury stock
           
3
 
Share-based payments
           
3
 
Change related to acquisition of interests held by noncontrolling owners
           
(33
)
Balance at end of period
         
$
91,064
 
                 
Retained Earnings
               
Balance at beginning of year
         
$
31,141
 
Net income attributable to AT&T ($1.95 per diluted share)
           
10,201
 
Dividends to stockholders ($1.38 per share)
           
(7,177
)
Balance at end of period
         
$
34,165
 
                 
Treasury Stock
               
Balance at beginning of year
   
(1,269
)
 
$
(45,619
)
Repurchase of common stock
   
(48
)
   
(1,617
)
Issuance of treasury stock
   
7
     
199
 
Balance at end of period
   
(1,310
)
 
$
(47,037
)
                 
Accumulated Other Comprehensive Income Attributable to AT&T, net of tax
               
Balance at beginning of year
         
$
7,880
 
Other comprehensive income attributable to AT&T
           
46
 
Balance at end of period
         
$
7,926
 
                 
Noncontrolling Interest
               
Balance at beginning of year
         
$
494
 
Net income attributable to noncontrolling interest
           
213
 
Distributions
           
(200
)
Acquisitions of noncontrolling interests
           
69
 
Acquisition of interests held by noncontrolling owners
           
(70
)
Balance at end of period
         
$
506
 
                 
Total Stockholders' Equity at beginning of year
         
$
91,482
 
Total Stockholders' Equity at end of period
         
$
93,119
 
See Notes to Consolidated Financial Statements.
               
6

AT&T INC.
SEPTEMBER 30, 2014

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, 2013.

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 wireline voice services, data/broadband and Internet services, video services, telecommunications equipment, managed networking and wholesale services. On March 13, 2014, we closed our acquisition of Leap Wireless International, Inc. (Leap) (see Note 7), and we incorporated Leap into our wireless operations following the date of acquisition.

All significant intercompany transactions are eliminated in the consolidation process. Investments in less than majority-owned subsidiaries and partnerships 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 recorded 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. On June 30, 2014, we completed the sale of our investment in América Móvil, S.A.B. de C.V. (América Móvil) to an unrelated third party (see Note 7).

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.

During the fourth-quarter we conduct our annual impairment testing of intangible assets, remeasure the plan assets and obligations of our benefit plans and, due to our continued access line losses and technology changes, we are assessing certain network assets for under-utilization and/or abandonment.

Stock Repurchase Program  During the first nine months of 2014, we repurchased approximately 48 million shares for $1,617 under a repurchase authorization that was approved by our Board of Directors in March 2013. In March 2014, our Board of Directors approved a fourth authorization to repurchase 300 million shares of our common stock. As of September 30, 2014, we had approximately 415 million shares remaining from these authorizations. The repurchase authorizations have no expiration date, and we expect to make future repurchases opportunistically.
 
Software Costs  During 2014, we completed studies evaluating the periods that we were utilizing our software assets. As of April 1 and July 1, 2014, we extended our estimated useful lives for capitalized non-network and network software, respectively, to five years to better reflect the estimated periods during which these assets will remain in service and to align with the estimated useful lives used in the industry. This change in accounting estimate increased net income $198, or $0.04 per diluted share, in the third quarter and $330, or $0.06 per diluted share, for the first nine months of 2014.

New Accounting Standards  In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09, "Revenue from Contracts with Customers (Topic 606)" (ASU 2014-09), which replaces existing revenue recognition rules with a comprehensive revenue measurement and recognition standard and expanded disclosure requirements. Upon initial evaluation, we believe the key changes in the standard that impact our revenue recognition relate to the allocation of contract revenues between service and equipment, and the timing in which those revenues are recognized. ASU 2014-09 also specifies that incremental costs of obtaining or fulfilling our contracts with customers should be deferred. ASU 2014-09 becomes effective for annual reporting periods beginning after December 15, 2016.
 
7


AT&T INC.
SEPTEMBER 30, 2014

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
The FASB will allow two adoption methods under ASU 2014-09. Under one method, a company will apply the rules to contracts in all reporting periods presented, subject to certain allowable exceptions. Under the other method, a company will apply the rules to all contracts existing as of January 1, 2017, recognizing in beginning retained earnings an adjustment for the cumulative effect of the change and provide additional disclosures comparing results to previous rules. We continue to evaluate the impact of the new standard and available adoption methods.

NOTE 2. EARNINGS PER SHARE

A reconciliation of the numerators and denominators of basic earnings per share and diluted earnings for the three and nine months ended September 30, 2014 and 2013, is shown in the table below:

   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
Numerators
               
Numerator for basic earnings per share:
               
   Net Income
 
$
3,059
   
$
3,905
   
$
10,414
   
$
11,558
 
   Less:  Net income attributable to noncontrolling interest
   
(57
)
   
(91
)
   
(213
)
   
(222
)
   Net Income attributable to AT&T
   
3,002
     
3,814
     
10,201
     
11,336
 
   Dilutive potential common shares:
                               
      Share-based payment
   
3
     
3
     
10
     
9
 
Numerator for diluted earnings per share
 
$
3,005
   
$
3,817
   
$
10,211
   
$
11,345
 
Denominators (000,000)
                               
Denominator for basic earnings per share:
                               
   Weighted average number of common shares outstanding
   
5,198
     
5,315
     
5,208
     
5,402
 
   Dilutive potential common shares:
                               
      Share-based payment (in shares)
   
16
     
16
     
16
     
17
 
Denominator for diluted earnings per share
   
5,214
     
5,331
     
5,224
     
5,419
 
Basic earnings per share attributable to AT&T
 
$
0.58
   
$
0.72
   
$
1.96
   
$
2.10
 
Diluted earnings per share attributable to AT&T
 
$
0.58
   
$
0.72
   
$
1.95
   
$
2.09
 

At September 30, 2014 and 2013, we had issued and outstanding options to purchase approximately 11 million and 12 million shares of AT&T common stock. For the quarter ended September 30, 2014 and 2013, the exercise prices of 3 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.

8

AT&T INC.
SEPTEMBER 30, 2014

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 included in accumulated other comprehensive income (accumulated OCI) for the nine months ended September 30, 2014 and 2013, are presented below. For the period ended September 30, 2014, the amounts reclassified from accumulated OCI include the adjustments resulting from our change in accounting for América Móvil (see Note 7). All amounts are net of tax and exclude noncontrolling interest.
 
At September 30, 2014 and for the period ended:
                   
 
Foreign
Currency
Translation
Adjustment
   
Net Unrealized
Gains (Losses)
on Available-
for-Sale
Securities
   
Net Unrealized
Gains (Losses)
on Cash Flow
Hedges
   
Defined Benefit
Postretirement
Plans
   
Accumulated
Other
Comprehensive
Income
 
Balance as of December 31, 2013
$
(367
)
 
$
450
   
$
445
   
$
7,352
     
$
7,880
 
Other comprehensive income
   (loss) before reclassifications
 
(29
)
   
30
     
272
     
-
       
273
 
Amounts reclassified
   from accumulated OCI
 
416
 1
 
 
(15
)2
 
 
29
 3
 
 
(657
)4
 
   
(227
)
Net other comprehensive
   income (loss)
 
387
     
15
     
301
     
(657
)
     
46
 
Balance as of September 30, 2014
$
20
   
$
465
   
$
746
   
$
6,695
     
$
7,926
 
 
                                       
At September 30, 2013 and for the period ended:
                                   
 
Foreign
Currency
Translation
Adjustment
   
Net Unrealized
Gains (Losses)
on Available-
for-Sale
Securities
   
Net Unrealized
Gains (Losses)
on Cash Flow
Hedges
   
Defined Benefit
Postretirement
Plans
   
Accumulated
Other
Comprehensive
Income
 
Balance as of December 31, 2012
$
(284
)
 
$
272
   
$
(110
)
 
$
5,358
     
$
5,236
 
Other comprehensive income
   (loss) before reclassifications
 
(153
)
   
155
     
526
     
-
       
528
 
Amounts reclassified
   from accumulated OCI
 
34
 1
 
 
(13
)2
 
 
22
 3
 
 
(525
)4
 
   
(482
)
Net other comprehensive
   income (loss)
 
(119
)
   
142
     
548
     
(525
)
     
46
 
Balance as of September 30, 2013
$
(403
)
 
$
414
   
$
438
   
$
4,833
     
$
5,282
 
1 Pre-tax translation loss reclassifications are included in Other income (expense) - net in the consolidated statements of income.
2 Pre-tax gains are included in Other income (expense) - net in the consolidated statements of income.
3 (Gains) losses are included in interest expense in the consolidated statements of income. See Note 6 for additional information.
4 The amortization of 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 in the consolidated statements of income (see Note 5).
  Actuarial loss reclassifications related to our equity method investees are included in Other income (expense) - net in the consolidated statements of income.
 
9


AT&T INC.
SEPTEMBER 30, 2014

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
NOTE 4. SEGMENT INFORMATION

Our segments are strategic business units that offer different products and services over various technology platforms and are managed accordingly. We analyze our 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 demands 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 two reportable segments: (1) Wireless and (2) Wireline.

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 SoftcardTM mobile wallet joint venture 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 Internet, video and VoIP services and managed networking to business customers.

The Corporate and Other column includes unallocated corporate expenses, which includes costs to support corporate-driven activities and operations, 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 as well as our actuarial gains and losses on our pension and postretirement plan valuations. Results from equity method investments in América Móvil (prior to the June 2014 disposal of our investment), YP Holdings LLC, and Otter Media (our joint venture with The Chernin Group), are also excluded from our segment results as those results are not considered in our assessment of segment performance. We have revised our prior-period presentation to conform to our current reporting.

10

AT&T INC.
SEPTEMBER 30, 2014

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 September 30, 2014
             
   
Wireless
   
Wireline
   
Corporate
and Other
   
Consolidated 
Results
Service
 
$
15,423
   
$
14,368
   
$
-
   
$
29,791
 
Equipment
   
2,914
     
247
     
5
     
3,166
 
Total segment operating revenues
   
18,337
     
14,615
     
5
     
32,957
 
Operations and support expenses
   
11,855
     
10,761
     
400
     
23,016
 
Depreciation and amortization expenses
   
1,965
     
2,571
     
3
     
4,539
 
Total segment operating expenses
   
13,820
     
13,332
     
403
     
27,555
 
Segment operating income (loss)
   
4,517
     
1,283
     
(398
)
   
5,402
 
Interest expense
   
-
     
-
     
1,016
     
1,016
 
Equity in net income (loss) of affiliates
   
(26
)
   
1
     
23
     
(2
)
Other income (expense) – net
   
-
     
-
     
42
     
42
 
Segment income (loss) before income taxes
 
$
4,491
   
$
1,284
   
$
(1,349
)
 
$
4,426
 
                                 
For the nine months ended September 30, 2014
                   
Consolidated 
 Results
   
Wireless
   
Wireline
   
Corporate
and Other
 
Service
 
$
45,958
   
$
43,165
   
$
-
   
$
89,123
 
Equipment
   
8,175
     
688
     
22
     
8,885
 
Total segment operating revenues
   
54,133
     
43,853
     
22
     
98,008
 
Operations and support expenses
   
34,305
     
31,918
     
783
     
67,006
 
Depreciation and amortization expenses
   
5,931
     
7,769
     
6
     
13,706
 
Total segment operating expenses
   
40,236
     
39,687
     
789
     
80,712
 
Segment operating income (loss)
   
13,897
     
4,166
     
(767
)
   
17,296
 
Interest expense
   
-
     
-
     
2,757
     
2,757
 
Equity in net income (loss) of affiliates
   
(75
)
   
2
     
261
     
188
 
Other income (expense) – net
   
-
     
-
     
1,456
     
1,456
 
Segment income (loss) before income taxes
 
$
13,822
   
$
4,168
   
$
(1,807
)
 
$
16,183
 
11

AT&T INC.
SEPTEMBER 30, 2014

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


For the three months ended September 30, 2013
             
   
Wireless
   
Wireline
   
Corporate
and Other
   
Consolidated 
Results
Service
 
$
15,460
   
$
14,403
   
$
-
   
$
29,863
 
Equipment
   
2,020
     
267
     
8
     
2,295
 
Total segment operating revenues
   
17,480
     
14,670
     
8
     
32,158
 
Operations and support expenses
   
10,982
     
10,385
     
(12
)
   
21,355
 
Depreciation and amortization expenses
   
1,875
     
2,736
     
4
     
4,615
 
Total segment operating expenses
   
12,857
     
13,121
     
(8
)
   
25,970
 
Segment operating income
   
4,623
     
1,549
     
16
     
6,188
 
Interest expense
   
-
     
-
     
829
     
829
 
Equity in net income (loss) of affiliates
   
(18
)
   
-
     
109
     
91
 
Other income (expense) – net
   
-
     
-
     
50
     
50
 
Segment income (loss) before income taxes
 
$
4,605
   
$
1,549
   
$
(654
)
 
$
5,500
 
                                 
For the nine months ended September 30, 2013
                   
 
Consolidated
 Results
   
Wireless
   
Wireline
   
Corporate
and Other
 
Service
 
$
45,892
   
$
43,266
   
$
-
   
$
89,158
 
Equipment
   
5,570
     
832
     
29
     
6,431
 
Total segment operating revenues
   
51,462
     
44,098
     
29
     
95,589
 
Operations and support expenses
   
31,932
     
31,137
     
564
     
63,633
 
Depreciation and amortization expenses
   
5,553
     
8,146
     
16
     
13,715
 
Total segment operating expenses
   
37,485
     
39,283
     
580
     
77,348
 
Segment operating income (loss)
   
13,977
     
4,815
     
(551
)
   
18,241
 
Interest expense
   
-
     
-
     
2,481
     
2,481
 
Equity in net income (loss) of affiliates
   
(55
)
   
1
     
548
     
494
 
Other income (expense) – net
   
-
     
-
     
370
     
370
 
Segment income (loss) before income taxes
 
$
13,922
   
$
4,816
   
$
(2,114
)
 
$
16,624
 

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.

In July 2014, the U.S. Department of Labor (DOL) published in the Federal Register their final retroactive approval of our September 9, 2013 voluntary contribution of a preferred equity interest in AT&T Mobility II LLC, the primary holding company for our wireless business, to the trust used to pay pension benefits under our qualified pension plans. The preferred equity interest had a value of $9,114 at September 30, 2014. The trust is entitled to receive cumulative cash distributions of $560 per annum, which will be distributed quarterly in equal amounts and will be accounted for as contributions. We distributed $420 to the trust during the nine months ended September 30, 2014. So long as we make the distributions, the terms of the preferred interest will impose no limitations on our ability to declare a dividend, or repurchase shares. This preferred equity interest is a plan asset under ERISA and is recognized as such in the plan's separate financial statements. However, because the preferred equity interest is not unconditionally transferable to an unrelated party, it is not reflected in plan assets in our consolidated financial statements and instead has been eliminated in consolidation.
 
12

 
AT&T INC.
SEPTEMBER 30, 2014

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
We recognize actuarial gains and losses on pension and postretirement plan assets in our operating results at our annual measurement date of December 31, unless earlier remeasurements are required. The following table details pension and postretirement benefit costs included in operating expenses in the accompanying consolidated statements of income, 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
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
Pension cost:
               
   Service cost – benefits earned during the period
 
$
282
   
$
331
   
$
846
   
$
991
 
   Interest cost on projected benefit obligation
   
661
     
608
     
1,984
     
1,822
 
   Expected return on assets
   
(849
)
   
(828
)
   
(2,549
)
   
(2,484
)
   Amortization of prior service credit
   
(24
)
   
(25
)
   
(71
)
   
(71
)
   Net pension cost
 
$
70
   
$
86
   
$
210
   
$
258
 
                                 
Postretirement cost:
                               
   Service cost – benefits earned during the period
 
$
59
   
$
95
   
$
175
   
$
286
 
   Interest cost on accumulated postretirement benefit obligation
   
365
     
389
     
1,094
     
1,168
 
   Expected return on assets
   
(165
)
   
(177
)
   
(491
)
   
(533
)
   Amortization of prior service credit
   
(362
)
   
(263
)
   
(1,086
)
   
(788
)
   Net postretirement (credit) cost
 
$
(103
)
 
$
44
   
$
(308
)
 
$
133
 
                                 
   Combined net pension and postretirement (credit) cost
 
$
(33
)
 
$
130
   
$
(98
)
 
$
391
 

Our combined net pension and postretirement cost decreased $163 in the third quarter and $489 for the first nine months of 2014. The decrease reflects higher amortization of prior service credits due to plan changes, including changes to future costs for continued retiree healthcare coverage. The decrease also reflects increasing corporate bond rates, which contributed to lower service cost and higher interest costs.

Our fourth-quarter 2014 results will include the effects of settlement accounting for a portion of our pension plan. Due in part to our 2013 enhanced retirement offer and other distributions, lump sum distributions from the plan during 2014 exceeded service and interest costs in early October.

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 $29 in the third quarter of 2014, of which $27 was interest cost, and $87 for the first nine months, of which $82 was interest cost. In 2013, net supplemental retirement pension benefits cost was $27 in the third quarter, of which $25 was interest cost, and $82 for the first nine months, of which $76 was interest cost.
 
13


AT&T INC.
SEPTEMBER 30, 2014

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, 2013.

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

 
September 30, 2014
 
December 31, 2013
 
 
Carrying
 
Fair
 
Carrying
 
Fair
 
 
Amount
 
Value
 
Amount
 
Value
 
Notes and debentures
$
75,226
   
$
82,938
   
$
74,484
   
$
79,309
 
Commercial paper
 
-
     
-
     
20
     
20
 
Bank borrowings
 
5
     
5
     
1
     
1
 
Investment securities
 
2,643
     
2,643
     
2,450
     
2,450
 

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 and are determined using various methods, including quoted prices for identical or similar securities in both active and inactive markets.
 
14

AT&T INC.
SEPTEMBER 30, 2014

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
Following is the fair value leveling for available-for-sale securities and derivatives as of September 30, 2014 and December 31, 2013:

 
September 30, 2014
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Available-for-Sale Securities
             
   Domestic equities
$
1,108
   
$
-
   
$
-
   
$
1,108
 
   International equities
 
541
     
-
     
-
     
541
 
   Fixed income bonds
 
-
     
913
     
-
     
913
 
Asset Derivatives
                             
   Interest rate swaps
 
-
     
131
     
-
     
131
 
   Cross-currency swaps
 
-
     
1,536
     
-
     
1,536
 
Liability Derivatives
                             
   Interest rate swaps
 
-
     
(10
)
   
-
     
(10
)
   Cross-currency swaps
 
-
     
(901
)
   
-
     
(901
)
 
                             
 
December 31, 2013
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Available-for-Sale Securities
                             
   Domestic equities
$
1,049
   
$
-
   
$
-
   
$
1,049
 
   International equities
 
563
     
-
     
-
     
563
 
   Fixed income bonds
 
-
     
759
     
-
     
759
 
Asset Derivatives
                             
   Interest rate swaps
 
-
     
191
     
-
     
191
 
   Cross-currency swaps
 
-
     
1,951
     
-
     
1,951
 
Liability Derivatives
                             
   Interest rate swaps
 
-
     
(7
)
   
-
     
(7
)
   Cross-currency swaps
 
-
     
(519
)
   
-
     
(519
)
1 Derivatives designated as hedging instruments are reflected as Other assets, Other noncurrent liabilities and, for a portion of interest rate swaps, Other current assets.
 
 
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 was 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 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, $277 within one to three years, $292 within three to five years, and $253 for five or more years.

Our cash equivalent (money market securities) short-term investments (certificate and time deposits) and customer deposits are recorded at amortized cost, and the respective carrying amounts approximate fair values. Our short-term investments of $1,890 are recorded in "Other current assets" and our investment securities are recorded in "Other Assets" on the consolidated balance sheets.

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.
 
15

 
AT&T INC.
SEPTEMBER 30, 2014

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
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 in 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 values of the interest rate swaps are exactly offset by changes in the fair value of the underlying debt. Gains or losses realized upon early termination of our fair value hedges are recognized in interest expense. In the nine months ended September 30, 2014 and September 30, 2013, no ineffectiveness was measured on interest rate swaps designated as fair value hedges.

Cash Flow Hedging  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, British pound sterling and Canadian dollar 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.

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 (expense) – net" in the consolidated statements of income in each period. We evaluate the effectiveness of our cross-currency swaps each quarter. In the nine months ended September 30, 2014 and September 30, 2013, no ineffectiveness was measured on cross-currency swaps designated as cash flow hedges.

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 $42 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 nine months ended September 30, 2014 and September 30, 2013, no ineffectiveness was measured on foreign exchange contracts designated as cash flow hedges.

Collateral and Credit-Risk Contingency  We have entered into agreements with our derivative counterparties establishing collateral thresholds based on respective credit ratings and netting agreements. At September 30, 2014, we had posted collateral of $58 (a deposit asset) and held collateral of $1,396 (a receipt liability). Under the agreements, if our credit rating had been downgraded one rating level by Moody's Investors Service and Standard & Poor's Rating Services and two rating levels by Fitch Ratings, before the final collateral exchange in September, we would have been required to post additional collateral of $71. At December 31, 2013, we had posted collateral of $8 (a deposit asset) and held collateral of $1,600 (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.
 
16

 
AT&T INC.
SEPTEMBER 30, 2014

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
Following is the notional amount of our outstanding derivative positions:

 
September 30,
 
December 31,
 
 
2014
 
2013
 
Interest rate swaps
 
$
6,550
   
$
4,750
 
Cross-currency swaps
   
20,650
     
17,787
 
Total
 
$
27,200
   
$
22,537
 

Following is the related hedged items affecting our financial position and performance:
 
               
Effect of Derivatives on the Consolidated Statements of Income
             
Fair Value Hedging Relationships
Three months ended
 
Nine months ended
 
September 30,
2014
 
September 30,
2013
 
September 30,
2014
 
September 30,
2013
 
Interest rate swaps (Interest expense):
             
     Gain (Loss) on interest rate swaps
$
(70
)
 
$
9
   
$
(59
)
 
$
(78
)
     Gain (Loss) on long-term debt
 
70
     
(9
)
   
59
     
78
 

In addition, the net swap settlements that accrued and settled in the quarter ended September 30 were offset against interest expense.

 
Three months ended
   
Nine months ended
 
Cash Flow Hedging Relationships
 
September 30,
2014
   
September 30,
2013
   
September 30,
2014
   
September 30,
2013
 
Cross-currency swaps:
               
     Gain (Loss) recognized in accumulated OCI
 
$
567
   
$
482
   
$
418
   
$
807
 
                                 
Interest rate locks:
                               
     Interest income (expense) reclassified from
        accumulated OCI into income
   
(11
)
   
(11
)
   
(33
)
   
(34
)
                                 
Foreign exchange contracts:
                               
     Gain (Loss) recognized in accumulated OCI
   
-
     
5
     
(2
)
   
5
 
 
17


AT&T INC.
SEPTEMBER 30, 2014

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
NOTE 7. ACQUISITIONS, DISPOSITIONS AND OTHER ADJUSTMENTS

Acquisitions
Leap  On March 13, 2014, we acquired Leap, a provider of prepaid wireless service, for fifteen dollars per outstanding share of Leap's common stock, or $1,248 (excluding Leap's cash on hand), plus one nontransferable contingent value right (CVR) per share. The CVR will entitle each Leap stockholder to a pro rata share of the net proceeds of the future sale of the Chicago 700 MHz A-band Federal Communications Commission (FCC) license held by Leap.

The preliminary values of assets acquired under the terms of the agreement were: $3,000 in licenses, $510 in property, plant and equipment, $520 of customer lists, $340 for trade names and $744 of goodwill. The estimated fair value of debt associated with the acquisition of Leap was $3,889, all of which was redeemed or matured by July 31, 2014.

Pending Acquisition
DIRECTV  In May 2014, we announced a merger agreement to acquire DIRECTV in a stock-and-cash transaction for ninety-five dollars per share of DIRECTV's common stock, or approximately $48,500 at the date of announcement. As of September 30, 2014, DIRECTV had approximately $16,852 in net debt based on DIRECTV's financial statements included in the Form 10-Q for the third quarter of 2014. Each DIRECTV shareholder will receive cash of $28.50 per share and $66.50 per share in our stock. The stock portion will be subject to a collar such that DIRECTV shareholders will receive 1.905 AT&T shares if our stock price is below $34.90 per share at closing and 1.724 AT&T shares if our stock price is above $38.58 at closing. If our average stock price (calculated in accordance with the merger agreement with DIRECTV) is between $34.90 and $38.58 at closing, then DIRECTV shareholders will receive a number of shares between 1.724 and 1.905, equal to $66.50 in value. DIRECTV is a premier pay TV provider in the United States and Latin America, with a high-quality customer base, the best selection of programming, the best technology for delivering and viewing high-quality video on any device and the best customer satisfaction among major U.S. cable and satellite TV providers.

The merger agreement was adopted by DIRECTV's stockholders on September 25, 2014 and remains subject to review by the FCC and the Department of Justice and to other closing conditions. It is also a condition that all necessary consents by certain foreign governmental entities have been obtained and are in full force and effect. The transaction is expected to close in the first half of 2015. The merger agreement provides certain mutual termination rights for us and DIRECTV, including the right of either party to terminate the agreement if the merger is not consummated by May 18, 2015, subject to extension in certain cases to a date no later than November 13, 2015. Either party may also terminate the agreement if an order permanently restraining, enjoining, or otherwise prohibiting consummation of the merger becomes final and nonappealable. In October 2014, DIRECTV and the National Football League renewed their agreement for the "NFL Sunday Ticket" service substantially on the terms discussed between AT&T and DIRECTV, satisfying one of the conditions to closing the merger. Under certain circumstances relating to a competing transaction, DIRECTV may be required to pay a termination fee to us in connection with or following a termination of the agreement.

Dispositions
América Móvil  In May 2014, in conjunction with the announcement of our intention to dispose of our investment in América Móvil and the resignation of our board members from the board of América Móvil, we discontinued accounting for this investment under the equity method due to our lack of significant influence. On June 30, 2014, we sold our remaining stake in América Móvil for approximately $5,566 and recorded a pre-tax gain of $1,243. At closing, we received $4,565 cash and we received the remaining cash in the third quarter.

18


AT&T INC.
SEPTEMBER 30, 2014

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
Connecticut Wireline  In December 2013, we agreed to sell our incumbent local exchange operations in Connecticut to Frontier Communications Corporation for $2,000 in cash. The transaction was approved by the FCC in July 2014 and was approved by the Connecticut Public Utilities Regulatory Authority on October 15, 2014. The transaction closed on October 24, 2014.

We applied held-for-sale treatment to the assets and liabilities of the Connecticut operations, and, accordingly, included the assets in "Other current assets," and the related liabilities in "Accounts payable and accrued liabilities," on our consolidated balance sheets. However, the business does not qualify as discontinued operations as we expect significant continuing direct cash flows related to the disposed operations. Assets and liabilities of the Connecticut operations included the following:

   
September 30,
   
December 31,
 
   
2014
   
2013
 
Assets held for sale:
       
Current assets
 
$
138
   
$
155
 
Property, plant and equipment - net
   
1,436
     
1,289
 
Goodwill
   
799
     
799
 
Other assets
   
18
     
17
 
Total assets
 
$
2,391
   
$
2,260
 
                 
Liabilities related to assets held for sale:
               
Current liabilities
 
$
122
   
$
128
 
Noncurrent liabilities
   
537
     
480
 
Total liabilities
 
$
659
   
$
608
 

19

AT&T INC.
SEPTEMBER 30, 2014

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
NOTE 8. SALES OF EQUIPMENT INSTALLMENT RECEIVABLES
We offer our customers the option to purchase certain wireless devices in installments over a period of up to 24 months, with the right to trade in the original equipment for a new device and have the remaining unpaid balance satisfied. As of September 30, 2014, gross equipment installment receivables of $3,002 were included on our consolidated balance sheets, of which $1,861 are notes receivable that are included in "Accounts receivable, net."
On June 27, 2014, we entered into uncommitted agreements pertaining to the sale of equipment installment receivables and related security with Citibank, N.A. and various other relationship banks as purchasers (collectively, the Purchasers) with a funding amount not expected to exceed $2,000 at any given time. Under the agreement, we may transfer the receivables to the Purchasers for cash and additional consideration upon settlement of the receivables. Under the terms of the arrangement, we continue to bill and collect on behalf of our customers for the receivables sold.
The following table sets forth a summary of equipment installment receivables sold during the three months and nine months ended September 30, 2014:
 
Three months
   
Nine months
 
Net receivables sold1
 
$
885
   
$
2,276
 
Cash proceeds received
   
556
     
1,375
 
Deferred purchase price recorded
   
324
     
889
 
1 Gross receivables sold were $1,028 and $2,665 for the third quarter and the first nine months of 2014, respectively, before deducting the allowance, imputed interest and trade-in right guarantees.
 

The deferred purchase price was initially recorded at estimated fair value, which was based on remaining installment payments expected to be collected, adjusted by the expected timing and value of the device trade-ins, and is subsequently carried at the lower of cost or net realizable value. The value of the device trade-ins considers estimated prices offered to us by independent, third parties that contemplate changes in value after the launch of a device. At September 30, 2014, our deferred purchase price receivable was $901, which is included in "Other Assets" on our consolidated balance sheets. Our maximum exposure to loss as a result of selling these receivables is limited to the amount of our deferred purchase price at any point in time.
These transactions did not have a material impact in our consolidated statements of income or to "Total Assets" reported on our consolidated balance sheets. We reflect the cash flows related to the arrangement as operating activities in our consolidated statements of cash flows because the cash received from the Purchasers upon both the sale of the receivables and the collection of the deferred purchase price is not subject to significant interest rate risk.
 
20

AT&T INC.
SEPTEMBER 30, 2014

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 both in the United States and internationally, providing wireless and wireline telecommunication 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, 2013. 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. Certain amounts have been reclassified to conform to the current period's presentation.

Consolidated Results  Our financial results in the third quarter and for the first nine months of 2014 and 2013 are summarized as follows:

   
Third Quarter
   
Nine-Month Period
 
   
2014
   
2013
   
Percent
Change
   
2014
   
2013
   
Percent
Change
 
 
Operating Revenues
 
$
32,957
   
$
32,158
     
2.5
 %
 
$
98,008
   
$
95,589
     
2.5
 %
Operating expenses
                                               
   Cost of services and sales
   
14,541
     
13,403
     
8.5
     
42,074
     
39,227
     
7.3
 
   Selling, general and administrative
   
8,475
     
7,952
     
6.6
     
24,932
     
24,406
     
2.2
 
   Depreciation and amortization
   
4,539
     
4,615
     
(1.6
)
   
13,706
     
13,715
     
(0.1
)
Total Operating Expenses
   
27,555
     
25,970
     
6.1
     
80,712
     
77,348
     
4.3
 
Operating Income
   
5,402
     
6,188
     
(12.7
)
   
17,296
     
18,241
     
(5.2
)
Income Before Income Taxes
   
4,426
     
5,500
     
(19.5
)
   
16,183
     
16,624
     
(2.7
)
Net Income
   
3,059
     
3,905
     
(21.7
)
   
10,414
     
11,558
     
(9.9
)
Net Income Attributable to AT&T
 
$
3,002
   
$
3,814
     
(21.3
)%
 
$
10,201
   
$
11,336
     
(10.0
)%

Overview
Operating income decreased $786, or 12.7%, in the third quarter and $945, or 5.2%, for the first nine months of 2014. Operating income in the third quarter and for the first nine months reflects continued decline in legacy voice and data product revenues as well as higher AT&T U-verse® (U-verse) content costs. This decline is partially offset by higher wireless equipment revenue for device sales under our AT&T NextSM (AT&T Next) program as well as continued growth in our U-verse and strategic business services. Our operating results include the operations of Leap Wireless International, Inc. (Leap) from March 13, 2014, the date of acquisition.

Operating revenues increased $799, or 2.5%, in the third quarter and $2,419, or 2.5%, for the first nine months of 2014. Growth in wireless revenues reflected the continuing trend by our postpaid subscribers to choose devices on installment purchase rather than the device subsidy model, which resulted in increased equipment revenue recognized for device sales. Wireline revenues were slightly lower and continue to be driven by service revenues from our U-verse services and strategic business services, which almost offset decreases from our legacy voice and data products.

The telecommunications industry is rapidly evolving from fixed location, voice-oriented services into an industry driven by customer demand for instantly available, data-based services (including video). Our products, services and plans are changing as we transition to sophisticated, high-speed, IP-based alternatives. In addition to re-designing our networks to accommodate these new demands and to take advantage of related technological efficiencies, we are also repositioning our wireless model by moving to simple pricing and no-device-subsidy plans. We expect continued growth in our wireless and wireline IP-based services as we bundle and price plans with greater focus on data and video offerings. We expect continued declines in voice services and our basic wireline data services as customers choose these next-generation services.
21
 
AT&T INC.
SEPTEMBER 30, 2014

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 increased $1,138, or 8.5%, in the third quarter and $2,847, or 7.3%, for the first nine months of 2014. The increases were primarily due to higher sales volume and customers choosing higher-priced devices, which contributed to increased wireless equipment costs, and handset insurance costs. The increases also reflect higher wireless network costs and wireline costs attributable to U-verse content costs and subscriber growth and employee-related charges.

Selling, general and administrative expenses increased $523, or 6.6%, in the third quarter and $526, or 2.2%, for the first nine months of 2014. The increases were primarily due to the 2013 gains on spectrum transactions of $293, which resulted in lower expense in the third quarter and for the first nine months of 2013. Also contributing to increased selling and administrative expenses were increased sales expense in our Wireless segment and unallocated corporate expenses related to information technology enhancements, legal and new product and development costs. Partially offsetting the increases were lower Wireless commissions expenses and lower employee-related costs in our Wireline segment.

Depreciation and amortization expense decreased $76, or 1.6%, in the third quarter and $9, or 0.1%, for the first nine months of 2014. The decreases were primarily due to extending the estimated useful life of software and an increase in fully depreciated assets, which were largely offset by ongoing capital spending for network upgrades and expansion and additional expense due to assets acquired from Leap.

Interest expense increased $187, or 22.6%, in the third quarter and $276, or 11.1%, for the first nine months of 2014. The increases were primarily due to charges associated with the early redemption of debt, interest related to our December 2013 tower transaction, and higher debt balances. These increases were partially offset by lower interest rates resulting from 2013 refinancing activity.

Equity in net income (loss) of affiliates decreased $93 in the third quarter and $306, or 61.9%, for the first nine months of 2014. This decrease in equity income for the third quarter and the first nine months primarily resulted from the sale of América Móvil, S.A. de C.V. (América Móvil) in June 2014 (see Note 7).

   
Third Quarter
   
Nine-Month Period
 
   
2014
   
2013
   
2014
   
2013
 
América Móvil
 
$
-
   
$
85
   
$
153
   
$
410
 
YP Holdings LLC (YP Holdings)
   
23
     
23
     
108
     
138
 
SoftcardTM Mobile Wallet Joint Venture
   
(25
)
   
(18
)
   
(74
)
   
(55
)
Other
   
-
     
1
     
1
     
1
 
Equity in Net Income (Loss) of Affiliates
 
$
(2
)
 
$
91
   
$
188
   
$
494
 

Other income (expense) – net We had other income of $42 in the third quarter and $1,456 for the first nine months of 2014, compared to other income of $50 in the third quarter and $370 for the first nine months of 2013. Results in the third quarter of 2014 included interest and dividend income of $15, a net gain on the sale of various investments of $9 and leveraged lease income of $7. Results for the first nine months of 2014 included a net gain on the sale of América Móvil shares and other investments of $1,376, interest and dividend income of $51 and leveraged lease income of $20.

Other income in the third quarter and for the first nine months of 2013 included interest and dividend income of $14 and $54 and leveraged lease income of $6 and $21, respectively. Income for the first nine months of 2013 also included a net gain on the sale of América Móvil shares and other investments of $272.

Income taxes decreased $228, or 14.3%, in the third quarter and increased $703, or 13.9%, for the first nine months of 2014. Our effective tax rate was 30.9% for the third quarter and 35.6% for the first nine months of 2014, as compared to 29.0% for the third quarter and 30.5% for the first nine months of 2013. The increase in effective tax rate for the first nine months was primarily due to the sale of América Móvil shares in 2014. We had previously assumed that a portion of our undistributed earnings for our investment in América Móvil would be returned through dividends that, when received, would qualify for foreign tax credits. As a result of our strategic decision to sell this equity position in connection with our pending acquisition of DIRECTV, these foreign tax credits were not available to be realized.
 
22
 
AT&T INC.
SEPTEMBER 30, 2014

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued
Dollars in millions except per share amounts
 
Selected Financial and Operating Data
       
   
September 30,
 
Subscribers and connections in (000s)
 
2014
   
2013
 
Wireless subscribers
   
118,650
     
109,460
 
Network access lines in service
   
21,464
     
25,680
 
U-Verse VoIP connections
   
4,756
     
3,616
 
Total wireline broadband connections
   
16,486
     
16,427
 
Debt ratio
   
44.8
%
   
46.9
%
Ratio of earnings to fixed charges
   
4.99
     
5.50
 
Number of AT&T employees
   
247,700
     
246,740
 
1 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.
2 See Exhibit 12.

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 demands 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 two reportable segments: (1) Wireless and (2) Wireline.

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 wallet joint venture 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 Internet, video and VoIP services and managed networking to business customers.

We discuss capital expenditures for each segment in "Liquidity and Capital Resources."
23

AT&T INC.
SEPTEMBER 30, 2014

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
                       
   
Third Quarter
   
Nine-Month Period
 
   
2014
   
2013
   
Percent
Change
   
2014
   
2013
   
Percent
Change
 
 
Segment operating revenues
                       
   Service
 
$
15,423
   
$
15,460
     
(0.2
)%
 
$
45,958
   
$
45,892
     
0.1
 %
   Equipment
   
2,914
     
2,020
     
44.3
     
8,175
     
5,570
     
46.8
 
Total Segment Operating Revenues
   
18,337
     
17,480
     
4.9
     
54,133
     
51,462
     
5.2
 
Segment operating expenses
                                               
   Operations and support
   
11,855
     
10,982
     
7.9
     
34,305
     
31,932
     
7.4
 
   Depreciation and amortization
   
1,965
     
1,875
     
4.8
     
5,931
     
5,553
     
6.8
 
Total Segment Operating Expenses
   
13,820
     
12,857
     
7.5
     
40,236
     
37,485
     
7.3
 
Segment Operating Income
   
4,517
     
4,623
     
(2.3
)
   
13,897
     
13,977
     
(0.6
)
Equity in Net Income (Loss) of
                                               
   Affiliates
   
(26)
 
   
(18)
 
   
(44.4
)
   
(75)
 
   
(55)
 
   
(36.4
)
Segment Income
 
$
4,491
   
$
4,605
     
(2.5
)%
 
$
13,822
   
$
13,922
     
(0.7
)%

24

AT&T INC.
SEPTEMBER 30, 2014

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share amounts
 
The following table highlights other key measures of performance for the Wireless segment:
 
             
 
 
Third Quarter
   
Nine-Month Period
 
 
 
2014
   
2013
   
Percent
Change
   
2014
   
2013
   
Percent
Change
 
(in 000s)
Wireless Subscribers
               
118,650
     
109,460
     
8.4
%
   Postpaid smartphones
               
55,791
     
50,637
     
10.2
 
   Postpaid feature phones and data-centric
                                   
     devices
               
19,314
     
21,395
     
(9.7
)
Postpaid
               
75,105
     
72,032
     
4.3
 
Prepaid
               
11,179
     
7,425
     
50.6
 
Reseller
               
13,884
     
14,089
     
(1.5
)
Connected devices
               
18,482
     
15,914
     
16.1
 
Total Wireless Subscribers
               
118,650
     
109,460