10-Q 1 q1_10q.htm AT&T 2018 FORM 10-Q


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, 2018
 
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, a smaller reporting company, or emerging growth company. See definition of "accelerated filer," "large accelerated filer," "smaller reporting company" and "emerging growth 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
[   ]
     
Emerging growth company
[   ]

If an emerging growth company, indicate by checkmark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
                                                                                                                                                                              Yes [   ]   No [   ]

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, 2018, there were 6,141 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,
 
   
2018
   
2017
 
         
As Adjusted
 
Operating Revenues
           
Service
 
$
33,646
   
$
36,456
 
Equipment
   
4,392
     
2,909
 
Total operating revenues
   
38,038
     
39,365
 
                 
Operating Expenses
               
Cost of services and sales
               
   Equipment
   
4,848
     
3,848
 
   Broadcast, programming and operations
   
5,166
     
4,974
 
   Other cost of services (exclusive of depreciation and
         amortization shown separately below)
   
7,932
     
9,288
 
Selling, general and administrative
   
7,897
     
8,772
 
Depreciation and amortization
   
5,994
     
6,127
 
Total operating expenses
   
31,837
     
33,009
 
Operating Income
   
6,201
     
6,356
 
Other Income (Expense)
               
Interest expense
   
(1,771
)
   
(1,293
)
Equity in net income (loss) of affiliates
   
9
     
(173
)
Other income (expense) – net
   
1,702
     
488
 
Total other income (expense)
   
(60
)
   
(978
)
Income Before Income Taxes
   
6,141
     
5,378
 
Income tax expense
   
1,382
     
1,804
 
Net Income
   
4,759
     
3,574
 
Less: Net Income Attributable to Noncontrolling Interest
   
(97
)
   
(105
)
Net Income Attributable to AT&T
 
$
4,662
   
$
3,469
 
Basic Earnings Per Share Attributable to AT&T
 
$
0.75
   
$
0.56
 
Diluted Earnings Per Share Attributable to AT&T
 
$
0.75
   
$
0.56
 
Weighted Average Number of Common Shares Outstanding – Basic (in millions)
   
6,161
     
6,166
 
Weighted Average Number of Common Shares Outstanding with Dilution (in millions)
   
6,180
     
6,186
 
Dividends Declared Per Common Share
 
$
0.50
   
$
0.49
 
See Notes to Consolidated Financial Statements.
               
 
 

2


 
AT&T INC.
           
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
           
Dollars in millions
           
(Unaudited)
           
   
Three months ended
 
   
March 31,
 
   
2018
   
2017
 
Net income
 
$
4,759
   
$
3,574
 
Other comprehensive income (loss), net of tax:
               
    Foreign currency:
               
        Translation adjustment (includes $2 and $6 attributable to noncontrolling interest),
            net of taxes of $175 and $391
   
108
     
372
 
    Available-for-sale securities:
               
        Net unrealized gains (losses), net of taxes of $(4) and $15
   
(12
)
   
33
 
        Reclassification adjustment included in net income, net of taxes of $0, and $3
   
-
     
5
 
     Cash flow hedges:
               
        Net unrealized gains, net of taxes of $180 and $7
   
674
     
13
 
        Reclassification adjustment included in net income, net of taxes of $3 and $5
   
12
     
10
 
     Defined benefit postretirement plans:
               
        Net prior service credit arising during period, net of taxes of $185 and $0
   
567
     
-
 
        Amortization of net prior service credit included in net income, net of taxes of $(105)
            and $(139)
   
(323
)
   
(228
)
Other comprehensive income (loss)
   
1,026
     
205
 
Total comprehensive income
   
5,785
     
3,779
 
Less: Total comprehensive income attributable to noncontrolling interest
   
(99
)
   
(111
)
Total Comprehensive Income Attributable to AT&T
 
$
5,686
   
$
3,668
 
See Notes to Consolidated Financial Statements.
               
 

3


 
 
AT&T INC.
 
CONSOLIDATED BALANCE SHEETS
 
Dollars in millions except per share amounts
 
   
March 31,
   
December 31,
 
   
2018
   
2017
 
Assets
 
(Unaudited)
       
Current Assets
           
Cash and cash equivalents
 
$
48,872
   
$
50,498
 
Accounts receivable - net of allowances for doubtful accounts of $642 and $663
   
16,290
     
16,522
 
Prepaid expenses
   
1,335
     
1,369
 
Other current assets
   
12,008
     
10,757
 
Total current assets
   
78,505
     
79,146
 
Property, plant and equipment
   
317,127
     
313,499
 
   Less: accumulated depreciation and amortization
   
(192,003
)
   
(188,277
)
Property, Plant and Equipment – Net
   
125,124
     
125,222
 
Goodwill
   
105,482
     
105,449
 
Licenses
   
96,556
     
96,136
 
Customer Lists and Relationships – Net
   
9,878
     
10,676
 
Other Intangible Assets – Net
   
7,201
     
7,464
 
Investments in and Advances to Equity Affiliates
   
2,623
     
1,560
 
Other Assets
   
20,974
     
18,444
 
Total Assets
 
$
446,343
   
$
444,097
 
                 
Liabilities and Stockholders' Equity
               
Current Liabilities
               
Debt maturing within one year
 
$
29,322
   
$
38,374
 
Accounts payable and accrued liabilities
   
31,569
     
34,470
 
Advanced billings and customer deposits
   
5,081
     
4,213
 
Accrued taxes
   
1,534
     
1,262
 
Dividends payable
   
3,074
     
3,070
 
Total current liabilities
   
70,580
     
81,389
 
Long-Term Debt
   
133,724
     
125,972
 
Deferred Credits and Other Noncurrent Liabilities
               
Deferred income taxes
   
45,730
     
43,207
 
Postemployment benefit obligation
   
30,116
     
31,775
 
Other noncurrent liabilities
   
19,117
     
19,747
 
Total deferred credits and other noncurrent liabilities
   
94,963
     
94,729
 
                 
Stockholders' Equity
               
Common stock ($1 par value, 14,000,000,000 authorized at March 31, 2018 and
               
   December 31, 2017: issued 6,495,231,088 at March 31, 2018 and December 31, 2017)
   
6,495
     
6,495
 
Additional paid-in capital
   
89,404
     
89,563
 
Retained earnings
   
55,067
     
50,500
 
Treasury stock (347,690,578 at March 31, 2018 and 355,806,544
               
   at December 31, 2017, at cost)
   
(12,432
)
   
(12,714
)
Accumulated other comprehensive income
   
7,386
     
7,017
 
Noncontrolling interest
   
1,156
     
1,146
 
Total stockholders' equity
   
147,076
     
142,007
 
Total Liabilities and Stockholders' Equity
 
$
446,343
   
$
444,097
 
See Notes to Consolidated Financial Statements.
               
 
 

4


 
AT&T INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Dollars in millions
 
(Unaudited)
           
   
Three months ended
 
   
March 31,
 
   
2018
   
2017
 
         
As Adjusted
 
Operating Activities
           
Net income
 
$
4,759
   
$
3,574
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
   Depreciation and amortization
   
5,994
     
6,127
 
   Undistributed earnings from investments in equity affiliates
   
(2
)
   
182
 
   Provision for uncollectible accounts
   
438
     
393
 
   Deferred income tax expense
   
1,222
     
480
 
   Net (gain) loss from investments, net of impairments
   
2
     
61
 
   Actuarial (gain) loss on pension and postretirement benefits
   
(930
)
   
-
 
Changes in operating assets and liabilities:
               
   Accounts receivable
   
(439
)
   
445
 
   Other current assets
   
614
     
229
 
   Accounts payable and other accrued liabilities
   
(1,962
)
   
(1,582
)
   Equipment installment receivables and related sales
   
505
     
394
 
   Deferred customer contract acquisition and fulfillment costs
   
(826
)
   
(436
)
Retirement benefit funding
   
(140
)
   
(140
)
Other - net
   
(288
)
   
(762
)
Total adjustments
   
4,188
     
5,391
 
Net Cash Provided by Operating Activities
   
8,947
     
8,965
 
                 
Investing Activities
               
Capital expenditures:
               
   Purchase of property and equipment
   
(5,957
)
   
(5,784
)
   Interest during construction
   
(161
)
   
(231
)
Acquisitions, net of cash acquired
   
(234
)
   
(162
)
Dispositions
   
56
     
6
 
Sales (purchases) of securities, net
   
(116
)
   
17
 
Advances to and investments in equity affiliates, net
   
(1,007
)
   
-
 
Cash collections of deferred purchase price
   
267
     
185
 
Net Cash Used in Investing Activities
   
(7,152
)
   
(5,969
)
                 
Financing Activities
               
Issuance of long-term debt
   
2,565
     
12,440
 
Repayment of long-term debt
   
(4,911
)
   
(3,053
)
Purchase of treasury stock
   
(145
)
   
(177
)
Issuance of treasury stock
   
11
     
21
 
Dividends paid
   
(3,070
)
   
(3,009
)
Other
   
2,048
     
(173
)
Net Cash (Used in) Provided by Financing Activities
   
(3,502
)
   
6,049
 
Net (decrease) increase in cash and cash equivalents and restricted cash
   
(1,707
)
   
9,045
 
Cash and cash equivalents and restricted cash beginning of year
   
50,932
     
5,935
 
Cash and Cash Equivalents and Restricted Cash End of Period
 
$
49,225
   
$
14,980
 
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)
 
   
March 31, 2018
 
   
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
         
$
89,563
 
Issuance of treasury stock
           
(4
)
Share-based payments
           
(155
)
Balance at end of period
         
$
89,404
 
                 
Retained Earnings
               
Balance at beginning of year
         
$
50,500
 
Net income attributable to AT&T ($0.75 per diluted share)
           
4,662
 
Dividends to stockholders ($0.50 per share)
           
(3,092
)
Cumulative effect of accounting changes
           
2,997
 
Balance at end of period
         
$
55,067
 
                 
Treasury Stock
               
Balance at beginning of year
   
(356
)
 
$
(12,714
)
Repurchase and acquisition of common stock
   
(4
)
   
(164
)
Issuance of treasury stock
   
12
     
446
 
Balance at end of period
   
(348
)
 
$
(12,432
)
                 
Accumulated Other Comprehensive Income Attributable to AT&T, net of tax
               
Balance at beginning of year
         
$
7,017
 
Other comprehensive income attributable to AT&T
           
1,024
 
Amounts reclassified to retained earnings
           
(655
)
Balance at end of period
         
$
7,386
 
                 
Noncontrolling Interest
               
Balance at beginning of year
         
$
1,146
 
Net income attributable to noncontrolling interest
           
97
 
Distributions
           
(124
)
Translation adjustments attributable to noncontrolling interest, net of taxes
           
2
 
Cumulative effect of accounting changes
           
35
 
Balance at end of period
         
$
1,156
 
                 
Total Stockholders' Equity at beginning of year
         
$
142,007
 
Total Stockholders' Equity at end of period
         
$
147,076
 
See Notes to Consolidated Financial Statements.
               
 
 

6


 
AT&T INC.
MARCH 31, 2018
 
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 and digital entertainment services industry. Our subsidiaries and affiliates provide services and equipment that deliver voice, video and broadband services domestically and internationally. 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, 2017. The results for the interim periods are not necessarily indicative of those for the full year.

In the tables throughout this document, percentage increases and decreases that are not considered meaningful are denoted with a dash.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Dollars in millions except per share amounts
 
NOTE 1. PREPARATION OF INTERIM FINANCIAL STATEMENTS

Basis of Presentation  These consolidated financial statements include all adjustments that are necessary to present fairly the results for the presented interim periods, consisting of normal recurring accruals and other items. The consolidated financial statements include the accounts of the Company and our majority-owned subsidiaries and affiliates.

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 investments accounted for using the equity method are included for periods ended within up to one quarter of our period end. We also record our proportionate share of our equity method investees' other comprehensive income (OCI) items, including translation adjustments. We treat distributions received from equity method investees as returns on investment and classify them as cash flows from operating activities until those distributions exceed our cumulative equity in the earnings of that investment. We treat the excess amount as a return of investment and classify it as cash flows from investing activities.

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 conformed to the current period's presentation, including impacts for the adoption of recent accounting standards and the realignment of certain business units within our reportable segments (see Note 4).

Tax Reform  The Tax Cuts and Jobs Acts (the Act) was enacted on December 22, 2017. The Act reduced the U.S. federal corporate income tax rate from 35% to 21% and required companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred. Recognizing the late enactment of the Act and complexity of accurately accounting for its impact, the Securities and Exchange Commission (SEC) in Staff Accounting Bulletin (SAB) 118 provided guidance that allows registrants to provide a reasonable estimate of the impact to their financial statements and adjust the reported impact in a measurement period not to exceed one year. We included the estimated impact of the Act in our financial results at or for the period ended December 31, 2017 and did not record any adjustments thereto during the first quarter of 2018. Our future results could include additional adjustments, and those adjustments could be material.
 
 

7



AT&T INC.
MARCH 31, 2018

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

Revenue Recognition  As of January 1, 2018, we adopted Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) No. 2014-09, "Revenue from Contracts with Customers (Topic 606)," as modified (ASC 606), using the modified retrospective method, which does not allow us to adjust prior periods. We applied the rules to all open contracts existing as of January 1, 2018, recording an increase of $2,342 to retained earnings for the cumulative effect of the change, with an offsetting contract asset of $1,737, deferred contract acquisition costs of $1,454, other asset reductions of $239, other liability reductions of $212, deferred income taxes of $787 and noncontrolling interest of $35. (See Note 5)

Pension and Other Postretirement Benefits  As of January 1, 2018, we adopted, with retrospective application, ASU No. 2017-07, "Compensation – Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost" (ASU 2017-07). We are no longer allowed to present interest, estimated return on assets and amortization of prior service credits components of our net periodic benefit cost in our consolidated operating expenses, but rather are required to include those amounts in "other income (expense) – net" in our consolidated statements of income. We continue to present service costs with the associated compensation costs within our operating expenses. As a practical expedient, we used the amounts disclosed as the estimated basis for applying the retrospective presentation requirement.

The following table presents our results under our historical method and as adjusted to reflect ASU 2017-07 (presentation of benefit cost):

   
Historical
   
Effect of
       
   
Accounting
   
Adoption of
   
As
 
   
Method
   
ASU 2017-07
   
Adjusted
 
For the three months ended March 31, 2018
                 
Consolidated Statements of Income
                 
Other cost of services
 
$
7,572
   
$
360
   
$
7,932
 
Selling, general and administrative expenses
   
6,755
     
1,142
     
7,897
 
Operating Income
   
7,703
     
(1,502
)
   
6,201
 
Other Income (Expense) - net
   
200
     
1,502
     
1,702
 
Net Income
   
4,759
     
-
     
4,759
 
                         
For the three months ended March 31, 2017
                       
Consolidated Statements of Income
                       
Other cost of services
 
$
9,065
   
$
223
   
$
9,288
 
Selling, general and administrative expenses
   
8,487
     
285
     
8,772
 
Operating Income
   
6,864
     
(508
)
   
6,356
 
Other Income (Expense) - net
   
(20
)
   
508
     
488
 
Net Income
   
3,574
     
-
     
3,574
 

 
 

8


 
AT&T INC.
MARCH 31, 2018

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
Cash Flows  As of January 1, 2018, we adopted, with retrospective application, ASU No. 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments" (ASU 2016-15). Under ASU 2016-15, we continue to recognize cash receipts on owned equipment installment receivables as cash flows from operations. However, cash receipts on the deferred purchase price described in Note 9 are now required to be classified as cash flows from investing activities instead of cash flows from operating activities.

As of January 1, 2018, we adopted, with retrospective application, ASU No. 2016-18, "Statement of Cash Flows (Topic 230) – Restricted Cash," (ASU 2016-18). The primary impact of ASU 2016-18 was to require us to include restricted cash in our reconciliation of beginning and ending cash and cash equivalents (restricted and unrestricted) on the face of the statements of cash flows. (See Note 10)

The following table presents our results under our historical method and as adjusted to reflect ASU 2016-15 (cash receipts on deferred purchase price) and ASU 2016-18 (restricted cash):

   
Historical
   
Effect of
   
Effect of
       
   
Accounting
   
Adoption of
   
Adoption of
   
As
 
   
Method
   
ASU 2016-15
   
ASU 2016-18
   
Adjusted
 
For the three months ended March 31, 2018
                       
Consolidated Statements of Cash Flows
                       
Equipment installment receivables and related sales
 
$
772
   
$
(267
)
 
$
-
   
$
505
 
Other - net
   
(322
)
   
-
     
34
     
(288
)
Cash Provided by (Used in) Operating Activities
   
9,180
     
(267
)
   
34
     
8,947
 
Sales (purchases) of securities - net
   
-
     
-
     
(116
)
   
(116
)
Cash collections of deferred purchase price
   
-
     
267
     
-
     
267
 
Cash Used in Investing Activities
   
(7,303
)
   
267
     
(116
)
   
(7,152
)
Change in cash and cash equivalents and restricted cash
 
$
(1,625
)
 
$
-
   
$
(82
)
 
$
(1,707
)
                                 
For the three months ended March 31, 2017
                               
Consolidated Statements of Cash Flows
                               
Changes in other current assets
 
$
228
   
$
-
   
$
1
   
$
229
 
Equipment installment receivables and related sales
   
579
     
(185
)
   
-
     
394
 
Other - net
   
(693
)
   
-
     
(69
)
   
(762
)
Cash Provided by Operating Activities
   
9,218
     
(185
)
   
(68
)
   
8,965
 
Sales (purchases) of securities - net
   
-
     
-
     
17
     
17
 
Cash collections of deferred purchase price
   
-
     
185
     
-
     
185
 
Cash Used in Investing Activities
   
(6,171
)
   
185
     
17
     
(5,969
)
Change in cash and cash equivalents and restricted cash
 
$
9,096
   
$
-
   
$
(51
)
 
$
9,045
 

Financial Instruments  As of January 1, 2018, we adopted ASU No. 2016-01, "Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities" (ASU 2016-01), which requires us to prospectively record changes in the fair value of our equity investments, except for those accounted for under the equity method, in net income instead of in accumulated other comprehensive income. As of January 1, 2018, we recorded an increase of $655 in retained earnings for the cumulative effect of the adoption of ASU 2016-01, with an offset to accumulated other comprehensive income (accumulated OCI).
 
 

9


 
AT&T INC.
MARCH 31, 2018

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
New Accounting Standards and Accounting Standards Not Yet Adopted

Leases  In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)," as modified (ASC 842), which replaces existing leasing rules with a comprehensive lease measurement and recognition standard and expanded disclosure requirements. ASC 842 will require lessees to recognize most leases on their balance sheets as liabilities, with corresponding "right-of-use" assets, and is effective for annual reporting periods beginning after December 15, 2018, subject to early adoption. For income statement recognition purposes, leases will be classified as either a finance or an operating lease without relying upon the bright-line tests under current GAAP.

Upon initial evaluation, we believe the key change upon adoption will be the balance sheet recognition. At adoption, we will recognize a right-to-use asset and corresponding lease liability on our consolidated balance sheets. The income statement recognition of lease expense appears similar to our current methodology. We are continuing to evaluate the magnitude and other potential impacts to our financial statements.
 
NOTE 2. EARNINGS PER SHARE

A reconciliation of the numerators and denominators of basic and diluted earnings per share for the three months ended March 31, 2018 and 2017, is shown in the table below:

   
Three months ended
 
   
March 31,
 
   
2018
   
2017
 
Numerators
           
Numerator for basic earnings per share:
           
   Net Income
 
$
4,759
   
$
3,574
 
   Less: Net income attributable to noncontrolling interest
   
(97
)
   
(105
)
   Net Income attributable to AT&T
   
4,662
     
3,469
 
   Dilutive potential common shares:
               
      Share-based payment
   
5
     
4
 
Numerator for diluted earnings per share
 
$
4,667
   
$
3,473
 
Denominators (000,000)
               
Denominator for basic earnings per share:
               
   Weighted average number of common shares outstanding
   
6,161
     
6,166
 
   Dilutive potential common shares:
               
      Share-based payment (in shares)
   
19
     
20
 
Denominator for diluted earnings per share
   
6,180
     
6,186
 
Basic earnings per share attributable to AT&T
 
$
0.75
   
$
0.56
 
Diluted earnings per share attributable to AT&T
 
$
0.75
   
$
0.56
 
 
 

10


 
AT&T INC.
MARCH 31, 2018

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 OCI are presented below. All amounts are net of tax and exclude noncontrolling interest.

 
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, 2017
$
(2,054)
 
$
660
 
$
1,402
 
$
7,009
 
$
7,017
Other comprehensive income
   (loss) before reclassifications
 
106
   
(12)
   
674
   
567
   
1,335
Amounts reclassified
   from accumulated OCI
 
-
1
 
 
-
1
 
 
12
2
 
 
(323)
3
 
 
(311)
Net other comprehensive
   income (loss)
 
106
   
(12)
   
686
   
244
   
1,024
Amounts reclassified to
   retained earnings
 
-
   
(655)
4
 
 
-
   
-
   
(655)
Balance as of March 31, 2018
$
(1,948)
 
$
(7)
 
$
2,088
 
$
7,253
 
$
7,386
                               
 
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, 2016
$
(1,995)
 
$
541
 
$
744
 
$
5,671
 
$
4,961
Other comprehensive income
   (loss) before reclassifications
 
366
   
33
   
13
   
-
   
412
Amounts reclassified
   from accumulated OCI
 
-
1
 
 
5
1
 
 
10
2
 
 
(228)
3
 
 
(213)
Net other comprehensive
   income (loss)
 
366
   
38
   
23
   
(228)
   
199
Balance as of March 31, 2017
$
(1,629)
 
$
579
 
$
767
 
$
5,443
 
$
5,160
 1 (Gains) losses are included in Other income (expense) - net in the consolidated statements of income.
 2 (Gains) losses are included in Interest expense in the consolidated statements of income. See Note 7 for additional information.
 3 The amortization of prior service credits associated with postretirement benefits are included in Other income (expense) in the
   consolidated statements of income (see Note 6).
 4 With the adoption of ASU 2016-01, the unrealized (gains) losses on our equity investments
   are reclassified to retained earnings (see Note 1).

NOTE 4. SEGMENT INFORMATION

Our segments are strategic business units that offer products and services to different customer segments over various technology platforms and/or in different geographies that are managed accordingly. We analyze our segments based on Segment Contribution, which consists of operating income, excluding acquisition-related costs and other significant items (as discussed below), and equity in net income (loss) of affiliates for investments managed within each segment. We have four reportable segments: (1) Consumer Mobility, (2) Business Solutions, (3) Entertainment Group and (4) International.
 
 

11



AT&T INC.
MARCH 31, 2018

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
We also evaluate segment performance based on EBITDA and/or EBITDA margin, which is defined as Segment Contribution excluding equity in net income (loss) of affiliates and depreciation and amortization. We believe EBITDA to be a relevant and useful measurement to our investors as it is part of our internal management reporting and planning processes and it is an important metric that management uses to evaluate segment operating performance. EBITDA does not give effect to cash used for debt service requirements and thus does not reflect available funds for distributions, reinvestment or other discretionary uses. EBITDA margin is EBITDA divided by total revenues.

To most effectively implement our strategies for 2018, we have realigned certain responsibilities and operations within our reportable segments. The most significant of these changes is to report individual wireless accounts with employer discounts in our Consumer Mobility segment, instead of our Business Solutions segment. As a result of these realignments, $19,686 of goodwill from the Business Solutions segment was reallocated to the Consumer Mobility segment. Our reported segment results include the impact for the adoption of recent accounting standards, which affects the comparability between 2018 and 2017 (see Note 5).

The Consumer Mobility segment provides nationwide wireless service to consumers, wholesale and resale wireless subscribers located in the United States or in U.S. territories. We provide voice and data services, including high-speed internet over wireless devices.

The Business Solutions segment provides services to business customers, including multinational companies and governmental and wholesale customers. We provide advanced IP-based services including Virtual Private Networks (VPN); Ethernet-related products; FlexWare, a service that relies on Software Defined Networking and Network Function Virtualization to provide application-based routing, and broadband, collectively referred to as strategic services; as well as traditional data and voice products. We provide a complete communications solution to our business customers.

The Entertainment Group segment provides video, internet, voice communication, and interactive and targeted advertising services to customers located in the United States or in U.S. territories.

The International segment provides entertainment services in Latin America and wireless services in Mexico. Video entertainment services are provided to primarily residential customers using satellite technology. We utilize our regional and national networks in Mexico to provide consumer and business customers with wireless data and voice communication services. Our international subsidiaries conduct business in their local currency, and operating results are converted to U.S. dollars using official exchange rates (operations in countries with highly inflationary economies consider the U.S. dollar as the functional currency).

In reconciling items to consolidated operating income and income before income taxes, Corporate and Other includes: (1) operations that are not considered reportable segments and that are no longer integral to our operations or which we no longer actively market, (2) corporate support functions and operations, (3) impacts of corporate-wide decisions for which the individual operating segments are not being evaluated, and (4) the reclassification of the amortization of prior service credits, which we continue to report with segment operating expenses, to consolidated other income (expense) – net.

Certain operating items are not allocated to our business segments, and those include:
·
Acquisition-related items which consists of (1) items associated with the merger and integration of acquired businesses and (2) the noncash amortization of intangible assets acquired in acquisitions.
·
Certain significant items which consists of (1) employee separation charges associated with voluntary and/or strategic offers, (2) losses resulting from abandonment or impairment of assets and (3) other items for which the segments are not being evaluated.

Interest expense and other income (expense) – net, are managed only on a total company basis and are, accordingly, reflected only in consolidated results.

Our domestic communications business strategies reflect bundled product offerings that increasingly cut across product lines and utilize our shared asset base. Therefore, asset information and capital expenditures by segment are not presented. Depreciation is allocated based on asset utilization by segment.
 
 

12


 
AT&T INC.
MARCH 31, 2018

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
For the three months ended March 31, 2018
 
   
Revenues
   
Operations
and Support
Expenses
   
EBITDA
   
Depreciation
and
Amortization
   
Operating
Income (Loss)
   
Equity in Net
Income (Loss) of
Affiliates
   
Segment
Contribution
 
Consumer Mobility
 
$
14,986
   
$
8,524
   
$
6,462
   
$
1,807
   
$
4,655
   
$
-
   
$
4,655
 
Business Solutions
   
9,185
     
5,638
     
3,547
     
1,462
     
2,085
     
(1
)
   
2,084
 
Entertainment Group
   
11,577
     
8,939
     
2,638
     
1,312
     
1,326
     
9
     
1,335
 
International
   
2,025
     
1,804
     
221
     
332
     
(111
)
   
-
     
(111
)
Segment Total
   
37,773
     
24,905
     
12,868
     
4,913
     
7,955
   
$
8
   
$
7,963
 
Corporate and Other
   
265
     
691
     
(426
)
   
19
     
(445
)
               
Acquisition-related items
   
-
     
67
     
(67
)
   
1,062
     
(1,129
)
               
Certain significant items
   
-
     
180
     
(180
)
   
-
     
(180
)
               
AT&T Inc.
 
$
38,038
   
$
25,843
   
$
12,195
   
$
5,994
   
$
6,201
                 

For the three months ended March 31, 2017
 
   
Revenues
   
Operations
and Support
Expenses
   
EBITDA
   
Depreciation
and
Amortization
   
Operating
Income (Loss)
   
Equity in Net
Income (Loss) of
Affiliates
   
Segment
Contribution
 
Consumer Mobility
 
$
14,806
   
$
8,560
   
$
6,246
   
$
1,716
   
$
4,530
   
$
-
   
$
4,530
 
Business Solutions
   
9,692
     
6,040
     
3,652
     
1,465
     
2,187
     
-
     
2,187
 
Entertainment Group
   
12,601
     
9,605
     
2,996
     
1,420
     
1,576
     
(6
)
   
1,570
 
International
   
1,929
     
1,759
     
170
     
290
     
(120
)
   
20
     
(100
)
Segment Total
   
39,028
     
25,964
     
13,064
     
4,891
     
8,173
   
$
14
   
$
8,187
 
Corporate and Other
   
337
     
829
     
(492
)
   
34
     
(526
)
               
Acquisition-related items
   
-
     
207
     
(207
)
   
1,202
     
(1,409
)
               
Certain significant items
   
-
     
(118
)
   
118
     
-
     
118
                 
AT&T Inc.
 
$
39,365
   
$
26,882
   
$
12,483
   
$
6,127
   
$
6,356
                 
 
 

13


 
AT&T INC.
MARCH 31, 2018

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
The following table is a reconciliation of Segment Contribution to "Income Before Income Taxes" reported on our consolidated statements of income.
 
             
   
First Quarter
 
   
2018
   
2017
 
Consumer Mobility
 
$
4,655
   
$
4,530
 
Business Solutions
   
2,084
     
2,187
 
Entertainment Group
   
1,335
     
1,570
 
International
   
(111
)
   
(100
)
Segment Contribution
   
7,963
     
8,187
 
Reconciling Items:
               
  Corporate and Other
   
(445
)
   
(526
)
  Amortization of intangibles acquired
   
(1,062
)
   
(1,202
)
  Merger and integration charges
   
(67
)
   
(207
)
  Venezuela devaluation
   
(25
)
   
-
 
  Employee separation costs
   
(51
)
   
-
 
  Natural disaster charges
   
(104
)
   
-
 
  Gain on wireless spectrum transactions
   
-
     
118
 
  Segment equity in net (income) loss of affiliates
   
(8
)
   
(14
)
AT&T Operating Income
   
6,201
     
6,356
 
Interest expense
   
1,771
     
1,293
 
Equity in net income (loss) of affiliates
   
9
     
(173
)
Other income (expense) - net
   
1,702
     
488
 
Income Before Income Taxes
 
$
6,141
   
$
5,378
 

NOTE 5. REVENUE RECOGNITION

As of January 1, 2018, we adopted FASB ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)," as modified (ASC 606). With our adoption of ASC 606, we made a policy election to record certain regulatory fees, primarily Universal Service Fund (USF) fees, on a net basis. See the Notes to the Consolidated Financial Statements of our 2017 Annual Report on Form 10-K for additional information regarding our policies prior to adoption of ASC 606.

When implementing ASC 606, we utilized the practical expedient allowing us to reflect the aggregate effect of all contract modifications occurring before the beginning of the earliest period presented when allocating the transaction price to performance obligations.

Contracts with Customers
Our products and services are offered to customers in service-only contracts and in contracts that bundle equipment used to access the services and/or with other service offerings. Service revenue is recognized when services are provided, based upon either usage (e.g., minutes of traffic/bytes of data processed) or period of time (e.g., monthly service fees). We record the sale of equipment when title has passed and the products are accepted by the customer. Some contracts have fixed terms and others are cancellable on a short-term basis (i.e., month-to-month arrangements).

Revenues from transactions between us and our customers are recorded net of regulatory fees and taxes. Cash incentives given to customers are recorded as a reduction of revenue. Nonrefundable, upfront service activation and setup fees associated with service arrangements are deferred and recognized over the associated service contract period or customer life. We record the sale of equipment and services to customers as gross revenue when we are the principal in the arrangement and net of the associated costs incurred when we act as an agent in the arrangement.

Our contracts allow for customers to frequently modify their arrangement, without incurring penalties in many cases. When a contract is modified, we evaluate the change in scope or price of the contract to determine if the modification should be
 
 

14


 
AT&T INC.
MARCH 31, 2018

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
treated as a new contract or if it should be considered a change of the existing contract. We generally do not have significant impacts from contract modifications.

Service-Only Contracts and Standalone Equipment Sales
Revenue is recognized as service is provided or when control has transferred. For devices sold through indirect channels (e.g., national dealers), revenue is recognized when the dealer accepts the device, not upon activation.

Arrangements with Multiple Performance Obligations
Revenue recognized from fixed term contracts that bundle services and/or equipment are allocated based on the standalone selling price of all required performance obligations of the contract (i.e., each item included in the bundle). Promotional discounts are attributed to each required component of the arrangement, resulting in recognition over the contract term. Standalone selling prices are determined by assessing prices paid for service-only contracts (e.g., arrangements where customers bring their own devices) and standalone device pricing.

We offer the majority of our customers the option to purchase certain wireless devices in installments over a specified period of time, and, in many cases, they may be eligible to trade in the original equipment for a new device and have the remaining unpaid balance paid or settled. For customers that elect these equipment installment payment programs, at the point of sale, we recognize revenue for the entire amount of revenue allocated to the customer receivable net of fair value of the trade-in right guarantee. The difference between the revenue recognized and the consideration received is recorded as a note receivable when the devices are not discounted and our right to consideration is unconditional. When installment sales include promotional discounts (e.g., "buy one get one free"), the difference between revenue recognized and consideration received is recorded as a contract asset to be amortized over the contract term.

Less commonly, we offer certain customers highly discounted devices when they enter into a minimum service agreement term. For these contracts, we recognize equipment revenue at the point of sale based on a standalone selling price allocation. The difference between the revenue recognized and the cash received is recorded as a contract asset that will amortize over the contract term.

For contracts that require the use of certain equipment in order to receive service (e.g., AT&T U-verse® and DIRECTV linear video services), we allocate the total transaction price to service if the equipment does not meet the criteria to be a distinct performance obligation.

Disaggregation of Revenue
The following table sets forth disaggregated reported revenue by category:

For the three months ended March 31, 2018
 
   
Consumer
Mobility
   
Business
Solutions
   
Entertainment
Group
   
International
   
Other
   
AT&T Inc.
 
                                     
Wireless service
 
$
11,612
   
$
1,791
   
$
-
   
$
404
   
$
-
   
$
13,807
 
Video entertainment
   
-
     
-
     
8,359
     
1,354
     
-
     
9,713
 
Strategic services
   
-
     
3,138
     
-
     
-
     
-
     
3,138
 
High-speed internet
   
-
     
-
     
1,878
     
-
     
-
     
1,878
 
Legacy voice and data
   
-
     
2,839
     
819
     
-
     
-
     
3,658
 
Other service
   
-
     
669
     
519
     
-
     
264
     
1,452
 
Wireless equipment
   
3,374
     
578
     
-
     
267
     
-
     
4,219
 
Other equipment
   
-
     
170
     
2
     
-
     
1
     
173
 
   
$
14,986
   
$
9,185
   
$
11,577
   
$
2,025
   
$
265
   
$
38,038
 

 
 

15



AT&T INC.
MARCH 31, 2018

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
Deferred Customer Contract Acquisition and Fulfillment Costs
Costs to fulfill customer contracts are deferred and amortized over periods ranging generally from four to five years, reflecting the estimated economic lives of the respective customer relationships, subject to an assessment of the recoverability of such costs. Costs to acquire customer contracts, including commissions on service activations, for our wireless and video entertainment services, are deferred and amortized over the contract period or expected customer life, which typically ranges from two to five years. For contracts with an estimated amortization period of less than one year, we expense incremental costs immediately.

Our deferred customer contract acquisition costs and deferred customer contract fulfillment costs balances were $2,117 and $10,763 as of March 31, 2018, respectively, of which $782 and $4,062 were included in Other current assets on our consolidated balance sheets. For the three months ended March 31, 2018, we amortized $263 and $1,047 of these costs, respectively.

Contract Assets and Liabilities
A contract asset is recorded when revenue is recognized in advance of our right to bill and receive consideration (i.e., we must perform additional services or satisfy another performance obligation in order to bill and receive additional consideration). The contract asset will decrease as services are provided and billed. When consideration is received in advance of the delivery of goods or services, a contract liability is recorded. Reductions in the contract liability will be recorded as we satisfy the performance obligations.

The following table presents contract assets and liabilities and revenue recorded at or for the period ended March 31, 2018:

   
March 31,
 
   
2018
 
       
Contract asset
 
$
1,757
 
Contract liability
   
5,510
 
         
Beginning of period contract liability recorded as customer contract revenue during period
   
3,625
 

Our consolidated balance sheet included approximately $1,252 for the current portion of our contract asset in "Other current assets" and $4,882 for the current portion of our contract liability in "Advanced billings and customer deposits."

Transaction Price Allocated to Remaining Performance Obligations
Our remaining performance obligations represent services we are required to provide to customers under bundled or discounted arrangements, which are satisfied as services are provided over the contract term. In determining the transaction price allocated, we do not include non-recurring charges and estimates for usage, nor do we consider arrangements with an original expected duration of less than one-year, which are primarily prepaid wireless, video and residential internet agreements.

Remaining performance obligations associated with business contracts reflect recurring charges billed, adjusted to reflect estimates for sales incentives and revenue adjustments. Performance obligations associated with wireless contracts are estimated using a portfolio approach in which we review all relevant promotional activities, calculating the remaining performance obligation using the average device price and average service component for the portfolio. As of March 31, 2018, the aggregate amount of the transaction price allocated to remaining performance obligations was $27,836, of which we expect to recognize approximately 50% over the remainder of 2018, with the balance recognized thereafter.

Comparative Results
Prior to 2018, revenue recognized from contracts that bundle services and equipment was limited to the lesser of the amount allocated based on the relative selling price of the equipment and service already delivered or the consideration received from the customer for the equipment and service already delivered. Our prior accounting also separately recognized regulatory fees as operating revenue when received and as an expense when incurred. Sales commissions were expensed as incurred.
 
 

16


 
AT&T INC.
MARCH 31, 2018

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
The following table presents our reported results under ASC 606 and our pro forma results using the historical accounting method:

At or for the three months ended March 31, 2018
 
As
Reported
   
Historical Accounting Method
 
Consolidated Statements of Income:
           
  Service Revenues
 
$
33,646
   
$
35,069
 
  Equipment Revenues
   
4,392
     
3,861
 
  Total Operating Revenues
   
38,038
     
38,930
 
  Other cost of services
   
7,932
     
8,861
 
  Selling, general and administrative expenses
   
7,897
     
8,497
 
  Total Operating Expenses
   
31,837
     
33,366
 
  Operating income
   
6,201
     
5,564
 
  Income before income taxes
   
6,141
     
5,504
 
  Income tax expense
   
1,382
     
1,226
 
  Net income
   
4,759
     
4,278
 
  Net income attributable to AT&T
   
4,662
     
4,187
 
                 
  Basic Earnings per Share Attributable to AT&T
 
$
0.75
   
$
0.68
 
  Diluted Earnings per Share Attributable to AT&T
 
$
0.75
   
$
0.68
 
                 
Consolidated Balance Sheets:
               
  Other current assets
   
12,008
     
10,124
 
  Other Assets
   
20,974
     
19,164
 
  Accounts payable and accrued liabilities     
31,569
     
31,748
 
  Advanced billings and customer deposits
   
5,081
     
5,140
 
  Deferred income taxes
   
45,730
     
44,787
 
  Other noncurrent liabilities
   
19,117
     
18,990
 
  Retained earnings
   
55,067
     
52,250
 
  Accumulated other comprehensive income
   
7,386
     
7,375
 
  Noncontrolling interest
   
1,156
     
1,115
 

NOTE 6. PENSION AND POSTRETIREMENT BENEFITS

Many 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. 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 provide benefits described in the plans to employees upon their retirement.

In 2013, we made a voluntary contribution of a preferred equity interest in AT&T Mobility II LLC, the primary holding company for our domestic wireless business, to the trust used to pay pension benefits under our qualified pension plans. The preferred equity interest had a value of $8,944 at March 31, 2018. The trust is entitled to receive cumulative cash distributions of $560 per annum, which are distributed quarterly by AT&T Mobility II LLC to the trust, in equal amounts and accounted for as contributions. We distributed $140 to the trust during the three months ended March 31, 2018. So long as we make the distributions, we will have 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.

We recognize actuarial gains and losses on pension and postretirement plan assets in our consolidated results as a component of other income (expense) – net at our annual measurement date of December 31, unless earlier remeasurements are required. During the first quarter of 2018, a substantive plan change involving the frequency of future health reimbursement account
 
 

17


 
AT&T INC.
MARCH 31, 2018

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
credit increases was communicated to our retirees. This plan change resulted in additional prior service credits recognized in other comprehensive income, reducing our liability by $752. Such credits amortize through earnings over a period approximating the average service period to full eligibility. The plan change also triggered a remeasurement of our postretirement benefit obligation, resulting in an actuarial gain of $930 recognized in the first quarter of 2018, for a total reduction in our liability of $1,682.

The following table details pension and postretirement benefit costs included in the accompanying consolidated statements of income. The service cost component of net periodic pension cost (benefit) is recorded in operating expenses in the consolidated statements of income while the remaining components are recorded in other income (expense) – net. Service costs are eligible for capitalization as part of internal construction projects, providing a small reduction in the net expense recorded.

   
Three months ended
 
   
March 31,
 
   
2018
   
2017
 
Pension cost:
           
   Service cost – benefits earned during the period
 
$
291
   
$
282
 
   Interest cost on projected benefit obligation
   
487
     
484
 
   Expected return on assets
   
(760
)
   
(783
)
   Amortization of prior service credit
   
(30
)
   
(31
)
   Net pension (credit) cost
 
$
(12
)
 
$
(48
)
                 
Postretirement cost:
               
   Service cost – benefits earned during the period
 
$
29
   
$
41
 
   Interest cost on accumulated postretirement benefit obligation
   
191
     
222
 
   Expected return on assets
   
(77
)
   
(80
)
   Amortization of prior service credit
   
(397
)
   
(336
)
   Actuarial (gain) loss
   
(930
)
   
-
 
   Net postretirement (credit) cost
 
$
(1,184
)
 
$
(153
)
                 
   Combined net pension and postretirement (credit) cost
 
$
(1,196
)
 
$
(201
)

As part of our first-quarter 2018 remeasurement, we increased the weighted-average discount rate used to measure our postretirement benefit obligation to 4.10%. The discount rate in effect for determining postretirement service and interest costs after remeasurement is 4.30% and 3.70%, respectively. As a result of our plan change and remeasurement, the total estimated prior service credits that will be amortized from accumulated OCI into net periodic benefit cost over the remainder of 2018 is $1,237 ($933 net of tax) for postretirement benefits.

We also provide senior- and middle-management employees with nonqualified, unfunded supplemental retirement and savings plans. For the first quarter ended 2018 and 2017, net supplemental pension benefits costs not included in the table above were $21 and $22.
 
 

18



AT&T INC.
MARCH 31, 2018

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

NOTE 7. 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. Our valuation techniques 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, 2017.

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, 2018
 
December 31, 2017
 
 
Carrying
 
Fair
 
Carrying
 
Fair
 
 
Amount
 
Value
 
Amount
 
Value
 
Notes and debentures1
 
$
161,161
   
$
169,388
   
$
162,526
   
$
171,938
 
Bank borrowings
   
2
     
2
     
2
     
2
 
Investment securities2
   
2,584
     
2,584
     
2,447
     
2,447
 
1 Includes credit agreement borrowings.
                               
2 Excludes investments accounted for under the equity method.
                               

The carrying amount 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.

Following is the fair value leveling for investment securities that are measured at fair value and derivatives as of March 31, 2018 and December 31, 2017. Derivatives designated as hedging instruments are reflected as "Other assets," "Other noncurrent liabilities" and, for a portion of interest rate swaps, "Other current assets" on our consolidated balance sheets.
 
 

19


 
AT&T INC.
MARCH 31, 2018

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

   
March 31, 2018
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Equity Securities
                       
   Domestic equities
 
$
1,065
   
$
-
   
$
-
   
$
1,065
 
   International equities
   
294
     
-
     
-
     
294
 
   Fixed income equities
   
-
     
149
     
-
     
149
 
Available-for-Sale Debt Securities
   
-
     
777
     
-
     
777
 
Asset Derivatives
                               
   Interest rate swaps
   
-
     
10
     
-
     
10
 
   Cross-currency swaps
   
-
     
2,761
     
-
     
2,761
 
   Foreign exchange contracts
   
-
     
12
     
-
     
12
 
Liability Derivatives
                               
   Interest rate swaps
   
-
     
(78
)
   
-
     
(78
)
   Cross-currency swaps
   
-
     
(706
)
   
-
     
(706
)
   Foreign exchange contracts
   
-
     
(15
)
   
-
     
(15
)

   
December 31, 2017
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Equity Securities
                       
   Domestic equities
 
$
1,142
   
$
-
   
$
-
   
$
1,142
 
   International equities
   
321
     
-
     
-
     
321
 
   Fixed income equities
   
-
     
152
     
-
     
152
 
Available-for-Sale Debt Securities
   
-
     
581
     
-
     
581
 
Asset Derivatives
                               
   Interest rate swaps
   
-
     
17
     
-
     
17
 
   Cross-currency swaps
   
-
     
1,753
     
-
     
1,753
 
Liability Derivatives
                               
   Interest rate swaps
   
-
     
(31
)
   
-
     
(31
)
   Cross-currency swaps
   
-
     
(1,290
)
   
-
     
(1,290
)
                                 
Investment Securities
Our investment securities include both equity and debt securities that are measured at fair value, as well as equity securities without readily determinable fair values. A substantial portion of the fair values of our investment securities are estimated based on quoted market prices. Investments in equity securities not traded on a national securities exchange are valued at cost, less any impairment, and adjusted for changes resulting from observable, orderly transactions for identical or similar securities. Investments in debt securities not traded on a national securities exchange are valued using pricing models, quoted prices of securities with similar characteristics or discounted cash flows.

Prior to 2018, realized gains and losses on investment securities were included in "Other income (expense) – net" in the consolidated statements of income, while unrealized gains and losses, net of tax, were recorded in accumulated OCI. ASU 2016-01 required unrealized gains and losses, net of tax, on equity securities to also be included in "Other income (expense) – net" while debt securities will continue to be recorded in accumulated OCI.

Upon the adoption of ASU 2016-01, we reclassified $655 of such unrealized gains and losses on equity securities to retained earnings and beginning in 2018, gains and losses, both realized and unrealized, on equity securities measured at fair value are included in "Other income (expense) – net" in the consolidated statements of income using the specific identification method.
 

20


 
AT&T INC.
MARCH 31, 2018

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
The components comprising total gains and losses on equity securities are as follows:
 
             
 
Three months ended
 
 
March 31,
 
 
2018
 
2017
 
Total gains (losses) recognized on equity securities
 
$
(13
)
 
$
89
 
Gains (Losses) recognized on equity securities sold
   
52
     
11
 
Unrealized gains (losses) recognized on equity securities held at end of period
   
(65
)
   
78
 

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.
 
Debt securities of $18 have maturities of less than one year, $137 within one to three years, $63 within three to five years and $559 for five or more years.

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

Derivative Financial Instruments
We enter into derivative transactions 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.

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 three months ended March 31, 2018 and March 31, 2017, 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, Canadian dollar and Swiss franc denominated debt. These agreements include initial and final exchanges of principal from fixed foreign currency denominated amounts to fixed U.S. dollar denominated amounts, to be exchanged at a specified rate that is usually determined by the market spot rate upon issuance. They also include an interest rate swap of a fixed or floating foreign currency-denominated rate to a fixed U.S. dollar 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. 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 three months ended March 31, 2018 and March 31, 2017, no ineffectiveness was measured on cross-currency swaps designated as cash flow hedges.
 
 

21


 
AT&T INC.
MARCH 31, 2018

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
Periodically, we enter into and designate interest rate locks to partially hedge the risk of changes in interest payments attributable to increases in the benchmark interest rate during the period leading up to the probable issuance of fixed-rate debt. We designate our interest rate locks as cash flow hedges. Gains and losses when we settle our interest rate locks are amortized into income over the life of the related debt, except where a material amount is deemed to be ineffective, which would be immediately reclassified to "Other income (expense) – net" in the consolidated statements of income. Over the next 12 months, we expect to reclassify $59 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. 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, 2018 and March 31, 2017, 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 March 31, 2018, we had posted collateral of $125 (a deposit asset) and held collateral of $2,672 (a receipt liability). Under the agreements, if AT&T's credit rating had been downgraded one rating level by Fitch Ratings, before the final collateral exchange in March, we would have been required to post additional collateral of $84. If DIRECTV Holdings LLC's credit rating had been downgraded below BBB- (S&P), we would have been required to post additional collateral of $72. At December 31, 2017, we had posted collateral of $495 (a deposit asset) and held collateral of $968 (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) exists, against the fair value of the derivative instruments.

Following are the notional amounts of our outstanding derivative positions:

   
March 31,
   
December 31,
 
   
2018
   
2017
 
Interest rate swaps
 
$
8,333
   
$
9,833
 
Cross-currency swaps
   
36,092
     
38,694
 
Foreign exchange contracts
   
2,908
     
-
 
Total
 
$
47,333
   
$
48,527
 

Following are 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
 
 
March 31,
 
 
2018
 
2017
 
Interest rate swaps (Interest expense):
           
     Gain (Loss) on interest rate swaps
 
$
(53
)
 
$
(25
)
     Gain (Loss) on long-term debt
   
53
     
25
 

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

22


 
AT&T INC.
MARCH 31, 2018

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

Cash Flow Hedging Relationships
Three months ended
 
 
March 31,
 
 
2018
 
2017
 
Cross-currency swaps:
           
     Gain (Loss) recognized in accumulated OCI
 
$
854
   
$
20
 
Interest rate locks:
               
     Interest income (expense) reclassified from accumulated OCI into income
   
(15
)
   
(15
)

NOTE 8. ACQUISITIONS, DISPOSITIONS AND OTHER ADJUSTMENTS

Pending Acquisition

Time Warner Inc.  On October 22, 2016, we entered into and announced a merger agreement (Merger Agreement) to acquire Time Warner Inc. (Time Warner) in a 50% cash and 50% stock transaction for $107.50 per share of Time Warner common stock, or approximately $85,400 at the date of the announcement (Merger). Combined with Time Warner's net debt at March 31, 2018, the total transaction value is approximately $105,962. Each share of Time Warner common stock will be exchanged for $53.75 per share in cash and a number of shares of AT&T common stock equal to the exchange ratio. If the average stock price (as defined in the Merger Agreement) at the time of closing the Merger is between (or equal to) $37.411 and $41.349 per share, the exchange ratio will be the quotient of $53.75 divided by the average stock price. If the average stock price is greater than $41.349, the exchange ratio will be 1.300. If the average stock price is less than $37.411, the exchange ratio will be 1.437. Post-transaction, Time Warner shareholders will own between 14.4% and 15.7% of AT&T shares on a fully-diluted basis based on the number of AT&T shares outstanding.

Time Warner is a global leader in media and entertainment whose major businesses encompass an array of some of the most respected and successful media brands. The deal combines Time Warner's vast library of content and ability to create new premium content for audiences around the world with our extensive customer relationships and distribution, one of the world's largest pay-TV subscriber bases and leading scale in TV, mobile and broadband distribution.

On November 20, 2017, the United States Department of Justice filed a complaint in the U.S. District Court, District of Columbia seeking a permanent injunction to prevent AT&T from acquiring Time Warner, alleging that the effect of the transaction "may be substantially to lessen competition" in violation of federal antitrust law. AT&T disputes the government allegations, and believes the merger is pro-consumer and pro-competition, and ultimately will be approved. The trial began in late March 2018, with oral arguments concluding on April 30, 2018. In light of the trial date and allowing time for a decision, both AT&T and Time Warner elected to further extend the termination date of the merger agreement to June 21, 2018. If the Merger is terminated as a result of reaching the extended termination date (and at that time one or more of the conditions relating to certain regulatory approvals have not been satisfied), or there is a final, non-appealable order preventing the transaction relating to antitrust laws, communications laws, utilities laws or foreign regulatory laws, then under certain circumstances, we would be obligated to pay Time Warner $500.

NOTE 9. SALES OF EQUIPMENT INSTALLMENT RECEIVABLES

We offer our customers the option to purchase certain wireless devices in installments over a specified period of time and, in many cases, once certain conditions are met, they may be eligible to trade in the original equipment for a new device and have the remaining unpaid balance paid or settled. As of March 31, 2018 and December 31, 2017, gross equipment installment receivables of $4,798 and $6,079 were included on our consolidated balance sheets, of which $2,627 and $3,340 are notes receivable that are included in "Accounts receivable - net."

In 2014, we entered into an uncommitted agreement pertaining to the sale of equipment installment receivables and related security with Citibank and various other relationship banks as purchasers (collectively, the Purchasers). Under this agreement, we transfer certain receivables to the Purchasers for cash and additional consideration upon settlement of the receivables, referred to as the deferred purchase price. Since 2014, we have made beneficial modifications to the agreement. During 2017, we modified the agreement and entered into a second uncommitted agreement with the Purchasers such that we receive more upfront cash consideration at the time the receivables are transferred to the Purchasers. Additionally, in the event a customer trades in a device prior to the end of the installment contract period, we agree to make a payment to the
 
 

23


 
AT&T INC.
MARCH 31, 2018

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
Purchasers equal to any outstanding remaining installment receivable balance. Accordingly, we record a guarantee obligation to the Purchasers for this estimated amount at the time the receivables are transferred. Under the terms of the agreement, we continue to bill and collect the payments from our customers on behalf of the Purchasers. As of March 31, 2018, total cash proceeds received, net of remittances (excluding amounts returned as deferred purchase price), were $5,569.

The following table sets forth a summary of equipment installment receivables sold during the three months ended March 31, 2018 and 2017:

 
Three months ended
 
 
March 31,
 
 
2018
   
2017
 
Gross receivables sold
 
$
3,010
   
$
2,846
 
Net receivables sold1
   
2,795
     
2,621
 
Cash proceeds received
   
2,395
     
1,432
 
Deferred purchase price recorded
   
519
     
1,189
 
Guarantee obligation recorded
   
123
     
-
 
1 Receivables net of allowance, imputed interest and trade-in right guarantees. 

The deferred purchase price and guarantee obligation are initially recorded at estimated fair value and subsequently carried at the lower of cost or net realizable value. The estimation of their fair values is based on remaining installment payments expected to be collected and the expected timing and value of device trade-ins. The estimated value of the device trade-ins considers prices offered to us by independent third parties that contemplate changes in value after the launch of a device model. The fair value measurements used for the deferred purchase price and the guarantee obligation are considered Level 3 under the Fair Value Measurement and Disclosure framework (see Note 7).

The following table shows the equipment installment receivables, previously sold to the Purchasers, which we repurchased in exchange for the associated deferred purchase price during the three months ended March 31, 2018 and 2017. We did not repurchase any installment receivables in the quarter ended March 31, 2018.

 
Three months ended
 
 
March 31,
 
 
2018
 
2017
 
Fair value of repurchased receivables
 
$
-
   
$
377
 
Carrying value of deferred purchase price
   
-
     
339
 
Gain (loss) on repurchases1
 
$
-
   
$
38
 
1 These gains (losses) are included in "Selling, general and administrative" in the consolidated statements of income. 

At March 31, 2018 and December 31, 2017, our deferred purchase price receivable was $3,009 and $2,749, respectively, of which $1,996 and $1,781 are included in "Other current assets" on our consolidated balance sheets, with the remainder in "Other Assets." The guarantee obligation at March 31, 2018 and December 31, 2017 was $309 and $204, respectively, of which $94 and $55 are included in "Accounts payable and accrued liabilities" on our consolidated balance sheets, with the remainder in "Other noncurrent liabilities." Our maximum exposure to loss as a result of selling these equipment installment receivables is limited to the total amount of our deferred purchase price and guarantee obligation.

The sales of equipment installment receivables did not have a material impact on our consolidated statements of income or to "Total Assets" reported on our consolidated balance sheets. We reflect cash receipts on owned equipment installment receivables as cash flows from operations in our consolidated statements of cash flows. With the retrospective adoption of ASU 2016-15 in 2018 (see Note 1), cash receipts on the deferred purchase price are now classified as cash flows from investing activities instead of cash flows from operating activities.
 
The outstanding portfolio of installment receivables derecognized from our consolidated balance sheets, but which we continue to service, was $8,895 and $7,446 at March 31, 2018 and December 31, 2017.
 
 

24



AT&T INC.
MARCH 31, 2018

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

NOTE 10. ADDITIONAL FINANCIAL INFORMATION

We typically maintain our restricted cash balances for purchases and sales of certain investment securities, investment income for those investments and funding of certain deferred compensation benefit payments. The following summarizes cash and cash equivalents and restricted cash balances contained on our consolidated balance sheets:

   
March 31,
   
December 31,
 
Cash and Cash Equivalents and Restricted Cash
 
2018
   
2017
   
2017
   
2016
 
                         
   Cash and cash equivalents
 
$
48,872
   
$
14,884
   
$
50,498
   
$
5,788
 
   Restricted cash in Other current assets
   
8
     
7
     
6
     
7
 
   Restricted cash in Other Assets
   
345
     
89
     
428
     
140
 
   Cash and cash equivalents and restricted cash
 
$
49,225
   
$
14,980
   
$
50,932
   
$
5,935
 

   
Three months ended
 
   
March 31,
 
Consolidated Statements of Cash Flows
 
2018
   
2017
 
Cash paid (received) during the period for:
           
   Interest
 
$
2,408
   
$
1,643
 
   Income taxes, net of refunds
   
(1,089
)
   
(160
)
 
 
 

25


 
AT&T INC.
MARCH 31, 2018

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share and per subscriber amounts
 
RESULTS OF OPERATIONS

AT&T is a holding company whose subsidiaries and affiliates operate in the communications and digital entertainment services industry. Our subsidiaries and affiliates provide services and equipment that deliver voice, video and broadband services both domestically and internationally. You should read this discussion in conjunction with the consolidated financial statements and accompanying notes. A reference to a "Note" in this section refers to the accompanying Notes to Consolidated Financial Statements. Certain amounts have been conformed to the current period's presentation, including impacts for the adoption of recent accounting standards (see Note 1) and the realignment of certain business units within our reportable segments (see Note 4).

Consolidated Results  In the first quarter of 2018, we adopted new revenue accounting rules that significantly affect the comparability of our consolidated and segment operating results (see Note 5). As a supplement to our discussion of operating results, comparable financial results presented under the historical method of accounting is available in "Supplemental Results Under Historical Accounting Method." Our reported financial results in the first quarter of 2018, including impacts from revenue accounting rules, and 2017 are summarized as follows:

   
First Quarter
 
               
Percent
 
   
2018
   
2017
   
Change
 
                   
Operating Revenues
                 
   Service
 
$
33,646
   
$
36,456
     
(7.7
)%
   Equipment
   
4,392
     
2,909
     
51.0
 
Total Operating Revenues
   
38,038
     
39,365
     
(3.4
)
                         
Operating expenses
                       
   Cost of services and sales
                       
      Equipment
   
4,848
     
3,848
     
26.0
 
      Broadcast, programming and operations
   
5,166
     
4,974
     
3.9
 
      Other cost of services
   
7,932
     
9,288
     
(14.6
)
   Selling, general and administrative
   
7,897
     
8,772
     
(10.0
)
   Depreciation and amortization
   
5,994
     
6,127
     
(2.2
)
Total Operating Expenses
   
31,837
     
33,009
     
(3.6
)
Operating Income
   
6,201
     
6,356
     
(2.4
)
Income Before Income Taxes
   
6,141
     
5,378
     
14.2
 
Net Income
   
4,759
     
3,574
     
33.2
 
Net Income Attributable to AT&T
 
$
4,662
   
$
3,469
     
34.4
%

Overview

Operating revenues decreased $1,327, or 3.4%, in the first quarter of 2018.
Service revenues decreased $2,810, or 7.7%, in the first quarter of 2018, reflecting our adoption of a new revenue accounting standard, which included our policy election to record Universal Service Fund (USF) fees on a net basis and also resulted in less revenue allocation to the service component of bundled contracts. Also contributing to the decrease was the continued decline in legacy wireline voice and data products, video services and lower wireless service revenues driven by customer migration to unlimited wireless plans.

Equipment revenues increased $1,483, or 51.0%, in the first quarter of 2018, driven by increased device sales and upgrades. The adoption of new accounting standards also contributed to higher revenue allocations from bundled contracts.
 
 

26


 
AT&T INC.
MARCH 31, 2018

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued
Dollars in millions except per share and per subscriber amounts
 
Operating expenses decreased $1,172, or 3.6%, in the first quarter of 2018.
Equipment expenses increased $1,000, or 26.0%, in the first quarter of 2018, driven by an increase in the sale of higher-priced devices as well as an overall increase in handset volumes.

Broadcast, programming and operations expenses increased $192, or 3.9%, in the first quarter of 2018, reflecting annual content cost increases and additional programming costs.

Other cost of services expenses decreased $1,356, or 14.6%, in the first quarter of 2018, primarily due to our adoption of new accounting rules, which included our policy election to record USF fees net. Also contributing to the decrease were lower expenses due to cost management and utilization of automation and digitalization where appropriate.

Selling, general and administrative expenses decreased $875, or 10.0%, in the first quarter of 2018, primarily due to commission deferrals resulting from new accounting standards, which are now deferred and amortized over the contract period or expected customer life. Also contributing to the decrease were lower expenses for merger and integration-related activities and expense reductions due to our disciplined cost management. Partially offsetting the decrease are higher costs arising from natural disasters and, in the comparable period of 2017, gains on wireless spectrum transactions.

Depreciation and amortization expense decreased $133, or 2.2%, in the first quarter of 2018. Amortization expense decreased $140, or 11.6%, in the first quarter of 2018 due to lower amortization of intangibles for the customer lists associated with acquisitions.
 
Depreciation expense increased $7, or 0.1%, in the first quarter. The increase was primarily due to ongoing capital spending for upgrades and expansion offset by our fourth-quarter 2017 abandonment of certain copper network assets.

Operating income decreased $155, or 2.4%, for the first quarter of 2018. Our operating income margin in the first quarter increased from 16.1% in 2017 to 16.3% in 2018.

Interest expense increased $478, or 37.0%, in the first quarter of 2018. The increase was primarily due to higher debt balances in anticipation of closing our acquisition of Time Warner Inc. (Time Warner), and an increase in average interest rates when compared to the prior year.

Equity in net income of affiliates increased $182 in the first quarter of 2018, predominantly due to losses in the first quarter of 2017 from our legacy publishing business, which was sold in June 2017.

Other income (expense) – net increased $1,214 in the first quarter of 2018. The increase was primarily due to an actuarial gain of $930 resulting from remeasurement of our postretirement benefit obligation and increased interest income of $164.

Income taxes decreased $422, or 23.4%, in the first quarter of 2018. Our effective tax rate was 22.5% for the first quarter of 2018, as compared to 33.5% for the first quarter of 2017. The decrease in income tax expense and our effective tax rate for the first quarter of 2018 was primarily due to the December 2017 enactment of U.S. corporate tax reform, which reduced the federal tax rate from 35% to 21%. Partially offsetting the decreased tax rate was higher earnings.
 
 

27


 
AT&T INC.
MARCH 31, 2018

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

Selected Financial and Operating Data
     
 
March 31,
Subscribers and connections in (000s)
2018
 
2017
Domestic wireless subscribers
143,832
 
133,804
Mexican wireless subscribers
15,642
 
12,606
North American wireless subscribers
159,474
 
146,410
       
North American branded subscribers
108,566
 
103,118
North American branded net additions
858
 
735
       
Domestic satellite video subscribers
20,270
 
21,012
AT&T U-verse® (U-verse) video subscribers
3,657
 
4,048
DIRECTV NOW video subscribers
1,467
 
339
Latin America satellite video subscribers1
13,573
 
13,678
Total video subscribers
38,967
 
39,077
       
Total domestic broadband connections
15,775
 
15,695
       
Network access lines in service
11,288
 
13,363
U-verse VoIP connections
5,585
 
5,858
       
Debt ratio2
52.6%
 
51.6%
Net debt ratio3
36.8%
 
45.8%
Ratio of earnings to fixed charges4
3.56
 
3.80
Number of AT&T employees
249,240
 
264,530
1 Excludes subscribers of our International segment equity investments in SKY Mexico, in which we own a 41% stake. At December 31, 2017, SKY Mexico had 8.0 million subscribers.
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 Net debt ratios are calculated by deriving total debt (debt maturing within one year plus long-term debt) less cash available by total capital (total debt plus total stockholders' equity).
4 See Exhibit 12.

Segment Results

Our segments are strategic business units that offer different products and services over various technology platforms and/or in different geographies that are managed accordingly. Our segment results presented in Note 4 and discussed below for each segment follow our internal management reporting. We analyze our segments based on Segment Contribution, which consists of operating income, excluding acquisition-related costs and other significant items, and equity in net income (loss) of affiliates for investments managed within each segment. We have four reportable segments: (1) Consumer Mobility, (2) Business Solutions, (3) Entertainment Group and (4) International.

We also evaluate segment performance based on EBITDA and/or EBITDA margin, which is defined as Segment Contribution, excluding equity in net income (loss) of affiliates and depreciation and amortization. We believe EBITDA to be a relevant and useful measurement to our investors as it is part of our internal management reporting and planning processes and it is an important metric that management uses to evaluate operating performance. EBITDA does not give effect to cash used for debt service requirements and thus does not reflect available funds for distributions, reinvestment or other discretionary uses. EBITDA margin is EBITDA divided by total revenues.
 
 

28


 
AT&T INC.
MARCH 31, 2018

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued
Dollars in millions except per share and per subscriber amounts
 
To most effectively implement our strategies for 2018, we have realigned certain responsibilities and operations within our reportable segments. The most significant of these changes is to report individual wireless accounts with employer discounts in our Consumer Mobility segment, instead of our Business Solutions segment.

The Consumer Mobility segment provides nationwide wireless service to consumers, wholesale and resale wireless subscribers located in the United States or in U.S. territories. We provide voice and data services, including high-speed internet over wireless devices.

The Business Solutions segment provides services to business customers, including multinational companies and governmental and wholesale customers. We provide advanced IP-based services including Virtual Private Networks (VPN); Ethernet-related products; FlexWare, a service that relies on Software Defined Networking and Network Function Virtualization to provide application-based routing, and broadband, collectively referred to as strategic services; as well as traditional data and voice products. We provide a complete communications solution to our business customers.

The Entertainment Group segment provides video, internet, voice communication, and interactive and targeted advertising services to customers located in the United States or in U.S. territories.

The International segment provides entertainment services in Latin America and wireless services in Mexico. Video entertainment services are provided to primarily residential customers using satellite technology. We utilize our regional and national networks in Mexico to provide consumer and business customers with wireless data and voice communication services. Our international subsidiaries conduct business in their local currency, and operating results are converted to U.S. dollars using official exchange rates. Our International segment is subject to foreign currency fluctuations (operations in countries with highly inflationary economies consider the U.S. dollar as the functional currency).

Our domestic communications business strategies reflect bundled product offerings that increasingly cut across product lines and utilize our shared asset base. Therefore, asset information and capital expenditures by segment are not presented. Depreciation is allocated based on asset utilization by segment. We push down administrative activities into the business units to better manage costs and serve our customers.

Consumer Mobility
                 
Segment Results
                 
   
First Quarter
 
   
2018
   
2017
   
Percent
Change
 
 
Segment operating revenues
                 
     Service
 
$
11,612
   
$
12,465
     
(6.8
)%
     Equipment
   
3,374
     
2,341
     
44.1
 
Total Segment Operating Revenues
   
14,986
     
14,806
     
1.2
 
                         
Segment operating expenses
                       
     Operations and support
   
8,524
     
8,560
     
(0.4
)
     Depreciation and amortization
   
1,807
     
1,716
     
5.3
 
Total Segment Operating Expenses
   
10,331
     
10,276
     
0.5
 
Segment Operating Income
   
4,655
     
4,530
     
2.8