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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNESEPTEMBER 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-1105
AT&T CORP.
A NEW YORK I.R.S. EMPLOYER
CORPORATION NO. 13-4924710
ONE AT&T WAY, BEDMINSTER, NEW JERSEY 07921
TELEPHONE -- AREA CODE 908-221-2000
INDICATE BY CHECK MARK WHETHER THE REGISTRANTIndicate by check mark whether the registrant (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTIONhas filed all reports
required to be filed by Section 13 ORor 15(d) OF THE SECURITIES EXCHANGE ACT OFof the Securities Exchange Act of
1934 DURING THE PRECEDINGduring the preceding 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS)months (or for such shorter period that the
registrant was required to file such reports), ANDand (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PASThas been subject to such
filing requirements for the past 90 DAYS. YESdays. Yes [X] No [ ]
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN EXCHANGE ACT RULE 12d-2) YESIndicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [ ]
AT JULY 30,At October 29, 2004, THE FOLLOWING SHARES OF STOCK WERE OUTSTANDING:the following shares of stock were outstanding: AT&T
COMMON STOCKcommon stock -- 794,714,883795,868,728.
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AT&T CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOMEOPERATIONS
(UNAUDITED)
FOR THE THREE MONTHS FOR THE SIXNINE MONTHS
ENDED MONTHSSEPTEMBER 30, ENDED JUNESEPTEMBER 30,
JUNE 30,
----------------------- --------------------------------------------- ----------------------
2004 2003 2004 2003
---------- --------- ---------- ---------- -------------------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
REVENUE................................................REVENUE.............................................. $ 7,6367,638 $ 8,795 $15,626 $17,7818,649 $ 23,264 $26,430
OPERATING EXPENSES
Access and other connection............................ 2,481 2,708 5,119 5,406connection.......................... 2,411 2,785 7,530 8,191
Costs of services and products (excludes depreciation
of $935, $965, $1,871$409, $942, $2,280 and $1,906$2,848 included below)..... 1,759 1,958 3,623 3,969... 1,783 1,954 5,406 5,923
Selling, general and administrative.................... 1,763 1,837 3,507 3,758administrative.................. 1,653 1,793 5,160 5,551
Depreciation and amortization.......................... 1,231 1,197 2,481 2,383
Netamortization........................ 647 1,224 3,128 3,607
Asset impairment and net restructuring and other
charges.................... 54 66 267 70charges............................................ 12,469 64 12,736 134
-------- ------- ------- --------------- -------
Total operating expenses............................... 7,288 7,766 14,997 15,586expenses............................. 18,963 7,820 33,960 23,406
-------- ------- ------- --------------- -------
OPERATING INCOME....................................... 348 1,029 629 2,195(LOSS) INCOME.............................. (11,325) 829 (10,696) 3,024
Other (expense) income, (expense), net............................ 36 86 (138) 96net.......................... (34) (7) (172) 89
Interest (expense)..................................... (191) (296) (419) (628)................................... (192) (289) (611) (917)
-------- ------- -------- -------
------- -------(LOSS) INCOME BEFORE INCOME TAXES, MINORITY INTEREST
INCOME, NET EARNINGS (LOSSES) RELATED TO EQUITY
INVESTMENTS AND CUMULATIVE EFFECT OF ACCOUNTING
CHANGE............... 193 819 72 1,663
(Provision) benefitCHANGES............................................ (11,551) 533 (11,479) 2,196
Benefit (provision) for income taxes................... (87) (308) 339 (605)taxes................. 4,402 (72) 4,741 (677)
Minority interest income............................... 1income............................. -- -- 1 1
Net earnings (losses) related to equity
investments............. 1 25investments........................................ 2 (3) 2 3
-------- ------- -------- -------
(LOSS) INCOME FROM CONTINUING OPERATIONS............. (7,147) 458 (6,735) 1,523
Net (loss) from discontinued operations (net of
income taxes of $0)................................ -- 6(13) -- (13)
-------- ------- -------- -------
------- -------(LOSS) INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING
CHANGE... 108 536 412 1,065CHANGES............................................ (7,147) 445 (6,735) 1,510
Cumulative effect of accounting changechanges (net of
income taxes of $(26)$17 and $(9))............................................................ -- (27) -- -- 4215
-------- ------- ------- --------------- -------
NET INCOME.............................................(LOSS) INCOME.................................... $ 108(7,147) $ 536418 $ 412(6,735) $ 1,1071,525
======== ======= ======= =============== =======
WEIGHTED-AVERAGE SHARES USED TO COMPUTE EARNINGS PER
SHARE:
Basic..................................................Basic................................................ 795 789 794 787
Diluted.............................................. 795 791 794 786
Diluted................................................ 797 787 796 786788
PER BASIC AND DILUTED SHARE:
Earnings before cumulative effect of accounting
change...............................................(Loss) earnings from continuing operations........... $ 0.14(8.99) $ 0.680.58 $ 0.52(8.48) $ 1.361.94
(Loss) from discontinued operations.................. -- (0.02) -- (0.02)
Cumulative effect of accounting change.................changes.............. -- (0.03) -- -- 0.050.02
-------- ------- -------- -------
------- -------(LOSS) EARNINGS PER BASIC ANDSHARE...................... $ (8.99) $ 0.53 $ (8.48) $ 1.94
======== ======= ======== =======
PER DILUTED SHARE...................SHARE:
(Loss) earnings from continuing operations........... $ 0.14(8.99) $ 0.680.58 $ 0.52(8.48) $ 1.411.93
(Loss) from discontinued operations.................. -- (0.02) -- (0.01)
Cumulative effect of accounting changes.............. -- (0.03) -- 0.02
-------- ------- -------- -------
(LOSS) EARNINGS PER DILUTED SHARE.................... $ (8.99) $ 0.53 $ (8.48) $ 1.94
======== ======= ======= =============== =======
DIVIDENDS DECLARED PER COMMON SHARE....................SHARE.................. $ 0.2375 $0.2375 $0.1875 $0.4750 $0.3750$ 0.7125 $0.6125
======== ======= ======= =============== =======
The notes are an integral part of the consolidated financial statements.
1
AT&T CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
AT AT
JUNESEPTEMBER 30, DECEMBER 31,
2004 2003
--------------------- ------------
(DOLLARS IN MILLIONS)
ASSETS
Cash and cash equivalents................................... $ 2,4592,627 $ 4,353
Accounts receivable, less allowances of $608$589 and $579....... 3,6613,516 4,036
Deferred income taxes....................................... 9711,116 715
Other current assets........................................ 1,3971,328 744
------- --------------- --------
TOTAL CURRENT ASSETS........................................ 8,4888,587 9,848
Property, plant and equipment, net of accumulated
depreciation of $36,191$1,155 and $34,300....................... 22,833$34,300........................ 11,654 24,376
Goodwill.................................................... 4,7814,778 4,801
Other purchased intangible assets, net of accumulated
amortization of $381$396 and $320............................. 437394 499
Prepaid pension costs....................................... 4,0043,939 3,861
Other assets................................................ 3,2752,707 4,603
------- --------------- --------
TOTAL ASSETS................................................ $43,818 $47,988
======= =======$ 32,059 $ 47,988
======== ========
LIABILITIES
Accounts payable and accrued expenses....................... $ 2,9202,586 $ 3,256
Compensation and benefit-related liabilities................ 1,4582,215 1,783
Debt maturing within one year............................... 1,9131,582 1,343
Other current liabilities................................... 2,2742,346 2,501
------- --------------- --------
TOTAL CURRENT LIABILITIES................................... 8,5658,729 8,883
Long-term debt.............................................. 9,2998,881 13,066
Long-term compensation and benefit-related liabilities...... 3,4493,947 3,528
Deferred income taxes....................................... 5,4521,138 5,395
Other long-term liabilities and deferred credits............ 2,9982,929 3,160
------- --------------- --------
TOTAL LIABILITIES........................................... 29,76325,624 34,032
SHAREOWNERS' EQUITY
Common stock, $1 par value, authorized 2,500,000,000 shares;
issued and outstanding 794,593,329795,590,783 shares (net of
171,981,708171,983,367 treasury shares) at JuneSeptember 30, 2004 and
791,911,022 shares (net of 172,179,303 treasury shares) at
December 31, 2003.................................................. 7952003......................................... 796 792
Additional paid-in capital.................................. 27,43727,287 27,722
Accumulated deficit......................................... (14,299)(21,446) (14,707)
Accumulated other comprehensive income...................... 122(loss) income............... (202) 149
------- --------------- --------
TOTAL SHAREOWNERS' EQUITY................................... 14,0556,435 13,956
------- --------------- --------
TOTAL LIABILITIES AND SHAREOWNERS' EQUITY................... $43,818 $47,988
======= =======$ 32,059 $ 47,988
======== ========
The notes are an integral part of the consolidated financial statements.
2
AT&T CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREOWNERS' EQUITY
(UNAUDITED)
FOR THE SIXNINE MONTHS
ENDED JUNESEPTEMBER 30,
---------------------
2004 2003
--------- ---------
(DOLLARS IN MILLIONS)
AT&T COMMON STOCK
Balance at beginning of year..............................year........................... $ 792 $ 783
Shares issued under employee plans........................plans..................... 2 4
Other..................................................... 15
Other.................................................. 2 1
-------- --------
Balance at end of period.................................... 795 788period.................................. 796 789
-------- --------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of year..............................year........................... 27,722 28,163
Shares issued, net:
Under employee plans................................... 46 71
Other.................................................. 15 16plans................................. 57 129
Other................................................ 22 25
Dividends declared..................................... (377) (295)(566) (482)
Other.................................................. 31 2552 20
-------- --------
Balance at end of period.................................... 27,437 27,980period.................................. 27,287 27,855
-------- --------
ACCUMULATED DEFICIT
Balance at beginning of year..............................year........................... (14,707) (16,566)
Net income................................................ 412 1,107(loss) income...................................... (6,735) 1,525
Treasury shares issued at less than cost..................cost............... (4) --(3)
-------- --------
Balance at end of period.................................... (14,299) (15,459)period.................................. (21,446) (15,044)
-------- --------
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Balance at beginning of year..............................year........................... 149 (68)
Other comprehensive (loss) income......................... (27) 42income...................... (351) 7
-------- --------
Balance at end of period.................................... 122 (26)period.................................. (202) (61)
-------- --------
TOTAL SHAREOWNERS' EQUITY................................... $ 14,0556,435 $ 13,28313,539
======== ========
SUMMARY OF TOTAL COMPREHENSIVE INCOME:
Income(Loss) income before cumulative effect of accounting
changes.....changes............................................... $ 412(6,735) $ 1,0651,510
Cumulative effect of accounting changes...................changes................ -- 4215
-------- --------
Net income................................................ 412 1,107(loss) income...................................... (6,735) 1,525
Other comprehensive (loss) income......................... (27) 42income...................... (351) 7
-------- --------
TOTAL COMPREHENSIVE INCOME..................................(LOSS) INCOME........................... $ 385(7,086) $ 1,1491,532
======== ========
AT&T accounts for treasury stock as retired stock. The amounts attributable to
treasury stock at JuneSeptember 30, 2004 and December 31, 2003, were $(17,014)$(17,011) and
$(17,026) million, respectively.
We have 100 million authorized shares of preferred stock at $1 par value.
The notes are an integral part of the consolidated financial statements.
3
AT&T CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE SIXNINE MONTHS
ENDED JUNESEPTEMBER 30,
-------------------------------------------
2004 2003
------------------- ---------
(DOLLARS IN MILLIONS)
OPERATING ACTIVITIES
Net income..................................................(loss) income........................................... $(6,735) $ 412 $1,1071,525
Deduct:
Loss from discontinued operations -- net of income
taxes.................................................. -- (13)
Cumulative effect of accounting change -- net of income
taxes.................................................. -- 4215
------- ------
Income before cumulative effect of accounting change........ 412 1,065-------
(Loss) income from continuing operations.................... (6,735) 1,523
Adjustments to reconcile (loss) income before cumulative effect of
accounting changefrom continuing
operations to net cash provided by operating activities:
Net gains on sales of businesses and investments.......... (14) (37)(16) (51)
Loss on early extinguishment of debt...................... 274 2
Net301 85
Asset impairment and net restructuring and other
charges....................... 226 70charges................................................ 12,662 87
Depreciation and amortization............................. 2,481 2,3833,128 3,607
Provision for uncollectible receivables................... 265 406371 588
Deferred income taxes..................................... (181) 376(4,469) 1,105
Net pretax lossesearnings related to equity investments........... -- (33)investments......... (4) (28)
Decrease in receivables................................... 98 140
(Decrease)178 231
Decrease in accounts payable and accrued expenses....... (189) (308)expenses......... (488) (428)
Net change in other operating assets and liabilities...... (770) 336(839) 443
Other adjustments, net.................................... (139) (47)(78) (49)
------- -------------
NET CASH PROVIDED BY OPERATING ACTIVITIES................... 2,463 4,3534,011 7,113
------- -------------
INVESTING ACTIVITIES
Capital expenditures and other additions.................... (1,018) (1,629)(1,459) (2,413)
Proceeds from sale or disposal of property, plant and
equipment................................................. 25 2358 134
Investment distributions and sales.......................... 36 10137 120
Net dispositions (acquisitions) of businesses, net of cash
disposed/acquired......................................... 8 (158)
(Increase)Decrease (increase) in restricted cash............................... (1) (30)cash...................... 7 (22)
Other investing activities, net............................. 6 (27)9 (50)
------- -------------
NET CASH USED IN INVESTING ACTIVITIES....................... (944) (1,720)(1,340) (2,389)
------- -------------
FINANCING ACTIVITIES
Retirement of long-term debt, including redemption
premiums.................................................. (3,210) (4,039)
(Decrease)(3,711) (4,576)
Decrease in short-term borrowings, net.................... (195) (1,270)net...................... (511) (1,263)
Issuance of AT&T common shares.............................. 33 6445 92
Dividends paid on common stock.............................. (377) (294)(565) (442)
Other financing activities, net............................. 336 148345 202
------- -------------
NET CASH USED IN FINANCING ACTIVITIES....................... (3,413) (5,391)(4,397) (5,987)
------- -------------
Net (decrease)decrease in cash and cash equivalents................. (1,894) (2,758)equivalents................... $(1,726) (1,263)
Cash and cash equivalents at beginning of year.............. 4,353 8,014
------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................. $ 2,459 $5,2562,627 $ 6,751
======= =============
The notes are an integral part of the consolidated financial statements.
4
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The consolidated financial statements have been prepared by AT&T Corp.
(AT&T) pursuant to the rules and regulations of the Securities and Exchange
Commission (SEC) and, in the opinion of management, include all adjustments of a
normal and recurring nature necessary for a fair statement of the consolidated
results of operations, financial position and cash flows for each period
presented. The consolidated results for interim periods are not necessarily
indicative of results for the full year. These financial results should be read
in conjunction with AT&T's Form 10-K for the year ended December 31, 2003.2003, and
Forms 10-Q for the quarters ended March 31, 2004 and June 30, 2004. We have
reclassified certain prior period amounts to conform to our current
presentation, including the transfer of our remaining payphone business from the
AT&T Consumer Services segment to the AT&T Business Services segment.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
AT&T has a Long Term Incentive Program under which we grant stock options,
performance shares, restricted stock and other awards in AT&T common stock, as
well as an Employee Stock Purchase Plan. Effective January 1, 2003, we adopted
the fair value recognition provisions of Statement of Financial Accounting
Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," and we
began to record stock-based compensation expense for all employee awards
(including stock options) granted or modified after January 1, 2003. For awards
issued prior to January 1, 2003, we apply Accounting Principles Board (APB)
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations in accounting for our plans. Under APB Opinion No. 25, no
compensation expense has been recognized for stock options.
If AT&T had elected to recognize compensation costs based on the fair value
at the date of grant of all awards granted prior to January 1,l, 2003, consistent
with the provisions of SFAS No. 123, net (loss) income and (loss) earnings per
share amounts would have been as follows:
FOR THE THREE MONTHS FOR THE SIXNINE MONTHS
ENDED MONTHSSEPTEMBER 30, ENDED JUNESEPTEMBER 30,
JUNE 30,
----------------- ----------------------------------------- ----------------------
2004 2003 2004 2003
------- ------- ----------------- -------- --------- --------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Net income............................................(loss) income.............................. $(7,147) $ 108 $ 536 $ 412 $1,107418 $(6,735) $1,525
ADD:
Stock-based employee compensation expense
included in reported results, net of
income taxes............ 17 24 35 34taxes.............................. 22 22 57 56
DEDUCT:
Total stock-based employee compensation
expense determined under the fair value
method for all awards, net of income
taxes.................................. (45) (61) (96) (109)taxes..................................... (49) (59) (145) (168)
------- ----- ----- ------------ ------
Pro forma net income................................(loss) income.................... $(7,174) $ 80 $ 499 $ 351 $1,032381 $(6,823) $1,413
======= ===== ===== ============ ======
Basic and diluted(loss) earnings per share.................. $0.14 $0.68 $0.52share................ $ 1.41(8.99) $0.53 $ (8.48) $ 1.94
Pro forma basic and diluted(loss) earnings per share........ $0.10 $0.63 $0.44share...... $ 1.31(9.02) $0.48 $ (8.59) $ 1.80
Diluted (loss) earnings per share.............. $ (8.99) $0.53 $ (8.48) $ 1.94
Pro forma diluted (loss) earnings per share.... $ (9.02) $0.48 $ (8.59) $ 1.79
Pro forma stock-based compensation expense reflected above may not be
indicative of future compensation expense that may be recorded. Future
compensation expense may differ due to various factors, such as the number of
awards granted and the market value of such awards at the time of grant.
Pro forma income before cumulative effect of accounting change was $80
million and $499 million for the three months ended June 30, 2004 and 2003,
respectively, and was $351 million and $990 million for the six months ended
June 30, 2004 and 2003, respectively.
5
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Pro forma (loss) earnings per basicfrom continuing operations were $(7,174) million
and diluted share before cumulative effect of
accounting change were $0.10 and $0.63$421 million for the three months ended JuneSeptember 30, 2004 and 2003,
respectively, and were $0.44$(6,823) million and $1.26$1,411 million for the sixnine months
ended JuneSeptember 30, 2004 and 2003, respectively.
Pro forma (loss) earnings per basic and diluted share from continuing
operations were $(9.02) and $0.53 for the three months ended September 30, 2004
and 2003, respectively, and were $(8.59) for the nine months ended September 30,
2004. Pro forma earnings per basic and diluted share from continuing operations
for the nine months ended September 30, 2003 were $1.80 and $1.78, respectively.
For a detailed discussion of significant accounting policies, please refer
to AT&T's Form 10-K for the year ended December 31, 2003.
3. SUPPLEMENTARY FINANCIAL INFORMATION
SUPPLEMENTARY BALANCE SHEET INFORMATION
AT&T AT&T
BUSINESS CONSUMER TOTAL
SERVICES SERVICES AT&T
-------- -------- ------
(DOLLARS IN MILLIONS)
Goodwill:
Balance at January 1, 2004............................... $4,731 $70 $4,801
Translation adjustment................................... (17)(20) -- (17)(20)
Other.................................................... (3) -- (3)
------ --- ------
Balance at JuneSeptember 30, 2004................................. $4,7112004............................ $4,708 $70 $4,781$4,778
====== === ======
CARRYING ACCUMULATED
AMOUNT AMORTIZATION NET
-------- ------------ ----
(DOLLARS IN MILLIONS)
Amortizable Other Purchased Intangible Assets:
Customer lists and relationships......................... $548 $162 $386
Other.................................................... 271 158 113
---- ---- ----
Balance at December 31, 2003............................. $819 $320 $499
==== ==== ====
Customer lists and relationships......................... $547 $202 $345$519 $208 $311
Other.................................................... 271 179 92188 83
---- ---- ----
Balance at JuneSeptember 30, 2004................................. $818 $381 $4372004............................ $790 $396 $394
==== ==== ====
The amortizationAmortization expense associated with purchased intangible assets for the
three and sixnine months ended JuneSeptember 30, 2004, was $28 million and $61$89 million,
respectively, and for the three and sixnine months ended JuneSeptember 30, 2003, was
$17$19 million and $33$52 million, respectively. Amortization expense for purchased
intangible assets is estimated to be approximately $110 million for each of the
years ending December 31, 2004, 2005 and 2006, and $80 million for each of the
years ending December 31, 2007 and 2008.
In July 2004, we announced a strategic change in our business focus away
from traditional consumer services and towards business markets and emerging
technologies. As a result of this strategic change, we are in the process of
performing an evaluation of our goodwill as we believe this creates a "trigger
event" necessitating such a review. We are in the process of determining if the
carrying value of any of our reporting units exceeds its fair value ("step 1")
under SFAS No. 142, "Goodwill and Other Intangible Assets." If we determine that
the carrying value of any of our reporting units exceeds its fair value, we will
then perform "step 2", which is to determine if the implied fair value of the
reporting unit goodwill is less than the carrying value of this goodwill. If so,
a goodwill impairment charge representing the difference between the implied
fair value of the reporting unit goodwill and its associated carrying value will
be recognized inDuring the third quarter of 2004.2004, we recorded a $15 million impairment
charge relating to other purchased intangible assets (customer lists and
relationships) (see note 5).
6
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
The strategic change in business focus also creates a "trigger event" for a
review of our property, plant and equipment. In assessing impairments we follow
the provisions of SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." If the total of the expected future undiscounted cash flows
is less than the carrying value of the asset and/or group of assets, a loss will
be recognized for the difference between the fair value and the carrying value
of the asset and/or group of assets in the third quarter of 2004.
Other Current Assets:
Recorded within other current assets as of JuneSeptember 30, 2004, was
restricted cash of $503$493 million relating to private debt that matures in
February 2005. This asset had a balance of $499 million at December 31, 2003,
and was recorded in other assets.
SUPPLEMENTARY SHAREOWNERS' EQUITY INFORMATION
NET FOREIGN NET REVALUATION NET ACCUMULATED
CURRENCY OF CERTAIN MINIMUM OTHER
TRANSLATION FINANCIAL PENSION COMPREHENSIVE
ADJUSTMENT INSTRUMENTS LIABILITY INCOME
----------- --------------- --------- -------------
(DOLLARS IN MILLIONS)
Accumulated other comprehensive
income (loss):
Balance at January 1, 2004.......... $200 $25 $(76) $149$ 25 $ (76) $ 149
Change.............................. (19) (8) -- (27)
---- ---(17) (13) (321) (351)
---- ---- ----- -----
Balance at JuneSeptember 30, 2004............ $181 $17 $(76) $1222004....... $183 $ 12 $(397) $(202)
==== === ==== ========= =====
FOR THE SIXNINE MONTHS
ENDED JUNESEPTEMBER 30,
---------------------------------
2004 2003
---- ------------- --------
(DOLLARS IN MILLIONS)
Other comprehensive income(loss)income (loss):
Net foreign currency translation adjustment (net[net of income
taxes of $11 and $(80))$(59)]................................... $(19) $ 128(17) $ 97
Net revaluation of certain financial instruments:
Unrealized gains (losses)(net [net of income taxes of $(6)$(7) and
$(60))$(66)]................................................. 10 9711 107
Recognition of previously unrealized (gains) losses (net[net
of income taxes of $11$15 and $110)$118](1).................... (18) (177)(24) (191)
Net minimum pension liability adjustment (net[net of income
taxes of $3 in 2003)...................................... --$173 and $3]..................................... (321) (6)
--------- -----
Total other comprehensive (loss) income..................... $(27)$(351) $ 42
====7
===== =====
- ---------------
(1) See below for a summary of recognition of previously unrealized (gains)
losses on available-for-sale securities.
7
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
FOR THE SIXNINE MONTHS ENDED JUNESEPTEMBER 30,
-------------------------------------------
2004 2003
-------------------- --------------------
PRETAX AFTER-TAXES PRETAX AFTER-TAXES
------ ----------- ------ -----------
Summary of Recognition of Previously Unrealized
(Gains) Losses:
Other income/expense, net:
Sale/exchange of various securities........... $(12) $ (7) $(187) $(115)$(209) $(129)
Other financial instrument activity........... (27) (17) (11) (100) (62)
---- ---- ----- -----
Total recognition of previously unrealized
(gains) losses................................ $(29) $(18) $(287) $(177)$(39) $(24) $(309) $(191)
==== ==== ===== =====
7
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
SUPPLEMENTARY STATEMENT OF OPERATIONS INFORMATION
ACCESS AND OTHER CONNECTION EXPENSES
In September 2003, in conjunction with our review of accounting and
internal control systems, we determined that the liability on the balance sheet
(included in accounts payable and accrued expenses) relating to costs incurred
in 2001 and 2002 pertaining to access and other connection expenses was
understated by $125 million. Since the impact to prior years' annual financial
statements was not material, we recorded an additional expense of $125 million
($77 million after taxes) in the third quarter of 2003 to reflect the proper
estimate of the liability.
FINANCIAL ACCOUNTING STANDARDS BOARD INTERPRETATION NO. 46 (FIN 46),
"CONSOLIDATION OF VARIABLE INTEREST ENTITIES -- AN INTERPRETATION OF
ACCOUNTING RESEARCH BULLETIN NO. 51"
Effective July 1, 2003, AT&T early adopted FIN 46, "Consolidation of
Variable Interest Entities -- an Interpretation of Accounting Research Bulletin
No. 51." This interpretation requires the primary beneficiary to consolidate a
variable interest entity (VIE) if it has a variable interest that will absorb a
majority of the entity's expected losses if they occur, receive a majority of
the entity's expected residual returns if they occur, or both. Based on the new
standard, two entities that AT&T leased buildings from qualified as VIEs and,
therefore, became subject to consolidation as of July 1, 2003. AT&T had no
ownership interest in either entity, but provided guarantees of the residual
values for the leased facilities with a maximum exposure of $427 million. Upon
adoption, FIN 46 added approximately $433 million of assets (included in
property, plant and equipment of AT&T Business Services and Corporate and Other
group) and $477 million of liabilities (included in short-term debt) to our
consolidated balance sheet and resulted in a charge of $27 million after taxes
($44 million pretax) as the cumulative effect of an accounting change in the
third quarter of 2003. In November 2003, AT&T exercised its purchase option on
certain of these leased buildings and thus repaid the associated debt.
4. EARNINGS PER COMMON SHARE AND POTENTIAL COMMON SHARE
Basic (loss) earnings per common share (EPS) is computed by dividing (loss)
income attributable to common shareowners by the weighted-average number of
common shares outstanding for the period. Diluted EPS reflects the potential
dilution (considering the combined income and share impact) that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock. The potential issuance of common stock is assumed to occur at
the beginning of the year (or at the time of issuance if later), and the
incremental shares are included using the treasury stock method. The proceeds
utilized in applying the treasury stock method consist of the amount, if any, to
be paid upon exercise, the amount of compensation cost attributed to future
service not yet recognized, and any tax benefits credited to paid-in-capital
related to the exercise. These proceeds are then assumed to be used by AT&T to
purchase common stock at the average market price during the period. The
incremental shares (difference between the shares assumed to be issued and the
shares assumed to be purchased), to the extent they would have been dilutive,
are included in the denominator of the diluted EPS calculation. Potentially
dilutive securities for all periods presented were stock options and restricted
stock units. Since AT&T recorded a loss from continuing operations for the three
and nine months ended September 30, 2004, diluted loss per share is the same as
basic loss per share, as any potentially dilutive securities would be
antidilutive to continuing operations. No adjustments were made to income for
the computation of diluted EPS.EPS in 2003.
5. ASSET IMPAIRMENT AND NET RESTRUCTURING AND OTHER CHARGES
NetAsset impairment and net restructuring and other charges of $54$12,469 million
for the three months ended JuneSeptember 30, 2004, were comprised of $11,389 million
of asset impairment charges and $1,080 million of net business restructuring and
other obligations.
8
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
In July 2004, we announced a strategic change in our business focus away
from traditional consumer services and towards business markets and emerging
technologies. As a result of this strategic change, we performed an evaluation
of our long-lived assets, including property, plant and equipment (PP&E) and
internal-use software (IUS) (the asset group) as of July 1, 2004, as this
strategic change created a "triggering event" necessitating such a review. In
assessing impairments for long-lived assets we follow the provisions of SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets." We
operate an integrated telecommunications network; therefore, we performed our
testing of the asset group at the entity level, as this is the lowest level for
which identifiable cash flows are available.
In performing the test, we determined that the total of the expected future
undiscounted cash flows directly related to the existing service potential of
the asset group was less than the carrying value of the asset group; therefore,
an impairment charge was required. The impairment charges of $11,389 million
represented the difference between the fair values of the asset group and its
carrying values and are included within asset impairment and net restructuring
and other charges in the consolidated statements of operations. The impairment
charges resulted from sustained pricing pressure and the evolution of services
toward newer technologies in the business market as well as changes in the
regulatory environment, which led to a shift away from traditional consumer
services.
AT&T Business Services recorded impairment charges of $11,330 million
resulting in reductions to PP&E of $11,023 million, IUS of $287 million, other
purchased intangibles of $15 million and other long-lived assets of $5 million.
AT&T Consumer Services recorded impairment charges of $59 million resulting in
reductions to PP&E of $11 million and IUS of $48 million. As a result of the
asset impairments, a new cost basis was established for those assets that were
impaired. The new cost basis resulted in a reduction of gross PP&E and IUS and
the write-off of accumulated depreciation and accumulated amortization.
We calculated the fair value of our asset group using discounted cash
flows. The discounted cash flows calculation was made utilizing various
assumptions and estimates regarding future revenue, expenses and cash flows
projections through 2012. The time horizon was determined based on the estimated
remaining useful life of the primary assets in the asset group; the primary
assets are those from which the most significant cash flows are generated,
principally consisting of the transport central office equipment. Pursuant to
SFAS No. 144, the forecasts were developed without contemplation of investments
in new products. The 10% discount rate utilized was determined using a weighted
average cost of capital (debt and equity) and was more heavily weighted towards
debt given that the asset group, which primarily consistedconsists of tangible assets,
can be financed with a larger proportion of debt. When allocating the impairment
to the asset categories, market values were utilized, to the extent
determinable, to ensure that no asset category was impaired below its fair
value.
The strategic change in business focus also created a "triggering event"
for a review of our goodwill. We follow the provisions of SFAS No. 142,
"Goodwill and Other Intangible Assets" for determining impairments. SFAS No. 142
indicates that if other types of assets (in addition to goodwill) of a reporting
unit are being tested for impairment at the same time as goodwill, then those
assets are to be tested for impairment prior to performing the goodwill
impairment testing. Accordingly, the impairment charges noted above reduced the
carrying value of the reporting units when performing the impairment test for
goodwill.
The goodwill impairment test requires us to estimate the fair value of our
overall business enterprise down to the reporting unit level. Our reporting
units are AT&T Business Services and AT&T Consumer Services. We estimated fair
value using both a discounted cash flows model, as well as an approach using
market comparables, both of which are weighted equally to determine fair value.
Under the discounted cash flows method, we utilized estimated long-term revenue
and cash flows forecasts, as well as assumptions of terminal value, together
with an applicable discount rate, to determine fair value. Under the market
approach, fair value was determined by comparing our reporting units to similar
businesses (or guideline companies). We
9
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
then compared the carrying value of our reporting units to their fair value.
Since the fair value of our reporting units exceeded their carrying amounts, no
goodwill impairment charge was recorded.
The net business restructuring activities associated withof $1,080 million for the third
quarter of 2004 consisted of $1,043 million for employee separations (of which
$339 million related to AT&T Business Services.benefit plan curtailment costs) and $37 million of
facility closing obligations.
This exit plan will impact approximately 11,200 employees (the majority of
which will be involuntary) across the company. This activity resulted from the
continued integration and automation of various functions within network
operations, as well as reorganizations throughoutand our non-U.S. operations. This exit plan impacted approximately 625 employees (more
than half of which were involuntary), approximately 35% of whom were managers.
Net restructuringstrategic change in focus away from traditional consumer
services and other charges of $267 million for the six months
ended June 30, 2004, were comprised of nettowards business restructuring obligations of
$145 millionmarkets and real estate impairment charges of $122 million. The business
restructuring activities consisted of $104 million of separation costs and $41
million of facility closing obligations. This exit plan impacted approximately
1,405 employees (the majority of which were involuntary) primarily within the
AT&T Business Services segment as a result of integration and automation of
various functions within network operations, as well as reorganizations
throughout our non-U.S. operations. Slightly less than halfemerging technologies. Approximately
60 percent of the employees impacted by this exit plan wereare managers.
About 75%Facility closing reserves of $37 million for the affected employees
had left their positions as of Junethree months ended
September 30, 2004, with the remaining anticipated to
exit our business by the end of the third quarter of 2004. In July 2004, we
announced certain strategic changes that are anticipated to have a significant
impact on our business. Such changes are anticipated to result in future
headcount reductions (see note 12).
The $41 million of facility closing reserves areprimarily associated with the continued consolidation of
our real estate portfolio and reflect the present value of contractual lease
obligations, net of estimated sublease income, 8
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
associated with vacant facilities
resulting from workforce reductions and network equipment space that will not be
used by AT&T.
Asset impairment and net restructuring and other charges of $12,736 million
for the nine months ended September 30, 2004, were comprised of $11,511 million
of asset impairments and $1,225 million in net business restructuring and other
obligations.
The asset impairment charges of $11,511 million primarily reflect the third
quarter asset impairments of $11,389 million as discussed above. In addition, we
recorded real estate impairment charges of $122 million relaterelated to the decision
made during the first quarter of 2004 to divest five owned properties in an
effort to further reduce costs and consolidate our real estate portfolio. In
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," an impairment charge was recorded within the
Corporate and Other group to reduce the book value of the five properties to
fair market value based on third party assessments (including broker
appraisals). TwoThe sales of these properties have been completed.
The net restructuring obligations of $1,225 million for the nine months
ended September 30, 2004, were soldprimarily comprised of $1,147 million of net
employee separations (of which $339 million related to benefit plan curtailment
costs) and $78 million of facility closing obligations. These exit plans will
impact approximately 12,600 employees (the majority of which will be
involuntary) across the company. These activities resulted from the continued
integration and automation of various functions within network operations,
reorganizations throughout our non-U.S. operations, and our strategic change in
June 2004focus away from traditional consumer services and one additional property was sold in Julytowards business markets and
emerging technologies. Nearly one-half of the employees impacted by these exit
plans are managers. About 13% of the affected employees had left their positions
as of September 30, 2004. We anticipate salesabout two-thirds of the remaining propertiesaffected
employees will be completednotified or will leave their positions by March
31,the end of 2004,
with the remaining employees to be notified during 2005 and anticipated to exit
our business by the end of 2005.
At JuneThe facility closing reserves of $78 million for the nine months ended
September 30, 2004, these remaining properties were recorded as assets
held-for-sale within other current assets onare primarily associated with the balance sheet.consolidation of our real
estate portfolio and reflect the present value of contractual lease obligations,
net of estimated sublease income, associated with vacant facilities resulting
from workforce reductions and network equipment space that will not be used by
AT&T.
10
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
The following table displays the activity and balances of the restructuring
reserve account:
TYPE OF COST
--------------------------------------
EMPLOYEE FACILITY
SEPARATIONS CLOSINGS OTHER TOTAL
----------- -------- ----- -----
(DOLLARS IN MILLIONS)
Balance at January 1, 2004........................ $ 156 $205 $2$ 2 $ 363
Additions....................................... 104 41808 78 -- 145886
Deductions...................................... (159) (58)(209) (70) -- (217)(279)
----- ---- ------- -----
Balance at JuneSeptember 30, 2004..........................2004..................... $ 101 $188 $2755 $213 $ 2912 $ 970
===== ==== ======= =====
Deductions primarily reflected total cash payments of $185$249 million. These
cash payments include cash termination benefits of $153$202 million and $32$47 million
of facility closing reserve payments, which were funded primarily through cash
from operations. Deductions also includeincluded a $26 million non-cash utilization of
facility closing reserves. Such activity is reflective of the assignment of
certain lease obligations associated with vacated facilities to third parties.
NetAsset impairment and net restructuring and other charges for the three and
sixnine months ended JuneSeptember 30, 2003, were $66$64 million and $70$134 million,
respectively. The year-to-date
chargecharges in both periods primarily consisted of $66 million recorded in the second quarter, which
was comprised of $57 million ofreflected separation costs and $9 million of benefit plan
curtailment costs
associated with our management realignment efforts (impacting
approximately 90 senior managers).efforts. Partially offsetting these
activities was the reversal of $11 million of sales obligation liabilities
recorded in a prior year, associated with the disposition of AT&T Communications
(U.K.) Ltd, where the liabilities incurred were below the original estimate.
6. DISCONTINUED OPERATIONS
Net (loss) from discontinued operations for the three and nine months ended
September 30, 2003, reflected an estimated cost related to potential legal
liabilities for certain environmental clean-up matters associated with NCR
Corporation (NCR), which was spun-off from AT&T in 1996. NCR has been formally
notified by federal and state agencies that it is a potentially responsible
party (PRP) for environmental claims under the Comprehensive Environmental
Response, Compensation and Liability Act of 1980 (CERCLA) and other statutes
arising out of the presence of polychlorinated biphenyls (PCBs) in sediments in
the lower Fox River and in the Bay of Green Bay, in Wisconsin. NCR was
identified as a PRP because of alleged PCB discharges from two carbonless copy
paper manufacturing facilities it previously owned, which were located along the
Fox River. In July 2003, the government clarified its planned approach for
remediation of the contaminated sediments, which caused NCR to increase its
estimated liability. Under the separation and distribution agreement between
AT&T and NCR, AT&T is required to pay a portion of such costs that NCR incurs
above a certain threshold. Therefore, in the third quarter of 2003, AT&T
recorded its estimated proportionate share of certain costs associated with the
Fox River matter, which totaled $13 million on both, a pretax and after-tax
basis. The extent of NCR's potential liability is subject to numerous variables
that are uncertain at this time, including the actual remediation costs and the
percentage NCR may ultimately be responsible for. As a result, AT&T's actual
liability may be different than the estimated amount. Pursuant to the separation
and distribution agreement, NCR is liable for the first $100 million of costs in
connection with this liability. AT&T is liable for 37% of costs incurred by NCR
beyond such $100 million threshold. All such amounts are determined after
reduction of any monies collected by NCR from other parties.
7. DEBT OBLIGATIONS
LONG-TERM DEBT
During the third quarter of 2004, we completed the early retirement of $326
million of our outstanding U.S. dollar denominated long-term debt, which was
comprised of $141 million of 6.0% Notes maturing in
11
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
March 2009, $87 million of 7.75% Notes maturing in March 2007, $84 million of
7.5% Notes maturing in June 2006 and $14 million of other notes with maturities
in 2005 and 2006. These notes were repurchased with cash and resulted in a loss
of $20 million recorded in other (expense) income, net.
In Marchaddition, during the third quarter of 2004, we completed the early
retirement of $93 million of outstanding $836 million 6.0% Euro Notes due
November 2006, which carried an interest rate of 6.75% at the time of
retirement. The notes were repurchased with cash and resulted in a loss of $7
million recorded in other (expense) income, net. The carrying value of these
notes was $129 million, including $36 million in associated foreign currency
mark-to-market adjustments, which were hedged.
In the first quarter of 2004, we completed the early retirement of $1.2
billion of $1.5 billion outstanding U.S. dollar denominated 6.5% Notes maturing
in November 2006, which carried an interest rate of 7.25% at the time of
retirement. The notes were repurchased with cash and resulted in a loss of $157
million recorded in other (expense) income,
(expense), net.
In addition, during Marchthe first quarter of 2004, we completed the early
retirement of $928 million of our outstanding $1.8 billion 6.0% Euro Notes due
November 2006, which carried an interest rate of 6.75% at the time of
retirement. The notes were repurchased with cash and resulted in a net loss of
$117 million recorded in other (expense) income, (expense), net. The carrying value of
these notes was $1.3 billion, including $0.4 billion in associated foreign
currency mark-to-market adjustments.
7.adjustments, which were hedged.
In July 2004, Moody's Investors Service (Moody's) and Fitch Ratings lowered
our long-term credit ratings to Ba1 and BB+, respectively, and lowered our
short-term credit and commercial paper ratings to NP (not prime) and B,
respectively. In August 2004, Standard & Poor's (S&P) lowered our long-term
credit rating to BB+ and lowered our short-term credit and commercial paper
rating to B. The rating actions by Moody's and S&P triggered a 100 basis point
interest rate step-up on approximately $6.5 billion in notional amount of debt
net of foreign currency hedge offsets (current carrying value of $6.8 billion).
This step-up is effective for interest payment periods that will begin in
November 2004, resulting in an expected increase in interest expense of
approximately $10 million in 2004 and $68 million in 2005.
8. FINANCIAL INSTRUMENTS
In the normal course of business, we use various financial instruments,
including derivative financial instruments, to manage our market risk associated
with changes in interest rates, foreign currency rates and
9
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED) equity prices. We do
not use financial instruments for trading or speculative purposes. These
instruments include letters of credit, guarantees of debt and certain
obligations of former affiliates, interest rate swap agreements, foreign
currency exchange contracts, option contracts, equity contracts and warrants.
GUARANTEES
AT&T provided a guarantee of an obligation that AT&T Wireless Services,
Inc. (AT&T Wireless) has to NTT DoCoMo. Under this guarantee, AT&T would have
been secondarily liable for up to $3.65 billion, plus accrued interest, in the
event AT&T Wireless was unable to satisfy its entire obligation to NTT DoCoMo.
AT&T's guarantee expired on June 30, 2004, in accordance with the terms of the
original agreement.
INTEREST RATE SWAP AGREEMENTS
We enter into interest rate swaps to manage our exposure to changes in
interest rates. We enter into swap agreements to manage the fixed/floating mix
of our debt portfolio in order to reduce aggregate risk of interest rate
movements. These agreements involve the exchange of floating-rate for fixed-rate
payments or the exchange of fixed-rate for floating-rate payments without the
exchange of the underlying notional amount. Floating-rate payments and receipts
are primarily tied to LIBOR (London Inter-Bank Offered Rate). The notional
amount of our fixed-rate to floating-rate swaps was $750 million as of JuneSeptember
30, 2004, a decline
12
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
of $250 million from December 31, 2003. This decline reflects the unwind of $250
million notional amount of fixed-to-floating interest rate swaps, which were
designated as fair value hedges, in conjunction with the early retirement of
$1.2 billion of long-term notes in March 2004 (see note 6)7). The weighted-average
receive rate and pay rate for the outstanding fixed-to-floating interest rate
swaps as of JuneSeptember 30, 2004, was 4.83% and 3.42%3.71%, respectively. The notional
amount of our floating-rate to fixed-rate swaps declined from $190 million as of
December 31, 2003 to $108 million as of September 30, 2004, as a result of the
maturity of a floating-rate to fixed-rate swap with a notional amount of $82
million during the third quarter of 2004. The weighted-average receive rate and
pay rate for the outstanding floating-rate to fixed-rate swaps as of September
30, 2004, was 1.75% and 8.26%, respectively.
In addition, we have combined interest rate, foreign currency swap
agreements for foreign-currency-denominated debt, which hedge our risk to both
interest rate and currency movements. As of JuneSeptember 30, 2004, the notional
amount and fair value of these contracts were $1.6was $1.5 billion and $561 million,$0.5 billion,
respectively, compared with $2.5 billion and $1.0 billion, respectively, at
December 31, 2003. The decreases in the notional amount and fair value of these
agreements were primarily related to $928 million$1.0 billion notional amount of combined
interest rate foreign currency swap contracts, designated as cash flow hedges,
which were unwound in Marchduring 2004 in connection with the early retirement of
long-term Euro notes in Marchduring the first and third quarters of 2004 (see note 6)7).
As a result of this unwind, we recognized $10$12 million of unrealized gains as
part of the net gain (loss) on the early extinguishment of debt within other
(expense) income, (expense), net. In addition, we returned $50$91 million of cash collateral
that we held at December 31, 2003, in connection with the unwind of these
combined interest rate swap agreements.
FOREIGN EXCHANGE
We enter into foreign currency forward contracts to manage our exposure to
changes in currency exchange rates related to foreign-currency-denominated
transactions. As of JuneSeptember 30, 2004, the notional amount outstanding on these
contracts was $1.7$0.8 billion, compared with $1.1 billion as of December 31, 2003.
The increasedecrease in the notional amount was primarily attributable to an increasea decrease in
our forward contract portfolio. In addition, in connection with the early
retirement of long-term Euro notes in March 2004, we unwound $29 million of
foreign currency forward contracts, which managed our exposureportfolio due to additional
interest required to be paid by us as a result of lowered credit ratings. As a
result of this unwind, we recognized $6 million of unrealized gains as part of
the net gain (loss) on the early extinguishment of debt within other income
(expense), net.
10
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)contract expirations.
EQUITY OPTION AND EQUITY SWAP CONTRACTS
We enter into equity options and equity swap contracts, which are
undesignated, to manage our exposure to changes in equity prices associated with
various equity awards of previously affiliated companies. The notional amount
relating to these contracts was $29$28 million as of JuneSeptember 30, 2004, compared
with $91 million as of December 31, 2003. The decrease in the notional amount
was primarily related to swaps on 1.71.8 million Comcast Corporation (Comcast)
shares, which expired during the first quarter of 2004.
DEBT SECURITIES
As of JuneSeptember 30, 2004, the carrying value of our long-term debt
(including currently maturing long-term debt), excluding capital leases, was
$10.4$10.0 billion, compared with $13.4 billion at December 31, 2003. The market
valuesvalue associated with this debt were $10.5was $10.7 billion and $14.8 billion as of
JuneSeptember 30, 2004 and December 31, 2003, respectively. The decreases in the
carrying value and fair value of debt were primarily attributed to early debt
repurchases and scheduled repayments made in the first halfnine months of 2004. The
carrying value of debt with an original maturity of less than one year
approximates market value. The fair valuesvalue of long-term debt werewas obtained based
on quotes for these securities.
8.13
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
9. PENSION AND POSTRETIREMENT EMPLOYEE BENEFIT PLANS
We sponsor noncontributory defined benefit pension plans covering the
majority of our U.S. employees. Our benefit plans for current and certain future
retirees include health-care benefits, life insurance coverage and telephone
concessions.
The following table shows the components of net periodic benefit (credit)
costs for our U.S. plans:
POSTRETIREMENTPENSION POSTRETIREMENT PENSION POSTRETIREMENT
BENEFITS BENEFITS PENSION BENEFITS BENEFITS
------------------------------ --------------- ----------------- ---------------
FOR THE THREE MONTHS ENDED JUNE 30, FOR THE SIXNINE MONTHS ENDED
JUNESEPTEMBER 30, -----------------------------------SEPTEMBER 30,
------------------------------- -----------------------------------
2004 2003 2004 2003 2004 2003 2004 2003
------- ------------ ----- ------ ------ ------- ------- ------ ------
(DOLLARS IN MILLIONS)
Service cost -- benefits
earned during the
period................period.................... $ 55 $ 5750 $ 6 $ 76 $ 110165 $ 114164 $ 1218 $ 1319
Interest cost on benefit
obligations...................... 233 229 90 83 460 470 179 166obligations............... 231 236 89 100 691 706 268 266
Amortization of unrecognized
prior service cost.....................cost........ 32 33 38 13 10 65 76 26 1997 109 39 29
Credit for expected return
on plan assets........................... (363)assets............ (359) (44) (36) (719) (719) (88) (69)(365) (45) (41) (1,078) (1,084) (133) (110)
Amortization of losses.............losses...... 1 1 25 19 2 2 50 3722 3 3 75 59
Charges for special
termination benefits*..... -- -- -- 4 -- -- -- 4
Net curtailment loss*..................... 220 -- 119 -- 220 9 119 --
Net settlement loss......... -- 7 -- -- -- 97 -- --
----- ----- ---- ---- ------- ------- ----- -----
---- ----
Net periodperiodic benefit
(credit) cost...cost............. $ (41)180 $ (25)(38) $207 $101 $ 9098 $ 83(86) $ (82)386 $ (48) $179 $166267
===== ===== ==== ==== ======= ======= ===== ===== ==== ====
- ---------------
* Included in asset impairment and net restructuring and other charges.
On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the Act) was signed into law. The Act introduces a
prescription drug benefit under Medicare (Medicare Part D) as well as a federal
subsidy to sponsors of retiree health care benefit plans that provide a benefit
that is at least actuarially equivalent to Medicare Part D. We are impacted by
the Act since we sponsor postretirement health care plans that provide
prescription drug benefits. We have elected to defer recognition ofOn May 19, 2004, the Act in
accordance with Financial Accounting Standards
Board (FASB) issued FASB Staff Position ("FSP") No. FAS 106-1, "Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and
11
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Modernization Act of 2003." As a result, any measures of the accumulated
postretirement benefit obligation or net periodic postretirement benefit cost do
not reflect the effects of the Act on the plans.
On May 19, 2004, the FASB issued FSP No. FAS 106-2, "Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003.2003," This Staff Position supersedes FSP No. FAS 106-1
andwhich provides guidance on accounting for the
effects of the new Medicare prescription drug legislation by employers whose
prescription drug benefits are actuarially equivalent to the drug benefit under
Medicare Part D.
The provisions
ofWe adopted FSP No. FAS 106-2 are effective for the first interim or annual period
beginning after June 15, 2004, and accordingly, we plan to adopt them effective July 1, 2004. The FSP provides two alternative methods of transition, either
retroactive application to the date of enactment or, the method we2004, and have selected,elected a
prospective application, fromwhich required the dateremeasurement of adoption.
Federalour postretirement
plan assets and accumulated postretirement benefit obligation (APBO) as of July
1, 2004. However, federal regulations for determining actuarial equivalence have
not yet been issued in either proposed or final form, which impacts our ability to estimaterecognize the
full adoption effects of the FSP.Act. Despite the lack of final federal regulations,
we believe that the prescription drug benefits provided to a specific portion of
our postretirement benefit plan participants would be deemed to be actuarially
equivalent to Medicare Part D benefits based on the benefits provided under the
plan. The estimated impact uponsubsidy-related reduction in the APBO related to the adoption for this
group will
be a reduction in the accumulated postretirement benefit obligation of
approximately $150 million to $175was $161 million, which will be amortized to income over time as
14
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
an actuarial gain. In addition, we will realizeDuring the third quarter, the amortization of the actuarial
gain as well as a reduction of interest cost resulted in a reduction to net
periodic postretirement benefit cost (recorded within SG&A and costs of services
and products) of approximately $10 million over the second half of 2004. Without
a firm definition of actuarial equivalence,$6 million. As we are unable to determine if the
prescription drug benefits provided to the remaining portion of the plan
participants are actuarially equivalent to Medicare Part D benefits until a firm
definition of actuarial equivalence is issued, we have not recorded any impact
of the Act for this group.
In connection with the restructuring charges taken in the third quarter
2004 associated with employee separations (see note 5), we recorded pension and
are therefore unable to
quantify any potential impact at this time.
9. INCOME TAXES
During February 2004, the subsidiariespostretirement benefit curtailment losses of AT&T Latin America were sold to
Telefonos de Mexico S.A. de C.V., or Telmex, and the AT&T Latin America plan of
liquidation became effective.$339 million. As a result we no longer needed a portion of the
valuation allowance established in 2002 attributableplan curtailments, our pension and postretirement plans were remeasured at
September 30, 2004. The discount rate used was reduced from 6.0% at December 31,
2003 to 5.75%, while the rate of compensation increase and the health care cost
trend rate remained at 4.0% and 10.2%, respectively, for the purposes of
determining the benefit obligations at remeasurement.
While our occupational pension has net assets of $2.6 billion, and
therefore is overfunded, our U.S. management pension plan and nonqualified
pension plan had a total unfunded accumulated benefit obligation of $1.4 billion
as of September 30, 2004. Due to the bookunder-funded status of these plans and tax basis
difference related to our investmentas a
result of the remeasurement in AT&T Latin America, andSeptember 30, 2004, we recorded an income tax benefitadditional
minimum pension liability of $371 million in the first quarter of 2004.$394 million. The effective
tax rate of (469.0)% in the first half of 2004 was positively impacted by 513.7
percentage points dueoffset to this reversal.liability was a
reduction of the intangible pension asset of $100 million and a pretax charge to
other comprehensive (loss) income of $494 million ($321 million after taxes).
10. COMMITMENTS AND CONTINGENCIES
In the normal course of business we are subject to proceedings, lawsuits
and other claims, including proceedings under laws and regulations related to
disputes with other carriers, environmental and other matters. Such matters are
subject to many uncertainties, and outcomes are not predictable with assurance.
Consequently, we are unable to ascertain the ultimate aggregate amount of
monetary liability or financial impact with respect to these matters at
JuneSeptember 30, 2004. However, if these matters are adversely settled, such
amounts could be material to our consolidated financial statements.
We have been named as a defendant in a consolidated group of purported
securities class action lawsuits filed in the United States District Courts for
the District of New Jersey on behalf of persons who purchased shares of AT&T
common stock from October 25, 1999 through May 1, 2000. These lawsuits allege,
among other things, that during the period referenced above, we made materially
false and misleading statements and omitted to state material facts concerning
our future business prospects. The consolidated complaint seeks unspecified
damages. Similar claimstrial commenced in October 2004 and as a
result of recent negotiations, we settled the claim for $100 million, subject to
final court approval. Under terms of a separation agreement between AT&T and its
former broadband subsidiary, which was spun off to Comcast in 2002, the
settlement will be shared equally between the two parties. Accordingly, we
recognized our proportionate share of the settlement of $50 million in the third
quarter of 2004. In addition, we recorded a $50 million receivable from Comcast
for its proportionate share. AT&T intends to seek reimbursement from its
insurers for the amounts to be paid. While we deny any wrongdoing and remain
confident that we would have been asserted by plaintiffs against us in two
derivative actions, which were dismissed byvindicated at the New Jersey federal court on
January 7, 2004. In early June 2004, the court granted AT&T's motion for summary
judgment (in part) in these cases and dismissed a substantial portion of this
case by narrowing the class period and rejecting a numberend of the allegations
upon which plaintiffs
12
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
complainttrial, given the
size of the claims compared to the relatively low amount of the settlement, the
inherent risk and uncertainty of legal proceedings, and the very substantial
expense of those proceedings, this settlement was based. We believe that the remaining complaints are without merit
and intend to defend them vigorously.prudent course for the
company.
On April 21, 2004, the Federal Communications Commission (FCC) ruled
against a petition we filed in October 2002, in which we asked the FCC to
confirm that our long distance phone-to-phone Internet Protocol (IP) telephony
services are exempt from terminating access charges and lawfully terminated over
end user local services. The total interstate and intrastate access savings we
obtained on AT&T long distance phone-to-phone IP telephony services since the
first quarter of 2000 through the date of the ruling was approximately $250
million. As a result of this ruling, we began paying terminating access charges
on long distance phone-to-phone IP telephony calls.
15
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
The FCC did not make any determination regarding the appropriateness of
retroactive application of its ruling. The FCC left the matter to be decided on
a fact specific, case-by-case basis. On April 22, 2004, SBC Communications, Inc.
(SBC) filed suit against us in federal district court in Missouri seeking
recovery of an estimated $141 million in interstate and intrastate access
charges that SBC alleges AT&T avoided by delivering long distance calls to SBC
for termination over SBC local facilities, together with interest and punitive
damages. In addition, on May 5, 2004, Qwest Corporation filed a similar
complaint against AT&T in federal district court in Colorado seeking "tens of
millions of dollars in access charges." While no additional lawsuits have been
filed, other incumbent local exchange carriers may assert similar claims. We
believe that we have a number of defenses to these claims and intend to defend
against them vigorously.
Another petition that is pending before the FCC relates to enhanced prepaid
card service. Because of the nature of our enhanced prepaid card service
(consisting first of a call to our prepaid card platform where the customer
interacts with advertising content and then a second call from the platform to
the called party), we pay access charges on the call to the enhanced prepaid
card platform and on the call from the enhanced prepaid card platform based on
the jurisdiction of each call. This does not impact the amount of access charges
we pay on enhanced prepaid card calls when the persons communicating are in
different states from each other and from the enhanced platform, but generally
results in lower access charges when the persons are both in the same state and
the enhanced platform is in a different state. In addition, because our prepaid
card calls are offered as an enhanced service, we do not make Universal Service
Fund (USF) contributions on revenue derived from these calls. Given that we
cannot predict with certainty how the FCC will rule on our petition, and the
FCC's recent decision to decline to address issues of retroactivity in the case
of phone-to-phone IP, it should be noted that the current classification of
AT&T's enhanced prepaid card service has generated approximately $290$340 million in
access savings since the third quarter of 2002, and approximately $150$160 million
in USF contribution savings since the beginning of 1999, compared with the cost
that would have been incurred by a basic prepaid card offering. Since these
savings have permitted us to sell prepaid cards to consumers and distributors at
prices below what otherwise would have been possible, an adverse ruling by the
FCC on the prepaid card petition would therefore increase the future cost of
providing prepaid cards and may materially adversely affect future sales of
prepaid cards, as well as potentially exposing us to retroactive liability,
penalties and interest.
In March 2004, the United States Court of Appeals for the District of
Columbia vacated a number of recent FCC rulings made in connection with the
Triennial Review Order, including the FCC's delegation to state commissions of
decisions over impairment as applied to mass market switching and certain
transport elements. That decision was stayed until June 16, 2004. On June 4,
2004, the Court of Appeals announced it would not extend that stay. On June 9,
2004, the Office of the Solicitor General informed the FCC that it had decided
not to appeal the D.C. Circuit decision vacating the FCC's local telephone
unbundling rules. On July 22, 2004, AT&T announced that we will be shifting our
focus away from traditional consumer services, and we will no longer be
investing to acquire new residential local and stand-alone long distance
customers (see note 12).
13
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)customers.
11. SEGMENT REPORTING
Our results are segmented according to the customers we service: AT&T
Business Services and AT&T Consumer Services.
Our existing segments reflect certain managerial changes that were
implemented during 2004. We transferred our remaining payphone business from
AT&T Consumer Services to AT&T Business Services.
AT&T Business Services provides a variety of communication services to
various sized businesses and government agencies including long distance,
international, toll-free and local voice, including wholesale transport
services, as well as data services and Internet protocol and enhanced (IP&E)
services, which includes the management of network servers and applications.
AT&T Business Services also provides outsourcing solutions and other
professional services.
16
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
AT&T Consumer Services provides a variety of communication services to
residential customers. These services include traditional long distance voice
services, such as domestic and international dial services (long distance or
local toll calls where the number "1" is dialed before the call) and calling
card services. Transaction services, such as prepaid card and operator-assisted
calls, are also offered. Collectively, these services represent stand-alone long
distance and are not offered in conjunction with any other service. AT&T
Consumer Services also provides dial-up Internet services and all distance
services, which bundle long distance, local and local toll.
The balance of AT&T's operations is included in a "Corporate and Other"
group. This group primarily reflects corporate staff functions and the
elimination of transactions between segments.
Total assets for our reportable segments include all assets, except
intercompany receivables. Nearly all prepaid pension assets, taxes and
corporate-owned or leased real estate are held at the corporate level and
therefore are included in the Corporate and Other group. Capital additions for
each segment include capital expenditures for property, plant and equipment,
additions to internal-use software (which are included in other assets) and
additions to nonconsolidated investments.
Generally, AT&T accounts for inter-segment transactions at market prices.
AT&T Business Services sells services to AT&T Consumer Services at
cost-based prices, which approximate average market prices. These sales are recorded by AT&T Business Services as
contra-expense.
14
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
REVENUE
FOR THE THREE MONTHS FOR THE SIXNINE MONTHS
ENDED MONTHSSEPTEMBER 30, ENDED JUNESEPTEMBER 30,
JUNE 30,
--------------- -------------------------------------- -------------------
2004 2003 2004 2003
------ -------------- -------- ------- -------
(DOLLARS IN MILLIONS)
AT&T Business Services
Long distance voice services................... $2,386 $2,895services........... $2,364 $2,820 $ 4,9997,363 $ 5,8788,698
Local voice services........................... 404 384 793 719services................... 390 379 1,183 1,098
------ ------ ------- -------
Total voice services........................... 2,790 3,279 5,792 6,597services...................... 2,754 3,199 8,546 9,796
Data services.................................. 1,690 1,943 3,405 3,899services.......................... 1,693 1,875 5,098 5,774
IP&E services.................................. 565 509 1,118 998services.......................... 587 550 1,705 1,548
------ ------ ------- -------
Total data and IP&E services................... 2,255 2,452 4,523 4,897services(1)........... 2,280 2,425 6,803 7,322
Outsourcing, professional and other
services... 566 697 1,168 1,393services............................... 611 677 1,779 2,070
------ ------ ------- -------
Total AT&T Business Services..................... 5,611 6,428 11,483 12,887Services................ 5,645 6,301 17,128 19,188
AT&T Consumer Services
Stand-alone long distance voice and other
services.................................... 1,327 1,894 2,789 3,984services............................... 1,256 1,813 4,045 5,797
Bundled services............................... 684 460 1,329 884services.......................... 724 521 2,053 1,405
------ ------ ------- -------
Total AT&T Consumer Services..................... 2,011 2,354 4,118 4,868Services................ 1,980 2,334 6,098 7,202
------ ------ ------- -------
Total reportable segments........................ 7,622 8,782 15,601 17,755segments................. 7,625 8,635 23,226 26,390
------ ------ ------- -------
Corporate and Other..............................Other......................... 13 14 13 25 2638 40
------ ------ ------- -------
Total revenue.................................... $7,636 $8,795 $15,626 $17,781revenue............................... $7,638 $8,649 $23,264 $26,430
====== ====== ======= =======
RECONCILIATION OF OPERATING INCOME TO INCOME BEFORE INCOME TAXES, MINORITY
INTEREST INCOME, NET EARNINGS RELATED TO EQUITY INVESTMENTS AND CUMULATIVE
EFFECT OF ACCOUNTING CHANGE
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, JUNE 30,
------------- -------------
2004 2003 2004 2003
---- ------ ---- ------
(DOLLARS IN MILLIONS)
AT&T Business Services................................ $152 $ 601 $235 $1,200
AT&T Consumer Services................................ 240 485 611 1,118
---- ------ ---- ------
Total reportable segments........................... 392 1,086 846 2,318
Corporate and Other................................... (44) (57) (217) (123)
---- ------ ---- ------
Operating income...................................... 348 1,029 629 2,195
Other income (expense), net........................... 36 86 (138) 96
Interest (expense).................................... (191) (296) (419) (628)
---- ------ ---- ------
Income before income taxes, minority interest income,
net earnings related to equity investments and
cumulative effect of accounting change.............. $193 $ 819 $ 72 $1,663
==== ====== ==== ======
15- ---------------
(1) Prior to June 30, 2004, data services revenue included all international
managed services. Effective June 30, 2004, international managed services
revenue was divided into data services and IP&E services, consistent with
the classifications of domestic managed services. As a result, data services
revenue and IP&E services revenue for prior periods have been restated to
reflect this reclassification. Such reclassification had no impact on total
data and IP&E services revenue, or total revenue. Adjusted for this
17
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
reclassification, data services revenue for the three months ended March 31,
2004, December 31, 2003 and March 31, 2003, was $1,715 million, $1,846
million and $1,956 million, respectively; and IP&E services revenue for the
same periods was $553 million, $554 million and $489 million, respectively.
RECONCILIATION OF OPERATING (LOSS) INCOME TO (LOSS) INCOME BEFORE INCOME
TAXES, MINORITY INTEREST INCOME, NET EARNINGS (LOSSES) RELATED TO EQUITY
INVESTMENTS AND CUMULATIVE EFFECT OF ACCOUNTING CHANGES
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- -------------------
2004 2003 2004 2003
---------- ------- --------- -------
(DOLLARS IN MILLIONS)
AT&T Business Services......................... $(11,095) $ 413 $(10,860) $1,613
AT&T Consumer Services......................... 281 503 892 1,621
-------- ----- -------- ------
Total reportable segments.................... (10,814) 916 (9,968) 3,234
Corporate and Other............................ (511) (87) (728) (210)
-------- ----- -------- ------
Operating (loss) income........................ (11,325) 829 (10,696) 3,024
Other (expense) income, net.................... (34) (7) (172) 89
Interest (expense)............................. (192) (289) (611) (917)
-------- ----- -------- ------
(Loss) income before income taxes, minority
interest income, net earnings (losses)
related to equity investments and cumulative
effect of accounting changes................. $(11,551) $ 533 $(11,479) $2,196
======== ===== ======== ======
ASSETS
AT AT
JUNESEPTEMBER 30, DECEMBER 31,
2004 2003
--------------------- ------------
(DOLLARS IN MILLIONS)
AT&T Business Services...................................... $32,468$20,813 $34,202
AT&T Consumer Services...................................... 885777 1,062
------- -------
Total reportable segments................................. 33,35321,590 35,264
Corporate and Other*........................................ 10,46510,469 12,724
------- -------
Total assets................................................ $43,818$32,059 $47,988
======= =======
- ---------------
* Includes cash of $2.1$2.2 billion at JuneSeptember 30, 2004, and $4.0 billion at
December 31, 2003.
18
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
CAPITAL ADDITIONS
FOR THE THREE MONTHS FOR THE SIXNINE MONTHS
ENDED MONTHSSEPTEMBER 30, ENDED JUNESEPTEMBER 30,
JUNE 30,
------------- --------------------------------- --------------------
2004 2003 2004 2003
----- ----- ---- ------ -------- ------- -------
(DOLLARS IN MILLIONS)
AT&T Business Services................................. $463 $763 $933 $1,401Services..................... $391 $ 995 $1,324 $2,396
AT&T Consumer Services................................. 15 19 28 41Services..................... 9 14 37 55
---- ---- ---------- ------ ------
Total reportable segments............................ 478 782 961 1,442segments................ 400 1,009 1,361 2,451
Corporate and Other.................................... 2 8 4 12Other........................ 6 198 10 210
---- ---- ---------- ------ ------
Total capital additions................................ $480 $790 $965 $1,454additions.................... $406 $1,207 $1,371 $2,661
==== ==== ========== ====== ======
GEOGRAPHIC INFORMATION
FOR THE THREE MONTHS FOR THE SIXNINE MONTHS
ENDED MONTHSSEPTEMBER 30, ENDED JUNESEPTEMBER 30,
JUNE 30,
--------------- -------------------------------------- -------------------
2004 2003 2004 2003
------ -------------- -------- ------- -------
(DOLLARS IN MILLIONS)
Revenue(l)Revenue(1)
United States(2)................................. $7,242 $8,407 $14,851 $17,009
International.................................... 394 388 775 772............................ $7,227 $8,258 $22,078 $25,267
International............................... 411 391 1,186 1,163
------ ------ ------- -------
Total revenue.................................... $7,636 $8,795 $15,626 $17,781revenue............................... $7,638 $8,649 $23,264 $26,430
====== ====== ======= =======
AT AT
JUNESEPTEMBER 30, DECEMBER 31,
2004 2003
--------------------- ------------
(DOLLARS IN MILLIONS)
Long-Lived Assets(3)
United States(2)............................................ $26,195$15,173 $27,758
International............................................... 1,8561,653 1,918
------- -------
Total long-lived assets..................................... $28,051$16,826 $29,676
======= =======
- ---------------
(1) Revenue is reported in the geographic area in which it originates.
(2) Includes amounts attributable to operations in Puerto Rico and the Virgin
Islands.
(3) Long-lived assets include property, plant and equipment, net,net; goodwill and
other purchased intangibles, net.
16
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Reflecting the dynamics of our business, we continually review our
management model and structure, which may result in additional adjustments to
our operating segments in the future.
12. SUBSEQUENT EVENTS
On July 22,October 6, 2004, we announcedentered into a $1.0 billion syndicated 364-day
credit facility led by J.P. Morgan Securities Inc., Citigroup Global Markets
Inc. and Banc of America Securities LLC that as a result of recent changes in
regulatory policy governing local telephone service, we will be shiftingreplaced our focus away from traditional consumer services, and we will no longer be
investing to acquire new residential local and stand-alone long distance
customers. We plan to concentrate our investments going forward on business
markets and emerging technologies.
In July 2004, Moody's and Fitch lowered our long-term credit ratings to Ba1
and BB+, respectively, and lowered our short-term credit and commercial paper
ratings to NP (not prime) and B, respectively. In August 2004, Standard & Poor's
(S&P) lowered our long-term credit rating to BB+ and lowered our short-term
credit and commercial paper rating to B. The rating actions by Moody's and S&P
triggered a 100 basis point interest rate step-up on approximately $6.5existing $2.0 billion
in notional amount of debt net of foreign currency hedge offsets. This step-up
is effective for interest payment periods that will begin after November 2004,
resulting in an expected increase in interest expense of approximately $10
million in 2004 and $70 million in 2005.
17facility.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
AT&T CORP. AND SUBSIDIARIES
FORWARD-LOOKING STATEMENTS
This document contains certain forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995 with respect to
financial condition, results of operations, cash flows, dividends, financing
plans, business strategies, operating efficiencies, capital and other
expenditures, competitive positions, availability of capital, growth
opportunities for new and existing products, benefits from new technologies,
availability and deployment of new technologies, plans and objectives of
management, and other matters.
Statements in this document that are not historical facts are hereby
identified as "forward-looking statements" for the purpose of the safe harbor
provided by Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. The words "estimate," "project," "intend,"
"expect," "believe," "plan," and similar expressions are intended to identify
forward-looking statements. Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of the date of this
document. Any Form 10-K, Annual Report to Shareholders, Form 10-Q or Form 8-K of
AT&T may include forward-looking statements. In addition, other written or oral
statements which constitute forward-looking statements have been made and may in
the future be made by or on behalf of AT&T, including with respect to the
matters referred to above. These forward-looking statements are necessarily
estimates, reflecting the best judgment of senior management that rely on a
number of assumptions concerning future events, many of which are outside of our
control, and involve a number of risks and uncertainties that could cause actual
results to differ materially from those suggested by the forward-looking
statements. These forward-looking statements should, therefore, be considered in
light of various important factors, including those set forth in this document.
Important factors that could cause actual results to differ materially from
estimates or projections contained in the forward-looking statements include,
without limitation:
- the impact of existing, new and restructured competitors in the markets
in which we compete, including competitors that may offer less expensive
products and services, desirable or innovative products, technological
substitutes, or have extensive resources or better financing,
- the impact of oversupply of capacity resulting from excessive deployment
of network capacity,
- the ongoing global and domestic trend toward consolidation in the
telecommunications industry, which may have the effect of making the
competitors of these entities larger and better financed and afford these
competitors with extensive resources and greater geographic reach,
allowing them to compete more effectively,
- the effects of vigorous competition in the markets in which we operate,
which may decrease prices charged and change customer mix and
profitability,
- the ability to establish a significant market presence in new geographic
and service markets,
- the availability and cost of capital,
- the impact of any unusual items resulting from ongoing evaluations of our
business strategies,
- the requirements imposed on us or latitude allowed to competitors by the
Federal Communications Commission (FCC) or state regulatory commissions
under the Telecommunications Act or other applicable laws and
regulations,
- the effects of our announcement that we will stop investing in
traditional consumer services and will no longer compete for residential
local and stand-alone long distance customers,
- the validity or invalidity of portions of the FCC's Triennial Review
Order, and the Office of the Solicitor General's decision not to appeal
the United States Court of Appeals for the District of Columbia's action
to vacate various related FCC rulings,
1820
- the risks associated with technological requirements; wireless, internet,
Voice over Internet Protocol (VoIP) or other technology substitution and
changes; and other technological developments,
- the risks associated with the repurchase by us of debt or equity
securities, which may adversely affect our liquidity or creditworthiness,
- the results of litigation filed or to be filed against us, and
- the possibility of one or more of the markets in which we compete being
impacted by changes in political, economic or other factors, such as
monetary policy, legal and regulatory changes, war, terrorism or other
external factors over which we have no control.
The discussion and analysis that follows provides information management
believes is relevant to an assessment and understanding of AT&T's consolidated
results of operations for the three and sixnine months ended JuneSeptember 30, 2004 and
2003, and financial condition as of JuneSeptember 30, 2004 and December 31, 2003.
OVERVIEW
AT&T Corp. (AT&T) is among the world's communications leaders, providing
voice and data communications services to large and small businesses, consumers
and government agencies. We provide domestic and international long distance,
regional and local communications services, data and Internet communications
services.
Our operating environment in 2004 remains competitive and challenging.
During the first halfnine months of 2004, we continued to see the effects of
industry oversupply and the associated impacts on pricing behavior in the
business marketplace. Recent escalation in competitiveCompetitive pricing continued to drive down the average
price per minute in both the retail and wholesale long distance voice
businesses. This, coupled with a continued mix shift from higher priced retail
minutes to lower priced wholesale minutes, will persist in pressuring AT&T
Business Services revenue and margin performance. Similarly, data services
revenue continues to be negatively impacted by competitive pricing pressure and
weak demand, primarily in bandwidth and packet services. As a result, we expect
the full year revenue decline for AT&T Business Services will exceed our
previously forecasted decline of 4% to 7%.demand.
AT&T Consumer Services also continues to be negatively impacted by
competition and substitution (consumers using wireless or Internet services in
lieu of a wireline call). Additionally, while we have experienced some success
with our bundled offers, recent regulatory developments have resulted in the
reassessment of our consumer acquisition initiatives as discussed below, and
while we will continue to provide our existing customers with quality service,
we will no longer invest to acquire new customers.
We have projected that AT&T
Consumer Services will experience a high-teens rate of revenue decline compared
with 2003. We expect operating margins for AT&T Consumer Services to be in the
mid-teens.
As a result of the weakness in both AT&T Business Services and AT&T
Consumer Services, we expect total company revenue to be between $29.5 billion
and $30.5 billion in 2004, and expect full-year 2004 consolidated operating
income between $1.0 billion and $1.4 billion (excluding net restructuring and
other charges).
Despite the operating environment, we remain focused on controlling our
costs and have made substantial progress in areas such as headcount reductions.
We are continuing to invest in our business prudently, focusing on making the
necessary investments in automation and process improvements. We expect to have
approximately $1.8 billion in capital expenditures for 2004. We have continued
to reduce debt levels and we believe the strength of our balance sheet will
continue to provide us with the flexibility to make investments in our business.
However, recent changes in regulatory policy governing local service have
forced us to reassess the way we do business. As a result, in July 2004, we
announced that we will be shiftinga strategic change in our business focus away from traditional
consumer services such as wireline residential services, and we will no longer
be investing to acquire new residential local and stand-alone long distance
customers. We plan to concentrate our investments going forward on business
markets and emerging technologies. 19
As a result of this change, we performed an
evaluation of our long-lived assets. Reflective of sustained pricing pressure
and the evolution of services toward newer technologies in the business market
as well as changes in the regulatory environment, it was determined that an
impairment charge of $11.4 billion was necessary in the third quarter of 2004.
CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenue and
expenses as well as the disclosure of contingent assets and liabilities.
Management bases its
21
estimates and judgments on historical experience and other factors that are
believed to be reasonable under the circumstances. Actual results may differ
from these estimates under different assumptions or conditions.
For a discussion of the critical accounting estimates we identified that we
believe require significant judgment in the preparation of our consolidated
financial statements, please refer to AT&T's Form 10-K for the year ended
December 31, 2003.
CONSOLIDATED RESULTS OF OPERATIONS
REVENUE
FOR THE THREE MONTHS FOR THE SIXNINE MONTHS
ENDED MONTHSSEPTEMBER 30, ENDED JUNESEPTEMBER 30,
JUNE 30,
--------------- -------------------------------------- -------------------
2004 2003 2004 2003
------ -------------- -------- ------- -------
(DOLLARS IN MILLIONS)
AT&T Business Services........................... $5,611 $6,428 $11,483 $12,887Services...................... $5,645 $6,301 $17,128 $19,188
AT&T Consumer Services........................... 2,011 2,354 4,118 4,868Services...................... 1,980 2,334 6,098 7,202
Corporate and Other..............................Other......................... 13 14 13 25 2638 40
------ ------ ------- -------
Total revenue.................................... $7,636 $8,795 $15,626 $17,781revenue............................... $7,638 $8,649 $23,264 $26,430
====== ====== ======= =======
Total REVENUE decreased $1.2$1.0 billion, or 13.2%11.7%, in the secondthird quarter of
2004, and decreased $2.2$3.2 billion, or 12.1%12.0%, in the first half ofnine months ended September
30, 2004, compared with the same periods in 2003. The decreases were primarily
driven by continued declines in stand-alone long distance voice revenue of
approximately $1.1$1.0 billion in the secondthird quarter of 2004, and $2.0$3.0 billion in the
first half ofnine months ended September 30, 2004, compared with the same periods in 2003.
These declines are reflective of increased competition, which has led to lower
prices and loss of market share, a decline in business retail volumes, the
impact of substitution, and consumer migration to lower priced products and
calling plans. The decline in stand-alone
long distance voice revenue was partially offset by strength in business
wholesale volumes. Total long distance voice volumes (including long distance
volumes sold as part of a bundled product) decreased approximately 4%6% for the
secondthird quarter of 2004 and approximately 3%4% for the sixnine months ended JuneSeptember
30, 2004, compared with the respective periods in 2003, primarily due to
declines in business retail and consumer long distance volumes, partially offset
by growth in lower-priced business wholesale. Also contributing to the revenue
decline was lower data services revenue of $0.2 billion in the secondthird quarter of
2004, and $0.4$0.7 billion in the sixnine months ended JuneSeptember 30, 2004, compared
with the respective periods in 2003, resulting from pricing pressure coupled with competitiveprimarily driven by competition, which has
led to declining prices and customer losses primarily in bandwidth and packet
services, as well as weak demand.demand, primarily in bandwidth services.
Partially offsetting the declines in stand-alone long distance voice and
data revenue was an increase in bundled services revenue (primarily local and
long distance voice) at AT&T Consumer Services of $0.2 billion in the secondthird
quarter of 2004, and $0.4$0.6 billion in the first half ofnine months ended September 30, 2004,
compared with the same periods in 2003, resulting from continued subscriber
growth.
Revenue by segment is discussed in greater detail in the Segment Results
section.
2022
OPERATING EXPENSES
FOR THE THREE MONTHS FOR THE SIXNINE MONTHS
ENDED MONTHSSEPTEMBER 30, ENDED JUNESEPTEMBER 30,
JUNE 30,
--------------- -------------------------------------- --------------------
2004 2003 2004 2003
------ ------ ------- ----------------- -------- --------- --------
(DOLLARS IN MILLIONS)
Access and other connection...................... $2,481 $2,708connection................... $ 5,1192,411 $2,785 $ 5,4067,530 $ 8,191
Costs of services and products................... 1,759 1,958 3,623 3,969products................ 1,783 1,954 5,406 5,923
Selling, general and administrative.............. 1,763 1,837 3,507 3,758administrative........... 1,653 1,793 5,160 5,551
Depreciation and amortization.................... 1,231 1,197 2,481 2,383
Netamortization................. 647 1,224 3,128 3,607
Asset impairment and net restructuring and
other charges.............. 54 66 267 70charges............................... 12,469 64 12,736 134
-------- ------ ------ --------------- -------
Total operating expenses......................... $7,288 $7,766 $14,997 $15,586expenses...................... $ 18,963 $7,820 $ 33,960 $23,406
======== ====== ====== =============== =======
Operating income.................................(loss) income....................... $(11,325) $ 348 $1,029829 $(10,696) $ 629 $ 2,1953,024
Operating margin................................. 4.6% 11.7% 4.0% 12.3%margin.............................. (148.3)% 9.6% (46.0)% 11.4%
Included within ACCESS AND OTHER CONNECTION EXPENSES are costs we pay to
connect calls using the facilities of other service providers, as well as the
Universal Service Fund contributions and per-line charges mandated by the FCC.
We pay domestic access charges to local exchange carriers to complete long
distance calls carried across the AT&T network and terminated on a local
exchange carrier's network. We also pay local connectivity charges for leasing
components of local exchange carrier networks in order to provide local service
to our customers. International connection charges paid to telephone companies
outside of the United States to connect international calls are also included
within access and other connection expenses. Universal Service Fund
contributions are charged to all telecommunications carriers by the FCC based on
a percentage of state-to-state and international services revenue to provide
affordable services to eligible customers. In addition, the FCC assesses charges
on a per-line basis. Since most of the Universal Service Fund contributions and
per-line charges are passed through to the customer, a reduction in these
expenses generally results in a corresponding reduction in revenue.
Access and other connection expenses decreased $0.2$0.4 billion, or 8.4%13.5%, in
the secondthird quarter of 2004 and declined $0.3$0.7 billion, or 5.3%8.1%, for the first
half ofnine
months ended September 30, 2004, compared with the same periods of 2003.
Domestic access charges for the third quarter and year-to-date period of 2003
included a $0.1 billion access expense adjustment to reflect the proper estimate
of liability relating to access costs incurred in 2001 and 2002 (see note 3 to
the consolidated financial statements). Excluding this adjustment, domestic
access charges declined $0.3 billion for the secondthird quarter, primarily due to
lower volumes, lower Universal Service Fund contributions resulting from the
decline in long distance revenue, as well asand changes in product mix (including whether
calls are interstate versus intrastate). Also contributing to the quarterly
decline were lower rates, including the impact of settlements, resulting in part
from a greater proportion of calls that have non-access incurring terminations
(such as when a call terminates over our own network or over a leased line), as
well as from rate negotiations and more efficient network usage. DomesticExcluding the
third quarter 2003 access expense adjustment, domestic access charges fell $0.5declined
$0.8 billion for the year-to-date period, primarily due to lower Universal
Service Fund contributions, changes in product mix, lower rates, and more efficient network usage, as well as
lower
Universal Service Fund contributions and reduced volumes. The quarterly and year-to-date declines in domestic access charges were
partially offset by increases inincreased local connectivity costs of $0.1 billion for the quarter and $0.2 billion, for the first half of 2004,
primarily as a result of subscriber increases due to new state entries and
increased penetration into existing states.
COSTS OF SERVICES AND PRODUCTS include the costs of operating and
maintaining our networks, the provision for uncollectible receivables and other
service-related costs, including cost of equipment sold.
Costs of services and products decreased $0.2 billion, or 10.2%8.7%, in the
secondthird quarter of 2004 and declined $0.3$0.5 billion, or 8.7%, in the first sixnine months
ofended September 30, 2004, compared with the comparable prior year periods. The
declines were primarily driven by the overall impact of lower revenue and
related costs, including cost cutting initiatives. Also contributing to the
decline was a lower provision for uncollectible receivables
23
resulting from improved collections and lower revenue. Partially offsetting
this declinethese declines was the impact of a weak U.S. dollar.
21
SELLING, GENERAL AND ADMINISTRATIVE (SG&A) EXPENSES decreased $0.1 billion,
or 4.1%7.7%, in the secondthird quarter of 2004 and declined $0.3 million,$0.4 billion, or 6.7%7.0%, in the
first sixnine months ofended September 30, 2004, compared with the comparable prior year
periods. The decline wasThese declines were primarily attributable to cost control efforts
throughout AT&T, as well as reduced customer care volumes at AT&T Consumer
Services resulting from a reduction in the number of residential customers. Cost
control efforts included headcount reductions as well as continued process
improvements. These
declines were partiallyThe quarterly decline also reflected the impact of lower marketing
and customer acquisition spending as a result of our strategic decision in the
third quarter of 2004 to shift our focus away from traditional consumer
services, somewhat offset by increased advertising and marketing spending on new
initiatives, primarily on our Voice over Internet Protocol (VoIP) offering. The
declines in both periods were partially offset by a $50 million legal accrual
recorded in the third quarter of 2004, associated with the settlement of the
AT&T shareholder class action lawsuit (see note 10 to the consolidated financial
statements).
DEPRECIATION AND AMORTIZATION EXPENSES increased $34 million,decreased $0.6 billion, or 2.9%47.2%, in
the secondthird quarter of 2004 and rose $0.1declined $0.5 billion, or 4.1%13.3%, in the first sixnine
months ofended September 30, 2004, compared with same periods in 2003. These
increasesdecreases were primarily dueattributable to a higher asset base,impairment charges of $11.4
billion taken in the third quarter of 2004, which includes a greater proportion of
shorter-lived assets. In addition, higher asset impairments during 2004
contributed to the increase indecreased depreciation and
amortization expenses.expense by approximately $0.5 billion. We expect that depreciation
and amortization expense will be similarly impacted in the fourth quarter of
2004. Capital expenditures were $0.5$0.4 billion and $0.8$1.2 billion for the three
months ended JuneSeptember 30, 2004 and 2003, respectively, and were $1.0$1.4 billion
and $1.5$2.7 billion for the sixnine months ended JuneSeptember 30, 2004 and 2003,
respectively. We continue to focus the majority of our capital spending on our
advanced services offerings of Internet protocol and enhanced (IP&E) services
and data services, both of which include managed services, as well as business local voice services.
In the secondthird quarter of 2004, ASSET IMPAIRMENT AND NET RESTRUCTURING AND
OTHER CHARGES of $54$12,469 million were primarily comprised of $11,389 million of asset
impairment charges and $1,080 million of net business restructuring obligations
associatedand other
charges. Charges in the amount of $11,859 million were recorded in AT&T Business
Services, $188 million in AT&T Consumer Services and $422 million in the
Corporate and Other group.
In July 2004, we announced a strategic change in our business focus away
from traditional consumer services and towards business markets and emerging
technologies. As a result of this strategic change, we performed an evaluation
of our long-lived assets, including property, plant and equipment (PP&E) and
internal-use software (IUS) (the asset group) as of July 1, 2004, as this
strategic change created a "triggering event" necessitating such a review. In
assessing impairments of long-lived assets we follow the provisions of Statement
of Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets." We operate an integrated telecommunications
network; therefore, we performed our testing of the asset group at the entity
level, as this is the lowest level for which identifiable cash flows are
available.
In performing the test, we determined that the total of the expected future
undiscounted cash flows directly related to the existing service potential of
the asset group was less than the carrying value of the asset group; therefore,
an impairment charge was required. The impairment charges of $11,389 million
represented the difference between the fair values of the asset group and its
carrying values and are included within asset impairment and net restructuring
and other charges in the consolidated statements of operations. The impairment
charges resulted from sustained pricing pressure and the evolution of services
toward newer technologies in the business market as well as changes in the
regulatory environment, which led to a shift away from traditional consumer
services.
AT&T Business Services recorded impairment charges of $11,330 million
resulting in reductions to PP&E of $11,023 million, IUS of $287 million, other
purchased intangibles of $15 million and other long-lived assets of $5 million.
AT&T Consumer Services recorded impairment charges of $59 million resulting in
reductions to PP&E of $11 million and IUS of $48 million.
24
We calculated the fair value of our asset group using discounted cash
flows. The discounted cash flows calculation was made utilizing various
assumptions and estimates regarding future revenue, expenses and cash flows
projections through 2012. The time horizon was determined based on the estimated
remaining useful life of the primary assets in the asset group; the primary
assets are those from which the most significant cash flows are generated,
principally consisting of the transport central office equipment. Pursuant to
SFAS No. 144, the forecasts were developed without contemplation of investments
in new products. The 10% discount rate utilized was determined, using a weighted
average cost of capital (debt and equity) and was more heavily weighted towards
debt given that the asset group, which primarily consists of tangible assets,
can be financed with a larger proportion of debt. When allocating the impairment
to the asset categories, market values were utilized, to the extent
determinable, to ensure that no asset category was impaired below its fair
value.
The use of different assumptions within our discounted cash flows model
when determining fair value, including the selection of the discount rate, could
result in different valuations for our long-lived assets. For every percentage
point difference in the discount rate selected, the amount of the impairment
would have increased or decreased by approximately $0.4 billion.
The strategic change in business focus also created a "triggering event"
for a review of our goodwill. We follow the provisions of SFAS No. 142,
"Goodwill and Other Intangible Assets" for determining impairments. SFAS No. 142
indicates that if other types of assets (in addition to goodwill) of a reporting
unit are being tested for impairment at the same time as goodwill, then those
assets are to be tested for impairment prior to performing the goodwill
impairment testing. Accordingly, the impairment charges noted above reduced the
carrying value of the reporting units when performing the impairment test for
goodwill.
The goodwill impairment test requires us to estimate the fair value of our
overall business enterprise down to the reporting unit level. Our reporting
units are AT&T Business Services and AT&T Consumer Services. We estimated fair
value using both a discounted cash flows model, as well as an approach using
market comparables, both of which are weighted equally to determine fair value.
Under the discounted cash flows method, we utilized estimated long-term revenue
and cash flows forecasts, as well as assumptions of terminal value, together
with an applicable discount rate, to determine fair value. Under the market
approach, fair value was determined by comparing our reporting units to similar
businesses (or guideline companies). We then compared the carrying value of our
reporting units to their fair value. Since the fair value of our reporting units
exceeded their carrying amounts, no goodwill impairment charge was recorded.
The net business restructuring activities of $1,080 million for the third
quarter of 2004 consisted of $1,043 million for employee separations.separations (of which
$339 million related to benefit plan curtailment costs) and $37 million of
facility closing obligations.
This exit plan will impact approximately 11,200 employees (the majority of
which will be involuntary) across the company. This activity resulted from the
continued integration and automation of various functions within network
operations, as
well as reorganizations throughoutand our non-U.S. operations. Thisstrategic change in focus away from traditional consumer
services and towards business markets and emerging technologies. Approximately
60 percent of the employees impacted by this exit plan impacted about 625 employees (more than halfare managers.
Facility closing reserves of which$37 million are primarily associated with the
continued consolidation of our real estate portfolio and reflect the present
value of contractual lease obligations, net of estimated sublease income,
associated with vacant facilities resulting from workforce reductions and
network equipment space that will not be used by AT&T.
Asset impairment and net restructuring and other charges of $12,736 million
for the nine months ended September 30, 2004, were involuntary),
approximately 35%comprised of whom were managers. Obligations$11,511 million
of asset impairments and $1,225 million in net business restructuring and other
obligations. In this period, charges in the amount of $52$12,002 million were
recorded in AT&T Business Services, $189 million in AT&T Consumer Services and
$2$545 million in the Corporate and Other group.
Net restructuring and otherThe asset impairment charges of $267$11,511 million forprimarily reflect the six months
ended June 30, 2004, were comprisedthird
quarter asset impairments of net business restructuring obligations of
$145$11,389 million andas discussed above. In addition, we
recorded real estate impairment charges of $122 million.million
25
related to the decision made during the first quarter of 2004 to divest five
owned properties in an effort to further reduce costs and consolidate our real
estate portfolio. In accordance with SFAS No. 144, an impairment charge was
recorded within the Corporate and Other group to reduce the book value of the
five properties to fair market value based on third party assessments (including
broker appraisals). The businesssales of these properties have been completed.
The net restructuring activities consistedobligations of $104$1,225 million for the nine months
ended September 30, 2004, were primarily comprised of $1,147 million of separation costsnet
employee separations (of which $339 million related to benefit plan curtailment
costs) and $41$78 million of facility closing obligations. ThisThese exit plan impactedplans will
impact approximately 1,40512,600 employees (the majority of which werewill be
involuntary) primarily withinacross the AT&T Business Services segment as a result ofcompany. These activities resulted from the continued
integration and automation of various functions within network operations,
as well as reorganizations throughout our non-U.S. operations. Slightly less than halfoperations, and our strategic change in
focus away from traditional consumer services and towards business markets and
emerging technologies. Nearly one-half of the employees associated with thisimpacted by these exit
plan wereplans are managers. About 75%13% of the affected employees had left their positions
as of JuneSeptember 30, 2004. We anticipate about two-thirds of the affected
employees will be notified or will leave their positions by the end of 2004,
with the remaining employees to be notified during 2005 and anticipated to exit
our business by the end of 2005. These exit plans are not expected to yield cash
savings (net of severance benefit payouts) or a benefit to operating income (net
of the third quarterrestructuring charge recorded) in 2004; however, we expect to realize
approximately $1.2 billion of 2004.annual cash savings and benefit to operating
income in subsequent years, upon completion of the exit plans.
The
$41 million of facility closing reserves of $78 million are primarily associated with
the consolidation of our real estate portfolio and reflect the present value of
contractual lease obligations, net of estimated sublease income, associated with
vacant facilities resulting from workforce reductions and network equipment
space that will not be used by AT&T.
These exit plans are not expected to yield cash savings (net of
severance benefit payouts) or a benefit to operating income (net of the
restructuring charge recorded) in 2004; however, we expect to realize roughly
$140 million of annual cash savingsAsset impairment and benefit to operating income in
subsequent years, upon completion of the exit plans.
The real estate impairment charges of $122 million related to the decision
made during the first quarter of 2004 to divest five owned properties in an
effort to further reduce costs and consolidate our real estate portfolio. In
accordance with Statement of Financial Accounting Standards (SFAS) No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," an impairment
charge was recorded within the Corporate and Other group to reduce the book
value of the five properties to fair market value based on third party
assessments (including broker appraisals). Two of these properties were sold in
June 2004 and one additional property was sold in July 2004. We anticipate the
sales of the remaining properties will be completed by March 31, 2005. At June
30, 2004, these remaining properties were recorded as assets held-for-sale
within other current assets on the balance sheet.
Netnet restructuring and other charges for the three and
sixnine months ended JuneSeptember 30, 2003 were $66$64 million and $70$134 million,
respectively. The year-to-date
chargecharges in both periods primarily consisted of $66 million recorded in the second quarter, which
was comprised of $57 million ofreflected separation costs and $9 million of benefit plan
22
curtailment costs
associated with our management realignment efforts (impacting
approximately 90 senior managers).efforts. Partially offsetting these
activities was the reversal of $11 million of sales obligation liabilities
recorded in a prior year, associated with the disposition of AT&T Communications
(U.K.) Ltd, where the liabilities incurred were below the original estimate.
OPERATING (LOSS) INCOME decreased $0.7declined to a loss of $11.3 billion or 66.2%,from income of
$0.8 billion in the secondthird quarter of 2004 and declined $1.6to a loss of $10.7
billion or 71.4%,from income of $3.0 billion in the first half ofnine months ended September 30, 2004,
compared with the same periods in 2003. Operating income for the three and nine
months ended September 30, 2004, included asset impairment and net restructuring
and other charges of $12.5 billion and $12.7 billion, respectively, compared
with $0.1 billion for both the comparable prior year periods. As a result of the
third quarter 2004 asset impairment charges, operating income for the three and
nine months ended September 30, 2004, included a $0.5 billion benefit due to
lower depreciation on assets impaired. Excluding the impacts of the asset
impairment and net restructuring and other charges for both periods, OPERATING
MARGIN was 4.6%declined 2.3 percentage points in the secondthird quarter of 2004 compared with 11.7%and declined
5.5 percentage points in the second quarter of 2003 and 4.0% in the first
half of 2004, compared with 12.3% in the first half of 2003.year-to-date period. The margin declines were
primarily due to decreased revenue coupled with a slower rate of decline in
operating expenses. This reflected pricing pressures, substitution and a shift
from higher-margin business retail voice and data services and residential long
distance services to lower-margin services, including advanced services and
business wholesale. Higher net restructuring and other charges also contributed
toIn addition, the year-to-date decline.2003 margins were negatively impacted by a
$0.1 billion access expense adjustment.
FOR THE THREE MONTHS FOR THE SIXNINE MONTHS
ENDED MONTHSSEPTEMBER 30, ENDED JUNESEPTEMBER 30,
JUNE 30,
-------------- --------------------------------- --------------------
2004 2003 2004 2003
----- ----- ----- ---------- ------ ------- ------
(DOLLARS IN MILLIONS)
Other (expense) income, (expense), net.............................. $36 $86 $(138) $96net.................... $(34) $(7) $(172) $89
OTHER (EXPENSE) INCOME, (EXPENSE), NET, in the secondthird quarter of 2004 was $36expense of
$34 million compared with $0.1 billionexpense of $7 million in the secondthird quarter of 2003.
The unfavorable variance of $50 million was primarily due to an
26
impairment in 2004 of our investment in leveraged leases of certain aircraft as
a result of financial difficulties in the airline industry, and lower investment
related income and
lower net gains on sales of businesses and investments, primarily the salewhich
aggregated $89 million. Partially offsetting this unfavorable variance was $56
million in lower losses on early repurchases of Time Warner Telecom stock in the second quarter of 2003.long-term debt.
Other (expense) income, (expense), net, in the first half ofnine months ended September 30, 2004
was expense of $0.1
billion$172 million compared with income of $0.1 billion$89 million in the first half ofnine
months ended September 30, 2003. The unfavorable variance can bewas primarily
attributed to $0.3 billion$216 million of higher losses on the early repurchase of long-term
debt in the first halfnine months of 2004. In2004 compared to the first
half of 2003, debt was also early repurchased. However, a $0.2 billion loss
associated with the early retirement of long-term debt was offset by a $0.2
billion gain associated with the early retirement of exchangeable notes that
were indexed to AT&T Wireless common stock.comparable period in 2003.
Also, in 2004, investment related income and net gains on sales of businesses
and investments declined $0.1
billion,$105 million, compared with the first half ofnine months ended
September 30, 2003. Partially offsetting these unfavorable variances was a $0.1 billion write-down in 2003 of the residual
value of certain aircraft as a result of financial difficulties in the airline
industry. Further contributing to the offsetdifferences were
settlements, in the first halfnine months of 2004, associated with businesses
previously disposed.
We continue to hold $0.6 billion of investments in leveraged leases,
including leases of commercial aircraft, which we lease to domestic airlines as
well as to aircraft related companies. Should the financial difficulties in the
U.S. airline industry lead to further bankruptcies or lease restructurings, we
could record additional losses associated with our aircraft lease portfolio. In
addition, in the event of bankruptcy or renegotiation of lease terms, if any
portion of the non-recourse debt is canceled, such amounts would result in
taxable income to AT&T and accordingly a cash tax expense.
FOR THE THREE MONTHS FOR THE SIXNINE MONTHS
ENDED MONTHSSEPTEMBER 30, ENDED JUNESEPTEMBER 30,
JUNE 30,
------------- --------------------------------- -------------------
2004 2003 2004 2003
----- ----- ----- ------------ ------- ------- -------
(DOLLARS IN MILLIONS)
Interest (expense)................................. $(191) $(296) $(419) $(628).............................. $(192) $(289) $(611) $(917)
INTEREST (EXPENSE) decreased 35.3%33.7%, or $0.1 billion, in the secondthird quarter
of 2004 compared with the secondthird quarter of 2003, and decreased 33.2%33.4%, or $0.2$0.3
billion, in the first half ofnine months ended September 30, 2004 compared with the first
23
halfnine months of 2003. The declines are reflective of our continuing deleveraging
activities, which included significant early debt redemptions in 2003 and 2004.
FOR THE THREE MONTHS FOR THE SIXNINE MONTHS
ENDED MONTHSSEPTEMBER 30, ENDED JUNESEPTEMBER 30,
JUNE 30,
------------- ----------------------------------- --------------------
2004 2003 2004 2003
----- ------------- ------ -------- ------- -----
(DOLLARS IN MILLIONS)
(Provision) benefitBenefit (provision) for income taxes.............. $ (87) $(308) $ 339 $(605)taxes............ $4,402 $(72) $4,741 $(677)
Effective tax rate................................ 44.4% 37.7% (469.0)% 36.4%rate.............................. 38.1% 13.5% 41.3% 30.8%
The EFFECTIVE TAX RATE is the provisionbenefit (provision) for income taxes as a
percentage of (loss) income before income taxes. The effective tax rate infor the
secondthird quarter of 20042003 was negativelypositively impacted by a catch-up effect resulting from an increaseapproximately 22.5 percentage
points due to the recognition of approximately $120 million of tax benefits
associated with refund claims related to additional research and experimentation
tax credits generated in prior years, which received governmental approval
during the estimated annual 2004 effective tax rate as a result of lower projected annual
income before income taxes relative to our estimated permanent differences.prior year third quarter.
The effective tax benefit rate infor the first half ofnine months ended September 30,
2004, was positively impacted by 513.7approximately 3.2 percentage points due to the
reversal of a portion of the valuation allowance we recognized in 2002
attributable to the book and tax basis difference related to our investment in
AT&T Latin America. During February 2004, the subsidiaries of AT&T Latin America
were sold to Telefonos de Mexico S.A. de C.V., or Telmex, and the AT&T Latin
America plan of liquidation became effective. As a result, we no longer needed a
portion of the valuation allowance and recorded an income tax benefit of $0.4
billion in the first quarter of 2004. As we continue to assess developments in
our tax position, additional federal tax benefits may be recorded for all or a
portion of the remaining AT&T Latin America tax benefit of $40 million not
recognized. The effective tax rate infor the first half ofnine months ended September 30, 2003,
was positively impacted by 2.4approximately 5.5 percentage points due to the
recognition of approximately $120 million of tax benefits recordedassociated with refund
claims related to additional research and experimentation tax credits. In
addition, the 2003 effective tax rate was positively impacted by approximately
1.8 percentage points due to the recognition
27
of tax benefits in connection with the exchange and sale of our remaining
interest in AT&T Wireless common stock.
FOR THE THREE MONTHS FOR THE SIXNINE MONTHS
ENDED MONTHSSEPTEMBER 30, ENDED JUNESEPTEMBER 30,
JUNE 30,
-------------- ---------------------------------- --------------------
2004 2003 2004 2003
------ ------ ------ ------
(DOLLARS IN MILLIONS)
Net (loss) from discontinued operations, net of
income taxes.................................. $-- $(13) $-- $(13)
NET (LOSS) FROM DISCONTINUED OPERATIONS for the three and nine months ended
September 30, 2003, reflects an estimated cost related to potential legal
liabilities for certain environmental clean-up matters associated with NCR
Corporation (NCR), which was spun-off from AT&T in 1996. NCR has been formally
notified by federal and state agencies that it is a potentially responsible
party (PRP) for environmental claims under the Comprehensive Environmental
Response, Compensation and Liability Act of 1980 (CERCLA) and other statutes
arising out of the presence of polychlorinated biphenyls (PCBs) in sediments in
the lower Fox River and in the Bay of Green Bay, in Wisconsin. NCR was
identified as a PRP because of alleged PCB discharges from two carbonless copy
paper manufacturing facilities it previously owned, which were located along the
Fox River. In July 2003, the government clarified its planned approach for
remediation of the contaminated sediments, which caused NCR to increase its
estimated liability. Under the separation and distribution agreement between
AT&T and NCR, AT&T is required to pay a portion of such costs that NCR incurs
above a certain threshold. Therefore, in the third quarter of 2003, AT&T
recorded its estimated proportionate share of certain costs associated with the
Fox River matter, which totaled $13 million on both, a pretax and after-tax
basis. The extent of NCR's potential liability is subject to numerous variables
that are uncertain at this time, including the actual remediation costs and the
percentage NCR may ultimately be responsible for. As a result, AT&T's actual
liability may be different than the estimated amount. Pursuant to the separation
and distribution agreement, NCR is liable for the first $100 million of costs in
connection with this liability. AT&T is liable for 37% of costs incurred by NCR
beyond such $100 million threshold. All such amounts are determined after
reduction of any monies collected by NCR from other parties.
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------- -------------------
2004 2003 2004 2003
------ ------ ----- ----- ----- ----
(DOLLARS IN MILLIONS)
Cumulative effect of accounting change.................... $ -- $ -- $ -- $42changes......... $-- $(27) $-- $15
Effective July 1, 2003, we early adopted Financial Accounting Standards
Board Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest
Entities -- an Interpretation of Accounting Research Bulletin (ARB) No. 51,"
resulting in a charge of $27 million, net of income taxes of $17 million,
recognized as the CUMULATIVE EFFECT OF ACCOUNTING CHANGE in the third quarter of
2003. This interpretation requires the primary beneficiary to consolidate a
variable interest entity (VIE) if it has a variable interest that will absorb a
majority of the entity's expected losses if they occur, receive a majority of
the entity's expected residual returns if they occur, or both. Based on this
standard, two entities that AT&T leases buildings from qualify as VIEs and,
therefore, were consolidated as of July 1, 2003.
Effective January 1, 2003, we adopted SFAS No. 143, "Accounting for Asset
Retirement Obligations," resulting in $42 million of income, net of income taxes
of $26 million, as the CUMULATIVE EFFECTcumulative effect of this accounting principle. This
standard requires that obligations that are legally enforceable and unavoidable,
and are associated with the retirement of tangible long-lived assets, be
recorded as liabilities when those obligations are incurred, with the amount of
the liability initially measured at fair value. We historically included in our
group depreciation rates an amount related to the cost of removal for certain
assets. However, such amounts are not legally enforceable or unavoidable;
therefore, the cumulative effect impact primarily reflects the reversal of such
amounts accrued in accumulated depreciation.
28
SEGMENT RESULTS
Our results are segmented according to the customers we service: AT&T
Business Services and AT&T Consumer Services. The balance of our continuing
operations is included in a Corporate and Other group. This group primarily
reflects corporate staff functions and the elimination of transactions between
segments. The discussion of segment results includes revenue, operating (loss)
income, capital additions and total assets.
Operating (loss) income is the primary measure used by our chief operating
decision makers to measure our operating results and to measure segment
profitability and performance. See note 11 to our consolidated financial
statements for a reconciliation of segment results to consolidated results.
Total assets for each segment include all assets, except intercompany
receivables. Nearly all prepaid pension assets, taxes and corporate-owned or
leased real estate are held at the corporate level, and therefore are included
in the Corporate and Other group. Capital additions for each segment include
capital
24
expenditures for property, plant and equipment, additions to
internal-use software and additions to nonconsolidated investments.
Our existing segments reflect certain managerial changes that were
implemented during 2004. We transferred our remaining payphone business from
AT&T Consumer Services to AT&T Business Services.
Reflecting the dynamics of our business, we continuously review our
management model and structure, which may result in additional adjustments to
our operating segments in the future.
AT&T BUSINESS SERVICES
AT&T Business Services provides a variety of global communications services
to small and medium-sized businesses, large domestic and multinational
businesses and government agencies. These services include long distance,
international, toll-free and local voice, including wholesale transport services
(sales of services to service resellers), as well as data services and Internet
protocol and enhanced (IP&E) services, which includes the management of network
servers and applications. AT&T Business Services also provides outsourcing
solutions and other professional services.
FOR THE THREE MONTHS FOR THE SIXNINE MONTHS
ENDED MONTHSSEPTEMBER 30, ENDED JUNESEPTEMBER 30,
JUNE 30,
--------------- -------------------------------------- --------------------
2004 2003 2004 2003
------ ------ ------- ----------------- -------- --------- --------
(DOLLARS IN MILLIONS)
Revenue(1)
Long distance voice services................... $2,386 $2,895services................ $ 4,9992,364 $2,820 $ 5,8787,363 $ 8,698
Local voice services........................... 404 384 793 719services........................ 390 379 1,183 1,098
-------- ------ ------ --------------- -------
Total voice services............................. 2,790 3,279 5,792 6,597services.......................... 2,754 3,199 8,546 9,796
Data services.................................. 1,690 1,943 3,405 3,899services............................... 1,693 1,875 5,098 5,774
IP&E services.................................. 565 509 1,118 998services............................... 587 550 1,705 1,548
-------- ------ ------ --------------- -------
Total data and IP&E services(2).................. 2,255 2,452 4,523 4,897............... 2,280 2,425 6,803 7,322
Outsourcing, professional and other
services..... 566 697 1,168 1,393services.................................... 611 677 1,779 2,070
-------- ------ ------ --------------- -------
Total revenue.................................... $5,611 $6,428 $11,483 $12,887revenue................................. $ 5,645 $6,301 $ 17,128 $19,188
Operating income.................................(loss) income....................... $(11,095) $ 152413 $(10,860) $ 6011,613
Capital additions............................. $ 235391 $ 1,200
Capital additions................................995 $ 4631,324 $ 763 $ 933 $ 1,4012,396
AT AT
JUNESEPTEMBER 30, DECEMBER 31,
2004 2003
--------------------- ------------
(DOLLARS IN MILLIONS)
Total assets................................................ $32,468$20,813 $34,202
29
- ---------------
(1) Revenue includes equipment and product sales of $64$103 million and $70$83 million
for the three months ended JuneSeptember 30, 2004 and 2003, respectively, and
$138$241 and $140$223 for the sixnine months ended JuneSeptember 30, 2004 and 2003,
respectively.
(2) Prior to June 30, 2004, data services revenue included all international
managed services. Effective June 30, 2004, international managed services
revenue was divided into data services and IP&E services, consistent with
the classifications of domestic managed services. As a result, data services
revenue and IP&E services revenue for prior periods have been restated to
reflect this reclassification. Such reclassification had no impact on total
data and IP&E services revenue, or total revenue. Adjusted for this
reclassification, data services revenue for the three months ended March 31,
2004, December 31, 2003, September 30, 2003 and March 31, 2003, was $1,715 million, $1,847 million, $1,874$1,846
million and $1,956 million, respectively; and IP&E services revenue for the
same periods was $553 million, $554 million $550 million and $489 million, respectively.
25
REVENUE
AT&T Business Services revenue decreased $0.8$0.7 billion, or 12.7%10.4%, in the
secondthird quarter of 2004 and $1.4$2.1 billion, or 10.9%10.7%, in the first half ofnine months ended
September 30, 2004, compared with the same prior year periods.
On a sequential basis revenue increased $34 million, or 0.6% in the third
quarter of 2004 compared with quarter ending June 30, 2004. The sequential
revenue growth benefited from early termination of a prepaid capacity sale.
Excluding this item, revenue would have been flat, reflecting a positive impact
of higher equipment sales.
Long distance voice revenue in the secondthird quarter of 2004 declined $0.5
billion, or 17.6%16.3%, and declined $0.9$1.3 billion, or 15.0%15.4%, in the first half ofnine months ended
September 30, 2004, compared with the same prior year periods. TheThese declines
were driven by a decrease in the average price per minute in both the retail and
wholesale businesses combined with a decline in retail volumes, primarily due to
the impacts of competition and substitution. Partially offsetting these declines
was an increase in lower-priced wholesale minutes. Total long distance volumes
were
flatdeclined about 2% in the secondthird quarter of 2004 and grew about 1% inwere flat for the first half ofnine months
ended September 30, 2004, compared with the same prior year periods.
Data services revenue for the secondthird quarter of 2004 declined 13.0%,$0.2 billion,
or $0.3 billion,9.7%, compared with the secondthird quarter of 2003, and declined 12.7%,$0.7 billion, or
$0.5 billion,11.7%, for the sixnine months ended JuneSeptember 30, 2004, compared with the sixnine
months ended JuneSeptember 30, 2003. These declines were primarily driven by
competitive
pricing pressurecompetition, which has led to declining prices and customer losses primarily in
bandwidth and packet services, as well as weak demand, primarily in bandwidth and packet
services. The decrease is reflective of a rise in cancellations of private line
and packet services, as customers continue to evaluate the overall efficiency
and effectiveness of their own networks (network grooming), combined with the
migration to more cost-effective and technologically advanced IP&E services.
Excluding equipment and product sales, data services revenue declined 13.3%10.0% in
the secondthird quarter of 2004 and decreased 12.9%11.9% in the sixnine months ended JuneSeptember
30, 2004, compared with the comparable prior year periods.
Sequentially, data services revenue increased 0.2%. This growth was
positively impacted by the early termination of a prepaid capacity sale.
Excluding this item, data revenue would have declined slightly.
Outsourcing, professional and other services revenue decreased $0.1
billion,$66 million,
or 18.9%9.7%, in the secondthird quarter of 2004 compared with the secondthird quarter of 2003.
For the sixnine months ended JuneSeptember 30, 2004, outsourcing, professional and
other services revenue decreased $0.2$0.3 billion, or 16.2%14.1%, compared with the sixnine
months ended JuneSeptember 30, 2003. The decrease in both periods was largely due to
contract terminations and renegotiations. Positively impacting outsourcing,
professional and other services revenue for the quarter were strength in
government professional services and equipment and product sales. Excluding
equipment and product sales, outsourcing, professional and other services
revenue declined 19.2%14.0% in the secondthird quarter of 2004, and decreased 16.7%15.9% in the
sixnine months ended JuneSeptember 30, 2004, compared with the comparable prior year
periods.
30
Sequentially, outsourcing, professional and other services revenue
increased 8.1%, reflecting the favorable impact of higher equipment sales.
Excluding equipment and product sales, sequentially revenue increased 3.0%.
IP&E services revenue increased $56$37 million, or 11.3%6.8%, in the secondthird quarter
of 2004, and increased $0.1$0.2 billion, or 12.2%10.3%, in the sixnine months ended
JuneSeptember 30, 2004, compared with the same prior year periods. The increase was
primarily attributable to growth in our customer base associated with advanced
products such as IP-enabled frame and E-VPN (Enhanced Virtual Private Network). and IP-enabled frame.
Excluding equipment and product sales, IP&E services revenue increased 13.6%10.0% in
the secondthird quarter of 2004 compared with the secondthird quarter of 2003, and increased
12.5%11.7% in the sixnine months ended JuneSeptember 30, 2004, compared with the sixnine months
ended JuneSeptember 30, 2003.
Local voice services revenue grew $20$11 million, or 5.0%3.3%, in the secondthird
quarter of 2004, and grew $0.1 billion,$85 million, or 10.1%7.8%, in the sixnine months ended
JuneSeptember 30, 2004, compared with the same prior year periods. This growth
reflects our continued focus on increasing the utilization of our existing
footprint including growth of our "All-in-One" bundled offer to small
businesses. There were over 4.6nearly 4.7 million access lines in service at JuneSeptember
30, 2004, an increase of more than 85,000nearly 56,000 lines since the end of the firstsecond quarter
of 2004.
OPERATING (LOSS) INCOME
Operating income declined $0.4The operating (loss) of $11.1 billion or 74.7%, in the secondthird quarter of 2004 declined
$11.5 billion, compared with operating income of $0.4 billion in the secondthird
quarter of 2003,2003. The operating (loss) for the nine months ended September 30,
2004 of $10.9 billion reflected a decline of $12.5 billion, compared with
operating income of $1.6 billion for the same period of 2003. The operating
losses for the three and declined $1.0 billion, or
80.4%,nine months ended September 30, 2004, included asset
impairment and net restructuring and other charges of $11,859 million and
$12,002 million, respectively, compared with $53 million and $104 million in the
sixcomparable prior year periods. As a result of the third quarter 2004 asset
impairment charges, operating losses for the three and nine months ended
JuneSeptember 30, 2004, included a $499 million benefit due to lower depreciation on
assets impaired by AT&T Business Services, partly offset by lower
network-related charges to AT&T Consumer Services. Excluding the impacts of the
asset impairment and net restructuring and other charges for both periods,
operating margin was 4.7% and 3.8% for the three and nine months ended September
30, 2004, compared with the six months ended
June 30, 2003. These declines were primarily due to decreases7.4% and 9.0% in the comparable prior year periods. The
downward margin trend is primarily reflective of the declining higher-margin
long distance retail voice and data businesses resulting from the impacts of
competition, which led to pricing pressures and declining retail volumes, and
substitution.substitution, coupled with the shift to lower-margin advanced and wholesale
services. Partially offsetting these declines were ongoing cost control efforts.
Operating margin decreased to 2.7%efforts
and a $0.1 billion access expense adjustment recorded in the secondthird quarter of
2004, and to
2.0% for the first half of 2004, from 9.3% in both the second quarter and first
half of 2003. The downward margin trend is primarily reflective of the declining
higher-margin long distance retail voice and data businesses, coupled with the
shift to lower-margin advanced services and wholesale services.
26
Operating margin of 2.7% in the second quarter of 2004 increased 1.3
percentage points, compared with a margin of 1.4% in the first quarter of 2004,
reflecting favorable access expense settlements in the second quarter of 2004.
As competitive pricing pressures are expected to continue throughout the year,
this favorable margin trend is not expected to continue in the second half of
2004.
OTHER ITEMS
Capital additions were $0.5$0.4 billion in the secondthird quarter of 2004, and were
$1.0$1.3 billion for the sixnine months ended JuneSeptember 30, 2004. We continue to
concentrate the majority of capital spending on our advanced services offerings
of IP&E services and data services, both of which include managed services, as well as
local services.
Total assets declined $1.7$13.4 billion, or 5.1%39.1%, at JuneSeptember 30, 2004, from
December 31, 2003, primarily driven by lower net property, plant and equipment,
as a result of depreciationasset impairment charges recorded during the period, partially
offset by capital expenditures. This decline was also attributable to lower accounts receivable
driven by lower revenue and improved cash collections.
AT&T CONSUMER SERVICES
AT&T Consumer Services provides a variety of communication services to
residential customers. These services include traditional long distance voice
services such as domestic and international dial services (long distance or
local toll calls where the number "1" is dialed before the call) and calling
card services. Transaction services, such as prepaid card and operator-assisted
calls, are also offered. Collectively, these represent stand-alone long distance
services and are not offered in conjunction with any other service. In
31
addition, AT&T Consumer Services provides dial-up Internet services and all
distance services, which bundle long distance, local and local toll.
FOR THE THREE MONTHS FOR THE SIXNINE MONTHS
ENDED MONTHSSEPTEMBER 30, ENDED JUNESEPTEMBER 30,
JUNE 30,
--------------- ------------------------------------ --------------------
2004 2003 2004 2003
------ ------ ------ -------------- -------- -------- --------
(DOLLARS IN MILLIONS)
Revenue
Stand-alone long distance voice and other
services...................................... $1,327 $1,894 $2,789 $3,984services................................... $1,256 $1,813 $4,045 $5,797
Bundled services................................. 684 460 1,329 884services.............................. 724 521 2,053 1,405
------ ------ ------ ------
Total revenue...................................... $2,011 $2,354 $4,118 $4,868revenue................................... $1,980 $2,334 $6,098 $7,202
Operating income...................................income................................ $ 240281 $ 485503 $ 611 $1,118892 $1,621
Capital additions..................................additions............................... $ 159 $ 1914 $ 2837 $ 4155
AT AT
JUNESEPTEMBER 30, DECEMBER 31,
2004 2003
--------------------- ------------
(DOLLARS IN MILLIONS)
Total assets................................................ $885$777 $1,062
REVENUE
AT&T Consumer Services revenue declined $0.3$0.4 billion, or 14.6%15.2%, in the
secondthird quarter of 2004 and declined $0.7$1.1 billion, or 15.4%15.3%, in the first half ofnine months
ended September 30, 2004, compared with the same prior year periods. The decline
in both periods was primarily due to stand-alone long distance voice services,
which decreased $0.6$0.5 billion to $1.3$1.2 billion in the secondthird quarter of 2004 and
decreased $1.2$1.7 billion to $2.7$3.8 billion in the first half ofnine months ended September 30,
2004, largely due to the impact of ongoing competition, which has led to a loss
of market share, and substitution. In addition, stand-alone long distance voice
services have been negatively impacted by the continued migration of customers
to lower priced optional calling plans and other products offered by AT&T, such
as bundled services. Partially offsetting the declines in stand-alone long
distance voice services were pricing
actions we implemented, includingtargeted price increases during 2004, and for the
year-to-date period, a monthly fee that we began billing in mid-2003 to recover
costs, such as certain access charges and property taxes,
and targeted price increases during 2004.taxes. Partially offsetting
27
the overall revenue decline was an increase in bundled revenue. Bundled revenue
rose $0.2 billion to $0.7 billion in the secondthird quarter of 2004, and rose $0.4$0.6
billion to $1.3$2.1 billion in the first half ofnine months ended September 30, 2004, compared
with the same prior year periods, reflecting an increase in subscribers
primarily due to new markets entered into, as well as increased penetration in
existing markets.markets since third quarter of 2003. The increase in bundled revenue
includes amounts previously incorporated in stand-alone long distance voice
revenue for existing customers that migrated to bundled offers.
Total long distance calling volumes (including long distance volumes sold
as part of a bundle) declined approximately 18% in19% for both the second quarter of 2004,three months and
approximately 19% in the first half ofnine months ended September 30, 2004, compared with the same prior year
periods, primarily as a result of competition and wireless and Internet
substitution.
We provided stand-alone long distance voice services to more than 24.5
million customers at June 30, 2004, compared with more than 30.3 million
customers at December 31, 2003. We provided local service to more than 4.6
million customers as of June 30, 2004, compared with more than 3.9 million
customers as of December 31, 2003.
As a result of recent changes in regulatory policy governing local telephone
service, earlier this year we announced that we will be shifting our focus away
from traditional consumer services, such as wireline residential telephone
services, and we will no longer invest to acquire new residential local and
stand-alone long distance customers. We will continue to provide our existing
customers with quality service.
OPERATING INCOME
Operating income declined $0.2 billion, or 50.6%44.2%, in the secondthird quarter of
2004 and declined $0.5$0.7 billion, or 45.4%45.0%, in the sixnine months ended JuneSeptember 30,
2004, compared with the same periods inof 2003. Operating margin declined to 11.9%income for the three and
nine months ended September 30, 2004, included asset impairment and net
restructuring and other charges of $188 million and $189 million, respectively,
compared with $4 million and $9 million in the secondcomparable prior year periods. As
a result of the third quarter 2004 asset impairment charges,
32
operating income for the three and nine months ended September 30, 2004,
included a $38 million benefit due to lower depreciation on assets impaired by
AT&T Consumer Services, as well as lower network-related charges from AT&T
Business Services. Excluding the impacts of the asset impairment and net
restructuring and other charges for both periods, the operating margin for the
third quarter of 2004 from 20.6% inwas essentially flat compared with the secondthird quarter of
2003, as revenue declines were mitigated by lower overall operating costs.
Declines in selling, general and declinedadministrative expenses, which reflected the
impact of lower marketing and customer acquisition spending as a result of our
strategic decision in the third quarter of 2004 to 14.8%shift our focus away from
traditional consumer services, more than offset increased local connectivity
costs. On the same basis, the operating margin for the first half ofnine months ended
September 30, 2004, from 23.0% fordeclined approximately 5.5 percentage points compared with
the first half of
2003. The margin declines were largely driven by lower margins within our
stand-alone long distance voice business,same prior year period, primarily due to declines inlower revenue coupled with
increased local connectivity costs and a lowerslower rate of decline in operating expenses, particularly within selling,
general and administrative expenses.
Partially offsetting the declines
in stand-alone long distance margins were pricing actions taken. In addition,
operating margins declined due to increased spending on new initiatives,
including our Voice over Internet Protocol (VoIP) offering.
OTHER ITEMS
Total assets declined $0.2$0.3 billion at JuneSeptember 30, 2004, from December 31,
2003. The decline was primarily due to lower accounts receivable, reflecting
lower revenue and improved cash collections.collections, as well as decreases in
internal-use software and property, plant and equipment, net, primarily due to
the third quarter 2004 asset impairment charges.
CORPORATE AND OTHER
This group primarily reflects the results of corporate staff functions,
brand licensing fee revenue and the elimination of transactions between
segments.
FOR THE THREE MONTHS FOR THE SIXNINE MONTHS
ENDED MONTHSSEPTEMBER 30, ENDED JUNESEPTEMBER 30,
JUNE 30,
------------- --------------------------------- -------------------
2004 2003 2004 2003
----- ----- ----- ------------ ------ ------- -------
(DOLLARS IN MILLIONS)
Revenue................................................Revenue......................................... $ 13 $ 14 $ 1338 $ 2540
Operating (loss)................................ $(511) $(87) $(728) $(210)
Capital additions............................... $ 26
Operating (loss)....................................... $(44) $(57) $(217) $(123)
Capital additions......................................6 $198 $ 210 $ 8 $ 4 $ 12210
AT AT
JUNESEPTEMBER 30, DECEMBER 31,
2004 2003
--------------------- ------------
(DOLLARS IN MILLIONS)
Total assets................................................ $10,465$10,469 $12,724
28
OPERATING (LOSS)
Operating (loss) decreased $13 millionincreased $0.4 billion to $44 million$0.5 billion for the quarter
ended JuneSeptember 30, 2004, and increased $0.1$0.5 billion to $0.2$0.7 billion infor the
first halfnine months of 2004, compared with the same periods in 2003. The $0.1 billionthird
quarter increase in operating (loss) for the year-to-date period was primarily related to higher net
restructuring and other charges of $0.4 billion, primarily due to abenefit plan
curtailment and employee separation costs, and $50 million recorded in
connection with the settlement of an outstanding lawsuit. Also contributing to
the year-to-date increase in operating (loss) was $0.1 billion of real estate
impairment charge recorded in the first quarter of 2004charges to write-down held-for-sale facilities, someall of which were sold duringhave
been sold.
OTHER ITEMS
Capital additions decreased $0.2 billion for the secondthird quarter and nine
months ended September 30, 2004, compared with the same periods in 2003, as a
result of 2004.
OTHER ITEMS$0.2 billion of property, plant and equipment recorded in connection
with the adoption of FIN 46 on July 1, 2003.
Total assets decreased $2.3 billion to $10.5 billion at JuneSeptember 30, 2004,
from December 31, 2003. This decrease was primarily driven by a lower cash
balance of $1.9$1.8 billion at JuneSeptember 30, 2004, primarily resulting from debt
repurchases and scheduled repayments made induring the first half of 2004.period.
33
FINANCIAL CONDITION
AT AT
JUNESEPTEMBER 30, DECEMBER 31,
2004 2003
--------------------- ------------
Total assets................................................ $43,818$32,059 $47,988
Total liabilities........................................... $29,763$25,624 $34,032
Total shareowners' equity................................... $14,055$ 6,435 $13,956
TOTAL ASSETS decreased $4.2$15.9 billion, or 8.7%,33.2% to $43.8$32.1 billion at
JuneSeptember 30, 2004, compared with December 31, 2003. This decrease was2003, largely driven by a
$1.9reduction of $12.7 billion in property, plant and equipment resulting from asset
impairment charges and depreciation during the period, partially offset by
capital expenditures. Also contributing to the decline in total assets was a
decrease in cash and cash equivalents. Property, plant and
equipment declined $1.5 billion primarily as a resultequivalents of depreciation during the
period coupled with a real estate impairment charge, partially offset by capital
expenditures. Exclusive$1.7 billion. In addition, exclusive of
a $0.7 billion reclassification of restricted cash and hedge receivable to other
current assets relating to debt maturing in 2005, other assets declined $0.6$1.2
billion primarily due to a decrease in internal-use software resulting from
amortization during the period and an impairment charge, partially offset by
capital additions. Additionally, other assets declined due to the settlement of
a foreign currency swapswaps associated with the Euro debt repurchase in the first quarter of
2004.repurchases. Accounts
receivable declined $0.4$0.5 billion driven by lower revenue and
improved cash collections.collections and lower
revenue. These declines were partially offset by a deferred income tax benefit of $0.4 billionbenefits
recorded in the first quarter of 2004 in conjunction with the reversal of a portion of the valuation
allowance attributable to our prior investment in AT&T Latin America.America and as a
result of net restructuring and other charges during the period.
TOTAL LIABILITIES decreased $4.3$8.4 billion, or 12.5%24.7%, to $29.8$25.6 billion at
JuneSeptember 30, 2004, compared with December 31, 2003. ThisThe decrease was due in
part to a $4.3 billion reduction in deferred income taxes primarily associated
with the resultthird quarter 2004 asset impairments of $3.2 billionproperty, plant and equipment
and internal-use software. The decrease in total liabilities was also largely
attributable to lower debt balances of $3.9 billion, reflecting the early
retirement of $2.1$2.6 billion face value of debt and $0.4 billion of associated
mark-to-market adjustments, coupled with scheduled repayments of debt amounting
to $0.6
billion.$1.1 billion, partially offset by a $0.2 increase in short-term borrowings.
Accounts payable and accrued expenses declined $0.3$0.7 billion as payments were
made against year-end capital and other accruals. Also contributing to the
decline were lowerPartially offsetting these
declines was an increase in short-term and long-term compensation and
benefit-related liabilities of $0.3$0.9 billion, primarily attributable to higher
reserves for employee separations and increased pension and postretirement
liabilities due in part to the payment of year-end bonusbenefit curtailment and salary
accruals and employee separation reserves. Additionally, other current
liabilities declined $0.2 billion primarily due toremeasurement during the
period, partially offset by a declinereduction in income taxes
payable.compensation accruals.
TOTAL SHAREOWNERS' EQUITY increased $0.1decreased $7.5 billion, or 0.7%53.9%, to $14.1$6.4 billion
at JuneSeptember 30, 2004, compared with December 31, 2003. This increasedecrease was
primarily due to the net income, partially offsetloss for the period largely driven by the asset
impairment charges recorded in the third quarter, coupled with dividends
declared.
29
LIQUIDITY
FOR THE SIXNINE MONTHS
ENDED JUNESEPTEMBER 30,
---------------------
2004 2003
--------- ---------
(DOLLARS IN MILLIONS)
CASH FLOWS:
Provided by operating activities.......................... $ 2,4634,011 $ 4,3537,113
(Used in) investing activities............................ (944) (1,720)(1,340) (2,389)
(Used in) financing activities............................ (3,413) (5,391)(4,397) (5,987)
------- -------
Net (decrease) in cash and cash equivalents............... $(1,894) $(2,758)$(1,726) $(1,263)
======= =======
Net cash provided by operating activities of $2.5$4.0 billion for the sixnine
months ended JuneSeptember 30, 2004, declined $1.9$3.1 billion, from $4.4$7.1 billion in the
comparable prior year period, which was in part driven by a decrease in
operating income reflective of the declining
stand-alone long distance voice and data businesses. The downward trend in cash
generated by operating activities was also impacted by a $0.7$1.3 billion decline in
income tax refunds received in the first halfnine
34
months of 2004 compared with the same prior year period. Favorably impacting
cash flow in 2004 compared with 2003, was a $0.3 billion decline in interest
payments resulting from our ongoing deleveraging efforts.
AT&T's investing activities resulted in a net use of cash of $0.9$1.3 billion
in the sixnine months ended JuneSeptember 30, 2004, compared with $1.7$2.4 billion in the
first sixnine months of 2003, primarily reflecting a reduction in capital
expenditures.
During the first halfnine months of 2004, net cash used in financing activities
was $3.4$4.4 billion, compared with $5.4$6.0 billion in the first halfnine months of 2003.
In the first halfnine months of 2004, we made net payments of $3.4$4.2 billion to reduce
debt (including redemption premiums and foreign currency mark-to-market
payments), primarily reflecting the early termination of debt, and paid
dividends of $0.4$0.6 billion. Reflected as an other financing item was the receipt
of approximately $0.4 billion for the settlement of a combined interest rate
foreign currency swap agreementagreements in conjunction with the early repayment of Euro
notes in the first halfnine months of 2004 (such repayment is included as retirement
of long-term debt). During the first halfnine months of 2003, we made net payments
of $5.3$5.8 billion to reduce debt, including the early termination of debt, paid
dividends of $0.3$0.4 billion and received $0.1$0.2 billion of cash collateral related
to favorable positions of certain combined interest rate foreign currency swap
agreements.
WORKING CAPITAL AND OTHER SOURCES OF LIQUIDITY
At JuneSeptember 30, 2004, our working capital ratio (current assets divided by
current liabilities) was 0.99.
At June 30,0.98.
On October 6, 2004, we hadentered into a $2.0$1.0 billion syndicated 364-day
credit facility available to usled by J.P. Morgan Securities Inc., Citigroup Global Markets
Inc. and Banc of America Securities LLC that was entered into on October 8, 2003. This credit facility
provides the option to extend the maturity of any borrowings outstanding under
the facility for an additional 364-day period beyond October 7, 2004.replaced our existing $2.0 billion
facility. No borrowings are currently outstanding under the facility. Up to $0.3$0.5
billion of the facility can be utilized to support letters of credit, which
reduces the amount available. As of JuneSeptember 30, 2004, approximately $0.2
billion of letters of credit were supported by the facility. No assurance can be givenfacility in place at that
the
facility will be renewed and if the facility is renewed it may be for a
substantially lesser amount and/or on substantially less favorable terms. If the
facility is not renewed, we would expect to be required to post cash collateral
to support the letters of credit previously supported by the facility.time.
In July 2004, we renewed our AT&T Business Services and AT&T Consumer
Services 364-day customer accounts receivable securitization facilities.
Together the programs provide up to $1.35 billion of available financing,
limited by the eligible receivablesreceivable balances, which vary from month to month.
Proceeds from the securitizations are recorded as borrowings and included in
short-term debt. At JuneSeptember 30, 2004, approximately $0.2$0.3 billion was
outstanding.outstanding under the facilities.
The credit facility and the securitization facilities contain a financial
covenant that requires AT&T to meet a debt-to-EBITDA ratio (as defined in the
agreements) not exceeding 2.25 to 1 and an EBITDA-to-net 30
interest expense ratio
(as defined in the agreements) of at least 3.50 to 1 for four consecutive
quarters ending on the last day of each fiscal quarter. At JuneSeptember 30, 2004,
we were in compliance with these covenants. Pursuant to the definitions in the
agreements, asset impairment and business restructuring charges have no impact
on the EBITDA financial covenants in the facilities.
We anticipate continuing to fund our operations in 2004 primarily with cash
and cash equivalents on hand, as well as with cash from operations. If economic
conditions worsen or do not improve and/or competition and product substitution
accelerate beyond current expectations, our cash flows from operations would
decrease, negatively impacting our liquidity. However, we believe our access to
the capital markets is adequate to provide the flexibility we desire in funding
our operations. Sources of liquidity, in addition to our substantial cash and
cash equivalents on hand, include $2.4 billion remaining under a universal shelf
registration; a $1.35 billion securitization program (limited by eligible
receivables); and a $2.0$1.0 billion credit facility, which expires on October 6,
2004.facility. In light of the recent
lowering of our commercial paper ratings discussed below, there is no longer any
assurance that we will continue to have any significant access to the commercial
paper market. The maximum amount of commercial paper outstanding during the
first halfnine months of 2004 was approximately $1.0 billion. At September 30, 2004,
there was $62 million of commercial paper outstanding, all of which has since
matured. We cannot provide any assurances that any or all of these other sources
of funding will be available at the time they are needed or in the amounts
required.
35
CREDIT RATINGS AND RELATED DEBT IMPLICATIONS
SinceDuring the endthird quarter of the second quarter,2004, AT&T's long-term and short-term and
commercial paper credit ratings have beenwere lowered by Standard & Poor's (S&P), Moody's
and Fitch, as reflected in the table below. The rating actions by S&P and
Moody's triggered a 100 basis point interest rate step-up on approximately $6.5
billion in notional amount of debt, net of foreign currency hedge offsets.offsets
(current carrying value of $6.8 billion). This step-up is effective for interest
payment periods that will begin afterin November 2004, resulting in an expected
increase in interest expense of approximately $10 million in 2004 and $70$68
million in 2005. Currently, none of AT&T's ratings are under review or on
CreditWatch for further downgrade.
SHORT-TERM LONG-TERM
CREDIT RATING AGENCY RATING RATING OUTLOOK
- -------------------- ---------- --------- --------
Standard & Poor's....................................Poor's................................... B BB+ Negative
Fitch................................................Fitch............................................... B BB+ Negative
Moody's..............................................Moody's............................................. NP Ba1 Negative
Our access to capital markets as well as the cost of our borrowings are
affected by our debt ratings. The recent rating actions discussed above and
further debt rating downgrades will require us to pay higher rates on certain
existing debt and have required us to post cash collateral for certain
interest-rate swaps in which we were in a net payable position.
Further
downgrades may require us to post collateral for certain equity swaps.
Additionally, if our debt ratings are further downgraded, our access to the
capital markets may be further restricted and/or such replacement financing may
be more costly or have additional covenants than we had in connection with our
debt at JuneSeptember 30, 2004. In addition, the market environment for financing in
general, and within the telecommunications sector in particular has been
adversely affected by economic conditions and bankruptcies of other
telecommunications providers.
AT&T Corp. is generally the obligor for debt issuances. However, there are
some instances where AT&T Corp. is not the obligor, for example, the
securitization facilities and certain capital leases. The total debt of these
entities, which are fully consolidated, is approximately $0.3$0.4 billion at
JuneSeptember 30, 2004, and is included within short-term and long-term debt.
CASH REQUIREMENTS
Our cash needs for 2004 will be primarily related to capital expenditures,
repayment of debt and payment of dividends. We expect our capital expenditures
for 2004 to be approximately $1.8 billion.
In the first halfquarter of 2004, we completed the repurchase, for cash, of
$1.2 billion of our $1.5 billion outstanding 6.5% Notes maturingdue in November 2006,
which carried an interest rate of 7.25% at2006.
Also in the time of retirement. Also,first quarter, we repurchased, for cash, $0.9 billion of our
outstanding $1.8 billion 6.0% Euro Notes due 31
November 2006, which carried an2006. During the third
quarter of 2004, we completed the repurchase, for cash, of $0.3 billion of U.S.
dollar denominated long-term debt, with interest raterates ranging from 6.0% to
7.75%, and maturities from 2005 through 2009. Also in the third quarter, we
repurchased, for cash, $0.1 billion of 6.75% at the time of
retirement.6.0% Euro Notes due in November 2006. The
$0.9 billion and $0.1 billion Euro denominated notes representsrepurchased in the first
and third quarters, respectively, represent the original U.S. dollar issuance
amountamounts and excludesexclude the foreign currency mark-to-market adjustments that were
hedged.
These redemptions are partAs we near the completion of our plan,2004 debt buy-back program, as announced
in January 2004 to repurchase up to $3.0 billion of debt which may
takein the form of calls,
tender offers or open market transactions, and is
expected to be completedwe may make additional purchases
subject to market conditions during 2004.conditions. The transactionsrepurchases completed during the first half ofthus far in 2004 are
expected to save approximately $0.1 billion in interest expense in 2004.
CONTRACTUAL CASH OBLIGATIONS
We have contractual obligations to purchase certain goods or services from
various other parties. During the first halfnine months of 2004, we entered into
contracts under which we are legally obligated for payment of approximately $70
million in 2004. Also during the first halfnine months of 2004, we entered into
contracts under which we have calculated the minimum obligation for such
agreements based on termination fees that can be
36
paid to exit the contract. Further, during this period, we exited certain
contracts that contained termination fees that were renegotiated and not paid.
The net effect of this activity on termination fees, which are considered to be
the minimum obligation under the contracts, in each year would be an increase of
approximately $83 million in 2004, $76$56 million in 2005, $64$50 million in 2006, $98
million in 2007, $88 million in 2008, or $50 million in 2009 and beyond.
OTHER COMMERCIAL COMMITMENTS
AT&T provided a guarantee of an obligation that AT&T Wireless has to NTT
DoCoMo. Under this guarantee, AT&T would have been secondarily liable for up to
$3.65 billion, plus accrued interest, in the event AT&T Wireless was unable to
satisfy its entire obligation to NTT DoCoMo. AT&T's guarantee expired on June
30, 2004, in accordance with the terms of the original agreement.
RISK MANAGEMENT
We are exposed to market risk from changes in interest and foreign exchange
rates, as well as changes in equity prices associated with previously affiliated
companies. In addition, we are exposed to market risk from fluctuations in
prices of securities. On a limited basis, we use certain derivative financial
instruments, including interest rate swaps, foreign exchange contracts, combined
interest rate foreign currency contracts, options, forwards, equity hedges and
other derivative contracts, to manage these risks. We do not use financial
instruments for trading or speculative purposes. All financial instruments are
used in accordance with board-approved policies.
NEW ACCOUNTING PRONOUNCEMENTS
On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the Act) was signed into law. The Act introduces a
prescription drug benefit under Medicare (Medicare Part D) as well as a federal
subsidy to sponsors of retiree health care benefit plans that provide a benefit
that is at least actuarially equivalent to Medicare Part D. We are impacted by
the Act since we sponsor postretirement health care plans that provide
prescription drug benefits. We have elected to defer recognition ofOn May 19, 2004, the Act in
accordance with Financial Accounting Standards
Board (FASB) issued FASB Staff Position ("FSP") No. FAS 106-1, "Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act of 2003." As a
result, any measures of the accumulated postretirement benefit obligation or net
periodic postretirement benefit cost do not reflect the effects of the Act on
the plans.
On May 19, 2004, the FASB issued FSP No. FAS 106-2, "Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003.2003," This Staff Position supersedes FSP No. FAS 106-1
andwhich provides guidance on accounting for the
effects of the new Medicare prescription drug legislation by employers whose
prescription drug benefits are actuarially equivalent to the drug benefit under
Medicare Part D.
The provisions
ofWe adopted FSP No. FAS 106-2 are effective for the first interim or annual period
beginning after June 15,July 1, 2004, and accordingly, wehave elected a
prospective application, which required the remeasurement of our postretirement
plan to adopt them effective
32
assets and accumulated postretirement benefit obligation (APBO) as of July
1, 2004. The FSP provides two alternative methods of transition, either
retroactive application to the date of enactment or, the method we have
selected, prospective application from the date of adoption.
FederalHowever, federal regulations for determining actuarial equivalence have
not yet been issued in either proposed or final form, which impacts our ability to estimaterecognize the
full adoption effects of the FSP.Act. Despite the lack of final federal regulations,
we believe that the prescription drug benefits provided to a specific portion of
our postretirement benefit plan participants would be deemed to be actuarially
equivalent to Medicare Part D benefits based on the benefits provided under the
plan. The estimated impact uponsubsidy-related reduction in the APBO related to the adoption for this
group will
be a reduction in the accumulated postretirement benefit obligation of
approximately $150 million to $175was $161 million, which will be amortized to income over time as an
actuarial gain. In addition, we will realizeDuring the third quarter, the amortization of the actuarial gain
as well as a reduction of interest cost resulted in a reduction to net periodic
postretirement benefit cost (recorded within SG&A and costs of services and
products) of approximately $10 million over the second half of 2004. Without
a firm definition of actuarial equivalence,$6 million.
As we are unable to determine if the prescription drug benefits provided to
the remaining plan participants are actuarially equivalent to Medicare Part D
benefits and are therefore unable to
quantifyuntil a firm definition of actuarial equivalence is issued, we have not
recorded any potential impact atof the Act for this time.
SUBSEQUENT EVENTS
On July 22, 2004, we announced that as a result of recent changes in
regulatory policy governing local telephone service, we will be shifting our
focus away from traditional consumer services, and we will no longer be
investing to acquire new residential local and stand-alone long distance
customers. We plan to concentrate our investments going forward on business
markets and emerging technologies.
In July 2004, Moody's and Fitch lowered our long-term credit ratings to Ba1
and BB+, respectively, and lowered our short-term credit and commercial paper
ratings to NP (not prime) and B, respectively. In August 2004, S&P lowered our
long-term credit rating to BB+ and lowered our short-term credit and commercial
paper rating to B. The rating actions by Moody's and S&P triggered a 100 basis
point interest rate step-up on approximately $6.5 billion in notional amount of
debt net of foreign currency hedge offsets. This step-up is effective for
interest payment periods that will begin after November 2004, resulting in an
expected increase in interest expense of approximately $10 million in 2004 and
$70 million in 2005.group.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we completed an
evaluation, under the supervision and with the participation of our management
including our Chief Executive Officer and Chief Financial Officer,
37
of the effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Exchange Act Rules 13a-15 or 15d-15. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures are effective in alerting
them timely to material information required to be included in our Exchange Act
filings. There have not been any changes in our internal controls over financial
reporting identified in connection with the evaluation required by Exchange Act
Rules 13a-15 or l5d-15 or otherwise that occurred during our last fiscal quarter
that has materially affected, or is reasonably likely to materially affect, our
internal controls over financial reporting.
33
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Refer to Part 1, Footnote 10, "Commitments and Contingencies" for
discussion of certain legal proceedings.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS AND ISSUER PURCHASES OF
EQUITY SECURITIES
The following table contains information about our purchases of our equity
securities during the secondthird quarter of 2004.
ISSUER PURCHASES OF EQUITY SECURITIES
MAXIMUM NUMBER
TOTAL NUMBER OF (OR APPROXIMATE
OF SHARES (OR UNITS) DOLLAR VALUE) OF
PURCHASED AS(OR UNITS) SHARES OR UNITS
THAT
TOTAL NUMBER OF AVERAGE PRICE PURCHASED AS THAT MAY YET
OF SHARES PAID PER PART OF PUBLICLY MAY YET BE SHARESPURCHASED
(OR UNITS) PAID PER SHARE ANNOUNCED PLANS PURCHASED UNDER THE PLANS
PERIOD PURCHASED(1) (OR UNIT) OR PROGRAMS PLANS OR PROGRAMS
- ------ ----------------- --------------- ----------------- --------------------------------- -------------- ---------------- ----------------
AprilJuly 1, 2004 to April 30, 2004..... 7,799 $18.8087July 31, 2004...... 5,115 $16.6727 0 0
MayAugust 1, 2004 to MayAugust 31,
2004........... 13,064 $16.95912004............................. 12,983 $14.0650 0 0
JuneSeptember 1, 2004 to JuneSeptember 30,
2004........... 10,875 $16.78532004............................. 8,262 $14.6481 0 0
Total.............. 31,738 $17.3541Total......................... 26,360 $14.7538 0 0
- ---------------
(1) Represents restricted stock units redeemed to pay taxes related to the
vesting of restricted stock units awarded under employee benefit plans.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
(a) The annual meeting of the shareholders of the registrant was held on
May 19, 2004.
(b) Election of Directors
VOTES
--------------
NOMINEE FOR WITHHELD
- ------- --- --------
(MILLIONS)
William F. Aldinger......................................... 600 68
Kenneth T. Derr............................................. 610 57
David W. Dorman............................................. 645 23
M. Kathryn Eickoff.......................................... 622 45
Herbert L. Henkel........................................... 648 20
Frank C. Herringer.......................................... 600 68
Shirley Ann Jackson......................................... 606 61
Jon C. Madonna.............................................. 627 41
Donald F. McHenry........................................... 619 48
Tony L. White............................................... 621 47
34
(c) Holders of common shares voted at this meeting on the following
matters, which were set forth in the registrant's proxy statement dated March
25, 2004.
(i) Ratification of Auditors
FOR AGAINST ABSTAIN
------- ------- -------
Ratification of the firm of PricewaterhouseCoopers, LLP
as the independent auditors to audit the registrant's
financial statements for the year 2004.(*)............. 620 37 11
(94.39)% (5.61)%
(ii) Shareholders' Proposals
FOR AGAINST ABSTAIN NON-VOTE
------ ------- ------- --------
AT&T 2004 Long Term Incentive Program(*)........ 416 123 12 117
(77.17)% (22.83)%
Establish Term Limits For Directors(*).......... 30 508 13 117
(5.66)% (94.34)%
Poison Pill Provision(*)........................ 358 179 14 117
(66.65)% (33.35)%
Separate the Chair and CEO Position(*).......... 138 400 12 117
(25.65)% (74.35)%
Executive Compensation(*)....................... 48 486 17 117
(8.95)% (91.05)%
- ---------------
(*) Percentages are based on the total common shares voted. Approval of this
proposal required a majority of the votes.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
EXHIBIT
NUMBER
- -------
10(iii)(A)1 AT&T 2004 Long Term Incentive Plan (incorporated by
reference to Exhibit 4.1 to Form S-8 filed on May 26, 2004,
File No. 1-1105)
10(iii)(A)2 AT&T Senior Officer Severance Plan effective October 9,
1997, as amended October 30, 1997 (incorporated by reference
to Exhibit (10)(iii)(A)18 to Form 10-K for 1997, File No.
1-1105), and as amended, restated and renamed AT&T Senior
Officer Separation Plan as of January 1, 2003 including Form
of Amendment of Appendix A of AT&T Senior Officer Severance
Plan dated as of July 28, 2003 (incorporated by reference to
Exhibit 10(iii)(A)5 to Form 10-Q for third quarter 2003,
File No. 1-1105). AT&T Senior Officer Separation Plan as
amended and restated May 19, 2004
10(iii)(A)3 Summary of actions taken to amend the definition of "Change
in Control" in AT&T benefit plans and programs generally
10(iii)(A)4 AT&T Deferred Compensation Plan for Non-Employee Directors,
as amended December 15, 1993 (incorporated by reference to
Exhibit (10) (iii)(A)6 to Form 10-K for 1993, File No.
1-1105). AT&T Corp. Deferred Compensation Plan for
Non-Employee Directors as amended May 18, 2004
12 Computation of Ratio of Earnings to Fixed ChargesCharges.
31.1 Certification by CEO pursuant to Rule 13a-14(a) or 15d-14(a)
of the Securities Exchange Act of 1934, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
35
EXHIBIT
NUMBER
-------
2002.
31.2 Certification by CFO pursuant to Rule 13a-14(a) or 15d-14(a)
of the Securities Exchange Act of 1934, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 20022002.
32.1 Certification by CEO pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
20022002.
32.2 Certification by CFO pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
20022002.
38
(b) Reports on Forms 8-K:
During the secondthird quarter of 2004, the following Forms 8-K were filed and/or
furnished: Form 8-K dated AprilJuly 22, 2004 was filed pursuant to Item 5
(Other Events and Regulation FD disclosure) Item 7 (Financial
Statements, Pro Forma Financial Information and Exhibits) and Item 12 (Results
of Operations and Financial Condition) on April 26,July 23, 2004.
3639
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AT&T CORP.
By: /s/ C. R. REIDY
--------------------------------------------------------------------------
By: Christopher R. Reidy
Vice President and Controller
Date: August 3,November 4, 2004
3740
EXHIBIT INDEX
EXHIBIT
NUMBER
- -------
10(iii)(A)1 AT&T 2004 Long Term Incentive Plan (incorporated by
reference to Exhibit 4.1 to Form S-8 filed on May 26, 2004,
File No. 1-1105)
10(iii)(A)2 AT&T Senior Officer Severance Plan effective October 9,
1997, as amended October 30, 1997 (incorporated by reference
to Exhibit (10)(iii)(A)18 to Form 10-K for 1997, File No.
1-1105), and as amended, restated and renamed AT&T Senior
Officer Separation Plan as of January 1, 2003 including Form
of Amendment of Appendix A of AT&T Senior Officer Severance
Plan dated as of July 28, 2003 (incorporated by reference to
Exhibit 10(iii)(A)5 to Form 10-Q for third quarter 2003,
File No. 1-1105). AT&T Senior Officer Separation Plan as
amended and restated May 19, 2004
10(iii)(A)3 Summary of actions taken to amend the definition of "Change
in Control" in AT&T benefit plans and programs generally
10(iii)(A)4 AT&T Deferred Compensation Plan for Non-Employee Directors,
as amended December 15, 1993 (incorporated by reference to
Exhibit (10)(iii)(A)6 to Form 10-K for 1993, File No.
1-1105). AT&T Corp. Deferred Compensation Plan for
Non-Employee Directors as amended May 18, 2004
12 Computation of Ratio of Earnings to Fixed ChargesCharges.
31.1 Certification by CEO pursuant to Rule 13a-14(a) or 15d-14(a)
of the Securities Exchange Act of 1934, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 20022002.
31.2 Certification by CFO pursuant to Rule 13a-14(a) or 15d-14(a)
of the Securities Exchange Act of 1934, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 20022002.
32.1 Certification by CEO pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
20022002.
32.2 Certification by CFO pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
20022002.
38