Form 10-Q AT&T INC. For: Mar 31

 

PART I - FINANCIAL INFORMATION

AT&T INC.
CONSOLIDATED STATEMENTS OF INCOME
Dollars in millions except per share amounts
(Unaudited)
		Three Months Ended
		March 31,
		2016				2015
Operating Revenues
Service		$	37,101			$	28,962
Equipment			3,434				3,614
Total operating revenues			40,535				32,576
Operating Expenses
Cost of services and sales
Equipment			4,375				4,546
Broadcast, programming and operations			4,629				1,122
Other cost of services (exclusive of depreciation
and amortization shown separately below)			9,396				8,812
Selling, general and administrative			8,441				7,961
Depreciation and amortization			6,563				4,578
Total operating expenses			33,404				27,019
Operating Income			7,131				5,557
Other Income (Expense)
Interest expense			(1,207	)			(899	)
Equity in net income of affiliates			13				-
Other income (expense) – net			70				70
Total other income (expense)			(1,124	)			(829	)
Income Before Income Taxes			6,007				4,728
Income tax expense			2,122				1,389
Net Income			3,885				3,339
Less: Net Income Attributable to Noncontrolling Interest			(82	)			(76	)
Net Income Attributable to AT&T		$	3,803			$	3,263
Basic Earnings Per Share Attributable to AT&T		$	0.62			$	0.63
Diluted Earnings Per Share Attributable to AT&T		$	0.61			$	0.63
Weighted Average Number of Common Shares Outstanding – Basic (in millions)			6,172				5,203
Weighted Average Number of Common Shares Outstanding – with Dilution (in millions)			6,190				5,219
Dividends Declared Per Common Share		$	0.48			$	0.47
See Notes to Consolidated Financial Statements.

 

2

AT&T INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Dollars in millions
(Unaudited)
		Three months ended
		March 31,
		2016				2015
Net income		$	3,885			$	3,339
Other comprehensive income, net of tax:
Foreign currency:
Foreign currency translation adjustment, net of taxes of $(10) and $(104)			(44	)			(186	)
Available-for-sale securities:
Net unrealized gains (losses), net of taxes of $(15) and $19			(26	)			33
Reclassification adjustment included in net income, net of taxes of $(2) and $(3)			(3	)			(5	)
Cash flow hedges:
Net unrealized gains (losses), net of taxes of $67 and $(190)			124				(354	)
Reclassification adjustment included in net income, net of taxes of $5 and $4			10				7
Defined benefit postretirement plans:
Amortization of net prior service credit included in net income, net of taxes of $(131)              and $(131)			(215	)			(215	)
Other comprehensive income (loss)			(154	)			(720	)
Total comprehensive income			3,731				2,619
Less: Total comprehensive income attributable to noncontrolling interest			(82	)			(76	)
Total Comprehensive Income Attributable to AT&T		$	3,649			$	2,543
See Notes to Consolidated Financial Statements.

 

3

AT&T INC.
CONSOLIDATED BALANCE SHEETS
Dollars in millions except per share amounts
		March 31,				December 31,
		2016				2015
Assets		(Unaudited)
Current Assets
Cash and cash equivalents		$	10,008			$	5,121
Accounts receivable - net of allowances for doubtful accounts of $697 and $704			16,070				16,532
Prepaid expenses			1,378				1,072
Other current assets			10,545				13,267
Total current assets			38,001				35,992
Property, plant and equipment			309,380				306,227
Less: accumulated depreciation and amortization			(185,926	)			(181,777	)
Property, Plant and Equipment – Net			123,454				124,450
Goodwill			104,651				104,568
Licenses			94,130				93,093
Customer Lists and Relationships - Net			17,197				18,208
Other Intangible Assets – Net			9,108				9,409
Investments in Equity Affiliates			1,594				1,606
Other Assets			15,503				15,346
Total Assets		$	403,638			$	402,672
Liabilities and Stockholders' Equity
Current Liabilities
Debt maturing within one year		$	8,399			$	7,636
Accounts payable and accrued liabilities			26,169				30,372
Advanced billing and customer deposits			4,550				4,682
Accrued taxes			2,455				2,176
Dividends payable			2,955				2,950
Total current liabilities			44,528				47,816
Long-Term Debt			122,104				118,515
Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes			57,489				56,181
Postemployment benefit obligation			34,114				34,262
Other noncurrent liabilities			20,998				22,258
Total deferred credits and other noncurrent liabilities			112,601				112,701
Stockholders' Equity
Common stock ($1 par value, 14,000,000,000 authorized at March 31, 2016 and
December 31, 2015: issued 6,495,231,088 at March 31, 2016 and December 31, 2015)			6,495				6,495
Additional paid-in capital			89,414				89,763
Retained earnings			34,506				33,671
Treasury stock (339,006,986 at March 31, 2016 and 350,291,239
at December 31, 2015, at cost)			(12,163	)			(12,592	)
Accumulated other comprehensive income			5,180				5,334
Noncontrolling interest			973				969
Total stockholders' equity			124,405				123,640
Total Liabilities and Stockholders' Equity		$	403,638			$	402,672
See Notes to Consolidated Financial Statements.

 

4

AT&T INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Dollars in millions
(Unaudited)
		Three months ended
		March 31,
		2016				2015
Operating Activities
Net income		$	3,885			$	3,339
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			6,563				4,578
Undistributed earnings from investments in equity affiliates			(13	)			-
Provision for uncollectible accounts			374				285
Deferred income tax expense			1,346				252
Net gain from sale of investments, net of impairments			(44	)			(33	)
Changes in operating assets and liabilities:
Accounts receivable			627				739
Other current assets			612				408
Accounts payable and accrued liabilities			(4,006	)			(1,817	)
Retirement benefit funding			(140	)			(140	)
Other - net			(1,304	)			(873	)
Total adjustments			4,015				3,399
Net Cash Provided by Operating Activities			7,900				6,738
Investing Activities
Construction and capital expenditures:
Capital expenditures			(4,451	)			(3,848	)
Interest during construction			(218	)			(123	)
Acquisitions, net of cash acquired			(165	)			(19,514	)
Dispositions			81				8
Sale of securities, net			445				1,890
Net Cash Used in Investing Activities			(4,308	)			(21,587	)
Financing Activities
Issuance of long-term debt			5,978				16,572
Repayment of long-term debt			(2,296	)			(596	)
Issuance of treasury stock			89				8
Dividends paid			(2,947	)			(2,434	)
Other			471				(2,860	)
Net Cash Provided by Financing Activities			1,295				10,690
Net increase (decrease) in cash and cash equivalents			4,887				(4,159	)
Cash and cash equivalents beginning of year			5,121				8,603
Cash and Cash Equivalents End of Period		$	10,008			$	4,444
Cash paid (received) during the three months ended March 31 for:
Interest		$	1,459			$	1,021
Income taxes, net of refunds		$	477			$	(247	)
See Notes to Consolidated Financial Statements.

 

5

AT&T INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Dollars and shares in millions except per share amounts
(Unaudited)
		March 31, 2016
		Shares				Amount
Common Stock
Balance at beginning of year			6,495			$	6,495
Issuance of stock			-				-
Balance at end of period			6,495			$	6,495
Additional Paid-In Capital
Balance at beginning of year						$	89,763
Issuance of treasury stock							(41	)
Share-based payments							(308	)
Balance at end of period						$	89,414
Retained Earnings
Balance at beginning of year						$	33,671
Net income attributable to AT&T ($0.61 per diluted share)							3,803
Dividends to stockholders ($0.48 per share)							(2,968	)
Balance at end of period						$	34,506
Treasury Stock
Balance at beginning of year			(350	)		$	(12,592	)
Issuance of treasury stock			11				429
Balance at end of period			(339	)		$	(12,163	)
Accumulated Other Comprehensive Income Attributable to AT&T, net of tax
Balance at beginning of year						$	5,334
Other comprehensive loss attributable to AT&T							(154	)
Balance at end of period						$	5,180
Noncontrolling Interest
Balance at beginning of year						$	969
Net income attributable to noncontrolling interest							82
Distributions							(78	)
Balance at end of period						$	973
Total Stockholders' Equity at beginning of year						$	123,640
Total Stockholders' Equity at end of period						$	124,405
See Notes to Consolidated Financial Statements.

 

6

		Three months ended
		March 31,
		2016				2015
Numerators
Numerator for basic earnings per share:
Net income		$	3,885			$	3,339
Less:  Net income attributable to noncontrolling interest			(82	)			(76	)
Net income attributable to AT&T			3,803				3,263
Dilutive potential common shares:
Share-based payment			4				4
Numerator for diluted earnings per share		$	3,807			$	3,267
Denominators (000,000)
Denominator for basic earnings per share:
Weighted-average number of common shares outstanding			6,172				5,203
Dilutive potential common shares:
Share-based payment (in shares)			18				16
Denominator for diluted earnings per share			6,190				5,219
Basic earnings per share attributable to AT&T		$	0.62			$	0.63
Diluted earnings per share attributable to AT&T		$	0.61			$	0.63

At March 31, 2016, and for the period ended:
		Foreign Currency Translation Adjustment			Net Unrealized Gains (Losses) on Available- for-Sale Securities			Net Unrealized Gains (Losses) on Cash Flow Hedges			Defined Benefit Postretirement Plans			Accumulated Other Comprehensive Income
Balance as of December 31, 2015		$	(1,198)		$	484		$	16		$	6,032		$	5,334
Other comprehensive income    (loss) before reclassifications			(44)			(26)			124			-			54
Amounts reclassified    from accumulated OCI			-	1		(3)	2		10	3		(215)	4		(208)
Net other comprehensive    income (loss)			(44)			(29)			134			(215)			(154)
Balance as of March 31, 2016		$	(1,242)		$	455		$	150		$	5,817		$	5,180
At March 31, 2015, and for the period ended:
		Foreign Currency Translation Adjustment			Net Unrealized Gains (Losses) on Available- for-Sale Securities			Net Unrealized Gains (Losses) on Cash Flow Hedges			Defined Benefit Postretirement Plans			Accumulated Other Comprehensive Income
Balance as of December 31, 2014		$	(26)		$	499		$	741		$	6,847		$	8,061
Other comprehensive income    (loss) before reclassifications			(186)			33			(354)			-			(507)
Amounts reclassified    from accumulated OCI			-	1		(5)	2		7	3		(215)	4		(213)
Net other comprehensive    income (loss)			(186)			28			(347)			(215)			(720)
Balance as of March 31, 2015		$	(212)		$	527		$	394		$	6,632		$	7,341
1	Translation (gain) loss reclassifications are included in Other income (expense) - net in the consolidated statements of income.
2	(Gains) losses are included in Other income (expense) - net in the consolidated statements of income.
3	(Gains) losses are included in interest expense in the consolidated statements of income. See Note 6 for additional information.
4	The amortization of prior service credits associated with postretirement benefits, net of amounts capitalized as part of construction labor, are included in Cost of services and sales and Selling, general and administrative in the consolidated statements of income (see Note 5).

For the three months ended March 31, 2016
		Revenue			Operations and Support Expenses			EBITDA			Depreciation and Amortization			Operating Income (Loss)			Equity in Net Income (Loss) of Affiliates			Segment Contribution
Business Solutions	$	17,609		$	10,802		$	6,807		$	2,508		$	4,299		$	-		$	4,299
Entertainment Group		12,658			9,578			3,080			1,488			1,592			3			1,595
Consumer Mobility		8,328			4,912			3,416			922			2,494			-			2,494
International		1,667			1,588			79			277			(198)			14			(184)
Segment Total		40,262			26,880			13,382			5,195			8,187		$	17		$	8,204
Corporate and Other		273			377			(104)			17			(121)
Acquisition-related items		-			295			(295)			1,351			(1,646)
Certain significant items		-			(711)			711			-			711
AT&T Inc.	$	40,535		$	26,841		$	13,694		$	6,563		$	7,131
For the three months ended March 31, 2015
		Revenue			Operations and Support Expenses			EBITDA			Depreciation and Amortization			Operating Income (Loss)			Equity in Net Income (Loss) of Affiliates			Segment Contribution
Business Solutions	$	17,557		$	11,073		$	6,484		$	2,342		$	4,142		$	-		$	4,142
Entertainment Group		5,660			4,859			801			1,065			(264)			(6)			(270)
Consumer Mobility		8,778			5,541			3,237			1,002			2,235			-			2,235
International		236			218			18			28			(10)			-			(10)
Segment Total		32,231			21,691			10,540			4,437			6,103		$	(6)		$	6,097
Corporate and Other		345			234			111			20			91
Acquisition-related items		-			299			(299)			121			(420)
Certain significant items		-			217			(217)			-			(217)
AT&T Inc.	$	32,576		$	22,441		$	10,135		$	4,578		$	5,557

 

11

 

The following table is a reconciliation of operating contribution to "Income Before Income Taxes" reported on our consolidated statements of income.
		First Quarter
		2016				2015
Business Solutions		$	4,299			$	4,142
Entertainment Group			1,595				(270	)
Consumer Mobility			2,494				2,235
International			(184	)			(10	)
Segment Operating Contribution			8,204				6,097
Reconciling Items:
Corporate and Other			(121	)			91
Merger and integration charges			(295	)			(299	)
Amortization of intangibles acquired			(1,351	)			(121	)
Employee separation charges			(25	)			(217	)
Gain on wireless spectrum transactions			736				-
Segment equity in net (income) loss     of affiliates			(17	)			6
AT&T Operating Income			7,131				5,557
Interest Expense			1,207				899
Equity in net income (loss) of affiliates			13				-
Other income (expense) - Net			70				70
Income Before Income Taxes		$	6,007			$	4,728

NOTE 5. PENSION AND POSTRETIREMENT BENEFITS

Substantially all of our employees are covered by one of our noncontributory pension plans. We also provide certain medical, dental, life insurance and death benefits to certain retired employees under various plans and accrue actuarially determined postretirement benefit costs. Our objective in funding these plans, in combination with the standards of the Employee Retirement Income Security Act of 1974, as amended (ERISA), is to accumulate assets sufficient to provide benefits described in the plans to employees upon their retirement.

In 2013, we made a voluntary contribution of a preferred equity interest in AT&T Mobility II LLC, the primary holding company for our domestic wireless business, to the trust used to pay pension benefits under our qualified pension plans. The preferred equity interest had a fair value of $8,787 at March 31, 2016. The trust is entitled to receive cumulative cash distributions of $560 per annum, which will be distributed quarterly in equal amounts and will be accounted for as contributions. We distributed $140 to the trust during the three months ended March 31, 2016. So long as we make the distributions, we will have no limitations on our ability to declare a dividend or repurchase shares. This preferred equity interest is a plan asset under ERISA and is recognized as such in the plan's separate financial statements. However, because the preferred equity interest is not unconditionally transferable to an unrelated party, it is not reflected in plan assets in our consolidated financial statements and instead has been eliminated in consolidation. We have also agreed to make a cash contribution to the trust of $175 no later than the due date of our federal income tax return for 2015.

We recognize actuarial gains and losses on pension and postretirement plan assets in our operating results at our annual measurement date of December 31, unless earlier remeasurements are required. The following table details pension and postretirement benefit costs included in operating expenses in the accompanying consolidated statements of income. A portion of these expenses is capitalized as part of internal construction projects, providing a small reduction in the net expense recorded.

 

12

 

		Three months ended
		March 31,
		2016				2015
Pension cost:
Service cost – benefits earned during the period		$	278			$	299
Interest cost on projected benefit obligation			495				474
Expected return on assets			(778	)			(826	)
Amortization of prior service credit			(26	)			(26	)
Net pension (credit) cost		$	(31	)		$	(79	)
Postretirement cost:
Service cost – benefits earned during the period		$	48			$	55
Interest cost on accumulated postretirement benefit obligation			243				242
Expected return on assets			(89	)			(105	)
Amortization of prior service credit			(319	)			(320	)
Net postretirement (credit) cost		$	(117	)		$	(128	)
Combined net pension and postretirement (credit) cost		$	(148	)		$	(207	)

The increase of $59 in the first quarter of 2016 is primarily due to a lower expected return on assets resulting from a decrease in the value in the plan assets.

We also provide senior- and middle-management employees with nonqualified, unfunded supplemental retirement and savings plans. For the first quarter ended 2016 and 2015, net supplemental retirement pension benefits costs not included in the table above, were $23 and $20, respectively.

NOTE 6. FAIR VALUE MEASUREMENTS AND DISCLOSURE

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

Level 1

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

Level 2

Inputs to the valuation methodology include:

·	Quoted prices for similar assets and liabilities in active markets.

·	Quoted prices for identical or similar assets or liabilities in inactive markets.

·	Inputs other than quoted market prices that are observable for the asset or liability.

·	Inputs that are derived principally from or corroborated by observable market data by correlation or other means.

Level 3

Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

·	Fair value is often based on developed models in which there are few, if any, external observations.

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

 

13

The valuation methodologies described above may produce a fair value calculation that may not be indicative of future net realizable value or reflective of future fair values. We believe our valuation methods are appropriate and consistent with other market participants. The use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date. There have been no changes in the methodologies used since December 31, 2015.

Long-Term Debt and Other Financial Instruments

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

	March 31, 2016							December 31, 2015
	Carrying			Fair				Carrying				Fair
	Amount			Value				Amount				Value
Notes and debentures1	$	129,229			$	137,865			$	124,847			$	128,993
Bank borrowings		4				4				4				4
Investment securities		2,592				2,592				2,704				2,704
1 Includes credit agreement borrowings.

The carrying value of debt with an original maturity of less than one year approximates market value. The fair value measurements used for notes and debentures are considered Level 2 and are determined using various methods, including quoted prices for identical or similar securities in both active and inactive markets. The carrying and fair values included above reflect our March 2016 debt exchange of $16,049 of DIRECTV notes for AT&T global notes with matching terms.

Following is the fair value leveling for available-for-sale securities and derivatives as of March 31, 2016, and December 31, 2015:

		March 31, 2016
		Level 1				Level 2				Level 3				Total
Available-for-Sale Securities
Domestic equities		$	1,111			$	-			$	-			$	1,111
International equities			541				-				-				541
Fixed income bonds			-				676				-				676
Asset Derivatives1
Interest rate swaps			-				197				-				197
Cross-currency swaps			-				519				-				519
Liability Derivatives1
Cross-currency swaps			-				(2,582	)			-				(2,582	)
1 Derivatives designated as hedging instruments are reflected as "Other assets," "Other noncurrent liabilities" and, for a portion of interest rate swaps, "Other current assets" in our consolidated balance sheets.

14

		December 31, 2015
		Level 1				Level 2				Level 3				Total
Available-for-Sale Securities
Domestic equities		$	1,132			$	-			$	-			$	1,132
International equities			569				-				-				569
Fixed income bonds			-				680				-				680
Asset Derivatives1
Interest rate swaps			-				136				-				136
Cross-currency swaps			-				556				-				556
Foreign exchange contracts			-				3				-				3
Liability Derivatives1
Cross-currency swaps			-				(3,466	)			-				(3,466	)
1 Derivatives designated as hedging instruments are reflected as "Other assets," "Other noncurrent liabilities" and, for a portion of interest rate swaps, "Other current assets" in our consolidated balance sheets.

Investment Securities

Our investment securities include equities, fixed income bonds and other securities. A substantial portion of the fair values of our available-for-sale securities was estimated based on quoted market prices. Investments in securities not traded on a national securities exchange are valued using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Realized gains and losses on securities are included in "Other income (expense) – net" in the consolidated statements of income using the specific identification method. Unrealized gains and losses, net of tax, on available-for-sale securities are recorded in accumulated OCI. Unrealized losses that are considered other than temporary are recorded in "Other income (expense) – net" with the corresponding reduction to the carrying basis of the investment. Fixed income investments of $99 have maturities of less than one year, $308 within one to three years, $65 within three to five years, and $204 for five or more years.

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

Derivative Financial Instruments

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

Fair Value Hedging We designate our fixed-to-floating interest rate swaps as fair value hedges. The purpose of these swaps is to manage interest rate risk by managing our mix of fixed-rate and floating-rate debt. These swaps involve the receipt of fixed-rate amounts for floating interest rate payments over the life of the swaps without exchange of the underlying principal amount. Accrued and realized gains or losses from interest rate swaps impact interest expense in the consolidated statements of income. Unrealized gains on interest rate swaps are recorded at fair market value as assets, and unrealized losses on interest rate swaps are recorded at fair market value as liabilities. Changes in the fair values of the interest rate swaps are exactly offset by changes in the fair value of the underlying debt. Gains or losses realized upon early termination of our fair value hedges are recognized in interest expense. In the three months ended March 31, 2016, and March 31, 2015, no ineffectiveness was measured on interest rate swaps designated as fair value hedges.

 

15

Cash Flow Hedging  We designate our cross-currency swaps as cash flow hedges. We have entered into multiple cross-currency swaps to hedge our exposure to variability in expected future cash flows that are attributable to foreign currency risk generated from the issuance of our Euro, British pound sterling, Canadian dollar and Swiss franc denominated debt. These agreements include initial and final exchanges of principal from fixed foreign currency denominations to fixed U.S. dollar denominated amounts, to be exchanged at a specified rate that is usually determined by the market spot rate upon issuance. They also include an interest rate swap of a fixed or floating foreign currency-denominated rate to a fixed U.S. dollar denominated interest rate.

Unrealized gains on derivatives designated as cash flow hedges are recorded at fair value as assets, and unrealized losses on derivatives designated as cash flow hedges are recorded at fair value as liabilities. For derivative instruments designated as cash flow hedges, the effective portion is reported as a component of accumulated OCI until reclassified into interest expense in the same period the hedged transaction affects earnings. The gain or loss on the ineffective portion is recognized as "Other income (expense) – net" in the consolidated statements of income in each period. We evaluate the effectiveness of our cross-currency swaps each quarter. In the three months ended March 31, 2016, and March 31, 2015, no ineffectiveness was measured on cross-currency swaps designated as cash flow hedges.

Periodically, we enter into and designate interest rate locks to partially hedge the risk of changes in interest payments attributable to increases in the benchmark interest rate during the period leading up to the probable issuance of fixed-rate debt. We designate our interest rate locks as cash flow hedges. Gains and losses when we settle our interest rate locks are amortized into income over the life of the related debt, except where a material amount is deemed to be ineffective, which would be immediately reclassified to "Other income (expense) – net" in the consolidated statements of income. Over the next 12 months, we expect to reclassify $59 from accumulated OCI to interest expense due to the amortization of net losses on historical interest rate locks.

We hedge a portion of the exchange risk involved in anticipation of highly probable foreign currency-denominated transactions. In anticipation of these transactions, we often enter into foreign exchange contracts to provide currency at a fixed rate. Gains and losses at the time we settle or take delivery on our designated foreign exchange contracts are amortized into income in the same period the hedged transaction affects earnings, except where an amount is deemed to be ineffective, which would be immediately reclassified to "Other income (expense) – net" in the consolidated statements of income. In the three months ended March 31, 2016, and March 31, 2015, no ineffectiveness was measured on foreign exchange contracts designated as cash flow hedges.

Collateral and Credit-Risk Contingency  We have entered into agreements with our derivative counterparties establishing collateral thresholds based on respective credit ratings and netting agreements. At March 31, 2016, we had posted collateral of $1,743 (a deposit asset) and held collateral of $111 (a receipt liability). Under the agreements, if our credit rating had been downgraded one rating level by Fitch Ratings, before the final collateral exchange in March, we would have been required to post additional collateral of $130. If DIRECTV Holdings LLC's credit rating had been downgraded below BBB- (S&P) and below Baa3 (Moody's), we would owe an additional $195. At December 31, 2015, we had posted collateral of $2,343 (a deposit asset) and held collateral of $124 (a receipt liability). We do not offset the fair value of collateral, whether the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) exists, against the fair value of the derivative instruments.

Following is the notional amount of our outstanding derivative positions:

		March 31,				December 31,
		2016				2015
Interest rate swaps		$	7,050			$	7,050
Cross-currency swaps			29,642				29,642
Foreign exchange contracts			3				100
Total		$	36,695			$	36,792

 

16

Following are the related hedged items affecting our financial position and performance:
Effect of Derivatives on the Consolidated Statements of Income
Fair Value Hedging Relationships	Three months ended
	March 31,			March 31,
	2016			2015
Interest rate swaps (Interest expense):
Gain (Loss) on interest rate swaps	$	66			$	41
Gain (Loss) on long-term debt		(66	)			(41	)

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

		Three months ended
		March 31,				March 31,
Cash Flow Hedging Relationships		2016				2015
Cross-currency swaps:
Gain (Loss) recognized in accumulated OCI		$	191			$	(228	)
Interest rate locks:
Gain (Loss) recognized in accumulated OCI			-				(316	)
Interest income (expense) reclassified from accumulated OCI into income			(15	)			(11	)

NOTE 7. ACQUISITIONS, DISPOSITIONS AND OTHER ADJUSTMENTS

Acquisitions

DIRECTV  In July 2015, we completed our acquisition of DIRECTV, a leading provider of digital television entertainment services in both the United States and Latin America. For accounting purposes, the transaction was valued at $47,409. Our operating results include the results of DIRECTV following the acquisition date.

The fair values of the assets acquired and liabilities assumed were preliminarily determined using the income, cost and market approaches. The fair value measurements were primarily based on significant inputs that are not observable in the market and are considered Level 3 under the Fair Value Measurement and Disclosure framework, other than long-term debt assumed in the acquisition (see Note 6). The income approach was primarily used to value the intangible assets, consisting of acquired customer relationships, orbital slots and trade names. The income approach estimates fair value for an asset based on the present value of cash flows projected to be generated by the asset. Projected cash flows are discounted at a required rate of return that reflects the relative risk of achieving the cash flows and the time value of money. The cost approach, which estimates value by determining the current cost of replacing an asset with another of equivalent economic utility, was used primarily for property, plant and equipment. The cost to replace a given asset reflects the estimated reproduction or replacement cost for the property, less an allowance for loss in value due to depreciation.

The fair value estimates are preliminary in nature and subject to adjustments, which could be material. Any necessary adjustments will be finalized within one year from the date of acquisition. Substantially all the receivables acquired are expected to be collectable. We have not identified any material unrecorded pre-acquisition contingencies where the related asset, liability or impairment is probable and the amount can be reasonably estimated. Goodwill is calculated as the difference between the acquisition date fair value of the consideration transferred and the fair value of the net assets acquired, and represents the future economic benefits that we expect to achieve as a result of acquisition. Prior to the finalization of the purchase price allocation, if information becomes available that would indicate it is probable that such events had occurred and the amounts can be reasonably estimated, such items will be included in the final purchase price allocation and may change goodwill.

 

17

The following table summarizes the preliminary estimated fair values of the DIRECTV assets acquired and liabilities assumed and related deferred income taxes that existed as of the acquisition date.

Assets acquired
Cash		$	4,797
Accounts receivable			2,026
All other current assets			1,535
Property, plant and equipment			9,331
Intangible assets not subject to amortization
Orbital slots			11,946
Trade name			1,371
Intangible assets subject to amortization
Customer lists and relationships			19,508
Trade name			2,915
Other			457
Investments and other assets			2,388
Goodwill			34,449
Total assets acquired			90,723
Liabilities assumed
Current liabilities, excluding current portion of long-term debt			5,733
Long-term debt			20,585
Other noncurrent liabilities			16,642
Total liabilities assumed			42,960
Net assets acquired			47,763
Noncontrolling interest			(354	)
Aggregate value of consideration paid		$	47,409

Purchased goodwill is not expected to be deductible for tax purposes. The goodwill was allocated to our Entertainment Group and International segments.

Nextel Mexico  In April 2015, we completed our acquisition of the subsidiaries of NII Holdings Inc., operating its wireless business in Mexico, for $1,875, including approximately $427 of net debt and other adjustments. The subsidiaries offered service under the name Nextel Mexico.

The purchase price allocation of assets acquired was: $376 in licenses, $1,167 in property, plant and equipment, $128 in customer lists and $193 of goodwill. The goodwill was allocated to our International segment.

GSF Telecom  In January 2015, we acquired Mexican wireless company GSF Telecom Holdings, S.A.P.I. de C.V. (GSF Telecom) for $2,500, including net debt of approximately $700. GSF Telecom offered service under both the Iusacell and Unefon brand names in Mexico.

The purchase price allocation of assets acquired was: $735 in licenses, $658 in property, plant and equipment, $378 in customer lists, $26 in trade names and $956 of goodwill. The goodwill was allocated to our International segment.

AWS-3 Auction  In January 2015, we submitted winning bids of $18,189 in the Advanced Wireless Service (AWS)-3 Auction (FCC Auction 97) a portion of which represented spectrum clearing and First Responder Network Authority funding. We provided the Federal Communications Commission (FCC) an initial down payment of $921 in October 2014 and paid the remaining $17,268 in the first quarter of 2015.

 

18

AT&T INC.

NOTE 8. SALES OF EQUIPMENT INSTALLMENT RECEIVABLES

 

We offer our customers the option to purchase certain wireless devices in installments over a period of up to 30 months, with the right to trade in the original equipment for a new device within a set period and have the remaining unpaid balance satisfied. As of March 31, 2016, and December 31, 2015, gross equipment installment receivables of $5,079 and $5,719 were included on our consolidated balance sheets, of which $3,007 and $3,239 are notes receivable that are included in "Accounts receivable - net."

In 2014, we entered into the first of a series of uncommitted agreements pertaining to the sale of equipment installment receivables and related security with Citibank and various other relationship banks as purchasers (collectively, the Purchasers). Under these agreements, we transferred the receivables to the Purchasers for cash and additional consideration upon settlement of the receivables, referred to as the deferred purchase price. Under the terms of the arrangements, we continue to bill and collect on behalf of our customers for the receivables sold.

The following table sets forth a summary of equipment installment receivables sold during the three months ended March 31, 2016 and 2015:

	Three months ended
	March 31,
	2016				2015
Gross receivables sold		$	2,482			$	2,635
Net receivables sold1			2,256				2,381
Cash proceeds received			1,521				1,524
Deferred purchase price recorded			719				858
1 Receivables net of allowance, imputed interest and trade-in right guarantees.

The deferred purchase price is initially recorded at estimated fair value, which is based on remaining installment payments expected to be collected, adjusted by the expected timing and value of device trade-ins, and subsequently carried at the lower of cost or net realizable value. The estimated value of the device trade-ins considers prices offered to us by independent third parties that contemplate changes in value after the launch of a device model. The fair value measurements used are considered Level 3 under the Fair Value Measurement and Disclosure framework (see Note 6).

During the first quarter of 2016, we repurchased installment receivables previously sold to the Purchasers, with a fair value of $532. These transactions reduced our current deferred purchase price receivable by $539, resulting in a loss of $7 during the quarter. This loss is included in "Selling, general and administrative" in the consolidated statements of income.

At March 31, 2016, and December 31, 2015, our deferred purchase price receivable was $2,975 and $2,961, respectively, of which $1,469 and $1,772 is included in "Other current assets" on our consolidated balance sheets, with the remainder in "Other Assets." Our maximum exposure to loss as a result of selling these equipment installment receivables is limited to the amount of our deferred purchase price at any point in time.

The sales of equipment installment receivables did not have a material impact on our consolidated statements of income or to "Total Assets" reported on our consolidated balance sheets. We reflect the cash flows related to the arrangement as operating activities in our consolidated statements of cash flows because the cash received from the Purchasers upon both the sale of the receivables and the collection of the deferred purchase price is not subject to significant interest rate risk.

19

 

For ease of reading, AT&T Inc. is referred to as "we," "AT&T" or the "Company" throughout this document, and the names of the particular subsidiaries and affiliates providing the services generally have been omitted. AT&T is a holding company whose subsidiaries and affiliates operate in the communications and digital entertainment services industry. Our subsidiaries and affiliates provide services and equipment that deliver voice, video and broadband services both domestically and internationally. During 2015, we completed our acquisitions of DIRECTV and wireless properties in Mexico, and the following discussion of changes in our operating revenues and expenses is affected by the timing of these acquisitions. In accordance with U.S. generally accepted accounting principles (GAAP), operating results from acquired businesses prior to acquisition are excluded. You should read this discussion in conjunction with the consolidated financial statements and accompanying notes. A reference to a "Note" in this section refers to the accompanying Notes to Consolidated Financial Statements. In the tables throughout this section, percentage increases and decreases that are not considered meaningful are denoted with a dash. Certain amounts have been reclassified to conform to the current period's presentation.

Consolidated Results  Our financial results in the first quarter of 2016 and 2015 are summarized as follows:

		First Quarter
		2016				2015				Percent Change
Operating Revenues
Service		$	37,101			$	28,962				28.1	%
Equipment			3,434				3,614				(5.0	)
Total Operating Revenues			40,535				32,576				24.4
Operating expenses
Cost of services and sales
Equipment			4,375				4,546				(3.8	)
Broadcast, programming and operations			4,629				1,122				-
Other cost of services			9,396				8,812				6.6
Selling, general and administrative			8,441				7,961				6.0
Depreciation and amortization			6,563				4,578				43.4
Total Operating Expenses			33,404				27,019				23.6
Operating Income			7,131				5,557				28.3
Income Before Income Taxes			6,007				4,728				27.1
Net Income			3,885				3,339				16.4
Net Income Attributable to AT&T		$	3,803			$	3,263				16.5	%

Overview

Operating revenues increased $7,959, or 24.4%, in the first quarter of 2016.

Service revenues increased $8,139, or 28.1%, in the first quarter of 2016. The increase was primarily due to our 2015 acquisitions of DIRECTV and wireless operations in Mexico and gains in IP broadband and fixed strategic business services. These were partially offset by continued declines in our legacy wireline voice and data products as well as from customers choosing to purchase devices through installment payment agreements, which entitle them to a lower monthly service rate under our wireless Mobile Share plans.

Equipment revenues decreased $180, or 5.0%, in the first quarter of 2016. This decline reflects fewer wireless handset sales, additional promotional activities during 2016 and lower revenue related to customer premises equipment. Revenue declines were partially offset by the continuing trend of our wireless customers to purchase higher priced devices and an increase in customers choosing to purchase devices on installment when compared to the prior year.

 

 

20

 

Operating expenses increased $6,385, or 23.6%, in the first quarter of 2016.

Equipment expenses decreased $171, or 3.8%, in the first quarter of 2016. The decrease was primarily due to the decline in devices sold to postpaid subscribers, who tend to buy more expensive devices. The decrease was partially offset by increased sales volumes to our prepaid subscribers.

Broadcast, programming and operations expenses increased $3,507 in the first quarter of 2016. Broadcast costs increased due to our acquisition of DIRECTV, slightly offset by fewer AT&T U-verse® (U-verse) subscribers.

Other cost of services expenses increased $584, or 6.6%, in the first quarter of 2016. The increase was primarily due to our acquisitions of DIRECTV and Mexican wireless properties. Also contributing to higher expenses was an increase in noncash financing-related costs associated with our pension and postretirement benefits. These increases were partially offset by lower network and access charges.

Selling, general and administrative expenses increased $480, or 6.0%, in the first quarter of 2016. The increase was primarily due to our acquisitions in 2015 and increased advertising activity in 2016. The increases were largely offset by a $736 noncash gain on wireless spectrum transactions, lower wireless commission expenses and lower employee separation charges.

Depreciation and amortization expense increased $1,985, or 43.4%, in the first quarter of 2016. Amortization expense increased $1,228 due to the amortization of intangibles from recent acquisitions. Depreciation expense increased $757 primarily due to the previously mentioned acquisitions and ongoing capital spending for network upgrades.

Operating income increased $1,574, or 28.3%, in the first quarter of 2016. Our operating income margin in the first quarter increased from 17.1% in 2015 to 17.6% in 2016.

Interest expense increased $308, or 34.3%, in the first quarter of 2016. The increase was primarily due to higher average debt balances, including debt issued and debt acquired in connection with our acquisition of DIRECTV. The increases were partially offset by higher capitalized interest resulting from spectrum acquired in the Advanced Wireless Service (AWS)-3 Auction (see Note 7).

Equity in net income of affiliates increased $13 in the first quarter of 2016. This increase primarily resulted from earnings from investments acquired in our purchase of DIRECTV in the third quarter of 2015, partially offset by lower earnings from Otter Media Holdings and YP Holdings LLC.

Other income (expense) – net We had other income of $70 in the first quarter of both 2016 and 2015. Results in the first quarter of 2016 and 2015 included a net gain on the sale of investments of $44 and $33 and interest and dividend income of $29 and $19, respectively.

Income taxes increased $733, or 52.8%, in the first quarter of 2016. Our effective tax rate was 35.3% for the first quarter of 2016, compared to 29.4% for first quarter of 2015. The increase in income tax expense for the first quarter of 2016 was primarily due to higher income before income taxes in 2016. In 2015, we recognized tax benefits related to the restructuring of a portion of our Business Solutions segment, which contributed to lower income tax expense and the effective tax rate in the first quarter of 2015.

 

21

Selected Financial and Operating Data
		March 31,
Subscribers and connections in (000s)		2016				2015
Domestic wireless subscribers			130,445				121,772
Mexican wireless subscribers			9,213				5,728
North American wireless subscribers			139,658				127,500
North American branded subscribers			98,158				91,448
North American branded net additions			1,195				539
Domestic satellite video subscribers			20,112				-
U-verse video subscribers			5,260				5,993
Latin America satellite video subscribers1			12,436				-
Total video subscribers			37,808				5,993
Total domestic broadband connections			15,764				16,097
Network access lines in service			15,975				18,949
U-Verse VoIP connections			5,484				5,200
Debt ratio2			51.2	%			51.5	%
Net Debt Ratio3			47.3	%			49.1	%
Ratio of earnings to fixed charges4			4.22				4.30
Number of AT&T employees			280,870				250,790

¹ Excludes subscribers of our International segment equity investments in SKY Mexico.

² Debt ratios are calculated by dividing total debt (debt maturing within one year plus long-term debt) by total capital (total debt plus total stockholders' equity) and do not consider cash available to pay down debt. See our "Liquidity and Capital Resources" section for discussion.

³ Net debt ratios are calculated by deriving total debt (debt maturing within one year plus long-term debt) less cash available by total capital (total debt plus total stockholders' equity).

⁴ See Exhibit 12.

Segment Results

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

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

The Business Solutions segment provides services to business, including multinational companies; governmental and wholesale customers; and individual subscribers who purchase wireless services through employer-sponsored plans. We provide advanced IP-based services including Virtual Private Networks (VPN); Ethernet-related products and broadband, collectively referred to as strategic business services; as well as traditional data and voice products. We utilize our wireless and wired networks (referred to as "wired" or "wireline") to provide a complete communications solution to our business customers.

 

22

The Entertainment Group segment provides video, Internet, voice communication and interactive and targeted advertising services to customers located in the U.S. or in U.S. territories. We utilize our copper and IP-based wired network and/or our satellite technology.

The Consumer Mobility segment provides nationwide wireless service to consumers and wireless wholesale and resale subscribers located in the U.S. or in U.S. territories. We utilize our U.S. wireless network to provide voice and data services, including high-speed Internet, video, and home monitoring services.

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

Our operating assets are utilized by multiple segments and consist of our wireless and wired networks as well as an international satellite fleet. We manage our assets to provide for the most efficient, effective and integrated service to our customers, not by operating segment, and therefore asset information and capital expenditures by operating segment are not presented. Depreciation is allocated based on network usage or asset utilization by segment.

We discuss capital expenditures in "Liquidity and Capital Resources."

Business Solutions
Segment Results
		First Quarter
		2016				2015				Percent Change
Segment operating revenues
Wireless service		$	7,855			$	7,515				4.5	%
Fixed strategic services			2,786				2,549				9.3
Legacy voice and data services			4,338				4,754				(8.8	)
Other service and equipment			859				846				1.5
Wireless equipment			1,771				1,893				(6.4	)
Total Segment Operating Revenues			17,609				17,557				0.3
Segment operating expenses
Operations and support			10,802				11,073				(2.4	)
Depreciation and amortization			2,508				2,342				7.1
Total Segment Operating Expenses			13,310				13,415				(0.8	)
Segment Operating Income			4,299				4,142				3.8
Equity in Net Income (Loss) of Affiliates			-				-				-
Segment Contribution		$	4,299			$	4,142				3.8	%

 

23

 

The following table highlights other key measures of performance for the Business Solutions segment:
		First Quarter
		2016				2015			Percent Change
(in 000s)
Business Wireless Subscribers
Postpaid			48,844				45,959				6.3	%
Reseller			64				14				-
Connected devices 1			26,863				20,972				28.1
Total Business Wireless Subscribers			75,771				66,945				13.2
Business Wireless Net Additions 2
Postpaid			133				297				(55.2	)
Reseller			(22	)			3				-
Connected devices 1			1,578				1,024				54.1
Business Wireless Net Subscriber Additions			1,689				1,324				27.6
Business Wireless Postpaid Churn 2, 3			1.02%				0.90%		12 BP
Business IP Broadband Connections			928				849				9.3
Business IP Broadband Net Additions			17				27				(37.0	) %
1 Includes data-centric devices such as session-based tablets, monitoring devices and automobile systems. Excludes postpaid tablets.
2 Excludes migrations between AT&T segments and/or subscriber categories and acquisition-related additions during the period.
3 Calculated by dividing the aggregate number of wireless subscribers who canceled service during a period divided by the total number of wireless subscribers at the beginning of that period. The churn rate for the period is equal to the average of the churn rate for each month of that period.

 

Operating revenues increased $52, or 0.3%, in the first quarter of 2016. Revenue growth was driven by wireless service revenues and increased fixed strategic business services. Revenue increases were partially offset by continued declines in our legacy voice and data products, lower equipment revenue and foreign exchange pressures.