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UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON,
Washington, DC 20549 FORM
Form 10-Q
[X]
þQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004 OR [ ]
For the quarterly period ended March 31, 2005
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO
For the transition period from           to
COMMISSION FILE NUMBER
Commission file number 1-1105
AT&T CORP. Corp.
A NEW YORK New YorkI.R.S. EMPLOYER CORPORATION NO.Employer
CorporationNo. 13-4924710
ONE
One AT&T WAY, BEDMINSTER, NEW JERSEYWay, Bedminster, New Jersey 07921 TELEPHONE -- AREA CODE
Telephone — Area Code 908-221-2000
      Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes [X]þ          No [ ]o
      Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).     Yes [X]þ          No [ ]o
      At OctoberApril 29, 2004,2005, the following shares of stock were outstanding: AT&T common stock -- 795,868,728. — 800,989,478.


TABLE OF CONTENTS

PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
CONSOLIDATED STATEMENTS OF INCOME
CONSOLIDATED BALANCE SHEETS
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREOWNERS’ EQUITY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 4. Controls and Procedures
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds and Issuer Purchases of Equity Securities
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
EXHIBIT INDEX
EX-12: COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
EX-31.1: CERTIFICATION
EX-31.2: CERTIFICATION
EX-32.1: CERTIFICATION
EX-32.2: CERTIFICATION


PART I -- FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS
Item 1.Financial Statements
AT&T CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ---------------------- ---------------------- 2004 2003 2004 2003 ---------- --------- ---------- --------- (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) REVENUE.............................................. $ 7,638 $ 8,649 $ 23,264 $26,430 OPERATING EXPENSES Access and other connection.......................... 2,411 2,785 7,530 8,191 Costs of services and products (excludes depreciation of $409, $942, $2,280 and $2,848 included below)... 1,783 1,954 5,406 5,923 Selling, general and administrative.................. 1,653 1,793 5,160 5,551 Depreciation and amortization........................ 647 1,224 3,128 3,607 Asset impairment and net restructuring and other charges............................................ 12,469 64 12,736 134 -------- ------- -------- ------- Total operating expenses............................. 18,963 7,820 33,960 23,406 -------- ------- -------- ------- 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 Benefit (provision) for income taxes................. 4,402 (72) 4,741 (677) Minority interest income............................. -- -- 1 1 Net earnings (losses) related to equity investments........................................ 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)................................ -- (13) -- (13) -------- ------- -------- ------- (LOSS) INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGES............................................ (7,147) 445 (6,735) 1,510 Cumulative effect of accounting changes (net of income taxes of $17 and $(9))...................... -- (27) -- 15 -------- ------- -------- ------- NET (LOSS) INCOME.................................... $ (7,147) $ 418 $ (6,735) $ 1,525 ======== ======= ======== ======= WEIGHTED-AVERAGE SHARES USED TO COMPUTE EARNINGS PER SHARE: Basic................................................ 795 789 794 787 Diluted.............................................. 795 791 794 788 PER BASIC SHARE: (Loss) earnings from continuing operations........... $ (8.99) $ 0.58 $ (8.48) $ 1.94 (Loss) from discontinued operations.................. -- (0.02) -- (0.02) Cumulative effect of accounting changes.............. -- (0.03) -- 0.02 -------- ------- -------- ------- (LOSS) EARNINGS PER BASIC SHARE...................... $ (8.99) $ 0.53 $ (8.48) $ 1.94 ======== ======= ======== ======= PER DILUTED SHARE: (Loss) earnings from continuing operations........... $ (8.99) $ 0.58 $ (8.48) $ 1.93 (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.................. $ 0.2375 $0.2375 $ 0.7125 $0.6125 ======== ======= ======== =======
INCOME
(Unaudited)
         
  For the Three Months
  Ended March 31,
   
  2005 2004
     
  (Dollars in millions,
  except per share
  amounts)
Revenue
 $7,015  $7,990 
Operating Expenses
        
Access and other connection  2,404   2,638 
Costs of services and products (excluding depreciation of $404 and $937 included below)  1,628   1,864 
Selling, general and administrative  1,277   1,744 
Depreciation and amortization  636   1,250 
Asset impairment and net restructuring and other charges     213 
       
Total operating expenses  5,945   7,709 
       
Operating Income
  1,070   281 
Other income (expense), net  30   (174)
Interest (expense)  (203)  (228)
       
Income (Loss) Before Income Taxes and Net (Losses) Related to Equity Investments
  897   (121)
(Provision) benefit for income taxes  (368)  426 
Net (losses) related to equity investments     (1)
       
Net Income
 $529  $304 
       
Weighted-Average Shares Used to Compute Earnings Per Share:
        
Basic  800   793 
Diluted  806   796 
 
Earnings per Basic and Diluted Share
 $0.66  $0.38 
       
Dividends Declared per Common Share
 $0.2375  $0.2375 
       
The notes are an integral part of the consolidated financial statements.

1


AT&T CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
AT AT SEPTEMBER 30, DECEMBER 31, 2004 2003 ------------- ------------ (DOLLARS IN MILLIONS) ASSETS Cash and cash equivalents................................... $ 2,627 $ 4,353 Accounts receivable, less allowances of $589 and $579....... 3,516 4,036 Deferred income taxes....................................... 1,116 715 Other current assets........................................ 1,328 744 -------- -------- TOTAL CURRENT ASSETS........................................ 8,587 9,848 Property, plant and equipment, net of accumulated depreciation of $1,155 and $34,300........................ 11,654 24,376 Goodwill.................................................... 4,778 4,801 Other purchased intangible assets, net of accumulated amortization of $396 and $320............................. 394 499 Prepaid pension costs....................................... 3,939 3,861 Other assets................................................ 2,707 4,603 -------- -------- TOTAL ASSETS................................................ $ 32,059 $ 47,988 ======== ======== LIABILITIES Accounts payable and accrued expenses....................... $ 2,586 $ 3,256 Compensation and benefit-related liabilities................ 2,215 1,783 Debt maturing within one year............................... 1,582 1,343 Other current liabilities................................... 2,346 2,501 -------- -------- TOTAL CURRENT LIABILITIES................................... 8,729 8,883 Long-term debt.............................................. 8,881 13,066 Long-term compensation and benefit-related liabilities...... 3,947 3,528 Deferred income taxes....................................... 1,138 5,395 Other long-term liabilities and deferred credits............ 2,929 3,160 -------- -------- TOTAL LIABILITIES........................................... 25,624 34,032 SHAREOWNERS' EQUITY Common stock, $1 par value, authorized 2,500,000,000 shares; issued and outstanding 795,590,783 shares (net of 171,983,367 treasury shares) at September 30, 2004 and 791,911,022 shares (net of 172,179,303 treasury shares) at December 31, 2003......................................... 796 792 Additional paid-in capital.................................. 27,287 27,722 Accumulated deficit......................................... (21,446) (14,707) Accumulated other comprehensive (loss) income............... (202) 149 -------- -------- TOTAL SHAREOWNERS' EQUITY................................... 6,435 13,956 -------- -------- TOTAL LIABILITIES AND SHAREOWNERS' EQUITY................... $ 32,059 $ 47,988 ======== ========
(Unaudited)
         
  At At
  March 31, December 31,
  2005 2004
     
  (Dollars in millions)
Assets
        
Cash and cash equivalents $3,705  $3,698 
Accounts receivable, less allowances of $473 and $523  3,112   3,195 
Deferred income taxes  1,094   1,111 
Other current assets  802   1,383 
       
Total Current Assets
  8,713   9,387 
Property, plant and equipment, net of accumulated depreciation of $1,936 and $1,588  11,203   11,509 
Goodwill  4,838   4,888 
Other purchased intangible assets, net of accumulated amortization of $389 and $428  348   375 
Prepaid pension costs  4,048   3,991 
Other assets  2,546   2,654 
       
Total Assets
 $31,696  $32,804 
       
Liabilities
        
Accounts payable and accrued expenses $2,626  $2,716 
Compensation and benefit-related liabilities  1,724   2,193 
Debt maturing within one year  1,982   1,886 
Other current liabilities  2,603   2,293 
       
Total Current Liabilities
  8,935   9,088 
Long-term debt  7,468   8,779 
Long-term compensation and benefit-related liabilities  3,406   3,322 
Deferred income taxes  1,358   1,356 
Other long-term liabilities and deferred credits  3,113   3,240 
       
Total Liabilities
  24,280   25,785 
Shareowners’ Equity
        
Common stock, $1 par value, authorized 2,500,000,000 shares; issued and outstanding 800,823,621 shares (net of 171,983,367 treasury shares) at March 31, 2005 and 798,570,623 shares (net of 171,983,367 treasury shares) at December 31, 2004  801   799 
Additional paid-in capital  27,049   27,170 
Accumulated deficit  (20,651)  (21,180)
Accumulated other comprehensive income  217   230 
       
Total Shareowners’ Equity
  7,416   7,019 
       
Total Liabilities and Shareowners’ Equity
 $31,696  $32,804 
       
The notes are an integral part of the consolidated financial statements.

2


AT&T CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREOWNERS'SHAREOWNERS’ EQUITY (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, --------------------- 2004 2003 --------- --------- (DOLLARS IN MILLIONS) AT&T COMMON STOCK Balance at beginning of year........................... $ 792 $ 783 Shares issued under employee plans..................... 2 5 Other.................................................. 2 1 -------- -------- Balance at end of period.................................. 796 789 -------- -------- ADDITIONAL PAID-IN CAPITAL Balance at beginning of year........................... 27,722 28,163 Shares issued, net: Under employee plans................................. 57 129 Other................................................ 22 25 Dividends declared..................................... (566) (482) Other.................................................. 52 20 -------- -------- Balance at end of period.................................. 27,287 27,855 -------- -------- ACCUMULATED DEFICIT Balance at beginning of year........................... (14,707) (16,566) Net (loss) income...................................... (6,735) 1,525 Treasury shares issued at less than cost............... (4) (3) -------- -------- Balance at end of period.................................. (21,446) (15,044) -------- -------- ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Balance at beginning of year........................... 149 (68) Other comprehensive (loss) income...................... (351) 7 -------- -------- Balance at end of period.................................. (202) (61) -------- -------- TOTAL SHAREOWNERS' EQUITY................................... $ 6,435 $ 13,539 ======== ======== SUMMARY OF TOTAL COMPREHENSIVE INCOME: (Loss) income before cumulative effect of accounting changes............................................... $ (6,735) $ 1,510 Cumulative effect of accounting changes................ -- 15 -------- -------- Net (loss) income...................................... (6,735) 1,525 Other comprehensive (loss) income...................... (351) 7 -------- -------- TOTAL COMPREHENSIVE (LOSS) INCOME........................... $ (7,086) $ 1,532 ======== ========
(Unaudited)
            
  For the Three Months
  Ended March 31,
   
  2005 2004
     
  (Dollars in millions)
AT&T Common Stock
        
  Balance at beginning of year $799  $792 
  Shares issued under employee plans  2   2 
       
 Balance at end of period  801   794 
       
Additional Paid-In Capital
        
  Balance at beginning of year  27,170   27,722 
  Shares issued, net:        
   Under employee plans  39   39 
   Other     8 
  Dividends declared  (190)  (189)
  Other  30   9 
       
 Balance at end of period  27,049   27,589 
       
Accumulated Deficit
        
  Balance at beginning of year  (21,180)  (14,707)
  Net income  529   304 
  Treasury shares issued at less than cost     (4)
       
 Balance at end of period  (20,651)  (14,407)
       
Accumulated Other Comprehensive Income
        
  Balance at beginning of year  230   149 
  Other comprehensive (loss)  (13)  (29)
       
 Balance at end of period  217   120 
       
Total Shareowners’ Equity
 $7,416  $14,096 
       
Summary of Total Comprehensive Income:
        
  Net income $529  $304 
  Other comprehensive (loss) [net of income taxes of $8 and $17]  (13)  (29)
       
Total Comprehensive Income
 $516  $275 
       
AT&T accounts for treasury stock as retired stock. The amountsamount attributable to treasury stock at September 30, 2004March 31, 2005 and December 31, 2003, were2004 was $(17,011) and $(17,026) million, respectively. million.
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 NINE MONTHS ENDED SEPTEMBER 30, --------------------- 2004 2003 --------- --------- (DOLLARS IN MILLIONS) OPERATING ACTIVITIES Net (loss) income........................................... $(6,735) $ 1,525 Deduct: Loss from discontinued operations -- net of income taxes.................................................. -- (13) Cumulative effect of accounting change -- net of income taxes.................................................. -- 15 ------- ------- (Loss) income from continuing operations.................... (6,735) 1,523 Adjustments to reconcile (loss) income from continuing operations to net cash provided by operating activities: Net gains on sales of businesses and investments.......... (16) (51) Loss on early extinguishment of debt...................... 301 85 Asset impairment and net restructuring and other charges................................................ 12,662 87 Depreciation and amortization............................. 3,128 3,607 Provision for uncollectible receivables................... 371 588 Deferred income taxes..................................... (4,469) 1,105 Net pretax earnings related to equity investments......... (4) (28) Decrease in receivables................................... 178 231 Decrease in accounts payable and accrued expenses......... (488) (428) Net change in other operating assets and liabilities...... (839) 443 Other adjustments, net.................................... (78) (49) ------- ------- NET CASH PROVIDED BY OPERATING ACTIVITIES................... 4,011 7,113 ------- ------- INVESTING ACTIVITIES Capital expenditures and other additions.................... (1,459) (2,413) Proceeds from sale or disposal of property, plant and equipment................................................. 58 134 Investment distributions and sales.......................... 37 120 Net dispositions (acquisitions) of businesses, net of cash disposed/acquired......................................... 8 (158) Decrease (increase) in restricted cash...................... 7 (22) Other investing activities, net............................. 9 (50) ------- ------- NET CASH USED IN INVESTING ACTIVITIES....................... (1,340) (2,389) ------- ------- FINANCING ACTIVITIES Retirement of long-term debt, including redemption premiums.................................................. (3,711) (4,576) Decrease in short-term borrowings, net...................... (511) (1,263) Issuance of AT&T common shares.............................. 45 92 Dividends paid on common stock.............................. (565) (442) Other financing activities, net............................. 345 202 ------- ------- NET CASH USED IN FINANCING ACTIVITIES....................... (4,397) (5,987) ------- ------- Net decrease in cash and cash 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.................. $ 2,627 $ 6,751 ======= =======
(Unaudited)
          
  For the Three Months
  Ended March 31,
   
  2005 2004
     
  (Dollars in millions)
Operating Activities
        
Net income $529  $304 
Adjustments to reconcile net income to net cash provided by operating activities:        
 Asset impairment and net restructuring and other charges     201 
 Net losses (gains) on sales of businesses and investments  7   (11)
 Loss on early extinguishment of debt     274 
 Depreciation and amortization  636   1,250 
 Provision for uncollectible receivables  48   146 
 Deferred income taxes  21   (295)
 (Increase) decrease in receivables  (126)  18 
 (Decrease) increase in accounts payable and accrued expenses  (140)  7 
 Net change in other operating assets and liabilities  (146)  (443)
 Other adjustments, net  (24)  (102)
       
Net Cash Provided by Operating Activities
  805   1,349 
       
Investing Activities
        
Capital expenditures and other additions  (326)  (546)
Proceeds from sale or disposal of property, plant and equipment  5   9 
Investment distributions and sales  7   14 
Net dispositions of businesses, net of cash disposed     8 
Decrease (increase) in restricted cash  546   (2)
Other investing activities, net  8   10 
       
Net Cash Provided by (Used in) Investing Activities
  240   (507)
       
Financing Activities
        
Retirement of long-term debt, including redemption premiums  (1,032)  (2,781)
(Decrease) increase in short-term borrowings, net  (98)  35 
Issuance of common shares  32   22 
Dividends paid on common stock  (190)  (188)
Other financing activities, net  250   295 
       
Net Cash Used in Financing Activities
  (1,038)  (2,617)
       
Net increase (decrease) in cash and cash equivalents  7   (1,775)
Cash and cash equivalents at beginning of year  3,698   4,353 
       
Cash and Cash Equivalents at End of Period
 $3,705  $2,578 
       
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(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&T’s Form 10-K10-K/ A for the year ended December 31, 2003,2004.
2.Merger Agreement With SBC Communications Inc.
      On January 31, 2005, AT&T and Forms 10-QSBC Communications Inc. (SBC) announced an agreement for SBC to acquire AT&T. Under the quarters ended March 31, 2004 and June 30, 2004. We have reclassified certain prior period amountsterms of the agreement, each AT&T share will be exchanged for 0.77942 of a share of SBC common stock. In addition, at the time of closing, we will pay our shareowners a special dividend of $1.30 per share. At the time of the announcement, this consideration was valued at $19.71 per share, or approximately $16.0 billion. The stock consideration in the transaction is expected to conformbe tax-free to our current presentation, including the transfershareowners. The acquisition, which is subject to approval by our shareowners and regulatory authorities, and other customary closing conditions, is expected to close in late 2005 or early 2006. However, it is possible that factors outside of our remaining payphone businesscontrol could require us to complete the merger at a later time or not to complete it at all. While the merger agreement prohibits us from the AT&T Consumer Services segmentsoliciting competing acquisition proposals, we may accept a superior proposal prior to the effective date of the merger, subject to compliance with the terms of the merger agreement and payment of a $560 million termination fee and all documented out-of-pocket fees incurred by SBC, up to $40 million. The terms of certain of our agreements including contracts, employee benefit arrangements and debt instruments have provisions, which could result in changes to the terms or settlement amounts of these agreements upon a change in control of AT&T Business Services segment. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AT&T has&T.
3.Summary of Significant Accounting Policies
      We have a Long Term Incentive Program under which we grant stock options, performance shares, restricted stock and other awards in AT&T common stock are granted, as well as an Employee Stock Purchase Plan.Plan (ESPP). Employee purchases of company stock under the ESPP were suspended in 2003. Effective January 1, 2003, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting“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“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.options, other than for certain occasions when we have modified the terms of the stock option vesting schedule.

5


AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)
      If AT&Twe had elected to recognize compensation costs based on the fair value at the date of grant of all awards granted prior to January l,1, 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 NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ----------------------- ---------------------- 2004 2003 2004 2003 ---------- -------- --------- -------- (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Net (loss) income.............................. $(7,147) $ 418 $(6,735) $1,525 ADD: Stock-based employee compensation expense included in reported results, net of income taxes.............................. 22 22 57 56 DEDUCT: Total stock-based employee compensation expense determined under the fair value method for all awards, net of income taxes..................................... (49) (59) (145) (168) ------- ----- ------- ------ Pro forma net (loss) income.................... $(7,174) $ 381 $(6,823) $1,413 ======= ===== ======= ====== Basic (loss) earnings per share................ $ (8.99) $0.53 $ (8.48) $ 1.94 Pro forma basic (loss) earnings per share...... $ (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
          
  For the Three Months
  Ended March 31,
   
  2005 2004
     
  (Dollars in millions,
  except per share
  amounts)
Net income $529  $304 
Add:
        
 Stock-based employee compensation expense included in reported results, net of income taxes  24   18 
Deduct:
        
 Total stock-based employee compensation expense determined under the fair value method for all awards, net of income taxes  (46)  (51)
       
Pro forma net income $507  $271 
       
Basic and diluted earnings per share $0.66  $0.38 
Pro forma basic and diluted earnings per share $0.63  $0.34 
      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. 5 AT&T CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED) Pro forma (loss) earnings from continuing operations were $(7,174) million and $421 million forgrant, as well as the three months ended September 30, 2004 and 2003, respectively, and were $(6,823) million and $1,411 million forplanned adoption of SFAS 123 (revised 2004), “Share-Based Payment,” beginning in the nine months ended September 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.first quarter of 2006 (see note 11).
      For a detailed discussion of significant accounting policies, please refer to AT&T'sour Form 10-K10-K/ A for the year ended December 31, 2003. 3. SUPPLEMENTARY2004.
4.Supplementary Financial Information
Supplementary Balance Sheet Information
             
  AT&T AT&T  
  Business Consumer  
  Services Services Total
       
  (Dollars in millions)
Goodwill:
            
Balance at January 1, 2004 $4,731  $70  $4,801 
Translation adjustment  90      90 
Other  (3)     (3)
          
Balance at December 31, 2004 $4,818  $70  $4,888 
Translation adjustment  (7)     (7)
Reclassification to assets held-for-sale (included in other current assets)  (43)     (43)
          
Balance at March 31, 2005 $4,768  $70  $4,838 
          

6


AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED 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................................... (20) -- (20) Other.................................................... (3) -- (3) ------ --- ------ Balance at September 30, 2004............................ $4,708 $70 $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......................... $519 $208 $311 Other.................................................... 271 188 83 ---- ---- ---- Balance at September 30, 2004............................ $790 $396 $394 ==== ==== ====
STATEMENTS (Unaudited) — (Continued)
             
  Gross    
  Carrying Accumulated  
  Amount Amortization Net
       
  (Dollars in millions)
Other purchased intangible assets:
            
Customer lists and relationships $528  $229  $299 
Other  275   199   76 
          
Balance at December 31, 2004 $803  $428  $375 
Customer lists and relationships $528  $248  $280 
Other  209   141   68 
          
Balance at March 31, 2005 $737  $389  $348 
          
      Amortization expense associated with purchased intangible assets for the threefirst quarter of 2005 and nine months ended September 30, 2004, was $28$27 million and $89 million, respectively, and for the three and nine months ended September 30, 2003, was $19 million and $52$33 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. During2008, at which time the third quarter of 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) Other Current Assets:will be fully amortized.
Restricted Cash:
      Recorded within other current assets as of September 30,December 31, 2004, was restricted cash of $493$546 million relating to private debt that maturesmatured in February 2005. This asset had a balance2005 (see note 7).
Income Taxes Payable:
      Recorded within other current liabilities were $539 million and $281 million of $499 million atincome taxes payable as of March 31, 2005 and December 31, 2003,2004, respectively.
Assets Held-for-Sale:
      In the first quarter of 2005, we entered into an agreement to sell our payphone business, which is part of the AT&T Business Services segment. As a result of this agreement, we reclassified the assets and liabilities related to this business as held-for-sale at fair market value, in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The assets and liabilities that were reclassified consisted of $43 million of goodwill, $28 million of net accounts receivable, $12 million of property, plant and equipment, $7 million of prepaid expenses and $2 million of current liabilities. The goodwill was determined based on the relative fair value of the payphone business to that of AT&T Business Services. We recorded a $9 million charge within other income (expense), net to write down the assets to fair market value. It is currently expected that this sale will close by the end of the second quarter of 2005. Also reclassified to assets held-for-sale was $81 million related to an administrative building, which we actively marketed in the first quarter of 2005 and entered into an agreement to sell in April 2005. It is anticipated that we will record a gain on the sale of the building of approximately $40 million. Since we will be leasing a portion of the building back from the buyer, approximately $6 million of the gain is expected to be recognized at the time of sale (within the Corporate and Other group), which is currently anticipated to occur in the second quarter of 2005. The remaining gain will be deferred and amortized over the lease period (up to 5 years). The reclassification of the assets and liabilities discussed above to held-for-sale (included 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 Change.............................. (17) (13) (321) (351) ---- ---- ----- ----- Balance at September 30, 2004....... $183 $ 12 $(397) $(202) ==== ==== ===== =====
FOR THE NINE MONTHS ENDED SEPTEMBER 30, --------------------- 2004 2003 -------- -------- (DOLLARS IN MILLIONS) Other comprehensive income (loss): Net foreign currency translation adjustment [net of income taxes of $11 and $(59)]................................... $ (17) $ 97 Net revaluation of certain financial instruments: Unrealized gains (losses) [net of income taxes of $(7) and $(66)]................................................. 11 107 Recognition of previously unrealized (gains) losses [net of income taxes of $15 and $118](1).................... (24) (191) Net minimum pension liability adjustment [net of income taxes of $173 and $3]..................................... (321) (6) ----- ----- Total other comprehensive (loss) income..................... $(351) $ 7 ===== =====
- --------------- (1) See belowcurrent assets and other current liabilities, respectively) represented non-cash activity for a summarythe first quarter of recognition of previously unrealized (gains) losses on available-for-sale securities.
FOR THE NINE MONTHS ENDED SEPTEMBER 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) $(209) $(129) Other financial instrument activity........... (27) (17) (100) (62) ---- ---- ----- ----- Total recognition of previously unrealized (gains) losses................................ $(39) $(24) $(309) $(191) ==== ==== ===== =====
2005.

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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(Unaudited) — (Continued)
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, 2005 $319  $19  $(108) $230 
Change  (14)  1      (13)
             
Balance at March 31, 2005 $305  $20  $(108) $217 
             
          
  For the
  Three Months
  Ended March 31,
   
  2005 2004
     
  (Dollars in
  millions)
Other comprehensive income (loss):
        
Net foreign currency translation adjustment [net of income taxes of $9 and $10] $(14) $(18)
Net revaluation of certain financial instruments:        
 Unrealized gains [net of income taxes of $(2)]     4 
 
Recognition of previously unrealized losses (gains) [net of income taxes of $0 and $9](1)
  1   (15)
       
Total other comprehensive (loss) $(13) $(29)
       
(1)See table below for a summary of recognition of previously unrealized losses (gains).
                  
  For the Three Months Ended March 31,
   
  2005 2004
     
  Pretax After-taxes Pretax After-taxes
         
  (Dollars in millions)
Recognition of previously unrealized losses (gains):
                
Other income/expense, net:                
 Sale of various securities $1  $1  $(7) $(4)
 Other financial instrument activity        (17)  (11)
             
Total recognition of previously unrealized losses (gains) $1  $1  $(24) $(15)
             
5.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

8


AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)
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 threeunits 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.performance shares. No adjustments were made to income for the computation of diluted EPS in 2003. 5. ASSET IMPAIRMENT AND NET RESTRUCTURING AND OTHER CHARGESEPS.
6.Asset Impairment and Net Restructuring and Other Charges
      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, 2005 $506  $228  $2  $736 
 Deductions  (136)  (17)     (153)
             
Balance at March 31, 2005 $370  $211  $2  $583 
             
      Deductions primarily reflected total cash payments of $151 million. These cash payments include cash termination benefits of $134 million and $17 million of facility closing reserve payments, which were funded primarily through cash from operations.
      Asset impairment and net restructuring and other charges of $12,469$213 million forin the three months ended September 30,first quarter of 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. Thereal estate impairment charges of $11,389$121 million representedincluded in the difference between the fair values of the assetCorporate and Other group and its carrying valuesbusiness restructuring obligations of $92 million, of which $91 million related to AT&T Business Services and are included within asset impairment and net restructuring and other charges in the consolidated statements of operations.$1 million related to AT&T Consumer Services. The real estate impairment charges resulted from sustained pricing pressurethe decision made during the first quarter of 2004 to divest five owned properties in an effort to further reduce costs 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 recordedconsolidate our real estate portfolio. The impairment charges of $11,330 million resulting in reductionswere recorded 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 ofreduce 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 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 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 carryingbook value of the reporting units when performingfive properties to fair market value, based on third party assessments (including broker appraisals). The sales of the impairment test for goodwill.properties were completed in 2004. The goodwill impairment test requires us$92 million related 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 of $1,080 million for the third quarter of 2004 consisted of $1,043$52 million for employee separations (of which $339 million related to benefit plan curtailment costs)of separation costs and $37$40 million of facility closing obligations. This exit plan will impactobligations associated with the consolidation of our real estate portfolio. The separations were primarily involuntary and impacted 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, and our strategic 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 are managers. Facility780 employees. The facility closing reserves of $37 million for the three months ended September 30, 2004, arewere primarily associated with the continued consolidation of our real estate portfolio and reflectreflected 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 chargesused.
      Approximately 70% of $12,736 million for the nine months ended September 30,headcount reductions associated with all of our 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 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 sales of these properties have been completed. The net restructuring obligations of $1,225 million for the nine months ended September 30, 2004, were primarily 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 focus away from traditional consumer services and towards 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 positionswere completed as of September 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 ofMarch 31, 2005. The facility closing reserves of $78 million for the nine months ended September 30, 2004, 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. 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 $ 363 Additions....................................... 808 78 -- 886 Deductions...................................... (209) (70) -- (279) ----- ---- ----- ----- Balance at September 30, 2004..................... $ 755 $213 $ 2 $ 970 ===== ==== ===== =====
7.Financial Instruments
Deductions primarily reflected total cash payments of $249 million. These cash payments include cash termination benefits of $202 million and $47 million of facility closing reserve payments, which were funded primarily through cash from operations. Deductions also included 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. Asset impairment and net restructuring and other charges for the three and nine months ended September 30, 2003, were $64 million and $134 million, respectively. The charges in both periods primarily reflected separation costs associated with our management realignment 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 addition, 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, net. In addition, during the first quarter of 2004, we completed the early retirement of $928 million of 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, net. The carrying value of these notes was $1.3 billion, including $0.4 billion in associated foreign currency mark-to-market 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 and foreign currency rates and equity prices.exchange rates. We do not use financial instruments for trading or speculative purposes. TheseThe following information pertains to financial instruments includewith significant activity since December 31, 2004.
Letters of Credit
      Letters of credit are guarantees we purchase, which ensure our performance or payment to third parties in accordance with specified terms and conditions. Management has determined that our letters of credit guaranteesdo not create additional risk to us. The notional amounts outstanding at March 31, 2005 and December 31, 2004,

9


AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)
were $0.3 billion and $1.2 billion, respectively. The decrease in the notional amount of the letters of credit was primarily related to the maturity of debt and certain obligationsin February 2005. In addition, restricted cash of former affiliates, interest rate swap agreements, foreign currency exchange contracts, option contracts, equity contracts and warrants. GUARANTEES AT&T provided a guarantee$546 million, recorded within other current assets as of an obligation that AT&T Wireless Services, Inc. (AT&T Wireless) has to NTT DoCoMo. UnderDecember 31, 2004, which collateralized these letters of credit, was released upon maturity of 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 AGREEMENTSdebt.
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 (LondonLondon Inter-Bank Offered Rate)Rate (LIBOR). The notional amountDuring the first quarter of our fixed-rate to floating-rate swaps was $750 million as of September 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 7). The weighted-average receive rate and pay rate for the outstanding fixed-to-floating interest rate swaps as of September 30, 2004, was 4.83% and 3.71%, respectively. The notional amount2005, all 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(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$108 million), designated as of September 30, 2004, was 1.75% and 8.26%, respectively.cash flow hedges, matured.
      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 September 30, 2004,March 31, 2005, the notional amount and fair value of these contracts was $1.5were $0.6 billion and $0.5$0.3 billion, respectively, compared with $2.5$1.4 billion and $1.0$0.7 billion, respectively, at December 31, 2003.2004. The decreases in the notional amount and fair value of these agreements were primarily related to $1.0the maturity in February 2005 of $0.7 billion notional amount of combined interest rate foreign currency swap contracts designated as cash flow hedges, which were unwound during 2004relating to debt that also matured in connection with the early retirement of long-term Euro notes during the first and third quarters of 2004 (see note 7). As a result of this unwind, we recognized $12 million of unrealized gains as part of the net gain (loss) on the early extinguishment of debt within other (expense) income, net. In addition, we returned $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 EXCHANGEFebruary 2005.
Equity Option and Equity Swap Contracts
      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 September 30, 2004, the notional amount outstanding on these contracts was $0.8 billion, compared with $1.1 billion as of December 31, 2003. The decrease in the notional amount was primarily attributable to a decrease in our forward contract portfolio due to contract expirations. EQUITY OPTION AND EQUITY SWAP CONTRACTS We enterentered into equity options and equity swap contracts, which arewere 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 $28 million as of September 30, 2004, compared with $91 million as of December 31, 2003. The decrease in the notional amount was primarily related to swaps on 1.8 million Comcast Corporation (Comcast) shares, which expired during 2004. DEBT SECURITIES As of September 30, 2004, the carrying value of our long-term debt (including currently maturing long-term debt), excluding capital leases, was $10.0 billion, compared with $13.4 billion at December 31, 2003. The market value associated with this debt was $10.7 billion and $14.8 billion as of September 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 inDuring the first nine monthsquarter of 2004. The carrying value2005, all of debt with an original maturity of less than one year approximates market value. The fair value of long-term debt was obtained based on quotes for these securities. 13 AT&T CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED) 9. PENSION AND POSTRETIREMENT EMPLOYEE BENEFIT PLANSthe previously outstanding equity awards and the related equity option and equity swap contracts expired.
8.Pension, Postretirement and Other Employee Benefit Plans
      We sponsor noncontributory defined benefit pension plans covering the majority of our U.S. employees. Our postretirement 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) costscost for our U.S. plans:
PENSION POSTRETIREMENT PENSION POSTRETIREMENT BENEFITS BENEFITS BENEFITS BENEFITS ------------- --------------- ----------------- --------------- FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------- ----------------------------------- 2004 2003 2004 2003 2004 2003 2004 2003 ----- ----- ------ ------ ------- ------- ------ ------ (DOLLARS IN MILLIONS) Service cost -- benefits earned during the period.................... $ 55 $ 50 $ 6 $ 6 $ 165 $ 164 $ 18 $ 19 Interest cost on benefit obligations............... 231 236 89 100 691 706 268 266 Amortization
                 
  Pension Postretirement
  Benefits Benefits
     
  For the Three Months Ended
  March 31,
   
  2005 2004 2005 2004
         
  (Dollars in millions)
Service cost — benefits earned during the period $44  $55  $4  $6 
Interest cost on benefit obligations  229   227   80   89 
Amortization of unrecognized prior service cost  22   32   9   13 
Credit for expected return on plan assets  (332)  (356)  (40)  (44)
Amortization of losses  24   1   22   25 
             
Net periodic benefit (credit) cost $(13) $(41) $75  $89 
             
      On January 21, 2005, the Department of Health and Human Services/ Centers for Medicare and Medicaid Services (CMS) released final regulations implementing major provisions of unrecognized prior service cost........ 32 33 13 10 97 109 39 29 Credit for expected return on plan assets............ (359) (365) (45) (41) (1,078) (1,084) (133) (110) Amortization of losses...... 1 1 25 22 3 3 75 59 Charges for special termination benefits*..... -- -- -- 4 -- -- -- 4 Net curtailment loss*....... 220 -- 119 -- 220 9 119 -- Net settlement loss......... -- 7 -- -- -- 7 -- -- ----- ----- ---- ---- ------- ------- ----- ----- Net periodic benefit (credit) cost............. $ 180 $ (38) $207 $101 $ 98 $ (86) $ 386 $ 267 ===== ===== ==== ==== ======= ======= ===== =====
- --------------- * 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). Pursuant to these final

10


AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)
regulations, 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. On May 19, 2004, the Financial Accounting Standards Board (FASB) issued FASB Staff Position ("FSP") No. FAS 106-2, "Accounting“Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003," which provides guidance on accounting for the effects of the new Medicare prescription drug legislation by employers whose prescription drug benefits are actuarially equivalent” we began recording a reduction to the drug benefit under Medicare Part D. We adopted FSP No. FAS 106-2 effective July 1, 2004, and have elected a prospective application, which required the remeasurement of our postretirement plan assets and accumulatednet periodic postretirement benefit obligation (APBO) as of July 1, 2004. However, federal regulations for determining actuarial equivalence have not yet been issuedcost in final form, which impacts our ability2004 relating to recognize the full adoption effects of the 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 deemedthat we deem to be actuariallyactuarial equivalent to Medicare Part D, benefits based on the benefits provided under the plan. The subsidy-related reduction in the APBO relatedWith respect to the adoption for this group was $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. During the third quarter, the amortizationimpact of the actuarial gain as well as a reductionAct to the remaining plan participants, we are assessing appropriate integration of interest cost resulted in a reductionthe federal subsidy into the plan benefits. We continue to review the regulations released on January 21, 2005, and the subsequent implementation guidance, to determine the impact to our accumulated postretirement benefit obligation and net periodic postretirement benefit cost.
Non-U.S. Plans
      Certain non-U.S. operations have varying types of pension programs providing benefits for substantially all of their employees.
      The following table shows the components of net periodic benefit cost (recorded within SG&A and costs of services and products) of approximately $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 postretirement benefit curtailment losses of $339 million. As a result of the plan 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 under-funded status of these plans and as a result of the remeasurement in September 30, 2004, we recorded an additional minimum pension liability of $394 million. The offset to this 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 CONTINGENCIESnon-U.S. plans:
         
  For the Three Months
  Ended March 31,
   
  2005 2004
     
  (Dollars in millions)
Service cost — benefits earned during the period $7  $7 
Interest cost on benefit obligations  10   11 
Credit for expected return on plan assets  (9)  (9)
Amortization of losses  3   3 
       
Net periodic benefit cost $11  $12 
       
9.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 September 30, 2004.March 31, 2005. 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 trial commenced in October
      In 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 vindicated at the end of the trial, 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 the prudent course for the company. On April 21, 2004, thefollowing an Federal Communications Commission (FCC) ruledruling against a petition we filed in October 2002, in which we asked the FCC to confirm that our long distancedecide the issue of whether certain phone-to-phone Internet Protocol (IP)IP telephony services are exempt from terminatingpaying 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. AsSBC filed 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 uslawsuit in federal district court in Missouri seeking recovery of an estimated $141 million inasserting claims that we avoided interstate and intrastate access charges thatcharges. During the first quarter of 2005, AT&T and SBC allegessettled a variety of claims and disputes between the parties, including this litigation. The settlement of all matters resulted in AT&T avoided by delivering long distance calls topaying 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 weapproximately $60 million, which did not 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 notmaterial 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 issuesresults 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 $340 million in access savings since the third quarter of 2002, and approximately $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. 11. SEGMENT REPORTINGoperations.
10.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

11


AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)
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"“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'sour operations is included in a "Corporate“Corporate and Other"Other” group. This group primarily reflects corporate staff functions and the elimination of transactions between segments.
      Total assets for our reportable segmentseach 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 expenditures for property, plant and equipment, additions to internal-use software (which are included(included in other assets) and additions to nonconsolidated investments. We evaluate performance based on several factors, of which the primarily financial measure is operating income.
      AT&T Business Services sells services to AT&T Consumer Services at cost-based prices. These sales are recorded by AT&T Business Services as contra-expense. REVENUE
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 Long distance voice services........... $2,364 $2,820 $ 7,363 $ 8,698 Local voice services................... 390 379 1,183 1,098 ------ ------ ------- ------- Total voice services...................... 2,754 3,199 8,546 9,796 Data services.......................... 1,693 1,875 5,098 5,774 IP&E services.......................... 587 550 1,705 1,548 ------ ------ ------- ------- Total data and IP&E services(1)........... 2,280 2,425 6,803 7,322 Outsourcing, professional and other services............................... 611 677 1,779 2,070 ------ ------ ------- ------- Total AT&T Business Services................ 5,645 6,301 17,128 19,188 AT&T Consumer Services Stand-alone long distance voice and other services............................... 1,256 1,813 4,045 5,797 Bundled services.......................... 724 521 2,053 1,405 ------ ------ ------- ------- Total AT&T Consumer Services................ 1,980 2,334 6,098 7,202 ------ ------ ------- ------- Total reportable segments................. 7,625 8,635 23,226 26,390 ------ ------ ------- ------- Corporate and Other......................... 13 14 38 40 ------ ------ ------- ------- Total revenue............................... $7,638 $8,649 $23,264 $26,430 ====== ====== ======= =======
Revenue
- --------------- (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
           
  For the Three Months
  Ended March 31,
   
  2005 2004
     
  (Dollars in millions)
AT&T Business Services        
  Long distance voice services $2,168  $2,613 
  Local voice services  371   389 
       
 Total voice services  2,539   3,002 
  Data services  1,585   1,715 
  IP&E services  589   553 
       
 Total data and IP&E services  2,174   2,268 
 Outsourcing, professional services and other  606   602 
       
Total AT&T Business Services  5,319   5,872 
AT&T Consumer Services        
 Stand-alone long distance voice and other services  1,025   1,462 
 Bundled services  660   645 
       
Total AT&T Consumer Services  1,685   2,107 
       
 Total reportable segments  7,004   7,979 
       
Corporate and Other  11   11 
       
Total revenue $7,015  $7,990 
      ��

12


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 (Unaudited) — (Continued)
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
Reconcilation of Operating Income to Income (Loss) before Income Taxes 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) relatedNet (Losses) Related to equity investmentsEquity Investments
          
  For the Three Months
  Ended March 31,
   
  2005 2004
     
  (Dollars in millions)
AT&T Business Services $588  $83 
AT&T Consumer Services  575   371 
       
 Total reportable segments  1,163   454 
Corporate and Other  (93)  (173)
       
Operating income  1,070   281 
Other income (expense), net  30   (174)
Interest (expense)  (203)  (228)
       
Income (loss) before income taxes and net (losses) related to equity investments $897  $(121)
       
 
Assets
 
  At At
  March 31, December 31,
  2005 2004
     
  (Dollars in millions)
AT&T Business Services $20,294  $20,621 
AT&T Consumer Services  646   743 
       
 Total reportable segments  20,940   21,364 
Corporate and Other*  10,756   11,440 
       
Total assets $31,696  $32,804 
       
Includes cash of $3.1 billion at March 31, 2005 and cumulative effect of accounting changes................. $(11,551) $ 533 $(11,479) $2,196 ======== ===== ======== ======
ASSETS
AT AT SEPTEMBER 30, DECEMBER$3.0 billion at December 31, 2004 2003 ------------- ------------ (DOLLARS IN MILLIONS) AT&T Business Services...................................... $20,813 $34,202 AT&T Consumer Services...................................... 777 1,062 ------- ------- Total reportable segments................................. 21,590 35,264 Corporate and Other*........................................ 10,469 12,724 ------- ------- Total assets................................................ $32,059 $47,988 ======= ======= 2004.
- --------------- * Includes cash of $2.2 billion at September 30, 2004, and $4.0 billion at December 31, 2003. 18
Capital Additions
          
  For the Three Months
  Ended March 31,
   
  2005 2004
     
  (Dollars in millions)
AT&T Business Services $          332  $          470 
AT&T Consumer Services     13 
       
 Total reportable segments  332   483 
Corporate and Other  3   2 
       
Total capital additions $335  $485 
       

13


AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED) CAPITAL ADDITIONS (Unaudited) — (Continued)
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..................... $391 $ 995 $1,324 $2,396 AT&T Consumer Services..................... 9 14 37 55 ---- ------ ------ ------ Total reportable segments................ 400 1,009 1,361 2,451 Corporate
Geographic Information
         
  For the Three Months
  Ended March 31,
   
  2005 2004
     
  (Dollars in millions)
Revenue(1)
        
United States(2)
 $6,588  $7,609 
International  427   381 
       
Total revenue $7,015  $7,990 
       
 
  At At
  March 31, December 31,
  2005 2004
     
  (Dollars in millions)
Long-Lived Assets(3)
        
United States(2)
 $14,601  $14,968 
International  1,788   1,804 
       
Total long-lived assets $16,389  $16,772 
       
(1)Revenue is reported in the geographic area in which it originates.
(2)Includes amounts attributable to operations in Puerto Rico and Other........................ 6 198 10 210 ---- ------ ------ ------ Total capital additions.................... $406 $1,207 $1,371 $2,661 ==== ====== ====== ======
GEOGRAPHIC INFORMATION
FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, --------------------- ------------------- 2004 2003 2004 2003 -------- -------- ------- ------- (DOLLARS IN MILLIONS) Revenue(1) United States(2)............................ $7,227 $8,258 $22,078 $25,267 International............................... 411 391 1,186 1,163 ------ ------ ------- ------- Total revenue............................... $7,638 $8,649 $23,264 $26,430 ====== ====== ======= =======
AT AT SEPTEMBER 30, DECEMBER 31, 2004 2003 ------------- ------------ (DOLLARS IN MILLIONS) Long-Lived Assets(3) United States(2)............................................ $15,173 $27,758 International............................................... 1,653 1,918 ------- ------- Total long-lived assets..................................... $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) the Virgin Islands.(3)Long-lived assets include property, plant and equipment, net; goodwill and other purchased intangibles, net.
     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 October 6,
11.New Accounting Pronouncements
      In March 2005, the FASB issued FASB Interpretation (FIN) No. 47, “Accounting for Conditional Asset Retirement Obligations,” an interpretation of SFAS No. 143, “Accounting for Asset Retirement Obligations.” FIN No. 47 clarifies that the term conditional asset retirement obligation, as used in SFAS No. 143, refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and/or method of settlement. FIN No. 47 requires an entity to recognize a liability for the fair value of the conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. FIN No. 47 is effective for fiscal years ending after December 15, 2005, which is December 31, 2005 for us; however, earlier application is permitted. We are currently evaluating the impact of FIN No. 47 on our results of operations, financial position and cash flows.
      In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment,” which requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. Additional guidance to assist in the initial interpretation of this revised statement was subsequently issued by the SEC in Staff Accounting Bulletin No. 107. SFAS No. 123 (revised 2004) eliminates the alternative of using APB Opinion No. 25 intrinsic value method of accounting that was provided for in SFAS No. 123 as originally issued. Effective January 1, 2003, we entered intoadopted the fair value recognition provisions of original SFAS No. 123 on a $1.0 billion syndicated 364-day credit facility led by J.P. Morgan Securities Inc., Citigroup Global Markets Inc.prospective basis and Bancwe began to record stock-based compensation expense for all employee awards (including stock options) granted or modified after January 1, 2003. Adoption of America Securities LLCthe revised standard will require that replaced our existing $2.0 billion facility. 19 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS we begin to recognize expense for unvested awards issued prior to January 1, 2003. Additionally, this standard requires that

14


AT&T CORP. AND SUBSIDIARIES FORWARD-LOOKING
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)
estimated forfeitures be considered in determining compensation expense. For equity awards other than stock options, we have not previously included estimated forfeitures in determining compensation expense. Accordingly, the difference between the expense we have recognized to date and the compensation expense as calculated considering estimated forfeitures will be reflected as a cumulative effect of accounting change upon adoption. Further, SFAS No. 123 (revised 2004) requires that excess tax benefits be recognized as an addition to paid-in capital and amends SFAS No. 95, “Statement of Cash Flows,” to require that the excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid. SFAS No. 123 (revised 2004) is effective for annual periods beginning after June 15, 2005, which is January 1, 2006 for us. We intend to elect a modified prospective adoption beginning in the first quarter of 2006 and do not anticipate that the adoption of SFAS No. 123 (revised 2004) will have a material impact on our recorded compensation expense.
      In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets — an amendment of APB Opinion No. 29.” APB Opinion No. 29 requires that nonmonetary exchanges of assets be recorded at fair value with an exception for exchanges of similar productive assets, which can be recorded on a carryover basis. SFAS No. 153 eliminates the current exception and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for nonmonetary asset exchanges that take place in fiscal periods beginning after June 15, 2005, which is July 1, 2005 for us; however, earlier application is permitted.
      In December 2004, the FASB issued FSP No. FAS 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004,” which provides guidance on the accounting and disclosure requirements for the repatriation provision of the Act. The Act creates a one-time tax incentive for U.S. corporations to repatriate accumulated income earned abroad by providing a tax deduction of 85% of dividends received for certain foreign earnings that are repatriated. The deduction is subject to a number of requirements and clarification is needed on various aspects of the law before the impact can be determined. In addition, the amount of the deduction remains subject to potential local country restrictions on remittances, as well as to management’s decisions with respect to any repatriation. Based upon the current wording of the law and assuming no technical corrections, we are considering possible dividend remittances of approximately $100 million, which, after consideration of deferred taxes previously recorded on foreign earnings, we estimate would result in a one-time income tax benefit in 2005 of approximately $5 million. We expect to complete our evaluation of the impact of the Act during 2005.
12.Subsequent Events
      During April 2005, we completed the early retirement of $1.25 billion of our outstanding 7.30% Notes maturing in November 2011, which carried an interest rate of 9.05% at the time of retirement. The notes were repurchased with cash and resulted in a loss of approximately $0.2 billion recorded in other income (expense), net.
      During May 2005, we settled litigation brought by the trustee for the bondholders’ liquidating trust of At Home Corporation for $340 million, subject to bankruptcy court approval. Under the terms of a separation agreement with our former broadband subsidiary, which was spun off to Comcast Corporation in 2002, the settlement will be shared equally between the two parties. The settlement of this litigation did not have a material impact on our results of operations.
      Also in May 2005, we repaid the $125 million of borrowings outstanding under the AT&T Consumer Services accounts receivable securitization facility and subsequently terminated this facility.

15


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, mergers and acquisitions, and other matters.
      Statements in this document that are not historical facts are hereby identified as "forward-looking statements"“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,"“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, 20 - 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 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 invalidity of portions of the FCC’s Triennial Review Order,
• the risks associated with technological requirements; wireless, internet, Voice over Internet Protocol (VoIP) or other technology substitution and changes; and other technological developments,

16


• the risks associated with the repurchase by us of debt or equity securities, which may adversely affect our liquidity or creditworthiness,
• the uncertainties created by the proposed acquisition of our company by SBC Communications, Inc.,
• the impact of the significant recent reductions in the number of our employees,
• 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&T’s consolidated results of operations for the three and nine months ended September 30,March 31, 2005 and 2004, and 2003, and financial condition as of September 30, 2004March 31, 2005 and December 31, 2003. OVERVIEW2004.

17


AT&T CORP. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
      AT&T Corp. (AT&T) is among the world'sworld’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
Critical Accounting Estimates and challenging. During the first nine months of 2004, we continued to see the effects of industry oversupply and the associated impacts on pricing behavior in the business marketplace. Competitive 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. 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. 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 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 a 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. 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 JUDGMENTSJudgments
      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&T’s Form 10-K10-K/ A for the year ended December 31, 2003. CONSOLIDATED RESULTS OF OPERATIONS REVENUE 2004.
Consolidated Results of Operations
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...................... $5,645 $6,301 $17,128 $19,188 AT&T Consumer Services...................... 1,980 2,334 6,098 7,202 Corporate and Other......................... 13 14 38 40 ------ ------ ------- ------- Total revenue............................... $7,638 $8,649 $23,264 $26,430 ====== ====== ======= =======
Revenue
         
  For the Three Months
  Ended March 31,
   
  2005 2004
     
  (Dollars in millions)
AT&T Business Services $5,319  $5,872 
AT&T Consumer Services  1,685   2,107 
Corporate and Other  11   11 
       
Total revenue $7,015  $7,990 
       
      Total REVENUE revenuedecreased $1.0 billion, or 11.7%12.2%, in the thirdfirst quarter of 2005 compared with the first quarter of 2004, and decreased $3.2 billion, or 12.0%, in the nine months ended September 30, 2004, compared with the same periods in 2003. The decreases were primarily driven by continued declinesa decline in stand-alone long distance voice revenue of approximately $1.0 billion in the third quarter of 2004, and $3.0 billion in the nine months ended September 30, 2004, compared with the same periods in 2003. These declines are$0.9 billion. This decline was reflective of increased competition, which has led to lower prices, and loss of market share a decline in AT&T Consumer Services and small- and medium-sized business retail volumes, the impact of substitution, and consumer migration to lower priced products and calling plans.markets. In addition, stand-alone long distance revenue was negatively impacted by substitution. Total long distance voice volumes (including long distance volumes sold as part of a bundled product) decreased approximately 6% for8% in the thirdfirst quarter of 2004 and approximately 4% for the nine months ended September 30, 2004,2005 compared with the respective periods in 2003,first quarter of 2004, primarily due to declines in consumer and business retail and consumer long distance volumes, partially offset by growth in lower-priced business wholesale.volumes. Also contributing to the overall revenue decline in the first quarter of 2005 was lower data services revenue of $0.2$0.1 billion, in the third quarter of 2004, and $0.7 billion in the nine months ended September 30, 2004, compared with the respective periods in 2003, primarily driven by competition, which has led to declining prices and customer losses primarily in bandwidth and packet services, as well as weak 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 third quarter of 2004, and $0.6 billion in the nine months ended September 30, 2004, compared with the same periods in 2003, resulting from continued subscriber growth.competitive pricing pressure.
      Revenue by segment is discussed in greater detail in the Segment Results section. 22 OPERATING EXPENSES

18


AT&T CORP. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS — (Continued)
FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, --------------------- -------------------- 2004 2003 2004 2003 ---------- -------- --------- -------- (DOLLARS IN MILLIONS) Access and other connection................... $ 2,411 $2,785 $ 7,530 $ 8,191 Costs of services and products................ 1,783 1,954 5,406 5,923 Selling, general and administrative........... 1,653 1,793 5,160 5,551 Depreciation and amortization................. 647 1,224 3,128 3,607 Asset impairment and net restructuring and other charges............................... 12,469 64 12,736 134 -------- ------ -------- ------- Total operating expenses...................... $ 18,963 $7,820 $ 33,960 $23,406 ======== ====== ======== =======
Operating (loss) income....................... $(11,325) $ 829 $(10,696) $ 3,024 Operating margin.............................. (148.3)% 9.6% (46.0)% 11.4% Expenses
         
  For the Three Months
  Ended March 31,
   
  2005 2004
     
  (Dollars in millions)
Access and other connection $2,404  $2,638 
Costs of services and products  1,628   1,864 
Selling, general and administrative  1,277   1,744 
Depreciation and amortization  636   1,250 
Asset impairment and net restructuring and other charges     213 
       
Total operating expenses $5,945  $7,709 
       
Operating income $1,070  $281 
Operating margin  15.3%  3.5%
      Included within ACCESS AND OTHER CONNECTION EXPENSES access and other connection expensesare 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.Federal Communications Commission (FCC). We pay domestic access charges to local exchange carriers to complete long distance calls carried across the AT&T network and originated or terminated on a local exchange carrier'scarrier’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 reductionchange in these expensesrates generally results in a corresponding reductionchange in revenue.
      Access and other connection expenses decreased $0.4$0.2 billion, or 13.5%8.8%, in the thirdfirst quarter of 2004 and declined $0.7 billion, or 8.1%, for the nine months ended September 30, 2004,2005 compared with the same periodsfirst quarter of 2003.2004. 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$0.2 billion for the thirdfirst quarter of 2005, primarily due to lower volumes, lower Universal Service Fund contributions resulting from the decline in long distance revenue, and changes in product mix (including whether calls are interstate versus intrastate). Also contributing to the quarterly declineaverage rates of $0.1 billion. The decreased rates were lower rates, including the impact of settlements, resultingdue in part fromto 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. Excluding the third quarter 2003 access expense adjustment, domesticusage, partially offset by higher access charges declined $0.8on prepaid card calls. Also contributing to the decline were lower costs of $0.1 billion for the year-to-date period, primarily due to lower Universal Service Fund contributions, changes in product mix, lower rates, as well as reducedoverall volumes. The year-to-date declines in domestic access charges were partially offset by increased local connectivity costs
Costs of $0.2 billion, primarily as a result of subscriber increases due to new state entriesservices and increased penetration into existing states. COSTS OF SERVICES AND PRODUCTS productsinclude 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 8.7%12.7%, in the thirdfirst quarter of 2004 and declined $0.5 billion, or 8.7%, in the nine months ended September 30, 2004,2005 compared with the comparable prior year periods.first quarter of 2004. The declines weredecline was primarily driven by the overall impact of lower revenue and related costs, including cost cutting initiatives.initiatives, primarily headcount reductions, as well as lower revenue. Also contributing to the decline was a lower provision for uncollectible receivables 23 resulting from improved collections and lower revenue. Partially offsetting these declines was the impact of a weak U.S. dollar. SELLING, GENERAL AND ADMINISTRATIVE (SG&A) EXPENSES
Selling, general and administrative expensesdecreased $0.1$0.5 billion, or 7.7%26.9%, in the thirdfirst quarter of 2004 and declined $0.4 billion, or 7.0%, in the nine months ended September 30, 2004,2005 compared with the comparable prior year periods. These declines werefirst quarter of 2004. This decline was 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. The quarterly decline also reflected the impact of lower marketing and customer acquisition spending of $0.3 billion 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 advertisingservices. In addition, this decline reflects cost control efforts throughout AT&T, as well as lower costs resulting from decreased customer levels, totaling $0.2 billion. Cost control efforts included headcount reductions as well as continued process improvements.

19


AT&T CORP. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS — (Continued)
Depreciation 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 amortization expensesdecreased $0.6 billion, or 47.2%49.1%, in the thirdfirst quarter of 2004 and declined $0.5 billion, or 13.3%, in the nine months ended September 30, 2004,2005 compared with same periods in 2003. These decreases werethe first quarter of 2004. This decrease was primarily attributable to asset impairment charges of $11.4 billion takenrecorded in the third quarter of 2004, which decreased depreciation and amortization 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 $0.4$0.3 billion and $1.2$0.5 billion for the three months ended September 30,first quarter of 2005 and 2004, and 2003, respectively, and were $1.4 billion and $2.7 billion for the nine months ended September 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. In the third quarter of 2004, ASSET IMPAIRMENT AND NET RESTRUCTURING AND OTHER CHARGES of $12,469 million were comprised of $11,389 million of asset impairment charges and $1,080 million of net business restructuring and 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
Asset impairment and net restructuring and other chargesof $0.2 billion in the consolidated statementsfirst quarter of operations.2004 were comprised of real estate impairment charges of $0.1 billion included in the Corporate and Other group and business restructuring obligations of $0.1 billion, primarily related to AT&T Business Services. The real estate impairment charges resulted from sustained pricing pressurethe decision made during the first quarter of 2004 to divest five owned properties in an effort to further reduce costs 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 recordedconsolidate our real estate portfolio. The impairment charges of $11,330 million resulting in reductionswere recorded 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 calculatedreduce 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 carryingbook value of the reporting units when performingfive properties to fair market value based on third party assessments (including broker appraisals). The sales of the impairment test for goodwill.properties were completed in 2004. The goodwill impairment test requires us$0.1 billion related 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$52 million for employee separations (of which $339 million related to benefit plan curtailment costs)of separation costs and $37$40 million of facility closing obligations. This exit plan will impactobligations associated with the consolidation of our real estate portfolio. The separations were primarily involuntary and impacted 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, and our strategic 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 are managers. Facility780 employees. The facility closing reserves of $37 million arewere primarily associated with the continued consolidation of our real estate portfolio and reflectreflected 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 comprised of $11,511 million of asset impairments and $1,225 millionused.
Operating incomeincreased to $1.1 billion in net business restructuring and other obligations. In this period, charges in the amount of $12,002 million were recorded in AT&T Business Services, $189 million in AT&T Consumer Services and $545 million in the Corporate and Other group. 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 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 sales of these properties have been completed. The net restructuring obligations of $1,225 million for the nine months ended September 30, 2004, were primarily 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 resulted2005 from the continued integration and automation of various functions within network operations, reorganizations throughout our non-U.S. operations, and our strategic change in focus away from traditional consumer services and towards 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 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 restructuring charge recorded) in 2004; however, we expect to realize approximately $1.2 billion of annual cash savings and benefit to operating income in subsequent years, upon completion of the exit plans. The 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. Asset impairment and net restructuring and other charges for the three and nine months ended September 30, 2003 were $64 million and $134 million, respectively. The charges in both periods primarily reflected separation costs associated with our management realignment 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 declined to a loss of $11.3 billion from income of $0.8$0.3 billion in the thirdfirst quarter of 2004 and declined to a loss of $10.7 billion from income of $3.0 billion in the nine 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.2004. As a result of the third quarter 2004 asset impairment charges, operating income for the three and nine months ended September 30, 2004,first quarter of 2005 included a $0.5 billion benefit due to lower depreciation on assets impaired. Excluding the impactsimpaired assets. Operating income for the first quarter of the2004 included asset impairment and net restructuring and other charges for both periods, OPERATING MARGIN declined 2.3of $0.2 billion.Operating marginimproved 11.8 percentage points in the thirdfirst quarter of 2005 compared with the first quarter of 2004. The benefit due to lower depreciation positively impacted the first quarter 2005 margin by 7.7 points. The asset impairment and net restructuring and other charges negatively impacted the first quarter 2004 and declined 5.5margin by 2.7 percentage pointspoints. The remaining 1.4 percentage point improvement in the year-to-date period.first quarter 2005 operating margin was primarily attributable to improved margins in AT&T Consumer Services resulting primarily from a decline in selling, general and administrative expenses due to our change in strategic focus, as well as lower customer care expenses. The margin declinesimproved margins in AT&T Consumer Services were partially offset by lower margins in AT&T Business Services, which were primarily due to decreased revenue coupled with a slower ratereflective of decline in operating expenses. This reflected pricing pressures, substitution and a shift fromthe declining higher-margin businesslong distance retail voice and data services and residential long distance services to lower-margin services, including advanced services and business wholesale. In addition, the 2003 margins were negatively impacted by a $0.1 billion access expense adjustment.
FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, --------------------- -------------------- 2004 2003 2004 2003 ------ ------ ------- ------ (DOLLARS IN MILLIONS) Other (expense) income, net.................... $(34) $(7) $(172) $89
OTHER (EXPENSE) INCOME, NET,businesses. See Segment Results section for more details.
         
  For the Three Months
  Ended March 31,
   
  2005 2004
     
  (Dollars in millions)
Other income (expense), net $30  $(174)
Other income (expense), net, in the thirdfirst quarter of 20042005 was expenseincome of $34$30 million compared with expense of $7 million$0.2 billion in the thirdfirst quarter of 2003.2004. The unfavorablefavorable variance was primarily due to an 26 impairment in 2004$0.3 billion 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 net gains on sales of businesses and investments, which aggregated $89 million. Partially offsetting this unfavorable variance was $56 million in lower losses on early repurchases of long-term debt. Other (expense) income, net, in the nine months ended September 30, 2004 was expense of $172 million comparedassociated with income of $89 million in the nine months ended September 30, 2003. The unfavorable variance was primarily attributed to $216 million of higher losses on the early repurchase of long-term debt in the first nine monthsquarter of 2004, compared to the comparable period in 2003. Also, inpartially offset by first quarter 2004 investment related income and net gains on sales of businesses and investments declined $105 million, compared with the nine months ended September 30, 2003. Partially offsetting these unfavorable differences were settlements in the first nine months of 2004, associated with businesses previously disposed.disposed businesses.
      We continue to hold $0.6$0.5 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

20


AT&T CORP. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS — (Continued)
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 NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------------------- ------------------- 2004 2003 2004 2003 ------- ------- ------- ------- (DOLLARS IN MILLIONS) Interest (expense).............................. $(192) $(289) $(611) $(917)
INTEREST (EXPENSE)
         
  For the Three Months
  Ended March,
   
  2005 2004
     
  (Dollars in millions)
Interest (expense) $(203) $(228)
Interest (expense)decreased 33.7%11.2%, or $0.1 billion,$25 million, in the thirdfirst quarter of 2004 compared with the third quarter of 2003, and decreased 33.4%, or $0.3 billion, in the nine months ended September 30, 20042005 compared with the first nine monthsquarter of 2003. The declines are2004. This decline was reflective of our continuing deleveraging activities, which included significant early debt redemptions and scheduled debt maturities in 2003 and2004, partially offset by the impact of interest rate step-ups on certain bonds as a result of long-term debt ratings downgrades in 2004.
FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------------------- -------------------- 2004 2003 2004 2003 -------- ------ -------- ------- (DOLLARS IN MILLIONS) Benefit (provision) for income taxes............ $4,402 $(72) $4,741 $(677) Effective tax rate.............................. 38.1% 13.5% 41.3% 30.8%
         
  For the Three Months
  Ended March 31,
   
  2005 2004
     
  (Dollars in millions)
(Provision) benefit for income taxes $(368) $426 
Effective tax rate  41.0%  350.6%
      The EFFECTIVE TAX RATE effective tax rateis the (provision) benefit (provision) for income taxes as a percentage of income (loss) income before income taxes. The effective tax rate forin the thirdfirst quarter of 20032005 was positivelynegatively impacted by approximately 22.5 percentage points due to the recognition of approximately $120 million of tax benefitscosts associated with refund claims related to additional research and experimentation tax credits generated in prior years, which received governmental approval during the prior year third quarter.our pending merger with SBC. The effective tax benefit rate forin the nine months ended September 30,first quarter of 2004 was positively impacted by approximately 3.2306.3 percentage points due to the reversal of a portion of the valuation allowance we recognizedrecorded 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 for the nine months ended September 30, 2003, was positively impacted by approximately 5.5 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. 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 NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 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 changes......... $-- $(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 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
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 1110 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. A substantial majority of our property, plant and equipment (including network assets) is included in the AT&T Business Services segment. Capital additions for each segment include capital 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 continuouslycontinually review our management model and structure, which may result in additional adjustments to our operating segments in the future.

21


AT&T BUSINESS SERVICESCORP. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS — (Continued)
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, government agencies and government agencies.small- and medium-sized businesses. These services include long distance, international, toll-free and local voice, including wholesale transport services (sales of services to service resellers)resellers, such as other long distance companies, local service providers, wireless carriers and cable companies), as well as data services and Internet protocol and enhanced (IP&E) services, which includes the management of network servers and applications.IP&E services. AT&T Business Services also provides outsourcing solutions and other professional services.
          
  For the Three Months Ended
  March 31,
   
  2005 2004
     
  (Dollars in millions)
Revenue(1)
        
 Long distance voice services $2,168  $2,613 
 Local voice services  371   389 
       
Total voice services  2,539   3,002 
 Data services  1,585   1,715 
 IP&E services  589   553 
       
Total data and IP&E services  2,174   2,268 
Outsourcing, professional services and other  606   602 
       
Total revenue $5,319  $5,872 
Operating income $588  $83 
Capital additions $332  $470 
     
   At At
   March 31, December 31,
   2005 2004
      
   (Dollars in millions)
Total assets $20,294  $20,621 
FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, --------------------- --------------------
(1)Revenue includes equipment and product sales of $95 million and $74 million for the three months ended March 31, 2005 and 2004, 2003 2004 2003 ---------- -------- --------- -------- (DOLLARS IN MILLIONS) Revenue(1) Long distance voice services................ $ 2,364 $2,820 $ 7,363 $ 8,698 Local voice services........................ 390 379 1,183 1,098 -------- ------ -------- ------- Total voice services.......................... 2,754 3,199 8,546 9,796 Data services............................... 1,693 1,875 5,098 5,774 IP&E services............................... 587 550 1,705 1,548 -------- ------ -------- ------- Total data and IP&E services(2)............... 2,280 2,425 6,803 7,322 Outsourcing, professional and other services.................................... 611 677 1,779 2,070 -------- ------ -------- ------- Total revenue................................. $ 5,645 $6,301 $ 17,128 $19,188 Operating (loss) income....................... $(11,095) $ 413 $(10,860) $ 1,613 Capital additions............................. $ 391 $ 995 $ 1,324 $ 2,396 respectively.
AT AT SEPTEMBER 30, DECEMBER 31, 2004 2003 ------------- ------------ (DOLLARS IN MILLIONS) Total assets................................................ $20,813 $34,202
Revenue
29 - --------------- (1) Revenue includes equipment and product sales of $103 million and $83 million for the three months ended September 30, 2004 and 2003, respectively, and $241 and $223 for the nine months ended September 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, 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. REVENUE
      AT&T Business Services revenue decreased $0.7$0.6 billion, or 10.4%9.4%, in the thirdfirst quarter of 20042005 compared with the first quarter of 2004. This decrease reflects continued pricing pressure in traditional long distance and $2.1data services as well as declines in retail volumes. Revenue was positively impacted by approximately 1.0 percentage point due to a customer disconnect of prepaid network capacity and higher equipment and product sales.
      Long distance voice revenue in the first quarter of 2005 declined $0.4 billion, or 10.7%17.0%, in the nine 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 third quarter of 2004 declined $0.5 billion, or 16.3%, and declined $1.3 billion, or 15.4%, in the nine months ended September 30, 2004, compared with the same prior year periods. These declines wereperiod. This decline was 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 declined about 2%3% in the thirdfirst quarter of 2004 and were flat for the nine months ended September 30, 2004,2005 compared with the same prior year periods.first quarter of 2004.
      Data services revenue for the thirdfirst quarter of 20042005 declined $0.2$0.1 billion, or 9.7%7.6%, compared with the thirdfirst quarter of 2003, and declined $0.7 billion, or 11.7%, for the nine months ended September 30, 2004, compared with the nine months ended September 30, 2003. These declines were2004. This decline was primarily driven by competition, which has led to declining prices andprices. Offsetting

22


AT&T CORP. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS — (Continued)
this decline was a customer losses primarily in bandwidth and packet services, as well as weak demand, primarily in bandwidth services. The decrease is reflectivedisconnect of a rise in cancellations of private line and packet services, as customers continue to evaluateprepaid network capacity, which positively impacted 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, datagrowth rate by approximately 2.0 percentage points.
      Local voice services revenue declined 10.0% in the third quarter of 2004 and decreased 11.9% in the nine months ended September 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 $66$18 million, or 9.7%4.6%, in the thirdfirst quarter of 2004 compared with the third quarter of 2003. For the nine months ended September 30, 2004, outsourcing, professional and other services revenue decreased $0.3 billion, or 14.1%, compared with the nine months ended September 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 14.0% in the third quarter of 2004, and decreased 15.9% in the nine months ended September 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 $37 million, or 6.8%, in the third quarter of 2004, and increased $0.2 billion, or 10.3%, in the nine months ended September 30, 2004,2005 compared with the same prior year periods.period. This decrease reflects declines in reciprocal compensation revenue (revenue generated when local exchange carriers use our local network to terminate calls) and our “All-in-One” bundled offer.
      IP&E services revenue increased $36 million, or 6.6%, in the first quarter of 2005 compared with the same prior year period. The increase was primarily attributable to growth in our customer base associated with advanced products such as E-VPN (Enhanced Virtual Private Network) and IP-enabled frame. Partially offsetting this increase was a significant customer contract renewal at current market rates in one of the more mature products within IP&E services. Excluding equipment and product sales, IP&E services revenue increased 10.0%5.4% in the thirdfirst quarter of 20042005 compared with the thirdfirst quarter of 2003,2004.
      Outsourcing, professional services and other revenue increased 11.7%$4 million, or 0.4%, in the nine months ended September 30, 2004,first quarter of 2005 compared with the nine months ended September 30, 2003. Local voicefirst quarter of 2004. The increase reflects continued strength in government professional services and equipment and product sales. Excluding equipment and product sales, outsourcing, professional and other services revenue grew $11 million, or 3.3%, in the thirdfirst quarter of 2004, and grew $85 million, or 7.8%, in the nine months ended September 30, 2004,2005 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 nearly 4.7 million access lines in service at September 30, 2004, an increase of nearly 56,000 lines since the end of the second quarter of 2004. OPERATING (LOSS) INCOME The operating (loss) of $11.1period was flat.
Operating Income
      Operating income increased $0.5 billion in the thirdfirst quarter of 2004 declined $11.5 billion,2005 compared with operating income of $0.4 billion in the thirdfirst quarter of 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 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 comparable prior year periods.2004. As a result of the third quarter 2004 asset impairment charges, operating losses for the three and nine months ended September 30, 2004,first quarter 2005 results included a $499 million$0.5 billion net benefit due to lower depreciation on assetsthe impaired by AT&T Business Services, partlyassets. First quarter 2004 included $0.1 billion of asset impairment and net restructuring and other charges. The remaining operating income change was due to decreased long distance voice and data services revenue resulting from continued competitive pricing pressures, partially offset by lower network-related charges to AT&T Consumer Services. Excludingour ongoing cost control efforts.
      Operating margin was 11.0% and 1.4% for the impactsfirst quarter of the2005 and 2004, respectively. The net depreciation benefit positively impacted first quarter 2005 operating margin by 9.5 percentage points. The asset impairment and net restructuring and other charges for both periods,negatively impacted first quarter 2004 operating margin was 4.7% and 3.8% forby 1.6 percentage points. Excluding the three and nine months ended September 30, 2004, compared with 7.4% and 9.0% inimpacts of these items, the comparable prior year periods. The downwarddecreased margin trend iswas 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, coupled with thea shift to lower-margin products, such as advanced and wholesale services. Partially offsetting these declines were ongoing cost control efforts and a $0.1 billion access expense adjustment recorded in the third quarter of 2003. OTHER ITEMS
Other Items
      Capital additions were $0.4$0.3 billion in the thirdfirst quarter of 2004, and were $1.3 billion for the nine months ended September 30, 2004.2005. 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.
      Total assets declined $13.4$0.3 billion, or 39.1%1.6%, at September 30, 2004,March 31, 2005, from December 31, 2003,2004, primarily driven by lower net property, plant and equipment and internal-use software as a result of asset impairment charges recorded during the period,depreciation and amortization expenses, partially offset by capital expenditures. additions.
AT&T CONSUMER SERVICESConsumer 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"“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

23


AT&T CORP. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS — (Continued)
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 Ended
  March 31,
   
  2005 2004
     
  (Dollars in millions)
Revenue        
 Stand-alone long distance voice and other services $1,025  $1,462 
 Bundled services  660   645 
       
Total revenue $1,685  $2,107 
Operating income $575  $371 
Capital additions $  $13 
         
  At At
  March 31, December 31,
  2005 2004
     
  (Dollars in millions)
Total assets $646  $743 
FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, --------------------- -------------------- 2004 2003 2004 2003 -------- -------- -------- -------- (DOLLARS IN MILLIONS)
Revenue Stand-alone long distance voice and other services................................... $1,256 $1,813 $4,045 $5,797 Bundled services.............................. 724 521 2,053 1,405 ------ ------ ------ ------ Total revenue................................... $1,980 $2,334 $6,098 $7,202 Operating income................................ $ 281 $ 503 $ 892 $1,621 Capital additions............................... $ 9 $ 14 $ 37 $ 55
AT AT SEPTEMBER 30, DECEMBER 31, 2004 2003 ------------- ------------ (DOLLARS IN MILLIONS) Total assets................................................ $777 $1,062
REVENUE
      AT&T Consumer Services revenue declined $0.4 billion, or 15.2%20.0%, in the thirdfirst quarter of 2004 and declined $1.1 billion, or 15.3%, in the nine months ended September 30, 2004,2005 compared with the same prior year periods.period. The decline in both periods was primarily due to stand-alone long distance voice services, which decreased $0.5$0.4 billion to $1.2$1.0 billion in the thirdfirst quarter of 2004 and decreased $1.7 billion to $3.8 billion in the nine months ended September 30, 2004,2005, largely due to the impact of ongoing competition, which has led to a loss of market share, andas well as 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 targeted 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. Partially offsetting the overall revenue decline was an increase in bundled revenue. Bundled revenue rose $0.2 billion to $0.7 billion in the third quarter of 2004, and rose $0.6 billion to $2.1 billion in the nine 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 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.2005.
      Total long distance calling volumes (including long distance volumes sold as part of a bundle) declined approximately 19%27% for both the three months and the nine months ended September 30, 2004,first quarter of 2005 compared with the same prior year periods,period, primarily as a result of competition and wireless and Internet substitution. As a result of 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
      Operating income declinedincreased $0.2 billion, or 44.2%54.8%, in the thirdfirst quarter of 2004 and declined $0.7 billion, or 45.0%, in the nine months ended September 30, 2004,2005 compared with the same periodsfirst quarter of 2003.2004. Operating 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 millionmargin increased to 34.1% in the comparable prior year periods.first quarter of 2005 from 17.6% in the first quarter of 2004. As a result of the third quarter 2004 asset impairment charges, 32 operating income for the three and nine months ended September 30, 2004,2005 included a $38$31 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, theThe increase in operating margin forin the thirdfirst quarter of 20042005 was essentially flat compared with the third quarterprimarily due to a greater rate of 2003, as revenue declines were mitigated by lower overall operating costs. Declinesdecline in selling, general and administrative expenses whichand costs of services and products in relation to revenue. The decline in selling, general and administrative expenses reflected the impact of lowerreductions in sales and marketing and customer acquisition spending as a result ofexpenses, primarily due to our strategic decision in the third quarter of 2004 to shift our focus away from traditional consumer services, more than offset increased local connectivity costs. Onas well as lower customer care expenses. Costs of services and products declined primarily due to reduced bad debt expenses as a result of improved collections and lower revenue. Also contributing to the same basis, theincrease in operating margin forwere targeted price increases during 2004 and 2005.
Other Items
      Capital additions declined $13 million during the nine months ended September 30, 2004, declined approximately 5.5 percentage pointsfirst quarter of 2005 compared with the same prior year period,first quarter of 2004, primarily due to lower revenue coupled with increased local connectivity costs and a slower rate of declineour change in selling, general and administrative expenses. OTHER ITEMSstrategic focus.

24


AT&T CORP. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS — (Continued)
      Total assets declined $0.3$0.1 billion at September 30, 2004,March 31, 2005, from December 31, 2003.2004. The decline was primarily due to lower accounts receivable, reflecting lower revenue and improved cash collections, as well as decreases in internal-use softwarecollections.
Corporate and property, plant and equipment, net, primarily due to the third quarter 2004 asset impairment charges. CORPORATE AND OTHEROther
      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
  Ended March 31,
   
  2005 2004
     
  (Dollars in millions)
Revenue $              11  $              11 
Operating (loss) $(93) $(173)
Capital additions $3  $2 
         
  At At
  March 31, December 31,
  2005 2004
     
  (Dollars in millions)
Total assets $10,756  $11,440 
FOR THE THREE MONTHS FOR THE NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------------------- ------------------- 2004 2003 2004 2003 ------- ------ ------- ------- (DOLLARS IN MILLIONS) Revenue......................................... $ 13 $ 14 $ 38 $ 40
Operating (loss)................................ $(511) $(87) $(728) $(210) Capital additions............................... $ 6 $198 $ 10 $ 210 (Loss)
AT AT SEPTEMBER 30, DECEMBER 31, 2004 2003 ------------- ------------ (DOLLARS IN MILLIONS) Total assets................................................ $10,469 $12,724
OPERATING (LOSS)
      Operating (loss) increased $0.4 billiondecreased $80 million to $0.5 billion for the quarter ended September 30, 2004, and increased $0.5 billion to $0.7 billion$(93) million for the first nine monthsquarter of 2004,2005 compared with the same periodsperiod in 2003.2004. The third quarter increasedecrease in operating (loss) was primarily related to higher net restructuring and other charges of $0.4 billion, primarily due to benefit 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 charges recorded in the first quarter of 2004 to write-downwrite down held-for-sale facilities, all of which have been sold. OTHER ITEMS Capital additions decreased $0.2 billion forwere sold during 2004. Such decrease in operating (loss) was partially offset by increased pension expenses in the thirdfirst quarter of 2005, primarily due to higher loss amortization and nine months ended September 30, 2004, compared withlower expected rate of return resulting from a 25 basis point decrease in both the same periodsdiscount rate and the expected rate of return in 2003, as a result of $0.2 billion of property, plant and equipment recorded in connection with the adoption of FIN 46 on July 1, 2003.2005.
Other Items
      Total assets decreased $2.3$0.7 billion to $10.5$10.8 billion at September 30, 2004,March 31, 2005, from December 31, 2003.2004. This decrease was primarily driven by a lower cash balancethe maturity of $1.8debt and related combined interest rate foreign currency swap agreements in February 2005.
Financial Condition
         
  At At
  March 31, December 31,
  2005 2004
     
  (Dollars in millions)
Total assets $31,696  $32,804 
Total liabilities $24,280  $25,785 
Total shareowners’ equity $7,416  $7,019 
Total assetsdeclined $1.1 billion, or 3.4%, to $31.7 billion at September 30, 2004, primarily resulting from debt repurchases and scheduled repayments made during the period. 33 FINANCIAL CONDITION
AT AT SEPTEMBER 30, DECEMBER 31, 2004 2003 ------------- ------------ Total assets................................................ $32,059 $47,988 Total liabilities........................................... $25,624 $34,032 Total shareowners' equity................................... $ 6,435 $13,956
TOTAL ASSETS decreased $15.9 billion, or 33.2% to $32.1 billion at September 30, 2004,March 31, 2005, compared with December 31, 2003, largely driven2004. Total assets declined primarily as a result of cash payments made related to scheduled maturities of debt, partially offset by a reduction of $12.7 billion incash from operations. See “Liquidity” discussion for further details. Total assets also declined due to lower net property, plant and equipment, primarily 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 of $1.7 billion.period. 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 $1.2 billion primarily due to a decrease in internal-use software resulting from amortizationactivity during the period and an impairment charge, partially offset by capital additions. Additionally, otherquarter resulted in changes between asset balances without impacting total assets. Other current assets declined due to the release of restricted cash and the settlement of foreign currency swaps associated with Euroa hedge related to debt repurchases. Accounts receivable declined $0.5 billion driven by improved cash collectionsthat matured in February 2005, which resulted in an increase to cash. Other current

25


AT&T CORP. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS — (Continued)
assets increased due to the reclassification of assets (principally property, plant and lower revenue. These declines were partially offset by deferred income tax benefits recorded in conjunction with the reversal of a portion of the valuation allowance attributableequipment, goodwill and accounts receivable) to assets held-for-sale related to our prior investment in AT&T Latin Americapayphone business and as a result of net restructuring and other charges during the period. TOTAL LIABILITIES building.
Total liabilitiesdecreased $8.4$1.5 billion, or 24.7%5.8%, to $25.6$24.3 billion at September 30, 2004,March 31, 2005, compared with December 31, 2003. The decrease was due in part to a $4.3 billion reduction in deferred income taxes primarily associated with the third quarter 2004 asset impairments of property, plant and equipment and internal-use software.2004. The decrease in total liabilities was also largely attributableprimarily due to lower debt balances of $3.9$1.2 billion, reflecting the early retirement of $2.6 billion face value of debt and $0.4 billion of associated mark-to-market adjustments, coupled withattributable to scheduled repayments of debt amountingdebt. Additionally, short-term and long-term compensation and benefit-related liabilities declined by $0.4 billion, primarily attributable to $1.1 billion,the payment of year-end bonus and salary accruals and employee separation reserves, partially offset by a $0.2 increase in short-term borrowings. Accounts payablehigher pension and accrued expenses declined $0.7 billion as payments were made against year-end capital and otherpostretirement benefit accruals. Partially offsetting these declines was an increase in short-term and long-term compensation and benefit-relatedother current liabilities of $0.9$0.3 billion, primarily due to higher income taxes payable, largely attributable to higher reserves for employee separationscurrent year income, and increased pension and postretirement liabilitiesan increase in interest payable due in part to the benefit curtailment and remeasurement duringtiming of interest payments.
Total shareowners’ equityincreased $0.4 billion, or 5.6%, to $7.4 billion at March 31, 2005, compared with December 31, 2004. This increase was primarily due to net income for the period, partially offset by a reduction in compensation accruals. TOTAL SHAREOWNERS' EQUITY decreased $7.5 billion, or 53.9%, to $6.4 billion at September 30, 2004, compared with December 31, 2003. This decrease was primarily due to the net loss for the period largely driven by the asset impairment charges recorded in the third quarter, coupled with dividends declared. LIQUIDITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, --------------------- 2004 2003 --------- --------- (DOLLARS IN MILLIONS) CASH FLOWS: Provided by operating activities.......................... $ 4,011 $ 7,113 (Used in) investing activities............................ (1,340) (2,389) (Used in) financing activities............................ (4,397) (5,987) ------- ------- Net (decrease) in cash and cash equivalents............... $(1,726) $(1,263) ======= =======
Liquidity
          
  For the Three Months
  Ended March 31,
   
  2005 2004
     
  (Dollars in millions)
Cash Flows:
        
 Provided by operating activities $805  $1,349 
 Provided by (used in) investing activities  240   (507)
 (Used in) financing activities  (1,038)  (2,617)
       
 Net increase (decrease) in cash and cash equivalents $7  $(1,775)
       
      Net cash provided byoperating activitiesof $4.0$0.8 billion forin the nine months ended September 30, 2004,first quarter of 2005 declined $3.1$0.5 billion from $7.1$1.3 billion in the comparable prior year period, which was in partlargely driven by the declining stand-alone long distance voice and data businesses. The downward trend in cash generated by operating activities was also impacted by a $1.3 billion decline in income tax refunds received in the first nine 34 months of 2004 compared with the same prior year period. Favorably impacting cash flowflows in 20042005 compared with 2003,2004 was a $0.3our continued focus on controlling costs.
      Ourinvesting activitiesresulted in net cash provided of $0.2 billion decline in interest payments resulting from our ongoing deleveraging efforts. AT&T's investing activities resulted infor the first quarter of 2005 compared with a net use of cash of $1.3$0.5 billion for the first quarter of 2004, primarily reflecting the release of restricted cash related to debt that matured in February 2005, as well as a reduction in capital expenditures and other additions.
      During the nine months ended September 30, 2004,first quarter of 2005, net cash used infinancing activitieswas $1.0 billion compared with $2.4$2.6 billion in the first nine monthsquarter of 2003, primarily reflecting a reduction in capital expenditures.2004. During the first nine monthsquarter of 2004,2005, we made net cash used inpayments of $1.1 billion to reduce debt (including foreign currency mark-to-market payments) as a result of scheduled maturities and paid dividends of $0.2 billion. In addition, reflected as an other financing activities was $4.4 billion, compared with $6.0 billion inactivity for the first nine monthsquarter of 2003. In2005 was the receipt of approximately $0.3 billion for the settlement of a combined interest rate foreign currency swap agreement in conjunction with the scheduled repayment of debt. During the first nine monthsquarter of 2004, we made net payments of $4.2$2.8 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 $0.6$0.2 billion. Reflected as an other financing item for the first quarter of 2004 was the receipt of approximately $0.4 billion for the settlement of a combined interest rate foreign currency swap agreementsagreement in conjunction with the early repayment of Euro notes induring the first nine monthsquarter of 2004, (such repayment is included as retirement of long-term debt). During the first nine months of 2003, we made net payments of $5.8partially offset by a $0.1 billion to reduce debt, including the early termination of debt, paid dividends of $0.4 billion and received $0.2 billion ofreduction in cash collateral held related to favorablethe positions of certain combined interest rate foreign currency swap agreements. WORKING CAPITAL

26


AT&T CORP. AND OTHER SOURCESSUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF LIQUIDITYFINANCIAL CONDITION AND
RESULTS OF OPERATIONS — (Continued)
Working Capital and Other Sources of Liquidity
      At September 30, 2004,March 31, 2005, our working capital ratio (current assets divided by current liabilities) was 0.98. On October 6, 2004,
      We have a variety of sources of liquidity available to us as discussed below. However, the SBC merger agreement provides that we entered intocannot incur additional indebtedness over $100 million in the aggregate or issue equity (other than for employee and shareowner plans) or convertible securities without the prior consent of SBC. The merger agreement also requires us to pay a special dividend in excess of $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 replaced our existing $2.0 billion facility. No borrowings are currently outstanding underin connection with the facility. Up to $0.5 billionclosing of the facility can be utilizedtransaction. We expect to support letters of credit, which reduces the amount available. As of September 30, 2004, approximately $0.2 billion of letters of credit were supported by the facility in place at that time. In July 2004, we renewed our AT&T Business Serviceshave sufficient liquidity from cash on hand 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 receivable balances, which varycash from month to month. Proceeds from the securitizations are recorded as borrowings and included in short-term debt. At September 30, 2004, approximately $0.3 billion was 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 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 September 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 continuingoperations to fund our operations in 2004 primarily with cash and cash equivalents on hand, as well as with cash from operations.all liquidity needs, including the special dividend, through the expected closing of the merger without any additional borrowings or financings. If economic conditions worsen or do not improve and/or competition and product substitution accelerate beyond current expectations and/or economic conditions worsen or do not improve, our cash flows from operations would decrease, negatively impacting our liquidity. Similarly, if we were to experience unexpected requirements to expend cash, our liquidity could be negatively impacted. However, we believe our access to the capital markets is adequate to provide the flexibility we desire in funding our operations. Sourcesoperations, subject to SBC’s consent.
      In the event we need additional financing and SBC agreed to such financing we could utilize the AT&T Business Services’ 364-day customer accounts receivable securitization facility, which extends through July 2005. The AT&T Business Services facility provides for up to $1.0 billion of liquidity,available financing, limited by the eligible receivables balance which varies from month to month. At March 31, 2005, we also had $0.35 billion of available financing under the AT&T Consumer Services Securitization facility. Proceeds from the securitizations are recorded as borrowings and are included in short-term debt. Approximately $0.3 billion was outstanding under the facilities at March 31, 2005. On May 6, 2005, we repaid the $0.1 billion of borrowings outstanding under the AT&T Consumer Services facility and subsequently terminated this facility. In addition, to our substantial cash and cash equivalents on hand, includewe have $2.4 billion remaining under a universal shelf registration; a $1.35 billion securitization program (limited by eligible receivables); and aregistration.
      Further financing is available through the $1.0 billion syndicated 364-day credit facility that was entered into on October 6, 2004. No borrowings are currently outstanding under the facility. In lightUp to $0.5 billion of the recent loweringfacility can be utilized for letters of credit, which reduces the amount available. At March 31, 2005, approximately $0.3 billion of letters of credit were outstanding under the facility.
      On April 1, 2005, we entered into a $0.3 billion credit facility maturing on March 20, 2006. This credit facility collateralizes our commercial paper ratings discussed below, there is no longer any assurance that we will continue to have any significant access toletters of credit issued in the commercial paper market. The maximum amountnormal course of commercial paper outstanding duringbusiness, which were previously issued against the first nine months of 2004 was approximately$0.5 billion sub-limit in our existing $1.0 billion. At September 30, 2004, there was $62 million of commercial paper outstanding, all of which has since matured.billion syndicated 364-day credit facility maturing in October 2005.
      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 RATINGSAdditionally, as our short-term credit ratings from Standard and Poor’s (S&P) and Moody’s Investors Services, Inc. (Moody’s) have been withdrawn at our request, there is no assurance that we will have any significant access to the commercial paper market. Furthermore, the combination of the requirement to reserve cash to pay the special dividend and the SBC-merger restrictions on incurring indebtedness could limit our ability to utilize sources of liquidity, which in turn, could negatively impact AT&T.
      Both the credit facility and the securitization facilities contain financial covenants that require us to meet a debt-to-EBITDA (defined as operating income plus depreciation and amortization expenses excluding any asset impairment or net restructuring and other charges) ratio not exceeding 2.25 to 1 (calculated pursuant to the credit facility) and an EBITDA-to-net interest expense ratio of at least 3.50 to 1 (calculated pursuant to the credit facility) for four consecutive quarters ending on the last day of each fiscal quarter. At March 31, 2005, we were in compliance with these covenants.

27


AT&T CORP. AND RELATED DEBT IMPLICATIONS During the third quarterSUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS — (Continued)
Credit Ratings and Related Debt Implications
      As of 2004, AT&T's long-term and short-term and commercial paperMarch 31, 2005, our credit ratings were lowered by Standard & Poor's (S&P), Moody'sas follows:
Short-TermLong-Term
Credit Rating AgencyRatingRatingOutlook
Standard & Poor’sWithdrawnBB+Watch Positive
FitchBBB+Watch Positive
Moody’sWithdrawnBa1Review for Possible Upgrade
      As a result of the SBC merger announcement, on January 31, 2005 and February 1, 2005, Fitch as reflected inand S&P, respectively, put our long-term debt ratings on “watch positive” and removed the table below. The“outlook negative” and on January 31, 2005, Moody’s placed our long-term debt rating actions byon “review for possible upgrade” and removed the “outlook negative.” In addition, based on our request, 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 (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. 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................................... B BB+ Negative Fitch............................................... B BB+ Negative Moody's............................................. NP Ba1 Negative
Moody’s have withdrawn our short-term credit ratings.
      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 furtherIf our debt rating downgrades will require usratings were downgraded, we would be required to pay higher rates on certain existing debt and havecould be required us to post cash collateral for certain interest-rate swaps in which we were in a net payable position.
      Additionally, if our debt ratings are furtherwere 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 September 30, 2004.March 31, 2005. 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 wherein which 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, iswas approximately $0.4 billion at September 30, 2004,March 31, 2005, and is included within short-term and long-term debt. CASH REQUIREMENTS
Cash Requirements
      Our cash needs for 20042005 will be primarily relatedrelate to capital expenditures, repayment of debt, andthe payment of dividends.dividends and income tax related payments. We expect our capital expenditures for 2004in 2005 to be approximately $1.8$1.5 billion. In the first quarter of 2004, we completed the repurchase, for cash, of $1.2 billion of our $1.5 billion outstanding 6.5% Notes due in November 2006. Also in the first quarter,During April 2005, we repurchased for cash, $0.9$1.25 billion of our outstanding $1.8debt, which resulted in a loss of $0.2 billion. We expect income tax payments to be significantly higher in 2005 compared with 2004.
      We anticipate contributing approximately $0.5 billion 6.0% Euro Notes due November 2006. Duringto the third quarter of 2004, we completed the repurchase,U.S. postretirement benefit plans in 2005. We expect to contribute approximately $30 million to our U.S. nonqualified pension plan in 2005. No contribution is expected for cash, of $0.3 billion ofour U.S. dollar denominated long-term debt, with interest rates ranging from 6.0% to 7.75%, and maturities from 2005 through 2009. Alsoqualified pension plans in the third quarter, we repurchased, for cash, $0.1 billion of 6.0% Euro Notes due in November 2006. The $0.9 billion and $0.1 billion Euro denominated notes repurchased in the first and third quarters, respectively, represent the original U.S. dollar issuance amounts and exclude the foreign currency mark-to-market adjustments that were hedged. As we near the completion of our 2004 debt buy-back program, as announced in January 2004 to repurchase up to $3.0 billion of debt in the form of calls, tender offers or open market transactions, we may make additional purchases subject to market conditions. The repurchases completed thus far in 2004 are expected to save approximately $0.1 billion in interest expense in 2004. CONTRACTUAL CASH OBLIGATIONS2005.
Contractual Cash Obligations
      We have contractual obligations to purchase certain goods or services from various other parties. During the first nine monthsquarter of 2004,2005, we entered into new contracts underand modified the commitment amounts of certain existing contracts, including commitments to utilize network facilities from local exchange carriers, which we are legally obligated for paymentwere previously assessed based on termination fees (see discussion below). The net effect of these changes was an increase to our unconditional purchase obligations of approximately $70$1,279 million in 2004.2005, $806 million in aggregate for 2006 and 2007, $53 million in aggregate for 2008 and 2009 and $1 million for 2010. A portion of the 2005 obligation was satisfied in the first quarter of 2005. Also during the first nine monthsquarter of 2004,2005, 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,In addition, we exited certainmodified existing contracts that

28


AT&T CORP. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS — (Continued)
contained termination fees that were renegotiated and not paid.fees. The net effect of this activity onthese changes is an increase to 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, $56$40 million in 2005, $50$104 million in aggregate for 2006 $98and 2007, $25 million in 2007, $88aggregate for 2008 and 2009 and $2 million in 2008, or $50 million in 20092010 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&TTermination fees for any individual contract would have been secondarily liable for up to $3.65 billion, plus accrued interest,not be paid in every year, rather only in the event AT&T Wireless was unableyear of termination.
      We have contractual obligations to satisfy its entire obligationutilize network facilities from local exchange carriers with terms greater than one year. Since the contracts have no minimum volume requirements, and are based on an interrelationship of volumes and discount rates, we assessed our minimum commitment based on the penalties to NTT DoCoMo. AT&T's guarantee expiredexit the contracts, assuming we exit the contracts as of December 31 of each year. During the first three months of 2005, we entered into new contracts with several local exchange carriers, which had minimum purchase requirements and therefore are discussed above and no longer assessed based on June 30, 2004,termination fees. In addition, the termination fees with other local exchange carriers changed based on increases or decreases to the level of services purchased. The net effect of these changes resulted in accordance witha decrease to termination fees of approximately $0.5 billion in 2005 and no material change to any other period. Termination fees for any individual contract would not be paid in every year, rather only in the termsyear of the original agreement. RISK MANAGEMENTtermination.
Risk Management
      We are exposed to market risk from changes in interest and foreign currency exchange rates, as well as changes in equity prices associated with previously affiliated companies.rates. In addition, we are exposed to market risk from fluctuations in the prices of securities. On a limited basis, we use certain derivative financial instruments, including interest rate swaps, foreign currency 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
Recently Issued Accounting Pronouncements
      In March 2005, the FASB issued FASB Interpretation (FIN) No. 47, “Accounting for Conditional Asset Retirement Obligations,” an interpretation of SFAS No. 143, “Accounting for Asset Retirement Obligations.” FIN No. 47 clarifies that the term conditional asset retirement obligation, as used in SFAS No. 143, refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and/or method of settlement. FIN No. 47 requires an entity to recognize a liability for the fair value of the conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. FIN No. 47 is effective for fiscal years ending after December 8,15, 2005, which is December 31, 2005 for us; however, earlier application is permitted. We are currently evaluating the impact of FIN No. 47 on our results of operations, financial position and cash flows.
      In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment,” which requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. Additional guidance to assist in the initial interpretation of this revised statement was subsequently issued by the SEC in Staff Accounting Bulletin No. 107. SFAS No. 123 (revised 2004) eliminates the alternative of using APB Opinion No. 25 intrinsic value method of accounting that was provided for in SFAS No. 123 as originally issued. Effective January 1, 2003, we adopted the Medicare Prescription Drug, Improvementfair value recognition provisions of original SFAS No. 123 on a prospective basis and Modernizationwe began to record stock-based compensation expense for all employee awards (including stock options) granted or modified after January 1, 2003. Adoption of the revised standard will require that we begin to recognize expense for unvested awards issued prior to January 1, 2003. Additionally, this standard requires that estimated forfeitures be considered in determining compensation expense. For equity awards other than stock

29


AT&T CORP. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS — (Continued)
options, we have not previously included estimated forfeitures in determining compensation expense. Accordingly, the difference between the expense we have recognized to date and the compensation expense as calculated considering estimated forfeitures will be reflected as a cumulative effect of accounting change upon adoption. Further, SFAS No. 123 (revised 2004) requires that excess tax benefits be recognized as an addition to paid-in capital and amends SFAS No. 95, “Statement of Cash Flows,” to require that the excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid. SFAS 123 (revised 2004) is effective for annual periods beginning after June 15, 2005, which is January 1, 2006 for us. We intend to elect a modified prospective adoption beginning in the first quarter of 2006 and do not anticipate that the adoption of SFAS No. 123 (revised 2004) will have a material impact on our recorded compensation expense.
      In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets — an amendment of APB Opinion No. 29.” APB Opinion No. 29 requires that nonmonetary exchanges of assets be recorded at fair value with an exception for exchanges of similar productive assets, which can be recorded on a carryover basis. SFAS No. 153 eliminates the current exception and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for nonmonetary asset exchanges that take place in fiscal periods beginning after June 15, 2005, which is July 1, 2005 for us; however, earlier application is permitted.
      In December 2004, the FASB issued FSP No. FAS 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation 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. On May 19, 2004, the Financial Accounting Standards Board (FASB) issued FASB Staff Position ("FSP") No. FAS 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003," which provides guidance on the accounting and disclosure requirements 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. We adopted FSP No. FAS 106-2 effective July 1, 2004, and have elected a prospective application, which required the remeasurement of our 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 final form, which impacts our ability to recognize the full adoption effectsrepatriation provision of the Act. Despite the lackThe Act creates a one-time tax incentive for U.S. corporations to repatriate accumulated income earned abroad by providing a tax deduction of final federal regulations, we believe85% of dividends received for certain foreign earnings that the prescription drug benefits providedare repatriated. The deduction is subject to a specific portionnumber of our postretirement benefit plan participants would be deemed to be actuarially equivalent to Medicare Part D benefits basedrequirements and clarification is needed on the benefits provided under the plan. The subsidy-related reduction in the APBO related to the adoption for this group was $161 million, which will be amortized to income over time as an actuarial gain. During the third quarter, the amortizationvarious aspects of the actuarial gainlaw before the impact can be determined. In addition, the amount of the deduction remains subject to potential local country restrictions on remittances, as well as a reductionto management’s decisions with respect to any repatriation. Based upon the current wording of interest cost resultedthe law and assuming no technical corrections, we are considering possible dividend remittances of approximately $100 million, which, after consideration of deferred taxes previously provided on foreign earnings, we estimate would result in a reduction to net periodic postretirementone-time income tax benefit cost (recorded within SG&A and costs of services and products)in 2005 of approximately $6$5 million. As we are unableWe expect to determine ifcomplete our evaluation of the prescription drug benefits provided to the remaining 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 during 2005.
Subsequent Events
      During May 2005, we settled litigation brought by the trustee for the bondholders’ liquidating trust of At Home Corporation for $340 million, subject to bankruptcy court approval. Under the terms of a separation agreement with our former broadband subsidiary, which was spun off to Comcast Corporation in 2002, the settlement will be shared equally between the two parties. The settlement of this group. ITEM 4. CONTROLSlitigation did not have a material impact on our results of operations.

30


AT&T CORP. AND PROCEDURESSUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS — (Continued)
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 arewere effective in alerting them timely to material information required to be included in our Exchange Act filings.as of March 31, 2005. 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 hashave materially affected, or isare reasonably likely to materially affect, our internal controls over financial reporting.

31


PART II -- OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS
Item 1.Legal Proceedings
      Refer to Part 1, Footnote 10, "Commitments9, “Commitments and Contingencies"Contingencies” for discussion of certain legal proceedings. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES
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 thirdfirst quarter of 2004. ISSUER PURCHASES OF EQUITY SECURITIES 2005.
Issuer Purchases of Equity Securities
                  
        Maximum Number
      Total Number (or Approximate
      of Shares Dollar Value) of
      (or Units) Shares or Units
  Total Number Average Price Purchased as That May Yet
  of Shares Paid per Part of Publicly Be Purchased
  (or Units) Share Announced Plans Under the Plans
Period Purchased(1)(2) (or Unit) or Programs or Programs
         
January 1, 2005 to January 31, 2005  40,801  $18.9445   0   0 
February 1, 2005 to February 28, 2005(3)
  112,235  $19.2056   0   0 
March 1, 2005 to March 31, 2005  5,057  $19.0394   0   0 
             
 Total  158,093  $19.1329   0   0 
MAXIMUM NUMBER TOTAL NUMBER (OR APPROXIMATE OF SHARES DOLLAR VALUE) OF (OR UNITS) SHARES OR UNITS TOTAL NUMBER AVERAGE PRICE PURCHASED AS THAT MAY YET OF SHARES PAID PER PART OF PUBLICLY BE PURCHASED (OR UNITS) SHARE ANNOUNCED PLANS UNDER THE PLANS PERIOD PURCHASED(1) (OR UNIT) OR PROGRAMS OR PROGRAMS - ------ ------------ -------------- ---------------- ---------------- July 1, 2004
(1)Represents restricted stock units and performance shares redeemed to July 31, 2004...... 5,115 $16.6727 0 0 August 1, 2004pay taxes related to August 31, 2004............................. 12,983 $14.0650 0 0 September 1, 2004 to September 30, 2004............................. 8,262 $14.6481 0 0 Total......................... 26,360 $14.7538 0 0 the vesting of restricted stock units and performance shares awarded under employee benefit plans.
(2)Does not include shares purchased in the open market by the trustee of our Shareowner Dividend Reinvestment and Stock Purchase Plan as follows: 16,613 shares in January at an average price paid per share of $18.6820; 323,419 shares in February at an average price paid per share of $19.3699; and 22,044 shares in March at an average price paid per share of $19.5035.
(3)Does not include 215,778 performance shares awarded under employee benefit plans redeemed in cash in February 2005 at an average price paid per share of $19.1410.
- --------------- (1) Represents restricted stock units redeemed to pay taxes related to the vesting of restricted stock units awarded under employee benefit plans. ITEM 6. EXHIBITS AND REPORTS ON FORM
Item 6.Exhibits and Reports on Form 8-K
      (a) Exhibits:
EXHIBIT NUMBER - ------- 12 Computation of Ratio of Earnings to Fixed Charges. 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. 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 2002. 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 2002. 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 2002.
38
     
Exhibit  
Number  
   
 12  Computation of Ratio of Earnings to Fixed Charges.
 
 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.
 
 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 2002.
 
 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 2002.
 
 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 2002.
      (b) Reports on Forms 8-K:
      During the thirdfirst quarter of 2004,2005, the following Forms 8-K were filed and/or furnished: Form 8-K dated July 22, 2004January 18, 2005 was filed pursuant to Item 71.01 (Entry into a Material Definitive Agreement) and Item 9.01 (Financial Statements Pro Forma Financial Information and Exhibits) and, on January 25, 2005; Form 8-K dated January 20, 2005 was furnished pursuant to Item 122.02 (Results of Operations and Financial Condition) and Item 9.01 (Financial Statements and Exhibits), on July 23, 2004. 39 January 21, 2005; Form 8-K dated January 30, 2005 was filed pursuant to Item 8.01 (Other

32


Events) and Item 9.01 (Financial statements and Exhibits), on January 31, 2005; Form 8-K dated January 30, 2005 was filed pursuant to Item 1.01 (Entry into a Material Definitive Agreement) and Item 9.01 (Financial Statements and Exhibits), on February 2, 2005.

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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. /s/ C. R. REIDY -------------------------------------- By: Christopher R. Reidy Vice President and Controller
AT&T Corp.
/s/C. R. Reidy
By: Christopher R. Reidy
Vice President and Controller
Date: November 4, 2004 40 May 6, 2005

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EXHIBIT INDEX
EXHIBIT NUMBER - ------- 12 Computation of Ratio of Earnings to Fixed Charges. 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. 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 2002. 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 2002. 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 2002.
     
Exhibit  
Number  
   
 12  Computation of Ratio of Earnings to Fixed Charges.
 
 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.
 
 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 2002.
 
 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 2002.
 
 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 2002.