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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON,
Washington, DC 20549
FORM
Form 10-Q
[X] | | |
| þ | | QUARTERLY 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 NUMBERCommission file number 1-1105
AT&T CORP.
Corp.
| | |
A NEW YORK New York | | I.R.S. EMPLOYER
CORPORATION NO.Employer |
| Corporation | | No. 13-4924710 |
ONEOne 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
| |
| 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)
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. 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).
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.
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. 7
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
SUPPLEMENTARY STATEMENT OF OPERATIONS INFORMATION
ACCESS AND OTHER CONNECTION EXPENSES
In September 2003, in conjunction with our review of accounting and
internal control systems, we determined that the liability on the balance sheet
(included in accounts payable and accrued expenses) relating to costs incurred
in 2001 and 2002 pertaining to access and other connection expenses was
understated by $125 million. Since the impact to prior years' annual financial
statements was not material, we recorded an additional expense of $125 million
($77 million after taxes) in the third quarter of 2003 to reflect the proper
estimate of the liability.
FINANCIAL ACCOUNTING STANDARDS BOARD INTERPRETATION NO. 46 (FIN 46),
"CONSOLIDATION OF VARIABLE INTEREST ENTITIES -- AN INTERPRETATION OF
ACCOUNTING RESEARCH BULLETIN NO. 51"
Effective July 1, 2003, AT&T early adopted FIN 46, "Consolidation of
Variable Interest Entities -- an Interpretation of Accounting Research Bulletin
No. 51." This interpretation requires the primary beneficiary to consolidate a
variable interest entity (VIE) if it has a variable interest that will absorb a
majority of the entity's expected losses if they occur, receive a majority of
the entity's expected residual returns if they occur, or both. Based on the new
standard, two entities that AT&T leased buildings from qualified as VIEs and,
therefore, became subject to consolidation as of July 1, 2003. AT&T had no
ownership interest in either entity, but provided guarantees of the residual
values for the leased facilities with a maximum exposure of $427 million. Upon
adoption, FIN 46 added approximately $433 million of assets (included in
property, plant and equipment of AT&T Business Services and Corporate and Other
group) and $477 million of liabilities (included in short-term debt) to our
consolidated balance sheet and resulted in a charge of $27 million after taxes
($44 million pretax) as the cumulative effect of an accounting change in the
third quarter of 2003. In November 2003, AT&T exercised its purchase option on
certain of these leased buildings and thus repaid the associated debt.
4. EARNINGS PER COMMON SHARE AND POTENTIAL COMMON SHARE(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 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 final10
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. 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. 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
| | | | | | | | | | |
| | | 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.
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 RESULTSSegment 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 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 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
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
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. 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.
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 by
operating 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-Term | | | Long-Term | | | |
| Credit Rating Agency | | Rating | | | Rating | | | Outlook |
| | | | | | | | |
| Standard & Poor’s | | | Withdrawn | | | | BB+ | | | Watch Positive |
| Fitch | | | B | | | | BB+ | | | Watch Positive |
| Moody’s | | | Withdrawn | | | | Ba1 | | | Review 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
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 that28
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
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 (Other32
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.
33
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, 200534
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. |
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| | 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. |