UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
.X. QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
OR
.... TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________to _____________
Commission file number 1-1105
AT&T CORP.
A New York I.R.S. Employer
Corporation No. 13-4924710
One AT&T Way, Bedminster, New Jersey 07921
Telephone - Area Code 908-221-2000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes .X No ...
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) Yes .X No ...
At October 31, 2003, the following shares of stock were outstanding: AT&T common
stock - 789,873,024
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
AT&T CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
-------------------------------------------------------------------
2003 2002 2003 2002
-------------------------------------------------------------------
Dollars in millions (except per share amounts)
Revenue $ 8,649 $ 9,409 $ 26,430 $ 28,537
Operating Expenses
Access and other connection 2,785 2,679 8,191 8,214
Costs of services and products (excluding depreciation
of $874, $826, $2,608 and $2,538 included below) 1,954 2,066 5,923 6,166
Selling, general and administrative 1,793 2,032 5,551 5,911
Depreciation and amortization 1,224 1,243 3,607 3,631
Net restructuring and other charges 64 (26) 134 (26)
-------- -------- -------- --------
Total operating expenses 7,820 7,994 23,406 23,896
-------- -------- -------- --------
Operating income 829 1,415 3,024 4,641
Other (expense) income, net (7) (180) 89 (285)
Interest (expense) (289) (355) (917) (1,087)
-------- -------- -------- --------
Income from continuing operations before income taxes,
minority interest income, and net (losses) earnings
related to equity investments 533 880 2,196 3,269
(Provision) for income taxes (72) (370) (677) (1,362)
Minority interest income - 28 1 81
Net (losses) earnings related to equity investments (3) (13) 3 (414)
-------- -------- -------- --------
Income from continuing operations 458 525 1,523 1,574
Net (loss) from discontinued operations (net of income tax
benefit of $0, $81, $0 and $5,887) (13) (318) (13) (14,316)
-------- -------- -------- --------
Income (loss) before cumulative effect of accounting changes 445 207 1,510 (12,742)
Cumulative effect of accounting changes [net of income taxes
of $17, $0, $(9) and $530] (27) - 15 (856)
-------- -------- -------- --------
Net income (loss) $ 418 $ 207 $ 1,525 $(13,598)
-------- -------- -------- --------
Per basic share:
Earnings from continuing operations $ 0.58 $ 0.68 $ 1.94 $ 2.14
(Loss) from discontinued operations (0.02) (0.41) (0.02) (19.45)
Cumulative effect of accounting changes (0.03) - 0.02 (1.16)
-------- -------- -------- --------
Earnings (loss) per basic share $ 0.53 $ 0.27 $ 1.94 $ (18.47)
-------- -------- -------- --------
Per diluted share:
Earnings from continuing operations $ 0.58 $ 0.67 $ 1.93 $ 2.07
(Loss) from discontinued operations (0.02) (0.41) (0.01) (18.86)
Cumulative effect of accounting changes (0.03) - 0.02 (1.13)
-------- -------- -------- --------
Earnings (loss) per diluted share $ 0.53 $ 0.26 $ 1.94 $ (17.92)
-------- -------- -------- --------
The notes are an integral part of the consolidated financial statements.
AT&T CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
At At
September 30, December 31,
2003 2002
------------- ------------
Dollars in millions
ASSETS
Cash and cash equivalents $ 6,751 $ 8,014
Accounts receivable, less allowances of $681 and $669 4,525 5,286
Deferred income taxes 617 910
Other current assets 1,109 1,693
---------- ----------
TOTAL CURRENT ASSETS 13,002 15,903
Property, plant and equipment, net of accumulated depreciation of
$33,689 and $31,021 24,719 25,604
Goodwill 4,691 4,626
Other purchased intangible assets, net of accumulated amortization
of $298 and $244 508 556
Prepaid pension costs 3,791 3,596
Other assets 4,596 4,987
---------- ----------
TOTAL ASSETS $ 51,307 $ 55,272
---------- ----------
LIABILITIES
Accounts payable $ 3,297 $ 3,819
Payroll and benefit-related liabilities 1,091 1,519
Debt maturing within one year 4,647 3,762
Other current liabilities 2,974 2,924
---------- ----------
TOTAL CURRENT LIABILITIES 12,009 12,024
Long-term debt 12,759 18,812
Long-term benefit-related liabilities 4,240 4,001
Deferred income taxes 5,580 4,739
Other long-term liabilities and deferred credits 3,180 3,384
---------- ----------
TOTAL LIABILITIES 37,768 42,960
SHAREOWNERS' EQUITY
AT&T Common Stock, $1 par value, authorized 6,000,000,000 shares; issued and
outstanding 789,220,022 shares (net of 171,692,349 treasury shares) at
September 30, 2003 and 783,037,580 shares
(net of 171,801,716 treasury shares) at December 31, 2002 789 783
Additional paid-in capital 27,855 28,163
Accumulated deficit (15,044) (16,566)
Accumulated other comprehensive (loss) (61) (68)
---------- ----------
TOTAL SHAREOWNERS' EQUITY 13,539 12,312
---------- ----------
TOTAL LIABILITIES AND SHAREOWNERS' EQUITY $ 51,307 $ 55,272
---------- ----------
The notes are an integral part of the consolidated financial statements.
AT&T CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREOWNERS' EQUITY
(UNAUDITED)
For the Nine Months Ended
September 30,
-------------- --------------
2003 2002
-------------- --------------
Dollars in millions
AT&T Common Stock
Balance at beginning of year $ 783 $ 708
Shares issued, net:
Under employee plans 5 5
For funding AT&T Canada obligation - 46
Redemption of TCI Pacific preferred stock - 10
Other 1 1
--------- ---------
Balance at end of period 789 770
--------- ---------
Additional Paid-In Capital
Balance at beginning of year 28,163 54,798
Shares issued, net:
Under employee plans 129 295
For funding AT&T Canada obligation - 2,485
Redemption of TCI Pacific preferred stock - 2,087
Other 25 33
Dividends declared (482) (422)
Other 20 34
--------- ---------
Balance at end of period 27,855 59,310
--------- ---------
Accumulated deficit
Balance at beginning of year (16,566) (3,484)
Net income (loss) 1,525 (13,598)
Treasury shares issued at less than cost (3) -
--------- ---------
Balance at end of period (15,044) (17,082)
--------- ---------
Accumulated Other Comprehensive (Loss)
Balance at beginning of year (68) (342)
Other comprehensive income 7 207
--------- ---------
Balance at end of period (61) (135)
--------- ---------
Total Shareowners' Equity $ 13,539 $ 42,863
--------- ---------
Summary of Total Comprehensive Income (Loss):
Income (loss) before cumulative effect of accounting changes $ 1,510 $ (12,742)
Cumulative effect of accounting changes 15 (856)
--------- ---------
Net income (loss) 1,525 (13,598)
Other Comprehensive Income 7 207
--------- ---------
Comprehensive Income (Loss) $ 1,532 $ (13,391)
--------- ---------
AT&T accounts for treasury stock as retired stock. We have 100 million authorized shares of preferred stock at $1 par value.
The notes are an integral part of the consolidated financial statements.
AT&T CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Nine Months Ended
September 30,
-------------- --------------
2003 2002
-------------- --------------
Dollars in millions
OPERATING ACTIVITIES
Net income (loss) $ 1,525 $ (13,598)
Deduct:
Loss from discontinued operations - net of income taxes (13) (14,316)
Cumulative effect of accounting changes - net of income taxes 15 (856)
------------ ------------
Income from continuing operations 1,523 1,574
Adjustments to reconcile income from continuing operations to net cash provided
by operating activities of continuing operations:
Net gains on sales of businesses and investments (51) (42)
Cost investment impairment charges - 141
Net restructuring and other charges 87 (28)
Depreciation and amortization 3,607 3,631
Provision for uncollectible receivables 588 701
Deferred income taxes 1,105 556
Net revaluation of certain financial instruments (3) 74
Minority interest income (1) (81)
Net pretax (earnings) losses related to equity investments (28) 670
Decrease in receivables 231 290
Decrease in accounts payable (428) (180)
Net change in other operating assets and liabilities 443 (409)
Other adjustments, net 40 47
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES OF CONTINUING OPERATIONS 7,113 6,944
------------ ------------
INVESTING ACTIVITIES
Capital expenditures and other additions (2,413) (2,813)
Proceeds from sale or disposal of property, plant and equipment 134 464
Investment sales and distributions 120 9
Net (acquisitions) dispositions of businesses, net of cash acquired (158) 19
Increase in restricted cash (22) (418)
Other investing activities, net (50) 125
------------ ------------
NET CASH (USED IN) INVESTING ACTIVITIES OF CONTINUING OPERATIONS (2,389) (2,614)
------------- ------------
FINANCING ACTIVITIES
Retirement of long-term debt, including redemption premiums (4,576) (999)
(Decrease) in short-term borrowings, net (1,263) (5,196)
Issuance of AT&T common shares 92 2,640
Dividends paid on common stock (442) (411)
Proceeds from long-term debt issuances - 79
Other financing activities, net 202 5
------------ ------------
NET CASH (USED IN) FINANCING ACTIVITIES OF CONTINUING OPERATIONS (5,987) (3,882)
------------ ------------
Net cash (used in) discontinued operations - (4,133)
Net (decrease) in cash and cash equivalents (1,263) (3,685)
Cash and cash equivalents at beginning of year 8,014 10,680
------------ ------------
Cash and cash equivalents at end of period $ 6,751 $ 6,995
------------ ------------
The notes are an integral part of the consolidated financial statements.
AT&T CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. BASIS OF PRESENTATION
The consolidated financial statements have been prepared by AT&T Corp.
(AT&T or the Company) pursuant to the rules and regulations of the
Securities and Exchange Commission (SEC) and, in the opinion of management,
include all adjustments necessary for a fair statement of the consolidated
results of operations, financial position and cash flows for each period
presented. The consolidated results for interim periods are not necessarily
indicative of results for the full year. These financial results should be
read in conjunction with AT&T's Form 10-K for the year ended December 31,
2002, and Form 10-Q for the quarters ended March 31, 2003, and June 30,
2003. We have reclassified certain prior period amounts to conform to our
current presentation including a restatement to reflect AT&T Broadband as a
discontinued operation and a restatement of shares and earnings per share
to reflect the November 18, 2002, 1-for-5 reverse stock split.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
STOCK-BASED COMPENSATION
AT&T has a Long-Term Incentive Program under which AT&T grants stock
options, performance shares, restricted stock and other awards in AT&T
common stock. We also have an Employee Stock Purchase Plan (ESPP).
Effective May 31, 2003, we suspended employee purchases of company stock
under the ESPP. Effective January 1, 2003, we adopted the fair value
recognition provisions of Statement of Financial Accounting Standards
(SFAS) No. 123, "Accounting for Stock-Based Compensation" and we began to
record stock-based compensation expense for all employee awards (including
stock options) granted or modified after January 1, 2003. For awards issued
prior to January 1, 2003, we apply Accounting Principals Board (APB)
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations in accounting for our plans. Under APB Opinion No. 25, no
compensation expense was recognized other than for our performance-based
and restricted stock awards, stock appreciation rights (SARs), and certain
occasions when we modified the terms of the stock option vesting schedule.
If we had elected to recognize compensation costs based on the fair value
at the date of grant of all awards, consistent with the provisions of SFAS
No. 123, net income (loss) and earnings (loss) per share amounts would have
been as follows:
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
2003 2002 2003 2002
-------- -------- -------- --------
Dollars in millions (except per share amounts)
Net income (loss) $ 418 $ 207 $ 1,525 $(13,598)
Add:
Stock-based employee compensation included in
reported results from continuing operations, net of taxes 22 (2) 56 33
Stock-based employee compensation included in
reported results from discontinued operations, net of taxes - 2 - 6
Deduct:
Total stock-based employee compensation expense
determined under the fair value method for all awards
relating to continuing operations, net of taxes (59) (44) (168) (171)
Total stock-based employee compensation expense
determined under the fair value method for all awards
relating to discontinued operations, net of taxes - (17) - (51)
------- ------- ------- --------
Pro forma net income (loss) $ 381 $ 146 $ 1,413 $(13,781)
------- ------- ------- --------
Basic earnings (loss) per share $ 0.53 $ 0.27 $ 1.94 $ (18.47)
Proforma basic earnings (loss) per share $ 0.48 $ 0.19 $ 1.79 $ (18.72)
Diluted earnings (loss) per share $ 0.53 $ 0.26 $ 1.94 $ (17.92)
Proforma diluted earnings (loss) per share $ 0.48 $ 0.18 $ 1.80 $ (18.16)
Pro forma earnings from continuing operations were $421 million and $479
million for the three months ended September 30, 2003 and 2002,
respectively, and $1,411 million and $1,436 million for the nine months
ended September 30, 2003 and 2002, respectively. Pro forma (loss) from
discontinued operations was $(13) million and $(333) million for the three
months ended September 30, 2003 and 2002, respectively, and $(13) million
and $(14,361) million for the nine months ended September 30, 2003 and
2002, respectively.
Pro forma earnings per basic share from continuing operations was $0.53 and
$0.62 for the three months ended September 30, 2003 and 2002, respectively,
and $1.79 and $1.95 for the nine months ended September 30, 2003 and 2002,
respectively. Pro forma (loss) per basic share from discontinued operations
was $(0.02) and $(0.43), for the three months ended September 30, 2003 and
2002, respectively, and $(0.02) and $(19.51) for the nine months ended
September 30, 2003 and 2002, respectively.
Pro forma earnings per diluted share from continuing operati ons was $0.53
and $0.61 for the three months ended September 30, 2003 and 2002,
respectively, and $1.79 and $1.89 for the nine months ended September 30,
2003 and 2002, respectively. Pro forma (loss) per diluted share from
discontinued operations was $(0.02) and $(0.43), respectively, for the
three months ended September 30, 2003 and 2002, respectively, and $(0.01)
and $(18.92), respectively, for the nine months ended September 30, 2003
and 2002, respectively.
For a detailed discussion of significant accounting policies, please refer
to AT&T's Form 10-K for the year ended December 31, 2002.
3. IMPACTS OF RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
SFAS No. 143, "Accounting for Asset Retirement Obligations"
Effective January 1, 2003, AT&T adopted SFAS No. 143. 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. The offset to the
initial asset retirement obligation is an increase in the carrying amount
of the related long-lived asset. Over time, this liability is accreted to
its future value, and the asset is depreciated over its useful life. Upon
settlement of the liability, an entity either settles the obligation for
its recorded amount or incurs a gain or loss upon settlement.
AT&T historically included in its group depreciation rates an amount
related to the cost of removal for certain assets. However, such amounts
are not legally enforceable or unavoidable; therefore, upon adoption of
SFAS No. 143, AT&T reversed the amount accrued in accumulated depreciation.
As of January 1, 2003, AT&T recorded income of $42 million as the
cumulative effect of a change in accounting principle primarily related to
this reversal. The impact of no longer including the cost of removal in the
group depreciation rates, partially offset by the cumulative effect impact
on accumulated depreciation, has resulted in a decrease to depreciation
expense in 2003. However, the costs incurred to remove these assets will be
reflected as a cost in the period incurred as "Costs of services and
products."
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. 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 leases buildings from qualify 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. The adoption of 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, net of income taxes, as the cumulative effect of an
accounting change in the third quarter of 2003. The noncash impacts of the
adoption of this interpretation include a $433 million increase in
property, plant and equipment and a $477 million increase in debt. (See
note 10 for discussion on exercise of purchase option).
Other Recently Adopted Accounting Pronouncements
During 2003, AT&T also adopted the following accounting pronouncements,
which did not have an impact upon the initial adoption:
- SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments
and Hedging Activities,"
- SFAS No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity,"
- EITF 02-18, "Accounting for Subsequent Investments in an Investee
after Suspension of Equity Method Loss Recognition,"
- EITF 00-21, "Revenue Arrangements with Multiple Deliverables" and
- EITF 01-8, "Determing Whether an Arrangement Contains a Lease."
4. SUPPLEMENTARY FINANCIAL INFORMATION
AT&T AT&T
Business Consumer Total
Services Services AT&T
------------- ------------ ----------
Dollars in millions
GOODWILL
Balance at January 1, 2003 $ 4,556 $ 70 $ 4,626
Translation adjustment 65 - 65
---------- ---------- ----------
Balance at September 30, 2003 $ 4,621 $ 70 $ 4,691
---------- ---------- ----------
Gross Carrying Accumulated Net
Amount Amortization Intangible Assets
-------------- ------------ -----------------
Dollars in millions
INTANGIBLE ASSETS
Amortizable purchased intangible assets at
September 30, 2003:
Customer lists and relationships $ 539 $ 152 $ 387
Other 267 146 121
---------- ---------- ----------
Total intangible assets $ 806 $ 298 $ 508
---------- ---------- ----------
The amortization expense associated with purchased intangible assets for
the three and nine months ended September 30, 2003, was $19 million and $52
million, respectively. Amortization expense for purchased intangible assets
is estimated to be approximately $70 million for the year ending December
31, 2003, $60 million for the year ending December 31, 2004, $55 million
for each of the years ending December 31, 2005 and 2006, and $30 million
for the year ending 2007.
Nine months ended
September 30,
-------- --------
2003 2002
-------- --------
Dollars in millions
OTHER COMPREHENSIVE INCOME (LOSS):
Net foreign currency translation adjustment [net of income taxes of $(59) and $(38)] $ 97 $ 61
Net revaluation of certain financial instruments:
Unrealized gains (losses) [net of income taxes of $(66) and $443] 107 (717)
Recognition of previously unrealized (gains) losses [net of income taxes of $118
and $(535)] (1) (191) 863
Net minimum pension liability adjustment (net of income taxes of $3 and $0] (6) -
-------- --------
Total other comprehensive income $ 7 $ 207
-------- --------
(1) See below for a summary of the "Recognition of previously
unrealized (gains) losses" and the Statement of Operations line
items impacted.
For the Nine Months Ended September 30,
----------------------------------------------
SUMMARY OF RECOGNITION OF PREVIOUSLY UNREALIZED 2003 2002
(GAINS) LOSSES AND THE LINE ITEMS IMPACTED: ----------------------------------------------
Pretax After-tax Pretax After-tax
------ --------- ------ ---------
Dollars in millions
Other income/expense, net:
Other-than-temporary investment impairments $ - $ - $ 142 $ 88
Sale/exchange of various securities (1) (209) (129) - -
Other financial instrument activity (100) (62) - -
Income from discontinued operations - - 1,256 775
------ --------- ------ ---------
Total recognition of previously unrealized (gains) losses $ (309) $ (191) $1,398 $ 863
------ --------- ------ ---------
(1) 2003 includes a $0.2 billion pretax gain associated with the
redemption of exchangeable notes that were indexed to AT&T Wireless
common stock.
5. ACCESS AND OTHER CONNECTION
In September 2003, in conjunction with our review of accounting and
internal control systems, the Company determined that the liability on the
balance sheet (included in accounts payable) relating to costs incurred in
2001 and 2002 pertaining to access and other connection expense was
understated by $125 million. Since the impact to prior years' annual
financial statements was not material, the Company recorded an additional
expense of $125 million ($77 million after-tax) in the third quarter of
2003 to reflect the proper estimate of the liability.
A review was conducted by outside legal counsel, under the direction of the
Audit Committee. This review found that two employees, one lower-level and
one mid-level management employee, circumvented the internal controls
process, resulting in the financial impacts noted below. The Company made
the appropriate personnel changes and enhanced its internal controls
accordingly.
The expense, properly recorded in the respective periods, would have
impacted quarterly and annual income from continuing operations as follows:
-------------------------------------------------------------------------------------------------------------
Income From Earnings Per Diluted
Continuing Share--Continuing
Impact: (Decrease)/Increase Operations Operations
-------------------------------------------------------------------------------------------------------------
Dollars in millions (except per share amounts)
For the Three Months Ended:
September 30, 2001 $ (33) $ (0.04)
December 31, 2001 $ 1 $ 0.01
March 31, 2002 $ (64) $ (0.08)
June 30, 2002 $ 12 $ 0.02
September 30, 2002 $ 14 $ 0.01
December 31, 2002 $ (7) $ (0.01)
For the Year Ended:
December 31, 2001 $ (32) $ (0.04)
December 31, 2002 $ (45) $ (0.06)
6. EARNINGS PER COMMON SHARE AND POTENTIAL COMMON SHARE
On November 18, 2002, a 1-for-5 reverse stock split of AT&T common stock,
as approved by shareowners on July 10, 2002, was effected. Shares (except
shares authorized) and per share amounts were restated to reflect the stock
split on a retroactive basis.
Basic earnings per common share (EPS) is computed by dividing net income 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 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, the employee must
pay upon exercise, the amount of compensation cost attributed to future
service not yet recognized, and any tax benefits credited to
paid-in-capital related to the exercise. These proceeds are then assumed to
be used by the Company 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.
A reconciliation of the share components for basic to diluted EPS is as
follows:
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
2003 2002 2003 2002
------- -------- ------- --------
Shares in millions
Weighted-average common shares 789 770 787 736
Effect of dilutive securities:
Stock options 2 - 1 1
Preferred stock of subsidiary - - - 4
Convertible quarterly income preferred securities - 18 - 18
Weighted-average common shares and potential --- --- --- ---
common shares 791 788 788 759
--- --- --- ---
For the three and nine months ended September 30, 2003 and 2002, no
adjustments were made to income for the computation of diluted EPS.
Preferred Stock of Subsidiary
Pursuant to the AT&T Broadband and Comcast merger agreement, AT&T was
required to redeem the outstanding TCI Pacific Communications, Inc. Class A
Senior Cumulative Exchangeable Preferred Stock (TCI Pacific preferred
stock) for AT&T common stock. All outstanding shares of TCI Pacific
preferred stock were either exchanged or redeemed for AT&T common stock
during 2001 and 2002. Dividends were included in "Net (loss) from
discontinued operations" for 2002.
Convertible Quarterly Income Preferred Securities
On June 16, 1999, AT&T Finance Trust I, a wholly owned subsidiary of AT&T,
completed the private sale of 100 million shares of 5.0% cumulative
quarterly income preferred securities (quarterly preferred securities) to
Microsoft Corporation. Such securities were convertible into AT&T common
stock. However, in connection with the AT&T Broadband spin-off, Comcast
assumed the quarterly preferred securities and Microsoft agreed to convert
these preferred securities into shares of Comcast common stock. Dividends
were included in "Net (loss) from discontinued operations" for 2002.
7. NET RESTRUCTURING AND OTHER CHARGES
For the three months ended September 30, 2003, net restructuring and other
charges of $64 million consisted of $75 million of costs associated with
the Company's management realignment efforts (involuntarily impacting
approximately 800 mid-level managers), primarily representing separation
costs, partially offset by 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. This quarter's business restructuring activity
reflects the next step towards completion of the Company's initiative to
streamline its management structure, which is expected to be completed by
the end of 2003.
Net restructuring and other charges of $134 million for the nine months
ended September 30, 2003, consists of costs associated with the Company's
management realignment efforts, primarily separation costs. These exit
plans involuntarily impacted approximately 900 managers across the Company,
almost 30% of which have exited the business as of September 30, 2003, with
substantially all of the remainder expected to be off roll by the end of
2003. These activities were partially offset by the reversal of $11million
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.
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, 2003 $ 379 $ 283 $ 3 $ 665
Additions 124 - - 124
Deductions (300) (60) (1) (361)
---------- ---------- ---------- ---------
Balance at September 30, 2003 $ 203 $ 223 $ 2 $ 428
---------- ---------- ---------- ---------
Deductions primarily reflect cash payments, which included cash termination
benefits of $285 million, funded primarily through cash from operations.
For the three and nine months ended September 30, 2002, AT&T recorded a net
reversal of $26 million of net restructuring and other charges. At that
time, AT&T's management reevaluated the business restructuring plan
established in the fourth quarter of 2001 and determined that the plan
needed to be modified, primarily for certain areas of AT&T Business
Services, including network services, given the industry conditions at that
time, as well as the redeployment of certain employees to different
functions within the Company. As a result, approximately $137 million of
net restructuring and other charges were reversed, which primarily
consisted of $110 million for employee separation costs. The reversals also
included $12 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. AT&T's
management developed a new exit plan to ensure proper management of our
cost structure in other areas of AT&T Business Services, including network
services, with an offsetting additional charge of $111 million. This plan
primarily consisted of $91 million for employee separation costs and $16
million for facility closings related to buildings becoming vacant as a
result of previously announced restructuring plans. Of the 1,400 employees
affected by this exit plan, slightly more than half were management
employees and 17% left voluntarily.
Relative to the business restructuring reserves recorded during the third
and fourth quarters of 2002, approximately 70% of the employees affected by
these exit plans have left their positions as of September 30, 2003, with
the remaining reductions to occur by the end of 2003.
8. DISCONTINUED OPERATIONS
NCR CORPORATION
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.
AT&T BROADBAND
AT&T Broadband, composed primarily of the AT&T Broadband segment, was
spun-off to AT&T shareowners on November 18, 2002, and simultaneously
combined with Comcast Corporation (Comcast). Pursuant to SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," AT&T
Broadband was accounted for as a discontinued operation. In accordance with
SFAS No. 144, prior period financial statements have been restated to
reflect AT&T Broadband as a discontinued operation in all periods. As a
discontinued operation, the revenue, expenses and cash flows of AT&T
Broadband have been excluded from the respective captions in the
Consolidated Statements of Operations and Consolidated Statements of Cash
Flows, and have been reported through the date of separation within "Net
(loss) from discontinued operations" and as "Net cash (used in)
discontinued operations."
Revenue for AT&T's Broadband business was $2,547 million and $7,512 million
for the three and nine months ended September 30, 2002, respectively. Net
(loss) from discontinued operations before income taxes was $(399) million
[$(318) million after-tax] for the three months ended September 30, 2002,
and $(20,071) million [$(14,228) million after-tax] for the nine months
ended September 30, 2002. For the three and nine months ended September 30,
2002, interest expense of $114 million and $287 million, respectively, was
allocated to discontinued operations based on the balance of intercompany
debt between AT&T Broadband and AT&T.
LUCENT TECHNOLOGIES INC.
Net (loss) from discontinued operations for the three and nine months ended
September 30, 2002, included an estimated loss on a litigation settlement
associated with the business of Lucent Technologies Inc. (Lucent), which
was spun-off from AT&T in 1996. Sparks, et al. v. AT&T and Lucent. et al.,
was a class action lawsuit filed in 1996 in Illinois state court. On August
9, 2002, a settlement proposal was submitted to and accepted by the court.
In accordance with the separation and distribution agreement between AT&T
and Lucent, AT&T's estimated proportionate share of the settlement and
legal costs recorded in the second quarter of 2002 totaled $132 million
pretax ($88 million after-tax). (In the fourth quarter of 2002, this
initial estimate was reduced to $45 million [$33 million after-tax]).
Depending upon the number of claims submitted and accepted, the actual cost
of the settlement to AT&T may be different than amounts accrued as of
September 30, 2003. While similar consumer class actions are pending in
various state courts, the Illinois state court has held that the class it
certified covers claims in the other state court class actions.
9. INVESTMENTS
AT&T CANADA
AT&T had an approximate 31% ownership interest in AT&T Canada. Pursuant to
a 1999 merger agreement, AT&T had a commitment to purchase, or arrange for
another entity to purchase, the publicly-owned shares of AT&T Canada for
the Back-end Price, which was the greater of a contractual floor price or
the fair market value. The floor price accreted 4% each quarter, commencing
on June 30, 2000.
In 2001, AT&T recorded charges reflecting the difference between the
underlying value of publicly owned AT&T Canada shares and the price AT&T
had committed to pay for them, including the 4% accretion of the floor
price. In the nine months ended September 30, 2002, AT&T recorded charges
of $0.3 billion after-tax ($0.5 billion pretax) within "Net (losses)
earnings related to equity investments," reflecting further deterioration
in the underlying value of AT&T Canada as well as accretion of the floor
price.
During 2002, AT&T arranged for third parties (Tricap Investment Corporation
and CIBC Capital Partners) to purchase the remaining 69% equity in AT&T
Canada. As part of this agreement, AT&T agreed to fund the purchase price
on behalf of the third parties. Tricap and CIBC Partners made a nominal
payment to AT&T upon completion of the purchase in October 2002. Although
AT&T held an equity interest in AT&T Canada throughout 2002, it did not
record equity earnings or losses since its investment balance was written
down to zero largely through losses generated by AT&T Canada. As of
September 30, 2003, AT&T had disposed of all of its AT&T Canada shares.
Summarized financial information for the three and nine months ended
September 30, 2002, for this investment accounted for under the equity
method was as follows:
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
2002 2002
-------------------- -------------------
Dollars in millions
Revenue $ 232 $ 719
Operating income (loss) 5 (869)
(Loss) from continuing operations before extraordinary
items and cumulative effect of accounting changes (163) (1,215)
Net (loss) (163) (2,194)
CONCERT
On April 1, 2002, Concert, our 50% owned joint venture with British
Telecommunications plc (BT), was unwound and the venture's assets and
customer accounts were distributed back to the parent companies, as agreed
to in 2001. Under the partnership termination agreement, each of the
partners generally reclaimed the customer contracts and assets that were
initially contributed to the joint venture, including international
transport facilities and gateway assets. In addition, AT&T assumed certain
other assets that BT originally contributed to the joint venture. In
conjunction with the unwind of Concert, AT&T paid BT $158 million in the
first quarter of 2003. In the second quarter of 2003, a $28 million
after-tax benefit ($45 million pretax) was recorded within "Net (losses)
earnings related to equity investments" due to the favorable settlement of
certain items in connection with the Concert unwind.
AT&T had various related party transactions with Concert until the joint
venture was unwound on April 1, 2002. Included in "Revenue" was $268
million for services provided to Concert for the nine months ended
September 30, 2002. Included in "Access and other connection" expense are
charges from Concert representing costs incurred on our behalf to connect
calls made to foreign countries (international settlements) and costs paid
by AT&T to Concert for distributing Concert products totaling $491 million
for the nine months ended September 30, 2002.
AT&T Wireless
In February 2003, AT&T redeemed exchangeable notes that were indexed to
AT&T Wireless common stock. The notes were settled with 78.6 million shares
of AT&T Wireless common stock and $152 million in cash (see note 10). Also
in February, AT&T sold its remaining investment in AT&T Wireless
(approximately 12.2 million shares) for $72 million, resulting in a gain of
$22 million recorded in "Other (expense) income, net."
10. DEBT OBLIGATIONS
LONG-TERM DEBT
On January 31, 2003, AT&T completed the early retirement of $1,152 million
and $2,590 million long-term notes, with interest rates of 6.375% and
6.50%, due in March 2004 and March 2013, respectively. The notes were
repurchased with cash and resulted in a loss of $178 million recorded in
"Other (expense) income, net."
On September 15, 2003, AT&T completed the early retirement of $322 million
and $184 million long-term notes, with an interest rate of 8.125%, due in
January 2022 and July 2024, respectively. The notes were repurchased with
cash and resulted in a loss of $23 million recorded in "Other (expense)
income, net."
On October 22, 2003, AT&T completed the early retirement of three long-term
notes totaling approximately $1.1 billion (as previously called for early
redemption on September 22, 2003). The first note of $236 million, had an
interest rate of 8.625%, and was due in December 2031. The other two notes,
with $410 million and $439 million of principal amounts outstanding, bore
interest rates of 5.625% and 6.375%, respectively, and were each due in
March 2004. The notes were repurchased with cash and resulted in a loss of
$32 million recorded in "Other (expense) income, net."
In September 2003, AT&T gave notice to exercise its purchase option on
buildings we lease, which were consolidated in July along with debt of
approximately $477 million, as a result of our adoption of FIN 46 (see note
3). A $28 million loss on the early extinguishment of debt was recorded in
"Other (expense) income, net."
EXCHANGEABLE NOTES
During 2001, we issued long-term debt (exchangeable notes) that was indexed
to AT&T Wireless common stock and, at AT&T's option, was mandatorily
redeemable with a number of shares of AT&T Wireless common stock that was
equal to the underlying shares multiplied by an exchange ratio, or its cash
equivalent. The notes were accounted for as indexed debt instruments,
because the carrying value of the debt was dependent upon the fair market
value of the underlying securities. In addition, the notes contained
embedded derivatives, which were designated as cash flow hedges and
required separate accounting. These designated options were carried at fair
value with changes in fair value recorded, net of income taxes, within
"Accumulated other comprehensive (loss)," a component of shareowners'
equity.
The shares of AT&T Wireless common stock were accounted for as
"available-for-sale" securities under SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," with changes in the carrying
value of the underlying securities that are not "other-than-temporary"
being recorded as unrealized gains or losses, net of income taxes, within
"Accumulated other comprehensive (loss)," a component of shareowners'
equity.
In February 2003, AT&T redeemed these exchangeable notes with 78.6 million
shares of AT&T Wireless common stock and $152 million in cash. The
settlement resulted in a pretax gain of approximately $176 million recorded
in "Other (expense) income, net." The noncash impacts of this transaction
include the use of $0.5 billion of our investment in AT&T Wireless to
settle long-term debt.
11. FINANCIAL INSTRUMENTS
In the normal course of business, we use various financial instruments,
including derivative financial instruments, for purposes other than
trading. These instruments include letters of credit, guarantees of debt
and certain obligations of former affiliates, interest rate swap
agreements, foreign currency exchange contracts, option contracts, equity
contracts and warrants.
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 the LIBOR (London
Inter-Bank Offered Rate). In 2003, we entered into $1.0 billion of notional
fixed-to-floating interest rate swaps, which we designated as fair value
hedges in accordance with SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", as amended. The weighted-average
receive rate and pay rate for these swaps at September 30, 2003, was 4.23%
and 2.55%, respectively.
In addition, we have combined interest rate, foreign currency swap
agreements for foreign-currency-denominated debt, which hedge our risk to
both interest rate and currency movements. The fair value of such
arrangements has increased $514 million since December 31, 2002, to $1,174
million at September 30, 2003, primarily due to the strength of the Euro
currency compared with the U.S. dollar.
In connection with the combined interest rate swap agreements, as of
September 30, 2003, we had received $200 million of cash collateral
(included in "Cash" in the Consolidated Balance Sheet) and $10 million of
security collateral (included in "Other current assets" in the Consolidated
Balance Sheet).
Debt Securities
As of September 30, 2003, the carrying value of our long-term debt
(including currently maturing long-term debt), excluding capital leases,
was $15.9 billion. The market value associated with this debt was $17.5
billion. The carrying value of debt with an original maturity of less than
one year approximates market value. The fair values of long-term debt were
obtained based on quotes for these securities.
12. EQUITY TRANSACTIONS
Pursuant to the AT&T Broadband and Comcast merger agreement, AT&T was
required to redeem the outstanding TCI Pacific Communications, Inc. Class A
Senior Cumulative Exchangeable Preferred Stock for AT&T common stock. Each
share of TCI Pacific preferred stock was exchangeable, at the option of the
holder, for 1.673 shares of AT&T common stock. As of June 30, 2002, all
outstanding shares (approximately 6.2 million) of TCI Pacific preferred
stock were either exchanged or redeemed for approximately 10.4 million
shares of AT&T common stock. No gain or loss was recorded on the
exchange/redemption of the TCI Pacific preferred stock.
During 2002, AT&T issued 2.9 million shares of AT&T common stock to certain
current and former senior managers in settlement of their deferred
compensation accounts. Approximately 2.8 million shares were issued in the
second quarter of 2002 and 0.1 million shares in the third quarter of 2002.
Pursuant to AT&T's deferred compensation plan, senior managers may defer
short- and long-term incentive compensation awards. The issuance of these
shares resulted in an increase to total shareowners' equity of $0.2
billion.
In June 2002, AT&T completed a public equity offering of 46 million shares
of AT&T common stock for net proceeds of $2.5 billion. AT&T utilized the
proceeds from the offering to satisfy a portion of its obligation to AT&T
Canada common shareholders (see note 9).
13. COMMITMENTS AND CONTINGENCIES
In connection with the separation of its former subsidiaries, AT&T has
entered into a number of separation and distribution agreements that
provide, among other things, for the allocation and/or sharing of certain
costs associated with potential litigation liabilities. For example,
pursuant to these agreements, AT&T shares in the cost of certain litigation
if the settlement exceeds certain thresholds. With the exception of two
matters already reserved for (Sparks, et al. v. AT&T Lucent Technologies
and NCR's Fox River environmental clean-up matter, see note 8), we have
assessed that none of the litigation liabilities allocated to former
subsidiaries were probable of incurring costs in excess of the threshold
above which we would be required to share in the costs. However, in the
event these former subsidiaries were unable to meet their obligations with
respect to these liabilities due to financial difficulties, AT&T could be
held responsible for all or a portion of the costs, irrespective of the
sharing agreements.
In October 2003, the Federal Communications Commission (FCC) found that
AT&T violated Section 203 of the Communications Act of 1934 (Act) for
refusing to transfer the customers of one reseller to the service plans of
another reseller. The actions which gave rise to this finding were the
subject of a lawsuit filed in March 1995 in the United States District
Court for the District of New Jersey by Combined Companies, Inc, Winback &
Conserve, One Stop Financial, 800 Discounts and Group discounts, Inc.
against AT&T. AT&T intends to appeal this decision, as it believes its
actions were consistent with its obligations under the Act. In addition,
AT&T's liability in this matter is subject to the plaintiff proving it
sustained damages and demonstrating the amount to which it claims to be
entitled. Thus, the extent of liability cannot be estimated at this time.
In the original lawsuit plaintiff had sought an injunction requiring AT&T
to transfer customers from one reseller to another. Plaintiff has not filed
an amended complaint asserting damages.
In the normal course of business we are subject to proceedings, lawsuits
and other claims, including proceedings under laws and regulations related
to 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, 2003. However, we believe that after final disposition, any
monetary liability or financial impact to us beyond that provided for at
September 30, 2003, would not be material to our annual consolidated
financial statements.
LEASES AND OTHER COMMITMENTS
Under certain real estate operating leases (with entities consolidated as a
result of FIN 46, see note 3), AT&T could have been required to make
payments to the lessors of up to $427 million at the end of the lease term.
In September 2003, AT&T gave notice to exercise its purchase options under
these leases. As a result of the exercise of these options, AT&T will no
longer have a potential payment requirement.
14. SEGMENT REPORTING
AT&T's results are segmented according to the customers we service: AT&T
Business Services and AT&T Consumer Services. AT&T evaluates performance
based on several factors, of which the primary financial measure is
operating income.
Our existing segments reflect certain managerial changes that were
implemented during 2003. The changes primarily include a redistribution of
property, plant and equipment from the Corporate and Other group to AT&T
Business Services and a transfer of deferred taxes from AT&T Consumer
Services to the Corporate and Other group.
AT&T Business Services provides a variety of communication services to
various sized businesses and government agencies including long distance,
international, toll-free and local voice, including wholesale transport
services, as well as data services and Internet protocol and enhanced
(IP&E) services, which includes the management of network servers and
applications. AT&T Business Services also provides outsourcing solutions
and other professional services.
AT&T Consumer Services provides a variety of communication services to
residential customers. These services include traditional long distance
voice services, such as domestic and international dial services (long
distance or local toll calls where the number "1" is dialed before the
call), calling card services and dial-up Internet. 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 all distance services, which bundle long distance, local and local
toll.
The balance of AT&T's continuing operations is included in a "Corporate and
Other" group. This group primarily reflects corporate staff functions and
the elimination of transactions between segments.
Total assets for our reportable segments include all assets, except
intercompany receivables. AT&T prepaid pension assets, taxes and
corporate-owned or leased real estate are generally 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 nonconsolidated investments and additions to
internal-use software (which are included in "Other assets").
AT&T Business Services sells services to AT&T Consumer Services at
cost-based prices. Generally, AT&T Business Services accounts for these
sales as contra-expense.
REVENUE
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
2003 2002 2003 2002
-------- -------- -------- --------
Dollars in millions
AT&T Business Services external revenue $ 6,282 $ 6,602 $ 19,125 $ 19,697
AT&T Business Services internal revenue - 98 - 273
-------- -------- -------- --------
Total AT&T Business Services revenue 6,282 6,700 19,125 19,970
AT&T Consumer Services external revenue 2,353 2,794 7,265 8,791
-------- -------- -------- --------
Total reportable segments 8,635 9,494 26,390 28,761
Corporate and Other 14 (85) 40 (224)
-------- -------- -------- --------
Total revenue $ 8,649 $ 9,409 $ 26,430 $ 28,537
-------- -------- -------- --------
RECONCILIATION OF OPERATING INCOME TO INCOME FROM CONTINUING
OPERATIONS BEFORE INCOME TAXES, MINORITY INTEREST INCOME,
AND NET (LOSSES) EARNINGS RELATED TO EQUITY INVESTMENTS
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
2003 2002 2003 2002
-------- -------- -------- --------
Dollars in millions
AT&T Business Services operating income $ 417 $ 854 $ 1,614 $ 2,577
AT&T Consumer Services operating income 500 595 1,621 2,203
-------- -------- -------- --------
Total reportable segments operating income 917 1,449 3,235 4,780
Corporate and Other operating (loss) (88) (34) (211) (139)
-------- -------- -------- --------
Operating income 829 1,415 3,024 4,641
Other (expense) income, net (7) (180) 89 (285)
Interest (expense) (289) (355) (917) (1,087)
-------- -------- -------- --------
Income from continuing operations before
income taxes, minority interest income, and
net (losses) earnings related to equity investments $ 533 $ 880 $ 2,196 $ 3,269
-------- -------- -------- --------
ASSETS
At At
September 30, December 31,
2003 2002
------------- ------------
Dollars in millions
AT&T Business Services assets $ 34,951 $ 36,389
AT&T Consumer Services assets 1,095 1,390
-------- --------
Total reportable segments assets 36,046 37,779
Corporate and Other assets* 15,261 17,493
-------- --------
Total assets $ 51,307 $ 55,272
-------- --------
* Includes cash of $6.4 billion at September 30, 2003, and $7.8 billion
at December 31, 2002.
Geographic information is not presented due to the immateriality of
revenue attributable to international customers.
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.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATONS
AT&T CORP. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
AT&T Corp. (AT&T or the Company) is among the world's communications leaders,
providing voice and data communications services to large and small businesses,
consumers and government agencies. We provide domestic and international long
distance, regional and local communications services, and data and Internet
communications services.
FORWARD-LOOKING STATEMENTS
This document may contain forward-looking statements with respect to AT&T's
financial condition, results of operations, cash flows, dividends, financing
plans, business strategies, operating efficiencies or synergies, budgets,
capital and other expenditures, network build-out and upgrade, competitive
positions, availability of capital, growth opportunities for existing products,
benefits from new technologies, availability and deployment of new technologies,
plans and objectives of management, and other matters.
These forward-looking statements, including, without limitation, those relating
to the future business prospects, revenue, working capital, liquidity, capital
needs, network build-out, interest costs and income, are necessary estimates
reflecting the best judgment of senior management that rely on a number of
assumptions concerning future events, many of which are outside AT&T's 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 that could cause actual results to differ materially
from estimates or projections contained in the forward-looking statements
including, without limitation:
|X| the impact of existing and new competitors in the markets in which AT&T
competes, including competitors that may offer less expensive products and
services, desirable or innovative products, technological substitutes, or
have extensive resources or better financing,
|X| the impact of oversupply of capacity resulting from excessive deployment of
network capacity,
|X| 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,
|X| the effects of vigorous competition in the markets in which the Company
operates, which may decrease prices charged, increase churn and change
customer mix and profitability,
|X| the ability to establish a significant market presence in new geographic
and service markets,
|X| the requirements imposed on the Company or latitude allowed to competitors
by the Federal Communications Commission (FCC) or state regulatory
commissions under the Telecommunications Act of 1996 or other applicable
laws and regulations,
|X| the risks associated with technological requirements, wireless, Internet or
other technology substitution and changes and other technological
developments,
|X| the results of litigation filed or to be filed against the Company, and
|X| the possibility of one or more of the markets in which the Company competes
being impacted by changes in political, economic or other factors, such as
monetary policy, legal and regulatory changes or other external factors
over which the Company has no control.
The words "estimate," "project," "intend," "expect," "believe," "plan" and
similar expressions are intended to identify forward-looking statements. Readers
are cautioned not to place undue reliance on these forward-looking statements,
which speak only as of the date this document is filed. Moreover, in the future,
AT&T, through its senior management, may make forward-looking statements about
the matters described in this document or other matters concerning AT&T.
The discussion and analysis that follows provides information management
believes is relevant to an assessment and understanding of AT&T's consolidated
results of operations for the three and nine months ended September 30, 2003,
and 2002, and financial condition as of September 30, 2003, and December 31,
2002.
Critical Accounting Estimates and Judgments
AT&T's financial statements are prepared in accordance with accounting
principles that are generally accepted in the United States. The preparation of
these financial statements 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
continually evaluates its estimates and judgments including those related to
useful lives of plant and equipment, pension and other postretirement benefits,
income taxes and legal contingencies. Management bases its 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 detailed discussion
of significant accounting policies that may involve a higher degree of judgment,
please refer to AT&T's Form 10-K for the year ended December 31, 2002.
CONSOLIDATED RESULTS OF OPERATIONS
The comparison of 2003 results with 2002 results was impacted by the April 1,
2002 unwind of Concert, our joint venture with British Telecommunications plc
(BT). The venture's assets and customer accounts were distributed back to the
parent companies. Under the partnership termination agreement, each of the
partners generally reclaimed the customer contracts and assets that were
initially contributed to the joint venture, including international transport
facilities and gateway assets. In addition, AT&T assumed certain other assets
that BT originally contributed to the joint venture. As a result, the results
for the second and third quarters of 2002 and year-to-date 2003 include revenue
and expenses associated with these customers and businesses, while the period of
January 1, 2002 through March 31, 2002 includes our proportionate share of
Concert's earnings and related charges in "Net (losses) earnings related to
equity investments."
During 2002, AT&T's interest in AT&T Latin America was fully consolidated in
AT&T's results. In December 2002, AT&T signed a non-binding term-sheet for the
sale of its 69% economic interest (95% voting interest) in AT&T Latin America
and began accounting for AT&T Latin America as an asset held for sale (the
operations of AT&T Latin America did not qualify for treatment as a discontinued
operation). As a result of this action, in the fourth quarter of 2002 we wrote
down AT&T Latin America's assets and liabilities to fair value and reclassified
these assets and liabilities to "Other current assets" and "Other current
liabilities" at December 31, 2002. The operating losses of AT&T Latin America
for the first half of 2003 are reflected in "Net restructuring and other
charges." On April 21, 2003, AT&T Latin America filed for Chapter 11 bankruptcy
and on June 30, 2003, the AT&T appointed members of the AT&T Latin America Board
of Directors resigned. They were replaced with three new independent directors.
This action resulted in the deconsolidation of AT&T Latin America as of June 30,
2003.
The consolidated financial statements of AT&T reflect AT&T Broadband as a
discontinued operation. AT&T Broadband was spun-off to AT&T shareowners on
November 18, 2002, and simultaneously combined with Comcast Corporation.
Accordingly, the revenue, expenses and cash flows of AT&T Broadband have been
excluded from the respective captions in the Consolidated Statements of
Operations and Consolidated Statements of Cash Flows, and have been reported as
"Net (loss) from discontinued operations" and as "Net cash (used in)
discontinued operations" for all applicable periods.
Revenue
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
2003 2002 2003 2002
-------- -------- -------- --------
Dollars in millions
AT&T Business Services $ 6,282 $ 6,700 $ 19,125 $ 19,970
AT&T Consumer Services 2,353 2,794 7,265 8,791
Corporate and Other 14 (85) 40 (224)
-------- -------- -------- --------
Total revenue $ 8,649 $ 9,409 $ 26,430 $ 28,537
-------- -------- -------- --------
Total revenue decreased $0.8 billion, or 8.1%, in the third quarter of 2003,
compared with the third quarter of 2002, and decreased $2.1 billion, or 7.4%, in
the nine months ended September 30, 2003, compared with the nine months ended
September 30, 2002. The declines were driven by continued declines in
stand-alone long distance voice revenue of approximately $1.0 billion for the
third quarter of 2003, and $2.9 billion for the nine months ended September 30,
2003, compared with the respective prior year periods. The declines in
stand-alone long distance voice revenue reflect competition, which has led to
lower prices and loss of market share, the impact of substitution by consumers
and a decline in business retail volumes, partially offset by strength in
business wholesale volumes. Total long distance voice volumes (including long
distance volumes sold as part of a bundled product) increased about 6% for the
third quarter of 2003, and increased about 5% for the nine months ended
September 30, 2003, compared with the same periods of 2002, as growth in
lower-priced business wholesale more than offset the declines in business retail
and traditional consumer long distance volumes.
Partially offsetting the decreases in stand-alone long distance voice revenue
were increases in bundled services revenue (local and long distance) at AT&T
Consumer Services of approximately $0.2 billion for the third quarter of 2003,
and $0.7 billion for the nine months ended September 30, 2003, compared with the
respective prior year periods. In addition, AT&T Business Services experienced
increases in local services revenue of $0.1 billion in the third quarter of
2003, and $0.3 billion for the nine months ended September 30, 2003, compared
with the respective prior year periods.
Revenue by segment is discussed in greater detail in the Segment Results
section.
Operating Expenses
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
-------------------- -------------------
2003 2002 2003 2002
-------- -------- -------- --------
Dollars in millions
Access and other connection $ 2,785 $ 2,679 $ 8,191 $ 8,214
Costs of services and products 1,954 2,066 5,923 6,166
Selling, general and administrative 1,793 2,032 5,551 5,911
Depreciation and amortization 1,224 1,243 3,607 3,631
Net restructuring and other charges 64 (26) 134 (26)
--------- -------- -------- --------
Total operating expenses $ 7,820 $ 7,994 $ 23,406 $ 23,896
--------- -------- -------- --------
Operating income $ 829 $ 1,415 $ 3,024 $ 4,641
Operating margin 9.6% 15.0% 11.4% 16.3%
Included within ACCESS AND OTHER CONNECTION EXPENSES are costs we pay to connect
calls using the facilities of other service providers, as well as the Universal
Service Fund contributions and per-line charges mandated by the FCC. Costs paid
to telephone companies outside of the United States to connect international
calls are also included within access and other connection expenses.
Access and other connection expenses increased 4.0%, or $0.1 billion, in the
third quarter of 2003 and decreased 0.3%, or $23 million, for the nine months
ended September 30, 2003, compared with the same periods of 2002. Domestic
access charges for the third quarter and year-to-date period included a $125
million access expense adjustment to reflect the proper estimate of liability
relating to access costs incurred in 2001 and 2002 (see note 5). Excluding this
adjustment, domestic access charges declined $0.1 billion for the third quarter
and $0.4 billion for the year-to-date period. These declines were primarily due
to lower Universal Service Fund contributions and per-line charges of $0.1
billion for the quarter and $0.3 billion for the year-to-date period primarily
resulting from the decline in long distance voice revenue. In addition, the
declines were due to more efficient network usage and product mix aggregating
$0.2 billion for the third quarter and $0.3 billion for the year-to-date period.
These declines in domestic access charges were partially offset by higher costs
of $0.1 billion for the quarter and $0.2 billion for the year-to-date period as
a result of overall long distance volume growth. Also contributing to the
decline in access and other connection expenses for the year-to-date period were
lower international connection charges of $0.1 billion as a result of lower
rates as well as the reintegration of customers and assets from the unwind of
Concert. These declines were partially offset by an increase in local
connectivity costs of $0.1 billion for the quarter and $0.4 billion for the
year-to-date period, primarily as a result of new state entries and subscriber
increases.
Since most of the Universal Service Fund contributions, and per-line charges are
passed through to the customer, these reductions generally result in a
corresponding reduction in revenue.
COSTS OF SERVICES AND PRODUCTS include costs of operating and maintaining our
networks, costs to support our outsourcing contracts, the provision for
uncollectible receivables and other service-related costs, including cost of
equipment sold.
Costs of services and products decreased $0.1 billion, or 5.4%, in the third
quarter of 2003 and $0.2 billion, or 3.9%, in the first nine months of 2003,
compared with comparable prior year periods. The declines were primarily driven
by the overall impact of lower revenue and the related costs, a lower provision
for uncollectibles, as well as by the deconsolidation of AT&T Latin America.
These declines were partially offset by the impact of a weak U.S. dollar.
Additionally, the decrease for the nine months ended September 30, 2003, was
partially offset by increased costs as a result of the reintegration of
customers and assets from the unwind of Concert.
SELLING, GENERAL AND ADMINISTRATIVE (SG&A) EXPENSES decreased $0.2 billion, or
11.8%, in the third quarter of 2003 and $0.4 billion, or 6.1%, in the nine
months ended September 30, 2003, compared with the corresponding periods in
2002. The decreases were driven by approximately $0.2 billion for the quarter
and $0.3 billion for the year-to-date period of lower expenses due to reduced
volumes at AT&T Consumer Services resulting from a reduction in the number of
residential customers, as well as overall cost control efforts. The year-to-date
decrease was also driven by $0.1 billion of lower long distance and brand
advertising and promotional spending, partially offset by $0.1 billion of
increased marketing, customer care and sales expenses associated with new local
service offerings by AT&T Consumer Services.
DEPRECIATION AND AMORTIZATION EXPENSES decreased $19 million, or 1.5%, in the
third quarter of 2003, compared with the third quarter of 2002, and decreased
$24 million, or 0.7%, in the nine months ended September 30, 2003, compared with
the corresponding period in 2002. The decreases were primarily due to the
adoption of Statement of Financial Accounting Standards (SFAS) No. 143,
"Accounting for Asset Retirement Obligations," and lower depreciation associated
with our AT&T Latin America subsidiary, which was classified as an asset held
for sale in December 2002. These declines were largely offset by an increase in
the asset base. Total capital expenditures were $1.2 billion and $1.0 billion
for the three months ended September 30, 2003 and 2002, respectively, and were
$2.7 billion and $2.6 billion for the nine months ended September 30, 2003 and
2002, respectively. These amounts include $0.4 billion recorded in the third
quarter of 2003 in connection with the adoption of Financial Accounting
Standards Board Interpretation (FIN) No. 46, "Consolidation of Variable Interest
Entities - an Interpretation of Accounting Research Bulletin No. 51." We
continue to focus the majority of our capital spending on Internet protocol &
enhanced services (IP&E services) and data services, both of which include
managed services, as well as local voice services.
In the third quarter of 2003, NET RESTRUCTURING AND OTHER CHARGES of $64 million
consisted of $75 million of costs associated with the Company's management
realignment efforts (involuntarily impacting approximately 800 mid-level
managers), primarily representing separation costs, partially offset by 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. This quarter's
business restructuring activity reflects the next step towards completion of the
Company's initiative to streamline its management structure, which is expected
to be completed by the end of 2003. The completion of these activities will
require AT&T to record an additional charge in the fourth quarter of 2003.
However, it is anticipated that it will be lower than the charge recorded in the
third quarter of 2003.
Net restructuring and other charges of $134 million for the nine months ended
September 30, 2003, consists of costs associated with the Company's management
realignment efforts, primarily separation costs. These exit plans involuntarily
impacted approximately 900 managers across the company, almost 30% of which have
exited the business as of September 30, 2003, with substantially all of the
remainder expected to be off roll by the end of 2003. These activities were
partially offset by 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. The
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 2003, however, we expect to realize approximately $225 million of
cash savings and benefit to operating income in subsequent years, when the exit
plan is completed.
For the three and nine months ended September 30, 2002, AT&T recorded a net
reversal of $26 million of net restructuring and other charges. At that time,
AT&T's management reevaluated the business restructuring plan established in the
fourth quarter of 2001 and determined that the plan needed to be modified,
primarily for certain areas of AT&T Business Services, including network
services, given the industry conditions at that time, as well as the
redeployment of certain employees to different functions within the Company. As
a result, approximately $137 million of net restructuring and other charges were
reversed, which primarily consisted of $110 million for employee separation
costs. The reversals also included $12 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.
AT&T's management developed a new exit plan to ensure proper management of our
cost structure in other areas of AT&T Business Services, including network
services, with an offsetting additional charge of $111 million. This plan
primarily consisted of $91 million for employee separation costs and $16 million
for facility closings related to buildings becoming vacant as a result of
previously announced restructuring plans. Of the 1,400 employees affected by
this exit plan, slightly more than half were management employees and 17% left
voluntarily.
Relative to the business restructuring reserves recorded during the third and
fourth quarters of 2002, approximately 70% of the employees affected by these
exit plans have left their positions as of September 30, 2003, with the
remaining reductions to occur by the end of 2003.
AT&T's OPERATING INCOME in the third quarter of 2003 decreased $0.6 billion, or
41.4%, compared with the third quarter of 2002. For the nine months ended
September 30, 2003, AT&T's operating income declined $1.6 billion, or 34.8%,
compared with the sameperiod in 2002. AT&T's operating margin was 9.6% in the
third quarter of 2003 compared with 15.0% in the third quarter of 2002, and was
11.4% in the 2003 year-to-date period, compared with 16.3% in the 2002
year-to-date period. The margin declines were primarily due to the decline in
revenue coupled with a lower rate of decline in related operating expenses
reflecting pricing pressures, product substitution and a shift from
higher-margin retail long distance services to lower-margin wholesale long
distance service and other lower-margin services. In addition, the margins were
negatively impacted by a $125 million access expense adjustment recorded in the
third quarter of 2003.
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
-------------------- -------------------
2003 2002 2003 2002
-------- -------- -------- --------
Dollars in millions
Other (expense) income, net $ (7) $ (180) $ 89 $ (285)
OTHER (EXPENSE) INCOME, NET, in the third quarter of 2003 was expense of $7
million compared with expense of $0.2 billion in the third quarter of 2002. The
favorable variance of $0.2 billion was primarily due to impairments of $0.2
billion in the third quarter of 2002 related to certain leases of aircraft which
are accounted for as leveraged leases. Additionally, investment-related income
for the third quarter of 2003 increased compared with the comparable prior year
period. Unfavorably impacting other (expense) income, net was a loss of $0.1
billion, associated with the early call of certain debt instruments.
Other (expense) income, net, in the nine months ended September 30, 2003, was
income of $0.1 billion compared with expense of $0.3 billion in the nine months
ended September 30, 2002. The favorable variance of $0.4 billion was primarily
due to impairments of $0.2 billion in the third quarter of 2002 related to
certain leases of aircraft, which are accounted for as leveraged leases and
lower investment impairment charges of $0.1 billion, primarily driven by
impairment charges recorded in 2002 for Time Warner Telecom. Also contributing
to the favorable variance were gains related to mark-to-market adjustments on
financial instruments recorded in 2003 versus losses in 2002 and increased
investment-related income totaling $0.1 billion. Partially offsetting these
favorable items was a $0.1 billion reserve recorded in 2003 related to certain
leases of aircraft which are accounted for as leveraged leases. Also included in
other (expense) income, net, in the first nine months of 2003 were losses of
$0.3 billion associated with the early call and repurchase of long-term debt
instruments. This loss was partially offset by a $0.2 billion gain, also in the
first nine months of 2003, associated with the early retirement of exchangeable
notes that were indexed to AT&T Wireless common stock.
We continue to hold investments in leveraged leases of commercial aircraft,
which we lease to domestic airlines as well as aircraft related companies.
Should the financial difficulties in the U.S, airline industry lead to further
bankruptcies or lease restructurings, AT&T could be expected to record
additional losses associated with its aircraft lease portfolio.
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
-------------------- -------------------
2003 2002 2003 2002
-------- -------- -------- --------
Dollars in millions
Interest (expense) $ (289) $ (355) $ (917) $(1,087)
INTEREST (EXPENSE) decreased 18.7%, or $0.1 billion, in the third quarter of
2003 compared with the third quarter of 2002, and decreased 15.7%, or $0.2
billion, in the nine months ended September 30, 2003 compared with the first
nine months of 2002. The decrease was primarily due to a lower average debt
balance in 2003 compared with 2002, reflecting our debt reduction efforts,
slightly offset by interest rate step-ups within our existing debt portfolio.
Ended September 30, Ended September 30,
------------------- -------------------
2003 2002 2003 2002
-------- -------- -------- --------
Dollars in millions
(Provision) for income taxes $ (72) $ (370) $ (677) $(1,362)
Effective tax rate 13.5% 42.0% 30.8% 41.7%
The (PROVISION) FOR INCOME TAXES decreased $0.3 billion in the third quarter of
2003 compared with the third quarter of 2002. This decrease was primarily due to
the impact of a lower effective tax rate and lower income before income taxes in
the third quarter of 2003. The effective tax rate in the third quarter of 2003
was 13.5%, compared with 42.0% in the prior year quarter. The effective tax rate
in 2003 was positively impacted by approximately 22.5 percentage points due to
the recognition of approximately $120 million of tax benefits associated with
refund claims, which received governmental approval during the third quarter.
The tax refund claims related to additional research and experimentation tax
credits generated in prior years. The effective tax rate in 2002 was negatively
impacted by charges we recorded in connection with certain investments in
leveraged leases, for which a limited tax benefit was recorded.
The (provision) for income taxes decreased $0.7 billion in the first nine months
of 2003 compared with the same period of 2002. This decrease was primarily due
to lower income before income taxes and the impact of a lower effective tax rate
in the first nine months of 2003. The effective tax rate in the first nine
months of 2003 was 30.8%, compared with 41.7% for the same period of 2002. The
effective tax rate in 2003 was positively impacted by approximately 5.5
percentage points due to the recognition of approximately $120 million of tax
benefits associated with tax refund claims related to additional research and
experimentation tax credits generated in prior years. In addition, the 2003
effective tax rate was positively impacted by the recognition of tax benefits in
connection with the exchange and sale of AT&T's remaining interest in AT&T
Wireless common stock. The effective tax rate in 2002 was negatively impacted by
the consolidation of AT&T Latin America's losses, for which the Company was
unable to record tax benefits, as well as by charges we recorded in 2002 in
connection with certain investments in leveraged leases for which a limited tax
benefit was recorded.
In the fourth quarter of 2002, AT&T recorded a valuation allowance against the
deferred tax asset attributable to the book and tax basis difference for our
investment in AT&T Latin America. AT&T's ability to realize the deferred tax
asset related to AT&T Latin America is dependent on factors outside of AT&T's
control. Based on the resolution of various matters, which are expected over the
next 12-15 months, AT&T may determine that all, or a portion of, the valuation
allowance established in 2002 would no longer be necessary.
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
-------------------- -------------------
2003 2002 2003 2002
-------- -------- -------- --------
Dollars in millions
Minority interest income $ - $ 28 $ 1 $ 81
MINORITY INTEREST INCOME represents an adjustment to AT&T's income to reflect
the less than 100% ownership of consolidated subsidiaries. Minority interest
income decreased $28 million in the third quarter of 2003 compared with the
third quarter of 2002, and decreased $80 million in the nine months ended
September 30, 2003, compared with the comparable period in 2002. The decreases
were primarily due to our no longer recording minority interest income related
to AT&T Latin America. In December 2002, AT&T fully utilized the minority
interest balance related to AT&T Latin America.
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
-------------------- -------------------