AT&T CORP - 10-Q Quarterly Report

Back to GetFilings.com

.
.
.

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 JUNE 30, 2004

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 1-1105

AT&T CORP.

A NEW YORK I.R.S. EMPLOYER
CORPORATION NO. 13-4924710

ONE AT&T WAY, BEDMINSTER, NEW JERSEY 07921

TELEPHONE -- AREA CODE 908-221-2000

INDICATE BY CHECK MARK WHETHER THE 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 12d-2) YES [X] No [ ]

AT JULY 30, 2004, THE FOLLOWING SHARES OF STOCK WERE OUTSTANDING: AT&T
COMMON STOCK -- 794,714,883

PART I -- FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

AT&T CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)

The notes are an integral part of the consolidated financial statements.
1

AT&T CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

The notes are an integral part of the consolidated financial statements.
2

AT&T CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREOWNERS' EQUITY
(UNAUDITED)

AT&T accounts for treasury stock as retired stock. The amounts attributable to
treasury stock at June 30, 2004 and December 31, 2003, were $(17,014) and
$(17,026) million, respectively.

We have 100 million authorized shares of preferred stock at $1 par value.

The notes are an integral part of the consolidated financial statements.
3

AT&T CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

The notes are an integral part of the consolidated financial statements.
4

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. BASIS OF PRESENTATION

The consolidated financial statements have been prepared by AT&T Corp.
(AT&T) pursuant to the rules and regulations of the Securities and Exchange
Commission (SEC) and, in the opinion of management, include all adjustments
necessary for a fair statement of the consolidated results of operations,
financial position and cash flows for each period presented. The consolidated
results for interim periods are not necessarily indicative of results for the
full year. These financial results should be read in conjunction with AT&T's
Form 10-K for the year ended December 31, 2003. We have reclassified certain
prior period amounts to conform to our current presentation, including the
transfer of our remaining payphone business from the AT&T Consumer Services
segment to the AT&T Business Services segment.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

AT&T has a Long Term Incentive Program under which we grant stock options,
performance shares, restricted stock and other awards in AT&T common stock, as
well as an Employee Stock Purchase Plan. Effective January 1, 2003, we adopted
the fair value recognition provisions of Statement of Financial Accounting
Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," and we
began to record stock-based compensation expense for all employee awards
(including stock options) granted or modified after January 1, 2003. For awards
issued prior to January 1, 2003, we apply Accounting Principles Board (APB)
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations in accounting for our plans. Under APB Opinion No. 25, no
compensation expense has been recognized for stock options.

If AT&T had elected to recognize compensation costs based on the fair value
at the date of grant of all awards granted prior to January 1, 2003, consistent
with the provisions of SFAS No. 123, net income and earnings per share amounts
would have been as follows:

Pro forma stock-based compensation expense reflected above may not be
indicative of future compensation expense that may be recorded. Future
compensation expense may differ due to various factors, such as the number of
awards granted and the market value of such awards at the time of grant.

Pro forma income before cumulative effect of accounting change was $80
million and $499 million for the three months ended June 30, 2004 and 2003,
respectively, and was $351 million and $990 million for the six months ended
June 30, 2004 and 2003, respectively.

5

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

Pro forma earnings per basic and diluted share before cumulative effect of
accounting change were $0.10 and $0.63 for the three months ended June 30, 2004
and 2003, respectively, and were $0.44 and $1.26 for the six months ended June
30, 2004 and 2003, respectively.

For a detailed discussion of significant accounting policies, please refer
to AT&T's Form 10-K for the year ended December 31, 2003.

3. SUPPLEMENTARY FINANCIAL INFORMATION

SUPPLEMENTARY BALANCE SHEET INFORMATION

The amortization expense associated with purchased intangible assets for
the three and six months ended June 30, 2004, was $28 million and $61 million,
respectively, and for the three and six months ended June 30, 2003, was $17
million and $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.

In July 2004, we announced a strategic change in our business focus away
from traditional consumer services and towards business markets and emerging
technologies. As a result of this strategic change, we are in the process of
performing an evaluation of our goodwill as we believe this creates a "trigger
event" necessitating such a review. We are in the process of determining if the
carrying value of any of our reporting units exceeds its fair value ("step 1")
under SFAS No. 142, "Goodwill and Other Intangible Assets." If we determine that
the carrying value of any of our reporting units exceeds its fair value, we will
then perform "step 2", which is to determine if the implied fair value of the
reporting unit goodwill is less than the carrying value of this goodwill. If so,
a goodwill impairment charge representing the difference between the implied
fair value of the reporting unit goodwill and its associated carrying value will
be recognized in the third quarter of 2004.

6

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

The strategic change in business focus also creates a "trigger event" for a
review of our property, plant and equipment. In assessing impairments we follow
the provisions of SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." If the total of the expected future undiscounted cash flows
is less than the carrying value of the asset and/or group of assets, a loss will
be recognized for the difference between the fair value and the carrying value
of the asset and/or group of assets in the third quarter of 2004.

Other Current Assets:

Recorded within other current assets as of June 30, 2004, was restricted
cash of $503 million relating to private debt that matures in February 2005.
This asset had a balance of $499 million at December 31, 2003, and was recorded
in other assets.

SUPPLEMENTARY SHAREOWNERS' EQUITY INFORMATION

- ---------------

(1) See below for a summary of recognition of previously unrealized (gains)
losses on available-for-sale securities.

7

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

4. EARNINGS PER COMMON SHARE AND POTENTIAL COMMON SHARE

Basic earnings per common share (EPS) is computed by dividing income
attributable to common shareowners by the weighted-average number of common
shares outstanding for the period. Diluted EPS reflects the potential dilution
(considering the combined income and share impact) that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock. The potential issuance of common stock is assumed to occur at
the beginning of the year (or at the time of issuance if later), and the
incremental shares are included using the treasury stock method. The proceeds
utilized in applying the treasury stock method consist of the amount, if any, to
be paid upon exercise, the amount of compensation cost attributed to future
service not yet recognized, and any tax benefits credited to paid-in-capital
related to the exercise. These proceeds are then assumed to be used by AT&T to
purchase common stock at the average market price during the period. The
incremental shares (difference between the shares assumed to be issued and the
shares assumed to be purchased), to the extent they would have been dilutive,
are included in the denominator of the diluted EPS calculation. Potentially
dilutive securities for all periods presented were stock options and restricted
stock units. No adjustments were made to income for the computation of diluted
EPS.

5. NET RESTRUCTURING AND OTHER CHARGES

Net restructuring and other charges of $54 million for the three months
ended June 30, 2004, primarily consisted of business restructuring activities
associated with employee separations related to AT&T Business Services. This
activity resulted from the continued integration and automation of various
functions within network operations, as well as reorganizations throughout our
non-U.S. operations. This exit plan impacted approximately 625 employees (more
than half of which were involuntary), approximately 35% of whom were managers.

Net restructuring and other charges of $267 million for the six months
ended June 30, 2004, were comprised of net business restructuring obligations of
$145 million and real estate impairment charges of $122 million. The business
restructuring activities consisted of $104 million of separation costs and $41
million of facility closing obligations. This exit plan impacted approximately
1,405 employees (the majority of which were involuntary) primarily within the
AT&T Business Services segment as a result of integration and automation of
various functions within network operations, as well as reorganizations
throughout our non-U.S. operations. Slightly less than half of the employees
impacted by this exit plan were managers. About 75% of the affected employees
had left their positions as of June 30, 2004, with the remaining anticipated to
exit our business by the end of the third quarter of 2004. In July 2004, we
announced certain strategic changes that are anticipated to have a significant
impact on our business. Such changes are anticipated to result in future
headcount reductions (see note 12).

The $41 million of facility closing reserves are associated with the
consolidation of our real estate portfolio and reflect the present value of
contractual lease obligations, net of estimated sublease income,

8

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

associated with vacant facilities resulting from workforce reductions and
network equipment space that will not be used by AT&T.

The real estate impairment charges of $122 million relate to the decision
made during the first quarter of 2004 to divest five owned properties in an
effort to further reduce costs and consolidate our real estate portfolio. In
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," an impairment charge was recorded within the Corporate and
Other group to reduce the book value of the five properties to fair market value
based on third party assessments (including broker appraisals). Two of these
properties were sold in June 2004 and one additional property was sold in July
2004. We anticipate sales of the remaining properties will be completed by March
31, 2005. At June 30, 2004, these remaining properties were recorded as assets
held-for-sale within other current assets on the balance sheet.

The following table displays the activity and balances of the restructuring
reserve account:

Deductions primarily reflected total cash payments of $185 million. These
cash payments include cash termination benefits of $153 million and $32 million
of facility closing reserve payments, which were funded primarily through cash
from operations. Deductions also include 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.

Net restructuring and other charges for the three and six months ended June
30, 2003, were $66 million and $70 million, respectively. The year-to-date
charge primarily consisted of $66 million recorded in the second quarter, which
was comprised of $57 million of separation costs and $9 million of benefit plan
curtailment costs associated with our management realignment efforts (impacting
approximately 90 senior managers).

6. DEBT OBLIGATIONS

LONG-TERM DEBT

In March 2004, we completed the early retirement of $1.2 billion of $1.5
billion outstanding 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 income
(expense), net.

In addition, during March 2004, we completed the early retirement of $928
million of our outstanding $1.8 billion 6.0% Euro Notes due November 2006, which
carried an interest rate of 6.75% at the time of retirement. The notes were
repurchased with cash and resulted in a net loss of $117 million recorded in
other income (expense), net. The carrying value of these notes was $1.3 billion,
including $0.4 billion in associated foreign currency mark-to-market
adjustments.

7. FINANCIAL INSTRUMENTS

In the normal course of business, we use various financial instruments,
including derivative financial instruments, to manage our market risk associated
with changes in interest rates, foreign currency rates and

9

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

equity prices. We do not use financial instruments for trading or speculative
purposes. These instruments include letters of credit, guarantees of debt and
certain obligations of former affiliates, interest rate swap agreements, foreign
currency exchange contracts, option contracts, equity contracts and warrants.

GUARANTEES

AT&T provided a guarantee of an obligation that AT&T Wireless has to NTT
DoCoMo. Under this guarantee, AT&T would have been secondarily liable for up to
$3.65 billion, plus accrued interest, in the event AT&T Wireless was unable to
satisfy its entire obligation to NTT DoCoMo. AT&T's guarantee expired on June
30, 2004, in accordance with the terms of the original agreement.

INTEREST RATE SWAP AGREEMENTS

We enter into interest rate swaps to manage our exposure to changes in
interest rates. We enter into swap agreements to manage the fixed/floating mix
of our debt portfolio in order to reduce aggregate risk of interest rate
movements. These agreements involve the exchange of floating-rate for fixed-rate
payments or the exchange of fixed-rate for floating-rate payments without the
exchange of the underlying notional amount. Floating-rate payments and receipts
are primarily tied to LIBOR (London Inter-Bank Offered Rate). The notional
amount of our fixed-rate to floating-rate swaps was $750 million as of June 30,
2004, a decline of $250 million from December 31, 2003. This decline reflects
the unwind of $250 million notional amount of fixed-to-floating interest rate
swaps, which were designated as fair value hedges, in conjunction with the early
retirement of $1.2 billion of long-term notes in March 2004 (see note 6). The
weighted-average receive rate and pay rate for the outstanding fixed-to-floating
interest rate swaps as of June 30, 2004, was 4.83% and 3.42%, respectively.

In addition, we have combined interest rate, foreign currency swap
agreements for foreign-currency-denominated debt, which hedge our risk to both
interest rate and currency movements. As of June 30, 2004, the notional amount
and fair value of these contracts were $1.6 billion and $561 million,
respectively, compared with $2.5 billion and $1.0 billion, respectively, at
December 31, 2003. The decreases in the notional amount and fair value of these
agreements were primarily related to $928 million notional amount of combined
interest rate foreign currency swap contracts, designated as cash flow hedges,
which were unwound in March 2004 in connection with the early retirement of
long-term Euro notes in March 2004 (see note 6). As a result of this unwind, we
recognized $10 million of unrealized gains as part of the net gain (loss) on the
early extinguishment of debt within other income (expense), net. In addition, we
returned $50 million of cash collateral that we held at December 31, 2003, in
connection with the unwind of these combined interest rate swap agreements.

FOREIGN EXCHANGE

We enter into foreign currency forward contracts to manage our exposure to
changes in currency exchange rates related to foreign-currency-denominated
transactions. As of June 30, 2004, the notional amount outstanding on these
contracts was $1.7 billion, compared with $1.1 billion as of December 31, 2003.
The increase in the notional amount was primarily attributable to an increase in
our forward contract portfolio. In addition, in connection with the early
retirement of long-term Euro notes in March 2004, we unwound $29 million of
foreign currency forward contracts, which managed our exposure to additional
interest required to be paid by us as a result of lowered credit ratings. As a
result of this unwind, we recognized $6 million of unrealized gains as part of
the net gain (loss) on the early extinguishment of debt within other income
(expense), net.

10

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

EQUITY OPTION AND EQUITY SWAP CONTRACTS

We enter into equity options and equity swap contracts, which are
undesignated, to manage our exposure to changes in equity prices associated with
various equity awards of previously affiliated companies. The notional amount
relating to these contracts was $29 million as of June 30, 2004, compared with
$91 million as of December 31, 2003. The decrease in the notional amount was
primarily related to swaps on 1.7 million Comcast Corporation shares, which
expired during the first quarter of 2004.

DEBT SECURITIES

As of June 30, 2004, the carrying value of our long-term debt (including
currently maturing long-term debt), excluding capital leases, was $10.4 billion,
compared with $13.4 billion at December 31, 2003. The market values associated
with this debt were $10.5 billion and $14.8 billion as of June 30, 2004 and
December 31, 2003, respectively. The decreases in the carrying value and fair
value of debt were primarily attributed to early debt repurchases and scheduled
repayments made in the first half of 2004. 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.

8. PENSION AND POSTRETIREMENT EMPLOYEE BENEFIT PLANS

We sponsor noncontributory defined benefit pension plans covering the
majority of our U.S. employees. Our benefit plans for current and certain future
retirees include health-care benefits, life insurance coverage and telephone
concessions.

The following table shows the components of net periodic benefit (credit)
costs for our U.S. plans:

- ---------------

* Included in net restructuring and other charges.

On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the Act) was signed into law. The Act introduces a
prescription drug benefit under Medicare (Medicare Part D) as well as a federal
subsidy to sponsors of retiree health care benefit plans that provide a benefit
that is at least actuarially equivalent to Medicare Part D. We are impacted by
the Act since we sponsor postretirement health care plans that provide
prescription drug benefits. We have elected to defer recognition of the Act in
accordance with Financial Accounting Standards Board (FASB) Staff Position
("FSP") No. FAS 106-1, "Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and

11

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

Modernization Act of 2003." As a result, any measures of the accumulated
postretirement benefit obligation or net periodic postretirement benefit cost do
not reflect the effects of the Act on the plans.

On May 19, 2004, the FASB issued FSP No. FAS 106-2, "Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003." This Staff Position supersedes FSP No. FAS 106-1
and provides guidance on accounting for the effects of the new Medicare
prescription drug legislation by employers whose prescription drug benefits are
actuarially equivalent to the drug benefit under Medicare Part D. The provisions
of FSP No. FAS 106-2 are effective for the first interim or annual period
beginning after June 15, 2004, and accordingly, we plan to adopt them effective
July 1, 2004. The FSP provides two alternative methods of transition, either
retroactive application to the date of enactment or, the method we have
selected, prospective application from the date of adoption.

Federal regulations for determining actuarial equivalence have not yet been
issued in either proposed or final form, which impacts our ability to estimate
the full adoption effects of the FSP. Despite the lack of final federal
regulations, we believe that the prescription drug benefits provided to a
specific portion of our postretirement benefit plan participants would be deemed
to be actuarially equivalent to Medicare Part D benefits based on the benefits
provided under the plan. The estimated impact upon adoption for this group will
be a reduction in the accumulated postretirement benefit obligation of
approximately $150 million to $175 million, which will be amortized to income
over time as an actuarial gain. In addition, we will realize a reduction in net
periodic postretirement benefit cost (recorded within SG&A and costs of services
and products) of approximately $10 million over the second half of 2004. Without
a firm definition of actuarial equivalence, we are unable to determine if the
prescription drug benefits provided to the remaining plan participants are
actuarially equivalent to Medicare Part D benefits and are therefore unable to
quantify any potential impact at this time.

9. INCOME TAXES

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 established in 2002 attributable to the book and tax basis
difference related to our investment in AT&T Latin America, and recorded an
income tax benefit of $371 million in the first quarter of 2004. The effective
tax rate of (469.0)% in the first half of 2004 was positively impacted by 513.7
percentage points due to this reversal.

10. COMMITMENTS AND CONTINGENCIES

In the normal course of business we are subject to proceedings, lawsuits
and other claims, including proceedings under laws and regulations related to
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 June 30, 2004. However, if these matters
are adversely settled, such amounts could be material to our consolidated
financial statements.

We have been named as a defendant in a consolidated group of purported
securities class action lawsuits filed in the United States District Courts for
the District of New Jersey on behalf of persons who purchased shares of AT&T
common stock from October 25, 1999 through May 1, 2000. These lawsuits allege,
among other things, that during the period referenced above, we made materially
false and misleading statements and omitted to state material facts concerning
our future business prospects. The consolidated complaint seeks unspecified
damages. Similar claims have been asserted by plaintiffs against us in two
derivative actions, which were dismissed by the New Jersey federal court on
January 7, 2004. In early June 2004, the court granted AT&T's motion for summary
judgment (in part) in these cases and dismissed a substantial portion of this
case by narrowing the class period and rejecting a number of the allegations
upon which plaintiffs
12

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

complaint was based. We believe that the remaining complaints are without merit
and intend to defend them vigorously.

On April 21, 2004, the Federal Communications Commission (FCC) ruled
against a petition we filed in October 2002, in which we asked the FCC to
confirm that our long distance phone-to-phone Internet Protocol (IP) telephony
services are exempt from terminating access charges and lawfully terminated over
end user local services. The total interstate and intrastate access savings we
obtained on AT&T long distance phone-to-phone IP telephony services since the
first quarter of 2000 through the date of the ruling was approximately $250
million. As a result of this ruling, we began paying terminating access charges
on long distance phone-to-phone IP telephony calls.

The FCC did not make any determination regarding the appropriateness of
retroactive application of its ruling. The FCC left the matter to be decided on
a fact specific, case-by-case basis. On April 22, 2004, SBC Communications, Inc.
(SBC) filed suit against us in federal district court in Missouri seeking
recovery of an estimated $141 million in interstate and intrastate access
charges that SBC alleges AT&T avoided by delivering long distance calls to SBC
for termination over SBC local facilities, together with interest and punitive
damages. In addition, on May 5, 2004, Qwest Corporation filed a similar
complaint against AT&T in federal district court in Colorado seeking "tens of
millions of dollars in access charges." While no additional lawsuits have been
filed, other incumbent local exchange carriers may assert similar claims. We
believe that we have a number of defenses to these claims and intend to defend
against them vigorously.

Another petition that is pending before the FCC relates to enhanced prepaid
card service. Because of the nature of our enhanced prepaid card service
(consisting first of a call to our prepaid card platform where the customer
interacts with advertising content and then a second call from the platform to
the called party), we pay access charges on the call to the enhanced prepaid
card platform and on the call from the enhanced prepaid card platform based on
the jurisdiction of each call. This does not impact the amount of access charges
we pay on enhanced prepaid card calls when the persons communicating are in
different states from each other and from the enhanced platform, but generally
results in lower access charges when the persons are both in the same state and
the enhanced platform is in a different state. In addition, because our prepaid
card calls are offered as an enhanced service, we do not make Universal Service
Fund (USF) contributions on revenue derived from these calls. Given that we
cannot predict with certainty how the FCC will rule on our petition, and the
FCC's recent decision to decline to address issues of retroactivity in the case
of phone-to-phone IP, it should be noted that the current classification of
AT&T's enhanced prepaid card service has generated approximately $290 million in
access savings since the third quarter of 2002, and approximately $150 million
in USF contribution savings since the beginning of 1999, compared with the cost
that would have been incurred by a basic prepaid card offering. Since these
savings have permitted us to sell prepaid cards to consumers and distributors at
prices below what otherwise would have been possible, an adverse ruling by the
FCC on the prepaid card petition would therefore increase the future cost of
providing prepaid cards and may materially adversely affect future sales of
prepaid cards, as well as potentially exposing us to retroactive liability,
penalties and interest.

In March 2004, the United States Court of Appeals for the District of
Columbia vacated a number of recent FCC rulings made in connection with the
Triennial Review Order, including the FCC's delegation to state commissions of
decisions over impairment as applied to mass market switching and certain
transport elements. That decision was stayed until June 16, 2004. On June 4,
2004, the Court of Appeals announced it would not extend that stay. On June 9,
2004, the Office of the Solicitor General informed the FCC that it had decided
not to appeal the D.C. Circuit decision vacating the FCC's local telephone
unbundling rules. On July 22, 2004, AT&T announced that we will be shifting our
focus away from traditional consumer services, and we will no longer be
investing to acquire new residential local and stand-alone long distance
customers (see note 12).

13

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

11. SEGMENT REPORTING

Our results are segmented according to the customers we service: AT&T
Business Services and AT&T Consumer Services.

Our existing segments reflect certain managerial changes that were
implemented during 2004. We transferred our remaining payphone business from
AT&T Consumer Services to AT&T Business Services.

AT&T Business Services provides a variety of communication services to
various sized businesses and government agencies including long distance,
international, toll-free and local voice, including wholesale transport
services, as well as data services and Internet protocol and enhanced (IP&E)
services, which includes the management of network servers and applications.
AT&T Business Services also provides outsourcing solutions and other
professional services.

AT&T Consumer Services provides a variety of communication services to
residential customers. These services include traditional long distance voice
services, such as domestic and international dial services (long distance or
local toll calls where the number "1" is dialed before the call) and calling
card services. Transaction services, such as prepaid card and operator-assisted
calls, are also offered. Collectively, these services represent stand-alone long
distance and are not offered in conjunction with any other service. AT&T
Consumer Services also provides dial-up Internet services and all distance
services, which bundle long distance, local and local toll.

The balance of AT&T's operations is included in a "Corporate and Other"
group. This group primarily reflects corporate staff functions and the
elimination of transactions between segments.

Total assets for our reportable segments include all assets, except
intercompany receivables. Nearly all prepaid pension assets, taxes and
corporate-owned or leased real estate are held at the corporate level and
therefore are included in the Corporate and Other group. Capital additions for
each segment include capital expenditures for property, plant and equipment,
additions to internal-use software (which are included in other assets) and
additions to nonconsolidated investments.

Generally, AT&T accounts for inter-segment transactions at market prices.
AT&T Business Services sells services to AT&T Consumer Services at cost-based
prices, which approximate average market prices. These sales are recorded by
AT&T Business Services as contra-expense.

14

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

REVENUE

RECONCILIATION OF OPERATING INCOME TO INCOME BEFORE INCOME TAXES, MINORITY
INTEREST INCOME, NET EARNINGS RELATED TO EQUITY INVESTMENTS AND CUMULATIVE
EFFECT OF ACCOUNTING CHANGE

15

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

ASSETS

- ---------------

* Includes cash of $2.1 billion at June 30, 2004, and $4.0 billion at December
31, 2003.

CAPITAL ADDITIONS

GEOGRAPHIC INFORMATION

- ---------------

(1) Revenue is reported in the geographic area in which it originates.

(2) Includes amounts attributable to operations in Puerto Rico and the Virgin
Islands.

(3) Long-lived assets include property, plant and equipment, net, goodwill and
other purchased intangibles, net.

16

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

Reflecting the dynamics of our business, we continually review our
management model and structure, which may result in additional adjustments to
our operating segments in the future.

12. SUBSEQUENT EVENTS

On July 22, 2004, we announced that as a result of recent changes in
regulatory policy governing local telephone service, we will be shifting our
focus away from traditional consumer services, and we will no longer be
investing to acquire new residential local and stand-alone long distance
customers. We plan to concentrate our investments going forward on business
markets and emerging technologies.

In July 2004, Moody's and Fitch lowered our long-term credit ratings to Ba1
and BB+, respectively, and lowered our short-term credit and commercial paper
ratings to NP (not prime) and B, respectively. In August 2004, 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. This step-up
is effective for interest payment periods that will begin after November 2004,
resulting in an expected increase in interest expense of approximately $10
million in 2004 and $70 million in 2005.

17

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

AT&T CORP. AND SUBSIDIARIES

FORWARD-LOOKING STATEMENTS

This document contains certain forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995 with respect to
financial condition, results of operations, cash flows, dividends, financing
plans, business strategies, operating efficiencies, capital and other
expenditures, competitive positions, availability of capital, growth
opportunities for new and existing products, benefits from new technologies,
availability and deployment of new technologies, plans and objectives of
management, and other matters.

Statements in this document that are not historical facts are hereby
identified as "forward-looking statements" for the purpose of the safe harbor
provided by Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. The words "estimate," "project," "intend,"
"expect," "believe," "plan," and similar expressions are intended to identify
forward-looking statements. Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of the date of this
document. Any Form 10-K, Annual Report to Shareholders, Form 10-Q or Form 8-K of
AT&T may include forward-looking statements. In addition, other written or oral
statements which constitute forward-looking statements have been made and may in
the future be made by or on behalf of AT&T, including with respect to the
matters referred to above. These forward-looking statements are necessarily
estimates, reflecting the best judgment of senior management that rely on a
number of assumptions concerning future events, many of which are outside of our
control, and involve a number of risks and uncertainties that could cause actual
results to differ materially from those suggested by the forward-looking
statements. These forward-looking statements should, therefore, be considered in
light of various important factors, including those set forth in this document.
Important factors that could cause actual results to differ materially from
estimates or projections contained in the forward-looking statements include,
without limitation:

- the impact of existing, new and restructured competitors in the markets
in which we compete, including competitors that may offer less expensive
products and services, desirable or innovative products, technological
substitutes, or have extensive resources or better financing,

- the impact of oversupply of capacity resulting from excessive deployment
of network capacity,

- the ongoing global and domestic trend toward consolidation in the
telecommunications industry, which may have the effect of making the
competitors of these entities larger and better financed and afford these
competitors with extensive resources and greater geographic reach,
allowing them to compete more effectively,

- the effects of vigorous competition in the markets in which we operate,
which may decrease prices charged and change customer mix and
profitability,

- the ability to establish a significant market presence in new geographic
and service markets,

- the availability and cost of capital,

- the impact of any unusual items resulting from ongoing evaluations of our
business strategies,

- the requirements imposed on us or latitude allowed to competitors by the
Federal Communications Commission (FCC) or state regulatory commissions
under the Telecommunications Act or other applicable laws and
regulations,

- the effects of our announcement that we will stop investing in
traditional consumer services and will no longer compete for residential
local and stand-alone long distance customers,

- the validity or invalidity of portions of the FCC's Triennial Review
Order, and the Office of the Solicitor General's decision not to appeal
the United States Court of Appeals for the District of Columbia's action
to vacate various related FCC rulings,

18

- the risks associated with technological requirements; wireless, internet,
Voice over Internet Protocol (VoIP) or other technology substitution and
changes; and other technological developments,

- the risks associated with the repurchase by us of debt or equity
securities, which may adversely affect our liquidity or creditworthiness,

- the results of litigation filed or to be filed against us, and

- the possibility of one or more of the markets in which we compete being
impacted by changes in political, economic or other factors, such as
monetary policy, legal and regulatory changes, war, terrorism or other
external factors over which we have no control.

The discussion and analysis that follows provides information management
believes is relevant to an assessment and understanding of AT&T's consolidated
results of operations for the three and six months ended June 30, 2004 and 2003,
and financial condition as of June 30, 2004 and December 31, 2003.

OVERVIEW

AT&T Corp. (AT&T) is among the world's communications leaders, providing
voice and data communications services to large and small businesses, consumers
and government agencies. We provide domestic and international long distance,
regional and local communications services, data and Internet communications
services.

Our operating environment in 2004 remains competitive and challenging.
During the first half of 2004, we continued to see the effects of industry
oversupply and the associated impacts on pricing behavior in the business
marketplace. Recent escalation in 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, primarily in bandwidth and packet services. As a result, we expect
the full year revenue decline for AT&T Business Services will exceed our
previously forecasted decline of 4% to 7%.

AT&T Consumer Services also continues to be negatively impacted by
competition and substitution (consumers using wireless or Internet services in
lieu of a wireline call). Additionally, while we have experienced some success
with our bundled offers, recent regulatory developments have resulted in the
reassessment of our consumer acquisition initiatives as discussed below, and
while we will continue to provide our existing customers with quality service,
we will no longer invest to acquire new customers. We have projected that AT&T
Consumer Services will experience a high-teens rate of revenue decline compared
with 2003. We expect operating margins for AT&T Consumer Services to be in the
mid-teens.

As a result of the weakness in both AT&T Business Services and AT&T
Consumer Services, we expect total company revenue to be between $29.5 billion
and $30.5 billion in 2004, and expect full-year 2004 consolidated operating
income between $1.0 billion and $1.4 billion (excluding net restructuring and
other charges).

Despite the operating environment, we remain focused on controlling our
costs and have made substantial progress in areas such as headcount reductions.
We are continuing to invest in our business prudently, focusing on making the
necessary investments in automation and process improvements. We expect to have
approximately $1.8 billion in capital expenditures for 2004. We have continued
to reduce debt levels and we believe the strength of our balance sheet will
continue to provide us with the flexibility to make investments in our business.

However, recent changes in regulatory policy governing local service have
forced us to reassess the way we do business. As a result, in July 2004, we
announced that we will be shifting our focus away from traditional consumer
services such as wireline residential services, and we will no longer be
investing to acquire new residential local and stand-alone long distance
customers. We plan to concentrate our investments going forward on business
markets and emerging technologies.
19

CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS

The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenue and
expenses as well as the disclosure of contingent assets and liabilities.
Management bases its estimates and judgments on historical experience and other
factors that are believed to be reasonable under the circumstances. Actual
results may differ from these estimates under different assumptions or
conditions.

For a discussion of the critical accounting estimates we identified that we
believe require significant judgment in the preparation of our consolidated
financial statements, please refer to AT&T's Form 10-K for the year ended
December 31, 2003.

CONSOLIDATED RESULTS OF OPERATIONS

REVENUE

Total REVENUE decreased $1.2 billion, or 13.2%, in the second quarter of
2004, and decreased $2.2 billion, or 12.1%, in the first half of 2004, compared
with the same periods in 2003. The decreases were primarily driven by continued
declines in stand-alone long distance voice revenue of approximately $1.1
billion in the second quarter of 2004, and $2.0 billion in the first half of
2004, compared with the same periods in 2003. These declines are reflective of
increased competition, which has led to lower prices and loss of market share, a
decline in business retail volumes, the impact of substitution, and consumer
migration to lower priced products and calling plans. The decline in stand-alone
long distance voice revenue was partially offset by strength in business
wholesale volumes. Total long distance voice volumes (including long distance
volumes sold as part of a bundled product) decreased approximately 4% for the
second quarter of 2004 and approximately 3% for the six months ended June 30,
2004, compared with the respective periods in 2003, primarily due to declines in
business retail and consumer long distance volumes, partially offset by growth
in lower-priced business wholesale. Also contributing to the revenue decline was
lower data services revenue of $0.2 billion in the second quarter of 2004, and
$0.4 billion in the six months ended June 30, 2004, compared with the respective
periods in 2003, resulting from pricing pressure coupled with competitive losses
and weak demand.

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 second
quarter of 2004, and $0.4 billion in the first half of 2004 compared with the
same periods in 2003, resulting from continued subscriber growth.

Revenue by segment is discussed in greater detail in the Segment Results
section.

20

OPERATING EXPENSES

Included within ACCESS AND OTHER CONNECTION EXPENSES are costs we pay to
connect calls using the facilities of other service providers, as well as the
Universal Service Fund contributions and per-line charges mandated by the FCC.
We pay domestic access charges to local exchange carriers to complete long
distance calls carried across the AT&T network and terminated on a local
exchange carrier's network. We also pay local connectivity charges for leasing
components of local exchange carrier networks in order to provide local service
to our customers. International connection charges paid to telephone companies
outside of the United States to connect international calls are also included
within access and other connection expenses. Universal Service Fund
contributions are charged to all telecommunications carriers by the FCC based on
a percentage of state-to-state and international services revenue to provide
affordable services to eligible customers. In addition, the FCC assesses charges
on a per-line basis. Since most of the Universal Service Fund contributions and
per-line charges are passed through to the customer, a reduction in these
expenses generally results in a corresponding reduction in revenue.

Access and other connection expenses decreased $0.2 billion, or 8.4%, in
the second quarter of 2004 and declined $0.3 billion, or 5.3%, for the first
half of 2004, compared with the same periods of 2003. Domestic access charges
declined $0.3 billion for the second quarter, primarily due to lower volumes,
lower Universal Service Fund contributions resulting from the decline in long
distance revenue, as well as changes in product mix (including whether calls are
interstate versus intrastate). Also contributing to the quarterly decline were
lower rates, including the impact of settlements, resulting in part from a
greater proportion of calls that have non-access incurring terminations (such as
when a call terminates over our own network or over a leased line), as well as
from rate negotiations and more efficient network usage. Domestic access charges
fell $0.5 billion for the year-to-date period, primarily due to changes in
product mix, lower rates and more efficient network usage, as well as lower
Universal Service Fund contributions and reduced volumes. The quarterly and
year-to-date declines in domestic access charges were partially offset by
increases in local connectivity costs of $0.1 billion for the quarter and $0.2
billion for the first half of 2004, primarily as a result of subscriber
increases due to new state entries and increased penetration into existing
states.

COSTS OF SERVICES AND PRODUCTS include the costs of operating and
maintaining our networks, the provision for uncollectible receivables and other
service-related costs, including cost of equipment sold.

Costs of services and products decreased $0.2 billion, or 10.2%, in the
second quarter of 2004 and declined $0.3 billion, or 8.7%, in the first six
months of 2004, compared with the comparable prior year periods. The declines
were primarily driven by the overall impact of lower revenue and related costs,
including cost cutting initiatives. Also contributing to the decline was a lower
provision for uncollectible receivables resulting from improved collections and
lower revenue. Partially offsetting this decline was the impact of a weak U.S.
dollar.

21

SELLING, GENERAL AND ADMINISTRATIVE (SG&A) EXPENSES decreased $0.1 billion,
or 4.1%, in the second quarter of 2004 and declined $0.3 million, or 6.7%, in
the first six months of 2004 compared with the comparable prior year periods.
The 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. These
declines were partially offset by increased advertising and marketing spending
on new initiatives, primarily on our Voice over Internet Protocol (VoIP)
offering.

DEPRECIATION AND AMORTIZATION EXPENSES increased $34 million, or 2.9%, in
the second quarter of 2004 and rose $0.1 billion, or 4.1%, in the first six
months of 2004 compared with same periods in 2003. These increases were
primarily due to a higher asset base, which includes a greater proportion of
shorter-lived assets. In addition, higher asset impairments during 2004
contributed to the increase in depreciation and amortization expenses. Capital
expenditures were $0.5 billion and $0.8 billion for the three months ended June
30, 2004 and 2003, respectively, and were $1.0 billion and $1.5 billion for the
six months ended June 30, 2004 and 2003, respectively. We continue to focus the
majority of our capital spending on our advanced services offerings of Internet
protocol and enhanced (IP&E) services and data services, both of which include
managed services, as well as business local voice services.

In the second quarter of 2004, NET RESTRUCTURING AND OTHER CHARGES of $54
million were primarily comprised of business restructuring obligations
associated with employee separations. This activity resulted from the continued
integration and automation of various functions within network operations, as
well as reorganizations throughout our non-U.S. operations. This exit plan
impacted about 625 employees (more than half of which were involuntary),
approximately 35% of whom were managers. Obligations in the amount of $52
million were recorded in AT&T Business Services and $2 million in the Corporate
and Other group.

Net restructuring and other charges of $267 million for the six months
ended June 30, 2004, were comprised of net business restructuring obligations of
$145 million and real estate impairment charges of $122 million. The business
restructuring activities consisted of $104 million of separation costs and $41
million of facility closing obligations. This exit plan impacted approximately
1,405 employees (the majority of which were involuntary) primarily within the
AT&T Business Services segment as a result of integration and automation of
various functions within network operations, as well as reorganizations
throughout our non-U.S. operations. Slightly less than half of the employees
associated with this exit plan were managers. About 75% of the affected
employees had left their positions as of June 30, 2004, with the remaining
anticipated to exit our business by the end of the third quarter of 2004. The
$41 million of facility closing reserves are associated with the consolidation
of our real estate portfolio and reflect the present value of contractual lease
obligations, net of estimated sublease income, associated with vacant facilities
resulting from workforce reductions and network equipment space that will not be
used by AT&T. These exit plans are not expected to yield cash savings (net of
severance benefit payouts) or a benefit to operating income (net of the
restructuring charge recorded) in 2004; however, we expect to realize roughly
$140 million of annual cash savings and benefit to operating income in
subsequent years, upon completion of the exit plans.

The real estate impairment charges of $122 million related to the decision
made during the first quarter of 2004 to divest five owned properties in an
effort to further reduce costs and consolidate our real estate portfolio. In
accordance with Statement of Financial Accounting Standards (SFAS) No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," an impairment
charge was recorded within the Corporate and Other group to reduce the book
value of the five properties to fair market value based on third party
assessments (including broker appraisals). Two of these properties were sold in
June 2004 and one additional property was sold in July 2004. We anticipate the
sales of the remaining properties will be completed by March 31, 2005. At June
30, 2004, these remaining properties were recorded as assets held-for-sale
within other current assets on the balance sheet.

Net restructuring and other charges for the three and six months ended June
30, 2003, were $66 million and $70 million, respectively. The year-to-date
charge primarily consisted of $66 million recorded in the second quarter, which
was comprised of $57 million of separation costs and $9 million of benefit plan

22

curtailment costs associated with our management realignment efforts (impacting
approximately 90 senior managers).

OPERATING INCOME decreased $0.7 billion, or 66.2%, in the second quarter of
2004 and declined $1.6 billion, or 71.4%, in the first half of 2004, compared
with the same periods in 2003. OPERATING MARGIN was 4.6% in the second quarter
of 2004 compared with 11.7% in the second quarter of 2003 and 4.0% in the first
half of 2004, compared with 12.3% in the first half of 2003. The margin declines
were primarily due to decreased revenue coupled with a slower rate of decline in
operating expenses. This reflected pricing pressures, substitution and a shift
from higher-margin business retail voice and data services and residential long
distance services to lower-margin services, including advanced services and
business wholesale. Higher net restructuring and other charges also contributed
to the year-to-date decline.

OTHER INCOME (EXPENSE), NET, in the second quarter of 2004 was $36 million
compared with $0.1 billion in the second quarter of 2003. The unfavorable
variance of $50 million was primarily due to lower investment related income and
lower net gains on sales of businesses and investments, primarily the sale of
Time Warner Telecom stock in the second quarter of 2003.

Other income (expense), net, in the first half of 2004 was expense of $0.1
billion compared with income of $0.1 billion in the first half of 2003. The
unfavorable variance can be primarily attributed to $0.3 billion of losses on
the early repurchase of long-term debt in the first half of 2004. In the first
half of 2003, debt was also early repurchased. However, a $0.2 billion loss
associated with the early retirement of long-term debt was offset by a $0.2
billion gain associated with the early retirement of exchangeable notes that
were indexed to AT&T Wireless common stock. Also, in 2004, investment related
income and net gains on sales of businesses and investments declined $0.1
billion, compared with the first half of 2003. Partially offsetting these
unfavorable variances was a $0.1 billion write-down in 2003 of the residual
value of certain aircraft as a result of financial difficulties in the airline
industry. Further contributing to the offset were settlements, in the first half
of 2004, associated with businesses previously disposed.

We continue to hold $0.6 billion of investments in leveraged leases,
including leases of commercial aircraft, which we lease to domestic airlines as
well as to aircraft related companies. Should the financial difficulties in the
U.S. airline industry lead to further bankruptcies or lease restructurings, we
could record additional losses associated with our aircraft lease portfolio. In
addition, in the event of bankruptcy or renegotiation of lease terms, if any
portion of the non-recourse debt is canceled, such amounts would result in
taxable income to AT&T and accordingly a cash tax expense.

INTEREST (EXPENSE) decreased 35.3%, or $0.1 billion, in the second quarter
of 2004 compared with the second quarter of 2003, and decreased 33.2%, or $0.2
billion, in the first half of 2004 compared with the first

23

half of 2003. The declines are reflective of our continuing deleveraging
activities, which included significant early debt redemptions in 2003 and 2004.

The EFFECTIVE TAX RATE is the provision for income taxes as a percentage of
income before income taxes. The effective tax rate in the second quarter of 2004
was negatively impacted by a catch-up effect resulting from an increase in the
estimated annual 2004 effective tax rate as a result of lower projected annual
income before income taxes relative to our estimated permanent differences.

The effective tax rate in the first half of 2004 was positively impacted by
513.7 percentage points due to the reversal of a portion of the valuation
allowance we recognized in 2002 attributable to the book and tax basis
difference related to our investment in AT&T Latin America. During February
2004, the subsidiaries of AT&T Latin America were sold to Telefonos de Mexico
S.A. de C.V., or Telmex, and the AT&T Latin America plan of liquidation became
effective. As a result, we no longer needed a portion of the valuation allowance
and recorded an income tax benefit of $0.4 billion in the first quarter of 2004.
As we continue to assess developments in our tax position, additional federal
tax benefits may be recorded for all or a portion of the remaining AT&T Latin
America tax benefit of $40 million not recognized. The effective tax rate in the
first half of 2003 was positively impacted by 2.4 percentage points due to the
recognition of tax benefits recorded in connection with the exchange and sale of
our remaining interest in AT&T Wireless common stock.

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.

SEGMENT RESULTS

Our results are segmented according to the customers we service: AT&T
Business Services and AT&T Consumer Services. The balance of our continuing
operations is included in a Corporate and Other group. This group primarily
reflects corporate staff functions and the elimination of transactions between
segments. The discussion of segment results includes revenue, operating income,
capital additions and total assets.

Operating income is the primary measure used by our chief operating
decision makers to measure our operating results and to measure segment
profitability and performance. See note 11 to our consolidated financial
statements for a reconciliation of segment results to consolidated results.

Total assets for each segment include all assets, except intercompany
receivables. Nearly all prepaid pension assets, taxes and corporate-owned or
leased real estate are held at the corporate level, and therefore are included
in the Corporate and Other group. Capital additions for each segment include
capital

24

expenditures for property, plant and equipment, additions to internal-use
software and additions to nonconsolidated investments.

Our existing segments reflect certain managerial changes that were
implemented during 2004. We transferred our remaining payphone business from
AT&T Consumer Services to AT&T Business Services.

Reflecting the dynamics of our business, we continuously review our
management model and structure, which may result in additional adjustments to
our operating segments in the future.

AT&T BUSINESS SERVICES

AT&T Business Services provides a variety of global communications services
to small and medium-sized businesses, large domestic and multinational
businesses and government agencies. These services include long distance,
international, toll-free and local voice, including wholesale transport services
(sales of services to service resellers), as well as data services and Internet
protocol and enhanced (IP&E) services, which includes the management of network
servers and applications. AT&T Business Services also provides outsourcing
solutions and other professional services.

- ---------------

(1) Revenue includes equipment and product sales of $64 million and $70 million
for the three months ended June 30, 2004 and 2003, respectively, and $138
and $140 for the six months ended June 30, 2004 and 2003, respectively.

(2) Prior to June 30, 2004, data services revenue included all international
managed services. Effective June 30, 2004, international managed services
revenue was divided into data services and IP&E services, consistent with
the classifications of domestic managed services. As a result, data services
revenue and IP&E services revenue for prior periods have been restated to
reflect this reclassification. Such reclassification had no impact on total
data and IP&E services revenue, or total revenue. Adjusted for this
reclassification, data services revenue for the three months ended March 31,
2004, December 31, 2003, September 30, 2003 and March 31, 2003, was $1,715
million, $1,847 million, $1,874 million and $1,956 million, respectively;
and IP&E services revenue for the same periods was $553 million, $554
million, $550 million and $489 million, respectively.

25

REVENUE

AT&T Business Services revenue decreased $0.8 billion, or 12.7%, in the
second quarter of 2004 and $1.4 billion, or 10.9%, in the first half of 2004,
compared with the same prior year periods.

Long distance voice revenue in the second quarter of 2004 declined $0.5
billion, or 17.6%, and declined $0.9 billion, or 15.0%, in the first half of
2004, compared with the same prior year periods. The declines were driven by a
decrease in the average price per minute in both the retail and wholesale
businesses combined with a decline in retail volumes, primarily due to the
impacts of competition and substitution. Partially offsetting these declines was
an increase in lower-priced wholesale minutes. Total long distance volumes were
flat in the second quarter of 2004 and grew about 1% in the first half of 2004,
compared with the same prior year periods.

Data services revenue for the second quarter of 2004 declined 13.0%, or
$0.3 billion, compared with the second quarter of 2003, and declined 12.7%, or
$0.5 billion, for the six months ended June 30, 2004, compared with the six
months ended June 30, 2003. These declines were primarily driven by competitive
pricing pressure and weak demand, primarily in bandwidth and packet services.
The decrease is reflective of a rise in cancellations of private line and packet
services, as customers continue to evaluate the overall efficiency and
effectiveness of their own networks (network grooming), combined with the
migration to more cost-effective and technologically advanced IP&E services.
Excluding equipment and product sales, data services revenue declined 13.3% in
the second quarter of 2004 and decreased 12.9% in the six months ended June 30,
2004, compared with the comparable prior year periods.

Outsourcing, professional and other services revenue decreased $0.1
billion, or 18.9%, in the second quarter of 2004 compared with the second
quarter of 2003. For the six months ended June 30, 2004, outsourcing,
professional and other services revenue decreased $0.2 billion, or 16.2%,
compared with the six months ended June 30, 2003. The decrease in both periods
was due to contract terminations and renegotiations. Excluding equipment and
product sales, outsourcing, professional and other services revenue declined
19.2% in the second quarter of 2004, and decreased 16.7% in the six months ended
June 30, 2004, compared with the comparable prior year periods.

IP&E services revenue increased $56 million, or 11.3%, in the second
quarter of 2004, and increased $0.1 billion, or 12.2%, in the six months ended
June 30, 2004, compared with the same prior year periods. The increase was
primarily attributable to growth in our customer base associated with advanced
products such as IP-enabled frame and E-VPN (Enhanced Virtual Private Network).
Excluding equipment and product sales, IP&E services revenue increased 13.6% in
the second quarter of 2004 compared with the second quarter of 2003, and
increased 12.5% in the six months ended June 30, 2004, compared with the six
months ended June 2003.

Local voice services revenue grew $20 million, or 5.0% in the second
quarter of 2004, and grew $0.1 billion, or 10.1%, in the six months ended June
30, 2004, compared with the same prior year periods. This growth reflects our
continued focus on increasing the utilization of our existing footprint
including growth of our "All-in-One" bundled offer to small businesses. There
were over 4.6 million access lines in service at June 30, 2004, an increase of
more than 85,000 since the end of the first quarter of 2004.

OPERATING INCOME

Operating income declined $0.4 billion, or 74.7%, in the second quarter of
2004, compared with the second quarter of 2003, and declined $1.0 billion, or
80.4%, in the six months ended June 30, 2004, compared with the six months ended
June 30, 2003. These declines were primarily due to decreases in the long
distance voice and data businesses resulting from the impacts of competition,
which led to pricing pressures and declining retail volumes, and substitution.
Partially offsetting these declines were ongoing cost control efforts.

Operating margin decreased to 2.7% in the second quarter of 2004, and to
2.0% for the first half of 2004, from 9.3% in both the second quarter and first
half of 2003. The downward margin trend is primarily reflective of the declining
higher-margin long distance retail voice and data businesses, coupled with the
shift to lower-margin advanced services and wholesale services.

26

Operating margin of 2.7% in the second quarter of 2004 increased 1.3
percentage points, compared with a margin of 1.4% in the first quarter of 2004,
reflecting favorable access expense settlements in the second quarter of 2004.
As competitive pricing pressures are expected to continue throughout the year,
this favorable margin trend is not expected to continue in the second half of
2004.

OTHER ITEMS

Capital additions were $0.5 billion in the second quarter of 2004, and were
$1.0 billion for the six months ended June 30, 2004. We continue to concentrate
the majority of capital spending on our advanced services offerings of IP&E
services and data services, both of which include managed services, as well as
local services.

Total assets declined $1.7 billion, or 5.1%, at June 30, 2004, from
December 31, 2003, primarily driven by lower net property, plant and equipment,
as a result of depreciation during the period, partially offset by capital
expenditures. This decline was also attributable to lower accounts receivable
driven by lower revenue and improved cash collections.

AT&T CONSUMER SERVICES

AT&T Consumer Services provides a variety of communication services to
residential customers. These services include traditional long distance voice
services such as domestic and international dial services (long distance or
local toll calls where the number "1" is dialed before the call) and calling
card services. Transaction services, such as prepaid card and operator-assisted
calls, are also offered. Collectively, these represent stand-alone long distance
services and are not offered in conjunction with any other service. In addition,
AT&T Consumer Services provides dial-up Internet services and all distance
services, which bundle long distance, local and local toll.

REVENUE

AT&T Consumer Services revenue declined $0.3 billion, or 14.6%, in the
second quarter of 2004 and declined $0.7 billion, or 15.4%, in the first half of
2004, compared with the same prior year periods. The decline in both periods was
primarily due to stand-alone long distance voice services, which decreased $0.6
billion to $1.3 billion in the second quarter of 2004 and decreased $1.2 billion
to $2.7 billion in the first half of 2004, largely due to the impact of ongoing
competition, which has led to a loss of market share, and substitution. In
addition, stand-alone long distance voice services have been negatively impacted
by the continued migration of customers to lower priced optional calling plans
and other products offered by AT&T, such as bundled services. Partially
offsetting the declines in stand-alone long distance voice services were pricing
actions we implemented, including a monthly fee that we began billing in
mid-2003 to recover costs, such as certain access charges and property taxes,
and targeted price increases during 2004. Partially offsetting

27

the overall revenue decline was an increase in bundled revenue. Bundled revenue
rose $0.2 billion to $0.7 billion in the second quarter of 2004, and rose $0.4
billion to $1.3 billion in the first half of 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. The increase
in bundled revenue includes amounts previously incorporated in stand-alone long
distance voice revenue for existing customers that migrated to bundled offers.

Total long distance calling volumes (including long distance volumes sold
as part of a bundle) declined approximately 18% in the second quarter of 2004,
and approximately 19% in the first half of 2004, compared with the same prior
year periods, as a result of competition and wireless and Internet substitution.

We provided stand-alone long distance voice services to more than 24.5
million customers at June 30, 2004, compared with more than 30.3 million
customers at December 31, 2003. We provided local service to more than 4.6
million customers as of June 30, 2004, compared with more than 3.9 million
customers as of December 31, 2003.

As a result of recent changes in regulatory policy governing local
telephone service, we announced that we will be shifting our focus away from
traditional consumer services, such as wireline residential telephone services,
and we will no longer invest to acquire new residential local and stand-alone
long distance customers. We will continue to provide our existing customers with
quality service.

OPERATING INCOME

Operating income declined $0.2 billion, or 50.6%, in the second quarter of
2004 and declined $0.5 billion, or 45.4%, in the six months ended June 30, 2004,
compared with the same periods in 2003. Operating margin declined to 11.9% in
the second quarter of 2004 from 20.6% in the second quarter of 2003, and
declined to 14.8% for the first half of 2004 from 23.0% for the first half of
2003. The margin declines were largely driven by lower margins within our
stand-alone long distance voice business, primarily due to declines in revenue
coupled with a lower rate of decline in operating expenses, particularly within
selling, general and administrative expenses. Partially offsetting the declines
in stand-alone long distance margins were pricing actions taken. In addition,
operating margins declined due to increased spending on new initiatives,
including our Voice over Internet Protocol (VoIP) offering.

OTHER ITEMS

Total assets declined $0.2 billion at June 30, 2004, from December 31,
2003. The decline was primarily due to lower accounts receivable, reflecting
lower revenue and improved cash collections.

CORPORATE AND OTHER

This group primarily reflects the results of corporate staff functions,
brand licensing fee revenue and the elimination of transactions between
segments.

28

OPERATING (LOSS)

Operating (loss) decreased $13 million to $44 million for the quarter ended
June 30, 2004, and increased $0.1 billion to $0.2 billion in the first half of
2004, compared with the same periods in 2003. The $0.1 billion increase in
operating (loss) for the year-to-date period was primarily due to a real estate
impairment charge recorded in the first quarter of 2004 to write-down
held-for-sale facilities, some of which were sold during the second quarter of
2004.

OTHER ITEMS

Total assets decreased $2.3 billion to $10.5 billion at June 30, 2004, from
December 31, 2003. This decrease was primarily driven by a lower cash balance of
$1.9 billion at June 30, 2004, primarily resulting from debt repurchases and
scheduled repayments made in the first half of 2004.

FINANCIAL CONDITION

TOTAL ASSETS decreased $4.2 billion, or 8.7%, to $43.8 billion at June 30,
2004, compared with December 31, 2003. This decrease was largely driven by a
$1.9 billion decrease in cash and cash equivalents. Property, plant and
equipment declined $1.5 billion primarily as a result of depreciation during the
period coupled with a real estate impairment charge, partially offset by capital
expenditures. Exclusive of a $0.7 billion reclassification of restricted cash
and hedge receivable to other current assets relating to debt maturing in 2005,
other assets declined $0.6 billion primarily due to the settlement of a foreign
currency swap associated with the Euro debt repurchase in the first quarter of
2004. Accounts receivable declined $0.4 billion driven by lower revenue and
improved cash collections. These declines were partially offset by a deferred
income tax benefit of $0.4 billion recorded in the first quarter of 2004 in
conjunction with the reversal of a portion of the valuation allowance
attributable to our prior investment in AT&T Latin America.

TOTAL LIABILITIES decreased $4.3 billion, or 12.5%, to $29.8 billion at
June 30, 2004, compared with December 31, 2003. This decrease was primarily the
result of $3.2 billion in lower debt balances, reflecting the early retirement
of $2.1 billion face value of debt and $0.4 billion of associated mark-to-market
adjustments, coupled with scheduled repayments of debt amounting to $0.6
billion. Accounts payable and accrued expenses declined $0.3 billion as payments
were made against year-end capital and other accruals. Also contributing to the
decline were lower short-term compensation and benefit-related liabilities of
$0.3 billion primarily attributable to the payment of year-end bonus and salary
accruals and employee separation reserves. Additionally, other current
liabilities declined $0.2 billion primarily due to a decline in income taxes
payable.

TOTAL SHAREOWNERS' EQUITY increased $0.1 billion, or 0.7%, to $14.1 billion
at June 30, 2004, compared with December 31, 2003. This increase was primarily
due to net income, partially offset by dividends declared.

29

LIQUIDITY

Net cash provided by operating activities of $2.5 billion for the six
months ended June 30, 2004, declined $1.9 billion, from $4.4 billion in the
comparable prior year period, which was in part driven by a decrease in
operating income reflective of the declining stand-alone long distance voice and
data businesses. The downward trend in cash generated by operating activities
was also impacted by a $0.7 billion decline in income tax refunds received in
the first half of 2004 compared with the same prior year period.

AT&T's investing activities resulted in a net use of cash of $0.9 billion
in the six months ended June 30, 2004, compared with $1.7 billion in the first
six months of 2003, primarily reflecting a reduction in capital expenditures.

During the first half of 2004, net cash used in financing activities was
$3.4 billion, compared with $5.4 billion in the first half of 2003. In the first
half of 2004, we made net payments of $3.4 billion to reduce debt (including
redemption premiums and foreign currency mark-to-market payments), primarily
reflecting the early termination of debt, and paid dividends of $0.4 billion.
Reflected as an other financing item was the receipt of approximately $0.4
billion for the settlement of a combined interest rate foreign currency swap
agreement in conjunction with the early repayment of Euro notes in the first
half of 2004 (such repayment is included as retirement of long-term debt).
During the first half of 2003, we made net payments of $5.3 billion to reduce
debt, including the early termination of debt, paid dividends of $0.3 billion
and received $0.1 billion of cash collateral related to favorable positions of
certain combined interest rate foreign currency swap agreements.

WORKING CAPITAL AND OTHER SOURCES OF LIQUIDITY

At June 30, 2004, our working capital ratio (current assets divided by
current liabilities) was 0.99.

At June 30, 2004, we had a $2.0 billion syndicated 364-day credit facility
available to us that was entered into on October 8, 2003. This credit facility
provides the option to extend the maturity of any borrowings outstanding under
the facility for an additional 364-day period beyond October 7, 2004. No
borrowings are currently outstanding under the facility. Up to $0.3 billion of
the facility can be utilized to support letters of credit, which reduces the
amount available. As of June 30, 2004, approximately $0.2 billion of letters of
credit were supported by the facility. No assurance can be given that the
facility will be renewed and if the facility is renewed it may be for a
substantially lesser amount and/or on substantially less favorable terms. If the
facility is not renewed, we would expect to be required to post cash collateral
to support the letters of credit previously supported by the facility.

In July 2004, we renewed our AT&T Business Services and AT&T Consumer
Services 364-day customer accounts receivable securitization facilities.
Together the programs provide up to $1.35 billion of available financing,
limited by eligible receivables balances, which vary month to month. Proceeds
from the securitizations are recorded as borrowings and included in short-term
debt. At June 30, 2004, approximately $0.2 billion was outstanding.

The credit facility and the securitization facilities contain a financial
covenant that requires AT&T to meet a debt-to-EBITDA ratio (as defined in the
agreements) not exceeding 2.25 to 1 and an EBITDA-to-net

30

interest expense ratio (as defined in the agreements) of at least 3.50 to 1 for
four consecutive quarters ending on the last day of each fiscal quarter. At June
30, 2004, we were in compliance with these covenants.

We anticipate continuing to fund our operations in 2004 primarily with cash
and cash equivalents on hand, as well as with cash from operations. If economic
conditions worsen or do not improve and/or competition and product substitution
accelerate beyond current expectations, our cash flows from operations would
decrease, negatively impacting our liquidity. However, we believe our access to
the capital markets is adequate to provide the flexibility we desire in funding
our operations. Sources of liquidity, in addition to our substantial cash and
cash equivalents on hand, include $2.4 billion remaining under a universal shelf
registration; a $1.35 billion securitization program (limited by eligible
receivables); and a $2.0 billion credit facility, which expires on October 6,
2004. In light of recent lowering of our commercial paper ratings discussed
below, there is no longer any assurance that we will continue to have any
significant access to the commercial paper market. The maximum amount of
commercial paper outstanding during the first half of 2004 was approximately
$1.0 billion. 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.

CREDIT RATINGS AND RELATED DEBT IMPLICATIONS

Since the end of the second quarter, AT&T's long-term and short-term and
commercial paper credit ratings have been lowered by Standard & Poor's (S&P),
Moody's and Fitch, as reflected in the table below. The rating actions by S&P
and Moody's triggered a 100 basis point interest rate step-up on approximately
$6.5 billion in notional amount of debt net of foreign currency hedge offsets.
This step-up is effective for interest payment periods that will begin after
November 2004, resulting in an expected increase in interest expense of
approximately $10 million in 2004 and $70 million in 2005. Currently, none of
AT&T's ratings are under review or on CreditWatch for further downgrade.

Our access to capital markets as well as the cost of our borrowings are
affected by our debt ratings. The recent rating actions discussed above and
further debt rating downgrades will require us to pay higher rates on certain
existing debt and have required us to post cash collateral for certain
interest-rate swaps in which we were in a net payable position. Further
downgrades may require us to post collateral for certain equity swaps.

Additionally, if our debt ratings are further downgraded, our access to the
capital markets may be further restricted and/or such replacement financing may
be more costly or have additional covenants than we had in connection with our
debt at June 30, 2004. In addition, the market environment for financing in
general, and within the telecommunications sector in particular has been
adversely affected by economic conditions and bankruptcies of other
telecommunications providers.

AT&T Corp. is generally the obligor for debt issuances. However, there are
some instances where AT&T Corp. is not the obligor, for example, the
securitization facilities and certain capital leases. The total debt of these
entities, which are fully consolidated, is approximately $0.3 billion at June
30, 2004, and is included within short-term and long-term debt.

CASH REQUIREMENTS

Our cash needs for 2004 will be primarily related to capital expenditures,
repayment of debt and payment of dividends. We expect our capital expenditures
for 2004 to be approximately $1.8 billion.

In the first half of 2004, we completed the repurchase, for cash, of $1.2
billion of our $1.5 billion outstanding 6.5% Notes maturing in November 2006,
which carried an interest rate of 7.25% at the time of retirement. Also, we
repurchased, for cash, $0.9 billion of our outstanding $1.8 billion 6.0% Euro
Notes due

31

November 2006, which carried an interest rate of 6.75% at the time of
retirement. The $0.9 billion Euro denominated notes represents the original U.S.
dollar issuance amount and excludes the foreign currency mark-to-market
adjustments that were hedged. These redemptions are part of our plan, as
announced in January 2004, to repurchase up to $3.0 billion of debt, which may
take the form of calls, tender offers or open market transactions and is
expected to be completed subject to market conditions during 2004. The
transactions completed during the first half of 2004 are expected to save
approximately $0.1 billion in interest expense in 2004.

CONTRACTUAL CASH OBLIGATIONS

We have contractual obligations to purchase certain goods or services from
various other parties. During the first half of 2004, we entered into contracts
under which we are legally obligated for payment of approximately $70 million in
2004. Also during the first half of 2004, we entered into contracts under which
we have calculated the minimum obligation for such agreements based on
termination fees that can be paid to exit the contract. Further, during this
period, we exited certain contracts that contained termination fees that were
renegotiated and not paid. The net effect of this activity on termination fees,
which are considered to be the minimum obligation under the contracts, in each
year would be an increase of approximately $83 million in 2004, $76 million in
2005, $64 million in 2006, $98 million in 2007, $88 million in 2008, or $50
million in 2009 and beyond.

OTHER COMMERCIAL COMMITMENTS

AT&T provided a guarantee of an obligation that AT&T Wireless has to NTT
DoCoMo. Under this guarantee, AT&T would have been secondarily liable for up to
$3.65 billion, plus accrued interest, in the event AT&T Wireless was unable to
satisfy its entire obligation to NTT DoCoMo. AT&T's guarantee expired on June
30, 2004, in accordance with the terms of the original agreement.

RISK MANAGEMENT

We are exposed to market risk from changes in interest and foreign exchange
rates, as well as changes in equity prices associated with previously affiliated
companies. In addition, we are exposed to market risk from fluctuations in
prices of securities. On a limited basis, we use certain derivative financial
instruments, including interest rate swaps, foreign exchange contracts, combined
interest rate foreign currency contracts, options, forwards, equity hedges and
other derivative contracts, to manage these risks. We do not use financial
instruments for trading or speculative purposes. All financial instruments are
used in accordance with board-approved policies.

NEW ACCOUNTING PRONOUNCEMENTS

On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the Act) was signed into law. The Act introduces a
prescription drug benefit under Medicare (Medicare Part D) as well as a federal
subsidy to sponsors of retiree health care benefit plans that provide a benefit
that is at least actuarially equivalent to Medicare Part D. We are impacted by
the Act since we sponsor postretirement health care plans that provide
prescription drug benefits. We have elected to defer recognition of the Act in
accordance with Financial Accounting Standards Board (FASB) Staff Position
("FSP") No. FAS 106-1, "Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act of 2003." As a
result, any measures of the accumulated postretirement benefit obligation or net
periodic postretirement benefit cost do not reflect the effects of the Act on
the plans.

On May 19, 2004, the FASB issued FSP No. FAS 106-2, "Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003." This Staff Position supersedes FSP No. FAS 106-1
and provides guidance on accounting for the effects of the new Medicare
prescription drug legislation by employers whose prescription drug benefits are
actuarially equivalent to the drug benefit under Medicare Part D. The provisions
of FSP No. FAS 106-2 are effective for the first interim or annual period
beginning after June 15, 2004, and accordingly, we plan to adopt them effective

32

July 1, 2004. The FSP provides two alternative methods of transition, either
retroactive application to the date of enactment or, the method we have
selected, prospective application from the date of adoption.

Federal regulations for determining actuarial equivalence have not yet been
issued in either proposed or final form, which impacts our ability to estimate
the full adoption effects of the FSP. Despite the lack of final federal
regulations, we believe that the prescription drug benefits provided to a
specific portion of our postretirement benefit plan participants would be deemed
to be actuarially equivalent to Medicare Part D benefits based on the benefits
provided under the plan. The estimated impact upon adoption for this group will
be a reduction in the accumulated postretirement benefit obligation of
approximately $150 million to $175 million, which will be amortized to income
over time as an actuarial gain. In addition, we will realize a reduction in net
periodic postretirement benefit cost (recorded within SG&A and costs of services
and products) of approximately $10 million over the second half of 2004. Without
a firm definition of actuarial equivalence, we are unable to determine if the
prescription drug benefits provided to the remaining plan participants are
actuarially equivalent to Medicare Part D benefits and are therefore unable to
quantify any potential impact at this time.

SUBSEQUENT EVENTS

On July 22, 2004, we announced that as a result of recent changes in
regulatory policy governing local telephone service, we will be shifting our
focus away from traditional consumer services, and we will no longer be
investing to acquire new residential local and stand-alone long distance
customers. We plan to concentrate our investments going forward on business
markets and emerging technologies.

In July 2004, Moody's and Fitch lowered our long-term credit ratings to Ba1
and BB+, respectively, and lowered our short-term credit and commercial paper
ratings to NP (not prime) and B, respectively. In August 2004, S&P lowered our
long-term credit rating to BB+ and lowered our short-term credit and commercial
paper rating to B. The rating actions by Moody's and S&P triggered a 100 basis
point interest rate step-up on approximately $6.5 billion in notional amount of
debt net of foreign currency hedge offsets. This step-up is effective for
interest payment periods that will begin after November 2004, resulting in an
expected increase in interest expense of approximately $10 million in 2004 and
$70 million in 2005.

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, of the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Exchange Act Rules 13a-15 or 15d-15. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures are effective in alerting
them timely to material information required to be included in our Exchange Act
filings. There have not been any changes in our internal controls over financial
reporting identified in connection with the evaluation required by Exchange Act
Rules 13a-15 or l5d-15 or otherwise that occurred during our last fiscal quarter
that has materially affected, or is reasonably likely to materially affect, our
internal controls over financial reporting.

33

PART II -- OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Refer to Part 1, Footnote 10, "Commitments and Contingencies" for
discussion of certain legal proceedings.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS AND ISSUER PURCHASES OF
EQUITY SECURITIES

The following table contains information about our purchases of our equity
securities during the second quarter of 2004.

ISSUER PURCHASES OF EQUITY SECURITIES

- ---------------

(1) Represents restricted stock units redeemed to pay taxes related to the
vesting of restricted stock units awarded under employee benefit plans.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS

(a) The annual meeting of the shareholders of the registrant was held on
May 19, 2004.

(b) Election of Directors

34

(c) Holders of common shares voted at this meeting on the following
matters, which were set forth in the registrant's proxy statement dated March
25, 2004.

(i) Ratification of Auditors

(ii) Shareholders' Proposals

- ---------------

(*) Percentages are based on the total common shares voted. Approval of this
proposal required a majority of the votes.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits:

(b) Reports on Forms 8-K:

During the second quarter of 2004, the following Forms 8-K were filed
and/or furnished: Form 8-K dated April 22, 2004, was filed pursuant to Item 5
(Other Events and Regulation FD disclosure) Item 7 (Financial Statements, Pro
Forma Financial Information and Exhibits) and Item 12 (Results of Operations and
Financial Condition) on April 26, 2004.

36

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

AT&T CORP.

By: /s/ C. R. REIDY
------------------------------------
Christopher R. Reidy
Vice President and Controller

Date: August 3, 2004

37

EXHIBIT INDEX