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EX-12 - COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES - AT&T INC.ex12.htm
EX-32 - SECTION 1350 CERTIFICATIONS - AT&T INC.ex32.htm
EX-31.2 - CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER - AT&T INC.ex31_2.htm
EX-31.1 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER - AT&T INC.ex31_1.htm
EX-10.B - AGREEMENT BETWEEN JAMES CICCONI AND AT&T INC. - AT&T INC.ex10_b.htm
EX-10.A - AT&T HEALTH PLAN - AT&T INC.ex10_a.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
                                                       
(Mark One)
 
x
 
 
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2016
 
or
 
 
 
o
 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 1-8610

AT&T INC.

Incorporated under the laws of the State of Delaware
I.R.S. Employer Identification Number 43-1301883

208 S. Akard St., Dallas, Texas 75202
Telephone Number: (210) 821-4105


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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
                                                                                                                                                               Yes [X]   No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of "accelerated filer," "large accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer
[X]
 
Accelerated filer
[   ]
Non-accelerated filer
[   ]
(Do not check if a smaller reporting company)
Smaller reporting company
[   ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
                                                                                                                                                                            Yes [   ]   No [X]
 
At October 31, 2016 there were 6,141 million common shares outstanding.

 
PART I - FINANCIAL INFORMATION
Item 1.  Financial Statements
 
AT&T INC.
 
CONSOLIDATED STATEMENTS OF INCOME
 
Dollars in millions except per share amounts
 
(Unaudited)
 
   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
                         
Operating Revenues
                       
Service
 
$
37,272
   
$
35,539
   
$
111,515
   
$
94,042
 
Equipment
   
3,618
     
3,552
     
10,430
     
10,640
 
Total operating revenues
   
40,890
     
39,091
     
121,945
     
104,682
 
                                 
Operating Expenses
                               
Cost of services and sales
                               
   Equipment
   
4,455
     
4,501
     
13,090
     
13,400
 
   Broadcast, programming and operations
   
4,909
     
4,081
     
14,239
     
6,351
 
   Other cost of services (exclusive of depreciation and
         amortization shown separately below)
   
9,526
     
9,214
     
28,436
     
27,604
 
Selling, general and administrative
   
9,013
     
9,107
     
26,363
     
24,535
 
Depreciation and amortization
   
6,579
     
6,265
     
19,718
     
15,539
 
Total operating expenses
   
34,482
     
33,168
     
101,846
     
87,429
 
Operating Income
   
6,408
     
5,923
     
20,099
     
17,253
 
Other Income (Expense)
                               
Interest expense
   
(1,224
)
   
(1,146
)
   
(3,689
)
   
(2,977
)
Equity in net income of affiliates
   
16
     
15
     
57
     
48
 
Other income (expense) – net
   
(7
)
   
(57
)
   
154
     
61
 
Total other income (expense)
   
(1,215
)
   
(1,188
)
   
(3,478
)
   
(2,868
)
Income Before Income Taxes
   
5,193
     
4,735
     
16,621
     
14,385
 
Income tax expense
   
1,775
     
1,657
     
5,803
     
4,784
 
Net Income
   
3,418
     
3,078
     
10,818
     
9,601
 
Less: Net Income Attributable to Noncontrolling Interest
   
(90
)
   
(84
)
   
(279
)
   
(262
)
Net Income Attributable to AT&T
 
$
3,328
   
$
2,994
   
$
10,539
   
$
9,339
 
Basic Earnings Per Share Attributable to AT&T
 
$
0.54
   
$
0.50
   
$
1.70
   
$
1.71
 
Diluted Earnings Per Share Attributable to AT&T
 
$
0.54
   
$
0.50
   
$
1.70
   
$
1.71
 
Weighted Average Number of Common Shares
                               
   Outstanding – Basic (in millions)
   
6,168
     
5,924
     
6,171
     
5,447
 
Weighted Average Number of Common Shares
                               
   Outstanding with Dilution (in millions)
   
6,189
     
5,943
     
6,191
     
5,463
 
Dividends Declared Per Common Share
 
$
0.48
   
$
0.47
   
$
1.44
   
$
1.41
 
See Notes to Consolidated Financial Statements.
                               
 
2

 
AT&T INC.
                       
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
                   
Dollars in millions
                       
(Unaudited)
                       
   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
                                 
Net income
 
$
3,418
   
$
3,078
   
$
10,818
   
$
9,601
 
Other comprehensive income (loss), net of tax:
                               
    Foreign Currency:
                               
        Foreign currency translation adjustment (includes $21,
            $(20), $21 and $(20) attributable to noncontrolling
            interest), net of taxes of $(91), $(535), $35 and $(638)
   
(225
)
   
(1,039
)
   
(51
)
   
(1,224
)
    Available-for-sale securities:
                               
        Net unrealized gains (losses), net of taxes of $28, $(49), $15
            and $(30)
   
46
     
(85
)
   
25
     
(51
)
        Reclassification adjustment included in net income, net of
            taxes of $(3), $2, $(3), and $(3)
   
(5
)
   
3
     
(5
)
   
(6
)
     Cash flow hedges:
                               
        Net unrealized gains (losses), net of taxes of $240, $(237),
            $99 and $(479)
   
446
     
(441
)
   
183
     
(890
)
        Reclassification adjustment included in net income, net of
            taxes of $5, $6, $15 and $15
   
10
     
11
     
29
     
28
 
     Defined benefit postretirement plans:
                               
        Amortization of net prior service credit included in net
            income, net of taxes of $(131), $(131), $(393) and $(393)
   
(215
)
   
(215
)
   
(644
)
   
(644
)
Other comprehensive income (loss)
   
57
     
(1,766
)
   
(463
)
   
(2,787
)
Total comprehensive income
   
3,475
     
1,312
     
10,355
     
6,814
 
Less: Total comprehensive income attributable to
            noncontrolling interest
   
(111
)
   
(64
)
   
(300
)
   
(242
)
Total Comprehensive Income Attributable to AT&T
 
$
3,364
   
$
1,248
   
$
10,055
   
$
6,572
 
See Notes to Consolidated Financial Statements.
                               
 
3

 
AT&T INC.
 
CONSOLIDATED BALANCE SHEETS
 
Dollars in millions except per share amounts
 
   
September 30,
   
December 31,
 
   
2016
   
2015
 
Assets
 
(Unaudited)
       
Current Assets
           
Cash and cash equivalents
 
$
5,895
   
$
5,121
 
Accounts receivable - net of allowances for doubtful accounts of $650 and $704
   
16,855
     
16,532
 
Prepaid expenses
   
1,333
     
1,072
 
Other current assets
   
13,291
     
13,267
 
Total current assets
   
37,374
     
35,992
 
Property, plant and equipment
   
316,261
     
306,227
 
   Less: accumulated depreciation and amortization
   
(192,339
)
   
(181,777
)
Property, Plant and Equipment – Net
   
123,922
     
124,450
 
Goodwill
   
105,271
     
104,568
 
Licenses
   
94,241
     
93,093
 
Customer Lists and Relationships – Net
   
15,227
     
18,208
 
Other Intangible Assets – Net
   
8,734
     
9,409
 
Investments in Equity Affiliates
   
1,679
     
1,606
 
Other Assets
   
16,527
     
15,346
 
Total Assets
 
$
402,975
   
$
402,672
 
                 
Liabilities and Stockholders' Equity
               
Current Liabilities
               
Debt maturing within one year
 
$
7,982
   
$
7,636
 
Accounts payable and accrued liabilities
   
28,849
     
30,372
 
Advanced billing and customer deposits
   
4,637
     
4,682
 
Accrued taxes
   
2,686
     
2,176
 
Dividends payable
   
2,948
     
2,950
 
Total current liabilities
   
47,102
     
47,816
 
Long-Term Debt
   
117,239
     
118,515
 
Deferred Credits and Other Noncurrent Liabilities
               
Deferred income taxes
   
59,649
     
56,181
 
Postemployment benefit obligation
   
33,483
     
34,262
 
Other noncurrent liabilities
   
20,899
     
22,258
 
Total deferred credits and other noncurrent liabilities
   
114,031
     
112,701
 
                 
Stockholders' Equity
               
Common stock ($1 par value, 14,000,000,000 authorized at September 30, 2016 and
               
   December 31, 2015: issued 6,495,231,088 at September 30, 2016 and December 31, 2015)
   
6,495
     
6,495
 
Additional paid-in capital
   
89,536
     
89,763
 
Retained earnings
   
35,319
     
33,671
 
Treasury stock (354,467,711 at September 30, 2016 and 350,291,239
               
   at December 31, 2015, at cost)
   
(12,589
)
   
(12,592
)
Accumulated other comprehensive income
   
4,850
     
5,334
 
Noncontrolling interest
   
992
     
969
 
Total stockholders' equity
   
124,603
     
123,640
 
Total Liabilities and Stockholders' Equity
 
$
402,975
   
$
402,672
 
See Notes to Consolidated Financial Statements.
               
 
4

 
AT&T INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Dollars in millions
 
(Unaudited)
           
   
Nine months ended
 
   
September 30,
 
   
2016
   
2015
 
Operating Activities
           
Net income
 
$
10,818
   
$
9,601
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
   Depreciation and amortization
   
19,718
     
15,539
 
   Undistributed earnings from investments in equity affiliates
   
(22
)
   
(36
)
   Provision for uncollectible accounts
   
1,036
     
895
 
   Deferred income tax expense
   
3,011
     
1,539
 
   Net gain from sale of investments, net of impairments
   
(88
)
   
(46
)
Changes in operating assets and liabilities:
               
   Accounts receivable
   
(1,108
)
   
737
 
   Other current assets
   
1,805
     
546
 
   Accounts payable and accrued liabilities
   
(1,173
)
   
1,332
 
   Equipment installment receivables and related sales
   
207
     
(1,682
)
   Deferred fulfillment costs
   
(1,883
)
   
(884
)
Retirement benefit funding
   
(770
)
   
(595
)
Other - net
   
(2,349
)
   
(251
)
Total adjustments
   
18,384
     
17,094
 
Net Cash Provided by Operating Activities
   
29,202
     
26,695
 
                 
Investing Activities
               
Capital expenditures:
               
   Purchase of property and equipment
   
(15,283
)
   
(13,356
)
   Interest during construction
   
(669
)
   
(566
)
Acquisitions, net of cash acquired
   
(2,922
)
   
(30,694
)
Dispositions
   
184
     
79
 
Sale of securities, net
   
501
     
1,490
 
Net Cash Used in Investing Activities
   
(18,189
)
   
(43,047
)
                 
Financing Activities
               
Net change in short-term borrowings with original maturities of three months or less
   
-
     
(1
)
Issuance of long-term debt
   
10,140
     
33,967
 
Repayment of long-term debt
   
(10,688
)
   
(9,962
)
Purchase of treasury stock
   
(444
)
   
-
 
Issuance of treasury stock
   
137
     
133
 
Dividends paid
   
(8,850
)
   
(7,311
)
Other
   
(534
)
   
(2,875
)
Net Cash (Used in) Provided by Financing Activities
   
(10,239
)
   
13,951
 
Net increase (decrease) in cash and cash equivalents
   
774
     
(2,401
)
Cash and cash equivalents beginning of year
   
5,121
     
8,603
 
Cash and Cash Equivalents End of Period
 
$
5,895
   
$
6,202
 
Cash paid during the nine months ended September 30 for:
               
   Interest
 
$
4,430
   
$
3,462
 
   Income taxes, net of refunds
 
$
3,166
   
$
873
 
See Notes to Consolidated Financial Statements.
 
 
5

AT&T INC.
 
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
 
Dollars and shares in millions except per share amounts
 
(Unaudited)
 
   
September 30, 2016
 
   
Shares
   
Amount
 
Common Stock
           
Balance at beginning of year
   
6,495
   
$
6,495
 
Issuance of stock
   
-
     
-
 
Balance at end of period
   
6,495
   
$
6,495
 
                 
Additional Paid-In Capital
               
Balance at beginning of year
         
$
89,763
 
Issuance of treasury stock
           
(43
)
Share-based payments
           
(207
)
Change related to acquisition of interests held by noncontrolling owners
           
23
 
Balance at end of period
         
$
89,536
 
                 
Retained Earnings
               
Balance at beginning of year
         
$
33,671
 
Net income attributable to AT&T ($1.70 per diluted share)
           
10,539
 
Dividends to stockholders ($1.44 per share)
           
(8,891
)
Balance at end of period
         
$
35,319
 
                 
Treasury Stock
               
Balance at beginning of year
   
(350
)
 
$
(12,592
)
Repurchase and acquisition of common stock
   
(14
)
   
(566
)
Issuance of treasury stock
   
10
     
569
 
Balance at end of period
   
(354
)
 
$
(12,589
)
                 
Accumulated Other Comprehensive Income Attributable to AT&T, net of tax
               
Balance at beginning of year
         
$
5,334
 
Other comprehensive loss attributable to AT&T
           
(484
)
Balance at end of period
         
$
4,850
 
                 
Noncontrolling Interest
               
Balance at beginning of year
         
$
969
 
Net income attributable to noncontrolling interest
           
279
 
Distributions
           
(252
)
Acquisition of interest held by noncontrolling owners
           
(25
)
Translation adjustments attributable to noncontrolling interest, net of taxes
           
21
 
Balance at end of period
         
$
992
 
                 
Total Stockholders' Equity at beginning of year
         
$
123,640
 
Total Stockholders' Equity at end of period
         
$
124,603
 
See Notes to Consolidated Financial Statements.
               
 
6

 
AT&T INC.
SEPTEMBER 30, 2016

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Dollars in millions except per share amounts
 
NOTE 1. PREPARATION OF INTERIM FINANCIAL STATEMENTS

Basis of Presentation  Throughout this document, AT&T Inc. is referred to as "AT&T," "we" or the "Company." These consolidated financial statements include all adjustments that are necessary to present fairly the results for the presented interim periods, consisting of normal recurring accruals and other items. The results for the interim periods are not necessarily indicative of those for the full year. You should read this document in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2015.

The consolidated financial statements include the accounts of the Company and our majority-owned subsidiaries and affiliates, including the results of DIRECTV and wireless properties in Mexico for the period from acquisition to the reporting date. Our subsidiaries and affiliates operate in the communications and digital entertainment services industry, providing services and equipment that deliver voice, video and broadband services domestically and internationally.

All significant intercompany transactions are eliminated in the consolidation process. Investments in less than majority-owned subsidiaries and partnerships where we have significant influence are accounted for under the equity method. Earnings from certain investments accounted for using the equity method are included for periods ended within up to one quarter of our period end. We also record our proportionate share of our equity method investees' other comprehensive income (OCI) items, including cumulative translation adjustments.

The preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes, including estimates of probable losses and expenses. Actual results could differ from those estimates. The consolidated statements of cash flows include revisions to present "Equipment installment receivables and related sales" and "Deferred fulfillment costs" separately from "Other – net" and previously reported changes in operating assets and liabilities.

Cash Flows  In August 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-15, "Statement of Cash Flows (Topic 230):  Classification of Certain Cash Receipts and Cash Payments" (ASU 2016-15), which provides guidance related to cash flows presentation and is effective for annual reporting periods beginning after December 15, 2017, subject to early adoption. The majority of the guidance in ASU 2016-15 is consistent with our current cash flow classifications. However, cash receipts on the deferred purchase price described in Note 8 will be classified as cash flows from investing activities instead of our current presentation as cash flow from operations. Under ASU 2016-15, we will continue to recognize cash receipts on owned equipment installment receivables as cash from operations. AT&T's cash flows from operating activities included cash receipts on the deferred purchase price of $534 for the nine months ended September 30, 2016, and $536 for the year ended December 31, 2015.

Leases  In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)" (ASU 2016-02), which replaces existing leasing rules with a comprehensive lease measurement and recognition standard and expanded disclosure requirements. ASU 2016-02 will require lessees to recognize most leases on their balance sheets as liabilities, with corresponding "right-of-use" assets and is effective for annual reporting periods beginning after December 15, 2018, subject to early adoption. For income statement recognition purposes, leases will be classified as either a finance or an operating lease without relying upon the bright-line tests under current GAAP.

Upon initial evaluation, we believe the key change upon adoption will be the balance sheet recognition. The income statement recognition of lease expense appears similar to our current methodology. We are continuing to evaluate other potential impacts to our financial statements.

Revenue Recognition  In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)" (ASU 2014-09) and has modified the standard thereafter. These standards replace existing revenue recognition rules with a comprehensive revenue measurement and recognition standard and expanded disclosure requirements. ASU 2014-09, as amended, becomes effective for annual reporting periods beginning after December 15, 2017, at which point we plan to adopt the standard.
 

7

 
AT&T INC.
SEPTEMBER 30, 2016

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  - Continued
Dollars in millions except per share amounts
 
The FASB allows two adoption methods under ASU 2014-09. Under one method, a company will apply the rules to contracts in all reporting periods presented, subject to certain allowable exceptions. Under the other method, a company will apply the rules to all contracts existing as of January 1, 2018, recognizing in beginning retained earnings an adjustment for the cumulative effect of the change and providing additional disclosures comparing results to previous rules ("modified retrospective method"). We continue to evaluate the available adoption methods.

Upon initial evaluation, we believe the key changes in the standard that impact our revenue recognition relate to the allocation of contract revenues between various services and equipment, and the timing of when those revenues are recognized. We are still in the process of evaluating these impacts. As a result of our accounting policy change for customer set-up and installation costs made in 2015, we believe that the requirement to defer such costs under the new standard will not result in a significant change to our results. However, the requirement to defer incremental contract acquisition costs and recognize them over the contract period or expected customer life will result in the recognition of a deferred charge on our balance sheets. We cannot currently estimate the impact of this change upon adoption, as the industry continues to undergo changes in how devices and services are sold to customers.

Customer Fulfillment Costs  During the second quarter of 2016, we updated our analysis of the economic lives of customer relationships, which included a review of satellite customer data following the DIRECTV acquisition. As of April 1, 2016, to better reflect the estimated economic lives of satellite and certain business customer relationships, we extended the amortization period to approximately 4.5 years. This change in accounting estimate decreased other cost of services and impacted net income $79, or $0.01 per diluted share, in the third quarter of 2016 and $161, or $0.03 per diluted share, for the nine months ended September 30, 2016.

NOTE 2. EARNINGS PER SHARE

A reconciliation of the numerators and denominators of basic and diluted earnings per share for the three and nine months ended September 30, 2016 and 2015, is shown in the table below:

   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
Numerators
                       
Numerator for basic earnings per share:
                       
   Net Income
 
$
3,418
   
$
3,078
   
$
10,818
   
$
9,601
 
   Less:  Net income attributable to noncontrolling interest
   
(90
)
   
(84
)
   
(279
)
   
(262
)
   Net Income attributable to AT&T
   
3,328
     
2,994
     
10,539
     
9,339
 
   Dilutive potential common shares:
                               
      Share-based payment
   
3
     
3
     
9
     
9
 
Numerator for diluted earnings per share
 
$
3,331
   
$
2,997
   
$
10,548
   
$
9,348
 
Denominators (000,000)
                               
Denominator for basic earnings per share:
                               
   Weighted average number of common shares outstanding
   
6,168
     
5,924
     
6,171
     
5,447
 
   Dilutive potential common shares:
                               
      Share-based payment (in shares)
   
21
     
19
     
20
     
16
 
Denominator for diluted earnings per share
   
6,189
     
5,943
     
6,191
     
5,463
 
Basic earnings per share attributable to AT&T
 
$
0.54
   
$
0.50
   
$
1.70
   
$
1.71
 
Diluted earnings per share attributable to AT&T
 
$
0.54
   
$
0.50
   
$
1.70
   
$
1.71
 

NOTE 3. OTHER COMPREHENSIVE INCOME

Changes in the balances of each component included in accumulated other comprehensive income (accumulated OCI) are presented below. All amounts are net of tax and exclude noncontrolling interest.
 
8

 
AT&T INC.
SEPTEMBER 30, 2016

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  - Continued
Dollars in millions except per share amounts
 
Following our 2015 acquisitions of DIRECTV and wireless properties in Mexico, we have additional foreign operations that are exposed to fluctuations in the exchange rates used to convert operations, assets and liabilities into U.S. dollars. Since December 31, 2015, when compared to the U.S. dollar, the Brazilian real exchange rate has appreciated 17.6%, the Argentine peso exchange rate has depreciated 18.4% and the Mexican peso exchange rate has depreciated 12.7%.

 
Foreign
Currency
Translation
Adjustment
 
Net Unrealized
Gains (Losses)
on Available-
for-Sale
Securities
 
Net Unrealized
Gains (Losses)
on Cash Flow
 Hedges
 
Defined Benefit
Postretirement
Plans
 
Accumulated
Other
Comprehensive
 Income
Balance as of December 31, 2015
$
(1,198)
 
$
484
 
$
16
 
$
6,032
 
$
5,334
Other comprehensive income
   (loss) before reclassifications
 
(72)
   
25
   
183
   
-
   
136
Amounts reclassified
   from accumulated OCI
 
-
1
 
(5)
1
 
29
2
 
(644)
3
 
(620)
Net other comprehensive
   income (loss)
 
(72)
   
20
   
212
   
(644)
   
(484)
Balance as of September 30,
   2016
$
(1,270)
 
$
504
 
$
228
 
$
5,388
 
$
4,850
                               
 
Foreign
Currency
Translation
Adjustment
 
Net Unrealized
Gains (Losses)
on Available-
for-Sale
Securities
 
Net Unrealized
Gains (Losses)
on Cash Flow
Hedges
 
Defined Benefit
Postretirement
Plans
 
Accumulated
Other
Comprehensive
 Income
Balance as of December 31, 2014
$
(26)
 
$
499
 
$
741
 
$
6,847
 
$
8,061
Other comprehensive income
   (loss) before reclassifications
 
(1,204)
   
(51)
   
(890)
   
-
   
(2,145)
Amounts reclassified
   from accumulated OCI
 
-
1
 
(6)
1
 
28
2
 
(644)
3
 
(622)
Net other comprehensive
   income (loss)
 
(1,204)
   
(57)
   
(862)
   
(644)
   
(2,767)
Balance as of September 30,
   2015
$
(1,230)
 
$
442
 
$
(121)
 
$
6,203
 
$
5,294
1 (Gains) losses are included in Other income (expense) - net in the consolidated statements of income.
2 (Gains) losses are included in Interest expense in the consolidated statements of income. See Note 6 for additional information.
3 The amortization of prior service credits associated with postretirement benefits, net of amounts capitalized as part of construction labor, are included in Cost of services and sales and Selling, general and administrative in the consolidated statements of income (see Note 5).

NOTE 4. SEGMENT INFORMATION

Our segments are strategic business units that offer products and services to different customer segments over various technology platforms and/or in different geographies that are managed accordingly. We analyze our operating segments based on Segment Contribution, which consists of operating income, excluding acquisition-related costs and other significant items (as discussed below), and equity in net income (loss) of affiliates for investments managed within each operating segment. We have four reportable segments: (1) Business Solutions, (2) Entertainment Group, (3) Consumer Mobility and (4) International.
 
9

 
AT&T INC.
SEPTEMBER 30, 2016

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  - Continued
Dollars in millions except per share amounts

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

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

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

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

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

In reconciling items to consolidated operating income and income before income taxes, Corporate and Other includes: (1) operations that are not considered reportable segments and that are no longer integral to our operations or which we no longer actively market, and (2) impacts of corporate-wide decisions for which the individual operating segments are not being evaluated, including interest costs and expected return on plan assets for our pension and postretirement benefit plans.

Certain operating items are not allocated to our business segments, and those include:
·
Acquisition-related items which consist of (1) operations and support items associated with the merger and integration of acquired businesses and (2) the noncash amortization of intangible assets acquired in acquisitions.
·
Certain significant items which consist of (1) noncash actuarial gains and losses from pension and other postretirement benefits, (2) employee separation charges associated with voluntary and/or strategic offers, (3) losses resulting from abandonment or impairment of assets and (4) other items for which the segments are not being evaluated.

Interest expense and other income (expense) – net, are managed only on a total company basis and are, accordingly, reflected only in consolidated results.

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

10

 
AT&T INC.
SEPTEMBER 30, 2016

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  - Continued
Dollars in millions except per share amounts
 
For the three months ended September 30, 2016
 
   
Revenue
   
Operations
and Support
Expenses
   
EBITDA
   
Depreciation
and
Amortization
   
Operating
Income (Loss)
   
Equity in Net
Income (Loss)
 of
Affiliates
   
Segment
Contribution
 
Business Solutions
 
$
17,767
   
$
10,925
   
$
6,842
   
$
2,539
   
$
4,303
   
$
-
   
$
4,303
 
Entertainment Group
   
12,720
     
9,728
     
2,992
     
1,504
     
1,488
     
-
     
1,488
 
Consumer Mobility
   
8,267
     
4,751
     
3,516
     
944
     
2,572
     
-
     
2,572
 
International
   
1,879
     
1,640
     
239
     
293
     
(54
)
   
1
     
(53
)
Segment Total
   
40,633
     
27,044
     
13,589
     
5,280
     
8,309
   
$
1
   
$
8,310
 
Corporate and Other
   
270
     
270
     
-
     
17
     
(17
)
               
Acquisition-related items
   
-
     
290
     
(290
)
   
1,282
     
(1,572
)
               
Certain significant items
   
(13
)
   
299
     
(312
)
   
-
     
(312
)
               
AT&T Inc.
 
$
40,890
   
$
27,903
   
$
12,987
   
$
6,579
   
$
6,408
                 
                                                         
For the nine months ended September 30, 2016
 
   
Revenue
   
Operations
and Support
Expenses
   
EBITDA
   
Depreciation
and
Amortization
   
Operating
Income (Loss)
   
Equity in Net
Income (Loss)
of
Affiliates
   
Segment
Contribution
 
Business Solutions
 
$
52,955
   
$
32,584
   
$
20,371
   
$
7,568
   
$
12,803
   
$
-
   
$
12,803
 
Entertainment Group
   
38,089
     
28,875
     
9,214
     
4,481
     
4,733
     
1
     
4,734
 
Consumer Mobility
   
24,781
     
14,343
     
10,438
     
2,798
     
7,640
     
-
     
7,640
 
International
   
5,374
     
4,951
     
423
     
868
     
(445
)
   
24
     
(421
)
Segment Total
   
121,199
     
80,753
     
40,446
     
15,715
     
24,731
   
$
25
   
$
24,756
 
Corporate and Other
   
759
     
940
     
(181
)
   
54
     
(235
)
               
Acquisition-related items
   
-
     
818
     
(818
)
   
3,949
     
(4,767
)
               
Certain significant items
   
(13
)
   
(383
)
   
370
     
-
     
370
                 
AT&T Inc.
 
$
121,945
   
$
82,128
   
$
39,817
   
$
19,718
   
$
20,099
                 
 
 
11

 
AT&T INC.
SEPTEMBER 30, 2016

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  - Continued
Dollars in millions except per share amounts
 
For the three months ended September 30, 2015
 
   
Revenue
   
Operations
and Support
Expenses
   
EBITDA
   
Depreciation
and
Amortization
   
Operating
Income (Loss)
   
Equity in Net
Income (Loss)
 of
Affiliates
   
Segment
Contribution
 
Business Solutions
 
$
17,692
   
$
10,921
   
$
6,771
   
$
2,474
   
$
4,297
   
$
-
   
$
4,297
 
Entertainment Group
   
10,858
     
8,450
     
2,408
     
1,389
     
1,019
     
2
     
1,021
 
Consumer Mobility
   
8,784
     
5,065
     
3,719
     
976
     
2,743
     
-
     
2,743
 
International
   
1,526
     
1,384
     
142
     
225
     
(83
)
   
(4
)
   
(87
)
Segment Total
   
38,860
     
25,820
     
13,040
     
5,064
     
7,976
   
$
(2
)
 
$
7,974
 
Corporate and Other
   
316
     
315
     
1
     
3
     
(2
)
               
Acquisition-related items
   
(85
)
   
611
     
(696
)
   
1,198
     
(1,894
)
               
Certain significant items
   
-
     
157
     
(157
)
   
-
     
(157
)
               
AT&T Inc.
 
$
39,091
   
$
26,903
   
$
12,188
   
$
6,265
   
$
5,923
                 
                                                         
For the nine months ended September 30, 2015
 
   
Revenue
   
Operations
and Support
Expenses
   
EBITDA
   
Depreciation
and
Amortization
   
Operating
Income (Loss)
   
Equity in Net
Income (Loss)
of
Affiliates
   
Segment
Contribution
 
Business Solutions
 
$
52,913
   
$
32,966
   
$
19,947
   
$
7,276
   
$
12,671
   
$
-
   
$
12,671
 
Entertainment Group
   
22,300
     
18,222
     
4,078
     
3,519
     
559
     
(16
)
   
543
 
Consumer Mobility
   
26,317
     
15,808
     
10,509
     
2,912
     
7,597
     
-
     
7,597
 
International
   
2,253
     
2,131
     
122
     
346
     
(224
)
   
(4
)
   
(228
)
Segment Total
   
103,783
     
69,127
     
34,656
     
14,053
     
20,603
   
$
(20
)
 
$
20,583
 
Corporate and Other
   
984
     
785
     
199
     
47
     
152
                 
Acquisition-related items
   
(85
)
   
1,604
     
(1,689
)
   
1,439
     
(3,128
)
               
Certain significant items
   
-
     
374
     
(374
)
   
-
     
(374
)
               
AT&T Inc.
 
$
104,682
   
$
71,890
   
$
32,792
   
$
15,539
   
$
17,253
                 
 
 
12

 
AT&T INC.
SEPTEMBER 30, 2016

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  - Continued
Dollars in millions except per share amounts
 
The following table is a reconciliation of Segment Contribution to "Income Before Income Taxes" reported on our consolidated statements of income.
 
                         
   
Third Quarter
   
Nine-Month Period
 
   
2016
   
2015
   
2016
   
2015
 
Business Solutions
 
$
4,303
   
$
4,297
   
$
12,803
   
$
12,671
 
Entertainment Group
   
1,488
     
1,021
     
4,734
     
543
 
Consumer Mobility
   
2,572
     
2,743
     
7,640
     
7,597
 
International
   
(53
)
   
(87
)
   
(421
)
   
(228
)
Segment Contribution
   
8,310
     
7,974
     
24,756
     
20,583
 
Reconciling Items:
                               
  Corporate and Other
   
(17
)
   
(2
)
   
(235
)
   
152
 
  Merger and integration items
   
(290
)
   
(696
)
   
(818
)
   
(1,689
)
  Amortization of intangibles acquired
   
(1,282
)
   
(1,198
)
   
(3,949
)
   
(1,439
)
  Employee separation charges
   
(260
)
   
(122
)
   
(314
)
   
(339
)
  Gain (loss) on wireless spectrum transactions
   
(22
)
   
-
     
714
     
-
 
  Other
   
(30
)
   
(35
)
   
(30
)
   
(35
)
  Segment equity in net (income) loss
    of affiliates
   
(1
)
   
2
     
(25
)
   
20
 
AT&T Operating Income
   
6,408
     
5,923
     
20,099
     
17,253
 
Interest expense
   
1,224
     
1,146
     
3,689
     
2,977
 
Equity in net income of affiliates
   
16
     
15
     
57
     
48
 
Other income (expense) - net
   
(7
)
   
(57
)
   
154
     
61
 
Income Before Income Taxes
 
$
5,193
   
$
4,735
   
$
16,621
   
$
14,385
 
 
NOTE 5. PENSION AND POSTRETIREMENT BENEFITS

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

In 2013, we made a voluntary contribution of a preferred equity interest in AT&T Mobility II LLC, the primary holding company for our domestic wireless business, to the trust used to pay pension benefits under our qualified pension plans. The preferred equity interest had a value of $8,630 at September 30, 2016. The trust is entitled to receive cumulative cash distributions of $560 per annum, which are distributed quarterly in equal amounts and accounted for as contributions. We distributed $420 to the trust during the nine months ended September 30, 2016. So long as we make the distributions, we will have no limitations on our ability to declare a dividend or repurchase shares. This preferred equity interest is a plan asset under ERISA and is recognized as such in the plan's separate financial statements. However, because the preferred equity interest is not unconditionally transferable to an unrelated party, it is not reflected in plan assets in our consolidated financial statements and instead has been eliminated in consolidation. We also agreed to make a cash contribution to the trust of $175 no later than the due dates of our federal income tax return for 2015 and 2016. Both such contributions, totaling $350, were made in September 2016.

We recognize actuarial gains and losses on pension and postretirement plan assets in our operating results at our annual measurement date of December 31, unless earlier remeasurements are required. The following table details pension and postretirement benefit costs included in operating expenses in the accompanying consolidated statements of income. A portion of these expenses is capitalized as part of internal construction projects, providing a small reduction in the net expense recorded. Service costs and prior service credits are reported in our segment results while interest costs and expected return on plan assets are included within Corporate and Other (see Note 4).
 
13

 
AT&T INC.
SEPTEMBER 30, 2016

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  - Continued
Dollars in millions except per share amounts
 
   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
Pension cost:
                       
   Service cost – benefits earned during the period
 
$
278
   
$
305
   
$
834
   
$
904
 
   Interest cost on projected benefit obligation
   
495
     
477
     
1,485
     
1,424
 
   Expected return on assets
   
(778
)
   
(832
)
   
(2,336
)
   
(2,484
)
   Amortization of prior service credit
   
(26
)
   
(25
)
   
(77
)
   
(77
)
   Net pension (credit) cost
 
$
(31
)
 
$
(75
)
 
$
(94
)
 
$
(233
)
                                 
Postretirement cost:
                               
   Service cost – benefits earned during the period
 
$
48
   
$
55
   
$
144
   
$
166
 
   Interest cost on accumulated postretirement benefit obligation
   
243
     
242
     
729
     
725
 
   Expected return on assets
   
(88
)
   
(105
)
   
(266
)
   
(315
)
   Amortization of prior service credit
   
(320
)
   
(320
)
   
(958
)
   
(959
)
   Net postretirement (credit) cost
 
$
(117
)
 
$
(128
)
 
$
(351
)
 
$
(383
)
                                 
   Combined net pension and postretirement (credit) cost
 
$
(148
)
 
$
(203
)
 
$
(445
)
 
$
(616
)

The decrease in the combined net pension and postretirement credit of $55 in the third quarter and $171 for the first nine months of 2016 is primarily due to a lower expected return on assets resulting from a decrease in the value in the plan assets.

We also provide senior- and middle-management employees with nonqualified, unfunded supplemental retirement and savings plans. For the third quarter ended 2016 and 2015, net supplemental pension benefits costs not included in the table above were $23 and $22. For the first nine months of 2016 and 2015, net supplemental pension benefit costs were $70 and $63.

NOTE 6. FAIR VALUE MEASUREMENTS AND DISCLOSURE

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

Level 1
Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets that we have the ability to access.

Level 2
Inputs to the valuation methodology include:
·
Quoted prices for similar assets and liabilities in active markets.
·
Quoted prices for identical or similar assets or liabilities in inactive markets.
·
Inputs other than quoted market prices that are observable for the asset or liability.
·
Inputs that are derived principally from or corroborated by observable market data by correlation or other means.

Level 3
Inputs to the valuation methodology are unobservable and significant to the fair value measurement.
·
Fair value is often based on developed models in which there are few, if any, external observations.

The fair value measurements level of an asset or liability within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Our valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs.
 
14

 
AT&T INC.
SEPTEMBER 30, 2016

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  - Continued
Dollars in millions except per share amounts
 
The valuation methodologies described above may produce a fair value calculation that may not be indicative of future net realizable value or reflective of future fair values. We believe our valuation methods are appropriate and consistent with other market participants. The use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date. There have been no changes in the methodologies used since December 31, 2015.

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

 
September 30, 2016
 
December 31, 2015
 
 
Carrying
 
Fair
 
Carrying
 
Fair
 
 
Amount
 
Value
 
Amount
 
Value
 
Notes and debentures1
$
123,962
   
$
137,894
   
$
124,847
   
$
128,993
 
Bank borrowings
 
4
     
4
     
4
     
4
 
Investment securities
 
2,622
     
2,622
     
2,704
     
2,704
 
1 Includes credit agreement borrowings.
                             

The carrying amount of debt with an original maturity of less than one year approximates market value. The fair value measurements used for notes and debentures are considered Level 2 and are determined using various methods, including quoted prices for identical or similar securities in both active and inactive markets.

Following is the fair value leveling for available-for-sale securities and derivatives as of September 30, 2016 and December 31, 2015:

   
September 30, 2016
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Available-for-Sale Securities
                       
   Domestic equities
 
$
1,171
   
$
-
   
$
-
   
$
1,171
 
   International equities
   
571
     
-
     
-
     
571
 
   Fixed income bonds
   
-
     
611
     
-
     
611
 
Asset Derivatives1
                               
   Interest rate swaps
   
-
     
145
     
-
     
145
 
   Cross-currency swaps
   
-
     
151
     
-
     
151
 
Liability Derivatives1
                               
   Cross-currency swaps
   
-
     
(3,260
)
   
-
     
(3,260
)
Derivatives designated as hedging instruments are reflected as "Other assets," "Other noncurrent liabilities" and, for a portion of interest rate swaps, "Other current assets" in our consolidated balance sheets.
 
 
15

 
AT&T INC.
SEPTEMBER 30, 2016

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

Investment Securities
Our investment securities include equities, fixed income bonds and other securities. A substantial portion of the fair values of our available-for-sale securities was estimated based on quoted market prices. Investments in securities not traded on a national securities exchange are valued using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Realized gains and losses on securities are included in "Other income (expense) – net" in the consolidated statements of income using the specific identification method. Unrealized gains and losses, net of tax, on available-for-sale securities are recorded in accumulated OCI. Unrealized losses that are considered other than temporary are recorded in "Other income (expense) – net" with the corresponding reduction to the carrying basis of the investment. Fixed income investments of $87 have maturities of less than one year, $277 within one to three years, $65 within three to five years and $182 for five or more years.

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

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

Fair Value Hedging We designate our fixed-to-floating interest rate swaps as fair value hedges. The purpose of these swaps is to manage interest rate risk by managing our mix of fixed-rate and floating-rate debt. These swaps involve the receipt of fixed-rate amounts for floating interest rate payments over the life of the swaps without exchange of the underlying principal amount. Accrued and realized gains or losses from interest rate swaps impact interest expense in the consolidated statements of income. Unrealized gains on interest rate swaps are recorded at fair market value as assets, and unrealized losses on interest rate swaps are recorded at fair market value as liabilities. Changes in the fair values of the interest rate swaps are exactly offset by changes in the fair value of the underlying debt. Gains or losses realized upon early termination of our fair value hedges are recognized in interest expense. In the nine months ended September 30, 2016 and September 30, 2015, no ineffectiveness was measured on interest rate swaps designated as fair value hedges.
 
16

 
AT&T INC.
SEPTEMBER 30, 2016

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  - Continued
Dollars in millions except per share amounts

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

Unrealized gains on derivatives designated as cash flow hedges are recorded at fair value as assets, and unrealized losses on derivatives designated as cash flow hedges are recorded at fair value as liabilities. For derivative instruments designated as cash flow hedges, the effective portion is reported as a component of accumulated OCI until reclassified into interest expense in the same period the hedged transaction affects earnings. The gain or loss on the ineffective portion is recognized as "Other income (expense) – net" in the consolidated statements of income in each period. We evaluate the effectiveness of our cross-currency swaps each quarter. In the nine months ended September 30, 2016 and September 30, 2015, no ineffectiveness was measured on cross-currency swaps designated as cash flow hedges.

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

We hedge a portion of the exchange risk involved in anticipation of highly probable foreign currency-denominated transactions. In anticipation of these transactions, we often enter into foreign exchange contracts to provide currency at a fixed rate. Gains and losses at the time we settle or take delivery on our designated foreign exchange contracts are amortized into income in the same period the hedged transaction affects earnings, except where an amount is deemed to be ineffective, which would be immediately reclassified to "Other income (expense) – net" in the consolidated statements of income. In the nine months ended September 30, 2016 and September 30, 2015, no ineffectiveness was measured on foreign exchange contracts designated as cash flow hedges.

Collateral and Credit-Risk Contingency  We have entered into agreements with our derivative counterparties establishing collateral thresholds based on respective credit ratings and netting agreements. At September 30, 2016, we had posted collateral of $2,369 (a deposit asset) and held collateral of $8 (a receipt liability). Under the agreements, if AT&T's credit rating had been downgraded one rating level by Fitch Ratings, before the final collateral exchange in September, we would have been required to post additional collateral of $162. If DIRECTV Holdings LLC's credit rating had been downgraded below BBB- (S&P), we would owe an additional $278. At December 31, 2015, we had posted collateral of $2,343 (a deposit asset) and held collateral of $124 (a receipt liability). We do not offset the fair value of collateral, whether the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) exists, against the fair value of the derivative instruments.

Following are the notional amounts of our outstanding derivative positions:

   
September 30,
   
December 31,
 
   
2016
   
2015
 
Interest rate swaps
 
$
7,050
   
$
7,050
 
Cross-currency swaps
   
29,642
     
29,642
 
Foreign exchange contracts
   
-
     
100
 
Total
 
$
36,692
   
$
36,792
 
 
17

 
AT&T INC.
SEPTEMBER 30, 2016

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  - Continued
Dollars in millions except per share amounts
 
Following are the related hedged items affecting our financial position and performance:
 
                         
Effect of Derivatives on the Consolidated Statements of Income
                   
Fair Value Hedging Relationships
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
 
Interest rate swaps (Interest expense):
                       
     Gain (Loss) on interest rate swaps
 
$
(54
)
 
$
54
   
$
17
   
$
65
 
     Gain (Loss) on long-term debt
   
54
     
(54
)
   
(17
)
   
(65
)

In addition, the net swap settlements that accrued and settled in the quarter ended September 30 were offset against interest expense.

   
Three months ended
   
Nine months ended
 
 
September 30,
   
September 30,
 
Cash Flow Hedging Relationships
 
2016
   
2015
   
2016
   
2015
 
Cross-currency swaps:
                       
     Gain (Loss) recognized in accumulated OCI
 
$
686
   
$
(678
)
 
$
282
   
$
(1,008
)
                                 
Interest rate locks:
                               
     Gain (Loss) recognized in accumulated OCI
   
-
     
-
     
-
     
(361
)
     Interest income (expense) reclassified from
        accumulated OCI into income
   
(15
)
   
(17
)
   
(44
)
   
(43
)

NOTE 7. ACQUISITIONS, DISPOSITIONS AND OTHER ADJUSTMENTS

Acquisitions

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

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

Goodwill was calculated as the difference between the acquisition date fair value of the consideration transferred and the fair value of the net assets acquired, and represents the future economic benefits that we expect to achieve as a result of the acquisition.
 
18

 
AT&T INC.
SEPTEMBER 30, 2016

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  - Continued
Dollars in millions except per share amounts
 
The following table summarizes the fair values of the DIRECTV assets acquired and liabilities assumed and related deferred income taxes that existed as of the acquisition date.
 
       
Assets acquired
     
    Cash
 
$
4,797
 
    Accounts receivable
   
2,038
 
    All other current assets
   
1,534
 
    Property, plant and equipment
   
9,320
 
    Intangible assets not subject to amortization
       
       Orbital slots
   
11,946
 
       Trade name
   
1,371
 
    Intangible assets subject to amortization
       
       Customer lists and relationships
   
19,508
 
       Trade name
   
2,915
 
       Other
   
445
 
    Investments and other assets
   
2,375
 
    Goodwill
   
34,619
 
Total assets acquired
   
90,868
 
         
Liabilities assumed
       
    Current liabilities, excluding current portion of long-term debt
   
5,645
 
    Long-term debt
   
20,585
 
    Other noncurrent liabilities
   
16,875
 
Total liabilities assumed
   
43,105
 
Net assets acquired
   
47,763
 
Noncontrolling interest
   
(354
)
Aggregate value of consideration paid
 
$
47,409
 

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

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

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

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

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

AWS-3 Auction  In January 2015, we submitted winning bids of $18,189 in the Advanced Wireless Service (AWS)-3 Auction (FCC Auction 97), a portion of which represented spectrum clearing and First Responder Network Authority funding. We provided the Federal Communications Commission (FCC) an initial down payment of $921 in October 2014 and paid the remaining $17,268 in the first quarter of 2015.
 
19

 
AT&T INC.
SEPTEMBER 30, 2016

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  - Continued
Dollars in millions except per share amounts
 
NOTE 8. SALES OF EQUIPMENT INSTALLMENT RECEIVABLES

We offer our customers the option to purchase certain wireless devices in installments over a period of up to 30 months and, in many cases, they have the right to trade in the original equipment for a new device within a set period and have the remaining unpaid balance satisfied. As of September 30, 2016 and December 31, 2015, gross equipment installment receivables of $5,015 and $5,719 were included on our consolidated balance sheets, of which $3,053 and $3,239 are notes receivable that are included in "Accounts receivable - net."

In 2014, we entered into an uncommitted agreement pertaining to the sale of equipment installment receivables and related security with Citibank and various other relationship banks as purchasers (collectively, the Purchasers). Under this agreement, we transferred the receivables to the Purchasers for cash and additional consideration upon settlement of the receivables, referred to as the deferred purchase price. Under the terms of the agreement, we continue to bill and collect the payments from our customers on behalf of the Purchasers. To date, cash proceeds received, net of remittances (excluding amounts returned as deferred purchase price), were $3,496.

The following table sets forth a summary of equipment installment receivables sold during the three months and nine months ended September 30, 2016 and 2015:

 
Three months ended
 
Nine months ended
 
 
September 30,
 
September 30,
 
 
2016
 
2015
 
2016
 
2015
 
Gross receivables sold
 
$
1,485
   
$
1,601
   
$
5,812
   
$
5,964
 
Net receivables sold1
   
1,336
     
1,431
     
5,263
     
5,367
 
Cash proceeds received
   
891
     
980
     
3,538
     
3,553
 
Deferred purchase price recorded
   
463
     
456
     
1,745
     
1,819
 
1 Receivables net of allowance, imputed interest and trade-in right guarantees.
 

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

The following table shows the equipment installment receivables, previously sold to the Purchasers, that we repurchased in exchange for the associated deferred purchase price during the three months and nine months ended September 30, 2016 and 2015:

 
Three months ended
 
Nine months ended
 
 
September 30,
 
September 30,
 
 
2016
 
2015
 
2016
 
2015
 
Fair value of repurchased receivables
 
$
749
   
$
412
   
$
1,281
   
$
412
 
Carrying value of deferred purchase price
   
722
     
314
     
1,261
     
314
 
Gain on repurchases1
 
$
27
   
$
98
   
$
20
   
$
98
 
1 These gains are included in "Selling, general and administrative" in the consolidated statements of income.
 

At September 30, 2016 and December 31, 2015, our deferred purchase price receivable was $3,022 and $2,961, respectively, of which $1,561 and $1,772 is included in "Other current assets" on our consolidated balance sheets, with the remainder in "Other Assets." Our maximum exposure to loss as a result of selling these equipment installment receivables is limited to the amount of our deferred purchase price at any point in time.
 
 
20

 
AT&T INC.
SEPTEMBER 30, 2016

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  - Continued
Dollars in millions except per share amounts
 
The sales of equipment installment receivables did not have a material impact on our consolidated statements of income or to "Total Assets" reported on our consolidated balance sheets. We reflect the cash flows related to the arrangement as operating activities in our consolidated statements of cash flows because the cash received from the Purchasers upon both the sale of the receivables and the collection of the deferred purchase price is not subject to significant interest rate risk.

NOTE 9. SUBSEQUENT EVENT
Pending Acquisition
On October 22, 2016, we announced a merger agreement (Merger Agreement) to acquire Time Warner Inc. (Time Warner) in a 50% cash and 50% stock transaction for $107.50 per share of Time Warner common stock, or approximately $85,400 at the date of the announcement (Merger). Combined with Time Warner's net debt at September 30, 2016, the total transaction value is approximately $108,700. Each share of Time Warner common stock will be exchanged for $53.75 per share in cash and a number of shares (exchange ratio) of AT&T common stock based on the average stock price at the time of closing the Merger. If the average stock price is between (or equal to) $37.411 and $41.349 per share, the exchange ratio will be the quotient of $53.75 divided by the average stock price. If the average stock price is greater than $41.349, the exchange ratio will be 1.300. If the average stock price is less than $37.411, the exchange ratio will be 1.437. Post-transaction, Time Warner shareholders will own between 14.4% and 15.7% of AT&T shares on a fully-diluted basis based on the number of AT&T shares outstanding. The cash portion of the purchase price will be financed with new debt and cash. As further discussed below, we have an 18-month commitment for an unsecured bridge term facility (Bridge Loan) for $40,000.
Time Warner is a leading media and entertainment company whose major businesses encompass an array of the most respected and successful media brands. The deal combines Time Warner's vast library of content and ability to create new premium content that connects with audiences around the world, with our extensive customer relationships, world's largest pay TV subscriber base and leading scale in TV, mobile and broadband distribution.
The Merger Agreement must be adopted by Time Warner shareholders and is subject to review by the U.S. Department of Justice and if certain FCC licenses remain with Time Warner at closing, those are subject to FCC review and approval. It is also a condition to closing that necessary consents from certain public utility commissions and foreign governmental entities must be obtained. The transaction is expected to close before year end 2017. If the Merger is terminated as a result of reaching the termination date (and at that time one or more of the conditions relating to certain regulatory approvals have not been satisfied) or there is a final, non-appealable order preventing the transaction relating to antitrust laws, communications laws, utilities laws or foreign regulatory laws, then under certain circumstances we would be obligated to pay Time Warner $500.

Bridge Loan
On October 22, 2016, in connection with entering into the Merger Agreement, AT&T entered into the Bridge Loan with JPMorgan Chase Bank, N.A., as agent, and JPMorgan Chase Bank, N.A. and Bank of America, N.A., as lenders.

In the event advances are made under the Bridge Loan, those advances would be used solely to finance a portion of the cash consideration to be paid in the Merger, the refinancing of debt of Time Warner and its subsidiaries and the payment of related fees and expenses. We have not drawn on this facility.

The obligations of the lenders under the Bridge Loan to provide advances will terminate on the earliest of (i) the Termination Date (as defined in the Merger Agreement), (ii) the consummation of the transactions contemplated by the Merger Agreement without the borrowing of advances under the Bridge Loan and (iii) the termination of the Merger Agreement.
 

21

 
AT&T INC.
SEPTEMBER 30, 2016

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  - Continued
Dollars in millions except per share amounts

Advances would bear interest, at the Company's option, either:

at a variable annual rate equal to: (1) the highest of (a) the prime rate of JPMorgan Chase Bank, N.A., (b) 0.5% per annum above the federal funds rate, and (c) the London Interbank Offered Rate (LIBOR) rate applicable to dollars for a period of one month plus 1.00%, plus (2) an applicable margin, as set forth in the Bridge Loan (the "Applicable Margin for Base Advances"); or
at a rate equal to: (i) LIBOR (adjusted upwards to reflect any bank reserve costs) for a period of one, two, three or six months, as applicable, plus (ii) an applicable margin, as set forth in the Bridge Loan (the "Applicable Margin for Eurodollar Rate Advances").

The Applicable Margin for Eurodollar Rate Advances will be equal to 0.750%, 1.000%, 1.125%, 1.250% or 1.500% per annum depending on the Company's unsecured long-term debt ratings. The Applicable Margin for Base Advances will be equal to the greater of (x) 0.00% and (y) the relevant Applicable Margin for Eurodollar Rate Advances minus 1.00% per annum, depending on the Company's unsecured long-term debt ratings.

The Applicable Margin for Eurodollar Rate Advances and the Applicable Margin for Base Advances are scheduled to increase by an additional 0.25% on the 90th day after the closing of the Merger and another 0.25% every 90 days thereafter.

The Company will also pay a commitment fee (Commitment Fee) of 0.070%, 0.090%, 0.100%, 0.125% or 0.175% of the commitment amount per annum, depending on the Company's unsecured long-term debt ratings.

The Company is scheduled to pay a duration fee of 0.50%, 0.75% and 1.00% on the amount of advances outstanding as of the 90th, 180th and 270th day after advances are made.

The Bridge Loan contains provisions requiring the reduction of the commitments of the lenders and the prepayment of outstanding advances by the amount of net cash proceeds resulting from the incurrence of certain indebtedness by the Company or its subsidiaries, the issuance of certain capital stock by the Company or its subsidiaries and non-ordinary course sales or dispositions of assets by the Company or its subsidiaries, in each case subject to exceptions set forth in the Bridge Loan.

Advances under the Bridge Loan are conditioned on the absence of a material adverse effect on Time Warner and certain customary events, and repayment of all advances must be made no later than 364 days after the date on which the advances are made.

The Bridge Loan contains covenants that are customary for an issuer with an investment grade senior debt credit rating, as well as a net debt-to-EBITDA (earnings before interest, taxes, depreciation and amortization, and other modifications described in the Bridge Loan) financial ratio covenant that the Company will maintain, as of the last day of each fiscal quarter of not more than 3.5-to-1.

The events of default contained in the Bridge Loan are customary for an agreement of this type and such events would result in the acceleration of, or would permit the lenders to accelerate, as applicable, required payments and would increase the Applicable Margin by 2.00% per annum.

Prior to the closing date of the Merger, only a payment or bankruptcy event of default would permit the lenders to terminate their commitments under the Bridge Loan.
 
22

 
AT&T INC.
SEPTEMBER 30, 2016

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations
Dollars in millions except per share and per subscriber amounts
 
RESULTS OF OPERATIONS

For ease of reading, AT&T Inc. is referred to as "we," "AT&T" or the "Company" throughout this document, and the names of the particular subsidiaries and affiliates providing the services generally have been omitted. AT&T is a holding company whose subsidiaries and affiliates operate in the communications and digital entertainment services industry. Our subsidiaries and affiliates provide services and equipment that deliver voice, video and broadband services both domestically and internationally. During 2015, we completed our acquisitions of DIRECTV and wireless properties in Mexico, and the following discussion of changes in our operating revenues and expenses is affected by the timing of these acquisitions. In accordance with U.S. generally accepted accounting principles (GAAP), our third-quarter 2015 results include 68 days of DIRECTV-related operations compared with a full quarter in 2016.You should read this discussion in conjunction with the consolidated financial statements and accompanying notes. A reference to a "Note" in this section refers to the accompanying Notes to Consolidated Financial Statements. In the tables throughout this section, percentage increases and decreases that are not considered meaningful are denoted with a dash. Certain amounts have been reclassified to conform to the current period's presentation.

Consolidated Results  Our financial results in the third quarter and for the first nine months of 2016 and 2015 are summarized as follows:
   
Third Quarter
   
Nine-Month Period
 
   
2016
   
2015
   
Percent
Change
   
2016
   
2015
   
Percent
Change
 
 
Operating Revenues
                                   
   Service
 
$
37,272
   
$
35,539
     
4.9
%
 
$
111,515
   
$
94,042
     
18.6
%
   Equipment
   
3,618
     
3,552
     
1.9
     
10,430
     
10,640
     
(2.0
)
Total Operating Revenues
   
40,890
     
39,091
     
4.6
     
121,945
     
104,682
     
16.5