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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-12 - COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES - AT&T INC.ex12.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 June 30, 2017
 
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," "smaller reporting company" and "emerging growth 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
[   ]
     
Emerging growth company
[   ]

If an emerging growth company, indicate by checkmark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
                                                                                                                                                                              Yes [   ]   No [   ]

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 July 31, 2017, there were 6,140 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
   
Six months ended
 
   
June 30,
   
June 30,
 
   
2017
   
2016
   
2017
   
2016
 
                         
Operating Revenues
                       
Service
 
$
36,538
   
$
37,142
   
$
72,994
   
$
74,243
 
Equipment
   
3,299
     
3,378
     
6,208
     
6,812
 
Total operating revenues
   
39,837
     
40,520
     
79,202
     
81,055
 
                                 
Operating Expenses
                               
Cost of services and sales
                               
   Equipment
   
4,138
     
4,260
     
7,986
     
8,635
 
   Broadcast, programming and operations
   
4,898
     
4,701
     
9,872
     
9,330
 
   Other cost of services (exclusive of depreciation and
         amortization shown separately below)
   
9,218
     
9,514
     
18,283
     
18,910
 
Selling, general and administrative
   
8,113
     
8,909
     
16,600
     
17,350
 
Depreciation and amortization
   
6,147
     
6,576
     
12,274
     
13,139
 
Total operating expenses
   
32,514
     
33,960
     
65,015
     
67,364
 
Operating Income
   
7,323
     
6,560
     
14,187
     
13,691
 
Other Income (Expense)
                               
Interest expense
   
(1,395
)
   
(1,258
)
   
(2,688
)
   
(2,465
)
Equity in net income (loss) of affiliates
   
14
     
28
     
(159
)
   
41
 
Other income (expense) – net
   
128
     
91
     
108
     
161
 
Total other income (expense)
   
(1,253
)
   
(1,139
)
   
(2,739
)
   
(2,263
)
Income Before Income Taxes
   
6,070
     
5,421
     
11,448
     
11,428
 
Income tax expense
   
2,056
     
1,906
     
3,860
     
4,028
 
Net Income
   
4,014
     
3,515
     
7,588
     
7,400
 
Less: Net Income Attributable to Noncontrolling Interest
   
(99
)
   
(107
)
   
(204
)
   
(189
)
Net Income Attributable to AT&T
 
$
3,915
   
$
3,408
   
$
7,384
   
$
7,211
 
Basic Earnings Per Share Attributable to AT&T
 
$
0.63
   
$
0.55
   
$
1.19
   
$
1.17
 
Diluted Earnings Per Share Attributable to AT&T
 
$
0.63
   
$
0.55
   
$
1.19
   
$
1.17
 
Weighted Average Number of Common Shares
   Outstanding – Basic (in millions)
   
6,165
     
6,174
     
6,166
     
6,173
 
Weighted Average Number of Common Shares
   Outstanding with Dilution (in millions)
   
6,184
     
6,195
     
6,185
     
6,193
 
Dividends Declared Per Common Share
 
$
0.49
   
$
0.48
   
$
0.98
   
$
0.96
 
See Notes to Consolidated Financial Statements.
                               

 
2

AT&T INC.
                       
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
                   
Dollars in millions
                       
(Unaudited)
                       
   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
   
2017
   
2016
   
2017
   
2016
 
Net income
 
$
4,014
   
$
3,515
   
$
7,588
   
$
7,400
 
Other comprehensive income (loss), net of tax:
                               
    Foreign currency:
                               
        Foreign currency translation adjustment (includes $(10),
            $0, $(4) and $0 attributable to noncontrolling interest),
            net of taxes of $115, $136, $506 and $126
   
(33
)
   
218
     
339
     
174
 
    Available-for-sale securities:
                               
        Net unrealized gains (losses), net of taxes of $29, $2, $44
            and $(13)
   
50
     
5
     
83
     
(21
)
        Reclassification adjustment included in net income, net of
            taxes of $(7), $2, $(4) and $0
   
(12
)
   
3
     
(7
)
   
-
 
     Cash flow hedges:
                               
        Net unrealized gains (losses), net of taxes of $(279), $(208),
            $(272) and $(141)
   
(517
)
   
(387
)
   
(504
)
   
(263
)
        Reclassification adjustment included in net income, net of
            taxes of $5, $5, $10 and $10
   
9
     
9
     
19
     
19
 
     Defined benefit postretirement plans:
                               
        Net prior service credit arising during period, net of
            taxes of $594, $0, $594 and $0
   
969
     
-
     
969
     
-
 
        Amortization of net prior service credit included in net
            income, net of taxes of $(151), $(131), $(290) and $(262)
   
(247
)
   
(214
)
   
(475
)
   
(429
)
Other comprehensive income (loss)
   
219
     
(366
)
   
424
     
(520
)
Total comprehensive income
   
4,233
     
3,149
     
8,012
     
6,880
 
Less: Total comprehensive income attributable to
        noncontrolling interest
   
(89
)
   
(107
)
   
(200
)
   
(189
)
Total Comprehensive Income Attributable to AT&T
 
$
4,144
   
$
3,042
   
$
7,812
   
$
6,691
 
See Notes to Consolidated Financial Statements.
                               
 

3

AT&T INC.
 
CONSOLIDATED BALANCE SHEETS
 
Dollars in millions except per share amounts
 
   
June 30,
   
December 31,
 
   
2017
   
2016
 
Assets
 
(Unaudited)
       
Current Assets
           
Cash and cash equivalents
 
$
25,617
   
$
5,788
 
Accounts receivable - net of allowances for doubtful accounts of $732 and $661
   
14,997
     
16,794
 
Prepaid expenses
   
1,371
     
1,555
 
Other current assets
   
11,562
     
14,232
 
Total current assets
   
53,547
     
38,369
 
Property, plant and equipment
   
323,098
     
319,648
 
   Less: accumulated depreciation and amortization
   
(196,914
)
   
(194,749
)
Property, Plant and Equipment – Net
   
126,184
     
124,899
 
Goodwill
   
105,546
     
105,207
 
Licenses
   
95,864
     
94,176
 
Customer Lists and Relationships – Net
   
12,414
     
14,243
 
Other Intangible Assets – Net
   
7,980
     
8,441
 
Investments in Equity Affiliates
   
1,615
     
1,674
 
Other Assets
   
17,645
     
16,812
 
Total Assets
 
$
420,795
   
$
403,821
 
                 
Liabilities and Stockholders' Equity
               
Current Liabilities
               
Debt maturing within one year
 
$
10,831
   
$
9,832
 
Accounts payable and accrued liabilities
   
26,471
     
31,138
 
Advanced billing and customer deposits
   
4,371
     
4,519
 
Accrued taxes
   
3,331
     
2,079
 
Dividends payable
   
3,008
     
3,008
 
Total current liabilities
   
48,012
     
50,576
 
Long-Term Debt
   
132,824
     
113,681
 
Deferred Credits and Other Noncurrent Liabilities
               
Deferred income taxes
   
61,926
     
60,128
 
Postemployment benefit obligation
   
31,422
     
33,578
 
Other noncurrent liabilities
   
20,753
     
21,748
 
Total deferred credits and other noncurrent liabilities
   
114,101
     
115,454
 
                 
Stockholders' Equity
               
Common stock ($1 par value, 14,000,000,000 authorized at June 30, 2017 and
               
   December 31, 2016: issued 6,495,231,088 at June 30, 2017 and December 31, 2016)
   
6,495
     
6,495
 
Additional paid-in capital
   
89,471
     
89,604
 
Retained earnings
   
36,067
     
34,734
 
Treasury stock (355,448,811 at June 30, 2017 and 356,237,141
               
   at December 31, 2016, at cost)
   
(12,697
)
   
(12,659
)
Accumulated other comprehensive income
   
5,389
     
4,961
 
Noncontrolling interest
   
1,133
     
975
 
Total stockholders' equity
   
125,858
     
124,110
 
Total Liabilities and Stockholders' Equity
 
$
420,795
   
$
403,821
 
See Notes to Consolidated Financial Statements.
               

 
4

AT&T INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Dollars in millions
 
(Unaudited)
           
   
Six months ended
 
   
June 30,
 
   
2017
   
2016
 
Operating Activities
           
Net income
 
$
7,588
   
$
7,400
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
   Depreciation and amortization
   
12,274
     
13,139
 
   Undistributed loss (earnings) from investments in equity affiliates
   
167
     
(22
)
   Provision for uncollectible accounts
   
795
     
705
 
   Deferred income tax expense
   
964
     
1,767
 
   Net loss (gain) from sale of investments, net of impairments
   
12
     
(85
)
   Actuarial loss (gain) on pension and postretirement benefits
   
(259
)
   
-
 
Changes in operating assets and liabilities:
               
   Accounts receivable
   
119
     
(364
)
   Other current assets
   
471
     
2,229
 
   Accounts payable and other accrued liabilities
   
(2,761
)
   
(3,032
)
   Equipment installment receivables and related sales
   
907
     
464
 
   Deferred fulfillment costs
   
(796
)
   
(1,190
)
Retirement benefit funding
   
(280
)
   
(280
)
Other - net
   
(1,041
)
   
(2,524
)
Total adjustments
   
10,572
     
10,807
 
Net Cash Provided by Operating Activities
   
18,160
     
18,207
 
                 
Investing Activities
               
Capital expenditures:
               
   Purchase of property and equipment
   
(10,750
)
   
(9,702
)
   Interest during construction
   
(473
)
   
(437
)
Acquisitions, net of cash acquired
   
1,224
     
(485
)
Dispositions
   
51
     
107
 
Sale of securities, net
   
-
     
500
 
Net Cash Used in Investing Activities
   
(9,948
)
   
(10,017
)
                 
Financing Activities
               
Net change in short-term borrowings with original maturities of three months or less
   
(2
)
   
-
 
Issuance of long-term debt
   
24,115
     
10,140
 
Repayment of long-term debt
   
(6,118
)
   
(9,129
)
Purchase of treasury stock
   
(458
)
   
(197
)
Issuance of treasury stock
   
24
     
119
 
Dividends paid
   
(6,021
)
   
(5,899
)
Other
   
77
     
(1,137
)
Net Cash Provided by (Used in) Financing Activities
   
11,617
     
(6,103
)
Net increase in cash and cash equivalents
   
19,829
     
2,087
 
Cash and cash equivalents beginning of year
   
5,788
     
5,121
 
Cash and Cash Equivalents End of Period
 
$
25,617
   
$
7,208
 
Cash paid during the six months ended June 30 for:
               
   Interest
 
$
3,095
   
$
2,914
 
   Income taxes, net of refunds
 
$
1,470
   
$
2,468
 
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)
 
   
June 30, 2017
 
   
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
         
$
89,604
 
Issuance of treasury stock
           
4
 
Share-based payments
           
(137
)
Balance at end of period
         
$
89,471
 
                 
Retained Earnings
               
Balance at beginning of year
         
$
34,734
 
Net income attributable to AT&T ($1.19 per diluted share)
           
7,384
 
Dividends to stockholders ($0.98 per share)
           
(6,053
)
Other
           
2
 
Balance at end of period
         
$
36,067
 
                 
Treasury Stock
               
Balance at beginning of year
   
(356
)
 
$
(12,659
)
Repurchase and acquisition of common stock
   
(13
)
   
(504
)
Issuance of treasury stock
   
14
     
466
 
Balance at end of period
   
(355
)
 
$
(12,697
)
                 
Accumulated Other Comprehensive Income Attributable to AT&T, net of tax
               
Balance at beginning of year
         
$
4,961
 
Other comprehensive income attributable to AT&T
           
428
 
Balance at end of period
         
$
5,389
 
                 
Noncontrolling Interest
               
Balance at beginning of year
         
$
975
 
Net income attributable to noncontrolling interest
           
204
 
Distributions
           
(174
)
Acquisition of noncontrolling interest
           
132
 
Translation adjustments attributable to noncontrolling interest, net of taxes
           
(4
)
Balance at end of period
         
$
1,133
 
                 
Total Stockholders' Equity at beginning of year
         
$
124,110
 
Total Stockholders' Equity at end of period
         
$
125,858
 
See Notes to Consolidated Financial Statements.
               
 

6

AT&T INC.
JUNE 30, 2017

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. 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, 2016. The results for the interim periods are not necessarily indicative of those for the full year.

In the tables throughout this document, percentage increases and decreases that are not considered meaningful are denoted with a dash.

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

Basis of Presentation  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 consolidated financial statements include the accounts of the Company and our subsidiaries and affiliates over which we exercise control.

All significant intercompany transactions are eliminated in the consolidation process. Investments in unconsolidated 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.

Recently Adopted Accounting Standards
Income Taxes  As of January 1, 2017, we adopted Accounting Standards Update (ASU) No. 2016-16, "Income Taxes (Topic 740)" (ASU 2016-16), with modified retrospective application, resulting in our recognition of an immaterial adjustment to retained earnings. Under ASU 2016-16, we recognize the income tax effects of intercompany sales or transfers of assets other than inventory (e.g., intellectual property or property, plant and equipment) during the period of intercompany sale or transfer instead of the period of either sale or transfer to a third party or recognition of depreciation or impairment.

New Accounting Standards
Pension and Other Postretirement Benefits  In March 2017, the Financial Accounting Standards Board (FASB) issued ASU No. 2017-07, "Compensation – Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost" (ASU 2017-07), which changes the presentation of periodic benefit cost components. Under ASU 2017-07, we will continue to present service costs within our operating expenses but present amortization of prior service credits and other components of our net periodic benefit cost in "other income (expense) – net" in our consolidated statements of income. ASU 2017-07 is effective for annual reporting periods beginning after December 15, 2017. See Note 5 for our components of net periodic benefit cost.

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

7

AT&T INC.
JUNE 30, 2017

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
NOTE 2. EARNINGS PER SHARE

A reconciliation of the numerators and denominators of basic and diluted earnings per share for the three months and six months ended June 30, 2017 and 2016, is shown in the table below:

   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
   
2017
   
2016
   
2017
   
2016
 
Numerators
                       
Numerator for basic earnings per share:
                       
   Net Income
 
$
4,014
   
$
3,515
   
$
7,588
   
$
7,400
 
   Less: Net income attributable to noncontrolling interest
   
(99
)
   
(107
)
   
(204
)
   
(189
)
   Net Income attributable to AT&T
   
3,915
     
3,408
     
7,384
     
7,211
 
   Dilutive potential common shares:
                               
      Share-based payment
   
2
     
2
     
6
     
6
 
Numerator for diluted earnings per share
 
$
3,917
   
$
3,410
   
$
7,390
   
$
7,217
 
Denominators (000,000)
                               
Denominator for basic earnings per share:
                               
   Weighted average number of common shares outstanding
   
6,165
     
6,174
     
6,166
     
6,173
 
   Dilutive potential common shares:
                               
      Share-based payment (in shares)
   
19
     
21
     
19
     
20
 
Denominator for diluted earnings per share
   
6,184
     
6,195
     
6,185
     
6,193
 
Basic earnings per share attributable to AT&T
 
$
0.63
   
$
0.55
   
$
1.19
   
$
1.17
 
Diluted earnings per share attributable to AT&T
 
$
0.63
   
$
0.55
   
$
1.19
   
$
1.17
 
 

8

AT&T INC.
JUNE 30, 2017

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

 
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, 2016
$
(1,995)
 
$
541
 
$
744
 
$
5,671
 
$
4,961
Other comprehensive income
   (loss) before reclassifications
 
343
   
83
   
(504)
   
969
   
891
Amounts reclassified
   from accumulated OCI
 
-
1
 
 
(7)
1
 
 
19
2
 
 
(475)
3
 
 
(463)
Net other comprehensive
   income (loss)
 
343
   
76
   
(485)
   
494
   
428
Balance as of June 30, 2017
$
(1,652)
 
$
617
 
$
259
 
$
6,165
 
$
5,389
                               
 
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
 
174
   
(21)
   
(263)
   
-
   
(110)
Amounts reclassified
   from accumulated OCI
 
-
1
 
 
-
1
 
 
19
2
 
 
(429)
3
 
 
(410)
Net other comprehensive
   income (loss)
 
174
   
(21)
   
(244)
   
(429)
   
(520)
Balance as of June 30, 2016
$
(1,024)
 
$
463
 
$
(228)
 
$
5,603
 
$
4,814
 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 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 segment. We have four reportable segments: (1) Business Solutions, (2) Entertainment Group, (3) Consumer Mobility and (4) International.

We also evaluate segment performance based on EBITDA and/or EBITDA margin, which is defined as Segment Contribution excluding equity in net income (loss) of affiliates and depreciation and amortization. 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.

 
9

AT&T INC.
JUNE 30, 2017

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
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 fixed strategic services; as well as traditional data and voice products. We utilize our wireless and wired networks 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 United States or in U.S. territories. We utilize our copper and IP-based wired network and our satellite technology.

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

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 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 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 consists of (1) 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 consists 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 our satellite fleet. We manage our assets to provide for the most efficient, effective and integrated service to our customers, not by segment, and, therefore, asset information and capital expenditures by segment are not presented. Depreciation is allocated based on asset utilization by segment.
 
 

10

AT&T INC.
JUNE 30, 2017

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
For the three months ended June 30, 2017
 
   
Revenues
   
Operations
and Support
Expenses
   
EBITDA
   
Depreciation
and
Amortization
   
Operating
Income (Loss)
   
Equity in Net
Income (Loss) of
Affiliates
   
Segment
Contribution
 
Business Solutions
 
$
17,107
   
$
10,313
   
$
6,794
   
$
2,335
   
$
4,459
   
$
-
   
$
4,459
 
Entertainment Group
   
12,682
     
9,558
     
3,124
     
1,458
     
1,666
     
(11
)
   
1,655
 
Consumer Mobility
   
7,791
     
4,520
     
3,271
     
871
     
2,400
     
-
     
2,400
 
International
   
2,026
     
1,772
     
254
     
311
     
(57
)
   
25
     
(32
)
Segment Total
   
39,606
     
26,163
     
13,443
     
4,975
     
8,468
   
$
14
   
$
8,482
 
Corporate and Other
   
231
     
87
     
144
     
2
     
142
                 
Acquisition-related items
   
-
     
281
     
(281
)
   
1,170
     
(1,451
)
               
Certain significant items
   
-
     
(164
)
   
164
     
-
     
164
                 
AT&T Inc.
 
$
39,837
   
$
26,367
   
$
13,470
   
$
6,147
   
$
7,323
                 
                                                         
For the six months ended June 30, 2017
 
   
Revenues
   
Operations
and Support
Expenses
   
EBITDA
   
Depreciation
and
Amortization
   
Operating
Income (Loss)
   
Equity in Net
Income (Loss) of
Affiliates
   
Segment
Contribution
 
Business Solutions
 
$
33,955
   
$
20,489
   
$
13,466
   
$
4,647
   
$
8,819
   
$
-
   
$
8,819
 
Entertainment Group
   
25,305
     
19,159
     
6,146
     
2,877
     
3,269
     
(17
)
   
3,252
 
Consumer Mobility
   
15,531
     
9,048
     
6,483
     
1,744
     
4,739
     
-
     
4,739
 
International
   
3,955
     
3,531
     
424
     
601
     
(177
)
   
45
     
(132
)
Segment Total
   
78,746
     
52,227
     
26,519
     
9,869
     
16,650
   
$
28
   
$
16,678
 
Corporate and Other
   
456
     
308
     
148
     
33
     
115
                 
Acquisition-related items
   
-
     
488
     
(488
)
   
2,372
     
(2,860
)
               
Certain significant items
   
-
     
(282
)
   
282
     
-
     
282
                 
AT&T Inc.
 
$
79,202
   
$
52,741
   
$
26,461
   
$
12,274
   
$
14,187
                 
 

11

AT&T INC.
JUNE 30, 2017

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
For the three months ended June 30, 2016
 
   
Revenues
   
Operations
and Support
Expenses
   
EBITDA
   
Depreciation
and
Amortization
   
Operating
Income (Loss)
   
Equity in Net
Income (Loss) of
Affiliates
   
Segment
Contribution
 
Business Solutions
 
$
17,579
   
$
10,857
   
$
6,722
   
$
2,521
   
$
4,201
   
$
-
   
$
4,201
 
Entertainment Group
   
12,711
     
9,569
     
3,142
     
1,489
     
1,653
     
(2
)
   
1,651
 
Consumer Mobility
   
8,186
     
4,680
     
3,506
     
932
     
2,574
     
-
     
2,574
 
International
   
1,828
     
1,723
     
105
     
298
     
(193
)
   
9
     
(184
)
Segment Total
   
40,304
     
26,829
     
13,475
     
5,240
     
8,235
   
$
7
   
$
8,242
 
Corporate and Other
   
216
     
293
     
(77
)
   
20
     
(97
)
               
Acquisition-related items
   
-
     
233
     
(233
)
   
1,316
     
(1,549
)
               
Certain significant items
   
-
     
29
     
(29
)
   
-
     
(29
)
               
AT&T Inc.
 
$
40,520
   
$
27,384
   
$
13,136
   
$
6,576
   
$
6,560
                 
                                                         
For the six months ended June 30, 2016
 
   
Revenues
   
Operations
and Support
Expenses
   
EBITDA
   
Depreciation
and
Amortization
   
Operating
Income (Loss)
   
Equity in Net
Income (Loss) of
Affiliates
   
Segment
Contribution
 
Business Solutions
 
$
35,188
   
$
21,659
   
$
13,529
   
$
5,029
   
$
8,500
   
$
-
   
$
8,500
 
Entertainment Group
   
25,369
     
19,147
     
6,222
     
2,977
     
3,245
     
1
     
3,246
 
Consumer Mobility
   
16,514
     
9,592
     
6,922
     
1,854
     
5,068
     
-
     
5,068
 
International
   
3,495
     
3,311
     
184
     
575
     
(391
)
   
23
     
(368
)
Segment Total
   
80,566
     
53,709
     
26,857
     
10,435
     
16,422
   
$
24
   
$
16,446
 
Corporate and Other
   
489
     
670
     
(181
)
   
37
     
(218
)
               
Acquisition-related items
   
-
     
528
     
(528
)
   
2,667
     
(3,195
)
               
Certain significant items
   
-
     
(682
)
   
682
     
-
     
682
                 
AT&T Inc.
 
$
81,055
   
$
54,225
   
$
26,830
   
$
13,139
   
$
13,691
                 
 
 

12

AT&T INC.
JUNE 30, 2017

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.
 
                         
   
Second Quarter
   
Six Month Period
 
   
2017
   
2016
   
2017
   
2016
 
Business Solutions
 
$
4,459
   
$
4,201
   
$
8,819
   
$
8,500
 
Entertainment Group
   
1,655
     
1,651
     
3,252
     
3,246
 
Consumer Mobility
   
2,400
     
2,574
     
4,739
     
5,068
 
International
   
(32
)
   
(184
)
   
(132
)
   
(368
)
Segment Contribution
   
8,482
     
8,242
     
16,678
     
16,446
 
Reconciling Items:
                               
  Corporate and Other
   
142
     
(97
)
   
115
     
(218
)
  Merger and integration charges
   
(281
)
   
(233
)
   
(488
)
   
(528
)
  Amortization of intangibles acquired
   
(1,170
)
   
(1,316
)
   
(2,372
)
   
(2,667
)
  Actuarial gain (loss)
   
259
     
-
     
259
     
-
 
  Employee separation costs
   
(60
)
   
(29
)
   
(60
)
   
(54
)
  Gain on wireless spectrum transactions
   
63
     
-
     
181
     
736
 
  Venezuela devaluation
   
(98
)
   
-
     
(98
)
   
-
 
  Segment equity in net (income) loss of affiliates
   
(14
)
   
(7
)
   
(28
)
   
(24
)
AT&T Operating Income
   
7,323
     
6,560
     
14,187
     
13,691
 
Interest expense
   
1,395
     
1,258
     
2,688
     
2,465
 
Equity in net income (loss) of affiliates
   
14
     
28
     
(159
)
   
41
 
Other income (expense) - net
   
128
     
91
     
108
     
161
 
Income Before Income Taxes
 
$
6,070
   
$
5,421
   
$
11,448
   
$
11,428
 

NOTE 5. PENSION AND POSTRETIREMENT BENEFITS

Many 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 $8,294 at June 30, 2017. The trust is entitled to receive cumulative cash distributions of $560 per annum, which are distributed quarterly by AT&T Mobility II LLC to the trust, in equal amounts and accounted for as contributions. We distributed $280 to the trust during the six months ended June 30, 2017. 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 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. During the second quarter of 2017, a substantive plan change involving the frequency of considering potential health reimbursement account credit increases was communicated to our retirees. This plan change resulted in additional prior service credits recognized in other comprehensive income, reducing our liability by $1,563. Such credits will be amortized through earnings over a period approximating the average service period to full eligibility. Upon our adoption of ASU 2017-07, the amortization of these prior service credits will be recorded in other income (expense) - net. The plan change also triggered a remeasurement of our postretirement benefit obligation, resulting in an actuarial gain of $259 recognized in the second quarter of 2017.
 

13

AT&T INC.
JUNE 30, 2017

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
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 with Corporate and Other (see Note 4).

   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
   
2017
   
2016
   
2017
   
2016
 
Pension cost:
                       
   Service cost – benefits earned during the period
 
$
282
   
$
278
   
$
564
   
$
556
 
   Interest cost on projected benefit obligation
   
484
     
495
     
968
     
990
 
   Expected return on assets
   
(784
)
   
(780
)
   
(1,567
)
   
(1,558
)
   Amortization of prior service credit
   
(31
)
   
(25
)
   
(62
)
   
(51
)
   Net pension (credit) cost
 
$
(49
)
 
$
(32
)
 
$
(97
)
 
$
(63
)
                                 
Postretirement cost:
                               
   Service cost – benefits earned during the period
 
$
34
   
$
48
   
$
75
   
$
96
 
   Interest cost on accumulated postretirement benefit obligation
   
202
     
243
     
424
     
486
 
   Expected return on assets
   
(79
)
   
(89
)
   
(159
)
   
(178
)
   Amortization of prior service credit
   
(366
   
(319
)
   
(702
)
   
(638
)
   Actuarial (gain) loss     (259
)
          (259
     
   Net postretirement (credit) cost
 
$
(468
)
 
$
(117
)
 
$
(621
)
 
$
(234
)
                                 
   Combined net pension and postretirement (credit) cost
 
$
(517
)
 
$
(149
)
 
$
(718
)
 
$
(297
)

The decrease in the combined net pension and postretirement costs in the second quarter and first six months reflects higher amortization of prior service credits as well as decreasing corporate bond rates, which contributed to lower interest costs.

As part of our second-quarter 2017 remeasurement, we decreased the weighted-average discount rate used to measure our postretirement benefit obligation to 4.10%. The discount rate in effect for determining postretirement service and interest costs after remeasurement is 4.50% and 3.30%, respectively. Including the effects of our plan change and remeasurement, the total estimated prior service credits that will be amortized from accumulated OCI into net periodic benefit cost over the last half of 2017 is $764 ($474 net of tax) for postretirement benefits.

We also provide senior- and middle-management employees with nonqualified, unfunded supplemental retirement and savings plans. For the second quarter ended 2017 and 2016, net supplemental pension benefits costs not included in the table above were $23 and $24. For the first six months of 2017 and 2016, net supplemental pension benefit costs were $45 and $47.
 

14

AT&T INC.
JUNE 30, 2017

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

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, 2016.

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:

 
June 30, 2017
 
December 31, 2016
 
 
Carrying
 
Fair
 
Carrying
 
Fair
 
 
Amount
 
Value
 
Amount
 
Value
 
Notes and debentures1
 
$
142,816
   
$
151,338
   
$
122,381
   
$
128,726
 
Bank borrowings
   
2
     
2
     
4
     
4
 
Investment securities
   
2,556
     
2,556
     
2,587
     
2,587
 
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.
 

15

AT&T INC.
JUNE 30, 2017

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
Following is the fair value leveling for available-for-sale securities and derivatives as of June 30, 2017 and December 31, 2016:

   
June 30, 2017
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Available-for-Sale Securities
                       
   Domestic equities
 
$
1,276
   
$
-
   
$
-
   
$
1,276
 
   International equities
   
659
     
-
     
-
     
659
 
   Fixed income bonds
   
-
     
370
     
-
     
370
 
Asset Derivatives1
                               
   Interest rate swaps
   
-
     
57
     
-
     
57
 
   Cross-currency swaps
   
-
     
294
     
-
     
294
 
   Interest rate locks
   
-
     
3
     
-
     
3
 
Liability Derivatives1
                               
   Interest rate swaps
   
-
     
(42
)
   
-
     
(42
)
   Cross-currency swaps
   
-
     
(2,631
)
   
-
     
(2,631
)
   Interest rate locks
   
-
     
(82
)
   
-
     
(82
)
1 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. 

   
December 31, 2016
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Available-for-Sale Securities
                       
   Domestic equities
 
$
1,215
   
$
-
   
$
-
   
$
1,215
 
   International equities
   
594
     
-
     
-
     
594
 
   Fixed income bonds
   
-
     
508
     
-
     
508
 
Asset Derivatives1
                               
   Interest rate swaps
   
-
     
79
     
-
     
79
 
   Cross-currency swaps
   
-
     
89
     
-
     
89
 
Liability Derivatives1
                               
   Interest rate swaps
   
-
     
(14
)
   
-
     
(14
)
   Cross-currency swaps
   
-
     
(3,867
)
   
-
     
(3,867
)
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 $220 have maturities of less than one year, $33 within one to three years, $32 within three to five years and $85 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.
 
 

16

AT&T INC.
JUNE 30, 2017

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
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 six months ended June 30, 2017 and June 30, 2016, no ineffectiveness was measured on interest rate swaps designated as fair value hedges.

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 denominated amounts 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 six months ended June 30, 2017 and June 30, 2016, 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 six months ended June 30, 2017 and June 30, 2016, no ineffectiveness was measured on foreign exchange contracts designated as cash flow hedges.
 
 

17

AT&T INC.
JUNE 30, 2017

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
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 June 30, 2017, we had posted collateral of $2,297 (a deposit asset) and held collateral of $13 (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 June, we would have been required to post additional collateral of $133. If DIRECTV Holdings LLC's credit rating had been downgraded below BBB- (S&P), we would have been required to post additional collateral of $239. At December 31, 2016, we had posted collateral of $3,242 (a deposit asset) and held no collateral. 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:

   
June 30,
   
December 31,
 
   
2017
   
2016
 
Interest rate swaps
 
$
10,775
   
$
9,650
 
Cross-currency swaps
   
38,694
     
29,642
 
Interest rate locks
   
5,000
     
-
 
Total
 
$
54,469
   
$
39,292
 

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
 
Six months ended
 
June 30,
 
June 30,
 
2017
 
2016
 
2017
 
2016
 
Interest rate swaps (Interest expense):
                       
     Gain (Loss) on interest rate swaps
 
$
(23
)
 
$
5
   
$
(48
)
 
$
71
 
     Gain (Loss) on long-term debt
   
23
     
(5
)
   
48
     
(71
)

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

Three months ended
 
Six months ended
 
June 30,
 
June 30,
 
Cash Flow Hedging Relationships
2017
 
2016
 
2017
 
2016
 
Cross-currency swaps:
                       
     Gain (Loss) recognized in accumulated OCI
 
$
(717
)
 
$
(595
)
 
$
(697
)
 
$
(404
)
Interest rate locks:
                               
     Gain (Loss) recognized in accumulated OCI
   
(79
)
   
-
     
(79
)
   
-
 
     Interest income (expense) reclassified from
        accumulated OCI into income
   
(14
)
   
(14
)
   
(29
)
   
(29
)

 

18

AT&T INC.
JUNE 30, 2017

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
NOTE 7. ACQUISITIONS, DISPOSITIONS AND OTHER ADJUSTMENTS

Acquisitions
Auction 1000 On April 13, 2017, the Federal Communications Commission (FCC) announced that we were the successful bidder for $910 of spectrum in 18 markets. We provided the FCC an initial deposit of $2,348 in July 2016 and received a refund of $1,438 in April 2017.

Dispositions
YP Holdings LLC  In June 2017, YP Holdings LLC was acquired by Dex Media. Our second-quarter results include a gain of $36 for our portion of the proceeds.

Pending Acquisitions
Time Warner Inc.  On October 22, 2016, we entered into and 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 March 31, 2017, the total transaction value is approximately $107,160. Each share of Time Warner common stock will be exchanged for $53.75 per share in cash and a number of shares of AT&T common stock equal to the exchange ratio. If the average stock price (as defined in the Merger Agreement) at the time of closing the Merger 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.

Time Warner is a global leader in media and entertainment whose major businesses encompass an array of some 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 for audiences around the world with our extensive customer relationships and distribution, one of the world's largest pay-TV subscriber bases and leading scale in TV, mobile and broadband distribution.

The Merger Agreement was approved by Time Warner shareholders on February 15, 2017 and remains subject to review by the U.S. Department of Justice and certain foreign jurisdictions. The FCC has stated that it does not believe it will need to review the deal as no licenses are involved. It is also a condition to closing that necessary consents from 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.

Other Events
FirstNet  On March 30, 2017, the First Responder Network Authority (FirstNet) announced its selection of AT&T to build and manage the first nationwide broadband network dedicated to America's first responders. FirstNet expects to provide 20 MHz of valuable telecommunications spectrum and success-based payments of $6,500 over the next five years to support network buildout. The actual reach of the network and our investment over the 25-year period will be determined by the number of individual states electing to participate in FirstNet. As of July 31, 2017, seven states have opted-in to the program. We do not expect FirstNet to materially impact our 2017 results.
 

 

19

AT&T INC.
JUNE 30, 2017

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 June 30, 2017 and December 31, 2016, gross equipment installment receivables of $3,920 and $5,665 were included on our consolidated balance sheets, of which $2,230 and $3,425 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 transfer certain receivables to the Purchasers for cash and additional consideration upon settlement of the receivables, referred to as the deferred purchase price. In June 2017, we modified the agreement with the Purchasers such that we receive more upfront cash consideration at the time the receivables are transferred to the Purchasers. Additionally, in the event a customer trades in a device prior to the end of the installment contract period, we agree to make a payment to the Purchasers equal to any outstanding remaining installment receivable balance. Accordingly, we record a guarantee obligation to the Purchasers for this estimated amount at the time the receivables are transferred. Under the terms of the agreement, we continue to bill and collect the payments from our customers on behalf of the Purchasers. Since inception, cash proceeds received, net of remittances (excluding amounts returned as deferred purchase price), were $3,946.

The following table sets forth a summary of equipment installment receivables sold during the three and six months ended June 30, 2017 and 2016:

 
Three months ended
   
Six months ended
 
 
June 30,
   
June 30,
 
 
2017
   
2016
   
2017
   
2016
 
Gross receivables sold
 
$
1,752
   
$
1,845
   
$
4,598
   
$
4,327
 
Net receivables sold1
   
1,599
     
1,671
     
4,220
     
3,927
 
Cash proceeds received
   
1,415
     
1,126
     
2,847
     
2,647
 
Deferred purchase price recorded
   
293
     
563
     
1,482
     
1,282
 
Guarantee obligation recorded
   
74
     
-
     
74
     
-
 
1 Receivables net of allowance, imputed interest and trade-in right guarantees. 

The deferred purchase price and guarantee obligation are initially recorded at estimated fair value and subsequently carried at the lower of cost or net realizable value. The estimation of their fair values is based on remaining installment payments expected to be collected and the expected timing and value of device trade-ins. 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 for the deferred purchase price and the guarantee obligation 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, which we repurchased in exchange for the associated deferred purchase price during the three months and six months ended June 30, 2017 and 2016:

 
Three months ended
 
Six months ended
 
 
June 30,
 
June 30,
 
 
2017
 
2016
 
2017
 
2016
 
Fair value of repurchased receivables
 
$
337
   
$
-
   
$
714
   
$
532
 
Carrying value of deferred purchase price
   
301
     
-
     
640
     
539
 
Gain (loss) on repurchases1
 
$
36
   
$
-
   
$
74
   
$
(7
)
1 These gains (losses) are included in "Selling, general and administrative" in the consolidated statements of income. 

 

20

AT&T INC.
JUNE 30, 2017

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
 
At June 30, 2017 and December 31, 2016, our deferred purchase price receivable was $3,648 and $3,090, respectively, of which $2,232 and $1,606 are 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 total amount of our deferred purchase price and guarantee obligation.

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.

Derecognized Installment Receivables
The following table sets forth a summary of equipment installment receivables that were sold to Purchasers and are no longer considered our assets.

   
2017
 
Outstanding derecognized receivables at January 1,
 
$
7,232
 
   Gross receivables sold
   
4,598
 
   Collections on cash purchase price
   
(2,337
)
   Collections on deferred purchase price
   
(382
)
   Fees
   
(48
)
   Trade ins and other
   
(141
)
   Fair value of repurchased receivables
   
(714
)
Outstanding derecognized receivables at June 30,
 
$
8,208
 

NOTE 9. SUBSEQUENT EVENT
On July 27, 2017, we initiated a debt offering for $22,500 that will be completed on August 7, 2017. The proceeds will be used for general corporate purposes, including funding the cash consideration for the Time Warner acquisition. Upon settlement of the debt offering, we expect to terminate our bridge loan credit agreement.

Details for the offering are as follows:
·
$750 of floating rate notes due 2023.
·
$1,750 of 2.850% global notes due 2023.
·
$3,000 of 3.400% global notes due 2024.
·
$5,000 of 3.900% global notes due 2027.
·
$4,500 of 4.900% global notes due 2037.
·
$5,000 of 5.150% global notes due 2050.
·
$2,500 of 5.300% global notes due 2058.
The notes detailed above, along with $7,301 of floating rate and global notes issued in June 2017, are subject to a special mandatory redemption feature. If we do not consummate the Time Warner acquisition pursuant to the merger agreement on or prior to April 22, 2018, or, if prior to such date, the merger agreement is terminated, then in either case, we must redeem the notes at a redemption price equal to 101% of the principal amount of the notes, plus accrued but unpaid interest.
 
In conjunction with this offering, we settled our interest rate locks.


21

AT&T INC.
JUNE 30, 2017

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

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. 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.

Consolidated Results  Our financial results in the second quarter and for the first six months of 2017 and 2016 are summarized as follows:

   
Second Quarter
   
Six-Month Period
 
   
2017
   
2016
   
Percent
Change
   
2017
   
2016
   
Percent
Change
 
 
Operating Revenues
                                   
   Service
 
$
36,538
   
$
37,142
     
(1.6
)%
 
$
72,994
   
$
74,243
     
(1.7
)%
   Equipment
   
3,299
     
3,378
     
(2.3
)
   
6,208
     
6,812
     
(8.9
)
Total Operating Revenues
   
39,837
     
40,520
     
(1.7
)
   
79,202
     
81,055
     
(2.3
)
                                                 
Operating expenses
                                               
   Cost of services and sales