Edgar Filing: AT&T INC.

q1_10q.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 March 31, 2014

		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 April 30, 2014 there were 5,190 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
	March 31,
	2014			2013
Operating Revenues	$	32,476		$	31,356

Operating Expenses
Cost of services and sales (exclusive of depreciation
and amortization shown separately below)		13,321			12,554
Selling, general and administrative		8,260			8,333
Depreciation and amortization		4,617			4,529
Total operating expenses		26,198			25,416
Operating Income		6,278			5,940
Other Income (Expense)
Interest expense		(860	)		(827	)
Equity in net income of affiliates		88			185
Other income (expense) – net		145			32
Total other income (expense)		(627	)		(610	)
Income Before Income Taxes		5,651			5,330
Income tax expense		1,917			1,557
Net Income		3,734			3,773
Less: Net Income Attributable to Noncontrolling Interest		(82	)		(73	)
Net Income Attributable to AT&T	$	3,652		$	3,700
Basic Earnings Per Share Attributable to AT&T	$	0.70		$	0.67
Diluted Earnings Per Share Attributable to AT&T	$	0.70		$	0.67
Weighted Average Number of Common Shares Outstanding – Basic (in millions)		5,222			5,513
Weighted Average Number of Common Shares Outstanding – with Dilution (in millions)		5,238			5,530
Dividends Declared Per Common Share	$	0.46		$	0.45
See Notes to Consolidated Financial Statements.

AT&T INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Dollars in millions
(Unaudited)
	Three months ended
	March 31,
	2014			2013
Net income	$	3,734		$	3,773
Other comprehensive income, net of tax:
Foreign Currency:
Foreign currency translation adjustment (includes $0 and $0 attributable to noncontrolling interest), net of taxes of $(9) and $62		(20	)		121
Reclassification adjustment included in net income, net of taxes of $14 and $0		25			-
Available-for-sale securities:
Net unrealized gains, net of taxes of $10 and $40		16			75
Reclassification adjustment included in net income, net of taxes of $(7) and $(4)		(11	)		(7	)
Cash flow hedges:
Net unrealized gains, net of taxes of $3 and $49		6			90
Reclassification adjustment included in net income, net of taxes of $4 and $4		7			7
Defined benefit postretirement plans:
Reclassification adjustment included in net income, net of taxes of $2 and $0		3			-
Amortization of net prior service credit included in net income, net of taxes of $(147) and $(109)		(240	)		(178	)
Other comprehensive income (loss)		(214	)		108
Total comprehensive income		3,520			3,881
Less: Total comprehensive income attributable to noncontrolling interest		(82	)		(73	)
Total Comprehensive Income Attributable to AT&T	$	3,438		$	3,808
See Notes to Consolidated Financial Statements.

AT&T INC.
CONSOLIDATED BALANCE SHEETS
Dollars in millions except per share amounts
	March 31,			December 31,
	2014			2013
Assets	(Unaudited)
Current Assets
Cash and cash equivalents	$	3,611		$	3,339
Accounts receivable - net of allowances for doubtful accounts of $483 and $483		13,120			12,918
Prepaid expenses		1,000			960
Deferred income taxes		1,171			1,199
Other current assets		5,187			4,780
Total current assets		24,089			23,196
Property, plant and equipment		278,862			274,798
Less: accumulated depreciation and amortization		(166,053	)		(163,830	)
Property, Plant and Equipment – Net		112,809			110,968
Goodwill		69,720			69,273
Licenses		59,584			56,433
Other Intangible Assets – Net		6,515			5,779
Investments in Equity Affiliates		3,613			3,860
Other Assets		9,010			8,278
Total Assets	$	285,340		$	277,787

Liabilities and Stockholders’ Equity
Current Liabilities
Debt maturing within one year	$	8,301		$	5,498
Accounts payable and accrued liabilities		22,234			21,107
Advanced billing and customer deposits		4,121			4,212
Accrued taxes		2,784			1,774
Dividends payable		2,390			2,404
Total current liabilities		39,830			34,995
Long-Term Debt		71,575			69,290
Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes		36,448			36,308
Postemployment benefit obligation		30,029			29,946
Other noncurrent liabilities		16,089			15,766
Total deferred credits and other noncurrent liabilities		82,566			82,020

Stockholders’ Equity
Common stock ($1 par value, 14,000,000,000 authorized at March 31, 2014 and
December 31, 2013: issued 6,495,231,088 at March 31, 2014 and December 31, 2013)		6,495			6,495
Additional paid-in capital		91,027			91,091
Retained earnings		32,402			31,141
Treasury stock (1,300,637,055 at March 31, 2014 and 1,268,914,913
at December 31, 2013, at cost)		(46,684	)		(45,619	)
Accumulated other comprehensive income		7,666			7,880
Noncontrolling interest		463			494
Total stockholders’ equity		91,369			91,482
Total Liabilities and Stockholders’ Equity	$	285,340		$	277,787
See Notes to Consolidated Financial Statements.

AT&T INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Dollars in millions
(Unaudited)
	Three months ended
	March 31,
	2014			2013
Operating Activities
Net income	$	3,734		$	3,773
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		4,617			4,529
Undistributed earnings from investments in equity affiliates		17			(185	)
Provision for uncollectible accounts		241			262
Deferred income tax expense		578			433
Net (gain) loss from sale of investments, net of impairments		(122	)		(11	)
Changes in operating assets and liabilities:
Accounts receivable		(498	)		295
Other current assets		(340	)		864
Accounts payable and accrued liabilities		1,025			(1,675	)
Retirement benefit funding		(140	)		-
Other - net		(313	)		(86	)
Total adjustments		5,065			4,426
Net Cash Provided by Operating Activities		8,799			8,199

Investing Activities
Construction and capital expenditures:
Capital expenditures		(5,716	)		(4,252	)
Interest during construction		(55	)		(66	)
Acquisitions, net of cash acquired		(662	)		(1,045	)
Dispositions		351			5
Other		-			1
Net Cash Used in Investing Activities		(6,082	)		(5,357	)

Financing Activities
Net change in short-term borrowings with original maturities of three months or less		(17	)		274
Issuance of other short-term borrowings		-			1,474
Issuance of long-term debt		2,987			4,875
Repayment of long-term debt		(1,867	)		(1,791	)
Purchase of treasury stock		(1,237	)		(5,911	)
Issuance of treasury stock		13			56
Dividends paid		(2,398	)		(2,502	)
Other		74			(310	)
Net Cash Used in Financing Activities		(2,445	)		(3,835	)
Net increase (decrease) in cash and cash equivalents		272			(993	)
Cash and cash equivalents beginning of year		3,339			4,868
Cash and Cash Equivalents End of Period	$	3,611		$	3,875

Cash paid (received) during the three months ended March 31 for:
Interest	$	976		$	1,080
Income taxes, net of refunds	$	(40	)	$	(1,114	)
See Notes to Consolidated Financial Statements.

AT&T INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
Dollars and shares in millions except per share amounts
(Unaudited)
	March 31, 2014
	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		$	91,091
Issuance of treasury stock			4
Share-based payments			(68)
Balance at end of period		$	91,027

Retained Earnings
Balance at beginning of year		$	31,141
Net income attributable to AT&T ($0.70 per diluted share)			3,652
Dividends to stockholders ($0.46 per share)			(2,391)
Balance at end of period		$	32,402

Treasury Stock
Balance at beginning of year	(1,269)	$	(45,619)
Repurchase of common stock	(37)		(1,237)
Issuance of treasury stock	5		172
Balance at end of period	(1,301)	$	(46,684)

Accumulated Other Comprehensive Income Attributable to AT&T, net of tax
Balance at beginning of year		$	7,880
Other comprehensive loss attributable to AT&T			(214)
Balance at end of period		$	7,666

Noncontrolling Interest
Balance at beginning of year		$	494
Net income attributable to noncontrolling interest			82
Distributions			(113)
Balance at end of period		$	463

Total Stockholders’ Equity at beginning of year		$	91,482
Total Stockholders’ Equity at end of period		$	91,369
See Notes to Consolidated Financial Statements.

AT&T INC.

MARCH 31, 2014

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.” We believe that these consolidated financial statements include all adjustments, consisting only of normal recurring accruals, that are necessary to present fairly the results for the presented interim periods. 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, 2013. On March 13, 2014, we closed our acquisition of Leap Wireless International, Inc. (Leap) (see Note 7), and we incorporated them into our wireless operations following the date of acquisition.

The consolidated financial statements include the accounts of the Company and our majority-owned subsidiaries and affiliates. Our subsidiaries and affiliates operate in the communications services industry both domestically and internationally, providing wireless communications services, traditional wireline voice services, data/broadband and Internet services, video services, telecommunications equipment, managed networking and wholesale services.

All significant intercompany transactions are eliminated in the consolidation process. Investments in partnerships and less than majority-owned subsidiaries where we have significant influence are accounted for under the equity method. Earnings from certain foreign equity investments accounted for using the equity method are included for periods ended within up to one month of our period end. We also record our proportionate share of our equity method investees’ other comprehensive income (OCI) items, including actuarial gains and losses on pension and other postretirement benefit obligations.

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. Certain amounts have been reclassified to conform to the current period’s presentation.

Equipment Installment Plan Under our AT&T NextSM (AT&T Next) program, we offer our customers the option to purchase certain devices in installments over a period of up to 26 months. Additionally, after a specified period of time they also have the right to trade in the original device for a new device and have the remaining unpaid balance satisfied. For customers that elect these trade-in programs, we recognize revenue at the point of sale for the entire amount of the customer receivable, net of the fair value of the trade-in right guarantee and imputed interest. As of March 31, 2014, total equipment installment plan receivables of $2,447 were included on our consolidated balance sheets.

Stock Repurchase Program During the first quarter of 2014, we had repurchased approximately 37 million shares totaling $1,237 under a repurchase authorization that was approved by our Board of Directors in March 2013. In March 2014, our Board of Directors approved another authorization to repurchase 300 million shares of our common stock. At March 31, 2014, we had 425 million shares remaining under these authorizations. The repurchase authorizations have no expiration date, and we expect to make future repurchases opportunistically.

AT&T INC.

MARCH 31, 2014

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 earnings per share and diluted earnings per share for the three months ended March 31, 2014 and 2013, is shown in the table below:

	Three months ended
	March 31,
	2014			2013
Numerators
Numerator for basic earnings per share:
Net income	$	3,734		$	3,773
Less: Net income attributable to noncontrolling interest		(82	)		(73	)
Net income attributable to AT&T		3,652			3,700
Dilutive potential common shares:
Share-based payment		4			4
Numerator for diluted earnings per share	$	3,656		$	3,704
Denominators (000,000)
Denominator for basic earnings per share:
Weighted-average number of common shares outstanding		5,222			5,513
Dilutive potential common shares:
Share-based payment (in shares)		16			17
Denominator for diluted earnings per share		5,238			5,530
Basic earnings per share attributable to AT&T	$	0.70		$	0.67
Diluted earnings per share attributable to AT&T	$	0.70		$	0.67

At March 31, 2014 and 2013, we had issued and outstanding options to purchase approximately 12 million and 15 million shares of AT&T common stock. For the quarter ended March 31, 2014 and 2013, the exercise prices of 3 million and 4 million shares were above the market price of AT&T stock for the respective periods. Accordingly, we did not include these amounts in determining the dilutive potential common shares.

AT&T INC.

MARCH 31, 2014

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) for the three months ended March 31, 2014 and 2013, are presented below. All amounts are net of tax and exclude noncontrolling interest.


At March 31, 2014 and for the period ended:
		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, 2013		$	(367)	$	450	$	445	$	7,352	$	7,880
Other comprehensive income (loss) before reclassifications			(20)		16		6		-		2
Amounts reclassified from accumulated OCI			251		(11)2		73		(237)4		(216)
Net other comprehensive income (loss)			5		5		13		(237)		(214)
Balance as of March 31, 2014		$	(362)	$	455	$	458	$	7,115	$	7,666

At March 31, 2013 and for the period ended:
		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, 2012		$	(284)	$	272	$	(110)	$	5,358	$	5,236
Other comprehensive income before reclassifications			121		75		90		-		286
Amounts reclassified from accumulated OCI			- 1		(7)2		73		(178)4		(178)
Net other comprehensive income (loss)			121		68		97		(178)		108
Balance as of March 31, 2013		$	(163)	$	340	$	(13)	$	5,180	$	5,344
1	Pre-tax translation loss reclassifications are included in Other income (expense) - net in the consolidated statements of income.
2	Realized gains (losses) are included in Other income (expense) - net in the consolidated statements of income.
3	Realized (gains) losses are included in interest expense in the consolidated statements of income. See Note 6 for additional information.
4	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). Actuarial loss
	reclassifications related to our equity method investees are included in Other income (expense) - net in the consolidated statements of income.

AT&T INC.

MARCH 31, 2014

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

NOTE 4. SEGMENT INFORMATION

Our segments are strategic business units that offer different products and services over various technology platforms and are managed accordingly. We analyze our operating segments based on segment income before income taxes. We make our capital allocation decisions based on our strategic direction of the business, needs of the network (wireless or wireline) providing services and demands to provide emerging services to our customers. Actuarial gains and losses from pension and other postretirement benefits, interest expense and other income (expense) – net, are managed only on a total company basis and are, accordingly, reflected only in consolidated results. Therefore, these items are not included in each segment’s reportable results. The customers and long-lived assets of our reportable segments are predominantly in the United States. We have two reportable segments: (1) Wireless and (2) Wireline.

The Wireless segment uses our nationwide network to provide consumer and business customers with wireless data and voice communications services. This segment includes our portion of the results from our mobile payment joint venture marketed as the Isis Mobile WalletTM, which is accounted for as an equity investment.

The Wireline segment uses our regional, national and global network to provide consumer and business customers with data and voice communications services, AT&T U-verse® high speed Internet, video and VoIP services and managed networking to business customers.

The Corporate and Other column includes unallocated corporate expenses, which includes costs to support corporate-driven activities and operations, 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 as well as our actuarial gains and losses on our pension and postretirement plan valuations. Results from equity method investments in América Móvil, S.A. de C.V. and YP Holdings LLC are also excluded from our segment results as those results are nonoperational and not considered in our assessment of segment performance. We have revised our prior-period presentation to conform to our current reporting.

AT&T INC.

MARCH 31, 2014

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

In the following tables, we show how our segment results are reconciled to our consolidated results reported.

For the three months ended March 31, 2014:
	Wireless			Wireline		Corporate and Other			Consolidated Results
Service	$	15,387		$	14,389	$	-		$	29,776
Equipment		2,479			212		9			2,700
Total segment operating revenues		17,866			14,601		9			32,476
Operations and support expenses		10,882			10,457		242			21,581
Depreciation and amortization expenses		1,931			2,684		2			4,617
Total segment operating expenses		12,813			13,141		244			26,198
Segment operating income (loss)		5,053			1,460		(235	)		6,278
Interest expense		-			-		860			860
Equity in net income (loss) of affiliates		(20	)		1		107			88
Other income (expense) – net		-			-		145			145
Segment income (loss) before income taxes	$	5,033		$	1,461	$	(843	)	$	5,651

For the three months ended March 31, 2013:
	Wireless			Wireline		Corporate and Other			Consolidated Results
Service	$	15,062		$	14,381	$	-		$	29,443
Equipment		1,629			274		10			1,913
Total segment operating revenues		16,691			14,655		10			31,356
Operations and support expenses		10,180			10,335		372			20,887
Depreciation and amortization expenses		1,835			2,688		6			4,529
Total segment operating expenses		12,015			13,023		378			25,416
Segment operating income (loss)		4,676			1,632		(368	)		5,940
Interest expense		-			-		827			827
Equity in net income (loss) of affiliates		(18	)		1		202			185
Other income (expense) – net		-			-		32			32
Segment income (loss) before income taxes	$	4,658		$	1,633	$	(961	)	$	5,330

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 as active employees earn these benefits. 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 meet the plans’ obligations to provide benefits to employees upon their retirement.

On September 9, 2013, we made a voluntary contribution of a preferred equity interest in AT&T Mobility II LLC, the primary holding company for our wireless business, to the trust used to pay pension benefits under our qualified pension plans. The preferred equity interest had a value of $9,222 at March 31, 2014. The trust is entitled to receive cumulative cash distributions of $560 per annum, which will be distributed quarterly in equal amounts and will be accounted for as contributions. We distributed $140 to the trust during the three months ended March 31, 2014. 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.

AT&T INC.

MARCH 31, 2014

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

On September 9, 2013, the Department of Labor (DOL) published a proposed exemption that authorized retroactive approval of this voluntary contribution. The proposal was open for public comment and we are currently awaiting a final decision by the DOL. Our retirement benefit plans, including required contributions, are subject to the provisions of ERISA.

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, expense credits are denoted with parentheses. A portion of these expenses is capitalized as part of internal construction projects, providing a small reduction in the net expense recorded.

	Three months ended
	March 31,
	2014			2013
Pension cost:
Service cost – benefits earned during the period	$	282		$	330
Interest cost on projected benefit obligation		661			607
Expected return on assets		(849	)		(828	)
Amortization of prior service credit		(24	)		(23	)
Net pension cost	$	70		$	86

Postretirement cost:
Service cost – benefits earned during the period	$	58		$	95
Interest cost on accumulated postretirement benefit obligation		365			390
Expected return on assets		(164	)		(178	)
Amortization of prior service credit		(362	)		(263	)
Net postretirement (credit) cost	$	(103	)	$	44

Combined net pension and postretirement (credit) cost	$	(33	)	$	130

Our combined net pension and postretirement cost decreased $163 in the first quarter of 2014. The decrease reflects higher amortization of prior service credits due to plan changes, including changes to future costs for continued retiree healthcare coverage. The decrease also reflects increasing corporate bond rates, which contributed to lower service cost and higher interest costs.

Due in part to our 2013 enhanced retirement offer and projected distribution levels, we expect that lump sum distributions from the plan during 2014 could exceed service and interest costs, resulting in settlement accounting for a portion of our pension plan. This would result in remeasurement of the plans assets and obligations, with remeasurement for each interim period thereafter.

We also provide senior- and middle-management employees with nonqualified, unfunded supplemental retirement and savings plans. Net supplemental retirement pension benefits cost, which is not included in the table above, was $29 in the first quarter of 2014, of which $27 was interest cost, and $27 for the first quarter of 2013, of which $25 was interest cost.

AT&T INC.

MARCH 31, 2014

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. Valuation techniques used should 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, 2013.

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:

	March 31, 2014				December 31, 2013
		Carrying		Fair		Carrying		Fair
		Amount		Value		Amount		Value
Notes and debentures	$	79,552	$	85,698	$	74,484	$	79,309
Commercial paper		-		-		20		20
Bank borrowings		4		4		1		1
Investment securities		2,609		2,609		2,450		2,450

The carrying value 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.

AT&T INC.

MARCH 31, 2014

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

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 $116 have maturities of less than one year, $515 within one to three years, $65 within three to five years, and $251 for five or more years.

Our short-term investments (including money market securities) and customer deposits are recorded at amortized cost, and the respective carrying amounts approximate fair values. Our investment securities are recorded in “Other Assets” on the consolidated balance sheets.

Following is the fair value leveling for available-for-sale securities and derivatives as of March 31, 2014 and December 31, 2013:

	March 31, 2014
	Level 1		Level 2			Level 3		Total
Available-for-Sale Securities
Domestic equities	$	1,055	$	-		$	-	$	1,055
International equities		543		-			-		543
Fixed income bonds		-		947			-		947
Asset Derivatives1
Interest rate swaps		-		176			-		176
Cross-currency swaps		-		2,020			-		2,020
Liability Derivatives1
Interest rate swaps		-		(8	)		-		(8	)
Cross-currency swaps		-		(534	)		-		(534	)

	December 31, 2013
	Level 1		Level 2			Level 3		Total
Available-for-Sale Securities
Domestic equities	$	1,049	$	-		$	-	$	1,049
International equities		563		-			-		563
Fixed income bonds		-		759			-		759
Asset Derivatives1
Interest rate swaps		-		191			-		191
Cross-currency swaps		-		1,951			-		1,951
Liability Derivatives1
Interest rate swaps		-		(7	)		-		(7	)
Cross-currency swaps		-		(519	)		-		(519	)
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.

AT&T INC.

MARCH 31, 2014

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

Derivative Financial Instruments

We employ derivatives 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.

The majority of our derivatives are designated either as a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedge), or as a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge).

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 three months ended March 31, 2014 and March 31, 2013, 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 and Canadian dollar denominated debt. These agreements include initial and final exchanges of principal from fixed foreign denominations to fixed U.S. denominated amounts, to be exchanged at a specified rate, which was determined by the market spot rate upon issuance. They also include an interest rate swap of a fixed foreign-denominated rate to a fixed U.S. 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, both for the period they are outstanding. 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 or expense in each period. We evaluate the effectiveness of our cross-currency swaps each quarter. In the three months ended March 31, 2014 and March 31, 2013, 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 $43 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. Some of these instruments are designated as cash flow hedges while others remain nondesignated, largely based on size and duration. 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) in the consolidated statements of income. In the three months ended March 31, 2014 and March 31, 2013, no ineffectiveness was measured on foreign exchange contracts designated as cash flow hedges.

AT&T INC.

MARCH 31, 2014

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 March 31, 2014, we had posted collateral of $28 (a deposit asset) and held collateral of $1,752 (a receipt liability). Under the agreements, if our credit rating had been downgraded one rating level by Moody’s Investors Service and Standard & Poor’s and two rating levels by Fitch, Inc., before the final collateral exchange in March, we would have been required to post additional collateral of $51. At December 31, 2013, we had posted collateral of $8 (a deposit asset) and held collateral of $1,600 (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), against the fair value of the derivative instruments.

Following is the notional amount of our outstanding derivative positions:

	March 31,			December 31,
	2014			2013
Interest rate swaps		$	6,100		$	4,750
Cross-currency swaps			17,787			17,787
Total		$	23,887		$	22,537

Following is the related hedged items affecting our financial position and performance:

Effect of Derivatives on the Consolidated Statements of Income
	Three months ended
	March 31,			March 31,
Fair Value Hedging Relationships	2014			2013
Interest rate swaps (Interest expense):
Gain (Loss) on interest rate swaps	$	(11	)	$	(24	)
Gain (Loss) on long-term debt		11			24

In addition, the net swap settlements that accrued and settled in the quarter ended March 31 were offset against interest expense.

	Three months ended
	March 31,			March 31,
Cash Flow Hedging Relationships	2014			2013
Cross-currency swaps:
Gain (Loss) recognized in accumulated OCI	$	11		$	141
Interest rate locks:
Interest income (expense) reclassified from accumulated OCI into income		(11	)		(11	)
Foreign exchange contracts:
Gain (Loss) recognized in accumulated OCI		(2	)		(2	)

AT&T INC.

MARCH 31, 2014

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

NOTE 7. ACQUSISTIONS, DISPOSITIONS AND OTHER ADJUSTMENTS

Acquisitions

Leap On March 13, 2014, we acquired Leap, a provider of prepaid wireless service, for fifteen dollars per outstanding share of Leap’s common stock, or $1,248 (excluding Leap’s cash on hand), plus one nontransferable contingent value right (CVR) per share. The CVR will entitle each Leap stockholder to a pro rata share of the net proceeds of the future sale of the Chicago 700 MHz A-band Federal Communications Commission (FCC) license held by Leap.

The preliminary values of assets acquired under the terms of the agreement were: $3,070 in licenses, $520 in property, plant and equipment, $490 of customer lists, $340 for trade names and $346 of goodwill. The estimated fair value of debt associated with the acquisition of Leap was $3,889.

In connection with the acquisition, we retired Leap’s term and other loans and paid $1,869, including accrued interest in March 2014. In April 2014, we paid $1,889, including accrued interest and redemption premiums, to redeem additional Leap notes outstanding.

Pending Disposition

Connecticut Wireline In December 2013, we entered into an agreement to sell our incumbent local exchange operations in Connecticut for $2,000 in cash. The transaction is subject to review by the FCC and the Connecticut Public Utilities Regulatory Authority and other state regulatory authorities. We expect the deal to close in the fourth quarter of 2014, subject to customary closing conditions.

We applied held-for-sale treatment to the assets and liabilities of the Connecticut operations, and, accordingly, included the assets in “Other current assets,” and the related liabilities in “Accounts payable and accrued liabilities,” on our consolidated balance sheets. However, the business does not qualify as discontinued operations as we expect significant continuing direct cash flows related to the disposed operations. Assets and liabilities of the Connecticut operations included the following:

	March 31,		December 31,
	2014		2013
Assets held for sale:
Current assets	$	146	$	155
Property, plant and equipment - net		1,323		1,289
Goodwill		799		799
Other assets		18		17
Total assets	$	2,286	$	2,260

Liabilities related to assets held for sale:
Current liabilities	$	122	$	128
Noncurrent liabilities		567		480
Total liabilities	$	689	$	608

AT&T INC.

MARCH 31, 2014

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in millions except per share 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 services industry in both the United States and internationally, providing wireless and wireline telecommunications services and equipment. You should read this discussion in conjunction with the consolidated financial statements, accompanying notes and management’s discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the year ended December 31, 2013. 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.

Consolidated Results Our financial results in the first quarter of 2014 and 2013 are summarized as follows:

	First Quarter
	2014		2013		Percent Change
	2014		2013		Percent Change
Operating Revenues	$	32,476	$	31,356		3.6	%
Operating expenses
Cost of services and sales		13,321		12,554		6.1
Selling, general and administrative		8,260		8,333		(0.9	)
Depreciation and amortization		4,617		4,529		1.9
Total Operating Expenses		26,198		25,416		3.1
Operating Income		6,278		5,940		5.7
Income Before Income Taxes		5,651		5,330		6.0
Net Income		3,734		3,773		(1.0	)
Net Income Attributable to AT&T	$	3,652	$	3,700		(1.3	) %

Overview

Operating income increased $338, or 5.7%, in the first quarter of 2014 and our operating income margin increased from 18.9% in 2013 to 19.3% in 2014. Operating income in the first quarter reflects higher equipment revenue recorded for device sales under our wireless device installment program as well as continued growth in our AT&T U-verse® (U-verse) and strategic business services. This growth was partially offset by the continued decline in legacy voice and data products as well as higher wireless handset expenses and U-verse content costs. The operating results of Leap Wireless International, Inc. (Leap) (see Other Business Matters) acquired on March 13, 2014 did not have a meaningful impact on our first quarter operating results and accordingly are not discussed.

Operating revenues increased $1,120, or 3.6%, in the first quarter of 2014. Growth in wireless revenues was driven by device sales under our new wireless device installment program as well as the overall growth in our net subscriber base and the increasing percentage of smartphone customers. Wireline service revenues were essentially flat and continue to be driven by our U-verse services and strategic business services, which offset decreases from our legacy voice and data products.

The telecommunications industry is rapidly evolving from fixed location, voice-oriented services into an industry driven by customer demand for instantly available, data-based services (including video). Our products, services and plans are changing as we transition to sophisticated, high-speed, IP-based alternatives. We are also re-designing our networks to accommodate these new demands and to take advantage of related technological efficiencies. We expect continued growth in our wireless and wireline IP-based services as we bundle and price plans with greater focus on data and video offerings. We expect continued declines in voice services and our basic wireline data services as customers choose these next-generation services.

AT&T INC.

MARCH 31, 2014

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Continued

Dollars in millions except per share amounts

Cost of services and sales expenses increased $767, or 6.1%, in the first quarter of 2014. The increase was primarily due to higher wireless equipment costs resulting from customers choosing higher-priced devices, increased wireless network costs, higher expenses attributable to U-verse subscriber growth, and growth in Universal Service Fund (USF) fees. These increases were slightly offset by lower interconnect/long-distance costs.

Selling, general and administrative expenses decreased $73, or 0.9%, in the first quarter of 2014. The decrease was due to lower employee related costs and lower wireless commissions, which were partially offset by increases in our sales, advertising and marketing expenses resulting from increased competition and other administrative costs associated with our wireless segment.

Depreciation and amortization expense increased $88, or 1.9%, in the first quarter of 2014. Expenses increased due to ongoing capital spending for network upgrades and expansion, partially offset by assets becoming fully depreciated and lower amortization of intangibles for customer lists related to acquisitions.

Interest expense increased $33, or 4.0%, in the first quarter of 2014. The increase in interest expense was primarily due to higher interest related to our December 2013 tower transaction. The increase was partially offset by lower interest incurred as a result of 2013 refinancing activity.

Equity in net income of affiliates decreased $97, or 52.4%, in the first quarter of 2014 primarily due to lower equity income from América Móvil, S.A. de C.V. (América Móvil).

	First Quarter
	2014			2013
América Móvil	$	54		$	151
YP Holdings LLC (YP Holdings)		54			52
Isis Mobile WalletTM (ISIS)		(20	)		(18	)
Equity in Net Income of Affiliates	$	88		$	185

Other income (expense) – net We had other income of $145 in the first quarter of 2014, compared to other income of $32 in the first quarter of 2013. Results for first quarter 2014 included a gain on the sale of América Móvil shares and other investments of $122, interest and dividend income of $13 and leveraged lease income of $6. Results for first quarter 2013 included a net gain on the sale of investments of $11, interest and dividend income of $17 and leveraged lease income of $5.

Income taxes increased $360, or 23.1%, in the first quarter of 2014. Our effective tax rate was 33.9% for the first quarter 2014, compared to 29.2% for first quarter 2013. The increase in effective tax rate for the first quarter was primarily due to recognition of benefits related to tax audit settlements in the first quarter of 2013.

AT&T INC.

MARCH 31, 2014

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Continued

Dollars in millions except per share amounts

Selected Financial and Operating Data
	March 31,
	2014			2013
Wireless subscribers (000)		116,014			107,251
Network access lines in service (000)		23,582			28,043
Total wireline broadband connections (000)		16,503			16,514
Debt ratio1		46.6	%		45.6	%
Ratio of earnings to fixed charges2		5.50			5.25
Number of AT&T employees		246,730			243,340

1	Debt ratios are calculated by dividing total debt (debt maturing within one year plus long-term debt) by total capital (total debt plus total stockholders’ equity) and do not consider cash available to pay down debt. See our “Liquidity and Capital Resources” section for discussion.

2	See Exhibit 12.

Segment Results

Our segments are strategic business units that offer different products and services over various technology platforms and are managed accordingly. Our operating segment results are presented in Note 4 and discussed below for each segment follow our internal management reporting. We analyze our operating segments based on segment income before income taxes. We make our capital allocation decisions based on our strategic direction of the business, needs of the network (wireless or wireline) providing services and demands to provide emerging services to our customers. Actuarial gains and losses from pension and other postretirement benefits, interest expense and other income (expense) – net, are managed only on a total company basis and are, accordingly, reflected only in consolidated results. Therefore, these items are not included in each segment’s reportable results. The customers and long-lived assets of our reportable segments are predominantly in the United States. We have two reportable segments: (1) Wireless and (2) Wireline.

The Wireline segment uses our regional, national and global network to provide consumer and business customers with data and voice communications services, U-verse high speed Internet, video and VoIP services and managed networking to business customers.

We discuss capital expenditures for each segment in “Liquidity and Capital Resources.”

AT&T INC.

MARCH 31, 2014

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Continued

Dollars in millions except per share amounts

Wireless
Segment Results
	First Quarter
	2014			2013		Percent Change
	2014			2013		Percent Change
Segment operating revenues
Service	$	15,387		$	15,062		2.2	%
Equipment		2,479			1,629		52.2
Total Segment Operating Revenues		17,866			16,691		7.0
Segment operating expenses
Operations and support		10,882			10,180		6.9
Depreciation and amortization		1,931			1,835		5.2
Total Segment Operating Expenses		12,813			12,015		6.6
Segment Operating Income		5,053			4,676		8.1
Equity in Net Income (Loss) of Affiliates		(20	)		(18)		(11.1	)
Segment Income	$	5,033		$	4,658		8.1	%

AT&T INC.

MARCH 31, 2014

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Continued

Dollars in millions except per share amounts

The following table highlights other key measures of performance for the Wireless segment:

	First Quarter
	2014			2013		Percent Change
(in 000s)	2014			2013		Percent Change
Wireless Subscribers 1		116,014			107,251		8.2	%
Postpaid smartphones		53,020			48,302		9.8
Postpaid feature phones and data-centric devices		20,271			22,447		(9.7	)
Postpaid		73,291			70,749		3.6
Prepaid		11,812			7,104		66.3
Reseller		13,886			14,702		(5.6	)
Connected devices 2		17,025			14,696		15.8
Total Wireless Subscribers		116,014			107,251		8.2

Net Additions 3
Postpaid		625			296		-
Prepaid		(50	)		(184)		72.8
Reseller		(206	)		(252)		18.3
Connected devices2		693			431		60.8
Net Subscriber Additions		1,062			291		-

Mobile Share connections		32,585			9,989		-
Smartphones sold under our installment program during period		2,868			-		-

Total Churn4		1.39%			1.38%	1 BP
Postpaid Churn4		1.07%			1.04%	3 BP

1	Represents 100% of AT&T Mobility wireless subscribers.

2	Includes data-centric devices (eReaders and automobile monitoring systems). Excludes tablets, which are primarily included in postpaid.

3	Excludes merger and acquisition-related additions during the period.

4	Calculated by dividing the aggregate number of wireless subscribers who canceled service during a period divided by the total number of wireless subscribers at the beginning of that period. The churn rate for the period is equal to the average of the churn rate for each month of that period.

Subscriber Relationships

As the wireless industry continues to mature, we believe that future wireless growth will increasingly depend on our ability to offer innovative services, plans and devices and a wireless network that has sufficient spectrum and capacity to support these innovations on as broad a geographic basis as possible. To attract and retain subscribers in a maturing market, we have launched a wide variety of service plans, including Mobile Share and AT&T NextSM (AT&T Next). While we have historically focused on attracting and retaining postpaid subscribers, we have recently increased our focus on prepaid subscribers with our acquisition of Leap.

At March 31, 2014, we served 116.0 million subscribers (including approximately 4.5 million from Leap), an increase of 8.2% from the prior year. Our subscriber base consists primarily of postpaid accounts. Our prepaid services, which include results from services sold under the Cricket brand following our March 13, 2014 acquisition of Leap, are monthly, pay-as-you-go services.

AT&T INC.

MARCH 31, 2014

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Continued

Dollars in millions except per share amounts

ARPU

Total ARPU (average service revenue per average wireless subscribers) was down 1.9% and postpaid ARPU was down 1.3% when compared to the first quarter of 2013, reflecting the increasing number of lower-ARPU but higher margin tablets and the attractive Mobile Share pricing for customers who move off the traditional device subsidization model. As we adjust our service offerings and pricing structures, management believes that postpaid phone-only ARPU plus Next subscriber installment billings (postpaid phone-only ARPU plus AT&T Next) is a better representation of the monthly economic value per postpaid subscriber. Postpaid phone-only ARPU increased 0.4% versus the year-earlier quarter and postpaid phone-only ARPU plus AT&T Next increased 2.0%.

Churn

The effective management of subscriber churn is critical to our ability to maximize revenue growth and to maintain and improve margins. Total and postpaid churn rates were slightly higher for the first quarter of 2014 when compared to the first quarter of 2013, reflecting increased competition, especially for price-conscious customers.

Postpaid

Postpaid subscribers increased 3.6% in the first quarter of 2014. At March 31, 2014, 78% of our postpaid phone subscriber base used smartphones, compared to 72% at March 31, 2013. About 94% of our postpaid smartphone subscribers are on plans that provide for service on multiple devices at reduced rates, and such subscribers tend to have higher retention and lower churn rates. A growing percentage of our postpaid smartphone subscribers are on usage-based data plans, with approximately 81% on these plans as compared to 69% in the prior year, and about 46% of our Mobile Share subscribers have chosen the 10 gigabyte or higher plans. Such offerings are intended to encourage existing subscribers to upgrade their current services and/or add connected devices, attract subscribers from other providers and minimize subscriber churn.

As of March 31, 2014, approximately 81% of our postpaid smartphone subscribers use a 4G-capable device (i.e., a device that would operate on our HSPA+ or LTE network), and more than 55% of our postpaid smartphone subscribers use an LTE device.

Historically, our postpaid customers have signed two-year service contracts for subsidized handsets. However, through our Mobile Share plans, we have recently begun offering postpaid services at lower prices for those customers who either bring their own devices or participate in our AT&T Next program. Our AT&T Next program allows for postpaid subscribers to purchase certain devices in installments over a period of up to 26 months. Additionally, after a specified period of time they also have the right to trade in the original device for a new device and have the remaining unpaid balance satisfied. For customers that elect these trade-in programs, at the time of the sale, we recognize equipment revenue for the amount of the customer receivable, net of the fair value of the trade-in right guarantee and imputed interest. A significant percentage of our customers on the AT&T Next program pay a lower monthly service charge, which results in lower service revenue recorded for these subscribers. In the second quarter of 2014, we began offering the AT&T Next program through other distributors and we plan to expand the offering to additional distributors, which is expected to further accelerate the impacts on service revenues.

Prepaid

In March 2014, we completed our acquisition of Leap, which included 4.5 million prepaid subscribers. Excluding merger and acquisition related additions, prepaid subscribers increased 2.4% as of March 31, 2014 compared to the prior year period.

Operating Results

Our Wireless segment operating income margin in the first quarter increased from 28.0% in 2013 to 28.3% in 2014. Our Wireless segment operating income increased $377, or 8.1%, in the first quarter of 2014. The increase in operating margin and income reflected the impact of AT&T Next sales and further revenue growth from the company’s base of high-value smartphone subscribers, slightly offset by promotional activities and new business initiatives.

AT&T INC.

MARCH 31, 2014

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Continued

Dollars in millions except per share amounts

Service revenues increased $325, or 2.2%, in the first quarter of 2014. Wireless service revenues increased due to the increased number of subscribers moving to smartphones with larger data plans. Service revenue growth was lessened by, and will continue to reflect, the discounted monthly service charges subscribers pay under our Mobile Share plans.

Equipment revenues increased $850, or 52.2%, in the first quarter of 2014. The increase was primarily due from devices sold under our AT&T Next program. While we expect equipment revenues to increase under this program, we expect monthly services revenues will be pressured for these subscribers.

Operations and support expenses increased $702, or 6.9%, in the first quarter of 2014. The first-quarter increase was primarily due to the following:

·	Equipment costs increased $369 reflecting the sales of more expensive smartphones.

Selling (other than commissions) and administrative expenses increased $283 due primarily to a $93 increase in advertising expense, $60 increase in customer service expense, $45 increase in sales expense, $36 increase in information technology costs in conjunction with ongoing support systems development and a $26 increase in marketing expense.

·	Network system costs increased $111 due to higher network traffic and personnel-related network support costs and cell site related costs in conjunction with our network enhancement efforts.

·	Handset insurance cost increased $79 due to an increase in the cost of replacement phones.

Partially offsetting these increases were the following:

·	Commission expenses decreased $100 primarily due to the decline in upgrade transactions and lower average commission rates.

·	Interconnect and long-distance costs decreased $21 due to lower access costs in the current period.

Equity in net income (loss) of affiliates for the Wireless segment includes expenses for ISIS, our mobile payment joint venture with other wireless providers.

Depreciation and amortization expenses increased $96, or 5.2%, in the first quarter of 2014. Depreciation expense increased $146, or 8.3%, in the first quarter primarily due to ongoing capital spending for network upgrades and expansion, partially offset by fully depreciated assets. Amortization expense decreased $50, or 64.1%, in the first quarter primarily due to lower amortization of intangibles for customer lists related to acquisitions.

AT&T INC.

MARCH 31, 2014

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Continued

Dollars in millions except per share amounts

Wireline
Segment Results
	First Quarter
	2014		2013		Percent Change
	2014		2013		Percent Change
Segment operating revenues
Service	$	14,389	$	14,381		0.1	%
Equipment		212		274		(22.6	)
Total Segment Operating Revenues		14,601		14,655		(0.4	)
Segment operating expenses
Operations and support		10,457		10,335		1.2
Depreciation and amortization		2,684		2,688		(0.1	)
Total Segment Operating Expenses		13,141		13,023		0.9
Segment Operating Income		1,460		1,632		(10.5	)
Equity in Net Income of Affiliates		1		1		-
Segment Income	$	1,461	$	1,633		(10.5	)%

Our broadband, switched access lines and other services provided by our local exchange telephone subsidiaries at March 31, 2014 and 2013 are shown below and trends are addressed throughout this segment discussion.

	March 31,		March 31,		Percent
(in 000s)	2014		2013		Change
U-verse high speed Internet1		11,009		8,449		30.3	%
DSL and other broadband connections1		5,494		8,065		(31.9	)
Total Wireline Broadband Connections2		16,503		16,514		(0.1	)

Total U-verse Video Connections		5,661		4,768		18.7

Retail consumer switched access lines		11,655		14,840		(21.5	)
U-verse consumer VoIP connections		4,120		3,120		32.1
Total Retail Consumer Voice Connections		15,775		17,960		(12.2	)

Switched Access Lines
Retail consumer3		11,655		14,840		(21.5	)
Retail business3		10,088		11,185		(9.8	)
Retail Subtotal3		21,743		26,025		(16.5	)

Wholesale Subtotal1,3		1,605		1,726		(7.0	)

Total Switched Access Lines3		23,582		28,043		(15.9	)%

1	Prior-period amounts restated to conform to current-period reporting methodology.

2	Total wireline broadband connections include DSL, U-verse high speed Internet and satellite broadband.

3	Total switched access lines include access lines provided to national mass markets and private payphone service providers of 234 at March 31, 2014 and 292