PART I - FINANCIAL INFORMATION

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,
		2016				2015				2016				2015
Operating Revenues
Service		$	37,142			$	29,541			$	74,243			$	58,503
Equipment			3,378				3,474				6,812				7,088
Total operating revenues			40,520				33,015				81,055				65,591
Operating Expenses
Cost of services and sales
Equipment			4,260				4,353				8,635				8,899
Broadcast, programming and operations			4,701				1,148				9,330				2,270
Other cost of services (exclusive of depreciation and          amortization shown separately below)			9,514				9,578				18,910				18,390
Selling, general and administrative			8,909				7,467				17,350				15,428
Depreciation and amortization			6,576				4,696				13,139				9,274
Total operating expenses			33,960				27,242				67,364				54,261
Operating Income			6,560				5,773				13,691				11,330
Other Income (Expense)
Interest expense			(1,258	)			(932	)			(2,465	)			(1,831	)
Equity in net income of affiliates			28				33				41				33
Other income (expense) – net			91				48				161				118
Total other income (expense)			(1,139	)			(851	)			(2,263	)			(1,680	)
Income Before Income Taxes			5,421				4,922				11,428				9,650
Income tax expense			1,906				1,738				4,028				3,127
Net Income			3,515				3,184				7,400				6,523
Less: Net Income Attributable to Noncontrolling Interest			(107	)			(102	)			(189	)			(178	)
Net Income Attributable to AT&T		$	3,408			$	3,082			$	7,211			$	6,345
Basic Earnings Per Share Attributable to AT&T		$	0.55			$	0.59			$	1.17			$	1.22
Diluted Earnings Per Share Attributable to AT&T		$	0.55			$	0.59			$	1.17			$	1.22
Weighted Average Number of Common Shares
Outstanding – Basic (in millions)			6,174				5,204				6,173				5,204
Weighted Average Number of Common Shares
Outstanding – with Dilution (in millions)			6,195				5,220				6,193				5,220
Dividends Declared Per Common Share		$	0.48			$	0.47			$	0.96			$	0.94
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,
		2016				2015				2016				2015
Net income		$	3,515			$	3,184			$	7,400			$	6,523
Other comprehensive income (loss), net of tax:
Foreign Currency:
Foreign currency translation adjustment, net of taxes of            $136, $1, $126 and $(103)			218				1				174				(185	)
Available-for-sale securities:
Net unrealized gains (losses), net of taxes of $2, $0,            $(13) and $19			5				1				(21	)			34
Reclassification adjustment included in net income,            net of taxes of $2, $(2), $0 and $(5)			3				(4	)			-				(9	)
Cash flow hedges:
Net unrealized gains (losses), net of taxes of $(208),            $(52), $(141) and $(242)			(387	)			(95	)			(263	)			(449	)
Reclassification adjustment included in net income,            net of taxes of $5, $5, $10 and $9			9				10				19				17
Defined benefit postretirement plans:
Amortization of net prior service credit included in            net income, net of taxes of $(131), $(131), $(262)            and $(262)			(214	)			(214	)			(429	)			(429	)
Other comprehensive income (loss)			(366	)			(301	)			(520	)			(1,021	)
Total comprehensive income			3,149				2,883				6,880				5,502
Less: Total comprehensive income attributable to      noncontrolling interest			(107	)			(102	)			(189	)			(178	)
Total Comprehensive Income Attributable to AT&T		$	3,042			$	2,781			$	6,691			$	5,324
See Notes to Consolidated Financial Statements.

 

3

AT&T INC.
CONSOLIDATED BALANCE SHEETS
Dollars in millions except per share amounts
		June 30,				December 31,
		2016				2015
Assets		(Unaudited)
Current Assets
Cash and cash equivalents		$	7,208			$	5,121
Accounts receivable - net of allowances for doubtful accounts of $642 and $704			15,830				16,532
Prepaid expenses			1,197				1,072
Other current assets			11,770				13,267
Total current assets			36,005				35,992
Property, plant and equipment			313,018				306,227
Less: accumulated depreciation and amortization			(189,481	)			(181,777	)
Property, Plant and Equipment – Net			123,537				124,450
Goodwill			105,252				104,568
Licenses			94,098				93,093
Customer Lists and Relationships - Net			16,259				18,208
Other Intangible Assets – Net			9,107				9,409
Investments in Equity Affiliates			1,677				1,606
Other Assets			15,873				15,346
Total Assets		$	401,808			$	402,672
Liabilities and Stockholders' Equity
Current Liabilities
Debt maturing within one year		$	9,528			$	7,636
Accounts payable and accrued liabilities			26,746				30,372
Advanced billing and customer deposits			4,465				4,682
Accrued taxes			2,773				2,176
Dividends payable			2,953				2,950
Total current liabilities			46,465				47,816
Long-Term Debt			117,308				118,515
Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes			58,216				56,181
Postemployment benefit obligation			34,023				34,262
Other noncurrent liabilities			21,425				22,258
Total deferred credits and other noncurrent liabilities			113,664				112,701
Stockholders' Equity
Common stock ($1 par value, 14,000,000,000 authorized at June 30, 2016 and
December 31, 2015: issued 6,495,231,088 at June 30, 2016 and December 31, 2015)			6,495				6,495
Additional paid-in capital			89,486				89,763
Retained earnings			34,950				33,671
Treasury stock (343,397,505 at June 30, 2016 and 350,291,239
at December 31, 2015, at cost)			(12,343	)			(12,592	)
Accumulated other comprehensive income			4,814				5,334
Noncontrolling interest			969				969
Total stockholders' equity			124,371				123,640
Total Liabilities and Stockholders' Equity		$	401,808			$	402,672
See Notes to Consolidated Financial Statements.

 

4

AT&T INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Dollars in millions
(Unaudited)
		Six months ended
		June 30,
		2016				2015
Operating Activities
Net income		$	7,400			$	6,523
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			13,139				9,274
Undistributed earnings from investments in equity affiliates			(22	)			(23	)
Provision for uncollectible accounts			705				535
Deferred income tax expense			1,767				1,244
Net gain from sale of investments, net of impairments			(85	)			(50	)
Changes in operating assets and liabilities:
Accounts receivable			543				434
Other current assets			1,069				732
Accounts payable and accrued liabilities			(3,059	)			(1,125	)
Retirement benefit funding			(280	)			(455	)
Other - net			(2,970	)			(1,191	)
Total adjustments			10,807				9,375
Net Cash Provided by Operating Activities			18,207				15,898
Investing Activities
Capital expenditures:
Purchase of property and equipment			(9,702	)			(8,328	)
Interest during construction			(437	)			(339	)
Acquisitions, net of cash acquired			(485	)			(20,954	)
Dispositions			107				72
Sale of securities, net			500				1,890
Other			-				(1	)
Net Cash Used in Investing Activities			(10,017	)			(27,660	)
Financing Activities
Issuance of long-term debt			10,140				33,958
Repayment of long-term debt			(9,129	)			(2,919	)
Purchase of treasury stock			(197	)			-
Issuance of treasury stock			119				20
Dividends paid			(5,899	)			(4,873	)
Other			(1,137	)			(2,071	)
Net Cash (Used in) Provided by Financing Activities			(6,103	)			24,115
Net increase in cash and cash equivalents			2,087				12,353
Cash and cash equivalents beginning of year			5,121				8,603
Cash and Cash Equivalents End of Period		$	7,208			$	20,956
Cash paid (received) during the six months ended June 30 for:
Interest		$	2,914			$	2,178
Income taxes, net of refunds		$	2,468			$	(71	)
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, 2016
		Shares				Amount
Common Stock
Balance at beginning of year			6,495			$	6,495
Issuance of stock			-				-
Balance at end of period			6,495			$	6,495
Additional Paid-In Capital
Balance at beginning of year						$	89,763
Issuance of treasury stock							(43	)
Share-based payments							(258	)
Change related to acquisition of interests held by noncontrolling owners							24
Balance at end of period						$	89,486
Retained Earnings
Balance at beginning of year						$	33,671
Net income attributable to AT&T ($1.17 per diluted share)							7,211
Dividends to stockholders ($0.96 per share)							(5,932	)
Balance at end of period						$	34,950
Treasury Stock
Balance at beginning of year			(350	)		$	(12,592	)
Repurchase and acquisition of common stock			(7	)			(294	)
Issuance of treasury stock			14				543
Balance at end of period			(343	)		$	(12,343	)
Accumulated Other Comprehensive Income Attributable to AT&T, net of tax
Balance at beginning of year						$	5,334
Other comprehensive loss attributable to AT&T							(520	)
Balance at end of period						$	4,814
Noncontrolling Interest
Balance at beginning of year						$	969
Net income attributable to noncontrolling interest							189
Distributions							(164	)
Acquisition of interest held by noncontrolling owners							(25	)
Balance at end of period						$	969
Total Stockholders' Equity at beginning of year						$	123,640
Total Stockholders' Equity at end of period						$	124,371
See Notes to Consolidated Financial Statements.

 

6

AT&T INC.

 

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

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

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

The preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes, including estimates of probable losses and expenses. Actual results could differ from those estimates. Certain prior period amounts have been conformed to the current period's presentation, including our 2015 change in accounting to capitalize customer set-up and installation costs and amortize them over the expected economic life of the customer relationship. The consolidated statements of income also include revisions to present "Equipment" and "Broadcast, programming and operations" costs separately from "Other cost of services."

Leases  In February 2016, the Financial Accounting Standards Board (FASB) issued ASU No. 2016-02, "Leases (Topic 842)" (ASU 2016-02), which replaces existing leasing rules with a comprehensive lease measurement and recognition standard and expanded disclosure requirements. ASU 2016-02 will require lessees to recognize most leases on their balance sheets as liabilities, with corresponding "right-of-use" assets. Leases will be classified as either a finance or an operating lease without relying upon the bright-line tests under current GAAP.

Upon initial evaluation, we believe the key change upon adoption will be the balance sheet recognition. The income statement recognition appears similar to our current methodology.

ASU 2016-02 becomes effective for annual reporting periods beginning after December 15, 2018, subject to early adoption. We have just begun our evaluation of the impact on our financial statements, as well as available adoption methods, but we believe our implementation of the revenue recognition standard discussed below could influence the timing of our adoption of ASU 2016-02.

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

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

 

7

 

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

Customer Fulfillment Costs  During the second quarter of 2016, we updated our analysis of the economic lives of customer relationships, which included a review of satellite customer data following the DIRECTV acquisition. As of April 1, 2016, to better reflect the estimated economic lives of satellite and certain business customer relationships, we extended the period to approximately 4.5 years. This change in accounting estimate decreased other cost of services and impacted net income $82, or $0.01 per diluted share, in the second quarter of 2016.

NOTE 2. EARNINGS PER SHARE

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

		Three months ended								Six months ended
		June 30,								June 30,
		2016				2015				2016				2015
Numerators
Numerator for basic earnings per share:
Net Income		$	3,515			$	3,184			$	7,400			$	6,523
Less:  Net income attributable to noncontrolling interest			(107	)			(102	)			(189	)			(178	)
Net Income attributable to AT&T			3,408				3,082				7,211				6,345
Dilutive potential common shares:
Share-based payment			2				2				6				6
Numerator for diluted earnings per share		$	3,410			$	3,084			$	7,217			$	6,351
Denominators (000,000)
Denominator for basic earnings per share:
Weighted average number of common shares outstanding			6,174				5,204				6,173				5,204
Dilutive potential common shares:
Share-based payment (in shares)			21				16				20				16
Denominator for diluted earnings per share			6,195				5,220				6,193				5,220
Basic earnings per share attributable to AT&T		$	0.55			$	0.59			$	1.17			$	1.22
Diluted earnings per share attributable to AT&T		$	0.55			$	0.59			$	1.17			$	1.22

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.

Following our 2015 acquisitions of DIRECTV and wireless businesses in Mexico, we have additional foreign operations that are exposed to fluctuations in the exchange rates used to convert operations, assets and liabilities into U.S. dollars. Since December 31, 2015, when compared to the U.S. dollar, the Brazilian real exchange rate has appreciated 18.9%, the Argentine peso exchange rate has depreciated 16.4% and the Mexican peso exchange rate has depreciated 6.2%.

 

		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		-	2		19	3		(429)	4		(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
		Foreign Currency Translation Adjustment			Net Unrealized Gains (Losses) on Available- for-Sale Securities			Net Unrealized Gains (Losses) on Cash Flow Hedges			Defined Benefit Postretirement Plans			Accumulated Other Comprehensive Income
Balance as of December 31, 2014		$	(26)		$	499		$	741		$	6,847		$	8,061
Other comprehensive income    (loss) before reclassifications			(185)			34			(449)			-			(600)
Amounts reclassified    from accumulated OCI			-	1		(9)	2		17	3		(429)	4		(421)
Net other comprehensive    income (loss)			(185)			25			(432)			(429)			(1,021)
Balance as of June 30, 2015		$	(211)		$	524		$	309		$	6,418		$	7,040
1 Translation (gain) loss reclassifications are included in Other income (expense) - net in the consolidated statements of income.
2 (Gains) losses are included in Other income (expense) - net in the consolidated statements of income.
3 (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).

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. Due to organizational changes and our July 24, 2015 acquisition of DIRECTV, effective for the quarter ended September 30, 2015, we revised our operating segments to align with our new management structure and organizational responsibilities. We analyze our operating segments based on Segment Contribution, which consists of operating income, excluding acquisition-related costs and other significant items (as discussed below), and equity in net income (loss) of affiliates for investments managed within each operating segment. We have four reportable segments: (1) Business Solutions, (2) Entertainment Group, (3) Consumer Mobility and (4) International.

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

 

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

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

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

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

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

Certain operating items are not allocated to our business segments, and those include:

·	Acquisition-related items which consist of (1) operations and support items associated with the merger and integration of newly acquired businesses and (2) the noncash amortization of intangible assets acquired in acquisitions.

·

Certain significant items which consist of (1) noncash actuarial gains and losses from pension and other postretirement benefits, (2) employee separation charges associated with voluntary and/or strategic offers, (3) losses resulting from abandonment or impairment of assets and (4) other items for which the segments are not being evaluated.

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

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

 

For the three months ended June 30, 2016
		Revenue				Operations and Support Expenses				EBITDA				Depreciation and Amortization				Operating Income (Loss)				Equity in Net Income (Loss) of Affiliates				Segment Contribution
Business Solutions		$	17,579			$	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
		Revenue				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

 

For the three months ended June 30, 2015
		Revenue				Operations and Support Expenses				EBITDA				Depreciation and Amortization				Operating Income (Loss)				Equity in Net Income (Loss) of Affiliates				Segment Contribution
Business Solutions		$	17,664			$	10,972			$	6,692			$	2,460			$	4,232			$	-			$	4,232
Entertainment Group			5,782				4,913				869				1,065				(196	)			(12	)			(208	)
Consumer Mobility			8,755				5,202				3,553				934				2,619				-				2,619
International			491				529				(38	)			93				(131	)			-				(131	)
Segment Total			32,692				21,616				11,076				4,552				6,524			$	(12	)		$	6,512
Corporate and Other			323				236				87				24				63
Acquisition-related items			-				694				(694	)			120				(814	)
Certain significant items			-				-				-				-				-
AT&T Inc.		$	33,015			$	22,546			$	10,469			$	4,696			$	5,773
For the six months ended June 30, 2015
		Revenue				Operations and Support Expenses				EBITDA				Depreciation and Amortization				Operating Income (Loss)				Equity in Net Income (Loss) of Affiliates				Segment Contribution
Business Solutions		$	35,221			$	22,045			$	13,176			$	4,802			$	8,374			$	-			$	8,374
Entertainment Group			11,442				9,772				1,670				2,130				(460	)			(18	)			(478	)
Consumer Mobility			17,533				10,743				6,790				1,936				4,854				-				4,854
International			727				747				(20	)			121				(141	)			-				(141	)
Segment Total			64,923				43,307				21,616				8,989				12,627			$	(18	)		$	12,609
Corporate and Other			668				470				198				44				154
Acquisition-related items			-				993				(993	)			241				(1,234	)
Certain significant items			-				217				(217	)			-				(217	)
AT&T Inc.		$	65,591			$	44,987			$	20,604			$	9,274			$	11,330

 

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
		2016				2015				2016				2015
Business Solutions		$	4,201			$	4,232			$	8,500			$	8,374
Entertainment Group			1,651				(208	)			3,246				(478	)
Consumer Mobility			2,574				2,619				5,068				4,854
International			(184	)			(131	)			(368	)			(141	)
Segment Contribution			8,242				6,512				16,446				12,609
Reconciling Items:
Corporate and Other			(97	)			63				(218	)			154
Merger and integration charges			(233	)			(694	)			(528	)			(993	)
Amortization of intangibles acquired			(1,316	)			(120	)			(2,667	)			(241	)
Employee separation charges			(29	)			-				(54	)			(217	)
Gain on wireless spectrum transactions			-				-				736				-
Segment equity in net (income) loss     of affiliates			(7	)			12				(24	)			18
AT&T Operating Income			6,560				5,773				13,691				11,330
Interest expense			1,258				932				2,465				1,831
Equity in net income of affiliates			28				33				41				33
Other income (expense) - net			91				48				161				118
Income Before Income Taxes		$	5,421			$	4,922			$	11,428			$	9,650

NOTE 5. PENSION AND POSTRETIREMENT BENEFITS

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

In 2013, we made a voluntary contribution of a preferred equity interest in AT&T Mobility II LLC, the primary holding company for our domestic wireless business, to the trust used to pay pension benefits under our qualified pension plans. The preferred equity interest had a value of $8,704 at June 30, 2016. The trust is entitled to receive cumulative cash distributions of $560 per annum, which are distributed quarterly in equal amounts and accounted for as contributions. We distributed $280 to the trust during the six months ended June 30, 2016. So long as we make the distributions, we will have no limitations on our ability to declare a dividend or repurchase shares. This preferred equity interest is a plan asset under ERISA and is recognized as such in the plan's separate financial statements. However, because the preferred equity interest is not unconditionally transferable to an unrelated party, it is not reflected in plan assets in our consolidated financial statements and instead has been eliminated in consolidation. We also agreed to make a cash contribution to the trust of $175 no later than the due date of our federal income tax return for 2015.

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

 

		Three months ended								Six months ended
		June 30,								June 30,
		2016				2015				2016				2015
Pension cost:
Service cost – benefits earned during the period		$	278			$	300			$	556			$	599
Interest cost on projected benefit obligation			495				473				990				947
Expected return on assets			(780	)			(826	)			(1,558	)			(1,652	)
Amortization of prior service credit			(25	)			(26	)			(51	)			(52	)
Net pension (credit) cost		$	(32	)		$	(79	)		$	(63	)		$	(158	)
Postretirement cost:
Service cost – benefits earned during the period		$	48			$	56			$	96			$	111
Interest cost on accumulated postretirement benefit obligation			243				241				486				483
Expected return on assets			(89	)			(105	)			(178	)			(210	)
Amortization of prior service credit			(319	)			(319	)			(638	)			(639	)
Net postretirement (credit) cost		$	(117	)		$	(127	)		$	(234	)		$	(255	)
Combined net pension and postretirement (credit) cost		$	(149	)		$	(206	)		$	(297	)		$	(413	)

The decrease in the combined net pension and postretirement credit of $57 in the second quarter and $116 for the first six months of 2016 is primarily due to a lower expected return on assets resulting from a decrease in the value in the plan assets.

We also provide senior- and middle-management employees with nonqualified, unfunded supplemental retirement and savings plans. For the second quarter ended 2016 and 2015, net supplemental pension benefits costs not included in the table above were $24 and $21. For the first six months of 2016 and 2015, net supplemental pension benefit costs were $47 and $41.

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, 2015.

Long-Term Debt and Other Financial Instruments

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

	June 30, 2016							December 31, 2015
	Carrying			Fair				Carrying				Fair
	Amount			Value				Amount				Value
Notes and debentures1	$	125,568			$	137,112			$	124,847			$	128,993
Bank borrowings		4				4				4				4
Investment securities		2,550				2,550				2,704				2,704
1 Includes credit agreement borrowings.

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

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

	June 30, 2016
	Level 1				Level 2				Level 3				Total
Available-for-Sale Securities
Domestic equities	$	1,111			$	-			$	-			$	1,111
International equities		547				-				-				547
Fixed income bonds		-				621				-				621
Asset Derivatives1
Interest rate swaps		-				202				-				202
Cross-currency swaps		-				100				-				100
Liability Derivatives1
Cross-currency swaps		-				(3,821	)			-				(3,821	)
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, 2015
	Level 1				Level 2				Level 3				Total
Available-for-Sale Securities
Domestic equities	$	1,132			$	-			$	-			$	1,132
International equities		569				-				-				569
Fixed income bonds		-				680				-				680
Asset Derivatives1
Interest rate swaps		-				136				-				136
Cross-currency swaps		-				556				-				556
Foreign exchange contracts		-				3				-				3
Liability Derivatives1
Cross-currency swaps		-				(3,466	)			-				(3,466	)
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.

 

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 $95 have maturities of less than one year, $287 within one to three years, $62 within three to five years and $177 for five or more years.

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

Derivative Financial Instruments

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

Fair Value Hedging We designate our fixed-to-floating interest rate swaps as fair value hedges. The purpose of these swaps is to manage interest rate risk by managing our mix of fixed-rate and floating-rate debt. These swaps involve the receipt of fixed-rate amounts for floating interest rate payments over the life of the swaps without exchange of the underlying principal amount. Accrued and realized gains or losses from interest rate swaps impact interest expense in the consolidated statements of income. Unrealized gains on interest rate swaps are recorded at fair market value as assets, and unrealized losses on interest rate swaps are recorded at fair market value as liabilities. Changes in the fair values of the interest rate swaps are exactly offset by changes in the fair value of the underlying debt. Gains or losses realized upon early termination of our fair value hedges are recognized in interest expense. In the six months ended June 30, 2016 and June 30, 2015, 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 denominations to fixed U.S. dollar denominated amounts, to be exchanged at a specified rate that is usually determined by the market spot rate upon issuance. They also include an interest rate swap of a fixed or floating foreign currency-denominated rate to a fixed U.S. dollar denominated interest rate.

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

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

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

Collateral and Credit-Risk Contingency  We have entered into agreements with our derivative counterparties establishing collateral thresholds based on respective credit ratings and netting agreements. At June 30, 2016, we had posted collateral of $3,154 (a deposit asset) and held collateral of $8 (a receipt liability). Under the agreements, if AT&T's credit rating had been downgraded one rating level by Fitch Ratings, before the final collateral exchange in June, we would have been required to post additional collateral of $151. If DIRECTV Holdings LLC's credit rating had been downgraded below BBB- (S&P) and below Baa3 (Moody's), we would owe an additional $275. At December 31, 2015, we had posted collateral of $2,343 (a deposit asset) and held collateral of $124 (a receipt liability). We do not offset the fair value of collateral, whether the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) exists, against the fair value of the derivative instruments.

Following are the notional amounts of our outstanding derivative positions:

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

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, 2016			June 30, 2015				June 30, 2016				June 30, 2015
Interest rate swaps (Interest expense):
Gain (Loss) on interest rate swaps	$	5			$	(30	)		$	71			$	11
Gain (Loss) on long-term debt		(5	)			30				(71	)			(11	)

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
Cash Flow Hedging Relationships		June 30, 2016				June 30, 2015				June 30, 2016				June 30, 2015
Cross-currency swaps:
Gain (Loss) recognized in accumulated OCI		$	(595	)		$	(102	)		$	(404	)		$	(330	)
Interest rate locks:
Gain (Loss) recognized in accumulated OCI			-				(45	)			-				(361	)
Interest income (expense) reclassified from         accumulated OCI into income			(14	)			(15	)			(29	)			(26	)

NOTE 7. ACQUISITIONS, DISPOSITIONS AND OTHER ADJUSTMENTS

Acquisitions

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

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

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

 

The following table summarizes the fair values of the DIRECTV assets acquired and liabilities assumed and related deferred income taxes that existed as of the acquisition date.