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TMCNet:  AT&T INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations Dollars in millions except per share amounts

[August 02, 2013]

AT&T INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations Dollars in millions except per share amounts

(Edgar Glimpses Via Acquire Media NewsEdge) 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 both in the United States and internationally, providing wireless and wireline telecommunication 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, 2012. A reference to a "Note" in this section refers to the accompanying Notes to Consolidated Financial Statements. In the tables throughout this section, percentage increases and decreases that are not considered meaningful are denoted with a dash. Certain amounts have been reclassified to conform to the current period's presentation.

Consolidated Results Our financial results in the second quarter and for the first six months of 2013 and 2012 are summarized as follows: Second Quarter Six-Month Period Percent Percent 2013 2012 Change 2013 2012 Change Operating Revenues $ 32,075 $ 31,575 1.6 % $ 63,431 $ 63,397 0.1 % Operating expenses Cost of services and sales 13,270 12,254 8.3 25,824 25,071 3.0 Selling, general and administrative 8,121 8,005 1.4 16,454 16,349 0.6 Depreciation and amortization 4,571 4,499 1.6 9,100 9,059 0.5 Total Operating Expenses 25,962 24,758 4.9 51,378 50,479 1.8 Operating Income 6,113 6,817 (10.3) 12,053 12,918 (6.7) Income Before Income Taxes 5,794 6,031 (3.9) 11,124 11,548 (3.7) Net Income 3,880 3,965 (2.1) 7,653 7,617 0.5 Net Income Attributable to AT&T $ 3,822 $ 3,902 (2.1) % $ 7,522 $ 7,486 0.5 % Overview Operating income decreased $704, or 10.3%, in the second quarter and $865, or 6.7%, for the first six months of 2013. Both operating revenues and expenses in 2012 include results for our sold Advertising Solutions segment, which had a negative impact on comparisons to 2013 operating income. The decline in operating income also reflected increased handset upgrades, which contributed to higher wireless equipment and commission costs, increased expenses supporting AT&T U-verse® (U-verse) subscriber growth and declines in wireline voice and wireless voice and text revenues. Wireless data and equipment revenues and wireline data revenues helped to offset these impacts. Our operating income margin in the second quarter decreased from 21.6% in 2012 to 19.1% in 2013 and for the first six months decreased from 20.4% in 2012 to 19.0% in 2013.

Operating revenues increased $500, or 1.6%, in the second quarter and $34, or 0.1%, for the first six months of 2013. Wireless data and equipment revenues increased, reflecting the increasing percentage of wireless subscribers choosing smartphones. Continued growth in U-verse services from residential customers and strategic business services also contributed to higher operating revenues. The revenue increases were partially offset by the sale of the Advertising Solutions segment and continued declines in wireline voice and wireless voice and text revenues.

As the telecommunications industry continues to evolve from voice-oriented services into an industry driven by data-based services, technology, and efficiencies, our products, services and plans have also changed as we transition from traditional voice and basic data services to sophisticated, high-speed, IP-based alternatives. This transition of our offerings will result in continued growth in our wireless and wireline IP-based data revenues as we bundle and price plans with greater focus on the data services that our customers desire, provide new products and services, and transition customers from their current traditional services. We expect continued declines in voice revenues and our basic wireline data services as customers choose these next-generation services.

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JUNE 30, 2013 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 $1,016, or 8.3%, in the second quarter and $753, or 3.0%, for the first six months of 2013. The increases were primarily due to increased wireless equipment costs related to handset upgrades, increased wireline costs attributable to U-verse subscriber growth and wireless network costs. The increases were partially offset by the sale of the Advertising Solutions segment, decreased wireless interconnect and long-distance costs and lower costs associated with Universal Service Fund (USF) fees.

Selling, general and administrative expenses increased $116, or 1.4%, in the second quarter and $105, or 0.6%, for the first six months of 2013. The increases were primarily due to increased commissions related to smartphone upgrades and higher advertising expenses, partially offset by the sale of the Advertising Solutions segment, decreased employee related expenses and lower financing-related costs associated with our pension and postretirement benefits (referred to as Pension/OPEB expenses).

Depreciation and amortization expense increased $72, or 1.6%, in the second quarter and $41, or 0.5%, for the first six months of 2013. Expenses increased due to ongoing capital spending for network upgrades and expansion, partially offset by fully depreciated assets and lower amortization of intangibles for customer lists related to acquisitions. The sale of our Advertising Solutions segment also contributed to lower depreciation and amortization expenses.

Interest expense decreased $116, or 12.3%, in the second quarter and $148, or 8.2%, for the first six months of 2013. Interest expense in 2012 was higher due to charges associated with the early redemption of debt. The decrease in 2013 also reflects lower average interest rates, partially offset by higher average debt balances.

Equity in net income of affiliates increased $86, or 65.2%, in the second quarter and $48, or 13.5%, for the first six months of 2013. Increased equity in net income of affiliates in the second quarter was due to increased earnings at América Móvil, S.A. de C.V. (América Móvil) and YP Holdings LLC (YP Holdings).

Increased equity in net income of affiliates for the first six months was primarily due to increased earnings from YP Holdings, partially offset by foreign exchange impacts at América Móvil.

Other income (expense) - net We had other income of $288 in the second quarter and $320 for the first six months of 2013, compared to other income of $23 in the second quarter and $75 for the first six months of 2012. Results in the second quarter and for the first six months of 2013 included a net gain on the sale of América Móvil shares and other investments of $249 and $260, interest and dividend income of $23 and $40 and leveraged lease income of $10 and $15, respectively.

Other income in the second quarter and for the first six months of 2012 included interest and dividend income of $19 and $34 and leveraged lease income of $8 and $41 and a net loss on the sale of investments of $11 and $1, respectively.

Income taxes decreased $152, or 7.4%, in the second quarter and $460, or 11.7%, for the first six months of 2013. Our effective tax rate was 33.0% for the second quarter and 31.2% for the first six months of 2013, as compared to 34.3% for the second quarter and 34.0% for the first six months of 2012. The decrease in effective tax rate for both the second quarter and the first six months was primarily due to recognition of benefits related to tax audit settlements.

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JUNE 30, 2013 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 June 30, 2013 2012 Wireless subscribers (000) 107,884 105,206 Network access lines in service (000) 26,849 31,604 Total wireline broadband connections (000) 16,453 16,434 Debt ratio1 46.6% 38.4% Ratio of earnings to fixed charges2 5.45 5.36 Number of AT&T employees 245,350 242,380 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 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 the strategic needs of the business, needs of the network (wireless or wireline) provided services, and demands to provide emerging services to our customers. Actuarial gains and losses from pension and other postemployment benefits, interest expense and other income (expense) - net, are managed only on a total company basis and are, accordingly, reflected only in consolidated results. We have three reportable segments: (1) Wireless, (2) Wireline and (3) Other. Our operating results prior to May 9, 2012, also included Advertising Solutions, which was previously a reportable segment.

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 (ISIS), which is accounted for as an equity method investment.

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 broadband, video, voice services, and managed networking to business customers. Additionally, we receive commissions on sales of satellite television services offered through our agency arrangements.

The Advertising Solutions segment included our directory operations, which published Yellow and White Pages directories and sold directory advertising, Internet-based advertising and local search through May 8, 2012.

The Other segment includes our portion of the results from our international equity investments, our equity interest in YP Holdings, and costs to support corporate-driven activities and operations. Also included in the Other segment are 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.

The following sections discuss our operating results by segment. Operations and support expenses include certain network planning and engineering expenses; information technology; our repair technicians and repair services; property taxes; bad debt expense; advertising costs; sales and marketing functions, including customer service centers; real estate costs, including maintenance and utilities on all buildings; credit and collection functions; and corporate support costs, such as finance, legal, human resources and external affairs.

Pension and postretirement service costs, net of amounts capitalized as part of construction labor, are also included to the extent that they are associated with employees who perform these functions.

We discuss capital expenditures for each segment in "Liquidity and Capital Resources." 20 -------------------------------------------------------------------------------- AT&T INC.

JUNE 30, 2013 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 Second Quarter Six-Month Period Percent Percent 2013 2012 Change 2013 2012 Change Segment operating revenues Data $ 5,356 $ 4,471 19.8 % $ 10,481 $ 8,706 20.4 % Voice, text and other service 10,014 10,294 (2.7) 19,951 20,625 (3.3) Equipment 1,921 1,588 21.0 3,550 3,158 12.4 Total Segment Operating Revenues 17,291 16,353 5.7 33,982 32,489 4.6 Segment operating expenses Operations and support 10,770 9,590 12.3 20,950 19,568 7.1 Depreciation and amortization 1,843 1,696 8.7 3,678 3,362 9.4 Total Segment Operating Expenses 12,613 11,286 11.8 24,628 22,930 7.4 Segment Operating Income 4,678 5,067 (7.7) 9,354 9,559 (2.1) Equity in Net Loss of Affiliates (19) (15) (26.7) (37) (28) (32.1) Segment Income $ 4,659 5,052 (7.8) % $ 9,317 $ 9,531 (2.2) % 21-------------------------------------------------------------------------------- AT&T INC.

JUNE 30, 2013 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: Second Quarter Six-Month Period Percent Percent(Subscribers in 000s) 2013 2012 Change 2013 2012 Change Wireless Subscribers1 107,884 105,206 2.5 % Gross Subscriber Additions2 5,000 4,970 0.6 % 9,727 10,248 (5.1) Net Subscriber Additions2 632 1,266 (50.1) 923 1,992 (53.7) Total Churn3 1.36% 1.18% 18 BP 1.37% 1.32% 5 BP Postpaid Smartphone Subscribers 49,462 43,131 14.7 % Postpaid Data-Centric Device and Other Phone Subscribers 21,816 26,535 (17.8) Total Postpaid Subscribers 71,278 69,666 2.3 Net Postpaid Subscriber Additions2 551 320 72.2 % 847 507 67.1 Postpaid Churn3 1.02% 0.97% 5 BP 1.03% 1.03% 0 BP Prepaid Subscribers 7,084 7,473 (5.2) % Net Prepaid Subscriber Additions2 11 92 (88.0) % (173) 217 - Reseller Subscribers 14,330 14,382 (0.4) % Net Reseller Subscriber Additions2 (414) 472 - (666) 656 - Connected Device Subscribers4 15,192 13,685 11.0 % Net Connected Device Subscriber Additions 484 382 26.7 % 915 612 49.5 1 Represents 100% of AT&T Mobility wireless subscribers.

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

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 3 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.

Includes data-centric devices such as eReaders, automobile monitoring systems, and fleet management - excludes tablet, subscribers, which are primarily reflected in 4 our postpaid subscriber category, with the remainder in prepaid.

Wireless 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 and devices and a wireless network that has sufficient spectrum and capacity to support these innovations and make them available to more subscribers. To attract and retain subscribers, we offer a broad handset line and a wide variety of service plans.

As technology evolves, rapid changes are occurring in the handset and device industry with the continual introduction of new models or significant revisions of existing models. We believe a broad offering of a wide variety of smartphones reduces dependence on any single operating system or manufacturer as these products continue to evolve in terms of technology and subscriber appeal. In the first six months of 2013, we continued to see increasing use of smartphones by our postpaid subscribers. Of our total postpaid phone subscriber base, 73.3% (or 49.5 million subscribers) use smartphones, up from 64.0% (or 43.1 million subscribers) a year earlier. As is common in the industry, most of our subscribers' phones are designed to work only with our wireless technology, requiring subscribers who desire to move to a new carrier with a different technology to purchase a new device.

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JUNE 30, 2013 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Dollars in millions except per share amounts Our postpaid subscribers typically sign a two-year contract, which includes discounted handsets and early termination fees. About 90% of our postpaid smartphone subscribers are on FamilyTalk® Plans (family plans), Mobile Share plans or business plans, which provide for service on multiple devices at reduced rates, and such subscribers tend to have higher retention and lower churn rates. We offer our Mobile to Any Mobile feature, which enables our subscribers on these and other qualifying plans to make unlimited mobile calls to any mobile number in the United States, subject to certain conditions. We also offer data plans at different price levels (usage-based data plans) to attract a wide variety of subscribers and to differentiate us from our competitors. Our postpaid subscribers on data plans increased 11.5% year over year. A growing percentage of our postpaid smartphone subscribers are on usage-based data plans, with 71.0% (or 35.1 million) on these plans as of June 30, 2013, up from 61.6% (or 26.6 million) as of June 30, 2012. About 80% of subscribers on usage-based data plans have chosen the higher-priced plans. We recently expanded our Mobile Share data plans (which allow postpaid subscribers to share data at discounted prices among devices covered by their plan) to include additional, larger usage levels. Participation in these plans continues to increase. 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 June 30, 2013, about 65% 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 35% of our postpaid smartphone subscribers use an LTE device. Due to substantial increases in the demand for wireless service in the United States, AT&T is facing significant spectrum and capacity constraints on its wireless network in certain markets. We expect such constraints to increase and expand to additional markets in the coming years. While we are continuing to invest significant capital in expanding our network capacity, our capacity constraints could affect the quality of existing voice and data services and our ability to launch new, advanced wireless broadband services, unless we are able to obtain more spectrum. Any long-term spectrum solution will require that the Federal Communications Commission (FCC) make new or existing spectrum available to the wireless industry to meet the expanding needs of our subscribers. We will continue to attempt to address spectrum and capacity constraints on a market-by-market basis.

Wireless Metrics Subscriber Additions As of June 30, 2013, we served 107.9 million wireless subscribers, an increase of 2.5%. Market saturation and competition in the wireless industry will continue to limit the rate of growth in the industry's subscriber base, which has contributed to the modest 0.6% increase in gross subscriber additions (gross additions) when compared to the second quarter of 2012 and a 5.1% decrease when compared to the first six months of 2012. Lower net subscriber additions (net additions) were primarily attributable to losses in reseller low-revenue accounts. The increases in net postpaid additions reflect the migration of prepaid tablet subscribers to our postpaid plans, contributing to an increase in postpaid tablet subscribers of 398,000 in the second quarter and 763,000 for the first six months of 2013.

Average service revenue per user (ARPU) - Postpaid increased 1.8% in the second quarter and 1.3% for the first six months of 2013. Postpaid data services ARPU increased 17.6% in the second quarter and 17.8% for the first six months of 2013, reflecting greater use of smartphones and data-centric devices by our subscribers.

The growth in postpaid data services ARPU was partially offset by a 4.8% decrease in postpaid voice, text and other service ARPU in the second quarter and 5.4% decrease for the first six months of 2013. Voice, text and other service ARPU declined due to lower access and airtime charges, triggered in part by postpaid subscribers on our discount plans and lower roaming revenues.

ARPU - Total increased 1.3% in the second quarter and 0.7% for the first six months of 2013, reflecting growth in data services as more subscribers are using smartphones and tablets and choosing higher-priced usage-based data plans. Data services ARPU increased 16.6% in the second quarter and 16.8% for the first six months of 2013. Voice, text and other service ARPU declined 5.4% in the second quarter and 6.2% for the first six months of 2013 primarily due to voice access and usage trends and a shift toward a greater percentage of data-centric devices, as well as lower regulatory fees. We expect continued growth in data services ARPU as more subscribers use smartphones and data-centric devices and continue to choose higher-priced usage-based data plans. As we continue to expand our network, we also expect continued pressure on voice, text and other service ARPU.

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JUNE 30, 2013 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Dollars in millions except per share amounts Churn The effective management of subscriber churn is critical to our ability to maximize revenue growth and to maintain and improve margins. The total churn rate was higher in the second quarter and for the first six months of 2013, primarily associated with the disconnection of reseller low-revenue accounts.

The postpaid churn rate was slightly higher in the second quarter and flat for the first six months of 2013.

Operating Results Our Wireless segment operating income margin in the second quarter decreased from 31.0% in 2012 to 27.1% in 2013 and for the first six months decreased from 29.4% in 2012 to 27.5% in 2013. Wireless segment operating income decreased $389, or 7.7%, in the second quarter and $205, or 2.1%, for the first six months of 2013. The decreases in operating margin and income reflected higher costs associated with upgrade activity and subsidies associated with growing smartphone sales, partially offset by continuing data revenue growth.

Voice, text and other service revenues decreased $280, or 2.7%, in the second quarter and $674, or 3.3%, for the first six months of 2013. While we had a 2.5% year-over-year increase in the number of wireless subscribers, these revenues continue to decline due to lower access and airtime charges.

Data service revenues increased $885, or 19.8%, in the second quarter and $1,775, or 20.4%, for the first six months of 2013. The increases were primarily due to the increased number of subscribers using smartphones and data-centric devices, such as eReaders, tablets, and mobile navigation devices. Data service revenues accounted for 34.4% of our wireless service revenues for the first six months of 2013, compared to 29.7% last year.

Equipment revenues increased $333, or 21.0%, in the second quarter and $392, or 12.4%, for the first six months of 2013 due to year-over-year increases in smartphone sales as a percentage of total device sales to postpaid subscribers and higher device upgrades.

Operations and support expenses increased $1,180, or 12.3%, in the second quarter and $1,382, or 7.1%, for the first six months of 2013. The increases in the second quarter and for the first six months were primarily due to the following: · Equipment costs increased $875 and $1,005 reflecting an increase in upgrade activity and total device sales, as well as the sales of more expensive smartphones.

· Commission expenses increased $258 and $211 due primarily to higher upgrade activity and total device sales and a year-over-year increase in smartphone sales as a percentage of total device sales.

· Selling expenses (other than commissions) and administrative expenses increased $143 and $341 due primarily to increases of: $85 and $162 in employee-related costs; $79 and $147 in advertising costs; and $28 and $108 in information technology costs in conjunction with ongoing support systems development. Partially offsetting these increases were bad debt expense declines of $47 and $102.

· Network system costs increased $66 and $155 due to higher network traffic and personnel-related network support costs and cell site related costs in conjunction with our network enhancement efforts.

Partially offsetting these increases were the following: · Interconnect and long-distance costs decreased $108 and $212 due to third-party credits and lower usage costs in the current period.

· USF fees decreased $33 and $98 primarily due to federal rate decreases, which are offset by lower USF revenues.

Depreciation and amortization expenses increased $147, or 8.7%, in the second quarter and $316, or 9.4%, for the first six months of 2013. Depreciation expense increased $216, or 13.8%, in the second quarter and $457, or 14.8%, for the first six months primarily due to ongoing capital spending for network upgrades and expansion. Amortization expense decreased $69, or 52.7%, in the second quarter and $141, or 50.2%, for the first six months primarily due to lower amortization of intangibles for customer lists related to acquisitions.

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JUNE 30, 2013 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 Second Quarter Six-Month Period Percent Percent 2013 2012 Change 2013 2012 Change Segment operating revenues Data $ 8,400 $ 7,935 5.9 % $ 16,562 $ 15,735 5.3 % Voice 5,141 5,696 (9.7) 10,447 11,588 (9.8) Other 1,232 1,276 (3.4) 2,419 2,513 (3.7) Total Segment Operating Revenues 14,773 14,907 (0.9) 29,428 29,836 (1.4) Segment operating expenses Operations and support 10,417 10,201 2.1 20,752 20,603 0.7 Depreciation and amortization 2,722 2,766 (1.6) 5,410 5,574 (2.9) Total Segment Operating Expenses 13,139 12,967 1.3 26,162 26,177 (0.1) Segment Operating Income 1,634 1,940 (15.8) 3,266 3,659 (10.7) Equity in Net Income (Loss) of Affiliates - (1) - 1 (1) - Segment Income $ 1,634 $ 1,939 (15.7) % $ 3,267 $ 3,658 (10.7) % Operating Results Our Wireline segment operating income margin in the second quarter decreased from 13.0% in 2012 to 11.1% in 2013, and for the first six months decreased from 12.3% in 2012 to 11.1% in 2013. Segment operating income decreased $306, or 15.8%, in the second quarter and $393, or 10.7%, for the first six months of 2013. The decrease in operating margins and income was driven primarily by lower voice revenue and higher operations and support expense, partially offset by data revenue growth and lower depreciation and amortization expenses.

Data revenues increased $465, or 5.9%, in the second quarter and $827, or 5.3%, for the first six months of 2013. Data revenues accounted for approximately 56% of wireline operating revenues for the first six months of 2013 and 53% for the first six months of 2012. Data revenue includes IP, strategic business and traditional data services.

· IP data revenues (excluding strategic business services below) increased $410, or 11.2%, in the second quarter and $809, or 11.3%, for the first six months of 2013 primarily driven by higher U-verse penetration, customer additions, and migration from our legacy voice and DSL services. In the second quarter and for the first six months U-verse revenue from consumer customers increased $312 and $639 for high speed Internet access, $246 and $492 for video and $74 and $122 for voice, respectively. These increases were partially offset by a decrease of $186 and $366 in DSL revenue as customers continue to shift to our strategic high speed Internet access offerings. We expect DSL revenue to continue to decline as a percentage of our overall data revenues.

· Strategic business services, which include VPNs, Ethernet, hosting, IP conferencing, VoIP, Ethernet-access to Managed Internet Service (EaMIS), security services, and U-verse services provided to business customers, increased $287, or 15.8%, in the second quarter and $479, or 13.3%, for the first six months of 2013 primarily driven by migration from our legacy services. In the second quarter and for the first six months revenue from Ethernet increased $76 and $139, VPN increased by $87 and $135, U-verse services increased $46 and $71, and EaMIS increased $28 and $56, respectively.

· Traditional data revenues, which include circuit-based and packet-switched data services, decreased $234, or 9.5%, in the second quarter and $468, or 9.4%, for the first six months of 2013. This decrease was primarily due to lower demand as customers continue to shift to more advanced IP-based technology such as Ethernet, VPN, U-verse High Speed Internet access and managed Internet services. We expect these traditional services to continue to decline as a percentage of our overall data revenues.

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JUNE 30, 2013 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Dollars in millions except per share amounts Voice revenues decreased $555, or 9.7%, in the second quarter and $1,141, or 9.8%, for the first six months of 2013 primarily due to declining demand for traditional voice services by our consumer and business customers. Included in voice revenues are revenues from local voice, long-distance (including international) and local wholesale services. Voice revenues do not include VoIP revenues, which are included in data revenues.

· Local voice revenues decreased $350, or 10.0%, in the second quarter and $710, or 9.9%, for the first six months of 2013. The decrease was driven primarily by a 15.0% decline in total switched access lines. We expect our local voice revenue to continue to be negatively affected by competition from alternative technologies and continued declines in switched access lines.

· Long-distance revenues decreased $202, or 10.5%, in the second quarter and $425, or 10.8%, for the first six months of 2013. Lower demand for long-distance service from our business and consumer customers decreased revenues $167 in the second quarter and $356 for the first six months of 2013.

Additionally, expected declines in the number of our national mass-market customers decreased revenues $35 in the second quarter and $70 for the first six months of 2013.

Other operating revenues decreased $44, or 3.4%, in the second quarter and $94, or 3.7%, for the first six months of 2013. Major items included in other operating revenues are integration services and customer premises equipment, government-related services and outsourcing, which account for approximately 60% of total other revenue for the periods reported.

Operations and support expenses increased $216, or 2.1%, in the second quarter and $149, or 0.7%, for the first six months of 2013. Operations and support expenses consist of costs incurred to provide our products and services, including costs of operating and maintaining our networks and personnel costs, such as compensation and benefits.

The increase in the second quarter of 2013 was primarily due to increased cost of sales of $203, primarily related to U-verse related expenses, contract services of $96, advertising expense of $53 and materials and supplies expense of $42. These increases were partially offset by lower employee related expenses of $151 and USF fees of $43, which are offset by lower USF revenue.

The increase for the first six months of 2013 was primarily due to increased cost of sales of $366, primarily related to U-verse related expenses, and advertising expense of $115. These increases were partially offset by lower employee related expenses of $244 and USF fees of $118, which are offset by lower USF revenue.

Depreciation and amortization expenses decreased $44, or 1.6%, in the second quarter and $164, or 2.9%, for the first six months of 2013. The decrease was primarily related to lower amortization of intangibles for the customer lists associated with acquisitions and lower depreciation as assets become fully depreciated.

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JUNE 30, 2013 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Dollars in millions except per share amounts Supplemental Information Wireline Broadband, Telephone and Video Connections Summary Our broadband, switched access lines and other services provided at June 30, 2013 and 2012 are shown below and trends are addressed throughout this segment discussion.

June 30, June 30, Percent (in 000s) 2013 2012 Change U-verse High Speed Internet 9,090 6,494 40.0 % DSL and Other Broadband Connections 7,363 9,940 (25.9) Total Wireline Broadband Connections1 16,453 16,434 0.1 Total U-verse Video Connections 5,001 4,146 20.6 Retail Consumer Switched Access Lines 13,983 17,298 (19.2) U-verse Consumer VoIP Connections 3,379 2,567 31.6 Total Retail Consumer Voice Connections 17,362 19,865 (12.6) Switched Access Lines Retail Consumer 13,983 17,298 (19.2) Retail Business 10,905 12,115 (10.0) Retail Subtotal 24,888 29,413 (15.4) Wholesale Subtotal 1,685 1,860 (9.4) Total Switched Access Lines2 26,849 31,604 (15.0) % 1 Total wireline broadband connections include DSL, U-verse High Speed Internet and satellite broadband.

2 Total switched access lines includes access lines provided to national mass markets and private payphone service providers of 276 at June 30, 2013 and 331 at June 30, 2012.

Advertising Solutions Segment Results Second Quarter Six-Month Period Percent Percent 2013 2012 Change 2013 2012 Change Total Segment Operating Revenues $ - $ 305 - $ - $ 1,049 - Segment operating expenses Operations and support - 226 - - 773 - Depreciation and amortization - 29 - - 106 - Total Segment Operating Expenses - 255 - - 879 - Segment Income $ - $ 50 - $ - $ 170 - On May 8, 2012, we completed the sale of our Advertising Solutions segment to an affiliate of Cerberus Capital Management, L.P.

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JUNE 30, 2013 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Dollars in millions except per share amounts Other Segment Results Second Quarter Six-Month Period Percent Percent 2013 2012 Change 2013 2012 Change Total Segment Operating Revenues $ 11 $ 10 10.0 % $ 21 $ 23 (8.7) % Total Segment Operating Expenses 210 250 (16.0) 588 493 19.3 Segment Operating Loss (199) (240) 17.1 (567) (470) (20.6) Equity in Net Income of Affiliates 237 148 60.1 439 384 14.3 Segment Income (Loss) $ 38 $ (92) - $ (128) $ (86) (48.8) % The Other segment includes our portion of the results from our international equity method investment, our equity interest in YP Holdings, and costs to support corporate-driven activities and operations. Also included in the Other segment are 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.

Segment operating revenues increased $1, or 10.0%, in the second quarter and decreased $2, or 8.7%, for the first six months of 2013. Operating revenues are from leased equipment programs.

Segment operating expenses decreased $40, or 16.0%, in the second quarter and increased $95, or 19.3%, for the first six months of 2013. Lower operating expenses in the second quarter were primarily due to lower Pension/OPEB and other employee related charges. These decreases were partially offset by higher new product development expenses and higher corporate support and capital leasing operations costs. Increased costs over the first six months were due to higher new product development costs, as well as higher corporate support and capital leasing operations expenses. These increases were partially offset by lower Pension/OPEB financing costs and decreased employee related costs.

Our Other segment also includes our equity method investments in América Móvil and YP Holdings, the income from which we report as equity in net income of affiliates. Our earnings from foreign affiliates are sensitive to exchange-rate changes in the value of the respective local currencies.

Equity in net income of affiliates increased $89, or 60.1%, in the second quarter and $55, or 14.3%, for the first six months of 2013. Increased equity in net income of affiliates in the second quarter was primarily due to increased earnings from América Móvil and YP Holdings. The increase for the first six months was primarily due to increased earnings from YP Holdings, partially offset by foreign exchange impacts at América Móvil.

Our equity in net income of affiliates by major investment is listed below: Second Quarter Six-Month Period 2013 2012 2013 2012 América Móvil $ 174 $ 127 $ 325 $ 364 YP Holdings 63 19 115 19 Other - 2 (1) 1 Other Segment Equity in Net Income of Affiliates $ 237 $ 148 $ 439 $ 384 28-------------------------------------------------------------------------------- AT&T INC.

JUNE 30, 2013 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Dollars in millions except per share amounts OTHER BUSINESS MATTERS U-verse Services As of June 30, 2013, we are marketing U-verse services to approximately 25.3 million customer locations (locations eligible to receive U-verse service). As of June 30, 2013, we had 9.4 million total U-verse subscribers (high-speed Internet and video), including 9.1 million Internet and 5.0 million video subscribers (subscribers to both services are only counted once in the total). As part of Project Velocity IP (VIP), we plan to expand our U-verse services to a total of approximately 33 million customer locations and expect to be essentially complete by year-end 2015.

We believe that our U-verse TV service is a "video service" under the Federal Communications Act. However, some cable providers and municipalities have claimed that certain IP services should be treated as a traditional cable service and therefore subject to the applicable state and local cable regulation. Petitions have been filed at the FCC alleging that the manner in which we provision "public, educational and governmental" (PEG) programming over our U-verse TV service conflicts with federal law, and a lawsuit has been filed in a California state superior court raising similar allegations under California law. If courts having jurisdiction where we have significant deployments of our U-verse services were to decide that federal, state and/or local cable regulation were applicable to our U-verse services, or if the FCC, state agencies or the courts were to rule that we must deliver PEG programming in a manner substantially different from the way we do today or in ways that are inconsistent with our current network architecture, it could have a material adverse effect on the cost and extent of our U-verse offerings.

Wage and Hour Litigation Two wage and hour cases were filed in federal court in December 2009 each asserting claims under the Fair Labor Standards Act (Luque et al. v. AT&T Corp. et al., U.S. District Court in the Northern District of California) (Lawson et al. v. BellSouth Telecommunications, Inc., U.S. District Court in the Northern District of Georgia). Luque also alleges violations of a California wage and hour law, which varies from the federal law. In April 2012, we settled these cases, subject to court approval, on terms that will not have a material effect on our financial statements. On April 23, 2013, the court granted approval of the settlement in Lawson. On April 26, 2013, the court granted final approval following its earlier preliminary approval of the settlement in Luque.

Atlantic Tele-Network, Inc. Transaction In January 2013, we announced an agreement to acquire Atlantic Tele-Network, Inc.'s U.S. retail wireless operations, operated under the Alltel brand, for $780 in cash. Under the terms of the agreement, we will acquire wireless properties, including licenses, network assets, retail stores and approximately 585,000 subscribers. The transaction is subject to review by the FCC and the Department of Justice (DOJ) and to other customary closing conditions and is expected to close in the second half of 2013.

Spectrum Acquisitions In January 2013, we announced an agreement to acquire spectrum in the 700 MHz B band from Verizon Wireless for $1,900 in cash and an assignment of Advanced Wireless Service (AWS) spectrum licenses in five markets.

The 700 MHz licenses to be acquired by AT&T cover 42 million people in 18 states. The transaction is subject to review by the FCC and DOJ. We expect to close the transaction in the second half of 2013.

Leap Acquisition On July 12, 2013, we announced an agreement to acquire Leap Wireless International, Inc. (Leap), a provider of prepaid wireless service, for fifteen dollars per outstanding share of Leap's common stock, or approximately $1,260, plus one non-transferable 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 FCC license held by Leap. As of June 30, 2013, Leap had approximately $2,700 of debt, net of cash. Under the terms of the agreement, we will acquire all of Leap's stock and, thereby, acquire all of its wireless properties, including spectrum licenses, network assets, retail stores and approximately 5 million subscribers. Leap's spectrum licenses include Personal Communications Services (PCS) and AWS bands and are largely complementary to our licenses. Leap's network covers approximately 96 million people in 35 states and consists of a 3G Code Division Multiple Access (CDMA) network and an LTE network covering approximately 21 million people.

The agreement must be approved by Leap's stockholders and stockholders holding approximately 29.9 percent of the outstanding common stock have agreed to support the transaction. The transaction also is subject to review by the FCC and the DOJ and to other customary closing conditions and is expected to close in approximately six to nine months from the announcement. The agreement also provides both parties with certain termination rights if the transaction does not close by July 11, 2014, which can be extended until January 11, 2015 if certain conditions have not been met by that date. Under certain circumstances, Leap may be required to pay a termination fee or AT&T may be required to provide Leap with a three-year roaming agreement for LTE data coverage in certain Leap markets lacking LTE coverage, if the transaction does not close. If Leap enters into the roaming agreement, AT&T will then have the option within 30 days after entry into the roaming agreement to purchase certain specified Leap spectrum assets. If AT&T does not exercise its right to purchase all of the specified Leap spectrum assets, Leap can then within 60 days after expiration of AT&T's option require AT&T to purchase all of the specified spectrum assets.

29 -------------------------------------------------------------------------------- AT&T INC.

JUNE 30, 2013 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Dollars in millions except per share amounts Labor Contracts As of June 30, 2013, we employed approximately 245,000 persons.

Approximately 54 percent of our employees are represented by the Communications Workers of America (CWA), the International Brotherhood of Electrical Workers (IBEW) or other unions. In June 2013, approximately 3,000 Connecticut-based wireline employees represented by the CWA ratified a new four-year contract; the previous contract had expired in April 2012. In May 2013, approximately 6,500 wireline employees represented by the IBEW and located mainly in the Midwest ratified a new four-year contract.

COMPETITIVE AND REGULATORY ENVIRONMENT Overview AT&T subsidiaries operating within the United States are subject to federal and state regulatory authorities. AT&T subsidiaries operating outside the United States are subject to the jurisdiction of national and supranational regulatory authorities in the markets where service is provided, and regulation is generally limited to operational licensing authority for the provision of services to enterprise customers.

In the Telecommunications Act of 1996 (Telecom Act), Congress established a national policy framework intended to bring the benefits of competition and investment in advanced telecommunications facilities and services to all Americans by opening all telecommunications markets to competition and reducing or eliminating regulatory burdens that harm consumers. However, since the Telecom Act was passed, the FCC and some state regulatory commissions have maintained or expanded certain regulatory requirements that were imposed decades ago on our traditional wireline subsidiaries when they operated as legal monopolies. We are pursuing, at both the state and federal levels, additional legislative and regulatory measures to reduce regulatory burdens that are no longer appropriate in a competitive telecommunications market and that inhibit our ability to compete more effectively and offer services wanted and needed by our customers, including initiatives to transition services from traditional networks to all IP-based networks. At the same time, we also seek to ensure that legacy regulations are not extended to broadband or wireless services, which are subject to vigorous competition.

In addition, states representing a majority of our local service access lines have adopted legislation that enables new video entrants to acquire a single statewide or state-approved franchise (as opposed to the need to acquire hundreds or even thousands of municipal-approved franchises) to offer competitive video services. We also are supporting efforts to update and improve regulatory treatment for retail services. Regulatory reform and passage of legislation is uncertain and depends on many factors.

We provide wireless services in robustly competitive markets, but those services are subject to substantial and increasing governmental regulation. Wireless communications providers must obtain licenses from the FCC to provide communications services at specified spectrum frequencies within specified geographic areas and must comply with the FCC rules and policies governing the use of the spectrum. The FCC has recognized that the explosive growth of bandwidth-intensive wireless data services requires the U.S. Government to make more spectrum available. In February 2012, Congress authorized the FCC to conduct an "incentive auction," to make available for wireless broadband use certain spectrum that is currently used by broadcast television licensees. The FCC has initiated a proceeding to establish rules that would govern this process. It also initiated a separate proceeding to review its policies governing mobile spectrum holdings and consider whether there should be limits on the amount of spectrum a wireless service provider may possess. We seek to ensure that we have the opportunity, through the incentive auction and otherwise, to obtain the spectrum we need to provide our customers with high-quality service. While wireless communications providers' prices and service offerings are generally not subject to state regulation, states sometimes attempt to regulate or legislate various aspects of wireless services, such as in the area of consumer protection.

30 -------------------------------------------------------------------------------- AT&T INC.

JUNE 30, 2013 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Dollars in millions except per share amounts Intercarrier Compensation/Universal Service In October 2011, the FCC adopted an order fundamentally overhauling its high-cost universal service program, through which it disburses approximately $4,500 per year to carriers providing telephone service in high-cost areas, and its existing intercarrier compensation (ICC) rules, which govern payments between carriers for the exchange of traffic. The order adopted rules to immediately address certain practices that artificially increase ICC payments, as well as other practices to avoid such payments. The order also established a new ICC regime that will result in the elimination of virtually all terminating switched access charges and reciprocal compensation payments over a six-year transition. In the order, the FCC also repurposed its high-cost universal service program to encourage providers to deploy broadband facilities in unserved areas. To accomplish this goal, the FCC will transition support amounts disbursed through its existing high-cost program to its new Connect America Fund, which eventually will award targeted high-cost support amounts to providers through a competitive process. We support many aspects of the order and new rules. AT&T and other parties have filed appeals of the FCC's rules, which are pending in the Tenth Circuit Court of Appeals. Our appeal challenges only certain, narrow aspects of the order; AT&T intervened in support of the broad framework adopted by the order. We do not expect the FCC's rules to have a material impact on our operating results.

Transition to IP-Based Network In November 2012, we announced plans to significantly expand and enhance our wireless and wireline broadband networks to support future IP data growth and new services (referred to as Project VIP). In conjunction with Project VIP, we filed a petition with the FCC asking it to open a proceeding to facilitate the "telephone" industry's transition from traditional transmission platforms and services to all IP-based networks and services. Our petition asks the FCC to conduct trial runs of the transition to next-generation services, including the upgrading of traditional telephone facilities and offerings and their replacement with IP-based alternatives. The objective of the trials is to inform policymakers and other stakeholders regarding the technological and policy dimensions of the IP transition and, in the process, identify the regulatory reforms needed to promote consumer interests and preserve private incentives to upgrade America's broadband infrastructure. In May 2013, the FCC's Technology Transition Task Force sought comment on potential trials to obtain data to assist the FCC in managing the transition to next-generation networks. We expect the FCC will decide by the end of this year whether to conduct such trials. We expect to transition wireline customers to an all IP-based network by 2020.

31 -------------------------------------------------------------------------------- AT&T INC.

JUNE 30, 2013 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Dollars in millions except per share amounts LIQUIDITY AND CAPITAL RESOURCES We had $4,548 in cash and cash equivalents available at June 30, 2013. Cash and cash equivalents included cash of $328 and money market funds and other cash equivalents of $4,220. In the first six months of 2013, cash outflows were primarily used to meet the needs of the business, including, but not limited to, payment of operating expenses, funding capital expenditures, and the acquisition of wireless spectrum. Cash flows were also used to return value to stockholders through dividends and stock repurchases. We discuss many of these factors in detail below.

Cash Provided by or Used in Operating Activities During the first six months of 2013, cash provided by operating activities was $17,711, compared to $17,325 for the first six months of 2012.

Cash Used in or Provided by Investing Activities For the first six months of 2013, cash used in investing activities totaled $9,865, which consisted primarily of $9,665 for capital expenditures (excluding interest during construction), and wireless spectrum acquisitions of $1,169.

These expenditures were partially offset by cash receipts of approximately $771 from the sale of a portion of our shares in América Móvil, $200 from the repayment of advances to YP Holdings and $101 from the return of investment in YP Holdings.

Virtually all of our capital expenditures are spent on our wireless and wireline networks, our U-verse services, and support systems for our communications services. Capital spending in our Wireless segment of $5,227 represented 54% of our total spending and increased 14% in the first six months. Wireless expenditures were primarily used for network capacity expansion, integration and the deployment of LTE equipment upgrades and our High-Speed Downlink Packet Access network. The Wireline segment, which includes U-verse services, represented 46% of total capital expenditures and increased 7% in the first six months.

We continue to expect our capital expenditures during 2013 to be in the $21,000 range and expect capital expenditures for 2014 and 2015 to each be in the $20,000 range.

Cash Used in or Provided by Financing Activities For the first six months of 2013, our financing activities included proceeds of $6,416 from the following debt issuances: · February 2013 issuance of $1,000 of 0.900% global notes due 2016 and $1,250 of floating rate notes due 2016. The floating rate for the note is based upon the three-month London Interbank Offered Rate (LIBOR), reset quarterly, plus 38.5 basis points.

· March 2013 issuance of $500 of 1.400% global notes due 2017.

· March 2013 issuance of €1,250 of 2.500% global notes due 2023 (equivalent to $1,626 when issued) and €400 of 3.550% global notes due 2032 (equivalent to $520 when issued).

· May 2013 issuance of £1,000 of 4.250% global notes due 2043 (equivalent to approximately $1,560 when issued).

In March 2013, we repaid €1,250 of 4.375% notes (equivalent to $1,641 when repaid) and $147 of 6.5% notes. Additionally, in May 2013, we announced the redemption of $300 of 7.375% notes, which was completed in July 2013.

In May 2013, we completed a repurchase authorization that was approved by our Board of Directors in July 2012. In March 2013, our Board of Directors authorized the repurchase of an additional 300 million shares of our common stock. During the first six months of 2013, we repurchased 257 million shares for $9,217 under these authorizations. At the end of the second quarter, we had 272 million shares remaining on the March 2013 authorization. We expect to make future repurchases opportunistically, which will slow the pace of buybacks compared to recent activity.

32 -------------------------------------------------------------------------------- AT&T INC.

JUNE 30, 2013 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Dollars in millions except per share amounts We paid dividends of $4,930 during the first six months of 2013, compared with $5,187 for the first six months of 2012, primarily reflecting the decline in shares outstanding due to our repurchases during the year, which offset the increase in the quarterly dividend approved by our Board of Directors in November 2012. Dividends declared by our Board of Directors totaled $0.45 per share in the second quarter of 2013 and $0.90 per share for the first six months of 2013 and $0.44 per share in the second quarter and $0.88 per share for the first six months of 2012. Our dividend policy considers the expectations and requirements of stockholders, internal requirements of AT&T and long-term growth opportunities. It is our intent to provide the financial flexibility to allow our Board of Directors to consider dividend growth and to recommend an increase in dividends to be paid in future periods. All dividends remain subject to declaration by our Board of Directors.

At June 30, 2013, we had $3,256 of debt maturing within one year, $1,991 of which were long-term debt issuances. Debt maturing within one year includes the following notes that may be put back to us by the holders: · $1,000 of annual put reset securities issued by BellSouth Corporation (BellSouth) that may be put back to us each April until maturity in 2021.

· An accreting zero-coupon note that may be redeemed each May until maturity in 2022. If the zero-coupon note (issued for principal of $500 in 2007) is held to maturity, the redemption amount will be $1,030.

We have two revolving credit agreements with a syndicate of banks: a $5,000 agreement expiring in December 2016 and a $3,000 agreement expiring in December 2017. Advances under either agreement may be used for general corporate purposes. Advances are not conditioned on the absence of a material adverse change. All advances must be repaid no later than the date on which lenders are no longer obligated to make any advances under each agreement. Under each agreement, we can terminate, in whole or in part, amounts committed by the lenders in excess of any outstanding advances; however, we cannot reinstate any such terminated commitments. Under each agreement, we must maintain a debt-to-EBITDA, including modifications described in the agreement, ratio of not more than three-to-one as of the last day of each fiscal quarter for the four quarters then ended. Both agreements also contain a negative pledge covenant, which generally provides that if we pledge assets or permit liens on our property, then any advances must also be secured. At June 30, 2013, we had no advances outstanding under either agreement and were in compliance with all covenants under each agreement.

Other Our total capital consists of debt (long-term debt and debt maturing within one year) and stockholders' equity. Our capital structure does not include debt issued by América Móvil or YP Holdings. At June 30, 2013, our debt ratio was 46.6%, compared to 38.4% at June 30, 2012, and 43.0% at December 31, 2012. The debt ratio is affected by the same factors that affect total capital, and reflects our recent debt issuances.

In October 2012, we filed an application with the U.S. Department of Labor (DOL) for approval to contribute a preferred equity interest in our Mobility business to the trust used to pay pension benefits under plans sponsored by AT&T. At the time we filed the application, the interest had a fair market value of $9,500.

Prior to the contribution of the preferred interest, the estimated pension funding contribution for 2013 (required under ERISA) is approximately $175. We continue to work with the DOL to be able to make the contribution before the end of 2013. Our current financial statements reflect the impact of making this tax deductible contribution as a component of deferred tax expense and deferred tax liabilities. If we make the contribution after our 2012 tax return due date of September 16, 2013, we will take a tax deduction for our 2013 tax return and estimated payments.

33-------------------------------------------------------------------------------- AT&T INC.

JUNE 30, 2013

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