UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

Commission file number 1-1105

AT&T Corp.

One AT&T Way, Bedminster, New Jersey 07921

Telephone — Area Code 908-221-2000

      Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes þ          No o

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).     Yes þ          No o

      At July 29, 2005, the following shares of stock were outstanding: AT&T common stock — 802,018,306.

PART I — FINANCIAL INFORMATION

AT&T CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

The notes are an integral part of the consolidated financial statements.

AT&T CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

The notes are an integral part of the consolidated financial statements.

AT&T CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREOWNERS’ EQUITY

(Unaudited)

AT&T accounts for treasury stock as retired stock. The amount attributable to treasury stock at June 30, 2005 and December 31, 2004 was $(17,011) million.

We have 100 million authorized shares of preferred stock at $1 par value.

The notes are an integral part of the consolidated financial statements.

AT&T CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

The notes are an integral part of the consolidated financial statements.

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

      The consolidated financial statements have been prepared by AT&T Corp. (AT&T) pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) and, in the opinion of management, include all adjustments of a normal and recurring nature necessary for a fair statement of the consolidated results of operations, financial position and cash flows for each period presented. The consolidated results for interim periods are not necessarily indicative of results for the full year. These financial results should be read in conjunction with AT&T’s Form 10-Q for the quarter ended March 31, 2005, and Form 10-K/ A for the year ended December 31, 2004.

      On January 31, 2005, AT&T and SBC Communications Inc. (SBC) announced an agreement for SBC to acquire AT&T. Under the terms of the agreement, each AT&T share will be exchanged for 0.77942 of a share of SBC common stock. In addition, at the time of closing, we will pay our shareowners a special dividend of $1.30 per share. At the time of the announcement, this consideration was valued at $19.71 per share, or approximately $16.0 billion. The stock consideration in the transaction is expected to be tax-free to our shareowners. The acquisition, which is subject to approval by regulatory authorities, and other customary closing conditions, is expected to close in late 2005 or early 2006. However, it is possible that factors outside of our control could require us to complete the merger at a later time or not to complete it at all. The terms of certain of our agreements, including contracts, employee benefit arrangements and debt instruments, have provisions which could result in changes to the terms or settlement amounts of these agreements upon a change in control of AT&T. On June 30, 2005, AT&T shareholders voted to approve the proposed merger agreement with SBC.

      We have a Long Term Incentive Program under which stock options, performance shares, restricted stock and other awards in common stock are granted, as well as an Employee Stock Purchase Plan (ESPP). Employee purchases of company stock under the ESPP were suspended in 2003. Effective January 1, 2003, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation,” and we began to record stock-based compensation expense for all employee awards (including stock options) granted or modified after January 1, 2003. For awards issued prior to January 1, 2003, we apply Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for our plans. Under APB Opinion No. 25, no compensation expense has been recognized for stock options, other than for certain occasions when we have modified the terms of the stock option vesting schedule.

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

      If we had elected to recognize compensation costs based on the fair value at the date of grant of all awards granted prior to January 1, 2003, consistent with the provisions of SFAS No. 123, net income and earnings per share amounts would have been as follows:

      Pro forma stock-based compensation expense reflected above may not be indicative of future compensation expense that may be recorded. Future compensation expense may differ due to various factors, such as the number of awards granted and the market value of such awards at the time of grant, as well as the planned adoption of SFAS 123 (revised 2004), “Share-Based Payment,” beginning in the first quarter of 2006 (see note 12).

      For a detailed discussion of significant accounting policies, please refer to our Form 10-K/ A for the year ended December 31, 2004.

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

      Amortization expense associated with purchased intangible assets for the three and six months ended June 30, 2005, was $26 million and $53 million, respectively. Amortization expense for the three and six months ended June 30, 2004, was $28 million and $61 million, respectively. Amortization expense for purchased intangible assets is estimated to be approximately $110 million for each of the years ending December 31, 2005 and 2006 and $80 million for each of the years ending December 31, 2007 and 2008, at which time the purchased intangible assets will be fully amortized.

      Recorded within other current assets as of December 31, 2004, was restricted cash of $546 million relating to debt that matured in February 2005 (see note 8).

      Recorded within other current liabilities were $411 million and $281 million of income taxes payable as of June 30, 2005 and December 31, 2004, respectively.

      In May 2005, we completed the sale of an administrative building which was classified as an asset held-for-sale as of March 31, 2005. Since we are leasing back a portion of the building, the majority of the approximately $40 million gain was deferred, with $6 million recorded within other (expense) income, net, upon closing. In addition, in June 2005, we completed the sale of our payphone business which was also classified as an asset held-for-sale at March 31, 2005. The sale resulted in a loss of $14 million and was recorded within other (expense) income, net.

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

      Basic earnings per common share (EPS) is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution (considering the combined income and share impact) that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. The potential issuance of common stock is assumed to occur at the beginning of the year (or at the time of issuance if later), and the incremental shares are included using the treasury stock method. The proceeds utilized in applying the treasury stock method consist of the amount, if any, to be paid upon exercise, the amount of compensation cost attributed to future service not yet recognized, and any tax benefits credited to paid-in-capital related to the exercise. These proceeds are then assumed to be used to purchase common stock at the average market price during the period. The incremental shares (difference between the shares assumed to be issued and the shares assumed to be purchased), to the extent they would have been dilutive, are included in the denominator of the diluted EPS calculation. Potentially dilutive securities for all periods presented were stock options, restricted stock units and performance shares. No adjustments were made to income for the computation of diluted EPS.

      Asset impairment and net restructuring and other charges of $36 million for the three and six months ended June 30, 2005, consisted of $45 million of facility closing reserves and a related $5 million asset impairment charge in connection with leasehold improvements in these facilities. These activities were partially offset by the net reversal of $14 million of excess preexisting business restructuring liabilities.

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

      The $45 million of facility closing reserves were associated with the continued consolidation of our real estate portfolio and reflected the present value of contractual lease obligations, net of estimated sublease income, associated with vacant facilities primarily resulting from workforce reductions. Facility closing charges of $43 million were recorded in the Corporate and Other group and $2 million in AT&T Business Services. Additionally, the Corporate and Other group and AT&T Business Services recorded $2 million and $3 million, respectively, of leasehold improvement impairment charges.

      During the second quarter, management reevaluated preexisting business restructuring reserves and determined the actual or revised estimates of separation and related benefit payments differed from the estimates initially made, resulting in a net reversal of $14 million. AT&T Business Services recorded $23 million of the reversal and the Corporate and Other group recorded $1 million. AT&T Consumer Services recorded an additional $10 million as a result of this review. The adjustment to these reserves did not result from changes to the actual or planned headcount separations.

      The following table displays the activity and balances of the restructuring reserve accounts:

      Deductions primarily reflected total cash payments of $270 million. These cash payments included cash termination benefits of $234 million and $36 million of facility closing reserve payments, which were funded primarily through cash from operations.

      Asset impairment and net restructuring and other charges of $54 million for the three months ended June 30, 2004, consisted primarily of business restructuring activities associated with employee separations related to AT&T Business Services. This activity resulted from the continued integration and automation of various functions within network operations, as well as reorganizations throughout our non-U.S. operations. This exit plan impacted approximately 625 employees (more than half of which were involuntary), approximately 35% of whom were managers.

      Asset impairment and net restructuring and other charges of $267 million for the six months ended June 30, 2004, were comprised of business restructuring obligations of $145 million, primarily related to AT&T Business Services and real estate impairment charges of $122 million included in the Corporate and Other group.

      The business restructuring obligations consisted of $104 million of separation costs and $41 million of facility closing obligations. The separations, of which slightly less than half were managers, were primarily involuntary and impacted approximately 1,405 employees as a result of integration and automation of various functions within network operations, as well as reorganizations throughout our non-U.S. operations. The facility closing reserves were primarily associated with the consolidation of our real estate portfolio and reflected the present value of contractual lease obligations, net of estimated sublease income, associated with vacant facilities resulting from workforce reductions and network equipment space that will not be used.

      The real estate impairment charges resulted from the decision made during the first quarter of 2004 to divest five owned properties in an effort to further reduce costs and consolidate our real estate portfolio. The impairment charge was recorded to reduce the book value of the five properties to fair market value based on third party assessments (including broker appraisals). The sale of the properties was completed in 2004.

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

      Approximately 80% of headcount reductions associated with all of our 2004 exit plans were completed as of June 30, 2005. As of June 30, 2005, we had approximately 41,500 employees, compared with approximately 47,600 employees at December 31, 2004.

      In May 2005, we repaid $125 million of short-term borrowings outstanding under the AT&T Consumer Services accounts receivable securitization facility and subsequently terminated the facility.

      In April 2005, we completed the early retirement of $1.25 billion of our outstanding 7.30% Notes maturing in November 2011, which carried an interest rate of 9.05% at the time of retirement. The notes were repurchased with cash and resulted in a loss of approximately $0.2 billion recorded in other (expense) income, net.

      In the normal course of business, we use various financial instruments, including derivative financial instruments, to manage our market risk associated with changes in interest rates and foreign exchange rates. We do not use financial instruments for trading or speculative purposes. The following information pertains to financial instruments with significant activity since December 31, 2004.

      Letters of credit are guarantees we purchase, which ensure our performance or payment to third parties in accordance with specified terms and conditions. Management has determined that our letters of credit do not create additional risk to us. The notional amounts outstanding at June 30, 2005 and December 31, 2004, were $0.3 billion and $1.2 billion, respectively. The decrease in the notional amount of the letters of credit was primarily related to the maturity of debt in February 2005. In addition, restricted cash of $546 million, recorded within other current assets as of December 31, 2004, which collateralized these letters of credit, was released upon maturity of this debt.

      We enter into interest rate swap agreements to manage the fixed/floating mix of our debt portfolio in order to reduce aggregate risk of interest rate movements. These agreements involve the exchange of floating-rate for fixed-rate payments or the exchange of fixed-rate for floating-rate payments without the exchange of the underlying notional amount. Floating-rate payments and receipts are primarily tied to the London Inter-Bank Offered Rate (LIBOR). During the first quarter of 2005, all of our floating-rate to fixed-rate swaps (notional amount of $108 million), designated as cash flow hedges, matured.

      In addition, we have combined interest-rate foreign-currency swap agreements for foreign-currency-denominated debt, which hedge our risk to both interest rate and currency movements. As of June 30, 2005, the notional amount and fair value of these contracts was $0.6 billion and $0.3 billion, respectively, compared with $1.4 billion and $0.7 billion, respectively, at December 31, 2004. The decreases in the notional amount and fair value of these agreements were primarily related to the maturity in February 2005 of $0.7 billion notional amount of contracts relating to debt that also matured in February 2005.

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

      We entered into equity options and equity swap contracts, which were undesignated, to manage our exposure to changes in equity prices associated with various equity awards of previously affiliated companies. During the first quarter of 2005, all of the previously outstanding equity awards and the related equity option and equity swap contracts expired (notional amount of $29 million).

      We sponsor noncontributory defined benefit pension plans covering the majority of our U.S. employees. Our postretirement benefit plans for current and certain future retirees include health-care benefits, life insurance coverage and telephone concessions.

      The following table shows the components of net periodic benefit (credit) costs for our U.S. plans:

      In 2003, the Medicare Prescription Drug. Improvement and Modernization Act of 2003, was signed into law. The Act introduced a prescription drug benefit under Medicare (Medicare Part D, as well as a federal subsidy to sponsors of retiree health-care benefits. In 2004, we determined that the prescription drug benefit provided to a specific portion of our postretirement benefit plan participants was actuarially equivalent to Medicare Part D.

      In the second quarter of 2005, we determined that their prescription drug benefits provided to the remaining plan participants are also actuarially equivalent to the Medicare Part D benefits and therefore, we expect to be entitled to the federal subsidy. The impact of such expected federal subsidy will not have a significant effect on our accumulated postretirement benefit obligation and net periodic postretirement benefit cost.

      Certain non-U.S. operations have varying types of pension programs providing benefits for substantially all of their employees.

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

      The following table shows the components of net periodic benefit costs for non-U.S. plans:

      In the normal course of business we are subject to proceedings, lawsuits and other claims, including proceedings under laws and regulations related to disputes with other carriers, environmental and other matters. Such matters are subject to many uncertainties, and outcomes are not predictable with assurance. Consequently, we are unable to ascertain the ultimate aggregate amount of monetary liability or financial impact with respect to these matters at June 30, 2005. However, if these matters are adversely settled, such amounts could be material to our consolidated financial statements.

      During the second quarter of 2005, we reached a settlement for $29 million, subject to final approval by the Court, of the class action claims brought by participants in our Long Term Savings Plan for Management Employees (the Plan). The lawsuit alleged we breached our fiduciary duties to the Plan and Plan participants by making materially false and misleading statements and omitting to state material facts concerning our future business prospects. A hearing for final approval is currently expected to occur in September 2005. The settlement of this lawsuit, did not have a material impact to the results of operations for the three and six months ended June 30, 2005.

      In 2004, following a Federal Communications Commission (FCC) ruling against a petition we filed in which we asked the FCC to decide the issue of whether certain phone-to-phone Internet protocol (IP) telephony services are exempt from paying access charges, SBC filed a lawsuit in federal district court in Missouri asserting claims that we avoided interstate and intrastate access charges. During the first quarter of 2005, AT&T and SBC settled a variety of claims and disputes between the parties, including this litigation. The settlement of all matters resulted in AT&T paying SBC approximately $60 million, which did not have a material impact on our results of operations. Recently, other carriers, including BellSouth Telecommunications, Inc (BellSouth) have filed similar lawsuits in various jurisdictions. These claims did not specify damages.

      During the second quarter of 2005, we settled and paid lawsuits brought by the trustee for the bondholders’ liquidating trust, as well as a preference claim brought by creditors of At Home Corporation (At Home). Under the terms of the settlement agreement, the bondholders were paid $340 million, in addition to AT&T and Comcast Corporation (Comcast) relinquishing claims held in reserve by the At Home estate. Under the terms of a separation agreement with our former broadband subsidiary, which was spun off to Comcast in 2002, the settlement was shared equally between the two parties. The settlement of this litigation did not have a material impact on our results of operations for the three and six months ended June 30, 2005.

      Class action lawsuits filed in California on behalf of At Home shareholders, which alleged AT&T breached fiduciary obligations, have been dismissed and are on appeal.

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

      In February 2005, the FCC ruled against AT&T and its petition for a declaratory ruling that our enhanced prepaid card services is an interstate information service. Following this decision, Qwest Communication International, Inc. (Qwest) filed a lawsuit against us asserting claims for breach of federal and state tariffs, unjust enrichment, fraudulent misrepresentation and breach of contract. Qwest seeks unspecified damages. Recently, other carriers, including BellSouth, have filed similar lawsuits in various jurisdictions, all seeking unspecified damages.

      Our results are segmented according to the customers we service: AT&T Business Services and AT&T Consumer Services.

      AT&T Business Services provides a variety of communication services to various-sized businesses and government agencies including long distance, international, toll-free and local voice, including wholesale transport services, as well as data services and Internet protocol and enhanced (IP&E) services, which includes the management of network servers and applications. AT&T Business Services also provides outsourcing solutions and other professional services.

      AT&T Consumer Services provides a variety of communication services to residential customers. These services include traditional long distance voice services, such as domestic and international dial services (long distance or local toll calls where the number “1” is dialed before the call) and calling card services. Transaction services, such as prepaid card and operator-assisted calls, are also offered. Collectively, these services represent stand-alone long distance services and are not offered in conjunction with any other service. AT&T Consumer Services also provides dial-up Internet services, and all distance services, which generally bundle long distance, local and local toll.

      The balance of our operations is included in a “Corporate and Other” group. This group primarily reflects corporate staff functions and the elimination of transactions between segments.

      Total assets for each segment include all assets, except intercompany receivables. Nearly all prepaid pension assets, taxes and corporate-owned or leased real estate are held at the corporate level and, therefore, are included in the Corporate and Other group. Capital additions for each segment include capital expenditures for property, plant and equipment, additions to internal-use software (included in other assets) and additions to nonconsolidated investments. We evaluate performance based on several factors, of which the primary financial measure is operating income.

      AT&T Business Services sells services to AT&T Consumer Services at cost-based prices. These sales are recorded by AT&T Business Services as contra-expense.

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

     Reflecting the dynamics of our business, we continually review our management model and structure, which may result in adjustments to our operating segments in the future.

      In June 2005, the FASB issued FASB Staff Position FSP FAS No. 143-1, “Accounting for Electronic Equipment Waste Obligations,” to address the accounting for obligations associated with the Directive on Waste Electrical and Electronic Equipment (the Directive) issued by the European Union (EU). The Directive was enacted on February 13, 2003, and directs EU-member countries to adopt legislation to regulate the collection, treatment, recovery, and environmentally sound disposal of electrical and electronic waste equipment. The Directive concludes that commercial users are obligated to retire, in an environmentally sound manner, specific assets that qualify as historical waste. FAS 143-1 is effective for reporting periods ending after June 8, 2005, which is June 30, 2005 for us, or the date of adoption of the Directive by the applicable EU-member countries, if later. We have evaluated the impact to our operations in EU countries that have adopted legislation and have deemed these costs to be immaterial. We will continue to evaluate the impact as other EU-member countries enact legislation. However, if the remaining EU-member countries enact similar legislation, we do not expect a material impact to our results of operations.

      In March 2005, the FASB issued FASB Interpretation (FIN) 47, “Accounting for Conditional Asset Retirement Obligations,” an interpretation of SFAS No. 143, “Accounting for Asset Retirement Obligations.” FIN 47 clarifies that the term conditional asset retirement obligation, as used in SFAS No. 143, refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and/or method of settlement. FIN 47 requires an entity to recognize a liability for the fair value of the conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. FIN 47 is effective for fiscal years ending after December 15, 2005, which is December 31, 2005 for us; however, earlier application is permitted. We are currently evaluating the impact of FIN 47 on our results of operations, financial position and cash flows.

      In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment,” which requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. Additional guidance to assist in the initial interpretation of this revised statement was subsequently issued by the SEC in Staff Accounting Bulletin No. 107. SFAS No. 123 (revised 2004) eliminates the alternative of using APB Opinion No. 25 intrinsic value method of accounting that was provided for in SFAS No. 123 as originally issued. Effective January 1, 2003, we adopted the fair value recognition provisions of original SFAS No. 123 on a prospective basis and we began to record stock-based compensation expense for all employee awards (including stock options) granted or modified after January 1, 2003, using the nominal vesting approach. Had we used the non-substantive vesting method, which will be required upon adoption, our results of operations would not have been materially different from those reported in the first half of 2005 and 2004. Adoption of the revised standard will require that we begin to recognize expense for unvested awards issued prior to January 1, 2003. Additionally, this standard requires that estimated forfeitures be considered in determining compensation expense. For equity awards other than stock options, we have not previously included estimated forfeitures in determining compensation expense. Accordingly, the difference between the expense we have recognized to date and the compensation expense as calculated considering estimated forfeitures will be reflected as a cumulative effect of accounting change upon adoption. Further, SFAS No. 123 (revised 2004) requires that excess tax benefits be recognized as an addition to paid-in capital and amends SFAS No. 95, “Statement of Cash Flows,” to require that the excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid. SFAS No. 123 (revised 2004) is effective for annual periods beginning after June 15, 2005, which is January 1, 2006 for us. We intend to elect a modified prospective adoption beginning in the first

AT&T CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

quarter of 2006 and do not anticipate that the adoption of SFAS No. 123 (revised 2004) will have a material impact on our results of operations.

      In December 2004, the FASB issued FASB Staff Position FSP FAS 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004,” which provides guidance on the accounting and disclosure requirements for the repatriation provision of the Act. The Act creates a one-time tax incentive for U.S. corporations to repatriate accumulated income earned abroad by providing a tax deduction of 85% of dividends received for certain foreign earnings that are repatriated. In an effort to assist taxpayers with the interpretation of the repatriation provision of the Act, in May 2005, the United States Department of Treasury issued detailed guidance on certain technical aspects that required clarification. The deduction remains dependent upon a number of requirements and the amount of the deduction is subject to potential local country restrictions on remittances, as well as to management’s decisions with respect to any repatriation. Based upon the new guidance issued in second quarter of 2005, we are considering possible qualifying dividend remittances of approximately $0.1 billion, which, after consideration of deferred taxes previously provided on foreign earnings, we estimate would result in a one-time income tax benefit in 2005 of approximately $10 million. We expect to complete our evaluation of the impact of the Act during 2005.

AT&T CORP. AND SUBSIDIARIES

Forward-Looking Statements

      This document contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to financial condition, results of operations, cash flows, dividends, financing plans, business strategies, operating efficiencies, capital and other expenditures, competitive positions, availability of capital, growth opportunities for new and existing products, benefits from new technologies, availability and deployment of new technologies, plans and objectives of management, mergers and acquisitions, and other matters.

      Statements in this document that are not historical facts are hereby identified as “forward-looking statements” for the purpose of the safe harbor provided by Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The words “estimate,” “project,” “intend,” “expect,” “believe,” “plan,” and similar expressions are intended to identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this document. Any Form 10-K, Annual Report to Shareholders, Form 10-Q or Form 8-K of AT&T Corp. may include forward-looking statements. In addition, other written or oral statements which constitute forward-looking statements have been made and may in the future be made by or on behalf of AT&T, including with respect to the matters referred to above. These forward-looking statements are necessarily estimates, reflecting the best judgment of senior management that rely on a number of assumptions concerning future events, many of which are outside of our control, and involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the forward-looking statements. These forward-looking statements should, therefore, be considered in light of various important factors, including those set forth in this document. Important factors that could cause actual results to differ materially from estimates or projections contained in the forward-looking statements include, without limitation:

      The discussion and analysis that follows provides information management believes is relevant to an assessment and understanding of AT&T’s consolidated results of operations for the three and six months ended June 30, 2005 and 2004, and financial condition as of June 30, 2005 and December 31, 2004.

AT&T CORP. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Overview

      AT&T Corp. (AT&T) is among the world’s communications leaders, providing voice and data communications services to large and small businesses, consumers and government agencies. We provide domestic and international long distance, regional and local communications services, data and Internet services.

Critical Accounting Estimates and Judgments

      The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses as well as the disclosure of contingent assets and liabilities. Management bases its estimates and judgments on historical experience and other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

      For a discussion of the critical accounting estimates we identified that we believe require significant judgment in the preparation of our consolidated financial statements, please refer to AT&T’s Form 10-K/ A for the year ended December 31, 2004.

Consolidated Results of Operations

      Total revenue decreased $0.9 billion, or 11.5%, in the second quarter of 2005 and decreased $1.9 billion, or 11.8%, in the first half of 2005, compared with the same periods of 2004. These decreases were primarily driven by continued declines in stand-alone long distance voice revenue of approximately $0.7 billion in the second quarter of 2005 and $1.5 billion in the first half of 2005, compared with the same periods of 2004. These declines were reflective of increased competition, which has led to lower prices, and loss of market share in AT&T Consumer Services and small- and medium-sized business markets. In addition, stand-alone long distance revenue was negatively impacted by substitution. Total long distance voice volumes (including long distance volumes sold as part of a bundled product) decreased approximately 5% in the second quarter of 2005 and approximately 6% in the first half of 2005, compared with the respective periods of 2004, primarily due to declines in consumer and business retail volumes. Also contributing to the overall revenue decline was lower data services revenue of $0.2 billion in the second quarter of 2005 and $0.3 billion in the six months ended June 30, 2005, compared with the respective periods of 2004, primarily driven by competitive pricing pressure and technology migration.

      Revenue by segment is discussed in greater detail in the Segment Results section.

AT&T CORP. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS — (Continued)

      Included within access and other connection expenses are costs we pay to connect calls using the facilities of other service providers, as well as the Universal Service Fund contributions and per-line charges mandated by the Federal Communications Commission (FCC). We pay domestic access charges to local exchange carriers to complete long distance calls carried across the AT&T network and originated or terminated on a local exchange carrier’s network. We also pay local connectivity charges for leasing components of local exchange carrier networks in order to provide local service to our customers. International connection charges paid to telephone companies to connect international calls are also included within access and other connection expenses. Universal Service Fund contributions are charged to all telecommunications carriers by the FCC based on a percentage of state-to-state and international services revenue to provide affordable services to eligible customers. In addition, the FCC assesses charges on a per-line basis. Since most of the Universal Service Fund contributions and per-line charges are passed through to the customer, a change in these rates generally results in a corresponding change in revenue.

      Access and other connection expenses decreased $0.1 billion, or 3.7%, in the second quarter of 2005 and $0.3 billion, or 6.3%, for the first half of 2005, compared with the same periods of 2004. These declines were primarily attributable to lower volumes relating to domestic access and local connectivity charges of $0.1 billion and $0.2 billion for the second quarter of 2005 and the first half of 2005, respectively. In addition, the declines were due to lower average rates, including the impact of settlements, as well as changes in product and country mix relating to domestic access and international connection charges, totaling $0.1 billion for the second quarter of 2005 and $0.2 billion for the year-to-date period. The decreased rates reflect a greater proportion of calls that have non-access incurring terminations (such as when a call terminates over our own network or over a leased line), as well as the impact of rate negotiations and more efficient network usage. These declines were partially offset by an increase in Universal Service Fund contributions of $0.1 billion for the second quarter and the first half of 2005 due to higher assessable revenue.

      Costs of services and products include the costs of operating and maintaining our networks, the provision for uncollectible receivables and other service-related costs, including cost of equipment sold.

      Costs of services and products decreased $0.2 billion, or 11.3%, in the second quarter of 2005 and $0.4 billion, or 12.0%, for the first half of 2005, compared with the same periods of 2004. These declines were primarily driven by a lower provision for uncollectible receivables, resulting from improved collections and lower revenue. Also contributing to the decline was the overall impact of cost cutting initiatives, primarily headcount reductions, as well as lower revenue.

AT&T CORP. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS — (Continued)

      Selling, general and administrative expenses decreased $0.4 billion, or 24.8%, in the second quarter of 2005, and $0.9 billion, or 25.8%, for the first half of 2005, compared with the same periods of 2004. These declines were primarily attributable to lower marketing and customer acquisition spending of $0.3 billion in the second quarter of 2005 and $0.5 billion for the first half of 2005, primarily as a result of our strategic decision in the third quarter of 2004 to shift our focus away from traditional consumer services. In addition, the declines reflect cost control efforts throughout AT&T, as well as lower costs resulting from decreased customer levels, totaling $0.2 billion and $0.5 billion for the three and six months ended June 30, 2005, respectively. Cost control efforts included headcount reductions, as well as continued process improvements. These declines were partially offset by increased costs relating to the pending merger with SBC of $0.1 billion for the second quarter and first half of 2005.

      Depreciation and amortization expenses decreased $0.6 billion, or 48.8%, in the second quarter of 2005, and $1.2 billion, or 49.0%, for the first half of 2005, compared with the same periods of 2004. These decreases were primarily attributable to asset impairment charges of $11.4 billion recorded in the third quarter of 2004, which decreased depreciation and amortization expense by approximately $0.5 billion in the second quarter of 2005 and $1.1 billion in the first half of 2005. Capital expenditures were $0.4 billion and $0.5 billion for the three months ended June 30, 2005 and 2004, respectively, and were $0.7 billion and $1.0 billion for the six months ended June 30, 2005 and 2004, respectively. We continue to focus the majority of our capital spending on our advanced services offerings of Internet protocol and enhanced (IP&E) services and data services, both of which include managed services.

      Asset impairment and net restructuring and other charges of $36 million for the three and six months ended June 30, 2005, consisted of $45 million of facility closing reserves and a related $5 million asset impairment charge in connection with leasehold improvements in these facilities. These activities were partially offset by the net reversal of $14 million of excess preexisting business restructuring liabilities.

      The $45 million of facility closing reserves were associated with the continued consolidation of our real estate portfolio and reflected the present value of contractual lease obligations, net of estimated sublease income, associated with vacant facilities primarily resulting from workforce reductions. Facility closing charges of $43 million were recorded in the Corporate and Other group and $2 million in AT&T Business Services. Additionally, the Corporate and Other group and AT&T Business Services recorded $2 million and $3 million, respectively, of leasehold improvement impairment charges.

      During the second quarter, management reevaluated preexisting business restructuring reserves and determined the actual or revised estimates of separation and related benefit payments differed from the estimates initially made, resulting in a net reversal of $14 million. AT&T Business Services recorded $23 million of the reversal and the Corporate and Other group recorded $1 million. AT&T Consumer Services recorded an additional $10 million as a result of this review. The adjustment to these reserves did not result from changes to the actual or planned headcount separations.

      Asset impairment and net restructuring and other charges of $54 million for the three months ended June 30, 2004, consisted primarily of business restructuring activities associated with employee separations related to AT&T Business Services. This activity resulted from the continued integration and automation of various functions within network operations, as well as reorganizations throughout our non-U.S. operations. This exit plan impacted approximately 625 employees (more than half of which were involuntary), approximately 35% of whom were managers.

      Asset impairment and net restructuring and other charges of $267 million for the six months ended June 30, 2004, were comprised of business restructuring obligations of $145 million, primarily related to AT&T Business Services and real estate impairment charges of $122 million included in the Corporate and Other group.

AT&T CORP. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS — (Continued)

      The business restructuring obligations consisted of $104 million of separation costs and $41 million of facility closing obligations. The separations, of which slightly less than half were managers, were primarily involuntary and impacted approximately 1,405 employees as a result of integration and automation of various functions within network operations, as well as reorganizations throughout our non-U.S. operations. The facility closing reserves were primarily associated with the consolidation of our real estate portfolio and reflected the present value of contractual lease obligations, net of estimated sublease income, associated with vacant facilities resulting from workforce reductions and network equipment space that will not be used.

      The real estate impairment charges resulted from the decision made during the first quarter of 2004 to divest five owned properties in an effort to further reduce costs and consolidate our real estate portfolio. The impairment charge was recorded to reduce the book value of the five properties to fair market value based on third party assessments (including broker appraisals). The sale of the properties was completed in 2004.

      Operating income increased $0.5 billion, or 135.4%, in the second quarter of 2005 and increased $1.3 billion, or 200.5%, in the first half of 2005, compared with the same periods of 2004. As a result of the third quarter 2004 asset impairment charges, operating income for the three and six months ended June 30, 2005 included $0.5 billion and $1.1 billion, respectively, of benefits due to lower depreciation on the impaired assets. Operating margin improved 7.5 percentage points in the second quarter of 2005 and 9.7 percentage points in the first half of 2005, compared with the same periods of 2004. The benefits due to lower depreciation positively impacted the margins for the three and six months ended June 30, 2005 by 8.1 points and 7.9 points, respectively. Deal costs relating to the pending merger with SBC and the second quarter 2005 asset impairment and net restructuring and other charges negatively impacted operating margins for the three and six months ended June 30, 2005. Asset impairment and net restructuring and other charges also negatively impacted the three and six months ended June 30, 2004 operating margins. The remaining operating margin improvements in the second quarter and first half of 2005 were primarily attributable to improved margins in AT&T Consumer Services resulting primarily from greater rates of decline in selling, general and administrative expenses in relation to revenue, partially offset by lower margins in AT&T Business Services, which were primarily reflective of the declining higher-margin long distance retail voice and data businesses coupled with a shift to lower-margin products. See Segment Results section for more details.

      Other (expense) income, net, in the second quarter of 2005 was expense of $0.2 billion compared with income of $36 million in the second quarter of 2004. The unfavorable variance was primarily due to $0.2 billion of losses associated with the early repurchase of long-term debt in 2005. Other (expense) income, net, for the first half of 2005 compared with the same period of 2004 was relatively flat, reflecting lower losses on early repurchases of long-term debt, which were largely offset by settlements in 2004 associated with business dispositions and legal settlements.

      We continue to hold $0.5 billion of investments in leveraged leases, including leases of commercial aircraft, which we lease to domestic airlines, as well as aircraft-related companies. Should the financial difficulties in the U.S. airline industry lead to further bankruptcies or lease restructurings, we could record additional losses associated with our aircraft lease portfolio. In addition, in the event of bankruptcy or

AT&T CORP. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS — (Continued)

renegotiation of lease terms, if any portion of the non-recourse debt is canceled, such amounts would result in taxable income to AT&T and, accordingly, a cash tax expense.

      Interest (expense) decreased 11.2%, or $22 million, in the second quarter of 2005 compared with the second quarter of 2004, and decreased 11.2%, or $47 million, in the first half of 2005 compared with the first half of 2004. These declines were reflective of our early debt redemptions and scheduled debt maturities in 2004 and 2005, partially offset by the impact of interest rate step-ups on certain bonds as a result of long-term debt ratings downgrades in 2004.

      The effective tax rate is the (provision) benefit for income taxes as a percentage of income before income taxes. The effective tax rate in the second quarter and first half of 2005 was negatively impacted by costs associated with our pending merger with SBC. The effective tax rate in the second quarter of 2004 was negatively impacted by a catch-up effect resulting from an increase in the estimated annual 2004 effective tax rate, as a result of lower projected annual income before income taxes relative to our estimated permanent differences. The effective tax rate in the first half of 2004 was positively impacted by 513.7 percentage points due to the reversal of a portion of the valuation allowance we recorded in 2002 attributable to the book and tax basis difference related to our investment in AT&T Latin America. During February 2004, the subsidiaries of AT&T Latin America were sold to Telefonos de Mexico S.A. de C.V., or Telmex, and the AT&T Latin America plan of liquidation became effective. As a result, we no longer needed a portion of the valuation allowance and recorded an income tax benefit of $0.4 billion in the first quarter of 2004.

Segment Results

      Our results are segmented according to the customers we service: AT&T Business Services and AT&T Consumer Services. The balance of our operations is included in a Corporate and Other group. This group primarily reflects corporate staff functions and the elimination of transactions between segments. The discussion of segment results includes revenue, operating income, capital additions and total assets.

      Operating income is the primary measure used by our chief operating decision makers to measure our operating results and to measure segment profitability and performance. See note 11 to our consolidated financial statements for a reconciliation of segment results to consolidated results.

      Total assets for each segment include all assets, except intercompany receivables. Nearly all prepaid pension assets, taxes and corporate-owned or leased real estate are held at the corporate level, and therefore are included in the Corporate and Other group. A substantial majority of our property, plant and equipment (including network assets) is included in the AT&T Business Services segment. Capital additions for each segment include capital expenditures for property, plant and equipment, additions to internal-use software and additions to nonconsolidated investments.

      We continually review our management model and structure, which may result in additional adjustments to our operating segments in the future.

AT&T CORP. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS — (Continued)

      AT&T Business Services provides a variety of global communications services to large domestic and multinational businesses, government agencies and small- and medium-sized businesses. These services include long distance, international, toll-free and local voice, including wholesale transport services (sales of services to service resellers, such as other long distance companies, local service providers, wireless carriers and cable companies), as well as data services and IP&E services. AT&T Business Services also provides outsourcing solutions and other professional services.