10-Q 1 d10q.htm FORM 10-Q Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2011

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File No. 1-15577

 

 

QWEST COMMUNICATIONS INTERNATIONAL INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   84-1339282

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

100 CenturyLink Drive, Monroe, Louisiana   71203
(Address of principal executive offices)   (Zip Code)

(318) 388-9000

(Registrant’s telephone number, including area code)

N/A

(Former name and former fiscal year, if changed since last report)

1801 California Street, Denver, Colorado 80202

(Former address, if changed since last report)

 

 

THE REGISTRANT, A WHOLLY OWNED SUBSIDIARY OF CENTURYLINK, INC., MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONS H(1) (a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT.

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  x   Accelerated filer  ¨   

Non-accelerated filer  ¨

(Do not check if a smaller reporting company)

  Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of August 1, 2011, there were 1,000 shares of common stock outstanding.


Table of Contents
     Page No.  

Part I.             Financial Information:

     3   
  

Item 1.     Financial Statements

     3   
  

Consolidated Statements of Operations—Three months ended June  30, 2011 for the successor, three months ended March 31, 2011 and three and six months ended June 30, 2010 for the predecessor (Unaudited)

     3   
  

Consolidated Statements of Comprehensive (Loss) Income—Three months ended June  30, 2011 for the successor, three months ended March 31, 2011 and three and six months ended June 30, 2010 for the predecessor (Unaudited)

     4   
  

Consolidated Balance Sheets—June 30, 2011 for the successor and December  31, 2010 for the predecessor (Unaudited)

     5   
  

Consolidated Statements of Cash Flows—Three months ended June  30, 2011 for the successor, three months ended March 31, 2011 and six months ended June 30, 2010 for the predecessor (Unaudited)

     6   
  

Consolidated Statements of Stockholders’ Equity (Deficit)—Three months ended June  30, 2011 for the successor, three months ended March 31, 2011 and six months ended June 30, 2010 for the predecessor (Unaudited)

     7   
  

    Notes to Consolidated Financial Statements (Unaudited)*

     8   
  

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

     28   
  

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     41   
  

Item 4. Controls and Procedures

     41   
  

Part II.             Other Information:

     42   
  

Item 1. Legal Proceedings

     42   
  

Item 1A. Risk Factors

     42-48   
  

Item 6. Exhibits

     49-52   
  

Signature

     53   

 

 

* All references to “Notes” in this quarterly report refer to these Notes to Consolidated Financial Statements

 

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Qwest Communications International Inc.

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 

    Successor          Predecessor  
    Three months ended
June 30, 2011
         Three months ended
March 31, 2011
    Three months ended
June 30, 2010
    Six months ended
June 30, 2010
 
    (Dollars in millions)  
           
 

OPERATING REVENUES

           

Operating revenues

  $ 2,763            2,846        2,930        5,896   

Operating revenues—affiliates

    6                            
 

 

 

       

 

 

   

 

 

   

 

 

 

Total operating revenues

    2,769            2,846        2,930        5,896   
 

 

 

       

 

 

   

 

 

   

 

 

 

OPERATING EXPENSES

           

Cost of services and products (exclusive of depreciation and amortization)

                1,141            1,178        1,240        2,487   

Selling, general and administrative

    656            556        633        1,239   

Operating expenses—affiliates

    32                            

Depreciation and amortization

    823            533        548        1,093   
 

 

 

       

 

 

   

 

 

   

 

 

 

Total operating expenses

    2,652            2,267        2,421        4,819   
 

 

 

       

 

 

   

 

 

   

 

 

 

OPERATING INCOME

    117            579        509        1,077   

OTHER (EXPENSE) INCOME

           

Interest expense

    (150         (227     (265     (544

Loss on early retirement of debt

    (1                       (42

Other income, net

               5        22        22   
 

 

 

       

 

 

   

 

 

   

 

 

 

Total other (expense) income

    (151         (222     (243     (564
 

 

 

       

 

 

   

 

 

   

 

 

 

(LOSS) INCOME BEFORE INCOME TAX EXPENSE

    (34         357        266        513   

Income tax (benefit) expense

    (8         146        108        317   
 

 

 

       

 

 

   

 

 

   

 

 

 

NET (LOSS) INCOME

  $ (26         211        158        196   
 

 

 

       

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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Qwest Communications International Inc.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(UNAUDITED)

 

    Successor          Predecessor  
    Three months ended
June 30, 2011
         Three months ended
March 31, 2011
    Three months ended
June 30, 2010
    Six months ended
June 30, 2010
 
    (Dollars in millions)  

NET (LOSS) INCOME

  $ (26         211        158        196   
 

 

 

       

 

 

   

 

 

   

 

 

 
           

OTHER COMPREHENSIVE INCOME:

           

Defined benefit pension and postretirement plans, net of $—, $4, $4 and $11 tax

               7        6        11   

Other, net of $—, $—, $— and $2 tax

                             (3
 

 

 

       

 

 

   

 

 

   

 

 

 

Other comprehensive income

                      —            7        6        8   
 

 

 

       

 

 

   

 

 

   

 

 

 

COMPREHENSIVE (LOSS) INCOME

  $ (26         218        164        204   
 

 

 

       

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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Qwest Communications International Inc.

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

    Successor          Predecessor  
    June 30,
        2011         
         December 31,
          2010           
 
   

(Dollars in millions,

and shares in thousands)

 

 

ASSETS

       

CURRENT ASSETS

       

Cash and cash equivalents

  $ 47             372    

Accounts receivable, less allowance of $21 and $83

    1,187             1,264    

Accounts receivable—affiliates, net

    550             —    

Deferred income tax asset

    205             234    

Other

    234             360    
 

 

 

       

 

 

 

Total current assets

    2,223             2,230    

NET PROPERTY, PLANT AND EQUIPMENT

       

Property, plant and equipment

    9,846             47,407    

Accumulated depreciation

    (404)            (35,550)   
 

 

 

       

 

 

 

Net property, plant and equipment

    9,442             11,857    

GOODWILL AND OTHER ASSETS

       

Goodwill

    10,005             —    

Customer relationships, net

    7,365             —    

Other intangible assets, net

    1,954             938    

Deferred income taxes, net

    —             1,686    

Other

    298             509    
 

 

 

       

 

 

 

Total goodwill and other assets

    19,622             3,133    
 

 

 

       

 

 

 

TOTAL ASSETS

  $ 31,287             17,220    
 

 

 

       

 

 

 
       

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)

       

CURRENT LIABILITIES

       

Current maturities of long-term debt

  $ 1,600             1,089    

Accounts payable

    918             1,033    

Accrued expenses and other liabilities

       

Salaries and benefits

    516             553    

Income and other taxes

    250             267    

Interest

    196             219    

Other

    126             150    

Advance billings and customer deposits

    365             551    
 

 

 

       

 

 

 

Total current liabilities

    3,971             3,862    
 

 

 

       

 

 

 

LONG-TERM DEBT

    10,811             10,858    
 

 

 

       

 

 

 
       

DEFERRED CREDITS AND OTHER LIABILITIES

       

Deferred revenue

    75             459    

Benefit plan obligations, net

    2,820             2,979    

Deferred income taxes

    578             —    

Other

    813             717    
 

 

 

       

 

 

 

Total deferred credits and other liabilities

    4,286             4,155    
 

 

 

       

 

 

 

COMMITMENTS AND CONTINGENCIES (Note 10)

       
       

STOCKHOLDERS’ EQUITY (DEFICIT)

       

Preferred stock—$1.00 par value, no shares authorized (2011) and 200,000 shares authorized; none issued or outstanding (2010)

    —             —    

Common stock—$0.01 par value, 1 shares authorized; 1 shares issued, owned by CenturyLink (2011) and 5,000,000 shares authorized; 1,792,145 shares issued (2010)

    —             18    

Additional paid-in capital

    12,273             42,285    

Treasury stock—0 and 27,841 shares, respectively (including 0 and 22 shares held in rabbi trust, respectively)

    —             (157)   

Accumulated other comprehensive loss

    —             (376)   

Accumulated deficit

    (54)            (43,425)   
 

 

 

       

 

 

 

Total stockholders’ equity (deficit)

    12,219             (1,655)   
 

 

 

       

 

 

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)

  $ 31,287             17,220    
 

 

 

       

 

 

 

See accompanying notes to consolidated financial statements.

 

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Qwest Communications International Inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

    Successor          Predecessor  
    Three months
ended
June 30, 2011
         Three months
ended
March 31, 2011
    Six months
ended
June 30, 2010
 
    (Dollars in millions)  

OPERATING ACTIVITIES

         

Net (loss) income

  $ (26)            211         196    

  Adjustments to reconcile net (loss) income to net cash provided by operating activities:

         

Depreciation and amortization

    823             533         1,093    

Deferred income taxes

    (8)            145         303    

Provision for uncollectible accounts

    21             19         36    

Loss on early retirement of debt

               —         42    

Changes in current assets and current liabilities:

         

Receivables

    (15)            61           

Accounts payable

    (62)            (71)        20    

Affiliates receivables or payable, net

    39             —         —    

Accrued income and other taxes

    (61         31         (37

Other current assets and other current liabilities, net

    30             (117     (19

Changes in other noncurrent assets and liabilities

    21             (53     (55

Other, net

    (63         18         53    
 

 

 

       

 

 

   

 

 

 

Net cash provided by operating activities

    700             777         1,641    
 

 

 

       

 

 

   

 

 

 
         

INVESTING ACTIVITIES

         

Payments for property, plant and equipment and capitalized software

    (347)            (410)        (717)   

Proceeds from sales or maturities of investment securities

    —             —         159    

Changes in short-term affiliate loans

    (511)            —         —    

Purchases of investment securities

    —             —         (821)   

Other, net

                      —    
 

 

 

       

 

 

   

 

 

 

Net cash used in investing activities

    (856)            (408)        (1,379)   
 

 

 

       

 

 

   

 

 

 
         

FINANCING ACTIVITIES

         

Payments of long-term debt

    (851)            (203)        (2,005)   

Net proceeds from issuance of long-term debt

              643             —         775    

Dividends paid

    —             (141)        (277)   

Net proceeds from issuance of common stock

    —             14         17    

Early retirement of debt costs

    (13)            —         (40)   

Other, net

    —             13         (20)   
 

 

 

       

 

 

   

 

 

 

Net cash used in financing activities

    (221)            (317)        (1,550)   
 

 

 

       

 

 

   

 

 

 
         

Net (decrease) increase in cash and cash equivalents

    (377)            52         (1,288)   

Cash and cash equivalents at beginning of period

    424             372         2,406    
 

 

 

       

 

 

   

 

 

 

Cash and cash equivalents at end of period

  $ 47             424         1,118    
 

 

 

       

 

 

   

 

 

 
         

Supplemental cash flow information:

         

Income taxes refunded (paid), net

  $ 11                    (15)   

Interest paid (net of capitalized interest of $4, $5 and $7)

  $ (220)            (236)        (518)   

See accompanying notes to consolidated financial statements.

 

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Qwest Communications International Inc.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

(UNAUDITED)

 

     Successor          Predecessor  
     Three months ended
June  30, 2011
         Three months ended
March 31, 2011
    Six months ended
June 30, 2010
 
    

(Dollars in millions)

 

 

COMMON STOCK

          

Balance at beginning of period

   $ —             18         17   
  

 

 

       

 

 

   

 

 

 

Balance at end of period

     —             18         17   
  

 

 

       

 

 

   

 

 

 
          

ADDITIONAL PAID-IN CAPITAL

          

Balance at beginning of period

     12,273             42,285         42,269   

Share-based compensation and other, net

     —             18         43   

Embedded option in convertible debt

     —             —         (165

Asset transfers

     —             —         —    
  

 

 

       

 

 

   

 

 

 

Balance at end of period

     12,273             42,303         42,147    
  

 

 

       

 

 

   

 

 

 
          

TREASURY STOCK

          

Balance at beginning of period

     —             (157     (29

Other

     —                    1   
  

 

 

       

 

 

   

 

 

 

Balance at end of period

     —             (157     (28
  

 

 

       

 

 

   

 

 

 
          

ACCUMULATED OTHER COMPREHENSIVE LOSS

          

Balance at beginning of period

     —             (376     (489

Other comprehensive income

     —             7        8   
  

 

 

       

 

 

   

 

 

 

Balance at end of period

     —             (369     (481
  

 

 

       

 

 

   

 

 

 
          

ACCUMULATED DEFICIT

          

Balance at beginning of period

     —             (43,425     (42,953

Net (loss) income

     (26         211        196   

Dividends declared

     (28         (141     (139
  

 

 

       

 

 

   

 

 

 

Balance at end of period

     (54         (43,355     (42,896
  

 

 

       

 

 

   

 

 

 
          

TOTAL STOCKHOLDERS’ EQUITY (DEFICIT)

   $ 12,219            (1,560     (1,241
  

 

 

       

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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Qwest Communications International Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

(UNAUDITED)

Unless the context requires otherwise, references in this report to “Qwest,” “we,” “us,” the “Company” and “our” refer to Qwest Communications International Inc. and its consolidated subsidiaries, and references in this report to “QCII” refer to Qwest Communications International Inc. on an unconsolidated, stand-alone basis and references to “CenturyLink” refer to our direct parent company, CenturyLink, Inc. and its consolidated subsidiaries.

(1) Basis of Presentation

On April 1, 2011, we became a wholly owned subsidiary of CenturyLink, Inc. (“CenturyLink”) in a tax-free, stock-for-stock transaction. Although we continued as a surviving corporation and legal entity after the acquisition, the accompanying consolidated statements of operations, comprehensive (loss) income, cash flows and stockholders’ equity (deficit) are presented for two periods: predecessor and successor, which relate to the period preceding the acquisition and the period succeeding the acquisition, respectively. The recognition of assets and liabilities at fair value has been reflected in our financial statements and therefore has resulted in a new basis of accounting for the “successor period” beginning on April 1, 2011. This new basis of accounting means that our financial statements for the successor periods will not be comparable to our previously reported financial statements, including the predecessor period financial statements in this report.

Our consolidated balance sheet as of December 31, 2010, predecessor, which was derived from our audited financial statements, and our unaudited interim consolidated financial statements provided herein have been prepared in accordance with the instructions for Form 10-Q. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission; however, in our opinion, the disclosures made are adequate to make the information presented not misleading. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2010.

Our consolidated financial statements for the successor three months ended June 30, 2011, predecessor three months ended March 31, 2011, predecessor three months ended June 30, 2010 and predecessor six months ended June 30, 2010 have not been audited by independent registered public accountants; however, in our opinion, all normal recurring adjustments necessary to present fairly the results of operations for the three and six-month periods have been included therein. The results of operations for the first six months of the year are not indicative of the results of operations which might be expected for the entire year.

During the first quarter of 2011, we changed the definitions we use to classify expenses as cost of services and products and selling, general and administrative, and as a result, we reclassified previously reported amounts to conform to the current period presentation. We made these changes so that our expense classifications are more consistent with the expense classifications used by our new parent company, CenturyLink. These changes resulted in the reclassification of $300 million and $606 million from selling, general and administrative to cost of services and products for the predecessor three and six months ended June 30, 2010, respectively. Our current definitions are as follows:

 

   

Cost of services and products (exclusive of depreciation and amortization) are expenses incurred in providing products and services to our customers. These expenses include: employee-related expenses directly attributable to operating and maintaining our network (such as salaries, wages, benefits and professional fees); facilities expenses (which are third-party telecommunications expenses we incur for using other carriers’ networks to provide services to our customers); rents and utilities expenses;

 

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equipment sales expenses (such as data integration and modem expenses); charges for universal service funds (“USF”) (which are federal and state funds that are established to promote the availability of telecommunications services to all consumers at reasonable and affordable rates, among other things, and to which we are often required to contribute); and other expenses directly related to our network operations.

 

   

Selling, general and administrative expenses are expenses incurred in selling products and services to our customers, corporate overhead and other operating expenses. These expenses include: employee-related expenses (such as salaries, wages, internal commissions, benefits and professional fees) directly attributable to selling products or services and employee-related expenses for administrative functions; marketing and advertising; taxes (such as property and other taxes) and fees; external commissions; bad debt expense; and other selling, general and administrative expenses.

These expense classifications may not be comparable to those of other companies. These changes had no impact on total operating expenses or net income for any period.

We have reclassified certain prior year balance sheet amounts presented in our Annual Report on Form 10-K for the year ended December 31, 2010. We made these changes so that the classifications of our assets and liabilities are more consistent with the asset and liability classifications used by our new parent company, CenturyLink. These reclassifications primarily included: $241 million from accrued expenses and other current liabilities, $109 million from benefit plan obligations, net, $232 million to accounts payable, and $118 million to other deferred credits, $63 million to net property, plant and equipment and $59 million from capitalized software, net. These asset and liability classifications may not be comparable to those of other companies.

We provide our affiliates telecommunication services that we also provide to external customers. In addition, we provide to our affiliates computer system development and support services. We also purchase services from our affiliates including telecommunication services, marketing and employee related support services.

Recent accounting pronouncements.  In September 2009, the Financial Accounting Standards Board (the “FASB”) updated the accounting standard regarding revenue recognition for multiple deliverable arrangements, such as the service bundles we offer to customers. This update requires the use of the relative selling price method when allocating revenue in these types of arrangements. This method requires a vendor to use its best estimate of selling price if neither vendor specific objective evidence nor third party evidence of selling price exists when evaluating multiple deliverable arrangements. This standard update was effective for us on January 1, 2011 and we have adopted it prospectively for revenue arrangements entered into or materially modified after January 1, 2011. This standard update has not and will not have a material impact on our consolidated financial statements.

(2) Acquisition by CenturyLink

On April 1, 2011, we became a wholly owned subsidiary of CenturyLink. Each outstanding share of our common stock immediately prior to the acquisition converted into the right to receive 0.1664 shares of CenturyLink common stock, with cash paid in lieu of fractional shares. The estimated aggregate consideration was approximately $12.273 billion based on:

 

   

the number of shares of CenturyLink common stock issued to consummate the acquisition of 294 million;

 

   

the closing stock price of CenturyLink common stock as of March 31, 2011 of $41.55;

 

   

the estimated net value of the pre-combination portion of share-based compensation awards assumed by CenturyLink of $52 million (excluding the value of restricted stock included in shares issued above); and

 

   

cash paid in lieu of the issuance of fractional shares of $5 million.

Since April 1, 2011, our results of operations have been included in the consolidated results of operations of CenturyLink. CenturyLink has accounted for its acquisition of us under the acquisition method of accounting,

 

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which resulted in the assignment of the purchase price to the assets acquired and liabilities assumed based on our preliminary estimates of their acquisition date fair values. The determination of the fair values of the acquired assets and assumed liabilities (and the related determination of estimated lives of depreciable tangible and identifiable intangible assets) requires significant judgment. We expect to complete our final determinations no later than the first quarter of 2012. Our final determinations may be significantly different than those reflected in our consolidated financial statements as of June 30, 2011. Based on our preliminary estimate, the aggregate consideration exceeds the aggregate estimated fair value of the acquired assets and assumed liabilities by $10.005 billion, which has been recognized as goodwill. This goodwill is attributable to strategic benefits, including enhanced financial and operational scale, market diversification and leveraged combined networks that we expect CenturyLink and its consolidated subsidiaries, including us, to realize. None of the goodwill associated with this acquisition is deductible for income tax purposes.

The following is our preliminary assignment of the aggregate consideration based on currently available information (dollars in millions).

 

     April 1, 2011  

Cash, accounts receivable and other current assets

   $ 2,036    

Property, plant and equipment

     9,525    

Identifiable intangible assets

  

Customer relationships

             7,625    

Capitalized software

     1,702    

Other

     366    

Other noncurrent assets

     373    

Current liabilities, excluding current maturities of long-term debt

     (2,424)   

Current maturities of long-term debt

     (2,422)   

Long-term debt

     (10,253)   

Deferred credits and other liabilities

     (4,260)   

Goodwill

     10,005    
  

 

 

 

Aggregate consideration

   $ 12,273   
  

 

 

 

We have recognized certain expenses that were contingent on completion of the CenturyLink acquisition, including $127 million of compensation expense comprised of severance, retention bonuses and share-based compensation for the successor three months ended June 30, 2011. During the predecessor three months ended March 31, 2011, we had recognized $3 million of expenses associated with our activities surrounding the acquisition. As of April 1, 2011, as part of acquisition accounting, we also included in our goodwill $35 million for financial advisory fees, $23 million for certain performance awards and $16 million related to retention bonuses, all of which were contingent on the completion of the acquisition and had no benefit to CenturyLink after the acquisition.

CenturyLink has cash management arrangements between certain of its subsidiaries, including us, under which the majority of our cash balance is transferred on a daily basis to CenturyLink.

 

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(3) Goodwill, Customer Relationships and Other Intangible Assets

Goodwill, customer relationships and other intangible assets as of June 30, 2011 and December 31, 2010 consisted of the following:

 

     Successor           Predecessor  
     June 30, 2011           December 31, 2010  
     (Dollars in millions)  

Goodwill

   $ 10,005               
  

 

 

        

 

 

 

Customer relationships, less accumulated amortization of $260 and $2

   $ 7,365               
  

 

 

        

 

 

 

Other intangible assets subject to amortization

         

Capitalized software, less accumulated amortization of $117 and $1,741

                 1,631                             888   

Tradename and patent, less accumulated amortization of $43 and $5

     323             50   
  

 

 

        

 

 

 

Other intangible assets, net

   $ 1,954             938   
  

 

 

        

 

 

 

At June 30, 2011, the gross carrying amounts of goodwill, customer relationships and other intangible assets were $19.744 billion which were recorded at fair value on April 1, 2011 as a result of CenturyLink’s acquisition of us. We expect to complete the final determination of these estimates and related estimated lives for amortizable intangible assets no later than the first quarter of 2012.

Total amortization expense for intangible assets was $420 million for the successor three months ended June 30, 2011. Total amortization expense for intangible assets for the predecessor three months ended March 31, 2011 was $58 million. We amortize our customer relationships over an estimated life of 10 years, using the sum-of-the-years-digits and straight-line methods, depending on the classification of the customer. We amortize our capitalized software using the straight-line method over estimated lives ranging up to seven years and amortize our other intangible assets predominantly using the sum-of-the-years digits method over an estimated life of four years. We estimate that total successor amortization expense for the six months ending December 31, 2011 and the successor years ending December 31, 2012 through 2015 will be as follows (dollars in millions):

 

Six months ending December 31, 2011

   $ 825   

Year ending December 31,

  

2012

   $         1,475   

2013

   $ 1,331   

2014

   $ 1,185   

2015

   $ 1,017   

We periodically review the estimated lives and methods used to amortize our intangible assets. The actual amounts of amortization expense may differ materially from our estimates, depending on the results of our periodic reviews and our final determinations of value related to our intangible assets.

(4) Long-term Debt

On June 8, 2011, our wholly owned subsidiary, Qwest Corporation (“QC”), issued 7.375% Notes due June 1, 2051 in the aggregate principal amount of $661 million in exchange for net proceeds, after deducting underwriting discounts and expenses, of approximately $643 million. The notes are unsecured obligations of QC and may be redeemed, in whole or in part, on or after June 1, 2016 at a redemption price of 100%. QC used the net proceeds, together with available cash balances, to redeem $825 million aggregate principal amount of QC’s 7.875% Notes due 2011, and to pay related fees and expenses.

Until April 1, 2011, we had a revolving credit facility, which made available to us $1.035 billion of additional credit subject to certain restrictions. That credit facility was terminated in conjunction with the

 

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CenturyLink acquisition. In January 2011, CenturyLink entered into a new four-year revolving credit facility (the “Credit Facility”) that allows CenturyLink to borrow up to $1.700 billion for the general corporate purposes of itself and its subsidiaries. Up to $400 million of the Credit Facility can be used for letters of credit. Interest is assessed on borrowings using the London Interbank Offered Rate (“LIBOR”) plus an applicable margin between 0.5% and 2.5% per annum depending on the type of loan and CenturyLink’s current senior unsecured long-term debt rating. QCII and another of its wholly owned subsidiaries, Qwest Services Corporation (“QSC”), are guarantors of the Credit Facility.

In February 2011, our wholly owned subsidiary, Qwest Capital Funding, Inc. (“QCF”), paid at maturity the $179 million aggregate principal amount of its 7.25% Notes due 2011.

At June 30, 2011, we were in compliance with the provisions and covenants contained in our debt agreements.

(5) Employee Benefits

In connection CenturyLink’s acquisition of us on April 1, 2011, we performed a preliminary valuation analysis and recognized a $479 million liability as of April 1, 2011 for the unfunded status of our pension plans, reflecting estimated accumulated pension benefit obligations of $8.267 billion in excess of the $7.788 billion estimated fair value of plan assets.

Net periodic benefit expense for our pension and non-qualified pension plans for the successor three months ended June 30, 2011, predecessor three months ended March 31, 2011, predecessor three months ended June 30, 2010 and predecessor six months ended June 30, 2010 consisted of the following components:

 

     Successor           Predecessor  
     Three months ended
June 30, 2011
          Three months ended
March 31, 2011
    Three months ended
June 30, 2010
    Six months ended
June 30, 2010
 
     (Dollars in millions)  

Service cost

   $ 13             14        12        27   

Interest cost

             108                     104                111                224   

Expected return on plan assets

     (139          (133     (138     (278

Amortization of unrecognized prior service cost

                 (6     (5     (11

Amortization of unrecognized net actuarial loss

                 31        33        65   
  

 

 

        

 

 

   

 

 

   

 

 

 

Net periodic benefits (income) expense

   $ (18          10        13        27   
  

 

 

        

 

 

   

 

 

   

 

 

 

In connection CenturyLink’s acquisition of us on April 1, 2011, we performed a preliminary valuation analysis and recognized a $2.516 billion liability as of April 1, 2011 for the unfunded status of our postretirement benefit plan, reflecting estimated accumulated postretirement benefit obligations of $3.284 billion in excess of the $768 million estimated fair value of plan assets.

 

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Net periodic postretirement benefit expense for the successor three months ended June 30, 2011, predecessor three months ended March 31, 2011, predecessor three months ended June 30, 2010 and predecessor six months ended June 30, 2010 consisted of the following components:

 

     Successor           Predecessor  
     Three months ended
June 30, 2011
          Three months ended
March 31, 2011
    Three months ended
June 30, 2010
    Six months ended
June 30, 2010
 
     (Dollars in millions)  

Service cost

   $ 1             2        2        4   

Interest cost

                 41             41        45        91   

Expected return on plan assets

     (12          (13     (15     (30

Amortization of unrecognized prior service cost

                 (24     (25     (50

Amortization of unrecognized net actuarial loss

                             10                    10                    20   
  

 

 

        

 

 

   

 

 

   

 

 

 

Net periodic benefits expense

   $ 30             16        17        35   
  

 

 

        

 

 

   

 

 

   

 

 

 

We report net periodic pension expense and net periodic postretirement benefits expense in cost of services and products and selling, general and administrative expenses.

(6) Severance and Restructuring

We have announced reductions in our workforce in prior periods and have accrued liabilities for related severance costs. These workforce reductions resulted primarily from progression of merger integration plans, increased competitive pressures and the loss of access lines.

We report severance liabilities in salaries and benefits within accrued expenses and other liabilities in our consolidated balance sheets and report severance expenses in selling, general and administrative expenses and cost of services and products in our consolidated statements of operations.

During 2004 and previous years, as part of our ongoing efforts to evaluate our operating costs, we established restructuring programs, which included workforce reductions, consolidation of excess facilities, and restructuring of certain business functions. As of the April 1, 2011 acquisition date, we recorded liabilities to reflect our preliminary estimates of the fair values of the existing lease obligations, net of estimated sublease rentals. Our fair value estimates were determined using discounted cash flow techniques. Periodically, we recognize expense to reflect accretion of the discounted liabilities and we adjust the expense when our actual experience differs from our initial estimates. We report the current portion of liabilities for ceased-use real estate leases in accrued expenses and other liabilities and report the noncurrent portion in deferred credits and other liabilities in our consolidated balance sheets. We report the related expenses in selling, general and administrative expenses in our consolidated statements of operations.

As of June 30, 2011, successor and December 31, 2010, predecessor, the current portion of our leased real estate accrual was $28 million and $28 million, respectively, and the long-term portion was $144 million and $195 million, respectively. The remaining lease terms range up to 15 years.

 

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Changes in our accrued liabilities for severance expenses and leased real estate for the three months ended June 30, 2011 and the predecessor three months ended March 31, 2011 were as follows:

 

     Severance     Real Estate  
     (Dollars in millions)  

Balance at December 31, 2010 (Predecessor)

   $     29                223   

Accrued to expense

     3        4   

Payments, net

     (12     (12
  

 

 

   

 

 

 

Balance at March 31, 2011 (Predecessor)

     20        215   
  

 

 

   

 

 

 
    

 

 

   

 

 

 

Fair value adjustment

            (47
  

 

 

   

 

 

 

Balance at April 1, 2011 (Successor)

     20        168   
  

 

 

   

 

 

 

Accrued to expense

     97        10   

Payments, net

     (65     (6
  

 

 

   

 

 

 

Balance at June 30, 2011 (Successor)

   $ 52        172   
  

 

 

   

 

 

 

On April 1, 2011 our leased real estate accrual was revalued in conjunction with CenturyLink’s acquisition of us.

Our severance expenses for the successor three months ended June 30, 2011 also included $11 million of share-based compensation associated with the accelerated vesting of stock awards that occurred in connection with workforce reductions relating to CenturyLink’s acquisition of us.

(7) Fair Value Disclosure

At June 30, 2011, successor, and December 31, 2010, predecessor, our financial instruments consisted of cash and cash equivalents, accounts receivable, accounts payable and long-term debt excluding capital lease obligations. The carrying amounts of our cash and cash equivalents, accounts receivable, accounts receivable—affiliates, accounts payable and accounts payable—affiliates approximate their fair values.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between independent and knowledgeable parties who are willing and able to transact for an asset or liability at the measurement date. We use valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs when determining fair value and then we rank the estimated values based on the reliability of the inputs used following the fair value hierarchy set forth by the FASB.

The three input levels in the hierarchy of fair value measurements are defined by the FASB generally as follows:

 

Input Level

  

Description of Input

Level 1

   Observable inputs such as quoted market prices in active markets.

Level 2

   Inputs other than quoted prices in active markets that are either directly or indirectly observable.

Level 3

   Unobservable inputs in which little or no market data exists.

During the second quarter of 2011, the rights to our auction rate securities were assigned to CenturyLink. Upon assignment, the fair market value of these securities was $79 million.

 

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The following table presents the carrying amounts and estimated fair values of our investment securities, which are reported in noncurrent other assets, and long-term debt excluding capital lease obligations, as well as the input levels used to determine the fair values as of the successor date of June 30, 2011 and the predecessor date of December 31, 2010:

 

     Input Level      Successor
June 30, 2011
           Predecessor
December 31, 2010
 
        Carrying Amount      Fair Value            Carrying Amount      Fair Value  
            (Dollars in millions)  

Assets—Investment securities

     3       $                      92         92   

Long-term debt excluding capital lease obligations

     2       $         12,050         11,976              11,583         12,480   

The table below presents a rollforward of our auction rate securities valued using Level 3 inputs for the predecessor three months ended March 31, 2011 and the successor three months ended June 30, 2011:

 

     Auction Rate Securities  
     (Dollars in millions)  

Balance at December 31, 2010 (Predecessor)

   $ 92   

Dispositions and settlements

       

Included in other (expense) income

       
  

 

 

 

Balance at March 31, 2011 (Predecessor)

   $ 92   
  

 

 

 
    

 

 

 

Fair value adjustment

     (13
  

 

 

 

Balance at April 1, 2011 (Successor)

     79   
  

 

 

 

Assignments to CenturyLink

     (79
  

 

 

 

Balance at June 30, 2011 (Successor)

   $             —   
  

 

 

 

(8) Income Taxes

In connection with CenturyLink’s acquisition of us on April 1, 2011, we recorded a $2.2 billion deferred tax liability under the acquisition method of accounting. Our preliminary acquisition date assignment of deferred income taxes and the related valuation allowance are subject to adjustment as discussed in Note 2—Acquisition by CenturyLink.

The CenturyLink acquisition caused an “Ownership Change” within the meaning of Section 382 of the Internal Revenue Code. As a result, CenturyLink’s ability to use our accumulated net operating loss carryforwards, or NOLs, and certain other tax attributes to reduce future consolidated federal and combined or consolidated state taxable incomes are subject to annual limits imposed by Section 382. Despite this, our evaluations indicate that we and CenturyLink expect to realize all federal NOLs and certain other deferred tax attributes prior to their respective expirations. Thus, we have made no adjustments to our valuation allowances to reflect limitations imposed by virtue of the acquisition.

Included in income tax expense for the predecessor six months ended June 30, 2010 is a $113 million charge related to the change in the tax treatment of the Medicare Part D subsidy as a result of the comprehensive health care reform legislation enacted in March 2010.

(9) Products and Services Revenues

We are an integrated communications company engaged primarily in providing an array of communications services, including local and long distance voice, wholesale network access, broadband, other data services and video services. We strive to maintain our customer relationships by, among other things,

 

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bundling our service offerings to provide our customers with a complete offering of integrated communications services. Currently, we categorize our products and services into the following four categories:

 

   

Strategic services, which include primarily private line (including special access), broadband, MPLS, hosting, video, voice over Internet Protocol, or VoIP, services and Verizon Wireless services;

 

   

Legacy services, which include primarily local, long-distance, access, integrated services digital network, or ISDN, services and traditional wide area network, or WAN, services; and

 

   

Data integration, which is telecommunications equipment we sell that is located on customers’ premises and related professional services. These services include network management, installation and maintenance of data equipment and building of proprietary fiber-optic broadband networks for our government and business customers.

 

   

Affiliates and other services, which consist primarily of USF surcharges and services we provide to our affiliates. We provide to our affiliates data, local services and billing and collections services that we also provide to external customers. In addition, we provide to our affiliates: marketing, sales and advertising services; computer system development and support services; network support and technical services; and other support services, such as legal, regulatory, finance and accounting, tax and human resources.

Since the April 1, 2011 closing of the CenturyLink acquisition, our operations were integrated into and are reported as part of the segments of CenturyLink. CenturyLink’s CODM has become our CODM and does not review Qwest-only segment information. Consequently, we no longer provide Qwest-only segment information.

Our operating revenues for our products and services consisted of the following categories for the successor three months ended June 30, 2011 and predecessor three months ended March 31, 2011 and predecessor three and six months ended June 30, 2010:

 

     Successor          Predecessor  
     Three months ended
June 30, 2011
         Three months ended
March 31, 2011
     Three months ended
June 30, 2010
     Six months ended
June 30, 2010
 
                (Dollars in millions)         

Strategic services

   $ 1,206            1,201         1,149         2,287   

Legacy services

     1,317            1,395         1,499         3,056   

Data integration

     118            123         142         278   

Affiliates and other services

             128            127         140         275   
  

 

 

       

 

 

    

 

 

    

 

 

 

Total operating revenues

   $ 2,769            2,846         2,930         5,896   
  

 

 

       

 

 

    

 

 

    

 

 

 

Affiliates and other operating revenues include certain surcharges to our customers, including billings for our required contributions to several USF programs. Such amounts are reflected on a gross basis in our statements of operations (included in both operating revenues and expenses) and aggregated approximately $92 million for the successor three months ended June 30, 2011, $96 million for the predecessor three months ended March 31, 2011, $106 million for the predecessor three months ended June 30, 2010 and $207 million for the predecessor six months ended June 30, 2010.

(10) Commitments and Contingencies

CenturyLink is involved in several legal proceedings to which we are not a party that, if resolved against CenturyLink, could have a material adverse effect on its business and financial condition. As a wholly owned subsidiary of CenturyLink, our business and financial condition could be similarly affected. You can find descriptions of these legal proceedings in CenturyLink’s quarterly and annual reports filed with the SEC. Because we are not a party to any of these matters, we have not accrued any liabilities for these matters.

 

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In this section, when we refer to a class action as “putative” it is because a class has been alleged, but not certified in that matter. Until and unless a class has been certified by the court, it has not been established that the named plaintiffs represent the class of plaintiffs they purport to represent.

To the extent appropriate, we have accrued liabilities for the matters described below.

The terms and conditions of applicable bylaws, certificates or articles of incorporation, agreements or applicable law may obligate us to indemnify our former directors, officers or employees with respect to certain of the matters described below, and we have been advancing legal fees and costs to certain former directors, officers or employees in connection with certain matters described below.

KPNQwest Litigation/Investigation

On September 29, 2010, the trustees in the Dutch bankruptcy proceeding for KPNQwest, N.V. (of which we were a major shareholder) filed a lawsuit in district court in Haarlem, the Netherlands, alleging tort and mismanagement claims under Dutch law. We and Koninklijke KPN N.V. (“KPN”) are defendants in this lawsuit along with a number of former KPNQwest supervisory board members and a former officer of KPNQwest, some of whom were formerly affiliated with us. Plaintiffs allege, among other things, that defendants’ actions were a cause of the bankruptcy of KPNQwest, and they seek damages for the bankruptcy deficit of KPNQwest, which is claimed to be approximately €4.2 billion (or approximately $6.1 billion based on the exchange rate on June 30, 2011), plus statutory interest. Two lawsuits asserting similar claims were previously filed against Qwest and others in federal courts in New Jersey in 2004 and Colorado in 2009; those courts dismissed the lawsuits without prejudice on the grounds that the claims should not be litigated in the United States.

On September 13, 2006, Cargill Financial Markets, Plc and Citibank, N.A. filed a lawsuit in the District Court of Amsterdam, the Netherlands, against us, KPN, KPN Telecom B.V., and other former officers, employees or supervisory board members of KPNQwest, some of whom were formerly affiliated with us. The lawsuit alleges that defendants misrepresented KPNQwest’s financial and business condition in connection with the origination of a credit facility and wrongfully allowed KPNQwest to borrow funds under that facility. Plaintiffs allege damages of approximately €219 million (or approximately $320 million based on the exchange rate on June 30, 2011).

We will continue to defend against the pending KPNQwest litigation matters vigorously.

Other Matters

Several putative class actions relating to the installation of fiber-optic cable in certain rights-of-way were filed against us on behalf of landowners on various dates and in various courts in Alabama, Arizona, California, Colorado, Florida, Georgia, Illinois (where there is a federal and a state court case), Indiana, Kansas, Massachusetts, Michigan, Mississippi, Missouri, Nevada, New Mexico, New York, Oregon, South Carolina, Tennessee, Texas, Utah and Washington. For the most part, the complaints challenge our right to install our fiber-optic cable in railroad rights-of-way. The complaints allege that the railroads own the right-of-way as an easement that did not include the right to permit us to install our fiber-optic cable in the right-of-way without the plaintiffs’ consent. Most of the actions purport to be brought on behalf of state-wide classes in the named plaintiffs’ respective states, although two of the currently pending actions purport to be brought on behalf of multi-state classes. Specifically, the Illinois state court action purports to be on behalf of landowners in Illinois, Iowa, Kentucky, Michigan, Minnesota, Nebraska, Ohio and Wisconsin, and the Indiana state court action purports to be on behalf of a national class of landowners. In general, the complaints seek damages on theories of trespass and unjust enrichment, as well as punitive damages. On July 18, 2008, a federal district court in Massachusetts entered an order preliminarily approving a settlement of all of the actions described above, except the action pending in Tennessee. On September 10, 2009, the court denied final approval of the settlement on grounds that it lacked subject matter jurisdiction. On December 9, 2009, the court issued a revised ruling that, among other things, denied a motion for approval as moot and dismissed the matter for lack of subject matter jurisdiction. The parties are now engaged in negotiating settlements on a state-by-state basis, and have filed and received preliminary approval of a settlement in Illinois and Alabama federal courts as well as Tennessee state court.

 

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A putative class action filed on behalf of certain of our retirees was brought against us, the Qwest Group Life Insurance Plan and other related entities in federal district court in Colorado in connection with our decision to reduce the life insurance benefit for these retirees to a $10,000 benefit. The action was filed on March 30, 2007. The plaintiffs allege, among other things, that we and other defendants were obligated to continue their life insurance benefit at the levels in place before we decided to reduce them. Plaintiffs seek restoration of the life insurance benefit to previous levels and certain equitable relief. The district court ruled in our favor on the central issue of whether we properly reserved our right to reduce the life insurance benefit under applicable law and plan documents. The plaintiffs subsequently amended their complaint to assert additional claims. In 2009, the court dismissed or granted summary judgment to us on all of the plaintiffs’ claims. The plaintiffs appealed the court’s decision to the Tenth Circuit Court of Appeals. On June 2, 2011, the Tenth Circuit affirmed the District Court’s decision.

(11) Financial Statements of Guarantors

QCII and two of its subsidiaries, QCF and QSC, guarantee the payment of certain of each other’s registered debt securities. As of June 30, 2011, QCII’s total outstanding debt included $2.7 billion aggregate principal amount of senior notes that were issued in February 2004, June 2005, September 2009 and January 2010 and that are guaranteed by QCF and QSC (the “QCII Guaranteed Notes”). These notes are guaranteed through their respective maturity dates, the latest of which is in April 2018. In addition, each series of QCF’s outstanding notes totaling approximately $1 billion in aggregate principal amount is guaranteed on a senior unsecured basis by QCII (the “QCF Guaranteed Notes”). These notes are guaranteed through their respective maturity dates, the latest of which is in February 2031. The guarantees described above are full and unconditional and joint and several. All of the QCF Guaranteed Notes and $1.3 billion of the QCII Guaranteed Notes are registered debt securities. A significant amount of QCII’s and QSC’s income and cash flow are generated by their subsidiaries. As a result, the funds necessary to meet their debt service or guarantee obligations are provided in large part by distributions or advances from their subsidiaries.

The following information sets forth our condensed consolidating statements of operations for the three months ended June 30, 2011, March 31, 2011, June 30, 2010 and six months ended June 30, 2010, our condensed consolidating balance sheets as of June 30, 2011 and December 31, 2010, and our condensed consolidating statements of cash flows for the three months ended June 30, 2011, March 31, 2011 and six months ended June 30, 2010. The information for QCII is presented on a stand-alone basis, information for QSC and QCF is presented on a combined basis and information for all of our other subsidiaries is presented on a combined basis. Each entity’s investments in its subsidiaries, if any, are presented under the equity method. The consolidating statements of operations and balance sheets include the effects of consolidating adjustments to our subsidiaries’ tax provisions and the related income tax assets and liabilities in the QSC and QCII results. Both QSC and QCF are 100% owned by QCII, and QCF is a finance subsidiary of QCII. Other than as already described in this note, the accounting principles used to determine the amounts reported in this note are the same as those used in our consolidated financial statements.

We periodically restructure the internal capital structure of our subsidiaries based on the needs of our business.

 

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Qwest Communications International Inc.

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

THREE MONTHS ENDED JUNE 30, 2011

SUCCESSOR

(UNAUDITED)

 

     QCII(1)     QSC(2) &
QCF(3)
    Subsidiary
Non-
Guarantors
    Eliminations     QCII
Consolidated
 
     (Dollars in millions)  
                                

OPERATING REVENUES

          

Operating revenues

   $               2,763               2,763   

Operating revenues—affiliates

            3        15        (12     6   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating revenues

            3        2,778        (12               2,769   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

OPERATING EXPENSES

          

Cost of services and products (exclusive of depreciation and amortization)

                   1,141               1,141   

Selling, general and administrative

     5        3                  648               656   

Operating expenses—affiliates

                   44        (12     32   

Depreciation and amortization

     43               780               823   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     48        3        2,613        (12     2,652   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

OPERATING (LOSS) INCOME

     (48            165               117   

OTHER INCOME (EXPENSE)

          

Interest expense

     (44     (18     (88            (150

Interest expense—affiliates

     (4     (23     1                  26          

Interest income—affiliates

                      26               (26       

Loss on early retirement of debt

                   (1            (1

Income (loss) from equity investments in subsidiaries

             67        (52            (15       
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expense)

     19        (67     (88     (15     (151
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(LOSS) INCOME BEFORE INCOME TAX (BENEFIT) EXPENSE

     (29     (67     77        (15     (34

Income tax (benefit) expense

     (3     (131     126               (8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET (LOSS) INCOME

   $ (26     64        (49     (15     (26
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

  (1) QCII is the issuer of the QCII Guaranteed Notes and is a guarantor of the QCF Guaranteed Notes.
  (2) QSC is a guarantor of the QCII Guaranteed Notes.
  (3) QCF is the issuer of the QCF Guaranteed Notes and is a guarantor of the QCII Guaranteed Notes.

 

19


Table of Contents

Qwest Communications International Inc.

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

THREE MONTHS ENDED MARCH 31, 2011

PREDECESSOR

(UNAUDITED)

 

     QCII(1)     QSC(2) &
QCF(3)
    Subsidiary
Non-
Guarantors
    Eliminations     QCII
Consolidated
 
     (Dollars in millions)  
                                

OPERATING REVENUES

          

Operating revenues

   $               2,846               2,846   

Operating revenues—affiliates

            2        9        (11       
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating revenues

            2        2,855        (11     2,846   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

OPERATING EXPENSES

          

Cost of services and products (exclusive of depreciation and amortization)

                   1,178               1,178   

Selling, general and administrative

     3        2        551               556   

Operating expenses—affiliates

                   11        (11       

Depreciation and amortization

                   533               533   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     3        2        2,273        (11     2,267   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

OPERATING (LOSS) INCOME

     (3            582               579   

OTHER INCOME (EXPENSE)

          

Interest expense

     (56     (19     (152            (227

Interest expense—affiliates

     (1     (26     (1     28          

Interest income—affiliates

            28               (28       

Income from equity investments in subsidiaries

                 272        226               (498       

Other (expense) income, net

            (1     6               5   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expense)

     215        208        (147     (498     (222
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

INCOME BEFORE INCOME TAX EXPENSE (BENEFIT)

     212        208        435        (498     357   

Income tax expense (benefit)

     1        (64     209               146   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME

   $ 211                    272                    226        (498                 211   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

  (1) QCII is the issuer of the QCII Guaranteed Notes and is a guarantor of the QCF Guaranteed Notes.
  (2) QSC is a guarantor of the QCII Guaranteed Notes.
  (3) QCF is the issuer of the QCF Guaranteed Notes and is a guarantor of the QCII Guaranteed Notes.

 

20


Table of Contents

Qwest Communications International Inc.

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

THREE MONTHS ENDED JUNE 30, 2010

PREDECESSOR

(UNAUDITED)

 

     QCII(1)     QSC(2) &
QCF(3)
    Subsidiary
Non-
Guarantors
    Eliminations     QCII
Consolidated
 
     (Dollars in millions)  

OPERATING REVENUES

          

Operating revenues

   $               2,930               2,930   

Operating revenues—affiliates

            (1     1                 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating revenues

            (1     2,931               2,930   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
          

OPERATING EXPENSES

          

Cost of services and products (exclusive of depreciation and amortization)

                   1,240               1,240   

Selling, general and administrative

     35        (2     600               633   

Depreciation and amortization

                   548               548   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     35        (2     2,388               2,421   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
          

OPERATING (LOSS) INCOME

     (35     1        543               509   

OTHER INCOME (EXPENSE)

          

Interest expense

     (82     (22     (161            (265

Interest expense—affiliates

            (71            71          

Interest income—affiliates

            71               (71       

Income from equity investments in subsidiaries

     237        187          (424       

Other income, net

                 21        1                      22   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expense)

     176        166        (161     (424     (243
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

INCOME BEFORE INCOME TAX EXPENSE (BENEFIT)

     141        167        382        (424     266   

Income tax (benefit) expense

     (17     (74     199               108   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME

   $ 158                    241                    183        (424                 158   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

  (1) QCII is the issuer of the QCII Guaranteed Notes and is a guarantor of the QCF Guaranteed Notes.
  (2) QSC is a guarantor of the QCII Guaranteed Notes.
  (3) QCF is the issuer of the QCF Guaranteed Notes and is a guarantor of the QCII Guaranteed Notes.

 

21


Table of Contents

Qwest Communications International Inc.

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

SIX MONTHS ENDED JUNE 30, 2010

PREDECESSOR

(UNAUDITED)

 

     QCII(1)     QSC(2) &
QCF(3)
    Subsidiary
Non-
Guarantors
    Eliminations     QCII
Consolidated
 
     (Dollars in millions)  

OPERATING REVENUES

          

Operating revenues

   $               5,896               5,896   

Operating revenues—affiliates

            2        8        (10       
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating revenues

            2        5,904        (10     5,896   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
          

OPERATING EXPENSES

          

Cost of services and products (exclusive of depreciation and amortization)

                   2,487               2,487   

Selling, general and administrative

     39        1        1,199               1,239   

Operating expenses—affiliates

                   10        (10       

Depreciation and amortization

                   1,093               1,093   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     39        1        4,789        (10     4,819   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
          

OPERATING (LOSS) INCOME

     (39     1        1,115               1,077   

OTHER INCOME (EXPENSE)

          

Interest expense

     (168     (58     (318            (544

Interest expense—affiliates

            (155            155          

Interest income—affiliates

            155               (155       

Loss on early retirement of debt

     (2     (40                   (42

Income from equity investments in subsidiaries

     366        335               (701       

Other income (expense), net

                 21        1                                  22   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expense)

     217        238        (318     (701     (564
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

INCOME BEFORE INCOME TAX EXPENSE (BENEFIT)

     178        239        797        (701     513   

Income tax (benefit) expense

     (18     (131     466               317   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME

   $ 196                    370                    331        (701     196   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

  (1) QCII is the issuer of the QCII Guaranteed Notes and is a guarantor of the QCF Guaranteed Notes.
  (2) QSC is a guarantor of the QCII Guaranteed Notes.
  (3) QCF is the issuer of the QCF Guaranteed Notes and is a guarantor of the QCII Guaranteed Notes.

 

22


Table of Contents

Qwest Communications International Inc.

CONDENSED CONSOLIDATING BALANCE SHEETS

JUNE 30, 2011

SUCCESSOR

(UNAUDITED)

 

     QCII(1)
     QSC(2) &
QCF(3)
     Subsidiary
Non-
Guarantors
     Eliminations     QCII
Consolidated
 
     (Dollars in millions)  

ASSETS

             

CURRENT ASSETS

             

Cash and cash equivalents

   $         33         14                47   

Accounts receivable, less allowance

     15         25         1,147                1,187   

Accounts receivable—affiliates

     235         869         375         (929     550   

Notes receivable—affiliates

             1,402         100         (1,502       

Deferred income taxes, net

     65         11         168         (39     205   

Other

     5         4         244         (19     234   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total current assets

     320         2,344         2,048         (2,489     2,223   
             
             

Net property, plant and equipment

                     9,442                9,442   

Goodwill

                     10,005                10,005   

Customer relationships, net

                     7,365           7,365   

Other intangible assets, net

     323                 1,631                1,954   

Investments in subsidiaries

     15,324         13,888                 (29,212       

Deferred income taxes, net

     756         1,738         11         (2,505       

Prepaid pension, post-retirement and other post-employment benefits—affiliate

     2,853         72         922         (3,847       

Other

     37         8         253                298   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

TOTAL ASSETS

     19,613         18,050         31,677         (38,053     31,287   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 
             

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)

             

CURRENT LIABILITIES

             

Current maturities of long-term debt

                     1,600                1,600   

Current debt—affiliates

     314         1,188                 (1,502       

Accounts payable

     5         5         908                918   

Accounts payable—affiliates

     46         2         2         (50       

Accrued expenses and other liabilities

     300         32         762         (6     1,088   

Accrued expenses and other—affiliates

     1         118         760         (879       

Deferred income taxes, net

             39                 (39       

Advance billings and customer deposits

                     378         (13     365   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total current liabilities

     666         1,384         4,410         (2,489     3,971   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

LONG-TERM DEBT

     2,779         1,010         7,022                10,811   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 
             

DEFERRED CREDITS AND OTHER LIABILITIES

             

Deferred revenues

                     75                75   

Benefit plan obligations, net

     2,820                                2,820   

Pension, post-retirement and other post-employment benefits obligations and other—affiliates

     994         337         2,516         (3,847       

Deferred income taxes

                     3,083         (2,505     578   

Other

     135         29         649                813   

Total deferred credits and other liabilities

     3,949         366         6,323         (6,352     4,286   

Stockholders’ equity

     12,219         15,290         13,922         (29,212     12,219   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 19,613         18,050         31,677         (38,053     31,287   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

 

  (1) QCII is the issuer of the QCII Guaranteed Notes and is a guarantor of the QCF Guaranteed Notes.
  (2) QSC is a guarantor of the QCII Guaranteed Notes.
  (3) QCF is the issuer of the QCF Guaranteed Notes and is a guarantor of the QCII Guaranteed Notes.

 

23


Table of Contents

Qwest Communications International Inc.

CONDENSED CONSOLIDATING BALANCE SHEETS

DECEMBER 31, 2010

PREDECESSOR

(UNAUDITED)

 

    QCII(1)     QSC(2) &
QCF(3)
    Subsidiary
Non-
Guarantors
    Eliminations     QCII
Consolidated
 
    (Dollars in millions)  

ASSETS

         

CURRENT ASSETS

         

Cash and cash equivalents

  $        148        224               372   

Accounts receivable, less allowance

    16        22        1,226               1,264   

Accounts receivable—affiliates

    296        277        154        (727       

Notes receivable—affiliates

           1,568        110        (1,678       

Deferred income taxes, net

           36        208        (10     234   

Other

    9        26        353        (28     360   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total current assets

    321        2,077        2,275        (2,443     2,230   
         
         

Property, plant and equipment, net

                  11,857               11,857   

Other intangible assets, net

    50               888               938   

Investments in subsidiaries

    1,355        429               (1,784       

Deferred income taxes, net

    840        2,045        139        (1,338     1,686   

Prepaid pension, post-retirement and other post-employment benefits—affiliate

    2,848        71        914        (3,833       

Other

    75        45        389               509   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

TOTAL ASSETS

  $ 5,489        4,667        16,462        (9,398     17,220   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
         

LIABILITIES AND STOCKHOLDERS’ (DEFICIT) EQUITY

         

CURRENT LIABILITIES

         

Current maturities of long-term debt

  $        179        910               1,089   

Current debt—affiliates

    118        1,560               (1,678       

Accounts payable

    8        4        1,021               1,033   

Accounts payable—affiliates

    26        20        186        (232       

Accrued expenses and other liabilities

    296        58        842        (7     1,189   

Accrued expenses and other—affiliates

           175        320        (495       

Deferred income taxes, net

    10                      (10       

Advance billings and customer deposits

                  572        (21     551   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total current liabilities

    458        1,996        3,851        (2,443     3,862   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

LONG-TERM DEBT

    2,598        978        7,282               10,858   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
         

DEFERRED CREDITS AND OTHER LIABILITIES

         

Deferred revenues

                  459               459   

Benefit plan obligations, net

    2,979                             2,979   

Pension, post-retirement and other post-employment benefits obligations and other—affiliates

    985        356        2,492        (3,833       

Deferred income taxes

           11        1,327        (1,338       

Other

    124        2        591               717   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total deferred credits and other liabilities

    4,088        369                4,869        (5,171             4,155   

Stockholders’ (deficit) equity

    (1,655     1,324        460        (1,784     (1,655
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

TOTAL LIABILITIES AND STOCKHOLDERS’ (DEFICIT) EQUITY

  $         5,489                4,667        16,462        (9,398     17,220   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

  (1) QCII is the issuer of the QCII Guaranteed Notes and is a guarantor of the QCF Guaranteed Notes.
  (2) QSC is a guarantor of the QCII Guaranteed Notes.
  (3) QCF is the issuer of the QCF Guaranteed Notes and is a guarantor of the QCII Guaranteed Notes.

 

24


Table of Contents

Qwest Communications International Inc.

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

THREE MONTHS ENDED JUNE 30, 2011

SUCCESSOR

(UNAUDITED)

 

     QCII(1)     QSC(2) &
QCF(3)
    Subsidiary
Non-
Guarantors
    Eliminations     QCII
Consolidated
 
     (Dollars in millions)  

Net cash (used in) provided by operating activities

   $ (76     213        563               700   
          

INVESTING ACTIVITIES

          

Payments for property, plant and equipment and capitalized software

                   (347            (347

Cash infusion to subsidiaries

            (168            168          

Changes in short-term affiliate loans

            (243     (272     4        (511

Dividends received from subsidiaries

            120               (120       

Other, net

                   2               2   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by investing activities

            (291     (617     52        (856
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
          

FINANCING ACTIVITIES

          

Payments of debt

                   (851            (851

Net proceeds from (repayments of) short-term affiliate debt

     76        (72            (4       

Net proceeds from issuance of long-term debt

                   643               643   

Cash infusion from parent

                   168        (168       

Dividends paid to parent

                   (120     120          

Early retirement of debt costs

                   (13            (13
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

             76        (72     (173     (52     (221
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
          
          

Net decrease in cash and cash equivalents

            (150     (227            (377

Cash and cash equivalents at beginning of period

            183        241               424   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $                33                14                       47   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

  (1) QCII is the issuer of the QCII Guaranteed Notes and is a guarantor of the QCF Guaranteed Notes.
  (2) QSC is a guarantor of the QCII Guaranteed Notes.
  (3) QCF is the issuer of the QCF Guaranteed Notes and is a guarantor of the QCII Guaranteed Notes.

 

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Qwest Communications International Inc.

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

THREE MONTHS ENDED MARCH 31, 2011

PREDECESSOR

(UNAUDITED)

 

     QCII(1)     QSC(2) &
QCF(3)
    Subsidiary
Non-
Guarantors
    Eliminations     QCII
Consolidated
 
     (Dollars in millions)  

Net cash provided by (used in) operating activities

   $ 7        (62     828        4        777   
          

INVESTING ACTIVITIES

          

Payments for property, plant and equipment and capitalized software

                   (410            (410

(Purchases) proceeds of investments managed by QSC

            (3     3                 

Cash infusion to subsidiaries

            (191            191          

Net decrease (increase) in short-term affiliate loans

            180        1        (181       

Dividends received from subsidiaries

            590               (590       

Other, net

                   2               2   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) investing activities

            576        (404     (580     (408
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
          

FINANCING ACTIVITIES

          

Payments of debt

            (179     (24            (203

Net proceeds from (repayments of) short-term affiliate debt

             119        (300            181          

Dividends paid

     (141                          (141

Proceeds from issuance of common stock

     14                             14   

Cash infusion from parent

                   191        (191       

Dividends paid to parent

                   (590     590          

Other, net

     1               16        (4     13   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

     (7     (479     (407     576        (317
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
          
          

Net increase in cash and cash equivalents

            35        17               52   

Cash and cash equivalents at beginning of period

            148        224               372   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $                183                241                       424   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

  (1) QCII is the issuer of the QCII Guaranteed Notes and is a guarantor of the QCF Guaranteed Notes.
  (2) QSC is a guarantor of the QCII Guaranteed Notes.
  (3) QCF is the issuer of the QCF Guaranteed Notes and is a guarantor of the QCII Guaranteed Notes.

 

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Qwest Communications International Inc.

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

SIX MONTHS ENDED JUNE 30, 2010

PREDECESSOR

(UNAUDITED)

 

    QCII(1)     QSC(2) &
QCF(3)
    Subsidiary
Non-
Guarantors
    Eliminations     QCII
Consolidated
 
    (Dollars in millions)  

Net cash (used in) provided by operating activities

  $ (140     421        1,333        27        1,641   
         

INVESTING ACTIVITIES

         

Payments for property, plant and equipment and capitalized software

                  (717            (717

Proceeds from sales or maturities of investment securities

           159                      159   

Purchases of investment securities

           (821                   (821

Changes in interest in investments managed by QSC

    (15     187        (172              

Cash infusion to subsidiaries

           (321            321          

Net decrease (increase) in short-term affiliate loans

           923        16        (939       

Dividends received from subsidiaries

           1,150               (1,150       
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by investing activities

    (15     1,277        (873     (1,768     (1,379
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
         

FINANCING ACTIVITIES

         

Payments of debt

    (525     (960     (520            (2,005

Net proceeds from issuance of long-term debt

    775                             775   

Net (repayments of) proceeds from short-term affiliate debt

    (16     (923            939          

Dividends paid

    (277                          (277

Proceeds from issuance of common stock

    17                             17   

Cash infusion from parent

                  321        (321       

Dividends paid to parent

                  (1,150     1,150          

Early retirement of debt costs

           (40                   (40

Other, net

    20               (13     (27     (20
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by financing activities

    (6     (1,923     (1,362     1,741        (1,550
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
         

Net decrease in cash and cash equivalents

    (161     (225     (902            (1,288

Cash and cash equivalents at beginning of period

            194        987        1,225               2,406   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

  $ 33                762                323                       1,118   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

  (1) QCII is the issuer of the QCII Guaranteed Notes and is a guarantor of the QCF Guaranteed Notes.
  (2) QSC is a guarantor of the QCII Guaranteed Notes.
  (3) QCF is the issuer of the QCF Guaranteed Notes and is a guarantor of the QCII Guaranteed Notes.

 

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Item 2.

Qwest Communications International Inc.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Unless the context requires otherwise, references in this report to “Qwest,” “we,” “us,” the “Company” and “our” refer to Qwest Communications International Inc. and its consolidated subsidiaries, and references in this report to “QCII” refer to Qwest Communications International Inc. on an unconsolidated, stand-alone basis.

Overview

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) included herein should be read in conjunction with MD&A and the other information included in our Annual Report on Form 10-K for the year ended December 31, 2010. The results of operations for the successor three months ended June 30, 2011, the predecessor three months ended March 31, 2010, the combined six months ended June 30, 2011 and predecessor six months ended June 30, 2011 are not necessarily indicative of the results of operations which might be expected for the entire year.

On April 1, 2011, we became a wholly owned subsidiary of CenturyLink. Each outstanding share of our common stock was converted into 0.1664 shares of CenturyLink common stock, with cash paid in lieu of fractional shares. The estimated aggregate consideration was approximately $12.273 billion.

Since April 1, 2011, our results of operations have been included in the consolidated results of operations of CenturyLink. CenturyLink has accounted for its acquisition of us under the acquisition method of accounting, which resulted in the assignment of the purchase price to the assets acquired and liabilities assumed based on preliminary estimates of their acquisition date fair values. The determination of the fair values of the acquired assets and assumed liabilities (and the related determination of estimated lives of depreciable tangible and identifiable intangible assets) requires significant judgment. We expect to complete our final determinations no later than the first quarter of 2012. Our final determinations may be significantly different than those reflected in our consolidated financial statements as of June 30, 2011. Based on our preliminary estimate, the aggregate consideration exceeds the aggregate estimated fair value of the acquired assets and assumed liabilities by $10.005 billion, which has been recognized as goodwill. This goodwill is attributable to strategic benefits, including enhanced financial and operational scale, market diversification and leveraged combined networks that we expect CenturyLink and its consolidated subsidiaries, including us, to realize. None of the goodwill associated with this acquisition is deductible for income tax purposes. The recognition of assets and liabilities at fair value is reflected in our financial statements and therefore has resulted in a new basis of accounting for the “successor period” beginning on April 1, 2011. This new basis of accounting means that our financial statements for the successor periods will not be comparable to our previously reported financial statements, including the predecessor period financial statements in this report.

We have recognized $127 million of certain expenses that were contingent on completion of the CenturyLink acquisition, primarily compensation expense comprised of severance, retention bonuses and share-based compensation for the successor three months ended June 30, 2011. During the predecessor three months ended March 31, 2011, we had recognized $3 million of expenses associated with our activities surrounding the acquisition. As of April 1, 2011, as part of acquisition accounting, we also included in our goodwill $35 million for financial advisory fees, $23 million for certain performance awards and $16 million related to retention bonuses, all of which were contingent on the completion of the acquisition and had no benefit to CenturyLink after the acquisition.

CenturyLink has cash management arrangements between certain of its subsidiaries, including us, under which the majority of our cash balance is transferred on a daily basis to CenturyLink.

 

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The discussion in this MD&A is presented on a combined basis of the predecessor and successor periods for 2011. The 2011 predecessor and successor results are presented but are not discussed separately. We believe that the discussion on a combined basis is more meaningful as it allows the results of operations to be analyzed to a comparable period in 2010.

We are an integrated communications company primarily engaged in providing an array of communications services, including local and long distance voice, wholesale network access, broadband, managed hosting, other data services and video services. In certain local and regional markets, we also provide fiber transport and services to competitive local exchange carriers and other communications, professional and business information services. We generate the majority of our revenues from services provided in the 14-state region of Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington and Wyoming. We operate approximately 8.8 million access lines, which are telephone lines reaching from the customers’ premises to a connection with the public switched telephone network. We also serve approximately 3.0 million broadband subscribers as of June 30, 2011. During the second quarter of 2011, we updated our methodology for counting our subscribers and access lines where we provide the services. We now count access lines when we install the service. Our access line methodology includes only those access lines that we use to provide services to external customers and excludes lines used solely by us and our affiliates. Our new methodology also excludes unbundled loops and includes stand alone broadband subscribers.

For certain products and services we provide, and for a variety of internal communications functions, we use parts of CenturyLink’s telecommunications network to transport voice and data traffic.

During the second quarter of 2011, our dedicated internet access services were reclassified from our legacy services to strategic services and certain USF surcharges were reclassified from our legacy services to affiliates and other services revenues to better align with the classifications that our parent, CenturyLink, uses. As a result, we reclassified previously reported amounts to conform to the current period presentation. For the predecessor three months ended March 31, 2011 this reclassification resulted in a reduction of legacy service revenues of $65 million, an increase of strategic service revenues of $30 million and an increase of affiliates and other services revenues of $34 million. For the predecessor three months ended June 30, 2010 this reclassification resulted in a reduction of legacy service revenues of $71 million, an increase of strategic service revenues of $37 million and an increase of affiliates and other services revenues of $34 million. For the predecessor six months ended June 30, 2010 this reclassification resulted in a reduction of legacy service revenues of $148 million, an increase of strategic service revenues of $77 million and an increase of affiliates and other services revenues of $70 million. We currently categorize our products and services among the following four categories:

 

   

Strategic services, which include primarily private line (including special access), broadband, MPLS (which is a data networking technology that can deliver the quality of service required to support real-time voice and video), hosting, video, voice over Internet Protocol, or VoIP, services and Verizon Wireless services;

 

   

Legacy services, which include primarily local, long-distance, access, integrated services digital network, or ISDN, services and traditional wide area network, or WAN, services; and

 

   

Data integration, which is telecommunications equipment we sell that is located on customers’ premises and related professional services. These services include network management, installation and maintenance of data equipment and building of proprietary fiber-optic broadband networks for our government and business customers.

 

   

Affiliates and other services, which consist primarily of USF surcharges and services we provide to our affiliates. We provide to our affiliates data, local services and billing and collections services that we also provide to external customers. In addition, we provide to our affiliates: marketing, sales and

 

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Table of Contents
 

advertising services; computer system development and support services; network support and technical services; and other support services, such as legal, regulatory, finance and accounting, tax and human resources.

Our analysis presented below is organized to provide the information we believe will be useful for understanding the trends affecting our business. This discussion should be read in conjunction with our consolidated financial statements in Item 1 of Part I of this report.

Since the April 1, 2011 closing of the CenturyLink acquisition, our operations were integrated into and are reported as part of the segments of CenturyLink. CenturyLink’s CODM has become our CODM, but reviews our financial information on an aggregate basis only in connection with our quarterly and annual reports that we file with the SEC. Consequently, we no longer provide Qwest-only segment information.

Our financial results were impacted by several significant trends, which are described below. We expect that these trends will continue to affect our results of operations, cash flows or financial position.

 

   

Strategic services. We continue to see shifts in the makeup of our total revenues as customers move to strategic services, such as private line, broadband and video services, from legacy services, such as local and access services. Revenues from our strategic services represented 44% and 39% of our total revenues for the successor three months ended June 30, 2011 and the predecessor three months ended June 30, 2010, respectively, and 43% and 39% of our total revenues for the combined six months ended June 30, 2011 and the predecessor six months ended June 30, 2010, respectively, and this percentage continues to grow. With respect to broadband services, we continue to focus on increasing subscribers, particularly among consumer and small business customers. We reached approximately 3.0 million broadband subscribers at June 30, 2011 compared to approximately 2.9 million at June 30, 2010. In order to remain competitive, we believe the ability to continually increase connection speeds is important. As a result, we continue to invest in our fiber to the node, or FTTN, deployment, which we launched to meet customer demand for higher broadband speeds. FTTN is a type of telecommunications network that combines fiber-optic cables (which run from a telecommunication provider’s central office to a single location within a particular neighborhood or geographic area) and traditional copper wires (which run from this location to individual residences and businesses within the neighborhood or geographic area). Fiber to the node allows for the delivery of higher speed broadband services than would otherwise generally be available through a more traditional telecommunications network made up of only copper wires. In addition to the FTTN deployment, we continue to expand our product offerings and enhance our marketing efforts as we compete in a competitive and maturing market in which a significant portion of consumers already have broadband services. We expect these efforts will improve our ability to compete and grow our broadband subscribers. Demand for the private line services we offer to business and wholesale customers continues to increase, despite our customers’ optimization of their networks, industry consolidation and technological migration. While we expect that these factors will continue to impact our business, we ultimately believe the growth in fiber based special access provided to wireless carriers for backhaul will, over time, offset the decline in copper based special access provided to wireless carriers as they migrate to Ethernet, although the timing of this technological migration is uncertain.

 

   

Legacy services. Revenues from our legacy services represented 48% and 53% of our total revenues for the successor three months ended June 30, 2011 and the predecessor three months ended June 30, 2010, respectively, and 48% and 52% of our total revenues for the combined six months ended June 30, 2011 and the predecessor six months ended June 30, 2010, respectively, and continue to decline. Our legacy services revenues have been, and we expect they will continue to be, adversely affected by access line losses. Intense competition and product substitution continue to drive our access line losses. For example, many consumers are substituting cable and wireless voice services for traditional voice telecommunications services. This has increased the number and type of competitors within our industry

 

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and has decreased our market share. We expect that these factors will continue to impact our business. Service bundling and other product promotions, as described below, continue to be some of our responses to offset the loss of revenues as a result of access line losses.

 

   

Data integration. We expect both data integration revenue and the related costs will fluctuate from quarter to quarter as this revenue stream tends to be more sensitive than revenues from our other services to changes in the economy and to changes in spending trends of our federal government customers. We currently expect revenue and costs for the remainder of 2011 to be lower than they were during the comparable period of 2010.

 

   

Service bundling and product promotions. We offer our customers, primarily consumers and small businesses, the ability to bundle multiple products and services. These customers can bundle local services with other services such as broadband, video, long-distance and wireless. While video and wireless subscribers are an important piece of our customer retention strategy, they do not make a large contribution to strategic services revenues. However, we believe customers value the convenience of, and price discounts associated with, receiving multiple services through a single company. In addition to our bundle discounts, we also offer limited time promotions on our broadband service for qualifying customers who have our broadband product in their bundle, which we believe will positively affect our acquisition volume and drive customers to purchase more expanded offerings. While bundle price discounts have resulted in lower average revenues for our individual products, we believe service bundles continue to positively impact our customer retention.

 

   

Operating efficiencies. We continue to evaluate our operating structure and focus. This involves balancing our workforce in response to our workload, productivity improvements, changes in the telecommunications industry and governmental regulations. Through planned reductions and normal employee attrition, we have reduced our workforce and employee-related expenses (net of severance) while achieving operational efficiencies and improving processes through automation and other innovative ways of operating our business.

 

   

Pension and post-retirement benefits expenses. We are required to recognize in our consolidated financial statements certain expenses relating to our pension and post-retirement health care and life insurance benefits plans. These expenses are calculated based on several assumptions, including among other things discount rates and expected rates of return on plan assets that are generally set at December 31 of each year. Changes in these assumptions can cause significant changes in the combined net periodic benefits expenses we recognize. We allocate the expenses of these plans to certain of our other affiliates. The allocation of expenses is based upon the demographics of employees and retirees at our affiliates. Changes in our assumptions can cause significant changes in the net periodic pension and post-retirement benefits expenses we recognize.

 

   

Disciplined capital expenditures. Our capital expenditures continue to be focused on our strategic services such as broadband and fiber to the cell site, or FTTCS. FTTCS is a type of telecommunications network consisting of fiber-optic cables that run from a telecommunication provider’s broadband interconnection points to cellular sites. Fiber to the cell site services allow for the delivery of higher bandwidth services supporting mobile technologies than would otherwise generally be available through a more traditional telecommunications network.

While these trends are important to understanding and evaluating our financial results, the other transactions, additional events and trends discussed in “Risk Factors” in Item 1A of Part II of this report may also materially impact our business operations and financial results.

 

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RESULTS OF OPERATIONS

Three and Six Months Ended June 30, 2011 Compared

to Three and Six Months Ended June 30, 2010

The following table summarizes our results of operations for the successor three months ended June 30, 2011, predecessor three months ended June 30, 2010, combined six months ended June 30, 2011 and predecessor six months ended June 30, 2010 and the number of employees as of June 30, 2011, successor and June 30, 2010, predecessor:

 

    Successor          Predecessor                 Combined     Predecessor              
    Three months
ended
June 30, 2011
         Three months
ended
June 30, 2010
    Increase/
(Decrease)
    %
Change
    Six months
ended
June 30, 2011
    Six months
ended
June 30, 2010
    Increase/
(Decrease)
    %
  Change  
 
    (Dollars in millions)  

Operating revenues by category:

                   

Strategic and legacy services:

                   

Strategic services

  $         1,206            1,149        57        5   $ 2,407        2,287        120        5

Legacy services

    1,317            1,499        (182     (12 )%      2,712        3,056        (344     (11 )% 
 

 

 

       

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

Total strategic and legacy services

    2,523            2,648        (125     (5 )%      5,119        5,343        (224     (4 )% 

Data integration

    118            142        (24     (17 )%      241        278        (37     (13 )% 
 

 

 

       

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

Total revenues

    2,641            2,790        (149     (5 )%      5,360        5,621        (261     (5 )% 

Affiliate revenues

    6                   6        nm        6               6        nm   

Other revenues (primarily USF surcharges)

    122            140        (18     (13 )%      249        275        (26     (9 )% 
 

 

 

       

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

Total operating revenues

    2,769            2,930        (161     (5 )%      5,615        5,896        (281     (5 )% 

Operating expenses

    2,652            2,421        231        10     4,919        4,819        100        2
 

 

 

       

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

Operating income

    117            509        (392     (77 )%      696        1,077        (381     (35 )% 

Other expense

    151            243        (92     (38 )%      373        564        (191     (34 )% 
 

 

 

       

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

Income before income taxes

    (34         266        (300     (113 )%      323        513        (190     (37 )% 

Income tax (benefit) expense

    (8         108        (116     (107 )%      138        317        (179     (56 )% 
 

 

 

       

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

Net (loss) income

  $ (26         158        (184     (116 )%    $ 185        196        (11     (6 )% 
 

 

 

       

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

Employees (as of June 30)

                27,589        29,221        (1,632     (6 )% 

 

nm—Percentages greater than 200% and comparisons between positive and negative values or to/from zero values are considered not meaningful.

During the second quarter of 2011, we updated our methodology for counting our subscribers and access lines where we provide the services. We now count access lines when we install the service, which resulted in an approximately 69,000 decrease in our successor June 30, 2011 access lines versus what we would have shown under our historical methodology of counting access lines when revenue was generated from them. We have not retrospectively adjusted our predecessor period access lines for this methodology adjustment as it was not reasonably practicable for us to do so. Our access line methodology includes only those access lines that we use to provide services to external customers and excludes lines used solely by us and our affiliates. Our new methodology also excludes unbundled loops and includes stand alone broadband subscribers. We have conformed prior periods to our current presentation, unless noted above.

 

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The following table summarizes our total broadband subscribers and access lines as of June 30, 2011, successor and June 30, 2010, predecessor:

 

     Successor          Predecessor               
     June 30,
2011
         June 30,
2010
     Increase/
(Decrease)
    %
    Change    
 
     (in thousands)        

Total broadband subscribers

     3,009