EX-99.4 6 exhibit99-4.htm EXHIBIT 99.4 exhibit99-4.htm
Exhibit 99.4

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF EMBARQ CORPORATION
FOR THE YEAR TO DATE PERIODS ENDED MARCH 31, 2009 AND 2008
 
   
 
Page
    Reference    
Consolidated Balance Sheets as of March 31, 2009 and December 31, 2008 (Unaudited)
F-2
Consolidated Statements of Operations and Comprehensive Income for the Year to Date Periods Ended March 31, 2009 and 2008 (Unaudited)
F-3
Consolidated Statements of Cash Flows for the Year to Date Periods Ended March 31, 2009 and 2008 (Unaudited)
F-4
Consolidated Statement of Stockholders’ Equity for the Year to Date Period Ended March 31, 2009 (Unaudited)
F-5
Condensed Notes to Consolidated Financial Statements (Unaudited)
F-6


INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF EMBARQ CORPORATION
FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

   
 
Page
    Reference    
Report of KPMG LLP, Independent Registered Public Accounting Firm
F-12
Consolidated Balance Sheets as of December 31, 2008 and 2007
F-13
Consolidated Statements of Operations and Comprehensive Income (Loss) for the Years Ended December 31, 2008, 2007 and 2006
F-14
Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and 2006
F-15
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2008, 2007 and 2006
F-16
Notes to Consolidated Financial Statements
F-17
 

EXPLANATORY NOTE

On March 12, 2009, Embarq Corporation (Embarq) completed the sale of its wholly owned subsidiary, Embarq Logistics, Inc., pursuant to an agreement previously entered into on January 29, 2009.  Consequently, the consolidated financial statements of Embarq for the three years ended December 31, 2008 have been retrospectively reclassified for all periods to report the financial results of Embarq Logistics’ third party wholesale distribution operations, which previously comprised the Logistics business segment, as discontinued operations pursuant to Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for Impairment or Disposal of Long Lived Assets.  See Note 1B, Discontinued Operations, of the Notes to Consolidated Financial Statements for the years ended December 31, 2008, 2007, and 2006 for additional information.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
F-1
 
EMBARQ CORPORATION
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(millions, except per share data)
 
As of March 31,
   
As of Dec. 31,
 
   
2009
   
2008
 
             
  Assets
           
  Current assets
           
         Cash and equivalents
  $ 95       107  
         Accounts receivable, net of allowance for doubtful accounts of $55 and $54
    444       494  
         Materials and supplies
    51       52  
         Deferred tax assets
    72       89  
         Prepaid expenses and other current assets
    70       81  
         Current assets of discontinued operations
    -       67  
                Total current assets
    732       890  
  Gross property, plant and equipment
    20,960       20,946  
  Accumulated depreciation
    (13,709 )     (13,547 )
         Net property, plant and equipment
    7,251       7,399  
  Goodwill
    25       27  
  Other assets
    43       43  
  Noncurrent assets of discontinued operations
    -       12  
  Total
  $ 8,051       8,371  
                 
  Liabilities and Stockholders’ Equity
               
  Current liabilities
               
         Current maturities of long-term debt
  $ 2       2  
         Accounts payable
    245       279  
         Payroll and employee benefits
    196       219  
        Accrued operating taxes
    86       78  
         Deferred revenue
    175       184  
         Accrued interest
    139       58  
         Other current liabilities
    52       42  
         Current liabilities of discontinued operations
    -       34  
                 Total current liabilities
    895       896  
  Noncurrent liabilities
               
         Long-term debt
    5,288       5,743  
         Deferred income taxes
    872       793  
         Benefit plan obligations
    1,332       1,341  
         Other noncurrent liabilities
    191       206  
                 Total noncurrent liabilities
    7,683       8,083  
                 
  Stockholders’ equity
               
         Preferred stock, $.01 par value; 200 shares authorized; no shares issued
    -       -  
         Common stock, $.01 par value; 1,250 shares authorized; 154.6 and 154.2 shares issued; 142.8 and 142.4 shares outstanding
    2       2  
         Paid-in capital
    (193 )     (193 )
         Retained earnings
    1,062       986  
         Accumulated other comprehensive loss
    (898 )     (903 )
         Treasury stock, 11.8 shares held in treasury
    (500 )     (500 )
                 Total stockholders’ equity
    (527 )     (608 )
 Total
  $ 8,051       8,371  
 
See accompanying Condensed Notes to Consolidated Financial Statements (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
F-2
 
 
EMBARQ CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (UNAUDITED)
(millions, except per share data)
 
Year to Date March 31,
 
   
2009
   
2008
 
Net Operating Revenues
  $ 1,346     $ 1,456  
Operating Expenses
               
Cost of services and products
    363       422  
Selling, general and administrative
    329       348  
Depreciation
    244       250  
Total operating expenses
    936       1,020  
Operating Income
    410       436  
Interest expense
    (96 )     (104 )
Other income (expense), net
    1       1  
Income From Continuing Operations Before Income Taxes
    315       333  
Income tax expense
    (115 )     (119 )
Income From Continuing Operations
    200       214  
Loss from discontinued operations (net of income taxes)
    (2 )     (2 )
Loss on sale of discontinued operations (net of income taxes)
    (24 )     -  
Net Income
  $ 174     $ 212  
Amortization (net of income taxes) of:
               
Employee benefit plans prior service cost and actuarial losses
    6       1  
Cash flow derivative
    (1 )     (1 )
Comprehensive Income, Net of Income Taxes
  $ 179     $ 212  
                 
Basic Earnings per Common Share
               
Continuing operations
  $ 1.40     $ 1.39  
Discontinued operations
    (0.18 )     (0.01 )
Total
  $ 1.22     $ 1.38  
                 
Diluted Earnings per Common Share
               
Continuing operations
  $ 1.39     $ 1.38  
Discontinued operations
    (0.18 )     (0.01 )
Total
  $ 1.21     $ 1.37  
                 
Weighted Average Common Shares Outstanding
               
Basic
    143.2       153.8  
Potentially dilutive shares under equity incentive plans
    0.3       0.5  
Diluted
    143.5       154.3  
 
See accompanying Condensed Notes to Consolidated Financial Statements (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
F-3
EMBARQ CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)  
(millions)  
 
Year to Date March 31,
 
   
2009
   
2008
 
Operating Activities
           
Net income
  $ 174     $ 212  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Loss from operations and sale of discontinued operations
    26       2  
Depreciation
    244       250  
Provision for losses on accounts receivable
    22       21  
Deferred and noncurrent income taxes
    79       (20 )
Stock-based compensation expense
    6       9  
Other, net
    12       11  
Changes in assets and liabilities:
               
Accounts receivable
    28       18  
Materials and supplies and other current assets
    (3 )     (21 )
Accounts payable and other current liabilities
    60       131  
Noncurrent assets and liabilities, net
    (14 )     (26 )
Net cash provided by operating activities - continuing operations
    634       587  
Discontinued operations
    -       6  
Net cash provided by operating activities
    634       593  
Investing Activities
               
Capital expenditures
    (108 )     (179 )
Proceeds from construction reimbursements
    3       2  
Proceeds from sales of assets
    7       2  
Proceeds from sale of discontinued operations
    12       -  
Net cash used by investing activities
    (86 )     (175 )
Financing Activities
               
    Principal payments on long-term debt
    (80 )     -  
Borrowings under revolving credit facility
    -       230  
Repayments under revolving credit facility
    (375 )     (435 )
Proceeds from common stock issued
    1       4  
Repurchase of common stock
    -       (115 )
Dividends paid to stockholders
    (100 )     (107 )
Tax effects of stock-based compensation
    (1 )     (3 )
Other, net
    (5 )     (9 )
Net cash used by financing activities
    (560 )     (435 )
Increase (Decrease) in Cash and Equivalents
    (12 )     (17 )
Cash and Equivalents at Beginning of Period
    107       69  
Cash and Equivalents at End of Period
  $ 95     $ 52  
 
See accompanying Condensed Notes to Consolidated Financial Statements (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
F-4

 
EMBARQ CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)
 
(millions, except per share data)
 
 
 
Preferred Stock
 
Common
Stock
 
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Treasury Stock
   
Total
Stockholders’
Equity
 
January 1, 2009 Balance
  $ -   $ 2   $ (193 ) $ 986   $ (903 ) $ (500 )   $ (608 )
Net income
    -     -     -     174     -     -       174  
Dividends to shareholders ($0.6875 per share)
    -     -     -     (98 )   -     -       (98 )
Common stock issued
    -     -     1     -     -     -       1  
Stock-based compensation expense
    -     -     6     -     -     -       6  
Tax effects of stock-based compensation
    -     -     (1 )   -     -     -       (1 )
Restricted stock units surrendered for tax withholding
    -     -     (6 )   -     -     -       (6 )
Amortization (net of income taxes) of:
                                             
Employee benefit plans prior service cost and
   actuarial losses
    -     -     -     -     6     -       6  
Cash flow derivative
    -     -     -     -     (1 )   -       (1 )
March 31, 2009 Balance
  $ -   $ 2   $ (193 ) $ 1,062   $ (898 ) $ (500 )   $ (527 )
 
See accompanying Condensed Notes to Consolidated Financial Statements (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
F-5
EMBARQ CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
This information has been prepared according to Securities and Exchange Commission (SEC) rules and regulations. The consolidated interim financial statements of Embarq Corporation (Embarq) reflect all adjustments, consisting only of normal recurring accruals needed to fairly present Embarq’s consolidated financial position, results of operations and cash flows.
 
Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States were condensed or omitted. As a result, these consolidated financial statements should be read along with Embarq’s consolidated financial statements for the three years ended December 31, 2008. Operating results for the 2009 year to date period do not necessarily represent the results that may be expected for the year ending December 31, 2009.
 
Note 1. Background and Basis of Presentation
 
Background
 
Embarq was incorporated in 2005 under the laws of Delaware and was formerly a wholly owned subsidiary of Sprint Nextel Corporation (Sprint Nextel). On May 17, 2006, Embarq was established as a separate, stand-alone company upon its operations being spun off from Sprint Nextel.
 
Embarq provides a suite of integrated communications services including local and long distance voice, data, high-speed Internet, satellite video, professional services and communications equipment to consumer and business customers primarily in local service territories in 18 states. Embarq also provides wholesale access to its local network and other communications services primarily to wireline and wireless service providers.
 
As of March 31, 2009, Embarq had approximately 15 thousand active employees. Approximately 35% of these employees were represented by unions subject to collective bargaining agreements. Of the union-represented employees, approximately 21% have collective bargaining agreements that will expire within one year. There were no material changes related to any collective bargaining agreements during the year to date period ended March 31, 2009.
 
Sale of Logistics Business
 
On March 12, 2009, Embarq completed the sale of its wholly owned subsidiary, Embarq Logistics, Inc., pursuant to an agreement previously entered into on January 29, 2009. Consequently, the financial results of Embarq Logistics’ third party wholesale distribution operations, which previously comprised the Logistics business segment, are now reported as discontinued operations for all periods presented pursuant to Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for Impairment or Disposal of Long Lived Assets. See Note 2, Discontinued Operations, for additional information.
 
A commercial agreement was also completed whereby the buyer will provide certain logistics and supply chain services to Embarq’s telecommunications operations. While there is no minimum purchase obligation associated with this agreement, Embarq agreed to continue to purchase certain products and services exclusively from the buyer. Based on Embarq’s requirements in the 2008 fourth quarter, costs over the four-year term of this agreement may approximate $450 million.
 
Pending Merger with CenturyTel
 
On October 26, 2008, Embarq and CenturyTel Inc. (CenturyTel), a Louisiana corporation, entered into a merger agreement whereby a wholly owned subsidiary of CenturyTel, will merge with and into Embarq. As a result of the merger, Embarq will continue as a wholly owned subsidiary of CenturyTel. At the effective date of the merger, each share of Embarq’s common stock, par value $0.01 per share, will be converted into the right to receive 1.37 shares of CenturyTel common stock, par value $1.00 per share, plus cash in lieu of fractional shares. It is expected that the merger will qualify as a tax-free reorganization for U.S. Federal income tax purposes. In conjunction with this transaction, Embarq may incur additional costs including, but not limited to potential asset impairments; employee retention and severance costs; and other merger and integration costs.
 
On January 23, 2009, Embarq entered into an amendment to modify its existing credit agreement, which will only become effective upon consummation of the merger with CenturyTel and the satisfaction of other customary conditions. Among other matters, the amendment would cause the credit agreement to remain in place after consummation of the merger; reduce the size of the revolving credit facility to $800 million from $1.5 billion (and the sub-limit for letters of credit to $100 million from $200 million); and require repayment in full of the outstanding term borrowings of $280 million as of March 31, 2009 on or before the closing date of the merger. See Note 10, Subsequent Events, for additional information.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
F-6
On January 27, 2009, the Embarq and CenturyTel shareholders approved the matters required to complete the transaction as proposed in the merger agreement. Completion of the merger is now subject to approval by the Federal Communications Commission (FCC) and various state regulatory agencies as well as other customary closing conditions, and is expected to occur during the 2009 second quarter.
 
Basis of Presentation
 
The accompanying consolidated financial statements reflect all the accounts of Embarq and its wholly owned subsidiaries. All intercompany transactions have been eliminated.
 
The consolidated financial statements were prepared using accounting principles generally accepted in the United States. These principles require management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Actual results could differ from those estimates.
 
Certain prior year amounts have been reclassified to conform to the current year presentation. These reclassifications had no effect on the results of operations or stockholders’ equity as previously reported.
 
Change in Reported Business Segments
 
As a result of the sale of Embarq Logistics, Embarq’s continuing operations are now comprised solely of its telecommunications business. Accordingly, information about this business is now represented by Embarq’s consolidated financial position and results from continuing operations.
 
Universal Service Fund
 
Embarq records federal and state Universal Service Fund (USF) surcharges on a gross basis. The total amount of surcharges recorded in net operating revenue was as follows:
 
   
Year to Date March 31,
 
   
2009
   
2008
 
   
(millions)
 
Federal and state USF surcharges
  $ 18     $ 21  
 
 
Depreciation Rate Adjustments
 
On an annual basis, Embarq performs an analysis of the remaining life depreciation rates. Depreciation rates were adjusted principally for packet switching equipment in 2009 and for digital switching equipment, digital loop carrier equipment and high-speed Internet equipment in 2008, which resulted in depreciation expense being reduced by the following:
 
 
Year to Date March 31,
 
 
2009
 
2008
 
Depreciation expense reduction (millions)
  $ 7     $ 12  
Basic and diluted earning per common share increase
    0.03       0.05  
 
 
Adoption of New Accounting Pronouncements
 
Financial Accounting Standards Board Staff Position (FSP) Emerging Issues Task Force (EITF), 03-6-1, Determining Whether Instruments Granted in Share-based Payment Transactions are Participating Securities - On January 1, 2009, Embarq adopted this standard, which concluded that unvested share-based payment awards that contain a nonforfeitable right to receive dividends, whether paid or unpaid, are participating securities and should be included in the computation of basic earnings per share. As required by this statement, prior period earnings per share and weighted average common shares outstanding were adjusted to conform to the provisions of this standard.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
F-7
The impact to basic and diluted earnings per share and weighted average common shares outstanding was as follows:
 
   
Year to Date Period Ended March 31, 2008
 
   
As Adjusted
   
Previously Reported
   
Difference
 
Total Earnings per Common Share
                 
Basic
  $ 1.38     $ 1.39     $ (0.01 )
Diluted
    1.37       1.38       (0.01 )
                         
Weighted Average Common Shares Outstanding
                       
Basic (millions)
    153.8       152.7       1.1  
Diluted (millions)
    154.3       154.1       0.2  
 
 
FSP SFAS No. 132(R)-1, Employers Disclosures about Postretirement Benefit Plan Assets - On January 1, 2009, Embarq adopted this standard, which expands the disclosures required by SFAS No. 132(R), Employers’ Disclosures about Pensions and Other Postretirement Benefits, to discuss the assumptions and risks used to compute fair value of each category of plan assets. As Embarq uses a year end measurement date to value plan assets, all disclosures required by this standard will initially be adopted as of December 31, 2009.
 
SFAS No. 141(R), Business Combinations - On January 1, 2009, Embarq adopted this standard, which maintains the fundamental guidance provided under SFAS No. 141, Business Combinations, but requires the acquirer to recognize all acquired assets and liabilities, including goodwill, at fair value at the acquisition date as opposed to the announcement date. In addition, the standard requires most transaction related costs to be expensed as incurred as well as provides expanded disclosure requirements for such transactions in the financial statements. Prior to completion of the pending merger with CenturyTel, Embarq does not expect the adoption of this standard to have a material impact on its financial position, results of operations or liquidity.
 
FSP SFAS No. 157-2, Effective Date of FASB Statement No. 157 - Embarq elected to defer until January 1, 2009, the adoption of SFAS No. 157 for all nonfinancial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. This includes goodwill and nonfinancial long-lived assets that are measured at fair value in impairment testing and asset retirement obligations initially measured at fair value. The adoption of SFAS No. 157 for those nonfinancial assets and liabilities within the scope of FSP SFAS No. 157-2 did not have a material impact on Embarq’s financial position, results of operations or liquidity.
 
Recently Issued Accounting Pronouncements
 
FSP SFAS No. 107-1 and Accounting Principles Board (APB) 28-1, Interim Disclosures about Fair Value of Financial Instruments - This standard amends SFAS No. 107, Disclosures about Fair Value of Financial Instruments, and APB Opinion No. 28, Interim Financial Reporting, to require disclosures about the fair value of financial instruments for interim periods as well as in annual financial statements. Although Embarq has historically provided most of these disclosures in its interim financial statements, this standard will be formally adopted for periods ending after June 15, 2009.
 
FSP SFAS No. 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly - This standard clarifies the application of SFAS No. 157, Fair Value Measurements, when the volume and activity of the asset and liability has significantly decreased and reemphasizes that fair value is the price that would be received to sell an asset or pay a liability in an orderly transaction between market participants at the measurement date. In addition, it requires additional disclosures noting the inputs and valuation techniques used for all assets and liabilities measured at fair value and the major security types for any debt or equity securities. Embarq will adopt this standard for periods ending after June 15, 2009. Embarq does not expect the adoption of this standard will have a material impact on its financial position, results of operations or liquidity.
 
Note 2. Discontinued Operations
 
On March 12, 2009, Embarq completed the sale of its wholly owned subsidiary, Embarq Logistics, Inc., in exchange for an initial cash payment and future contingent consideration. As a result of the sale, the financial results of Embarq Logistics’ third party wholesale distribution operations, which previously comprised the Logistics business segment, are now reported and disclosed as discontinued operations for all periods presented.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
F-8
The results of operations reclassified to discontinued operations were as follows:
 
   
Year to Date March 31,
 
   
2009
   
2008
 
   
(millions)
 
Net operating revenues
  $ 58     $ 115  
Operating expenses
    62       117  
Loss before income taxes
    (4 )     (2 )
Income tax benefit
    2       -  
Loss from discontinued operations
  $ (2 )   $ (2 )
 
For the year to date period ended March 31, 2009, the loss on the sale of discontinued operations, including severance and benefit plan curtailments associated with the sale, was $24 million net of an income tax benefit of $12 million.
 
Note 3. Commitments and Contingencies
 
Litigation, Claims and Assessments
 
Seven former manufactured gas plant sites have been identified that may have been owned or operated by entities acquired by Embarq’s subsidiary, Centel Corporation (Centel), before that company was acquired by Sprint Nextel. These sites are not currently owned or operated by either Sprint Nextel or Embarq. On three sites, Embarq and the current landowners are working with the Environmental Protection Agency (EPA) pursuant to administrative consent orders. Expenditures pursuant to the orders are not expected to be material. On five sites, including the three sites where the EPA is involved, Centel has entered into agreements with other potentially responsible parties to share costs. Further, Sprint Nextel has agreed to indemnify Embarq for most of any eventual liability arising from all seven of these sites.
 
In early December 2008, an individual shareholder filed suit in Johnson County Kansas District Court against Embarq, each of its directors and CenturyTel, challenging the pending merger with CenturyTel and alleging that the defendants failed to maximize shareholder value, made misleading proxy statements and obtained personal benefits in the form of positions with the combined company. To avoid the expense and uncertainty of litigation, a settlement in principle has been reached between plaintiff and defendants where additional disclosures regarding the transaction were made in a public filing and a limited amount of legal costs will be reimbursed. A definitive settlement agreement will be executed following confirmatory discovery, and the final settlement must be approved by the court.
 
            In December 2007, a group of retirees filed a putative class action lawsuit in the United States District Court for the District of Kansas, challenging the decision to make certain modifications to Embarq’s retiree benefits programs generally effective January 1, 2008. Defendants include Embarq Corporation, certain of its benefit plans, its Employee Benefits Committee and its plan administrator. Additional defendants include Sprint Nextel and certain of its benefit plans. In addition, a complaint in arbitration has been filed by 15 former Centel executives, similarly challenging the benefits changes. Embarq and other defendants intend to vigorously contest these claims and charges.
 
In addition, Embarq is subject to various other lawsuits, regulatory proceedings against Embarq and other claims typical for a business enterprise. While it is not possible to determine the ultimate disposition of each of these proceedings and whether they will be resolved consistent with Embarq’s expectations, Embarq expects that the outcome of these proceedings, individually or in the aggregate, will not have a material adverse effect on its financial condition, results of operations or liquidity.
 
Note 4. Debt and Financial Instruments
 
During the year to date period ended March 31, 2009, Embarq repaid the $375 million balance outstanding under its revolving credit facility. Additionally, Embarq repaid $80 million of borrowings outstanding under its term credit facility. See Note 10, Subsequent Events, for additional information.
 
As of March 31, 2009, Embarq’s long-term debt had a carrying value of approximately $5.3 billion and a fair value of approximately $4.7 billion. This fair value was computed primarily based on quoted market prices.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
F-9
Note 5. Income Taxes
 
The differences that caused Embarq’s effective income tax rates to vary from the 35% federal statutory rate for income taxes related to continuing operations were as follows:
 
   
Year to Date March 31,
 
   
2009
   
2008
 
   
(millions)
 
Income tax expense at the federal statutory rate
  $ 110     $ 116  
Effect of:
               
State income taxes, net of federal income tax effect
    6       2  
Other, net
    (1 )     1  
Income tax expense
  $ 115     $ 119  
Effective income tax rate
    36.5 %     35.7 %
 
During the year to date period ended March 31, 2009, Embarq received consent from the Internal Revenue Service to modify its accounting method for income tax purposes related to repairs and maintenance expenditures. This change, which became effective on January 1, 2008, will allow certain costs to be deducted immediately rather than capitalized and depreciated. As a result, approximately $100 million of income tax liabilities were reclassified from other current liabilities to deferred income taxes in the Consolidated Balance Sheets.
 
Note 6. Employee Benefit Plans
 
The components of net periodic benefit cost were as follows:
 
   
Year to Date March 31, 2009
   
Year to Date March 31, 2008
 
   
Pension Benefits
   
Other Post-retirement Benefits
   
Pension Benefits
   
Other Post-
retirement Benefits
 
   
(millions)
 
Service cost
  $ 12     $ 2     $ 14     $ 2  
Interest cost
    53       4       51       4  
Expected return on plan assets
    (67 )     -       (69 )     (1 )
Amortization of prior service cost (benefit)
    3       (14 )     3       (13 )
Amortization of actuarial losses
    14       3       9       3  
Contractual retirement benefits
    1       -       -       -  
    Net cost (benefit)
  $ 16     $ (5 )   $ 8     $ (5 )
 
 
For the year to date period ended March 31, 2009, the assets in the plan’s trust declined due to negative market conditions by an additional $157 million, as compared to December 31, 2008. This decline has not been recognized in the consolidated balance sheet as of March 31, 2009, pursuant to the provisions of SFAS No. 87, Employers’ Accounting for Pensions. Embarq made no contributions to the plan’s trust during the year to date period ended March 31, 2009. See Note 10, Subsequent Events, for additional information.
 
Note 7. Stock-based Compensation
 
On February 18, 2009, approximately 0.1 million restricted stock units were granted to executive officers and other executive level employees as a result of performance and market adjustments to unvested awards granted under the 2007 long-term incentive program. These restricted stock units vested on February 22, 2009.
 
On February 27, 2009, approximately 0.3 million restricted stock units were granted to certain non-executive employees as part of Embarq’s 2008 short-term incentive program. These awards are scheduled to vest in full on December 1, 2009. In addition, approximately 0.7 million restricted stock units were granted to executive officers and other executive level employees as part of Embarq’s 2009 long-term incentive program. These awards will vest 34% on February 27, 2010, and 33% will vest on February 27, 2011 and 2012. The fair value of each of these awards was $34.97 per restricted stock unit.
 
Total compensation expense related to all of the awards noted above was $33 million, which is expected to be recognized over a weighted average vesting period of 1.6 years. Compensation expense for these awards, as well as remaining unvested awards related to previous grants, will be recognized over a shorter period in the event of a change in control related to the pending merger with CenturyTel.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
F-10
 
Note 8. Business Segment Information
 
Embarq provides a suite of integrated communications services to consumer and business customers primarily in local service territories in 18 states. Embarq also provides wholesale access to its local network and other communications services primarily to wireline and wireless service providers. As a result of the sale of Embarq Logistics in March 2009, Embarq’s continuing operations are now comprised solely of its telecommunications business.
 
Embarq’s net operating revenues for its services and products were as follows:
 
   
Year to Date March 31,
 
   
2009
   
2008
 
   
(millions)
 
Voice
  $ 916     $ 1,024  
Data
    203       198  
High-speed Internet
    143       133  
Other
    84       101  
      Total net operating revenues
  $ 1,346     $ 1,456  
 
Voice revenues are principally derived from local and long distance services, switched access charges and USF receipts. Data revenues are principally derived from various data protocol and special access services. Other revenues include professional services, intelligent network database services, billing and collection services, sales agency commissions and sales of customer premise equipment.
 
Note 9. Supplemental Cash Flow Information and Non-Cash Activities
 
Embarq’s supplemental cash flow information and non-cash activities were as follows:
 
   
Year to Date March 31,
 
   
2009
   
2008
 
   
(millions)
 
Supplemental Cash Flow Information
           
    Cash paid for interest, net of amounts capitalized
  $ 16     $ 25  
    Cash paid (refunded) for income taxes
    (7 )     4  
Non-Cash Activities
               
    Capital expenditure accrual
  $ (8 )   $ (14 )
    Pending settlement of repurchases of common stock
    -       20  
 
Note 10. Subsequent Events Through May 7, 2009
 
Pension Trust Contribution
 
During April 2009, Embarq made a discretionary contribution of $15 million to its pension plan’s trust. Embarq continues to expect total contributions in 2009 to approximate $150 million.
 
Term Loan Repayment
 
In April 2009, Embarq repaid in full the remaining $280 million balance under its term credit facility, which satisfies the repayment requirement under the January 23, 2009, credit agreement amendment related to the pending merger with CenturyTel.
 
Dividend Declaration
 
On May 6, 2009, Embarq announced that its board of directors declared a dividend of $0.6875 per share payable June 30, 2009 to stockholders of record on June 16, 2009. Payment of this dividend will only occur if the pending merger with CenturyTel has not been consummated by the June 16, 2009 record date.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
F-11
Report of Independent Registered Public Accounting Firm

 
The Board of Directors and Stockholders
Embarq Corporation:
 
We have audited the accompanying consolidated balance sheets of Embarq Corporation and subsidiaries (the Company) as of December 31, 2008 and 2007, and the related consolidated statements of operations and comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2008. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
 
We conducted our audits in accordance the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Embarq Corporation and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.
 
As discussed in Note 1A to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 157, Fair Value Measurements, for its financial assets and liabilities as of January 1, 2008. Also, as discussed in Notes 1A and 5 to the consolidated financial statements, the Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes- an interpretation of FASB Statement No. 109, as of January 1, 2007. Lastly, as discussed in Note 6 to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R), as of December 31, 2006.
 
 
/s/ KPMG LLP 
 
Kansas City, Missouri
 
February 12, 2009, except for
  Note 1B, as to which the date
  is June 17, 2009                                                                           
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
F-12
EMBARQ CORPORATION
CONSOLIDATED BALANCE SHEETS   
(millions, except per share data)  
 
As of December 31,
 
   
2008
   
2007
 
Assets
           
Current assets
           
Cash and equivalents
  $ 107     $ 69  
Accounts receivable, net of allowance for doubtful accounts of $54 and $58
    494       582  
Materials and supplies
    52       73  
Deferred tax assets
    89       76  
Prepaid expenses and other current assets
    81       84  
Current assets of discontinued operations
    67       102  
Total current assets
    890       986  
Gross property, plant and equipment
    20,946       20,667  
Accumulated depreciation
    (13,547 )     (12,933 )
Net property, plant and equipment
    7,399       7,734  
Goodwill
    27       27  
Prepaid pension asset
    -       108  
Other assets
    43       31  
Noncurrent assets of discontinued operations
    12       15  
Total
  $ 8,371     $ 8,901  
                 
Liabilities and Stockholders’ Equity
               
Current liabilities
               
Current maturities of long-term debt
  $ 2     $ 99  
Accounts payable
    279       343  
Payroll and employee benefits
    219       274  
Accrued income taxes
    -       27  
Accrued operating taxes
    78       97  
Deferred revenue
    184       202  
Accrued interest
    58       56  
Other current liabilities
    42       46  
Current liabilities of discontinued operations
    34       54  
Total current liabilities
    896       1,198  
Noncurrent liabilities
               
Long-term debt
    5,743       5,779  
Deferred income taxes
    793       1,130  
Benefit plan obligations
    1,341       320  
Other noncurrent liabilities
    206       210  
Total noncurrent liabilities
    8,083       7,439  
                 
Stockholders’ equity
               
Preferred stock, $.01 par value; 200 shares authorized; no shares issued and outstanding
    -       -  
Common stock, $.01 par value; 1,250 shares authorized; 154.2 and 153.1 shares issued; 142.4 and 153.1 shares outstanding
    2       2  
Paid-in capital
    (193 )     (231 )
Retained earnings
    986       623  
Accumulated other comprehensive income (loss)
    (903 )     (130 )
Treasury stock, 11.8 and no shares held in treasury
    (500 )     -  
Total stockholders’ equity
    (608 )     264  
Total
  $ 8,371     $ 8,901  
 
See accompanying Notes to Consolidated Financial Statements.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
F-13

 
EMBARQ CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(millions, except per share data)
       
   
For the Years Ended December 31,
 
   
2008
   
2007
   
2006
 
Net Operating Revenues
  $ 5,689     $ 5,899     $ 5,833  
                         
Operating Expenses
                       
     Cost of services and products
    1,656       1,778       1,709  
     Selling, general and administrative
    1,394       1,567       1,548  
     Depreciation
    1,000       1,048       1,016  
          Total operating expenses
    4,050       4,393       4,273  
Operating Income
    1,639       1,506       1,560  
  Interest expense
    (404 )     (432 )     (324 )
  Other income (expense), net
    3       2       15  
Income From Continuing Operations Before Income Taxes
    1,238       1,076       1,251  
  Income tax expense
    (464 )     (391 )     (456 )
Income From Continuing Operations
    774       685       795  
  Loss from discontinued operations (net of income taxes)
    (5 )     (2 )     (11 )
Net Income
  $ 769     $ 683     $ 784  
      Remeasurements of and amendments to employee benefit plans (net of income taxes)
    (773 )     232       -  
          Amortization of employee benefit plans prior service cost and actuarial losses (net of income taxes)
    3       5       -  
          Unrealized holding gains on cash flow derivatives (net of income taxes)
    -       -       39  
          Amortization of cash flow derivatives (net of income taxes)
    (3 )     (4 )     (1 )
Comprehensive Income (Loss), Net of Income Taxes
  $ (4 )   $ 916     $ 822  
                         
Basic Earnings per Common Share
                 
(Pro forma)
 
     Continuing operations
  $ 5.30     $ 4.51     $ 5.33  
     Discontinued operations
    (0.03 )     (0.01 )     (0.07 )
     Total
  $ 5.27     $ 4.50     $ 5.26  
                         
Diluted Earnings per Common Share
                       
     Continuing operations
  $ 5.25     $ 4.45     $ 5.28  
     Discontinued operations
    (0.03 )     (0.01 )     (0.07 )
     Total
  $ 5.22     $ 4.44     $ 5.21  
                         
Weighted Average Common Shares Outstanding
                       
     Basic
    146.0       151.9       149.2  
     Potentially dilutive shares under equity incentive plans
    1.4       2.0       1.2  
     Diluted
    147.4       153.9       150.4  
 
See accompanying Notes to Consolidated Financial Statements.
 
 
 
 
 
 
 
 
 
 
 
 
 
F-14
 
EMBARQ CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(millions)  
   
For the Years Ended December 31,
 
   
2008
   
2007
   
2006
 
Operating Activities
                 
Net income
  $ 769     $ 683     $ 784  
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Loss from discontinued operations
    5       2       11  
Depreciation
    1,000       1,048       1,016  
Provision for losses on accounts receivable
    101       95       54  
Deferred and noncurrent income taxes
    103       (50 )     (64 )
Stock-based compensation expense
    47       50       31  
Net losses (gains) on sales of assets
    (9 )     (7 )     (17 )
Other, net
    53       45       39  
Changes in assets and liabilities:
                       
Accounts receivable
    (13 )     (94 )     (57 )
Materials, supplies and other current assets
    (24 )     (31 )     33  
Accounts payable and other current liabilities
    (168 )     (86 )     241  
Noncurrent assets and liabilities, net
    (129 )     (78 )     (26 )
Net cash provided by operating activities – continuing operations
    1,735       1,577       2,045  
Discontinued operations
    13       47       8  
Net cash provided by operating activities
    1,748       1,624       2,053  
                         
Investing Activities
                       
Capital expenditures
    (686 )     (829 )     (923 )
Proceeds from construction reimbursements
    11       10       10  
Proceeds from sales of assets
    11       25       33  
Net cash used by investing activities
    (664 )     (794 )     (880 )
                         
Financing Activities
                       
Issuance of long-term debt
    -       -       1,600  
Principal payments on long-term debt
    (99 )     (787 )     (492 )
Borrowings under revolving credit agreement
    1,150       1,430       920  
Repayments under revolving credit agreement
    (1,185 )     (1,220 )     (720 )
Net cash paid to Sprint Nextel associated with the spin-off
    -       -       (2,208 )
Proceeds from common stock issued
    14       116       20  
Repurchase of common stock
    (500 )     (2 )     -  
Dividends paid to stockholders
    (404 )     (367 )     (150 )
Dividends paid to Sprint Nextel
    -       -       (194 )
Tax effects of stock-based compensation
    (1 )     25       2  
Other, net
    (21 )     (9 )     (1 )
Net cash used by financing activities
    (1,046 )     (814 )     (1,223 )
Increase (Decrease) in Cash and Equivalents
    38       16       (50 )
Cash and Equivalents at Beginning of Period
    69       53       103  
Cash and Equivalents at End of Period
  $ 107     $ 69     $ 53  
 
See accompanying Notes to Consolidated Financial Statements.
 
 
 
 
 
 
 
 
 
 
 
 
F-15

 
EMBARQ CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(millions, except per share data)
 
Preferred
Stock
Common
Stock
Paid-in
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss)
Business
Equity
Treasury
Stock
Total
Stockholders’
Equity
January 1, 2006 balance
             -
             -
               -
               -
    (525)
       5,377
             -
      4,852
Net income
             -
             -
               -
               -
               -
          326
             -
         326
Dividends paid to Sprint Nextel
             -
             -
               -
               -
               -
        (194)
             -
        (194)
Cash flow derivatives, net of tax
             -
             -
               -
               -
              39
               -
             -
           39
Net transfer to Sprint Nextel
             -
             1
         (467)
               -
          516
     (5,509)
-
     (5,459)
May 17, 2006 balance
            -
            1
         (467)
               -
              30
               -
-
        (436)
Net income
             -
             -
               -
          458
               -
               -
             -
         458
Dividends paid to shareholders ($1.00 per share)
             -
             -
               -
        (150)
               -
               -
             -
        (150)
Common stock issued
             -
             -
            20
              -
               -
               -
             -
           20
Stock-based compensation expense
             -
             -
            31
               -
               -
               -
             -
           31
Tax effect of stock-based compensation
-
-
            2
-
-
-
-
            2
Amortization of cash flow derivative (net of tax)
             -
             -
               -
               -
             (1)
               -
             -
            (1)
Adoption of SFAS No. 158 (net of tax)
-
-
-
-
(392)
-
-
(392)
December 31, 2006 balance
        -
        1
 (414)
308
 (363)
             -
           -
 (468)
Cumulative effect of adoption of FIN 48 (net of tax)
-
-
-
1
-
-
-
1
January 1, 2007 Balance
-
1
(414)
309
(363)
-
-
(467)
Net income
-
-
-
683
-
-
-
683
Dividends to shareholders ($2.375 per share)
-
-
-
(369)
-
-
-
(369)
Common stock issued
-
1
115
-
-
-
-
116
Stock-based compensation expense
-
-
50
-
-
-
-
50
Tax effect of stock-based compensation
-
-
25
-
-
-
-
25
Restricted stock units surrendered for tax withholding
-
-
(10)
-
-
-
-
(10)
Remeasurements of and amendments to employee benefit
  plans (net of tax)
-
-
-
-
232
-
-
232
Amortization (net of tax) of:
               
     Employee benefit plans prior service cost and actuarial losses
-
-
-
-
5
-
-
5
     Cash flow derivative
-
-
-
-
(4)
-
-
(4)
Repurchase of common stock
-
-
-
-
-
-
(2)
(2)
Issuance of treasury stock
-
-
-
-
-
-
2
2
Other
-
-
3
-
-
-
-
3
December 31, 2007 Balance
 $        -
 $        2
 $      (231)
 $       623
 $       (130)
$            -
$            -
 $       264
Net income
-
-
-
769
-
-
-
769
Dividends to shareholders ($2.75 per share)
-
-
-
(406)
-
-
-
(406)
Common stock issued
-
-
14
-
-
-
-
14
Stock-based compensation expense
-
-
47
-
-
-
-
47
Tax effect of stock-based compensation
-
-
(1)
-
-
-
-
(1)
Restricted stock units surrendered for tax withholding
-
-
(22)
-
-
-
-
(22)
Remeasurement of employee benefit plans (net of tax)
-
-
-
-
(773)
-
-
(773)
Amortization (net of tax) of:
               
     Employee benefit plans prior service cost and actuarial losses
-
-
-
-
3
-
-
3
     Cash flow derivative
-
-
-
-
(3)
-
-
(3)
Repurchase of common stock
-
-
-
-
-
-
(500)
(500)
December 31, 2008 Balance
$       -
$       2
$    (193)
$      986
$       (903)
$           -
$     (500)
$      (608)
                 
Shares Outstanding
         
2008
2007
2006
Beginning shares outstanding
         
153.1
149.7
149.1
Stock issued under equity incentive plans
         
1.1
3.4
0.6
Repurchase of common stock
         
(11.8)
-
-
Ending shares outstanding
         
142.4
153.1
149.7
 
 
 
See accompanying Notes to Consolidated Financial Statements.
 
 
 
 
 
F-16
EMBARQ CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Note 1A. Background, Basis of Presentation and Significant Accounting Policies
 
Background
 
Embarq was incorporated in 2005 under the laws of Delaware and was formerly a wholly owned subsidiary of Sprint Nextel Corporation (Sprint Nextel). On May 17, 2006, Sprint Nextel spun-off its local communications business and product distribution operations, thereby establishing Embarq as a separate, stand-alone company.
 
Embarq provides a suite of integrated communications services including local and long distance voice, data, high-speed Internet, satellite video, professional services and communications equipment to consumer and business customers primarily in local service territories in 18 states. Embarq also provides wholesale access to its local network and other communications services primarily to wireline and wireless service providers.
 
As of December 31, 2008, Embarq had approximately 16 thousand active employees. Approximately 34% of these employees were represented by unions subject to collective bargaining agreements. Of the union-represented employees, approximately 27% have collective bargaining agreements that will expire during 2009. There were no material changes related to any employee collective bargaining agreements during 2008.
 
Pending Merger with CenturyTel
 
On October 26, 2008, Embarq and CenturyTel, a Louisiana corporation, entered into a merger agreement whereby a wholly owned subsidiary of CenturyTel, will merge with and into Embarq.  As a result of the merger, Embarq will continue as a wholly owned subsidiary of CenturyTel.  Pursuant to the merger agreement, at the effective date of the merger, each share of Embarq’s common stock, par value $0.01 per share, will be converted into the right to receive 1.37 shares of CenturyTel common stock, par value $1.00 per share, plus cash in lieu of fractional shares.  It is expected that the merger will qualify as a tax-free reorganization for U.S. Federal income tax purposes. In conjunction with this transaction, Embarq may incur additional costs prior to closing including, but not limited to potential impairments of duplicate systems and technology; employee retention and severance costs; and other merger and integration costs.
 
Basis of Presentation
 
The accompanying consolidated financial statements reflect all the accounts of Embarq and its wholly owned subsidiaries. All intercompany transactions have been eliminated.
 
On March 12, 2009, Embarq completed the sale of its wholly owned subsidiary, Embarq Logistics, Inc.  Consequently, the financial results of Embarq Logistics’ third party wholesale distribution operations, which previously comprised the Logistics business segment, are now reported as discontinued operations for all periods presented pursuant to Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for Impairment or Disposal of Long Lived Assets. See Note 1B, Discontinued Operations, for additional information.
 
The consolidated financial statements were prepared using accounting principles generally accepted in the United States. These principles require management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Actual results could differ from those estimates.
 
Certain prior year amounts have been reclassified to conform to the current year presentation. These reclassifications had no effect on the results of operations or stockholders’ equity as previously reported.
 
Significant Accounting Policies
 
Cash and Equivalents
 
Cash and equivalents include cash and highly liquid investments with original maturities of three months or less.
 
Revenue Recognition
 
Embarq recognizes revenue in accordance with SAB No. 104, Revenue Recognition. Embarq collects fees for fixed rate services, such as local, unlimited long distance, high-speed Internet and certain data services, in advance and defers revenue recognition until these services are provided to the customer. Variable rate billing services, including minute driven long distance, data and access revenue, are billed in arrears. Embarq has multiple billing cycles spread throughout each month resulting in trade accounts receivables and deferred revenue balances at the end of each reporting period. In the event that the variable rate usage data is not available at the end of a reporting period, Embarq will estimate revenue based on historic and other relevant factors.
 
 
 
 
 
 
 
 
 
 
 
 
 
F-17
Revenue for bundled services is allocated to an individual unit of accounting based on the relative fair value of each individual service when it is regularly sold on a stand-alone basis as prescribed by Emerging Issues Task Force (EITF) Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. Cash incentives given to customers are recognized as reductions to revenue ratably over the average life of the customer in accordance with EITF 01-9, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products) and other applicable guidance. Service activation and installation fees are deferred and amortized on a straight-line basis over the average life of the customer.
 
Embarq records revenue from services offered through various wholesale, sales agency and other professional service arrangements on either a gross or net basis in accordance with EITF Issue No. 99-19, Reporting Revenue Gross as a Principal versus net as an Agent.
 
Embarq records federal and state USF surcharges on a gross basis. The total amount of surcharges recorded in net operating revenue was as follows:
 
   
For the Years Ended December 31,
 
   
2008
   
2007
   
2006
 
   
(millions)
 
Federal and state USF surcharges
  $ 86     $ 92     $ 98  
 
Net operating revenues include certain revenue reserves for billing disputes and errors and returns on product sales. These reserves require management’s judgment and are based on many factors including historical trending, contract and tariff interpretations and developments during the resolution process.
 
Allowance for Doubtful Accounts
 
Allowance for doubtful accounts represents the estimate of accounts receivable that are deemed to be uncollectible. This allowance typically reflects Embarq’s best estimates based on historic credit losses and aged account receivable balances at the end of the reporting period. These estimates are subject to management’s judgment based on payment terms, industry norms and recognition of current economic indicators and may be increased to include the entire accounts receivable balance when specific collection risk exists.
 
Property, Plant and Equipment
 
Embarq records property, plant and equipment at historical cost. Repair and maintenance costs are expensed as incurred. Embarq capitalizes software in accordance with American Institute of Certified Public Accountants Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, and EITF Issue No. 97-13, Accounting for Costs Incurred in Connection with a Consulting Contract or an Internal Project that Combines Business Process Reengineering and Information Technology Transformation.
 
Embarq categorizes its property, plant and equipment into three main categories: network assets; buildings and improvements; and administrative and other. Network assets principally consist of metallic cable and wire facilities, fiber optic cable facilities, switching equipment, conduit, poles and other central office equipment. Buildings and improvements principally consist of owned general office facilities and leasehold improvements. Administrative and other assets principally consist of land, furniture, information technology equipment and vehicles.
 
The costs of homogeneous units of property, plant and equipment are aggregated to form groups of assets that are depreciated on a straight-line basis over the estimated remaining useful life established for each specific group. Estimates and assumptions used in establishing the depreciation rates associated with each group are based on internal studies of use, industry data on lives, recognition of technological advancements and understanding of business strategy. Assumptions are evaluated annually. Generally, changes in depreciation rates are effected through changes in the remaining depreciable lives of the applicable group assets and are considered an accounting estimate in accordance with SFAS No. 154, Accounting Changes and Error Corrections.
 
Ordinary asset retirements are generally charged against accumulated depreciation with no gain or loss recognized. Ordinary asset retirements totaled $382 million in 2008 and $493 million in 2007. Embarq recognizes gains and losses on unusual or unanticipated asset dispositions. See Note 10, Sale of Properties, for additional information.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
F-18
Embarq’s gross property, plant and equipment and associated range of estimated remaining useful lives by category were as follows: 
 
     
As of December 31,
 
 
Range of Estimated Remaining Useful Lives
 
2008
   
2007
 
 
(years)
 
(millions)
 
               
Network assets
3 to 35
  $ 19,351     $ 18,900  
Buildings and improvements
5 to 30
    1,031       1,031  
Administrative and other assets
3 to 15
    564       736  
Gross property, plant and equipment
    $ 20,946     $ 20,667  
 
Embarq evaluates property, plant and equipment for impairment whenever indicators of impairment exist. Accounting standards require that if an impairment indicator is present, Embarq must assess whether the carrying amount of the asset is recoverable by estimating the sum of the future undiscounted cash flows, excluding interest costs, expected to result from the asset. If the carrying amount is more than the recoverable amount, an impairment charge must be recognized based on the fair value of the asset. No such impairments occurred during 2008, 2007 or 2006.
 
On an annual basis, Embarq performs an analysis of the remaining life depreciation rates. Depreciation rates for various digital switching equipment, digital loop carrier equipment and high-speed Internet equipment were adjusted in each year, which resulted in depreciation expense being reduced by the following: 
 
   
For the Years Ended December 31,
 
   
2008
   
2007
   
2006(1)
 
Depreciation expense reduction (millions)
  $ 50     $ 48     $ 27  
Basic and diluted earnings per share
    0.21       0.20       0.11  
(1)  Pro forma earnings per share information. See Note 1A, Earnings per Common Share, for additional information.
 
Goodwill
 
Embarq accounts for goodwill in accordance with SFAS No. 142, Goodwill and Other Intangible Assets. Goodwill represents the excess of the purchase price over the fair value of the net assets acquired in business combinations accounted for as purchases. The book value of goodwill was $27 million at December 31, 2008 and 2007 with $12 million related to United Telephone Southeast LLC and $11 million related to acquisitions completed by Centel, both subsidiaries of Embarq. The remaining $4 million was related to various other Embarq businesses.
 
Embarq evaluates goodwill for impairment on an annual basis and whenever events or circumstances indicate goodwill may be impaired. Embarq determines impairment by comparing net assets of the reporting unit to its respective fair value. In the event the unit’s net assets exceed its fair value, an implied fair value of goodwill must be determined by assigning the unit’s fair value to each asset and liability of the unit. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. An impairment loss is measured by the difference between the goodwill carrying value and the implied fair value. No such impairments occurred during 2008, 2007 or 2006.
 
Derivatives
 
Embarq recognizes derivative instruments as either assets or liabilities in the Consolidated Balance Sheets and measures those instruments at fair value in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities as Amended. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income (loss) depending on the use of the derivative and whether it qualifies for hedge accounting.
 
Embarq uses derivative instruments only for hedging and risk management purposes. Hedging activity may be done for the purpose of mitigating the risks associated with an asset, liability, committed transaction or probable forecasted transaction. Embarq is primarily exposed to the market risk associated with unfavorable movements in interest rates. Embarq does not enter into derivative transactions for speculative or trading purposes.
 
At inception and on an on-going basis, Embarq assesses whether each derivative that qualifies for hedge accounting continues to be highly effective in offsetting changes in the cash flows of the hedged item. If and when a derivative instrument is no longer expected to be highly effective, hedge accounting is discontinued. Hedge ineffectiveness, if any, is included in current period earnings.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
F-19
 
Treasury Stock
 
Shares of common stock repurchased by Embarq are reflected as treasury stock on the trade date and are carried at cost, including any direct third-party fees. Embarq uses the weighted average cost method for the issue of common stock from treasury. In the event shares are not retired and subsequently issued from treasury, paid-in capital will increase for any gains and paid-in capital, or retained earnings in the event of negative paid-in capital, will decrease for any losses.
 
Workforce Actions
 
Embarq provides severance benefits for involuntarily terminated employees. Such benefits are recorded in accordance with SFAS No. 112, Employers’ Accounting for Postemployment Benefits. Voluntary offers for separation or other contractual separation benefits are recorded in accordance with SFAS No. 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination. Other one-time benefit arrangements or exit costs that are part of an organized restructuring plan are recorded in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities.
 
In order to better align organizational resources with Embarq’s business needs as well as to improve its overall cost structure, Embarq has taken various steps, including both voluntary and involuntary reductions in its workforce. Related to these reductions, Embarq recognized the following charges (including $13 million of contractual early retirement benefits for the year ended December 31, 2008):
 
   
For the Years Ended December 31,
 
   
2008
   
2007
   
2006
 
   
(millions)
 
Cost of services and products
  $ 37     $ 37     $ 20  
Selling, general and administrative
    38       40       10  
Total severance expense
  $ 75     $ 77     $ 30  
 
Legal and Other Contingent Liabilities
 
Embarq accrues loss contingencies for legal, environmental and other contingent liabilities in accordance with SFAS No. 5, Accounting for Contingencies. See Note 3, Commitment and Contingencies, for additional information.
 
Leases
 
Embarq accounts for capital and operating leases in accordance with SFAS No. 13, Accounting for Leases. See Note 3, Commitments and Contingencies, for additional information.
 
Advertising
 
Embarq recognizes advertising expenses as incurred. This includes production, media and other promotional and sponsorship costs. Total advertising expense was as follows:
 
   
For the Years Ended December 31,
 
   
2008
   
2007
   
2006
 
   
(millions)
 
Advertising expense
  $ 91     $ 93     $ 102  
 
Income Taxes
 
Embarq accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. Before spin-off, Embarq’s operations were included in the consolidated federal income tax return and certain combined or consolidated state income tax returns of Sprint Nextel. In accordance with Sprint Nextel’s tax sharing arrangement, income tax expense was recorded and charged to Embarq on the basis of filing separate returns in each taxing jurisdiction. After spin-off, Embarq was subject to income taxes as a stand alone entity.
 
As of January 1, 2007, Embarq adopted FIN 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109. This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. As prescribed by the interpretation, the cumulative effect of applying these provisions was reported as an adjustment to the opening balance of retained earnings.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
F-20
Embarq records interest associated with these liabilities as interest expense. Associated penalties are recorded as income tax expense. The total amount of interest and penalties recognized were as follows:
 
   
Interest
   
Penalties
 
   
2008
   
2007
   
2008
   
2007
 
   
(millions)
 
Recognized in the Consolidated Balance Sheet
  $ 9     $ 4     $ -     $ 2  
 Recognized in the Consolidated Statement of Operations and Comprehensive Income (Loss)
    5       3       (2 )     2  
 
Asset Retirement Obligations
 
Embarq recognizes Asset Retirement Obligations, or ARO, in accordance with SFAS No. 143, Accounting for Asset Retirement Obligations and FIN 47, Accounting for Conditional Asset Retirement Obligations.
 
Embarq has recognized an ARO related to the removal and disposal of the asbestos in company buildings, removal and environmental cleanup of fuel storage tanks used in standby power supply systems and decommissioning of leased building spaces. The fair value of the assets legally restricted to settle the ARO and the corresponding liability was as follows:
 
   
As of December 31,
 
   
2008
   
2007
 
   
(millions)
 
  ARO assets
  $ 4     $ 4  
  ARO liability
    34       32  
 
In addition, an ARO liability exists, but was not recognized, in situations where Embarq has been granted easements and rights-of-way by the United States government, municipalities and private landowners to route its cable facilities. Most cable facilities are buried, however, some metallic and fiber cable are above-ground on company-owned poles. In addition, Embarq contracts with other utilities to connect cable and wire to their poles. As of December 31, 2008, an estimated settlement date for these obligations was indeterminate.
 
Stock-based Compensation
 
Effective January 1, 2006, Sprint Nextel adopted SFAS No. 123R, Share-Based Payment, utilizing the modified prospective method. The revised standard requires the recognition of compensation cost of unvested share-based awards granted to employees before January 1, 2003, which were outstanding as of January 1, 2006. The allocated impact of the adoption of this standard was immaterial to Embarq because Sprint Nextel had previously accounted for share-based awards in accordance with SFAS No. 123,  Accounting for Stock Compensation , as amended by SFAS No. 148,  Accounting for Stock Compensation – Transition and Disclosure  as of January 1, 2003, using the prospective method. Following the spin-off, Embarq implemented the provisions of SFAS No. 123R related to the options, nonvested stock and nonvested stock units held by its employees. As SFAS No. 123R was adopted using the modified prospective method, no retrospective application of net income was required for awards granted prior to January 1, 2003, that were vested in prior years.
 
Embarq recognizes compensation expense related to share-based awards with graded vesting that only have a service condition on a straight line basis over the requisite service period for the entire award. See Note 7, Stock-Based Compensation, for additional information.
 
Earnings per Common Share
 
Embarq calculates basic and diluted earnings per share in accordance with SFAS No. 128, Earnings per Share. For purposes of calculating pro forma basic and diluted earnings per share for the year ended December 31, 2006, Embarq assumed that the total common shares issued at spin-off, as well as its related potential dilutive securities, were outstanding for the period from January 1, 2006, through May 17, 2006.
 
The dilution effect on Embarq’s common stock has been primarily related to outstanding stock options and restricted stock units. The following represents stock options that had an exercise price that was above the average annual market price of Embarq stock and were not included in the computation of diluted earnings per share:
 
   
As of December 31,
 
   
2008
   
2007
   
2006
 
   
(millions)
 
Stock options
    5.2       2.1       3.3  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
F-21
 
Adoption of SFAS No. 157
 
On January 1, 2008, Embarq adopted SFAS No. 157, Fair Value Measurements, for its financial assets and liabilities. Embarq’s adoption of SFAS No. 157 did not impact its financial position, results of operations, liquidity or disclosures. Embarq does not have financial assets or liabilities that are measured at fair value on a recurring basis. In accordance with Financial Accounting Standards Board Staff Position (FSP) SFAS No. 157-2, Effective Date of FASB Statement No. 157, Embarq elected to defer until January 1, 2009, the adoption of SFAS No. 157 for all nonfinancial assets and liabilities that are not recognized or disclosed at fair value in the financial statements on a recurring basis. This includes goodwill and nonfinancial long-lived assets that are measured at fair value in impairment testing and asset retirement obligations initially measured at fair value. The adoption of SFAS No. 157 for those nonfinancial assets and liabilities within the scope of FSP SFAS No. 157-2 is not expected to have a material impact on Embarq’s financial position, results of operations or liquidity.
 
Recently Issued Accounting Pronouncements
 
FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-based Payment Transactions are Participating Securities. This standard concluded that unvested share-based payment awards that contain a nonforfeitable right to receive dividends, whether paid or unpaid, are participating securities and should be included in the computation of earnings per share pursuant to the two-class method prescribed under SFAS No. 128, Earnings per Share. This standard is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. Embarq does not expect the adoption of this standard to have a material impact on basic or diluted earnings per share.
 
FSP SFAS No. 132(R)-1, Employers Disclosures about Postretirement Benefit Plan Assets - This standard expands the disclosures required by SFAS No. 132(R), Employers’ Disclosures about Pensions and Other Postretirement Benefits, to discuss the assumptions and risks used to compute fair value of each category of plan assets. Although early adoption is permitted, Embarq plans to adopt this standard when it becomes effective for fiscal years ending after December 15, 2009. Embarq does not expect the adoption of this standard to have a material impact to on the financial position, results of operations or liquidity.
 
SFAS No. 141(R), Business Combinations - This standard maintains the fundamental guidance provided under SFAS No. 141, Business Combinations, but requires the acquirer to recognize all acquired assets and liabilities, including goodwill, at fair value at the acquisition date as opposed to the announcement date. In addition, the standard requires all transition related costs to be expensed as incurred as well as provides expanded disclosure requirements for such transactions in the financial statements. This standard is effective for business combinations where the acquisition date is on or after the first annual reporting period beginning after December 15, 2008. Prior to completing the proposed merger with CenturyTel, Embarq does not expect the adoption of this standard to have a material impact on the financial position, results of operations or liquidity.
 
Note 1B.  Discontinued Operations
 
On March 12, 2009, Embarq completed the sale of its wholly owned subsidiary, Embarq Logistics, Inc., in exchange for an initial cash payment and future contingent consideration. Consequently, the financial results of Embarq Logistics’ third party wholesale distribution operations, which previously comprised the Logistics segment, are now reported and disclosed as discontinued operations for all periods presented.
 
A commercial services agreement was also completed whereby the buyer will provide certain logistics and supply chain services to Embarq’s telecommunications operations. While there are no minimum purchase obligations with this agreement, Embarq agreed to continue to purchase certain products and services exclusively from the buyer. Based on Embarq’s requirements in the 2008 fourth quarter, costs over the four-year term may approximate $450 million.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
F-22
 
The results of operations presented in discontinued operations were as follows:
 
   
For the Years Ended December 31,
 
   
2008
   
2007