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Basis of Presentation

9 Months Ended

Sep. 30, 2012

(1) Basis of Presentation

We are an integrated communications company engaged primarily in providing an array of communications services to our residential, business, governmental and wholesale customers. Our communications services include local and long-distance, network access, private line (including special access), public access, broadband, data, managed hosting (including cloud hosting), colocation, wireless and video services. In certain local and regional markets, we also provide local access and fiber transport services to competitive local exchange carriers and security monitoring services.

Our consolidated balance sheet as of December 31, 2011, which was derived from our audited consolidated 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 ("SEC"); however, in our opinion, the disclosures made are adequate to make the information presented not misleading. We believe that these consolidated financial statements include all normal recurring adjustments necessary to fairly present the results for the interim periods. The consolidated results of operations for the first nine months of the year are not indicative of the consolidated results of operations that might be expected for the entire year. 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, 2011.

The accompanying consolidated financial statements include our accounts and the accounts of our subsidiaries over which we exercise control. These subsidiaries include Savvis, since we acquired it on July 15, 2011, and Qwest, since we acquired it on April 1, 2011. For more information on these acquisitions and the revisions made to our original estimates of the fair value of the assets acquired and the liabilities assumed, see Note 2—Acquisitions. All intercompany amounts and transactions with our consolidated subsidiaries have been eliminated.

To simplify the overall presentation of our consolidated financial statements, we report immaterial amounts attributable to noncontrolling interests in certain of our subsidiaries as follows: (i) income attributable to noncontrolling interests in other income (expense), (ii) equity attributable to noncontrolling interests in additional paid-in capital and (iii) cash flows attributable to noncontrolling interests in other financing activities.

We also have reclassified certain other prior period amounts to conform to the current period presentation, including the categorization of our revenues and our segment reporting. For more information on our segments, see Note 9—Segment Information. These changes had no impact on total revenues, total operating expenses or net income for any period.

Effective January 1, 2012, we changed our rates of capitalized labor as we transitioned certain of Qwest's legacy systems to our historical company systems. This transition resulted in an estimated $30 million to $45 million increase in the amount of labor capitalized as an asset compared to the amount that would have been capitalized if Qwest had continued to use its legacy systems and a corresponding estimated $30 million to $45 million decrease in operating expenses for the nine months ended September 30, 2012. This change is expected to result in an estimated operating expense reduction of approximately $35 million to $60 million for the year ending December 31, 2012. The reduction in expenses described above, net of tax, increased net income approximately $18 million to $27 million, or $0.03 to $0.04 per basic and diluted common share, for the nine months ended September 30, 2012 and is expected to increase net income by approximately $21 million to $36 million, or $0.03 to $0.06 per basic and diluted common share, for the year ending December 31, 2012.

Effective January 1, 2012, we changed our estimates of the economic lives and net salvage value for certain telecommunications equipment. These changes resulted in additional depreciation expense of approximately $7 million and $20 million for the three and nine months ended September 30, 2012, respectively, and are expected to result in additional depreciation expense of approximately $26 million for the year ending December 31, 2012. This additional depreciation expense, net of tax, reduced net income by approximately $4 million and $12 million, or $0.01 and $0.02 per basic and diluted common share, for the three and nine months ended September 30, 2012, respectively, and is expected to reduce net income by approximately $16 million, or approximately $0.03 per basic and diluted common share, for the year ending December 31, 2012.

On April 2, 2012, our subsidiary, Qwest Corporation ("QC"), sold an office building for net proceeds of $133 million. As part of the transaction, QC agreed to lease a portion of the building from the new owner. As a result, the $16 million gain from the sale was deferred and will be recognized as a reduction to rent expense over the 10 year lease term.

During the second quarter of 2012, we committed to a plan to sell our Advanced Wireless Services A Block and 700 MHz wireless spectrum in the A, B, and C Blocks. We have agreed to sales terms with two purchasers and expect to reach agreements with various other purchasers within the next twelve months. These transactions are subject to regulatory approval. In connection with reclassifying our wireless spectrum assets as assets held for sale, we reclassified $154 million from "other intangible assets, net" to "current assets—other".

Out-of-Period Adjustment

During the third quarter of 2012, we discovered and corrected an error that resulted in an overstatement of depreciation expense in 2011 and the six months ended June 30, 2012. We evaluated the error considering both quantitative and qualitative factors and concluded that the error was immaterial to our previously issued and current period financial statements. Therefore, we recognized a $45 million reduction in depreciation expense during the third quarter of 2012 which includes $30 million related to 2011 and $15 million related to the six months ended June 30, 2012. The correction of the error resulted in an increase in net income of $28 million, or approximately $0.05 per share, for the three months ended September 30, 2012, and an increase in net income of $18 million, or approximately $0.03 per share, for the nine months ended September 30, 2012.

Recent Accounting Pronouncements

In July 2012, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2012-2, Intangibles—Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. This update simplifies the indefinite-lived intangible asset impairment assessment by allowing a company to first review qualitative factors to determine the likelihood of whether the indefinite-lived intangible asset is impaired before performing the quantitative impairment test. Under this approach, if we determine that it is more likely than not that the indefinite-lived intangible asset is impaired, we will be required to compute and compare the fair value of the indefinite-lived intangible asset to its carrying value to determine and measure the impairment loss, if any. We have elected to implement ASU 2012-2 effective as of the fourth quarter of 2012, when we intend to perform our annual impairment testing of indefinite-lived intangible assets other than goodwill.