Segment Information

9 Months Ended

Sep. 30, 2012

Segment Information

Segment Information

(9)   Segment Information

        In the second quarter of 2012, in order to more effectively leverage the strategic assets from our recent acquisitions of Embarq, Qwest and Savvis and to better serve our business and government customers, we restructured our business into the following operating segments:

• •

  Regional markets.  Consists generally of providing strategic and legacy products and services to residential consumers, state and local governments, small to medium-sized businesses and enterprise customers that in each case are located mainly within one of our six regions. Our strategic products and services offered to these customers include our private line, broadband, Multi-Protocol Label Switching ("MPLS"), hosting, and video services. Our legacy services offered to these customers include local and long-distance service;

  •

  Wholesale markets.  Consists generally of providing strategic and legacy products and services to other domestic and international communications providers. Our strategic products and services offered to these customers are mainly private line (including special access) and MPLS. Our legacy services offered to these customers include unbundled network elements ("UNEs") which allow our wholesale customers the use of our network or a combination of our network and their own networks to provide voice and data services to their customers, long-distance and switched access services;

  •

  Enterprise markets—network.  Consists generally of providing strategic and legacy network communications products and services to national and international enterprise and government customers. Our strategic products and services offered to these customers include our private line, broadband, MPLS and hosting services. Our legacy services offered to these customers include local and long-distance services;

  •

  Enterprise markets—data hosting.  Consists generally of providing colocation, managed hosting and cloud services to national and international enterprise and government customers.

        We have restated previously reported segment results due to the above-described reorganization of our business. Segment results are summarized below:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2012		2011		2012		2011
	(Dollars in millions)
Total segment revenues	$	4,314		4,349		13,004		10,072
Total segment expenses		2,037		2,043		6,039		4,428
Total segment income	$	2,277		2,306		6,965		5,644
Total margin percentage		53%		53%		54%		56%
Regional markets:
Revenues	$	2,468		2,522		7,431		6,199
Expenses		1,079		1,092		3,158		2,592
Income	$	1,389		1,430		4,273		3,607
Margin percentage		56%		57%		58%		58%
Wholesale markets:
Revenues	$	908		982		2,813		2,344
Expenses		273		307		846		708
Income	$	635		675		1,967		1,636
Margin percentage		70%		69%		70%		70%
Enterprise markets—network:
Revenues	$	658		622		1,938		1,298
Expenses		466		479		1,402		961
Income	$	192		143		536		337
Margin percentage		29%		23%		28%		26%
Enterprise markets—data hosting:
Revenues	$	280		223		822		231
Expenses		219		165		633		167
Income	$	61		58		189		64
Margin percentage		22%		26%		23%		28%

        We categorize our products and services into the following four categories:

• •

  Strategic services, which include primarily broadband, private line (including special access which we market to wholesale and business customers who require dedicated equipment to transmit large amounts of data between sites), MPLS (which is a data networking technology that can deliver the quality of service required to support real-time voice and video), hosting (including cloud hosting and managed hosting), colocation, Ethernet, video (including resold satellite and our facilities-based video services), voice over Internet Protocol ("VoIP") and Verizon Wireless services;

  •

  Legacy services, which include primarily local, long-distance, switched access, public access, integrated services digital network ("ISDN") (which uses regular telephone lines to support voice, video and data applications), and traditional wide area network ("WAN") services (which allows a local communications network to link to networks in remote locations);

  •

  Data integration, which includes the sale of telecommunications equipment located on customers' premises and related professional services, such as network management, installation and maintenance of data equipment and building of proprietary fiber-optic broadband networks for our government and business customers; and

  •

  Other, which consists primarily of universal service funds ("USF") revenue and surcharges.

        Operating revenues for our products and services are summarized below:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2012		2011		2012		2011
	(Dollars in millions)
Strategic services	$	2,101		1,960		6,237		4,229
Legacy services		2,045		2,223		6,284		5,494
Data integration		168		166		483		349
Other		257		247		789		626
Total operating revenues	$	4,571		4,596		13,793		10,698

        Other operating revenues include revenues from universal service funds which allow us to recover a portion of our costs under federal and state cost recovery mechanisms and certain surcharges to our customers, including billings for our required contributions to several USF programs. These surcharge billings to our customers are reflected on a gross basis in our statements of operations (included in both operating revenues and expenses) and aggregated approximately $398 million and $268 million for the nine months ended September 30, 2012 and 2011, respectively. We also generate other operating revenues from leasing and subleasing of space in our office buildings, warehouses and other properties. We centrally manage the activities that generate these other operating revenues and consequently these revenues are not included in any of our four operating segments.

        Our segment revenues include all revenues from our strategic, legacy and data integration services as described in more detail above. Segment revenues are based upon each customer's classification to an individual segment. We report our segment revenues based upon all services provided to that segment's customers. We report our segment expenses for our four segments as follows:

• •

  Direct expenses, which primarily are specific expenses incurred as a direct result of providing services and products to segment customers, along with selling, general and administrative expenses that are directly associated with specific segment customers or activities; and

  •

  Allocated expenses, which include network expenses, facilities expenses and other expenses such as fleet and real estate expenses.

        During the first quarter of 2012, as we transitioned certain of Qwest's legacy systems to our historical company systems, we updated our methodologies for reporting our direct expenses and for allocating our expenses to our segments. Specifically, we no longer include certain fleet expenses for our regional markets segment in direct expenses; they are now expenses allocated to our segments, with the exception of enterprise markets—data hosting. In addition, we now more fully allocate network building rent and power expenses to our regional markets, wholesale markets and enterprise markets—network segments. We determined that it was impracticable to recast our segment results for prior periods to reflect these changes in methodology.

        During the second quarter of 2012, as we reorganized our business into our four segments as indicated above, we further revised our methodology for how we allocate our expenses to our segments to better align segment expenses with related revenues. Under our revised methodology, we no longer allocate certain product development costs to our segments, but we do now allocate certain expenses from our enterprise markets—data hosting segment to our other three segments. We have restated prior periods to reflect these changes in our methodology.

        We do not assign depreciation and amortization expense to our segments, as the related assets and capital expenditures are centrally managed. Similarly, severance expenses, restructuring expenses and, subject to an exception for our enterprise markets—data hosting segment, certain centrally managed administrative functions (such as finance, information technology, legal and human resources) are not assigned to our segments. Interest expense is also excluded from segment results because we manage our financing on a total company basis and have not allocated assets or debt to specific segments. In addition, other income (expense) does not relate to our segment operations and is therefore excluded from our segment results. Our segment results do not include any intersegment revenue or expenses.

        The following table reconciles segment income to net income:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2012		2011		2012		2011
	(Dollars in millions)
Total segment income	$	2,277		2,306		6,965		5,644
Other operating revenues		257		247		789		626
Depreciation and amortization		(1,144)		(1,228)		(3,560)		(2,774)
Other unassigned operating expenses		(654)		(777)		(2,147)		(2,004)
Other income (expense)		(314)		(317)		(1,171)		(736)
Income tax expense		(152)		(93)		(332)		(292)
Net income	$	270		138		544		464