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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 September 30, 2006
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. 001-15577
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.) | |
1801 California Street, Denver, Colorado | 80202 | |
(Address of principal executive offices) | (Zip Code) |
(303) 992-1400
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):
Large accelerated filer x | Accelerated filer ¨ | Non-accelerated filer ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
On October 27, 2006, 1,914,377,278 shares of common stock were outstanding.
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QWEST COMMUNICATIONS INTERNATIONAL INC.
FORM 10-Q
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Our industry uses many terms and acronyms that may not be familiar to you. To assist you in reading this document, we have provided below definitions of some of these terms.
• | Access Lines. Telephone lines reaching from the customer’s premises to a connection with the public switched telephone network. When we refer to our access lines we mean all our mass markets, wholesale and business access lines, including those used by us and our affiliates. |
• | Asynchronous Transfer Mode (ATM). A broadband, network transport service utilizing data switches that provides a fast, efficient way to move large quantities of information. |
• | Competitive Local Exchange Carriers (CLECs). Telecommunications providers that compete with us in providing local voice services in our local service area. |
• | Data Integration. Voice and data telecommunications customer premises equipment (CPE) and associated professional services, including network management, the installation and maintenance of data equipment and the building of proprietary fiber-optic broadband networks, for our governmental and business customers. |
• | Frame Relay. A high speed data switching technology primarily used to interconnect multiple local networks. |
• | Incumbent Local Exchange Carrier (ILEC). A traditional telecommunications provider, such as our subsidiary, Qwest Corporation, that, prior to the Telecommunications Act of 1996, had the exclusive right and responsibility for providing local telecommunications services in its local service area. |
• | Integrated Services Digital Network (ISDN). A telecommunications standard that uses digital transmission technology to support voice, video and data communications applications over regular telephone lines. |
• | Interexchange Carriers (IXCs). Telecommunications providers that provide long-distance services to end-users by handling calls that extend beyond a customer’s local exchange service area. |
• | InterLATA long-distance services. Telecommunications services, including “800” services, that cross LATA boundaries. |
• | Internet Dial Access. Provides ISPs and business customers with a comprehensive, reliable and cost-effective dial-up network infrastructure. |
• | Internet Protocol (IP). Those protocols that facilitate transferring information in packets of data and that enable each packet in a transmission to “tell” the data switches it encounters where it is headed and enables the computers on each end to confirm that message has been accurately transmitted and received. |
• | Internet Service Providers (ISPs). Businesses that provide Internet access to retail customers. |
• | IntraLATA long-distance services. These services include calls that terminate outside a caller’s local calling area but within their LATA, including wide area telecommunications service or “800” services for customers with geographically highly concentrated demand. |
• | Local Access Transport Area (LATA).A geographical area associated with the provision of telecommunications services by local exchange and long distance carriers. There are 163 LATAs in the United States, of which 27 are in our 14 state local service area. |
• | Local Calling Area. A geographical area, usually smaller than a LATA, within which a customer can make telephone calls without incurring long-distance charges. Multiple local calling areas generally make up a LATA. |
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• | Private Lines. Direct circuits or channels specifically dedicated to the use of an end-user organization for the purpose of directly connecting two or more sites. |
• | Public Switched Telephone Network (PSTN). The worldwide voice telephone network that is accessible to every person with a telephone equipped with dial tone. |
• | Unbundled Network Elements (UNEs). Discrete elements of our network that are sold or leased to competitive telecommunications providers and that may be combined to provide their retail telecommunications services. |
• | Virtual Private Network (VPN). A private network that operates securely within a public network (such as the Internet) by means of encrypting transmissions. |
• | Voice over Internet Protocol (VoIP). An application that provides real-time, two-way voice capability originating in the Internet protocol over a broadband connection. |
• | Web Hosting. The providing of space, power and bandwidth in data centers for hosting of customers’ Internet equipment as well as related services. |
• | Wide Area Network (WAN). A communications network that covers a wide geographic area, such as a state or country. A WAN typically extends a local area network outside the building, over telephone common carrier lines to link to other local area networks in remote locations, such as branch offices or at-home workers and telecommuters. |
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QWEST COMMUNICATIONS INTERNATIONAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2006 | 2005 | 2006 | 2005 | |||||||||||||
(Dollars in millions except per share amounts, shares in thousands) | ||||||||||||||||
Operating revenue | $ | 3,487 | $ | 3,504 | $ | 10,435 | $ | 10,423 | ||||||||
Operating expenses: | ||||||||||||||||
Cost of sales (exclusive of depreciation and amortization) | 1,382 | 1,512 | 4,192 | 4,385 | ||||||||||||
Selling, general and administrative | 1,014 | 1,016 | 2,998 | 3,097 | ||||||||||||
Depreciation | 594 | 659 | 1,774 | 1,961 | ||||||||||||
Capitalized software and other intangible assets amortization | 97 | 109 | 301 | 346 | ||||||||||||
Total operating expenses | 3,087 | 3,296 | 9,265 | 9,789 | ||||||||||||
Other expense (income)—net: | ||||||||||||||||
Interest expense—net | 291 | 384 | 885 | 1,145 | ||||||||||||
Loss (gain) on early retirement of debt—net | 9 | (11 | ) | 4 | 32 | |||||||||||
Gain on sale of assets | — | — | (3 | ) | (257 | ) | ||||||||||
Other—net | (51 | ) | (20 | ) | (88 | ) | (35 | ) | ||||||||
Total other expense (income)—net | 249 | 353 | 798 | 885 | ||||||||||||
Income (loss) before income taxes | 151 | (145 | ) | 372 | (251 | ) | ||||||||||
Income tax benefit | 43 | 1 | 27 | — | ||||||||||||
Net income (loss) | $ | 194 | $ | (144 | ) | $ | 399 | $ | (251 | ) | ||||||
Weighted average shares outstanding: | ||||||||||||||||
Basic | 1,901,372 | 1,843,715 | 1,886,127 | 1,827,937 | ||||||||||||
Diluted | 2,004,502 | 1,843,715 | 1,962,558 | 1,827,937 | ||||||||||||
Basic income (loss) per share | $ | 0.10 | $ | (0.08 | ) | $ | 0.21 | $ | (0.14 | ) | ||||||
Diluted income (loss) per share | $ | 0.09 | $ | (0.08 | ) | $ | 0.20 | $ | (0.14 | ) |
The accompanying notes are an integral part of these condensed consolidated financial statements.
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QWEST COMMUNICATIONS INTERNATIONAL INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
September 30, 2006 | December 31, 2005 | |||||||
(Dollars in millions, shares in thousands) | ||||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 962 | $ | 846 | ||||
Short-term investments | 218 | 101 | ||||||
Accounts receivable (less allowance of $147 and $167, respectively) | 1,718 | 1,525 | ||||||
Prepaid expenses and other current assets | 677 | 692 | ||||||
Total current assets | 3,575 | 3,164 | ||||||
Property, plant and equipment—net | 14,828 | 15,568 | ||||||
Capitalized software and other intangible assets—net | 943 | 1,007 | ||||||
Prepaid pension asset | 1,111 | 1,165 | ||||||
Other assets | 657 | 593 | ||||||
Total assets | $ | 21,114 | $ | 21,497 | ||||
LIABILITIES AND STOCKHOLDERS’ DEFICIT | ||||||||
Current liabilities: | ||||||||
Current borrowings | $ | 1,685 | $ | 512 | ||||
Accounts payable | 833 | 773 | ||||||
Accrued expenses and other current liabilities | 2,004 | 2,317 | ||||||
Deferred revenue and advance billings | 622 | 633 | ||||||
Total current liabilities | 5,144 | 4,235 | ||||||
Long-term borrowings (net of unamortized debt discount of $212 and $221, respectively) | 13,228 | 14,968 | ||||||
Post-retirement and other post-employment benefit obligations | 3,436 | 3,459 | ||||||
Deferred revenue | 516 | 522 | ||||||
Other long-term liabilities | 1,366 | 1,530 | ||||||
Total liabilities | 23,690 | 24,714 | ||||||
Commitments and contingencies (Note 9) | ||||||||
Stockholders’ deficit: | ||||||||
Preferred stock—$1.00 par value, 200 million shares authorized; none issued or outstanding | — | — | ||||||
Common stock—$0.01 par value, 5 billion shares authorized; 1,914,789 and 1,867,422 shares issued, respectively | 19 | 19 | ||||||
Additional paid-in capital | 43,531 | 43,290 | ||||||
Treasury stock—1,198 and 1,062 shares, respectively (including 62 shares held in rabbi trust at both dates) | (18 | ) | (17 | ) | ||||
Accumulated deficit | (46,101 | ) | (46,500 | ) | ||||
Accumulated other comprehensive loss | (7 | ) | (9 | ) | ||||
Total stockholders’ deficit | (2,576 | ) | (3,217 | ) | ||||
Total liabilities and stockholders’ deficit | $ | 21,114 | $ | 21,497 | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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QWEST COMMUNICATIONS INTERNATIONAL. INC
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended September 30, | ||||||||
2006 | 2005 | |||||||
(Dollars in millions) | ||||||||
Operating activities: | ||||||||
Net income (loss) | $ | 399 | $ | (251 | ) | |||
Adjustments to reconcile net income (loss) to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 2,075 | 2,307 | ||||||
Provision for bad debts—net | 108 | 137 | ||||||
Deferred income taxes | (3 | ) | (4 | ) | ||||
Gain on sale of assets | (3 | ) | (257 | ) | ||||
Loss on early retirement of debt—net | 4 | 32 | ||||||
Other non-cash charges—net | 38 | 17 | ||||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable | (294 | ) | (138 | ) | ||||
Prepaid expenses and other current assets | 50 | 1 | ||||||
Accounts payable and accrued expenses and other current liabilities | (236 | ) | 57 | |||||
Deferred revenue and advance billings | (25 | ) | (61 | ) | ||||
Other non-current assets and liabilities | (184 | ) | (252 | ) | ||||
Cash provided by operating activities | 1,929 | 1,588 | ||||||
Investing activities: | ||||||||
Expenditures for property, plant and equipment and intangible assets (net of tax refund of $33 million in 2005) | (1,226 | ) | (1,110 | ) | ||||
Proceeds from sales of property and equipment | 63 | 418 | ||||||
Proceeds from sales of investment securities | 56 | 1,230 | ||||||
Purchases of investment securities | (173 | ) | (1,002 | ) | ||||
Acquisition of OnFiber Communications, Inc. | (107 | ) | — | |||||
Other | 6 | 22 | ||||||
Cash used for investing activities | (1,381 | ) | (442 | ) | ||||
Financing activities: | ||||||||
Proceeds from long-term borrowings | 600 | 1,887 | ||||||
Repayments of long-term borrowings, including current maturities | (1,145 | ) | (1,778 | ) | ||||
Proceeds from issuances of common stock | 150 | 10 | ||||||
Other | (37 | ) | (105 | ) | ||||
Cash (used for) provided by financing activities | (432 | ) | 14 | |||||
Cash and cash equivalents: | ||||||||
Increase in cash and cash equivalents | 116 | 1,160 | ||||||
Beginning balance | 846 | 1,151 | ||||||
Ending balance | $ | 962 | $ | 2,311 | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(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.
Note 1: Basis of Presentation
These condensed consolidated interim financial statements are unaudited and are prepared in accordance with the instructions for Form 10-Q. In compliance with those instructions, certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted.
In the opinion of management, these statements include all the adjustments necessary to fairly present our condensed consolidated results of operations, financial position and cash flows as of September 30, 2006 and for all periods presented. These condensed 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, 2005 (the “2005 Form 10-K”). The condensed consolidated results of operations for the three and nine months ended September 30, 2006 and the condensed consolidated statement of cash flows for the nine months ended September 30, 2006 are not necessarily indicative of the results or cash flows expected for the full year.
Certain prior period balances have been reclassified to conform to the current presentation.
Business Combination
On August 31, 2006, we completed our acquisition of OnFiber Communications, Inc., a provider of custom-built and managed network solutions, for a purchase price of $107 million in cash. We completed a preliminary purchase price allocation for this transaction based on a preliminary evaluation of the fair values of the tangible and identifiable intangible assets acquired and liabilities assumed. In our allocation, we assigned to goodwill the $58 million excess of the aggregate purchase price over the preliminary estimates of the fair value of the net assets acquired. We may adjust this preliminary purchase price allocation based upon our final determination of the fair value of the assets acquired and liabilities assumed. Our final determination is not complete due to the short time frame since the acquisition.
Use of Estimates
Our condensed consolidated financial statements are prepared in accordance with GAAP. These accounting principles require us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions made when accounting for items and matters such as, but not limited to, long-term contracts, customer retention patterns, allowance for bad debts, depreciation, amortization, asset valuations, internal labor capitalization rates, recoverability of assets, impairment assessments, employee benefits, taxes, reserves and other provisions and contingencies are reasonable, based on information available at the time they are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the condensed consolidated financial statements, as well as the reported amounts of revenue and expenses during the periods presented. We also assess potential losses in relation to threatened or pending legal and tax matters. For matters not related to income taxes, if a loss is considered probable and the amount can be reasonably estimated, we recognize an expense for the estimated loss. In instances where we have the potential to recover a portion of such a loss from a third party, we make a separate assessment of recoverability and reduce
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QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
the estimated loss if recovery is also deemed probable. For income tax related matters, we record a liability computed at the statutory income tax rate if we determine that (i) we do not believe we are more likely than not to prevail on an uncertainty related to the timing of recognition for an item, or (ii) we do not believe it is probable that we will prevail and the uncertainty is not related to the timing of recognition. Actual results could differ from these estimates. See Note 9—Commitments and Contingencies.
Depreciation and Amortization
Property, plant and equipment are shown net of accumulated depreciation on our condensed consolidated balance sheets. As of September 30, 2006 and December 31, 2005, accumulated depreciation was $31.7 billion and $30.4 billion, respectively.
Capitalized software and other intangible assets are shown net of accumulated amortization on our condensed consolidated balance sheets. Accumulated amortization was $1.5 billion and $1.3 billion as of September 30, 2006 and December 31, 2005, respectively.
Recently Adopted Accounting Pronouncements
In May 2005, the Financial Accounting Standards Board (“FASB”), as part of an effort to conform to international accounting standards, issued Statement of Financial Accounting Standards (“SFAS”) No. 154, “Accounting Changes and Error Corrections” (“SFAS No. 154”), which was effective for us beginning on January 1, 2006. SFAS No. 154 requires that all voluntary changes in accounting principles be retrospectively applied to prior financial statements as if that principle had always been used, unless it is impracticable to do so. When it is impracticable to calculate the effects on all prior periods, SFAS No. 154 requires that the new principle be applied to the earliest period practicable. The adoption of SFAS No. 154 has not had a material effect on our financial position or results of operations.
Effective January 1, 2006, we adopted SFAS No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”), which revises SFAS No. 123, “Accounting for Stock-Based Compensation.” See Note 2—Stock-Based Compensation for additional information on this recently adopted accounting pronouncement.
Recently Issued Accounting Pronouncements
In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), which is effective for us beginning on January 1, 2007. The validity of any tax position is a matter of tax law, and generally there is no controversy about recognizing the benefit of a tax position in a company’s financial statements when the degree of confidence is high that the tax position will be sustained upon examination by a taxing authority. However, in some cases, the law is subject to varied interpretation, and whether a tax position will ultimately be sustained may be uncertain. For us, FIN 48 establishes a different process to measure the impact of uncertainty associated with the income tax provision than we are currently using. Under FIN 48, the impact of an uncertain income tax position on the income tax provision must be recognized at the largest amount that is more likely than not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. FIN 48 also requires additional disclosures about unrecognized tax benefits associated with uncertain income tax positions and a reconciliation of the change in the unrecognized benefit. We currently recognize an uncertain income tax position related to the timing of recognition if we are more likely than not to prevail. For uncertain income tax positions not related to timing of recognition, we recognize the position if it is probable that
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QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
we will prevail. We are evaluating the impact of FIN 48 on our financial statements. The standard establishes a lower threshold for recognizing the benefit of some uncertain tax positions than we have historically used. Therefore, the adoption could have a significant impact on our financial statements.
In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”), which is effective for us beginning with our fiscal year ending on December 31, 2006. Additionally, in September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which is effective for us beginning January 1, 2008 and provides a definition of fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements for future transactions. We do not expect the adoption of these pronouncements to have an impact on our financial statements.
Also in September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans-An amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“SFAS No. 158”). SFAS No. 158 represents the first phase of the FASB’s two phase project to reconsider defined benefit pension and other postretirement plan accounting. SFAS No. 158 requires recognition of the over-funded or under-funded status of a defined benefit postretirement plan as an asset or liability in a company’s statement of financial position and requires a company to recognize changes in that funded status in comprehensive income in the year in which the changes occur. SFAS No 158 also requires measurement of the funded status of a plan as of the date of its year-end statement of financial position. Phase two will be a comprehensive examination of accounting for defined benefit pension and other postretirement plans and may reconsider the guidance of SFAS No. 158.
The guidance of SFAS No. 158 is effective for us in two steps. Step one is effective for us beginning with our fiscal year ending on December 31, 2006 and requires us to recognize on our consolidated balance sheet the over-funded or under-funded amount of our defined benefit postretirement plans. This amount is defined as the difference between the fair value of plan assets and the benefit obligation. We are also required to recognize as a component of other comprehensive income, net of tax, the actuarial gains and losses and the prior service costs and credits that arise but are not currently required to be recognized as components of net periodic benefit cost. Other comprehensive income is then adjusted as these amounts are later recognized into income as components of net periodic benefit cost. The adoption of step one requires us to record on our consolidated balance sheet increases in post-retirement and other post-employment benefit obligations and increases in accumulated other comprehensive loss. The adoption of step one could have a significant impact on our financial statements. Step two is effective for us beginning with our fiscal year ending on December 31, 2008 and requires us to disclose in the notes to our financial statements additional information about the expected effects on net periodic benefit cost of delayed recognition of the actuarial gains and losses and the prior service costs and credits. It also requires disclosure of information about any transition asset or obligation remaining from the application of pre-existing rules and requires a year end measurement date. We currently use December 31 as the measurement date of the funded status of our plans, which is the same date as our year end consolidated balance sheet. We do not expect the adoption of step two to have an impact on our financial statements.
Note 2: Stock-Based Compensation
Adoption of SFAS No. 123(R)
Effective January 1, 2006, we adopted SFAS No. 123(R). Prior to 2006, we accounted for stock awards granted to employees under the intrinsic-value recognition and measurement principles of Accounting Principles
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QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”). Under the intrinsic-value method, no compensation expense was recognized for options granted to employees when the strike price of those options equaled or exceeded the value of the underlying security on the measurement date. Under APB No. 25, stock-based compensation expense was generally limited to the excess of the stock price on the measurement date over the exercise price, if any, and was recorded as deferred compensation and amortized over the service period during which the stock option award vested. However, SFAS No. 123(R) requires that compensation expense be measured using estimates of the fair value of all stock-based awards.
We are applying the “modified prospective method” for recognizing the expense over the remaining vesting period for awards that were outstanding but unvested at January 1, 2006. Under the modified prospective method, the adoption of SFAS No. 123(R) applies to new awards and to awards modified, repurchased, or cancelled after December 31, 2005, as well as to the unvested portion of awards outstanding as of January 1, 2006. In accordance with the modified prospective method, we have not adjusted the financial statements for periods ended prior to December 31, 2005.
SFAS No. 123(R) also requires us to estimate forfeitures in calculating the expense related to stock-based compensation, which is estimated at 40% for 2006 grants.
Compensation cost arising from stock-based awards is recognized as expense using the straight-line method over the vesting period. As of September 30, 2006, there was $56 million of total unrecognized compensation cost related to unvested stock-based awards, which we expect to recognize over the remaining weighted average vesting terms of 2.8 years. For the three and nine months ended September 30, 2006, our total stock-based compensation expense was $7 million and $21 million, respectively, which includes $5 million and $13 million, respectively, of compensation expense for stock options and for stock issued under our Employee Stock Purchase Plan (“ESPP”) that would not have been recorded as expense under APB No. 25. We have not recorded any income tax benefit related to stock-based compensation in the three or nine-month periods ended September 30, 2006 and 2005.
The following table illustrates the effect on net loss and loss per share for the three and nine months ended September 30, 2005 as if our stock-based compensation had been determined based on the fair value at the grant dates:
September 30, 2005 | ||||||||
Three Months Ended | Nine Months Ended | |||||||
(Dollars in millions, per share amounts) | ||||||||
Net loss: | ||||||||
As reported | $ | (144 | ) | $ | (251 | ) | ||
Deduct: Total stock-based employee compensation expense determined under the fair-value-based method for all awards, net of related tax effects | (134 | ) | (168 | ) | ||||
Pro forma net loss | $ | (278 | ) | $ | (419 | ) | ||
Net loss per share: | ||||||||
As reported—basic and diluted | $ | (0.08 | ) | $ | (0.14 | ) | ||
Pro forma—basic and diluted | $ | (0.15 | ) | $ | (0.23 | ) |
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QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
We adopted an Equity Incentive Plan on June 23, 1997. This plan was most recently amended and restated on May 24, 2006 and permits the grant of non-qualified stock options, incentive stock options, stock appreciation rights, restricted stock, stock units and other stock grants. The maximum number of shares of our common stock that may be issued under the plan at any time pursuant to awards is equal to 10% of the aggregate number of our common shares issued and outstanding reduced by the aggregate number of options and other awards then outstanding under the plan or otherwise. Issued and outstanding shares are determined as of the close of trading on the New York Stock Exchange on the preceding trading day. Since our merger with U S WEST, Inc., all stock-based awards have been issued from this plan. As of September 30, 2006, options and unvested restricted stock representing 118 million shares of our common stock were outstanding under the plan, and 74 million shares were available for future issuance under the plan.
Stock Options
The Compensation and Human Resources Committee of our Board of Directors, or its delegate, approves the exercise price for each option. Stock options generally have an exercise price that is at least equal to the fair market value of the common stock on the date the stock option is granted, subject to certain restrictions. Stock option awards generally vest in equal increments over the vesting period of the granted option (generally three to five years). Unless otherwise provided by the Compensation and Human Resources Committee, our Equity Incentive Plan provides that, upon a “change in control,” all awards granted under the Equity Incentive Plan will vest immediately. Options that we granted to our employees from June 1999 to September 2002 typically provide for accelerated vesting if the optionee is terminated without cause following a change in control. Since September 2002, options that we grant to our executive officers (vice president level and above) typically provide for accelerated vesting and an extended exercise period upon a change of control and options that we grant to all other employees typically provide for accelerated vesting if the optionee is terminated without cause following a change in control. Options granted subsequent to 2002 have ten-year terms.
Summarized below is the activity of our stock option plans for the nine months ended September 30, 2006:
Number of Shares | Weighted Average Exercise Price | |||||
(in thousands) | ||||||
Outstanding December 31, 2005 | 134,940 | $ | 12.23 | |||
Granted | 9,923 | $ | 6.17 | |||
Exercised | (30,078 | ) | $ | 4.38 | ||
Canceled or expired | (4,612 | ) | $ | 18.93 | ||
Outstanding September 30, 2006 | 110,173 | $ | 13.55 | |||
The options to purchase 110 million shares of Qwest common stock that were outstanding at September 30, 2006 had remaining contractual terms with a weighted average of 6 years. The aggregate intrinsic value for those outstanding options that were in the money was $300 million at September 30, 2006. Of those outstanding options to purchase shares of Qwest common stock, 96 million were exercisable at September 30, 2006 and had a weighted-average exercise price of $14.82 and remaining contractual terms with a weighted average of 5 years. Options that were both exercisable and in the money on September 30, 2006 had an aggregate intrinsic value of $250 million on that date.
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QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
Except for option awards with market-based vesting conditions, we use the Black-Scholes model to estimate the fair value of new stock option grants and establish such fair value at the date of grant. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. Additionally, all option valuation models require the input of highly subjective assumptions including the expected life of the options and the expected stock price volatility. Because our employee stock options have characteristics significantly different from traded options, and changes in the input assumptions can materially affect the fair value estimate, estimates of the fair value of our stock option awards are subjective. Following are the weighted-average assumptions used and the resulting fair value estimates of options granted in the nine months ended September 30, 2006 and 2005 excluding the market-based vesting condition awards described below:
Nine Months Ended September 30, | ||||||
2006 | 2005 | |||||
Risk-free interest rate | 4.2% – 5.0 | % | 3.3% – 4.2 | % | ||
Expected dividend yield | 0.0 | % | 0.0 | % | ||
Expected option life (years) | 5.3 | 4.5 | ||||
Expected stock price volatility | 80.3 | % | 87.8 | % | ||
Weighted-average grant date fair value | $4.35 | $2.74 |
We believe the two most significant assumptions used in our estimates of fair value are the expected option life and the expected volatility, both of which we estimate based on historical information. During the nine months ended September 30, 2006 and 2005, options to purchase 30 million and 1 million shares were exercised with aggregate intrinsic values totaling $90 million and $1 million, respectively.
Restricted Stock
During the nine months ended September 30, 2006, 6 million shares of restricted stock were granted under the Equity Incentive Plan. Except for restricted stock awards with market-based vesting conditions, we use the closing price of our common stock on the date of the award as the fair value for restricted stock awards. Excluding the market-based vesting condition awards described below, the weighted average estimate of fair value for restricted stock awards granted during the nine months ended September 30, 2006 was $6.24 per share.
A summary of the status of unvested shares of restricted stock as of and during the nine months ended September 30, 2006 is as follows:
Number of Shares | Weighted Grant-Date Fair Value | |||||
(in thousands) | ||||||
Unvested at December 31, 2005 | 1,704 | $ | 4.19 | |||
Granted | 5,971 | $ | 5.77 | |||
Vested | — | $ | — | |||
Forfeited | (136 | ) | $ | 6.15 | ||
Unvested at September 30, 2006 | 7,539 | $ | 5.40 | |||
Compensation expense of $2 million and $8 million was recognized for restricted stock grants in the three and nine months ended September 30, 2006, respectively.
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QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
Employee Stock Purchase Plan
We are authorized to issue 27 million shares of our common stock to eligible employees under our ESPP. Under the terms of our ESPP, eligible employees may authorize payroll deductions of up to 15% of their base compensation, as defined, to purchase our common stock at a price of 85% of the fair market value of our common stock on the last trading day of the month in which our common stock is purchased. During the three and nine months ended September 30, 2006, approximately 350,000 shares and 1.2 million shares, respectively, were purchased under this plan at a weighted-average purchase price of $7.20 and $6.21 per share, respectively. During the three and nine months ended September 30, 2006, we recognized compensation expense of approximately $418,000 and $1 million, respectively, for the difference between the employees’ purchase price and the fair market value of the stock.
Market-Based Vesting Condition Awards
On February 16, 2006, we granted non-qualified option awards to purchase a total of 3,851,000 shares of our common stock at an exercise price of $6.15 and restricted stock awards totaling 2,407,000 shares of our common stock. As these awards include vesting provisions that are tied to the market value of our common stock, we do not believe our standard valuation models accurately estimate the fair value of these awards. We valued these awards using Monte-Carlo simulations and estimate that the grant date fair value of each option was $3.99 per option and the grant date fair value of each share of restricted stock was $5.07 per share. These estimates were based on the following assumptions:
• | Risk-free interest rate of 4.5%; |
• | Dividend yield of zero; and |
• | Volatility factor of the expected market price of our common stock of 60%. |
We believe the most significant assumption used in our estimate of fair value is the expected volatility, which we estimated based on historical information.
Note 3: Earnings Per Share
Basic earnings per share excludes dilution and is computed by dividing net income available to common stockholders by the weighted average number of shares of common stock outstanding for the period. For purposes of this calculation, common stock outstanding does not include shares of restricted stock on which the restrictions have not yet lapsed. Diluted earnings per share reflects the potential dilution that could occur if certain outstanding stock options are exercised, the premium on convertible debt is converted into common stock and restrictions lapse on restricted stock awards.
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QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
The following is a reconciliation of the number of shares used in the basic and diluted earnings per share computations:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||
2006 | 2005 | 2006 | 2005 | |||||||||||
(Dollars in millions except per share amounts, shares in thousands) | ||||||||||||||
Net income (loss) | $ | 194 | $ | (144 | ) | $ | 399 | $ | (251 | ) | ||||
Basic weighted average shares outstanding | 1,901,372 | 1,843,715 | 1,886,127 | 1,827,937 | ||||||||||
Dilutive effect of options with strike prices equal to or less than the average price of our common stock, calculated using the treasury stock method | 32,193 | — | 30,875 | — | ||||||||||
Dilutive effect of the equity premium on convertible debt at the average price of our common stock | 65,174 | — | 39,869 | — | ||||||||||
Dilutive effect of unvested restricted stock and other | 5,763 | — | 5,687 | — | ||||||||||
Diluted weighted average shares outstanding | 2,004,502 | 1,843,715 | 1,962,558 | 1,827,937 | ||||||||||
Basic income (loss) per share | $ | 0.10 | $ | (0.08 | ) | $ | 0.21 | $ | (0.14 | ) | ||||
Diluted income (loss) per share | $ | 0.09 | $ | (0.08 | ) | $ | 0.20 | $ | (0.14 | ) |
The following is a summary of the securities that could potentially dilute basic earnings per share, but have been excluded from the computations of diluted income (loss) per share:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||
2006 | 2005 | 2006 | 2005 | |||||
(Shares in thousands) | ||||||||
Outstanding options to purchase common stock excluded because the strike prices of the options exceeded the average price of common stock during the period | 43,125 | 118,791 | 43,346 | 118,747 | ||||
Outstanding options to purchase common stock and unvested restricted stock excluded because the market-based vesting conditions have not been met | 6,258 | — | 6,258 | — | ||||
Other outstanding options to purchase common stock excluded because the impact would have been antidilutive | 5,669 | — | 5,576 | — | ||||
Note 4: Sale of Property and Equipment
In the first quarter of 2005, we closed the sale of our personal communications services, or PCS, licenses and substantially all of our related wireless network assets in our local service area (including cell sites and wireless network infrastructure, site leases, and associated network equipment). We received $418 million for these assets and recorded a gain of $257 million from this sale and dispositions of other wireless assets.
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QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
Note 5: Borrowings
As of September 30, 2006 and December 31, 2005, our borrowings, net of discounts and premiums, consisted of the following:
September 30, 2006 | December 31, 2005 | |||||
(Dollars in millions) | ||||||
Current borrowings: | ||||||
Current portion of long-term borrowings | $ | 1,655 | $ | 492 | ||
Current portion of capital lease obligations and other | 30 | 20 | ||||
Total current borrowings | $ | 1,685 | $ | 512 | ||
Long-term borrowings: | ||||||
Long-term notes | $ | 13,131 | $ | 14,863 | ||
Long-term capital lease obligations and other | 97 | 105 | ||||
Total long-term borrowings | $ | 13,228 | $ | 14,968 | ||
Borrowings classified as current are due and payable within twelve months from the applicable balance sheet date. The balance of our $1.265 billion 3.50% Convertible Senior Notes due 2025 was classified as a current obligation as of September 30, 2006 because specified, market-based conversion provisions were met as of that date. These notes were classified as a non-current obligation as of December 31, 2005 because the market-based conversion provisions were not met as of that date. These market-based conversion provisions specify that, when our common stock has a closing price above $7.08 per share for twenty or more trading days during certain periods of thirty consecutive trading days, these notes become available for conversion for a period, and as a result all outstanding notes are reclassified as a current obligation. If our common stock does not maintain a closing price above $7.08 per share during certain subsequent periods, the notes would no longer be available for immediate conversion and the outstanding notes would again be reclassified as a non-current obligation. These notes are registered securities and freely tradable, and as of September 30, 2006, they had a market price of $1,621 per $1,000 principal amount of notes, compared to an estimated conversion value of $1,488. The conversion value is calculated based on the specified conversion provisions using the closing prices of our common stock during the 20 trading days ended September 30, 2006.
During the second quarter of 2006, we exchanged approximately $70 million in face amount of debt issued by our wholly-owned subsidiary, Qwest Capital Funding, Inc. (“QCF”), plus $2 million of accrued interest, for approximately 8.6 million shares of our common stock with an aggregate value of approximately $66 million at the time of issuance. The effective share price for the exchange transactions ranged from $7.79 per share to $8.72 per share (principal and accrued interest divided by the number of shares issued). The trading prices for our common stock at the times the exchange transactions were consummated ranged from $7.16 per share to $8.04 per share. As a result, we recorded a gain of $6 million on debt extinguishments.
We have available to us $850 million under a revolving credit facility (“the Credit Facility”), which is currently undrawn and which expires in October 2010. Until July 2006, our wholly-owned subsidiary, Qwest Services Corporation (“QSC”), was the potential borrower under the Credit Facility. The Credit Facility is guaranteed by QSC and is secured by a senior lien on the stock of its wholly-owned subsidiary, Qwest Corporation (“QC”).
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QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
On August 8, 2006, QC issued $600 million aggregate principal amount of its 7.5% Notes due 2014. The notes are unsecured obligations of QC and rank equally in right of payment with all other unsecured and unsubordinated indebtedness of QC. The covenant and default terms are substantially the same as those associated with QC’s other long-term debt. QC plans to file an exchange offer registration statement with the SEC for a new issue of substantially identical notes registered under the Securities Act of 1933, as amended, within 315 calendar days of the date of issuance of the notes. If QC fails to file this registration statement or fails to satisfy other obligations under the registration rights agreement relating to the notes, QC will be required to pay additional interest on the notes at a rate of 25 basis points per year. The net proceeds of approximately $592 million have been or will be used for general corporate purposes, including repayment of indebtedness and funding and refinancing investments in our telecommunications assets. Concurrent with the issuance of the notes, QC called the remaining $500 million aggregate principal amount of its floating rate term loan maturing in June 2007, plus accrued interest of $3 million. The prepayment resulted in a loss on early retirement of debt of $9 million.
On August 15, 2006, QCF paid at maturity $485 million aggregate principal amount of its 7.75% Notes due 2006.
On September 21, 2006, QC redeemed the remaining $90 million aggregate principal amount of its 39-year 6.25% debentures due January 1, 2007 at face value plus accrued interest of $1 million.
Note 6: Restructuring Charges and Severance Accruals
During 2004 and previous years, as part of our ongoing effort to evaluate our operating costs, we established restructuring programs, which included workforce reductions, consolidation of excess facilities, and restructuring of certain business functions. The restructuring reserve balances are included in our condensed consolidated balance sheets in accrued expenses and other current liabilities for the current portion and other long-term liabilities for the long-term portion. The charges and reversals are included in our condensed consolidated statements of operations in selling, general and administrative expense. As of September 30, 2006 and December 31, 2005, our restructuring reserve was $370 million and $428 million, respectively. The amount included as current liabilities was $45 million and $62 million, respectively, and the long term portion was $325 million and $366 million, respectively. In the nine months ended September 30, 2006, we added $11 million to these reserves in restructuring provisions. In the three and nine months ended September 30, 2006, we utilized $8 million and $54 million and reversed $5 million and $15 million, respectively.
Substantially all of the planned employee reductions associated with the 2004 and prior restructuring plans were complete as of September 30, 2006. The majority of the remaining restructuring reserve relates to real estate exit costs. We expect to utilize this remaining reserve over the remaining lease terms, which range from 0.5 years to 19.3 years, with a weighted average of 12.8 years.
We continue to manage our cost structure and reflect the impact of productivity gains achieved. For the three and nine months ended September 30, 2006, we recorded $43 million and $50 million of severance costs, respectively. These costs were included in our condensed consolidated statements of operations in selling, general and administrative expenses. We expect to substantially complete these payments in 2007.
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QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
Note 7: Employee Benefits
The components of the pension, non-qualified pension and post-retirement benefits expense for the three and nine months ended September 30, 2006 and 2005 are as follows:
Pension Expense | Pension Non-Qualified | Post-Retirement Expense | ||||||||||||||||||||
Three Months Ended September 30, | ||||||||||||||||||||||
2006 | 2005 | 2006 | 2005 | 2006 | 2005 | |||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||||
Service cost | $ | 37 | $ | 34 | $ | — | $ | 1 | $ | 4 | $ | 5 | ||||||||||
Interest cost | 120 | 124 | 1 | — | 73 | 71 | ||||||||||||||||
Expected return on plan assets | (165 | ) | (173 | ) | — | — | (33 | ) | (33 | ) | ||||||||||||
Amortization of transition asset | — | — | — | 1 | — | — | ||||||||||||||||
Amortization of prior service cost | (1 | ) | (1 | ) | — | — | (21 | ) | (14 | ) | ||||||||||||
Recognized net actuarial loss | 27 | 26 | 1 | 1 | 10 | 3 | ||||||||||||||||
Net expense included in net income (loss) | $ | 18 | $ | 10 | $ | 2 | $ | 3 | $ | 33 | $ | 32 | ||||||||||
Pension Expense | Pension Non-Qualified | Post-Retirement Expense | ||||||||||||||||||||
Nine Months Ended September 30, | ||||||||||||||||||||||
2006 | 2005 | 2006 | 2005 | 2006 | 2005 | |||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||||
Service cost | $ | 112 | $ | 112 | $ | 2 | $ | 2 | $ | 11 | $ | 15 | ||||||||||
Interest cost | 361 | 375 | 3 | 2 | 219 | 232 | ||||||||||||||||
Expected return on plan assets | (496 | ) | (522 | ) | — | — | (97 | ) | (98 | ) | ||||||||||||
Amortization of transition asset | — | — | 1 | 2 | — | — | ||||||||||||||||
Amortization of prior service cost | (4 | ) | (4 | ) | — | — | (63 | ) | (42 | ) | ||||||||||||
Recognized net actuarial loss | 81 | 60 | 1 | 1 | 30 | 43 | ||||||||||||||||
Net expense included in net income (loss) | $ | 54 | $ | 21 | $ | 7 | $ | 7 | $ | 100 | $ | 150 | ||||||||||
The pension, non-qualified pension and post-retirement benefit expense is allocated between cost of sales and selling, general and administrative expense in our condensed consolidated statements of operations. The measurement date used to determine pension, non-qualified pension and other post-retirement healthcare and life insurance benefit measurements for the plans is December 31.
Note 8: Segment Information
Our three segments are (1) wireline services, (2) wireless services and (3) other services. Our chief operating decision maker (“CODM”) regularly reviews the results of operations at a segment level to evaluate the performance of each segment and allocate capital resources based on segment income as defined below.
Segment income consists of each segment’s revenue and direct expenses. Segment revenue is based on the types of products and services offered as described below. Wireline and wireless segment expenses include employee-related costs, facility costs, network expenses and other non-employee related costs such as customer
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QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
support, collections and telephone marketing. Expenses are generally assigned to the wireline and wireless segment based primarily on usage. Therefore, the results presented herein are not necessarily indicative of the results of operations these segments would have achieved had they operated as stand-alone entities during the periods presented. We manage indirect administrative services costs such as finance, information technology, real estate, legal, marketing and advertising and human resources centrally; consequently, these costs are included in the other services segment. We evaluate depreciation, amortization, interest expense, interest income and other income (expense) on a total company basis. As a result, these charges are not assigned to any segment.
Our wireline services segment uses our network to provide voice services and data and Internet services to mass markets, business and wholesale customers. Our wireline services include:
• | Voice services. Voice services revenue includes local voice, long-distance voice and access services. Local voice services revenue includes basic local exchange, switching, enhanced voice, operator and collocation services and custom calling features. Local voice services revenue also includes the provisioning of network transport, billing services and access to our local network on a wholesale basis. Long-distance voice services revenue includes InterLATA and IntraLATA long-distance services. Access services revenue includes fees charged to other data and telecommunications providers to connect their customers and their networks to our network. |
• | Data and Internet services. Data and Internet services revenue includes data services (such as traditional private lines, wholesale private lines and WAN), Internet services (such as high-speed Internet, ISDN and web hosting) and data integration. |
We offer wireless services and equipment to residential and business customers, providing them the ability to use the same telephone number for their wireless phone as for their home or business phone. By utilizing a third-party’s nationwide PCS wireless network, we sell wireless services to mass markets and business customers primarily in the states within our local service area.
Our other services revenue is predominantly derived from the sublease of some of our real estate, such as space in our office buildings, warehouses and other properties. Our other services segment expenses include unallocated corporate expenses for functions such as finance, information technology, real estate, legal, marketing and advertising and human resources, which we centrally manage.
Depending on the products or services purchased, a customer may pay an up-front or monthly fee, a usage charge or a combination of these.
Other than as already described herein, the accounting principles used are the same as those used in our condensed consolidated financial statements. The revenue shown below for each segment is derived from transactions with external customers. Substantially all of our assets are in our wireline and other segments.
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QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
Segment information for the three and nine months ended September 30, 2006 and 2005 is summarized in the following table:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2006 | 2005 | 2006 | 2005 | |||||||||||||
(Dollars in millions) | ||||||||||||||||
Operating revenue: | ||||||||||||||||
Wireline services | $ | 3,343 | $ | 3,361 | $ | 9,990 | $ | 10,002 | ||||||||
Wireless services | 135 | 131 | 416 | 389 | ||||||||||||
Other services | 9 | 12 | 29 | 32 | ||||||||||||
Total operating revenue | $ | 3,487 | $ | 3,504 | $ | 10,435 | $ | 10,423 | ||||||||
Operating expenses: | ||||||||||||||||
Wireline services | $ | 1,612 | $ | 1,681 | $ | 4,785 | $ | 4,950 | ||||||||
Wireless services | 143 | 142 | 419 | 446 | ||||||||||||
Other services | 641 | 705 | 1,986 | 2,086 | ||||||||||||
Total segment expenses | $ | 2,396 | $ | 2,528 | $ | 7,190 | $ | 7,482 | ||||||||
Segment income (loss): | ||||||||||||||||
Wireline services | $ | 1,731 | $ | 1,680 | $ | 5,205 | $ | 5,052 | ||||||||
Wireless services | (8 | ) | (11 | ) | (3 | ) | (57 | ) | ||||||||
Other services | (632 | ) | (693 | ) | (1,957 | ) | (2,054 | ) | ||||||||
Total segment income | $ | 1,091 | $ | 976 | $ | 3,245 | $ | 2,941 | ||||||||
Capital expenditures: | ||||||||||||||||
Wireline services | $ | 321 | $ | 346 | $ | 1,007 | $ | 853 | ||||||||
Wireless services | — | — | — | 2 | ||||||||||||
Other services | 73 | 99 | 219 | 255 | ||||||||||||
Total capital expenditures | $ | 394 | $ | 445 | $ | 1,226 | $ | 1,110 | ||||||||
The following table reconciles segment income to net income (loss) for the three and nine months ended September 30, 2006 and 2005:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2006 | 2005 | 2006 | 2005 | |||||||||||||
(Dollars in millions) | ||||||||||||||||
Segment income | $ | 1,091 | $ | 976 | $ | 3,245 | $ | 2,941 | ||||||||
Depreciation | (594 | ) | (659 | ) | (1,774 | ) | (1,961 | ) | ||||||||
Capitalized software and other intangible assets amortization | (97 | ) | (109 | ) | (301 | ) | (346 | ) | ||||||||
Total other expense—net | (249 | ) | (353 | ) | (798 | ) | (885 | ) | ||||||||
Income tax benefit | 43 | 1 | 27 | — | ||||||||||||
Net income (loss) | $ | 194 | $ | (144 | ) | $ | 399 | $ | (251 | ) | ||||||
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QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
The following table provides information for the three and nine months ended September 30, 2006 and 2005 about revenue derived from external customers for our products and services:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||
2006 | 2005 | 2006 | 2005 | |||||||||
(Dollars in millions) | ||||||||||||
Wireline voice services | $ | 2,200 | $ | 2,262 | $ | 6,647 | $ | 6,866 | ||||
Wireline data and Internet services | 1,143 | 1,099 | 3,343 | 3,136 | ||||||||
Wireless services | 135 | 131 | 416 | 389 | ||||||||
Other services | 9 | 12 | 29 | 32 | ||||||||
Total operating revenue | $ | 3,487 | $ | 3,504 | $ | 10,435 | $ | 10,423 | ||||
We provide a variety of telecommunications services on a domestic and international basis to business, government, mass markets and wholesale customers; however, our internationally-based customers do not result in a material amount of revenue to us.
We do not have any single customer that provides more than ten percent of our total revenue derived from external customers.
Note 9: Commitments and Contingencies
Throughout this note, 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 provided reserves for each of the matters described below.
Settlement of Consolidated Securities Action
Twelve putative class actions purportedly brought on behalf of purchasers of our publicly traded securities between May 24, 1999 and February 14, 2002 were consolidated into a consolidated securities action pending in federal district court in Colorado. The first of these actions was filed on July 27, 2001. Plaintiffs alleged, among other things, that defendants issued false and misleading financial results and made false statements about our business and investments, including making materially false statements in certain of our registration statements. The most recent complaint in this matter sought unspecified compensatory damages and other relief. However, counsel for plaintiffs indicated that the putative class would seek damages in the tens of billions of dollars.
On November 23, 2005, we, certain other defendants, and the putative class representatives entered into and filed with the federal district court in Colorado a Stipulation of Partial Settlement that, if implemented, will settle the consolidated securities action against us and certain other defendants. In September 2006, the federal district court in Colorado issued an order approving the proposed settlement on behalf of purchasers of our publicly traded securities between May 24, 1999 and July 28, 2002. The order is subject to appeal.
Under the settlement, we will pay a total of $400 million in cash—$100 million of which was deposited into an escrow account in the first quarter of 2006, $100 million of which was deposited on October 27, 2006, and $200 million of which will be deposited on January 15, 2007, plus interest on the $200 million at 3.75% per year for the period from October 29, 2006 through January 14, 2007.
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QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
The settlement resolves and releases the individual claims of the class representatives and the claims of the class they represent against us and all defendants except Joseph Nacchio, our former chief executive officer, and Robert Woodruff, our former chief financial officer. As part of the settlement, we received $10 million from Arthur Andersen LLP, which is also being released by the class representatives and the class they represent. If the settlement is not ultimately effected, we will repay the $10 million to Arthur Andersen. No parties admit any wrongdoing as part of the settlement.
As noted below under “Remaining Securities Actions,” a number of persons, including large pension funds, were excluded from the settlement class at their request. Some of these pension funds have filed individual suits against us. We will vigorously defend against such claims.
Settlement of Consolidated ERISA Action
Seven putative class actions purportedly brought against us on behalf of all participants and beneficiaries of the Qwest Savings and Investment Plan and predecessor plans, or the Plan, from March 7, 1999 until January 12, 2004 have been consolidated into a consolidated action in federal district court in Colorado. Other defendants in this action include current and former directors of Qwest, former officers and employees of Qwest and Deutsche Bank Trust Company Americas, or Deutsche Bank (formerly doing business as Bankers Trust Company). These suits also purport to seek relief on behalf of the Plan. The first of these actions was filed in March 2002. Plaintiffs assert breach of fiduciary duty claims against us and others under the Employee Retirement Income Security Act of 1974, as amended, alleging, among other things, various improprieties in managing holdings of our stock in the Plan. Plaintiffs seek damages, equitable and declaratory relief, along with attorneys’ fees and costs and restitution. Counsel for plaintiffs indicated that the putative class would seek billions of dollars of damages.
On April 26, 2006, we, the other defendants, and the putative class representatives entered into a Stipulation of Settlement that, if implemented, will settle the consolidated ERISA action. We have deposited $33 million in cash into a settlement fund for the benefit of the Plan in connection with the proposed settlement. Deutsche Bank has deposited $4.5 million in cash into a settlement fund for the benefit of the Plan to settle the claims against it in connection with the proposed settlement. No parties admit any wrongdoing as part of the proposed settlement. We received certain insurance proceeds as a contribution by individual defendants to this settlement, which offset $10 million of our $33 million payment. If the settlement is not ultimately effected, we will repay these insurance proceeds. In addition to the $33 million cash settlement, we have also agreed to pay, subject to certain contingencies, the amount (if any) by which the Plan’s recovery from the settlement of the consolidated securities action is less than $20 million. If approved by the district court, the proposed settlement will settle and release the claims of the class against us and all other defendants in the consolidated ERISA action. The federal district court in Colorado has issued orders (1) preliminarily approving the proposed settlement, (2) setting a hearing for November 17, 2006 to consider final approval of the proposed settlement, and (3) certifying a settlement class on behalf of participants in and beneficiaries of the Plan who owned, bought, sold or held shares or units of the Qwest Shares Fund, U S WEST Shares Fund or Qwest common stock in their Plan accounts from March 7, 1999 until January 12, 2004. The proposed settlement is subject to review on appeal if the district court were finally to approve it.
DOJ Investigation and Remaining Securities Actions
The Department of Justice, or DOJ, investigation and the securities actions described below present material and significant risks to us. The size, scope and nature of the restatements of our consolidated financial statements
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QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
for 2001 and 2000, which are described in our previously issued consolidated financial statements for the year ended December 31, 2002, or our 2002 Financial Statements, affect the risks presented by this investigation and these actions, as these matters involve, among other things, our prior accounting practices and related disclosures. Plaintiffs in certain of the securities actions have alleged our restatement of items in support of their claims. We can give no assurance as to the impacts on our financial results or financial condition that may ultimately result from these matters.
We have a reserve recorded in our financial statements for the minimum estimated amount of loss we believe is probable with respect to the remaining securities actions described below as well as any additional actions that may be brought by parties that, as described below under “Remaining Securities Actions,” have opted out of the settlement of the consolidated securities action. We have recorded our estimate of the minimum liability for these matters because no estimate of probable loss for these matters is a better estimate than any other amount. If the recorded reserve is insufficient to cover these matters, we will need to record additional charges to our consolidated statement of operations in future periods. The amount we have reserved for these matters is our estimate of the lowest end of the possible range of loss. The ultimate outcomes of these matters are still uncertain and the amount of loss we may ultimately incur could be substantially more than the reserve we have provided.
We continue to defend against the remaining securities actions described below vigorously and are currently unable to provide any estimate as to the timing of the resolution of these actions. Any settlement of or judgment in one or more of these actions substantially in excess of our recorded reserves could have a significant impact on us, and we can give no assurance that we will have the resources available to pay any such judgment. The magnitude of any settlement or judgment resulting from these actions could materially and adversely affect our financial condition and ability to meet our debt obligations, potentially impacting our credit ratings, our ability to access capital markets and our compliance with debt covenants. In addition, the magnitude of any such settlement or judgment may cause us to draw down significantly on our cash balances, which might force us to obtain additional financing or explore other methods to generate cash. Such methods could include issuing additional securities or selling assets.
The terms and conditions of applicable bylaws, certificates or articles of incorporation, agreements or applicable law may obligate us to indemnify our current and former directors, officers and employees with respect to certain liabilities, and we have been advancing legal fees and costs to many current and former directors, officers and employees in connection with the DOJ investigation, securities actions and certain other matters.
DOJ Investigation
On July 9, 2002, we were informed by the U.S. Attorney’s Office for the District of Colorado of a criminal investigation of our business. We believe the U.S. Attorney’s Office has investigated various matters that include transactions related to the various adjustments and restatements described in our 2002 Financial Statements, transactions between us and certain of our vendors and certain investments in the securities of those vendors by individuals associated with us, and certain prior disclosures made by us. We are continuing in our efforts to cooperate fully with the U.S. Attorney’s Office in its investigation. However, we cannot predict the outcome of this investigation or the timing of its resolution.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
Remaining Securities Actions
We are a defendant in the securities actions described below. At their request, plaintiffs in these actions were excluded from the settlement class of the consolidated securities action. As a result, their claims were not released by the district court’s order approving the settlement of the consolidated securities action. These plaintiffs have variously alleged, among other things, that we and others violated federal and state securities laws, engaged in fraud, civil conspiracy and negligent misrepresentation, and breached fiduciary duties owed to investors by issuing false and misleading financial reports and statements, falsely inflating revenue and decreasing expenses, creating false perceptions of revenue and growth prospects and/or employing improper accounting practices. Other defendants in one or more of these actions include current and former directors of Qwest, former officers and employees of Qwest, Arthur Andersen LLP, certain investment banks and others. Plaintiffs variously seek, among other things, compensatory and punitive damages, restitution, equitable and declaratory relief, pre-judgment interest, costs and attorneys’ fees.
Together, the parties to these lawsuits contend that they have incurred losses resulting from their investments in our securities in excess of $1.51 billion; they have also asserted claims for punitive damages and interest, in addition to claims to recover their alleged losses.
Plaintiff(s) | Date Filed | Court Where Action Is Pending | ||
State of New Jersey (Treasury Department, Division of Investment) | November 27, 2002 | New Jersey Superior Court, Mercer County | ||
California State Teachers’ Retirement System | December 10, 2002 | Superior Court, State of California, County of San Francisco | ||
State Universities Retirement System of Illinois | January 10, 2003 | Circuit Court of Cook County, Illinois | ||
Stichting Pensioenfonds ABP (SPA) | February 9, 2004 | Federal District Court in Colorado | ||
Shriners Hospital for Children | March 22, 2004 | Federal District Court in Colorado | ||
Teachers’ Retirement System of Louisiana | March 30, 2004 | Federal District Court in Colorado | ||
A number of New York City pension and retirement funds | September 22, 2004 | Federal District Court in Colorado | ||
New York State Common Retirement Fund | April 18, 2006 | Federal District Court in Colorado | ||
San Francisco Employees Retirement System | April 18, 2006 | Federal District Court in Colorado | ||
Fire and Police Pension Association of Colorado | April 18, 2006 | Federal District Court in Colorado | ||
Commonwealth of Pennsylvania Public School Employees’ Retirement System | May 1, 2006 | Federal District Court in Colorado | ||
Merrill Lynch Investment Master Basic Value Trust Fund, et al. | June 21, 2006 | Federal District Court in Colorado | ||
Denver Employees Retirement Plan | August 7, 2006 | Federal District Court in Colorado | ||
FTWF Franklin Mutual Beacon Fund, et al. | October 17, 2006 | Superior Court, State of California, County of San Francisco |
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
At their request, other persons (including large pension funds) who have not yet filed suit were also excluded from the settlement class. As a result, their claims were not released by the order approving the settlement of the consolidated securities action. We expect that some of these other persons will file actions against us if we are unable to resolve those matters amicably. In the aggregate, the persons who have requested exclusion from the settlement class, excluding those listed in the table above, contend that they have incurred losses resulting from their investments in our securities of approximately $1.19 billion, which does not include any claims for punitive damages or interest. Due to the fact that many of the persons who requested exclusion from the settlement class have not filed lawsuits, it is difficult to evaluate the claims that they may assert. Regardless, we will vigorously defend against any such claims.
Other
A putative class action purportedly brought on behalf of purchasers of our stock between June 28, 2000 and June 27, 2002 and owners of U S WEST, Inc. stock on June 28, 2000 is pending in Colorado in the District Court for the County of Boulder. This action was filed on June 27, 2002. Plaintiffs allege, among other things, that we and other defendants issued false and misleading statements and engaged in improper accounting practices in order to accomplish the U S WEST/Qwest merger, to make us appear successful and to inflate the value of our stock. Plaintiffs seek unspecified monetary damages, disgorgement of illegal gains and other relief.
KPNQwest Litigation/Investigation
Settlement of Putative Securities Class Action
A putative class action is pending in the federal district court for the Southern District of New York against us, certain of our former executives who were also on the supervisory board of KPNQwest, N.V. (of which we were a major shareholder), and others. This lawsuit was initially filed on October 4, 2002. The current complaint alleges, on behalf of certain purchasers of KPNQwest securities, that, among other things, defendants engaged in a fraudulent scheme and deceptive course of business in order to inflate KPNQwest’s revenue and the value of KPNQwest securities. Plaintiffs seek compensatory damages and/or rescission as appropriate against defendants, as well as an award of plaintiffs’ attorneys’ fees and costs. On February 3, 2006, we, certain other defendants and the putative class representative in this action executed an agreement to settle the case against us and certain other defendants. Under the settlement agreement, we have deposited $5.5 million in cash into a settlement fund on behalf of the settlement class, and no later than 30 days following final approval by the court, we will issue shares of our stock to the settlement fund then valued at $5.5 million as additional consideration for the settlement. The settlement agreement would settle the individual claims of the putative class representative and the claims of the class he purports to represent against us and all defendants except Koninklijke KPN N.V. a/k/a Royal KPN N.V., Willem Ackermans, Eelco Blok, Joop Drechsel, Martin Pieters, and Rhett Williams. Those defendants are parties to a separate proposed settlement agreement with the putative class representative. The federal district court for the Southern District of New York has issued orders (1) preliminarily approving the proposed settlements, (2) setting a hearing for January 4, 2007 to consider final approval of the proposed settlements, and (3) certifying a settlement class on behalf of purchasers of KPNQwest’s publicly traded securities from November 9, 1999 through May 31, 2002.
Our settlement agreement with the putative class representative is subject to a number of conditions and future contingencies. Among others, it (i) requires final court approval; (ii) provides us with the right to terminate the settlement if class members representing more than a specified amount of alleged securities losses elect to opt out of the settlement; (iii) provides us with the right to terminate the settlement if we do not receive adequate protections for claims relating to substantive liabilities of non-settling defendants; and (iv) is subject to review on
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
appeal even if the district court were finally to approve it. Any lawsuits that may be brought by parties opting out of the settlement will be vigorously defended regardless of whether the proposed settlement is consummated. No parties admit any wrongdoing as part of the proposed settlement.
Certain individuals and entities have opted out of the KPNQwest securities settlement class. As a result, their claims will not be released even if the settlement is finally approved by the district court. Some of these individuals and entities have already filed actions against us, as described below. We expect that at least some of the others who opted out will also pursue actions against us if we are unable to resolve their claims amicably. In the aggregate, those who have requested exclusion from the settlement class currently contend that they have incurred losses resulting from their investments in KPNQwest securities during the settlement class period of at least $76 million, which does not include any claims for punitive damages or interest. The amount of these alleged losses may increase or decrease in the future as we learn more about the potential claims of those who opted out of the settlement class. Due to the fact that many of those who requested exclusion from the settlement class have not filed lawsuits based on the losses they claim to have incurred from their investments in KPNQwest securities during the settlement class period, it is difficult to evaluate the claims that they may assert. Regardless, we will vigorously defend against any such claims.
Other KPNQwest-Related Proceedings
On October 31, 2002, Richard and Marcia Grand, co-trustees of the R.M. Grand Revocable Living Trust, dated January 25, 1991, filed a lawsuit in Arizona Superior Court which, as amended, alleges, among other things, that the defendants violated state and federal securities laws and breached their fiduciary duty in connection with investments by plaintiffs in securities of KPNQwest. We were a defendant in this lawsuit along with Qwest B.V. (one of our subsidiaries), Joseph Nacchio and John McMaster, the former President and Chief Executive Officer of KPNQwest. Plaintiffs claim to have lost approximately $10 million in their investments in KPNQwest. The superior court granted defendants’ motion for partial summary judgment with respect to a substantial portion of plaintiffs’ claims and the remainder of plaintiffs’ claims were dismissed without prejudice. Plaintiffs have appealed the summary judgment order to the Arizona Court of Appeals.
On June 25, 2004, J.C. van Apeldoorn and E.T. Meijer, in their capacities as trustees in the Dutch bankruptcy proceeding for KPNQwest, filed a lawsuit in the federal district court for the District of New Jersey alleging violations of the Racketeer Influenced and Corrupt Organizations Act, and breach of fiduciary duty and mismanagement under Dutch law. We were a defendant in this lawsuit along with Joseph Nacchio, Robert S. Woodruff and John McMaster. Plaintiffs allege, among other things, that defendants’ actions were a cause of the bankruptcy of KPNQwest and they sought damages for the bankruptcy deficit of KPNQwest of approximately $2.4 billion. Plaintiffs also sought treble damages as well as an award of plaintiffs’ attorneys’ fees and costs. On October 17, 2006, the court issued an order granting defendants’ motion to dismiss the lawsuit, concluding that the dispute should not be adjudicated in the United States. That decision is subject to appeal.
On June 17, 2005, Appaloosa Investment Limited Partnership I, Palomino Fund Ltd., and Appaloosa Management L.P. filed a lawsuit in the federal district court for the Southern District of New York against us, Joseph Nacchio, John McMaster and Koninklijke KPN N.V., or KPN. The complaint alleges that defendants violated federal securities laws in connection with the purchase by plaintiffs of certain KPNQwest debt securities. Plaintiffs seek compensatory damages, as well as an award of plaintiffs’ attorneys’ fees and costs.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
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 Telecom B.V., Koninklijke KPN N.V., Joseph Nacchio, John McMaster, and other former employees or supervisory board members of us, KPNQwest, or KPN. 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. The plaintiffs allege damages of approximately €219 million (or $278 million based on the exchange rate on September 30, 2006).
On August 23, 2005, the Dutch Shareholders Association (Vereniging van Effectenbezitters, or VEB) filed a petition for inquiry with the Enterprise Chamber of the Amsterdam Court of Appeals, located in the Netherlands, with regard to KPNQwest. VEB seeks an inquiry into the policies and course of business at KPNQwest that are alleged to have caused the bankruptcy of KPNQwest in May 2002, and an investigation into alleged mismanagement of KPNQwest by its executive management, supervisory board members, joint venture entities (us and KPN), and KPNQwest’s outside auditors and accountants.
Other than the putative class action in which we have entered into a proposed settlement (and for which we have a remaining reserve of $5.5 million in connection with the proposed settlement), we will continue to defend against the pending KPNQwest litigation matters vigorously.
Regulatory Matter
On July 15, 2004, the New Mexico state regulatory commission opened a proceeding to investigate whether we were in compliance with or were likely to meet a commitment that we made in 2001 to invest $788 million in communications infrastructure in New Mexico through March 2006 pursuant to an Alternative Form of Regulation plan, or AFOR. Multiple parties filed comments in that proceeding and variously argued that we should be subject to a range of requirements including an escrow account for capital spending, new investment obligations, and customer credits or price reductions.
On April 14, 2005, the Commission issued its Final Order in connection with this investigation. The Commission concluded in this Final Order that we had an unconditional commitment to invest $788 million over the life of the AFOR. The Commission also ruled that if we failed to satisfy this investment commitment, any shortfall must be credited or refunded to our New Mexico customers. The Commission also opened an enforcement and implementation docket to review our investments and consider the structure and size of any refunds or credits to be issued to customers. On May 12 and 13, 2005, we filed appeals in federal district court and in the New Mexico State Supreme Court, respectively, challenging the lawfulness of the Commission’s Final Order. On February 24, 2006, the federal district court granted the defendants’ motion to dismiss and on June 29, 2006, the New Mexico Supreme Court issued its opinion affirming the Commission’s Final Order. The opinion concluded that the Commission had the authority to add to the AFOR the incentive requiring Qwest to issue credits or refunds in the amount of the shortfall between the investment commitment and the amount invested during the term of the AFOR.
On July 26, 2006, we entered into a settlement with the New Mexico General Services Department and the New Mexico Attorney General that would resolve the disputes described above. This settlement must be approved by the Commission, and the hearing to consider the settlement is set for November 2006. Under the settlement, we would contribute $15 million, for which we have established a liability, to the Students and Teachers Reaching Optimal New Goals Project, a program established and operated under the auspices of the
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
New Mexico Department of Education. In addition, we would invest in our New Mexico network a total of $250 million over 42 months in specific categories of telecommunications infrastructure projects. Our obligation to make these expenditures and investments will arise only upon approval of the settlement by the Commission. In the unlikely event that we do not achieve the required investment level over the 42 month period, we would be required under the settlement to refund any deficiency to our New Mexico customers.
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 California, Colorado, Georgia, Illinois, Indiana, Kansas, Mississippi, Missouri, Oregon, South Carolina, Tennessee and Texas. For the most part, the complaints challenge our right to install our fiber optic cable in railroad rights-of-way. Complaints in Colorado, Illinois and Texas, also challenge our right to install fiber optic cable in utility and pipeline rights-of-way. The complaints allege that the railroads, utilities and pipeline companies 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 actions (California, Colorado, Georgia, Kansas, Mississippi, Missouri, Oregon, South Carolina, Tennessee and Texas) purport to be brought on behalf of state-wide classes in the named plaintiffs’ respective states. Several actions purport to be brought on behalf of multi-state classes. The Illinois state court action purports to be on behalf of landowners in Illinois, Iowa, Kentucky, Michigan, Minnesota, Nebraska, Ohio and Wisconsin. The Illinois federal court action purports to be on behalf of landowners in Arkansas, California, Florida, Illinois, Indiana, Missouri, Nevada, New Mexico, Montana and Oregon. The Indiana action purports to be on behalf of a national class of landowners adjacent to railroad rights-of-way over which our network passes. The complaints seek damages on theories of trespass and unjust enrichment, as well as punitive damages.
On September 1, 2006, Ronald A. Katz Technology Licensing, L.P. (“Katz”) filed a lawsuit in Federal District Court in Delaware against us (including a number of our subsidiaries). The lawsuit alleges infringement by us of 24 patents. The lawsuit also names as defendants a number of other entities that are unrelated to us. Katz is also involved in approximately 24 other cases against numerous other unrelated entities both in Delaware and in the Eastern District of Texas. Although the complaint against us is vague, it generally alleges infringement based on our use of interactive voice response systems to automate processing of customer calls to us. Katz seeks unspecified damages, trebling of the damages based on alleged willful infringement, attorney’s fees and injunctive relief.
The Internal Revenue Service (“IRS”) proposed a tax adjustment for tax years 1994 through 1996. The principal issue involves the allocation of costs between long-term contracts with customers for the installation of conduit or fiber optic cable and additional conduit or fiber optic cable retained by us. The IRS disputes the allocation of the costs between us and third parties. Similar claims have been asserted against us with respect to the 1997 to 1998 and the 1998 to 2001 audit periods. On March 13, 2006, the Tax Court issued a decision for the tax years 1994 to 1996, which was favorable to Qwest. The IRS may appeal the decision to the 10th Circuit Court of Appeals. The trial for the 1997-1998 tax years has been scheduled for April 2007. If we ultimately were to lose this issue for the tax years 1994 through 1998, we estimate that we would have to pay approximately $57 million in tax plus approximately $51 million in interest pursuant to tax sharing agreements with the Anschutz Company relating to those time periods.
We have tax related matters pending against us, certain of which are before the Appeals Office of the IRS. In addition, tax sharing agreements have been executed between us and previous affiliates, and we believe the
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
liabilities, if any, arising from adjustments to previously filed returns would be borne by the affiliated group member determined to have a deficiency under the terms and conditions of such agreements and applicable tax law. Generally, we have not provided for liabilities of former affiliated members or for claims they have asserted or may assert against us. We believe we have adequately provided for these tax-related matters. If the recorded reserves for these tax-related matters are insufficient, we may need to record additional amounts in future periods.
Note 10: Income Taxes
We have tax sharing agreements with previous affiliates that require cash payments between the parties in certain situations. In the third quarter of 2006, we negotiated a settlement of certain open issues covered by one of these agreements. Under the settlement, we received $135 million on October 6, 2006, which was included in accounts receivable on our condensed consolidated balance sheet as of September 30, 2006. As a result of the settlement, we recognized $53 million in income tax benefit and $39 million in interest income. This interest income was included in other–net in the third quarter of 2006.
Note 11: Subsequent Events
On October 4, 2006, our Board of Directors approved a stock repurchase program for up to $2 billion of our common stock over the next two years.
Note 12: Financial Statements of Guarantors
We and two of our subsidiaries, QCF and QSC, guarantee certain of each other’s registered debt securities. QCII issued a total of $2.575 billion aggregate principal amount of senior notes in February 2004 and June 2005 that are guaranteed by QCF and QSC (the “QCII Guaranteed Notes”). Between December 2002 and April 2003, QSC issued a total of $3.7 billion aggregate principal amount of senior subordinated secured notes (approximately $21 million of which remain outstanding) that are guaranteed by QCF and QCII on a senior unsecured basis (the “QSC Guaranteed Notes”). Each series of QCF’s outstanding notes totaling approximately $2.9 billion in aggregate principal amount (the “QCF Guaranteed Notes”) is guaranteed on a senior unsecured basis by QCII. The guarantees are full and unconditional, and joint and several. A significant amount of QCII’s and QSC’s income and cash flow is generated by their subsidiaries. As a result, funds necessary to meet each issuer’s debt service obligations are provided in large part by distributions or advances from their subsidiaries.
The following information sets forth our condensed consolidating balance sheets as of September 30, 2006 and December 31, 2005, our condensed consolidating statements of operations for the three and nine months ended September 30, 2006 and 2005 and our condensed consolidating statements of cash flows for the nine months ended September 30, 2006 and 2005. The information for QCII, QSC and QCF is presented for each entity on a stand-alone basis, including that entity’s investments in all of its subsidiaries, if any, under the equity method. The condensed 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. The direct subsidiaries of QCII that are not guarantors of the QCII Guaranteed Notes or the QSC Guaranteed Notes are presented on a combined basis. The direct subsidiaries of QSC that are not guarantors of the QCII Guaranteed Notes or the QSC Guaranteed Notes are presented on a combined basis. Both QSC and QCF are 100% owned by QCII. Other than as already described herein, the accounting principles used are the same as those used in our condensed consolidated financial statements.
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QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
Allocations among Affiliates
We allocate the costs of shared services among our affiliates. These services include marketing and advertising, information technology, product and technical services as well as general support services. The allocation of these costs is based on market price or fully distributed cost (“FDC”). Most of our affiliate services are priced by applying an FDC methodology. FDC rates are determined using salary rates, which include payroll taxes, employee benefits, facilities and overhead costs Whenever possible, costs are directly assigned to the affiliate that uses the service. If costs cannot be directly assigned, they are allocated among all affiliates based on cost usage measures; or if no cost usage measure is available, these costs are allocated based on a general allocator. From time to time, we adjust the basis for allocating the costs of a shared service among our affiliates. Such changes in allocation methodologies are generally billed prospectively.
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QWEST COMMUNICATIONS INTERNATIONAL INC.
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
QCII(1) | QSC(2) | QCF(3) | QCII Subsidiary Non- Guarantors | QSC Subsidiary Non- Guarantors | Eliminations | QCII Consolidated | ||||||||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||||||||||
Operating revenue: | ||||||||||||||||||||||||||||
Operating revenue | $ | — | $ | — | $ | — | $ | 2 | $ | 3,485 | $ | — | $ | 3,487 | ||||||||||||||
Operating revenue—affiliates | — | 337 | — | 12 | 30 | (379 | ) | — | ||||||||||||||||||||
Total operating revenue | — | 337 | — | 14 | 3,515 | (379 | ) | 3,487 | ||||||||||||||||||||
Operating expenses: | ||||||||||||||||||||||||||||
Cost of sales (exclusive of depreciation and amortization) | — | 298 | — | — | 1,372 | (288 | ) | 1,382 | ||||||||||||||||||||
Cost of sales—affiliates | — | 41 | — | — | 21 | (62 | ) | — | ||||||||||||||||||||
Selling, general and administrative | (13 | ) | — | — | 14 | 725 | 288 | 1,014 | ||||||||||||||||||||
Selling, general and administrative—affiliates | — | — | — | — | 317 | (317 | ) | — | ||||||||||||||||||||
Depreciation | — | 1 | — | — | 593 | — | 594 | |||||||||||||||||||||
Capitalized software and other intangible assets amortization | — | — | — | — | 97 | — | 97 | |||||||||||||||||||||
Total operating expenses | (13 | ) | 340 | — | 14 | 3,125 | (379 | ) | 3,087 | |||||||||||||||||||
Other expense (income)—net: | ||||||||||||||||||||||||||||
Interest expense—net | 69 | 1 | 57 | 1 | 163 | — | 291 | |||||||||||||||||||||
Interest expense—affiliates | 4 | — | 131 | — | 309 | (444 | ) | — | ||||||||||||||||||||
Interest (income)—affiliates | — | (131 | ) | (312 | ) | (1 | ) | — | 444 | — | ||||||||||||||||||
Loss on early retirement of debt—net | — | — | — | — | 9 | — | 9 | |||||||||||||||||||||
Other (income) expense—net | (40 | ) | (9 | ) | — | 3 | (5 | ) | — | (51 | ) | |||||||||||||||||
(Income) loss from equity investments in subsidiaries | (167 | ) | 239 | — | — | — | (72 | ) | — | |||||||||||||||||||
Total other expense (income)—net | (134 | ) | 100 | (124 | ) | 3 | 476 | (72 | ) | 249 | ||||||||||||||||||
Income (loss) before income taxes | 147 | (103 | ) | 124 | (3 | ) | (86 | ) | 72 | 151 | ||||||||||||||||||
Income tax benefit (expense) | 47 | 196 | (47 | ) | — | (153 | ) | — | 43 | |||||||||||||||||||
Net income (loss) | $ | 194 | $ | 93 | $ | 77 | $ | (3 | ) | $ | (239 | ) | $ | 72 | $ | 194 | ||||||||||||
(1) | QCII is the issuer of the QCII Guaranteed Notes and is a guarantor of the QSC Guaranteed Notes and the QCF Guaranteed Notes. |
(2) | QSC is a guarantor of the QCII Guaranteed Notes and is the issuer of the QSC Guaranteed Notes. |
(3) | QCF is a guarantor of both the QCII Guaranteed Notes and the QSC Guaranteed Notes and is the issuer of the QCF Guaranteed Notes. |
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QWEST COMMUNICATIONS INTERNATIONAL INC.
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005
(UNAUDITED)
QCII(1) | QSC(2) | QCF(3) | QCII Subsidiary Non- Guarantors | QSC Subsidiary Non- Guarantors | Eliminations | QCII Consolidated | ||||||||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||||||||||
Operating revenue: | ||||||||||||||||||||||||||||
Operating revenue | $ | — | $ | — | $ | — | $ | 3 | $ | 3,501 | $ | — | $ | 3,504 | ||||||||||||||
Operating revenue—affiliates | — | 328 | — | 9 | 40 | (377 | ) | — | ||||||||||||||||||||
Total operating revenue | — | 328 | — | 12 | 3,541 | (377 | ) | 3,504 | ||||||||||||||||||||
Operating expenses: | ||||||||||||||||||||||||||||
Cost of sales (exclusive of depreciation and amortization) | — | 268 | — | — | 1,504 | (260 | ) | 1,512 | ||||||||||||||||||||
Cost of sales—affiliates | — | 50 | — | — | 24 | (74 | ) | — | ||||||||||||||||||||
Selling, general and administrative | 22 | — | — | 13 | 721 | 260 | 1,016 | |||||||||||||||||||||
Selling, general and administrative—affiliates | — | — | — | — | 303 | (303 | ) | — | ||||||||||||||||||||
Depreciation | — | 1 | — | — | 658 | — | 659 | |||||||||||||||||||||
Capitalized software and other intangible assets amortization | — | — | — | — | 109 | — | 109 | |||||||||||||||||||||
Total operating expenses | 22 | 319 | — | 13 | 3,319 | (377 | ) | 3,296 | ||||||||||||||||||||
Other expense (income)—net: | ||||||||||||||||||||||||||||
Interest expense—net | 52 | 99 | 66 | — | 167 | — | 384 | |||||||||||||||||||||
Interest expense—affiliates | 1 | — | 115 | — | 267 | (383 | ) | — | ||||||||||||||||||||
Interest (income)—affiliates | — | (116 | ) | (266 | ) | (1 | ) | — | 383 | — | ||||||||||||||||||
Gain on early retirement of debt—net | — | — | (11 | ) | — | — | — | (11 | ) | |||||||||||||||||||
Other (income) expense—net | (2 | ) | (8 | ) | — | (2 | ) | (8 | ) | — | (20 | ) | ||||||||||||||||
Loss (income) from equity investments in subsidiaries | 107 | 333 | — | — | — | (440 | ) | — | ||||||||||||||||||||
Total other expense (income)—net | 158 | 308 | (96 | ) | (3 | ) | 426 | (440 | ) | 353 | ||||||||||||||||||
(Loss) income before income taxes | (180 | ) | (299 | ) | 96 | 2 | (204 | ) | 440 | (145 | ) | |||||||||||||||||
Income tax benefit (expense) | 36 | 131 | (36 | ) | (1 | ) | (129 | ) | — | 1 | ||||||||||||||||||
Net (loss) income | $ | (144 | ) | $ | (168 | ) | $ | 60 | $ | 1 | $ | (333 | ) | $ | 440 | $ | (144 | ) | ||||||||||
(1) | QCII is the issuer of the QCII Guaranteed Notes and is a guarantor of the QSC Guaranteed Notes and the QCF Guaranteed Notes. |
(2) | QSC is a guarantor of the QCII Guaranteed Notes and is the issuer of the QSC Guaranteed Notes. |
(3) | QCF is a guarantor of both the QCII Guaranteed Notes and the QSC Guaranteed Notes and is the issuer of the QCF Guaranteed Notes. |
28
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QWEST COMMUNICATIONS INTERNATIONAL INC.
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
QCII(1) | QSC(2) | QCF(3) | QCII Subsidiary Non- Guarantors | QSC Subsidiary Non- Guarantors | Eliminations | QCII Consolidated | ||||||||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||||||||||
Operating revenue: | ||||||||||||||||||||||||||||
Operating revenue | $ | — | $ | — | $ | — | $ | 7 | $ | 10,428 | $ | — | $ | 10,435 | ||||||||||||||
Operating revenue—affiliates | — | 1,013 | — | 36 | 90 | (1,139 | ) | — | ||||||||||||||||||||
Total operating revenue | — | 1,013 | — | 43 | 10,518 | (1,139 | ) | 10,435 | ||||||||||||||||||||
Operating expenses: | ||||||||||||||||||||||||||||
Cost of sales (exclusive of depreciation and amortization) | — | 886 | — | — | 4,162 | (856 | ) | 4,192 | ||||||||||||||||||||
Cost of sales—affiliates | — | 125 | — | — | 68 | (193 | ) | — | ||||||||||||||||||||
Selling, general and administrative | 15 | — | — | 39 | 2,088 | 856 | 2,998 | |||||||||||||||||||||
Selling, general and administrative—affiliates | — | — | — | — | 946 | (946 | ) | — | ||||||||||||||||||||
Depreciation | — | 2 | — | — | 1,772 | — | 1,774 | |||||||||||||||||||||
Capitalized software and other intangible assets amortization | — | — | — | — | 301 | — | 301 | |||||||||||||||||||||
Total operating expenses | 15 | 1,013 | — | 39 | 9,337 | (1,139 | ) | 9,265 | ||||||||||||||||||||
Other expense (income)—net: | ||||||||||||||||||||||||||||
Interest expense—net | 205 | 5 | 184 | 1 | 490 | — | 885 | |||||||||||||||||||||
Interest expense—affiliates | 10 | — | 349 | — | 885 | (1,244 | ) | — | ||||||||||||||||||||
Interest (income)—affiliates | — | (349 | ) | (892 | ) | (3 | ) | — | 1,244 | — | ||||||||||||||||||
(Gain) loss on early retirement of debt—net | — | — | (5 | ) | — | 9 | — | 4 | ||||||||||||||||||||
Gain on sale of assets | — | — | — | — | (3 | ) | — | (3 | ) | |||||||||||||||||||
Other (income) expense—net | (42 | ) | (23 | ) | — | 1 | (24 | ) | — | (88 | ) | |||||||||||||||||
(Income) loss from equity investments in subsidiaries | (447 | ) | 644 | — | — | — | (197 | ) | — | |||||||||||||||||||
Total other (income) expense —net | (274 | ) | 277 | (364 | ) | (1 | ) | 1,357 | (197 | ) | 798 | |||||||||||||||||
Income (loss) before income taxes | 259 | (277 | ) | 364 | 5 | (176 | ) | 197 | 372 | |||||||||||||||||||
Income tax benefit (expense) | 140 | 496 | (138 | ) | (3 | ) | (468 | ) | — | 27 | ||||||||||||||||||
Net income (loss) | $ | 399 | $ | 219 | $ | 226 | $ | 2 | $ | (644 | ) | $ | 197 | $ | 399 | |||||||||||||
(1) | QCII is the issuer of the QCII Guaranteed Notes and is a guarantor of the QSC Guaranteed Notes and the QCF Guaranteed Notes. |
(2) | QSC is a guarantor of the QCII Guaranteed Notes and is the issuer of the QSC Guaranteed Notes. |
(3) | QCF is a guarantor of both the QCII Guaranteed Notes and the QSC Guaranteed Notes and is the issuer of the QCF Guaranteed Notes. |
29
Table of Contents
QWEST COMMUNICATIONS INTERNATIONAL INC.
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005
(UNAUDITED)
QCII(1) | QSC(2) | QCF(3) | QCII Subsidiary Non- Guarantors | QSC Subsidiary Non- Guarantors | Eliminations | QCII Consolidated | ||||||||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||||||||||
Operating revenue: | ||||||||||||||||||||||||||||
Operating revenue | $ | — | $ | — | $ | — | $ | 6 | $ | 10,417 | $ | — | $ | 10,423 | ||||||||||||||
Operating revenue—affiliates | — | 1,005 | — | 27 | 116 | (1,148 | ) | — | ||||||||||||||||||||
Total operating revenue | — | 1,005 | — | 33 | 10,533 | (1,148 | ) | 10,423 | ||||||||||||||||||||
Operating expenses: | ||||||||||||||||||||||||||||
Cost of sales (exclusive of depreciation and amortization) | — | 820 | — | — | 4,362 | (797 | ) | 4,385 | ||||||||||||||||||||
Cost of sales—affiliates | — | 144 | — | — | 72 | (216 | ) | — | ||||||||||||||||||||
Selling, general and administrative | 84 | — | — | 32 | 2,184 | 797 | 3,097 | |||||||||||||||||||||
Selling, general and administrative—affiliates | — | — | — | — | 932 | (932 | ) | — | ||||||||||||||||||||
Depreciation | — | 2 | — | — | 1,959 | — | 1,961 | |||||||||||||||||||||
Capitalized software and other intangible assets amortization | — | — | — | — | 346 | — | 346 | |||||||||||||||||||||
Total operating expenses | 84 | 966 | — | 32 | 9,855 | (1,148 | ) | 9,789 | ||||||||||||||||||||
Other expense (income)—net: | ||||||||||||||||||||||||||||
Interest expense—net | 127 | 324 | 204 | — | 490 | — | 1,145 | |||||||||||||||||||||
Interest expense—affiliates | 5 | — | 481 | — | 940 | (1,426 | ) | — | ||||||||||||||||||||
Interest (income)—affiliates | (18 | ) | (469 | ) | (937 | ) | (2 | ) | — | 1,426 | — | |||||||||||||||||
Loss (gain) on early retirement of debt—net | — | 18 | (23 | ) | — | 37 | — | 32 | ||||||||||||||||||||
Gain on sale of assets | — | — | — | — | (257 | ) | — | (257 | ) | |||||||||||||||||||
Other (income) expense—net | (5 | ) | (17 | ) | — | (2 | ) | (11 | ) | — | (35 | ) | ||||||||||||||||
Loss (income) from equity investments in subsidiaries | 163 | 962 | — | — | — | (1,125 | ) | — | ||||||||||||||||||||
Total other expense (income)—net | 272 | 818 | (275 | ) | (4 | ) | 1,199 | (1,125 | ) | 885 | ||||||||||||||||||
(Loss) income before income taxes | (356 | ) | (779 | ) | 275 | 5 | (521 | ) | 1,125 | (251 | ) | |||||||||||||||||
Income tax benefit (expense) | 105 | 442 | (104 | ) | (2 | ) | (441 | ) | — | — | ||||||||||||||||||
Net (loss) income | $ | (251 | ) | $ | (337 | ) | $ | 171 | $ | 3 | $ | (962 | ) | $ | 1,125 | $ | (251 | ) | ||||||||||
(1) | QCII is the issuer of the QCII Guaranteed Notes and is a guarantor of the QSC Guaranteed Notes and the QCF Guaranteed Notes. |
(2) | QSC is a guarantor of the QCII Guaranteed Notes and is the issuer of the QSC Guaranteed Notes. |
(3) | QCF is a guarantor of both the QCII Guaranteed Notes and the QSC Guaranteed Notes and is the issuer of the QCF Guaranteed Notes. |
30
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QWEST COMMUNICATIONS INTERNATIONAL INC.
CONDENSED CONSOLIDATING BALANCE SHEETS
SEPTEMBER 30, 2006
(UNAUDITED)
QCII(1) | QSC(2) | QCF(3) | QCII Subsidiary Non- Guarantors | QSC Subsidiary Non- Guarantors | Eliminations | QCII Consolidated | |||||||||||||||||||||
(Dollars in millions) | |||||||||||||||||||||||||||
ASSETS | |||||||||||||||||||||||||||
Current assets: | |||||||||||||||||||||||||||
Cash and cash equivalents | $ | — | $ | 657 | $ | — | $ | — | $ | 305 | $ | — | $ | 962 | |||||||||||||
Short-term investments | — | 161 | — | — | 57 | — | 218 | ||||||||||||||||||||
Accounts receivable—net | 152 | 9 | — | 1 | 1,556 | — | 1,718 | ||||||||||||||||||||
Accounts receivable—affiliates | 43 | 598 | 104 | — | 30 | (775 | ) | — | |||||||||||||||||||
Current tax receivable | 1 | — | — | — | — | (1 | ) | — | |||||||||||||||||||
Notes receivable—affiliates | — | 7,075 | 16,593 | 83 | — | (23,751 | ) | — | |||||||||||||||||||
Deferred income taxes | — | 28 | 6 | — | 114 | (6 | ) | 142 | |||||||||||||||||||
Prepaid expenses and other current assets | — | 58 | (1 | ) | 62 | 419 | (3 | ) | 535 | ||||||||||||||||||
Total current assets | 196 | 8,586 | 16,702 | 146 | 2,481 | (24,536 | ) | 3,575 | |||||||||||||||||||
Property, plant and equipment—net | — | 8 | — | — | 14,820 | — | 14,828 | ||||||||||||||||||||
Capitalized software and other intangible assets—net | 41 | — | — | — | 902 | — | 943 | ||||||||||||||||||||
Investments in subsidiaries | 1,808 | (14,155 | ) | — | — | — | 12,347 | — | |||||||||||||||||||
Deferred income taxes | — | 1,545 | 39 | 11 | (1 | ) | (1,594 | ) | — | ||||||||||||||||||
Prepaid pension asset (4) | — | 85 | — | — | 1,026 | — | 1,111 | ||||||||||||||||||||
Other assets | 196 | 38 | 13 | — | 410 | — | 657 | ||||||||||||||||||||
Total assets | $ | 2,241 | $ | (3,893 | ) | $ | 16,754 | $ | 157 | $ | 19,638 | $ | (13,783 | ) | $ | 21,114 | |||||||||||
LIABILITIES AND EQUITY | |||||||||||||||||||||||||||
Current liabilities: | |||||||||||||||||||||||||||
Current borrowings | $ | 1,271 | $ | — | $ | — | $ | — | $ | 414 | $ | — | $ | 1,685 | |||||||||||||
Current borrowings—affiliates | 194 | — | 7,075 | — | 16,482 | (23,751 | ) | — | |||||||||||||||||||
Accounts payable | 1 | 42 | — | — | 790 | — | 833 | ||||||||||||||||||||
Accounts payable—affiliates | 113 | 25 | — | 31 | 251 | (420 | ) | — | |||||||||||||||||||
Accrued expenses and other current liabilities | 385 | 191 | 34 | 31 | 1,199 | — | 1,840 | ||||||||||||||||||||
Accrued expenses and other current liabilities—affiliates | — | — | 46 | — | 309 | (355 | ) | — | |||||||||||||||||||
Current taxes payable | — | 31 | — | 2 | 132 | (1 | ) | 164 | |||||||||||||||||||
Deferred income taxes | 6 | — | — | — | — | (6 | ) | — | |||||||||||||||||||
Deferred revenue and advance billings | — | — | — | 3 | 622 | (3 | ) | 622 | |||||||||||||||||||
Total current liabilities | 1,970 | 289 | 7,155 | 67 | 20,199 | (24,536 | ) | 5,144 | |||||||||||||||||||
Long-term borrowings—net | 2,592 | 22 | 2,916 | — | 7,698 | — | 13,228 | ||||||||||||||||||||
Post-retirement and other post-employment benefit obligations (4) | — | 509 | — | — | 2,927 | — | 3,436 | ||||||||||||||||||||
Deferred income taxes | 47 | — | 2 | — | 1,662 | (1,594 | ) | 117 | |||||||||||||||||||
Deferred revenue | — | — | — | — | 516 | — | 516 | ||||||||||||||||||||
Other long-term liabilities | 208 | 179 | 1 | 70 | 791 | — | 1,249 | ||||||||||||||||||||
Total liabilities | 4,817 | 999 | 10,074 | 137 | 33,793 | (26,130 | ) | 23,690 | |||||||||||||||||||
Stockholders’ (deficit) equity | (2,576 | ) | (4,892 | ) | 6,680 | 20 | (14,155 | ) | 12,347 | (2,576 | ) | ||||||||||||||||
Total liabilities and stockholders’ equity (deficit) | $ | 2,241 | $ | (3,893 | ) | $ | 16,754 | $ | 157 | $ | 19,638 | $ | (13,783 | ) | $ | 21,114 | |||||||||||
(1) | QCII is the issuer of the QCII Guaranteed Notes and is a guarantor of the QSC Guaranteed Notes and the QCF Guaranteed Notes. |
(2) | QSC is a guarantor of the QCII Guaranteed Notes and is the issuer of the QSC Guaranteed Notes. |
(3) | QCF is a guarantor of both the QCII Guaranteed Notes and the QSC Guaranteed Notes and is the issuer of the QCF Guaranteed Notes. |
(4) | QCII sponsors employee benefit plans. The assets and obligations for these plans are allocated to QCII’s subsidiaries. |
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QWEST COMMUNICATIONS INTERNATIONAL INC.
CONDENSED CONSOLIDATING BALANCE SHEETS
DECEMBER 31, 2005
(UNAUDITED)
QCII(1) | QSC(2) | QCF(3) | QCII Subsidiary Non- Guarantors | QSC Subsidiary Non- Guarantors | Eliminations | QCII Consolidated | ||||||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||||||||
ASSETS | ||||||||||||||||||||||||||
Current assets: | ||||||||||||||||||||||||||
Cash and cash equivalents | $ | 67 | $ | 563 | $ | — | $ | — | $ | 216 | $ | — | $ | 846 | ||||||||||||
Short-term investments | 9 | 77 | — | — | 15 | — | 101 | |||||||||||||||||||
Accounts receivable—net | — | 10 | — | 3 | 1,512 | — | 1,525 | |||||||||||||||||||
Accounts receivable—affiliates | 43 | 428 | 94 | — | 21 | (586 | ) | — | ||||||||||||||||||
Current tax receivable | 34 | 28 | — | — | — | (62 | ) | — | ||||||||||||||||||
Notes receivable—affiliates | — | 4,728 | 14,568 | 76 | — | (19,372 | ) | — | ||||||||||||||||||
Deferred income taxes | — | 19 | — | — | 99 | — | 118 | |||||||||||||||||||
Prepaid expenses and other current assets | 20 | 38 | — | 112 | 412 | (8 | ) | 574 | ||||||||||||||||||
Total current assets | 173 | 5,891 | 14,662 | 191 | 2,275 | (20,028 | ) | 3,164 | ||||||||||||||||||
Property, plant and equipment—net | — | 6 | — | — | 15,562 | — | 15,568 | |||||||||||||||||||
Capitalized software and other intangible assets—net | 41 | — | — | — | 966 | — | 1,007 | |||||||||||||||||||
Investments in subsidiaries | 1,143 | (12,112 | ) | — | — | — | 10,969 | — | ||||||||||||||||||
Deferred income taxes | — | 1,791 | 22 | 11 | — | (1,824 | ) | — | ||||||||||||||||||
Prepaid pension asset (4) | — | 95 | — | — | 1,070 | — | 1,165 | |||||||||||||||||||
Other assets | 111 | 58 | 14 | — | 410 | — | 593 | |||||||||||||||||||
Total assets | $ | 1,468 | $ | (4,271 | ) | $ | 14,698 | $ | 202 | $ | 20,283 | $ | (10,883 | ) | $ | 21,497 | ||||||||||
LIABILITIES AND STOCKHOLDERS’ (DEFICIT) EQUITY | ||||||||||||||||||||||||||
Current liabilities: | ||||||||||||||||||||||||||
Current borrowings | $ | 6 | $ | — | $ | 485 | $ | — | $ | 21 | $ | — | $ | 512 | ||||||||||||
Current borrowings—affiliates | 165 | — | 4,728 | — | 14,479 | (19,372 | ) | — | ||||||||||||||||||
Accounts payable | 4 | 38 | — | — | 731 | — | 773 | |||||||||||||||||||
Accounts payable—affiliates | — | 34 | — | 9 | 248 | (291 | ) | — | ||||||||||||||||||
Accrued expenses and other current liabilities | 288 | 192 | 98 | 81 | 1,539 | — | 2,198 | |||||||||||||||||||
Accrued expenses and other current liabilities—affiliates | — | — | 34 | 30 | 239 | (303 | ) | — | ||||||||||||||||||
Current taxes payable | — | — | 34 | 2 | 145 | (62 | ) | 119 | ||||||||||||||||||
Deferred revenue and advance billings | — | — | — | — | 633 | — | 633 | |||||||||||||||||||
Total current liabilities | 463 | 264 | 5,379 | 122 | 18,035 | (20,028 | ) | 4,235 | ||||||||||||||||||
Long-term borrowings—net | 3,884 | 22 | 2,986 | — | 8,076 | — | 14,968 | |||||||||||||||||||
Post-retirement and other post-employment benefit obligations (4) | — | 506 | — | — | 2,953 | — | 3,459 | |||||||||||||||||||
Deferred income taxes | 33 | — | — | — | 1,881 | (1,824 | ) | 90 | ||||||||||||||||||
Deferred revenue | — | — | — | — | 522 | — | 522 | |||||||||||||||||||
Other long-term liabilities | 305 | 145 | — | 62 | 928 | — | 1,440 | |||||||||||||||||||
Total liabilities | 4,685 | 937 | 8,365 | 184 | 32,395 | (21,852 | ) | 24,714 | ||||||||||||||||||
Stockholders’ (deficit) equity | (3,217 | ) | (5,208 | ) | 6,333 | 18 | (12,112 | ) | 10,969 | (3,217 | ) | |||||||||||||||
Total liabilities and stockholders’ equity (deficit) | $ | 1,468 | $ | (4,271 | ) | $ | 14,698 | $ | 202 | $ | 20,283 | $ | (10,883 | ) | $ | 21,497 | ||||||||||
(1) | QCII is the issuer of the QCII Guaranteed Notes and is a guarantor of the QSC Guaranteed Notes and the QCF Guaranteed Notes. |
(2) | QSC is a guarantor of the QCII Guaranteed Notes and is the issuer of the QSC Guaranteed Notes. |
(3) | QCF is a guarantor of both the QCII Guaranteed Notes and the QSC Guaranteed Notes and is the issuer of the QCF Guaranteed Notes. |
(4) | QCII sponsors employee benefit plans. The assets and obligations for these plans are allocated to QCII’s subsidiaries. |
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Table of Contents
QWEST COMMUNICATIONS INTERNATIONAL INC.
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOW
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006
(UNAUDITED)
QCII(1) | QSC(2) | QCF(3) | QCII Subsidiary Non- Guarantors | QSC Subsidiary Non- Guarantors | Eliminations | QCII Consolidated | ||||||||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||||||||||
Cash (used for) provided by operating activities | $ | (243 | ) | $ | 1,189 | $ | 164 | $ | 7 | $ | 788 | $ | 24 | $ | 1,929 | |||||||||||||
Investing Activities: | ||||||||||||||||||||||||||||
Expenditures for property, plant and equipment and intangible assets | — | (4 | ) | — | — | (1,222 | ) | — | (1,226 | ) | ||||||||||||||||||
Proceeds from sale of property, plant and equipment | — | — | — | — | 63 | — | 63 | |||||||||||||||||||||
Proceeds from sales of investment securities | — | 56 | — | — | — | — | 56 | |||||||||||||||||||||
Purchases of investment securities | — | (173 | ) | — | — | — | — | (173 | ) | |||||||||||||||||||
Net proceeds (purchases) of investments managed by QSC | 9 | 32 | — | — | (41 | ) | — | — | ||||||||||||||||||||
Net (increase) decrease in short-term affiliate loans | — | (2,347 | ) | (2,025 | ) | (7 | ) | — | 4,379 | — | ||||||||||||||||||
Dividends received from subsidiaries | — | 1,341 | — | — | — | (1,341 | ) | — | ||||||||||||||||||||
Acquisition of OnFiber Communications, Inc. | — | — | — | — | (107 | ) | — | (107 | ) | |||||||||||||||||||
Other | — | — | — | — | 6 | — | 6 | |||||||||||||||||||||
Cash provided by (used for) investing activities | 9 | (1,095 | ) | (2,025 | ) | (7 | ) | (1,301 | ) | 3,038 | (1,381 | ) | ||||||||||||||||
Financing activities: | ||||||||||||||||||||||||||||
Proceeds from long-term borrowings | — | — | — | — | 600 | — | 600 | |||||||||||||||||||||
Repayments of long-term borrowings, including current maturities | (33 | ) | — | (486 | ) | — | (626 | ) | — | (1,145 | ) | |||||||||||||||||
Net proceeds from (repayments of) short-term affiliate borrowings | 29 | — | 2,347 | — | 2,003 | (4,379 | ) | — | ||||||||||||||||||||
Proceeds from issuances of common and treasury stock | 150 | — | — | — | — | — | 150 | |||||||||||||||||||||
Dividends paid to parent | — | — | — | — | (1,341 | ) | 1,341 | — | ||||||||||||||||||||
Other | 21 | — | — | — | (34 | ) | (24 | ) | (37 | ) | ||||||||||||||||||
Cash provided by (used for) financing activities | 167 | — | 1,861 | — | 602 | (3,062 | ) | (432 | ) | |||||||||||||||||||
Cash and cash equivalents: | ||||||||||||||||||||||||||||
(Decrease) increase in cash and cash equivalents | (67 | ) | 94 | — | — | 89 | — | 116 | ||||||||||||||||||||
Beginning balance | 67 | 563 | — | — | 216 | — | 846 | |||||||||||||||||||||
Ending balance | $ | — | $ | 657 | $ | — | $ | — | $ | 305 | $ | — | $ | 962 | ||||||||||||||
(1) | QCII is the issuer of the QCII Guaranteed Notes and is a guarantor of the QSC Guaranteed Notes and the QCF Guaranteed Notes. |
(2) | QSC is a guarantor of the QCII Guaranteed Notes and is the issuer of the QSC Guaranteed Notes. |
(3) | QCF is a guarantor of both the QCII Guaranteed Notes and the QSC Guaranteed Notes and is the issuer of the QCF Guaranteed Notes. |
33
Table of Contents
QWEST COMMUNICATIONS INTERNATIONAL INC.
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOW
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005
(UNAUDITED)
QCII(1) | QSC(2) | QCF(3) | QCII Subsidiary Non- Guarantors | QSC Subsidiary Non- Guarantors | Eliminations | QCII Consolidated | ||||||||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||||||||||
Cash (used for ) provided by operating activities | $ | (100 | ) | $ | 1,002 | $ | 102 | $ | 22 | $ | 562 | $ | — | $ | 1,588 | |||||||||||||
Investing Activities: | ||||||||||||||||||||||||||||
Expenditures for property, plant and equipment and intangible assets | (1 | ) | (20 | ) | — | — | (1,089 | ) | — | (1,110 | ) | |||||||||||||||||
Proceeds from sale of property, plant and equipment | — | — | — | — | 418 | — | 418 | |||||||||||||||||||||
Proceeds from sales of investment securities | — | 1,230 | — | — | — | — | 1,230 | |||||||||||||||||||||
Purchases of investment securities | — | (1,002 | ) | — | — | — | — | (1,002 | ) | |||||||||||||||||||
Net proceeds (purchases) of investments managed by QSC | 2 | (241 | ) | — | — | 239 | — | — | ||||||||||||||||||||
Cash infusion to subsidiaries | (530 | ) | (10,000 | ) | — | — | — | 10,530 | — | |||||||||||||||||||
Net decrease (increase) in short-term affiliate loans | — | 8,619 | 8,166 | (22 | ) | — | (16,763 | ) | — | |||||||||||||||||||
Dividends received from subsidiaries | — | 2,015 | — | — | — | (2,015 | ) | — | ||||||||||||||||||||
Other | — | 97 | — | — | 22 | (97 | ) | 22 | ||||||||||||||||||||
Cash (used for) provided by investing activities | (529 | ) | 698 | 8,166 | (22 | ) | (410 | ) | (8,345 | ) | (442 | ) | ||||||||||||||||
Financing activities: | ||||||||||||||||||||||||||||
Proceeds from long-term borrowings | 735 | — | — | — | 1,152 | — | 1,887 | |||||||||||||||||||||
Repayments of long-term borrowings, including current maturities | — | (452 | ) | (179 | ) | — | (1,147 | ) | — | (1,778 | ) | |||||||||||||||||
Net (repayments of) proceeds from short-term affiliate borrowings | (45 | ) | — | (8,619 | ) | — | (8,099 | ) | 16,763 | — | ||||||||||||||||||
Proceeds from issuances of common and treasury stock | 10 | — | — | — | — | — | 10 | |||||||||||||||||||||
Equity infusion from parent | — | — | 530 | — | 10,000 | (10,530 | ) | — | ||||||||||||||||||||
Dividends paid to parent | — | — | — | — | (2,015 | ) | 2,015 | — | ||||||||||||||||||||
Other | (13 | ) | (49 | ) | — | — | (140 | ) | 97 | (105 | ) | |||||||||||||||||
Cash provided by (used for) financing activities | 687 | (501 | ) | (8,268 | ) | — | (249 | ) | 8,345 | 14 | ||||||||||||||||||
Cash and cash equivalents: | ||||||||||||||||||||||||||||
Increase (decrease) in cash and cash equivalents | 58 | 1,199 | — | — | (97 | ) | — | 1,160 | ||||||||||||||||||||
Beginning balance | 34 | 608 | — | — | 509 | — | 1,151 | |||||||||||||||||||||
Ending balance | $ | 92 | $ | 1,807 | $ | — | $ | — | $ | 412 | $ | — | $ | 2,311 | ||||||||||||||
(1) | QCII is the issuer of the QCII Guaranteed Notes and is a guarantor of the QSC Guaranteed Notes and the QCF Guaranteed Notes. |
(2) | QSC is a guarantor of the QCII Guaranteed Notes and is the issuer of the QSC Guaranteed Notes. |
(3) | QCF is a guarantor of both the QCII Guaranteed Notes and the QSC Guaranteed Notes and is the issuer of the QCF Guaranteed Notes. |
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ITEM 2. 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.
Certain statements set forth below under this caption constitute forward-looking statements. See “Special Note Regarding Forward-Looking Statements” at the end of this Item 2 for additional factors relating to such statements, and see “Risk Factors” in Item 1A of Part II of this report for a discussion of certain risk factors applicable to our business, financial condition and results of operations.
Business Overview and Presentation
We provide local telecommunications and related services, long-distance services and wireless, data and video services within our local service area, which consists of the 14-state region of Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington and Wyoming. We also provide reliable, scalable and secure broadband data and voice (including long-distance) communications services outside our local service area as well as globally.
Our analysis presented below is organized to provide the information we believe will be instructive for understanding the relevant trends going forward. However, this discussion should be read in conjunction with our condensed consolidated financial statements in Item 1 of Part I of this report, including the notes thereto. Our operating revenue is generated from our wireline services, wireless services and other services segments. An overview of the segment results is provided in Note 8—Segment Information to our condensed consolidated financial statements in Item 1 of Part I of this report. The following segment discussions reflect the way we currently report our operating results to our Chief Operating Decision Maker, or CODM. These discussions include revenue results for each of the customer channels within the wireline services segment: mass markets, business and wholesale. Certain prior year revenue, expense and access line amounts have been reclassified to conform to the current year presentations.
Business Trends
Our financial results continue to be impacted by several significant trends, which are described below:
• | Access line losses.Our revenue has been, and we expect it to continue to be, adversely affected by access line losses. Increased competition, including product substitution, continues to be the primary reason for our access line losses. For example, consumers are increasingly substituting other telephony services for traditional telecommunications services, which has increased the number and type of competitors within our industry and decreased our market share. Product bundling, as described more fully below, has been one of our responses to our declining revenue due to access line losses. |
• | Data and Internet growth.Data and Internet revenue and subscribers continue to grow as customers continue to migrate Internet service to higher speed connections. We have expanded our availability of these services. In addition, we continue to increase the available connection speeds in order to meet customer demand and expect this trend will continue into the future. We also expect to face continuing competition for these subscribers. |
• | Product bundling.We believe consumers increasingly value the convenience of receiving multiple services from a single provider. As such, we increased our marketing and advertising spending levels in 2005 and 2006 focusing on product bundling and packaging. Product bundles and packages represent combinations of products and services (such as local voice, long-distance, high-speed Internet, video and wireless) and features and services (such as three-way calling and call forwarding) related to an access line. As a result of these offerings, our sales of bundled products have increased. |
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• | Variable expenses. Expenses associated with higher growth products, such as long-distance, high-speed Internet and wireless services, tend to be more variable in nature. While our traditional telecommunications services tend to rely upon our fixed cost structure, the mix of products we expect to sell, combined with regulatory and market pricing forces, will continue to pressure operating expense. In addition, facility costs (described below) do not always change proportionally with revenue fluctuations. |
• | Facility costs. Facility costs are third-party telecommunications expenses we incur to connect our customers to networks or to end-user product platforms not owned by us. We continue to reduce costs in this area from initiatives to optimize our usage of other local carriers’ services to connect our customers to our network, and we continue to benefit from reduced costs due to the renegotiation, termination or settlement of various service arrangements in prior periods. However, these cost reductions have been partially offset in varying degrees by increased costs from increased long-distance, data and Internet and wireless volumes. |
• | Operational efficiencies.We have continued to evaluate our operating structure and focus, and we continue to right-size our workforce in response to changes in the telecommunications industry and productivity improvements. Through targeted restructuring plans in prior years, focused improvements in operational efficiency, process improvements through automation and normal employee attrition, we have reduced our workforce and employee-related costs while achieving operational goals. |
While these trends are important to understanding and evaluating our financial results, the other transactions, 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.
Results of Operations
Overview
We generate revenue from our wireline services, wireless services and other services as described below.
• | Wireline services. The wireline services segment uses our network to provide voice services and data and Internet services to mass markets, business and wholesale customers. Our wireline services include: |
• | Voice services. Voice services revenue includes local voice, long-distance voice and access services. Local voice services revenue includes basic local exchange, switching, enhanced voice, operator and collocation services and custom calling features. Local voice services revenue also includes the provisioning of network transport, billing services and access to our local network on a wholesale basis. Long-distance voice services revenue includes InterLATA and IntraLATA long-distance services. Access services revenue includes fees charged to other data and telecommunications providers to connect their customers and their networks to our network. |
• | Data and Internet services. Data and Internet services revenue includes data services (such as traditional private lines, wholesale private lines and WAN), Internet services (such as high-speed Internet, ISDN and web hosting) and data integration. |
• | Wireless services. We offer wireless services and equipment to residential and business customers, providing them the ability to use the same telephone number for their wireless phone as for their home or business phone. By utilizing a third party’s nationwide PCS wireless network, we sell wireless services to residential and business customers primarily in the states within our local service area. |
• | Other services. Other services revenue is predominantly derived from the sublease of some of our real estate, such as space in our office buildings, warehouses and other properties. |
Depending on the products or services purchased, a customer may pay an up-front or monthly fee, a usage charge or a combination of these.
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The following table summarizes our results of operations for the three and nine months ended September 30, 2006 and 2005:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||
2006 | 2005 | Increase/ (Decrease) | % Change | 2006 | 2005 | Increase/ (Decrease) | % Change | |||||||||||||||||||||
(Dollars in millions, except per share amounts) | ||||||||||||||||||||||||||||
Operating revenue | $ | 3,487 | $ | 3,504 | $ | (17 | ) | (0 | )% | $ | 10,435 | $ | 10,423 | $ | 12 | 0 | % | |||||||||||
Operating expenses | 3,087 | 3,296 | (209 | ) | (6 | )% | 9,265 | 9,789 | (524 | ) | (5 | )% | ||||||||||||||||
Other expense—net | 249 | 353 | (104 | ) | (29 | )% | 798 | 885 | (87 | ) | (10 | )% | ||||||||||||||||
Income (loss) before income taxes | 151 | (145 | ) | 296 | nm | 372 | (251 | ) | 623 | nm | ||||||||||||||||||
Income tax benefit | 43 | 1 | 42 | nm | 27 | — | 27 | nm | ||||||||||||||||||||
Net income (loss) | $ | 194 | $ | (144 | ) | $ | 338 | nm | $ | 399 | $ | (251 | ) | $ | 650 | nm | ||||||||||||
Basic income (loss) per share | $ | 0.10 | $ | (0.08 | ) | $ | 0.18 | nm | $ | 0.21 | $ | (0.14 | ) | $ | 0.35 | nm | ||||||||||||
Diluted income (loss) per share | $ | 0.09 | $ | (0.08 | ) | $ | 0.17 | nm | $ | 0.20 | $ | (0.14 | ) | $ | 0.34 | nm |
nm—percentages greater than 200% and comparisons from positive to negative values or to zero values are considered not meaningful
Operating Revenue
The following table compares operating revenue by segment including the detail of customer channels within our wireline segment for the three and nine months ended September 30, 2006 and 2005:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||
2006 | 2005 | Increase/ (Decrease) | % Change | 2006 | 2005 | Increase/ (Decrease) | % Change | |||||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||||||||
Wireline services revenue: | ||||||||||||||||||||||||||
Voice services: | ||||||||||||||||||||||||||
Local voice services: | ||||||||||||||||||||||||||
Mass markets | $ | 994 | $ | 1,036 | $ | (42 | ) | (4 | )% | $ | 3,040 | $ | 3,155 | $ | (115 | ) | (4 | )% | ||||||||
Business | 303 | 325 | (22 | ) | (7 | )% | 928 | 971 | (43 | ) | (4 | )% | ||||||||||||||
Wholesale | 169 | 183 | (14 | ) | (8 | )% | 519 | 574 | (55 | ) | (10 | )% | ||||||||||||||
Total local voice services | 1,466 | 1,544 | (78 | ) | (5 | )% | 4,487 | 4,700 | (213 | ) | (5 | )% | ||||||||||||||
Long-distance services: | ||||||||||||||||||||||||||
Mass markets | 163 | 141 | 22 | 16 | % | 479 | 409 | 70 | 17 | % | ||||||||||||||||
Business | 137 | 140 | (3 | ) | (2 | )% | 419 | 432 | (13 | ) | (3 | )% | ||||||||||||||
Wholesale | 295 | 278 | 17 | 6 | % | 844 | 823 | 21 | 3 | % | ||||||||||||||||
Total long-distance services | 595 | 559 | 36 | 6 | % | 1,742 | 1,664 | 78 | 5 | % | ||||||||||||||||
Access services | 139 | 159 | (20 | ) | (13 | )% | 418 | 502 | (84 | ) | (17 | )% | ||||||||||||||
Total voice services | 2,200 | 2,262 | (62 | ) | (3 | )% | 6,647 | 6,866 | (219 | ) | (3 | )% | ||||||||||||||
Data and Internet services: | ||||||||||||||||||||||||||
Mass markets | 226 | 159 | 67 | 42 | % | 623 | 449 | 174 | 39 | % | ||||||||||||||||
Business | 581 | 625 | (44 | ) | (7 | )% | 1,748 | 1,728 | 20 | 1 | % | |||||||||||||||
Wholesale | 336 | 315 | 21 | 7 | % | 972 | 959 | 13 | 1 | % | ||||||||||||||||
Total data and Internet services | 1,143 | 1,099 | 44 | 4 | % | 3,343 | 3,136 | 207 | 7 | % | ||||||||||||||||
Total wireline services revenue | 3,343 | 3,361 | (18 | ) | (1 | )% | 9,990 | 10,002 | (12 | ) | (0 | )% | ||||||||||||||
Wireless services revenue | 135 | 131 | 4 | 3 | % | 416 | 389 | 27 | 7 | % | ||||||||||||||||
Other services revenue | 9 | 12 | (3 | ) | (25 | )% | 29 | 32 | (3 | ) | (9 | )% | ||||||||||||||
Total operating revenue | $ | 3,487 | $ | 3,504 | $ | (17 | ) | (0 | )% | $ | 10,435 | $ | 10,423 | $ | 12 | 0 | % | |||||||||
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Wireline Services Revenue
Voice Services
Local voice services. The decrease in mass markets and business local voice services revenue for the three and nine months ended September 30, 2006 was primarily due to access line losses from competitive pressures, including wireless and cable substitution, and a decline in mass markets local voice services revenue related to our bundle discounts. We are also seeing a more than offsetting increase in mass markets revenue on other products as discussed below. We continue to see declines in wholesale access lines as demand for UNEs decreases.
The following table summarizes our access lines by channel as of September 30, 2006 and 2005:
As of September 30, | ||||||||||
2006 | 2005 | Increase/ (Decrease) | % Change | |||||||
(in thousands) | ||||||||||
Mass markets | 9,601 | 10,145 | (544 | ) | (5 | )% | ||||
Business | 2,872 | 3,032 | (160 | ) | (5 | )% | ||||
Wholesale | 1,564 | 1,756 | (192 | ) | (11 | )% | ||||
Total | 14,037 | 14,933 | (896 | ) | (6 | )% | ||||
Long-distance services. The increase in long-distance services revenue was due to increased volumes and a higher percentage of customers migrating toward our fixed fee based offerings, partially offset by lower average rates on variable priced calling plans. The increased volumes were largely driven by growth of 195,000 long-distance subscribers primarily in our mass markets channel as of September 30, 2006 compared to September 30, 2005.
Access services. The decrease in access services revenue was primarily due to a $23 million favorable settlement of a customer billing dispute in the second quarter of 2005 and the recognition of a non-recurring benefit due to favorable regulatory rulings during the nine months ended September 30, 2005. Additionally, for the three and nine months ended September 30, 2006, regulated access rates decreased due to legislative action in certain states, and wholesale volumes decreased.
Data and Internet Services
The increase in data and Internet services revenue for the three and nine months ended September 30, 2006 compared to the same periods of 2005 was primarily due to a 47.2% increase in high-speed Internet subscribers and, to a lesser extent, increases in satellite and video subscribers in our mass markets channel as of September 30, 2006 compared to September 30, 2005. The growth in high-speed Internet revenue resulted from increased penetration and expanded service availability and from customers migrating from dial-up connections to higher speed plans.
The increase in our mass markets channel revenue was partially offset by a decrease in our business channel revenue for the third quarter of 2006 compared to the same period of 2005. This decrease was primarily due to $52 million of revenue recognized in the third quarter of 2005 from a large data integration arrangement. For the nine months ended September 30, 2006 as compared to the same period of 2005, private line and hosting revenue growth from our business customers was partially offset by reductions in traditional WAN and dial services revenue.
Wireless Services Revenue
For the nine months ended September 30, 2006, wireless services revenue increased due to a 4.4% increase in subscribers as of September 30, 2006 compared to September 30, 2005. In addition, wireless services revenue increased due to higher average rates as customers sign up for higher priced calling plans.
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Operating Expenses
The following table provides further detail regarding our operating expenses for the three and nine months ended September 30, 2006 and 2005:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||
2006 | 2005 | Increase/ (Decrease) | % Change | 2006 | 2005 | Increase/ (Decrease) | % Change | |||||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||||||||
Cost of sales: | ||||||||||||||||||||||||||
Facility costs | $ | 587 | $ | 692 | $ | (105 | ) | (15 | )% | $ | 1,815 | $ | 2,043 | $ | (228 | ) | (11 | )% | ||||||||
Network expenses | 69 | 72 | (3 | ) | (4 | )% | 183 | 198 | (15 | ) | (8 | )% | ||||||||||||||
Employee-related costs | 397 | 404 | (7 | ) | (2 | )% | 1,181 | 1,200 | (19 | ) | (2 | )% | ||||||||||||||
Other non-employee related costs | 329 | 344 | (15 | ) | (4 | )% | 1,013 | 944 | 69 | 7 | % | |||||||||||||||
Total cost of sales | 1,382 | 1,512 | (130 | ) | (9 | )% | 4,192 | 4,385 | (193 | ) | (4 | )% | ||||||||||||||
Selling, general and administrative: | ||||||||||||||||||||||||||
Property and other taxes | 96 | 100 | (4 | ) | (4 | )% | 256 | 310 | (54 | ) | (17 | )% | ||||||||||||||
Bad debt | 37 | 27 | 10 | 37 | % | 108 | 137 | (29 | ) | (21 | )% | |||||||||||||||
Restructuring, realignment and severance related costs | 43 | 26 | 17 | 65 | % | 63 | 40 | 23 | 58 | % | ||||||||||||||||
Employee-related costs | 407 | 401 | 6 | 1 | % | 1,213 | 1,218 | (5 | ) | (0 | )% | |||||||||||||||
Other non-employee related costs | 431 | 462 | (31 | ) | (7 | )% | 1,358 | 1,392 | (34 | ) | (2 | )% | ||||||||||||||
Total selling, general and administrative | 1,014 | 1,016 | (2 | ) | (0 | )% | 2,998 | 3,097 | (99 | ) | (3 | )% | ||||||||||||||
Depreciation | 594 | 659 | (65 | ) | (10 | )% | 1,774 | 1,961 | (187 | ) | (10 | )% | ||||||||||||||
Capitalized software and other intangible assets amortization | 97 | 109 | (12 | ) | (11 | )% | 301 | 346 | (45 | ) | (13 | )% | ||||||||||||||
Total operating expenses | $ | 3,087 | $ | 3,296 | $ | (209 | ) | (6 | )% | $ | 9,265 | $ | 9,789 | $ | (524 | ) | (5 | )% | ||||||||
Cost of Sales
Cost of sales includes employee-related costs (such as salaries, wages and benefits directly attributable to products or services), network expenses, facility costs and other non-employee related costs (such as real estate; Universal Service Fund, or USF, charges; call termination fees; materials and supplies; contracted engineering services; and the cost of data integration and wireless handsets).
Cost of sales decreased by $130 million, or to 39.6% from 43.1% as a percentage of revenue, for the third quarter of 2006 compared to the same period of 2005 and by $193 million, or to 40.2% from 42.1% as a percentage of revenue, for the nine months ended September 30, 2006 compared to the same period of 2005. Our facility costs decreased as we continue to implement initiatives to optimize our usage of other local carriers’ services to connect our customers to our network, and we continue to benefit from reduced costs due to the renegotiation, termination or settlement of service arrangements in prior periods.
For the third quarter of 2006 compared to the same period of 2005, other non employee related costs decreased due to the large data integration arrangement we recognized in 2005. Partially offsetting these costs was an increase in USF expenses associated with a refund in the third quarter of 2005 and increased charges on certain products in 2006.
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For the nine months ended September 30, 2006 compared to the same period of 2005, other non-employee related costs increased primarily due to costs associated with higher data integration revenue and increased USF expenses.
Selling, General and Administrative Expenses
Selling, general and administrative expenses, or SG&A, include employee-related costs (such as salaries, wages and benefits not directly attributable to products or services and sales commissions), severance related costs, bad debt charges, property and other taxes and other non-employee related costs such as real estate, marketing and advertising, professional service fees and computer systems support.
SG&A was flat for the third quarter of 2006 compared to the same period of 2005. In the third quarter of 2006, we incurred $43 million of severance related costs, primarily associated with the closing of two call centers and a planned reduction in network employees as we continue to right-size our workforce in response to changes in the telecommunications industry and productivity improvements. In the third quarter of 2005, we incurred $26 million of restructuring, realignment, and severance related costs, consisting primarily of real estate realignment costs. After excluding a non-recurring adjustment to the reserve in 2005, bad debt expense was flat for the third quarter of 2006 compared to the same period of 2005. There were decreases associated with third party information technology services, litigation and other professional fees, which were included in other non-employee related costs.
SG&A decreased to 28.7% from 29.7% as a percentage of revenue for the nine months ended September 30, 2006 compared to same period of 2005 as we continue to focus on reducing costs and increasing efficiencies. Contributing to this decrease were property tax reductions, sales and use tax refunds and a $25 million reduction in our estimated sales tax obligations for the nine months ended September 30, 2006. We do not expect these property and other tax reductions to continue. Bad debt expense decreased due to improvements in our collection practices and experience. We do not expect bad debt expense will continue to decrease at similar levels in future periods. Other non-employee related costs decreased primarily due to decreases associated with third party information technology services, litigation and other professional fees, which were partially offset by increased marketing and advertising costs primarily associated with our product bundling promotions.
Combined Pension and Post-Retirement Benefits
Our results include the combined cost of our pension, non-qualified pension and post-retirement healthcare and life insurance plans. We recorded expense of $53 million and $45 million for the three months ended September 30, 2006 and 2005, respectively, and $161 million and $178 million for the nine months ended September 30, 2006 and 2005, respectively. The expense is a function of the amount of benefits earned, interest on projected benefit obligations, amortization of costs and credits from prior benefit changes and the expected return on the assets held in the various plans.
The combined expense decreased for the nine months ended September 30, 2006 compared to the same period of 2005 as a result of decreased interest costs due to lower discount rates, increase in the expected benefit from the federal subsidy on prescription drug benefits, and plan design changes associated with a new union contract entered into in August 2005. Partially offsetting these impacts were increases in expense due to lower expected return on investments in the benefit trusts and amortization of actuarial losses caused by volatile equity markets and lower discount rates. The combined expense of the benefit plans is allocated to cost of sales and SG&A.
Operating Expenses by Segment
Segment expenses include employee-related costs, facility costs, network expenses and other non-employee related costs such as customer support, collections and telephone marketing. We manage indirect administrative
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services costs such as finance, information technology, real estate, legal, marketing and advertising and human resources centrally; consequently, these costs are included in the other services segment. We evaluate depreciation, amortization, interest expense, interest income, and other income (expense) on a total company basis. As a result, these charges are not assigned to any segment. Similarly, we do not include impairment charges in the segment results. Our CODM regularly reviews the results of operations at a segment level to evaluate the performance of each segment and allocate resources. The results presented herein are not necessarily indicative of the results of operations these segments would have achieved had they operated as stand-alone entities during the periods presented.
Wireline Services Segment Expenses
The following table sets forth wireline services expenses for the three and nine months ended September 30, 2006 and 2005:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||
2006 | 2005 | Increase/ (Decrease) | % Change | 2006 | 2005 | Increase/ (Decrease) | % Change | |||||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||||||||
Wireline services expenses: | ||||||||||||||||||||||||||
Facility costs | $ | 513 | $ | 617 | $ | (104 | ) | (17 | )% | $ | 1,596 | $ | 1,813 | $ | (217 | ) | (12 | )% | ||||||||
Network expenses | 68 | 70 | (2 | ) | (3 | )% | 181 | 190 | (9 | ) | (5 | )% | ||||||||||||||
Bad debt | 23 | 15 | 8 | 53 | % | 66 | 98 | (32 | ) | (33 | )% | |||||||||||||||
Restructuring, realignment and severance related costs | 40 | 2 | 38 | nm | 43 | 12 | 31 | nm | ||||||||||||||||||
Employee-related costs | 597 | 600 | (3 | ) | (1 | )% | 1,771 | 1,788 | (17 | ) | (1 | )% | ||||||||||||||
Other non-employee related costs | 371 | 377 | (6 | ) | (2 | )% | 1,128 | 1,049 | 79 | 8 | % | |||||||||||||||
Total wireline services expenses | $ | 1,612 | $ | 1,681 | $ | (69 | ) | (4 | )% | $ | 4,785 | $ | 4,950 | $ | (165 | ) | (3 | )% | ||||||||
nm—percentages greater than 200% and comparisons from positive to negative values or to zero values are considered not meaningful
Wireline services expenses decreased for the three and nine months ended September 30, 2006 compared to the same periods of 2005 primarily due to decreased facility costs driven by our implementation of initiatives to optimize our usage of other local carriers’ services to connect our customers to our network. Facility costs also decreased as we continue to benefit from reduced costs due to the renegotiation, termination or settlement of service arrangements in prior periods.
After excluding a non-recurring adjustment to the reserve in 2005, bad debt expense was flat for the third quarter of 2006 compared to the same period of 2005. For the nine months ended September 30, 2006 compared to the same period of 2005, bad debt expense decreased due to improvements in our collection practices and experience. We do not expect bad debt expense will continue to decrease at similar levels in future periods.
In the third quarter of 2006, we incurred $40 million of severance related expenses, primarily associated with the closing of two call centers and a planned reduction in network employees as we continue to right-size our workforce in response to changes in the telecommunications industry and productivity improvements.
For the third quarter of 2006 compared to the same period 2005, other non-employee related costs remained flat with decreased data integration expenses associated with the large data integration arrangement we recognized in 2005, offset by increased USF expenses as described above. For the nine months ended
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September 30, 2006 compared to the same period of 2005, other non-employee related costs increased primarily due to costs associated with data integration revenue growth and increased USF expenses.
Wireless Services Segment Expenses
The following table sets forth wireless services expenses for the three and nine months ended September 30, 2006 and 2005:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||
2006 | 2005 | Increase/ (Decrease) | % Change | 2006 | 2005 | Increase/ (Decrease) | % Change | |||||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||||||||
Wireless services expenses: | ||||||||||||||||||||||||||
Facility costs | $ | 74 | $ | 75 | $ | (1 | ) | (1 | )% | $ | 219 | $ | 230 | $ | (11 | ) | (5 | )% | ||||||||
Wireless equipment | 28 | 25 | 3 | 12 | % | 84 | 79 | 5 | 6 | % | ||||||||||||||||
Bad debt | 14 | 12 | 2 | 17 | % | 38 | 40 | (2 | ) | (5 | )% | |||||||||||||||
Employee-related costs | 12 | 12 | — | 0 | % | 35 | 38 | (3 | ) | (8 | )% | |||||||||||||||
Other non-employee related costs | 15 | 18 | (3 | ) | (17 | )% | 43 | 59 | (16 | ) | (27 | )% | ||||||||||||||
Total wireless services expenses | $ | 143 | $ | 142 | $ | 1 | 1 | % | $ | 419 | $ | 446 | $ | (27 | ) | (6 | )% | |||||||||
For the nine months ended September 30, 2006 compared to the same period of 2005, facility costs decreased primarily due to rate reductions, partially offset by increased minutes of use. Other non-employee related expenses decreased primarily due to lower marketing and advertising expenses and decreased costs associated with our transition to a third party vendor, which was completed in the first quarter of 2005.
Other Services Segment Expenses
The following table sets forth other services expenses for the three and nine months ended September 30, 2006 and 2005:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||
2006 | 2005 | Increase/ (Decrease) | % Change | 2006 | 2005 | Increase/ (Decrease) | % Change | |||||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||||||||
Other services expenses: | ||||||||||||||||||||||||||
Property and other taxes | $ | 96 | $ | 100 | $ | (4 | ) | (4 | )% | $ | 256 | $ | 309 | $ | (53 | ) | (17 | )% | ||||||||
Real estate costs | 110 | 110 | — | 0 | % | 325 | 314 | 11 | 4 | % | ||||||||||||||||
Restructuring, realignment and severance related costs | 3 | 25 | (22 | ) | (88 | )% | 20 | 27 | (7 | ) | (26 | )% | ||||||||||||||
Employee-related costs | 195 | 193 | 2 | 1 | % | 588 | 592 | (4 | ) | (1 | )% | |||||||||||||||
Other non-employee related costs | 237 | 277 | (40 | ) | (14 | )% | 797 | 844 | (47 | ) | (6 | )% | ||||||||||||||
Total other services expenses | $ | 641 | $ | 705 | $ | (64 | ) | (9 | )% | $ | 1,986 | $ | 2,086 | $ | (100 | ) | (5 | )% | ||||||||
Other services expenses include corporate expenses for services such as finance, information technology, real estate, legal, marketing and advertising and human resources, which we centrally manage and which are not assigned to the wireline or wireless services segments.
Other services expense decreased for the third quarter of 2006 compared to the same period of 2005 primarily due to decreased realignment costs for real estate and decreases associated with third party information technology services, litigation and other professional fees, which are included in other non-employee related costs.
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The decrease in property and other taxes for the nine months ended September 30, 2006 compared to the same period of 2005 was primarily attributable to property tax reductions, sales and use tax refunds and a $25 million reduction to our estimated sales tax obligations for the nine months ended September 30, 2006. We do not expect these property and other tax reductions to continue. The decrease in other non-employee related costs for these same time periods is primarily attributable to decreases associated with third party information technology services, lower litigation and other professional fees, offset by increased marketing and advertising.
Non-Segment Operating Expenses
Depreciation
Depreciation expense for the three and nine months ended September 30, 2006 was $594 million and $1.774 billion, respectively, or 10% lower than the same periods in the prior year. The primary driver of this decrease was decreased capital expenditures over a period of time and the changing mix of our investment in property, plant and equipment over that period of time. If our capital investment program stays approximately the same and there are no significant decreases in our estimates of the useful lives of assets, we expect that our year over year depreciation expense will continue to decrease.
Amortization
Amortization expense for the three and nine months ended September 30, 2006 was $97 million and $301 million or 11% and 13% lower than the same periods in the prior year, respectively. This reduction reflects the lower capital spending on software related assets since 2001.
Other Consolidated Results
Other Expense (Income)—Net
Other expense (income)—net generally includes interest expense net of capitalized interest, investment write-downs, gains and losses on the sales of investments and fixed assets, gains and losses on early retirement of debt and changes in derivative instrument market values.
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||
2006 | 2005 | Increase/ (Decrease) | % Change | 2006 | 2005 | Increase/ (Decrease) | % Change | |||||||||||||||||||||||
(Dollars in millions) | ||||||||||||||||||||||||||||||
Other expense (income)—net: | ||||||||||||||||||||||||||||||
Interest expense—net | $ | 291 | $ | 384 | $ | (93 | ) | (24 | )% | $ | 885 | $ | 1,145 | $ | (260 | ) | (23 | )% | ||||||||||||
Loss (gain) on early retirement of debt—net | 9 | (11 | ) | 20 | nm | 4 | 32 | (28 | ) | (88 | )% | |||||||||||||||||||
Gain on sale of assets | — | — | — | nm | (3 | ) | (257 | ) | 254 | 99 | % | |||||||||||||||||||
Other—net | (51 | ) | (20 | ) | (31 | ) | (155 | )% | (88 | ) | (35 | ) | (53 | ) | (151 | )% | ||||||||||||||
Total other expense (income)—net | $ | 249 | $ | 353 | $ | (104 | ) | (29 | )% | $ | 798 | $ | 885 | $ | (87 | ) | (10 | )% | ||||||||||||
nm—percentages greater than 200% and comparisons from positive to negative values or to zero values are considered not meaningful
Interest expense—net.Interest expense decreased primarily due to decreased total borrowings and lower interest rates on certain long-term borrowings as a result of retiring notes totaling $3.4 billion with coupon rates ranging from 13% to 14%. These retirements occurred primarily during the fourth quarter of 2005.
Loss (gain) on early retirement of debt—net. In the second quarter of 2005, we had a loss on early retirement of debt of $55 million from cash tender offers, and we prepaid $1.5 billion of debt. These losses were
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partially offset by a gain of $12 million from debt-for-equity exchanges. In the third quarter of 2006, we prepaid $500 million of debt resulting in a loss of $9 million, which was partially offset by a gain of $6 million from debt-for-equity exchanges in the second quarter of 2006.
Gain on sale of assets. In the first quarter of 2005, we closed the sale of all of our PCS licenses and substantially all of our related wireless network assets and recognized a gain of $257 million associated with this and related asset sales.
Other—net. In the third quarter of 2006, we recognized a gain of $39 million for interest income related to a settlement of certain open issues covered by a tax sharing agreement. In addition, interest income decreased by $13 million and $19 million for the three and nine months ended September 30, 2006, respectively, compared to the same periods in 2005 due to lower cash and short term investments balances in 2006.
Income Taxes
Prior to 2006, we had a history of generating net operating loss carryforwards for tax purposes; therefore we have recognized a valuation allowance for our net deferred tax assets. We have reported income before income taxes for the three and nine months ended September 30, 2006. If we continue to generate income before income taxes in future periods, our conclusion about the realizability of our deferred tax assets and therefore the appropriateness of the valuation allowance could change in a future period.
In the third quarter of 2006, we recognized a $53 million income tax benefit as the result of the settlement of certain open issues covered by a tax sharing agreement.
Liquidity and Capital Resources
Near-Term View
Our working capital deficit, or the amount by which our current liabilities exceed our current assets, was $1.569 billion and $1.071 billion as of September 30, 2006 and December 31, 2005, respectively. Our working capital deficit increased $498 million primarily due to the reclassification to current of $414 million of debt obligations maturing within twelve months, the reclassification to current of our $1.265 billion 3.50% convertible senior notes, the early retirement of debt of $623 million and capital expenditures of $1.226 billion. The impact of these items was partially offset by the proceeds from the issuance of new long-term debt of $600 million and cash generated by operating activities.
The 3.50% convertible senior notes were classified as a current obligation because specified, market-based conversion provisions were met as of September 30, 2006. As such, the holders of these notes have the right to convert the notes and receive from us cash for the principal value of notes and shares of our common stock in accordance with the terms of the notes. These notes were classified as a non-current obligation as of December 31, 2005 because the market-based conversion provisions were not met as of that date. These market-based conversion provisions specify that, when our common stock has a closing price above $7.08 per share for twenty or more trading days during certain periods of thirty consecutive trading days, these notes become available for conversion, and as a result all outstanding notes are reclassified as a current obligation. These notes are registered securities and freely tradable, and as of September 30, 2006, they had a market price of $1,621 per $1,000 principal amount of notes, compared to an estimated conversion value of $1,488. Therefore, we do not anticipate holders will elect to convert because we believe it would likely result in adverse economic consequences to such holders.
We believe that our cash on hand together with our short-term investments, our currently undrawn credit facility described below and our cash flows from operations should be sufficient to meet our cash needs through the next twelve months. However, if we become subject to significant judgments, settlements and/or tax payments, as further discussed in Note 9—Commitments and Contingencies to our condensed consolidated
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financial statements in Item 1 of Part I of this report, we could be required to make significant payments that we may not have the resources to make. The magnitude of any settlements or judgments resulting from these actions could materially and adversely affect our financial condition and ability to meet our debt obligations, potentially impacting our credit ratings, our ability to access capital markets and our compliance with debt covenants. In addition, the magnitude of any settlements or judgments may cause us to draw down significantly on our cash balances, which might force us to obtain additional financing or explore other methods to generate cash. Such methods could include issuing additional securities or selling assets.
To the extent that our EBITDA (as defined in our debt covenants) is reduced by cash judgments, settlements and/or tax payments, our debt to consolidated EBITDA ratios under certain debt agreements will be adversely affected. This could reduce our liquidity and flexibility due to potential restrictions on drawing on our line of credit and potential restrictions on incurring additional debt under certain provisions of our debt agreements.
We have $850 million available to us under a revolving credit facility (referred to as the Credit Facility), which is currently undrawn and which expires in October 2010. Until July 2006, our wholly-owned subsidiary, Qwest Services Corporation, or QSC, was the potential borrower under the Credit Facility. The Credit Facility contains various limitations, including a restriction on using any proceeds from the facility to pay settlements or judgments relating to the investigation and securities actions discussed in Note 9—Commitments and Contingencies to our condensed consolidated financial statements in Item 1 of Part I of this report. The Credit Facility is guaranteed by QSC and is secured by a senior lien on the stock of its wholly owned subsidiary, Qwest Corporation, or QC.
The wireline services segment provides over 95% of our total operating revenue with the balance attributed to our wireless services and other services segments and the wireline services segment also provides all of the consolidated cash flows from operations. Cash flows used in operations of our wireless services segment are not expected to be significant in the near term. Cash flows used in operations of our other services segment are significant; however, we expect that the cash flows provided by the wireline services segment will be sufficient to fund these operations in the near term.
On August 31, 2006, we completed our acquisition of OnFiber Communications, Inc., a provider of custom-built and managed network solutions, for a purchase price of $107 million in cash.
We expect our 2006 capital expenditures to approximate our 2005 level, with the majority being used in our wireline services segment.
On October 4, 2006, our Board of Directors approved a stock repurchase program for up to $2 billion of our common stock over the next two years. It is our intention to fully achieve this plan over the next two years, while reviewing, on a regular basis, opportunities to enhance shareholder returns.
We continue to pursue our strategy to improve our near-term liquidity and our capital structure in order to reduce financial risk. During the quarter ended September 30, 2006, we took the following measures to improve our near-term financial position:
• | On August 8, 2006, QC issued $600 million aggregate principal amount of its 7.5% Notes due 2014. The net proceeds from the issuance have been or will be used for general corporate purposes, including repayment of indebtedness and funding and refinancing investments in our telecommunications assets; |
• | Concurrent with the issuance of these notes, QC called the remaining $500 million aggregate principal amount of its floating rate term loan maturing in June 2007, plus accrued interest of $3 million; |
• | On August 15, 2006, QCF paid at maturity $485 million aggregate principal amount of its 7.75% Notes due 2006; and |
• | On September 21, 2006, QC redeemed the remaining $90 million aggregate principal amount of its 39-year 6.25% debentures due January 1, 2007 at face value plus accrued interest of $1 million. |
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Long-Term View
We have historically operated with a working capital deficit as a result of our highly leveraged position, and it is likely that we will operate with a working capital deficit in the future. We believe that cash provided by operations and our currently undrawn Credit Facility, combined with our current cash position and continued access to capital markets to refinance our current portion of debt, should allow us to meet our cash requirements for the foreseeable future.
We may periodically need to obtain financing in order to meet our debt obligations as they come due. We may also need to obtain additional financing or investigate other methods to generate cash (such as further cost reductions or the sale of assets) if revenue and cash provided by operations decline, if economic conditions weaken, if competitive pressures increase or if we become subject to significant judgments, settlements and/or tax payments as further discussed in Note 9—Commitments and Contingencies to our condensed consolidated financial statements in Item 1 of Part I of this report. In the event of an adverse outcome in one or more of these matters, we could be required to make significant payments that we do not have the resources to make. The magnitude of any settlements or judgments resulting from these actions could materially and adversely affect our financial condition and ability to meet our debt obligations, potentially impacting our credit ratings, our ability to access capital markets and our compliance with debt covenants. In addition, the magnitude of any settlements or judgments may cause us to draw down significantly on our cash balances, which might force us to obtain additional financing or explore other methods to generate cash. Such methods could include issuing additional securities or selling assets.
The Credit Facility makes available to us $850 million of additional credit subject to certain restrictions as described below, and is currently undrawn. This facility has a cross payment default provision, and this facility and certain other debt issues also have cross acceleration provisions. When present, such provisions could have a wider impact on liquidity than might otherwise arise from a default or acceleration of a single debt instrument. These provisions generally provide that a cross default under these debt instruments could occur if:
• | we fail to pay any indebtedness when due in an aggregate principal amount greater than $100 million; |
• | any indebtedness is accelerated in an aggregate principal amount greater than $100 million ($25 million in the case of one of the debt instruments); or |
• | judicial proceedings are commenced to foreclose on any of our assets that secure indebtedness in an aggregate principal amount greater than $100 million. |
Upon such a cross default, the creditors of a material amount of our debt may elect to declare that a default has occurred under their debt instruments and to accelerate the principal amounts due such creditors. Cross acceleration provisions are similar to cross default provisions, but permit a default in a second debt instrument to be declared only if in addition to a default occurring under the first debt instrument, the indebtedness due under the first debt instrument is actually accelerated. In addition, the Credit Facility contains various limitations, including a restriction on using any proceeds from the facility to pay settlements or judgments relating to the investigation and securities actions discussed in Note 9—Commitments and Contingencies to our condensed consolidated financial statements in Item 1 of Part I of this report.
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Historical View
The following table summarizes cash flow activities for the nine months ended September 30, 2006 and 2005:
Nine Months Ended September 30, | |||||||||||||||
2006 | 2005 | Increase/ (Decrease) | % Change | ||||||||||||
(Dollars in millions) | |||||||||||||||
Cash flows: | |||||||||||||||
Provided by operating activities | $ | 1,929 | $ | 1,588 | $ | 341 | 21 | % | |||||||
Used for investing activities | (1,381 | ) | (442 | ) | (939 | ) | nm | ||||||||
(Used for) provided by financing activities | (432 | ) | 14 | (446 | ) | nm | |||||||||
Increase in cash and cash equivalents | $ | 116 | $ | 1,160 | $ | (1,044 | ) | (90 | )% | ||||||
nm—percentages greater than 200% and comparisons between positive and negative values or to zero values are considered not meaningful
Operating Activities
Our cash provided by operating activities increased primarily due to decreased cost of sales and SG&A and decreased interest payments of $159 million. These decreases were partially offset by a $100 million deposit in the first quarter of 2006 relating to the settlement of the consolidated securities action.
Investing Activities
During the nine months ended September 30, 2006, capital expenditures increased $116 million compared to the same period of 2005. We expect our 2006 capital expenditures to approximate our 2005 level, with the majority being used in our wireline services segment. Our investments in securities resulted in a $117 million net use of cash in 2006 compared to $228 million net source of cash in 2005 primarily due to changes in the balance of our investments in auction rate securities. In the first quarter of 2005, we received proceeds of $418 million from the sale of our wireless assets in our local service area. Additionally, during the third quarter of 2006, we paid $107 million to acquire OnFiber Communications, Inc.
Financing Activities
We continue to pursue our strategy to improve our near-term liquidity and our capital structure in order to reduce financial risk. In 2005, we repaid $1.8 billion of debt and issued $1.9 billion of new debt. In 2006, we repaid $1.1 billion of debt and issued $600 million of new debt. Additionally, during the nine months ended September 30, 2006, our proceeds from issuances of common stock, related to stock options, increased $129 million compared to the same period of 2005.
Letters of Credit
We maintain letter of credit arrangements with various financial institutions for up to $130 million. At September 30, 2006, we had outstanding letters of credit of approximately $118 million.
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Credit Ratings
The table below summarizes our long-term debt ratings at September 30, 2006:
Moody’s | S&P | Fitch | ||||
Corporate rating/Sr. Implied rating | B1 | BB- | NR | |||
Qwest Corporation | Ba2 | BB | BB+ | |||
Qwest Communications Corporation | NR | NR | B+ | |||
Qwest Capital Funding, Inc. | B3 | B | B+ | |||
Qwest Communications International Inc.* | B2/B3 | B | BB/B+ |
NR = Not rated
* | = QCII notes have various ratings |
These ratings are the same as they were at December 31, 2005, except that Moody’s rating on Qwest Corporation was Ba3 at that date.
Debt ratings by the various rating agencies reflect each agency’s opinion of the ability of the issuers to repay debt obligations as they come due. In general, lower ratings result in higher borrowing costs and/or impaired ability to borrow. A security rating is not a recommendation to buy, sell, or hold securities and may be subject to revision or withdrawal at any time by the assigning rating organization.
Given our current credit ratings, as noted above, our ability to raise additional capital under acceptable terms and conditions may be negatively impacted.
Risk Management
We are exposed to market risks arising from changes in interest rates. The objective of our interest rate risk management program is to manage the level and volatility of our interest expense. We may employ derivative financial instruments to manage our interest rate risk exposure. We may also employ financial derivatives to hedge foreign currency exposures associated with particular debt.
Approximately $1.5 billion and $2.0 billion of floating-rate debt was exposed to changes in interest rates as of September 30, 2006 and December 31, 2005, respectively. This exposure is linked to LIBOR. A hypothetical increase of 100 basis points in LIBOR would not have had a material effect on interest expense for the nine months ended September 30, 2006. As of September 30, 2006 and December 31, 2005, we had approximately $400 million and $500 million, respectively, of long-term fixed rate debt obligations maturing in the subsequent 12 months. We are exposed to changes in interest rates at any time that we choose to refinance this debt. A hypothetical increase of 100 basis points in the interest rates on any refinancing of the current portion of long-term debt would not have a material effect on our earnings.
Our 3.50% convertible senior notes were classified as current as of September 30, 2006 because specified, market-based conversion provisions were met as of that date. As such, the holders of these notes have the right to convert the notes and receive from us cash for the principal value of notes and shares of our common stock in accordance with the terms of the notes. Although holders of these notes have the right to convert in the near term, we do not anticipate holders will elect to convert because we believe it would likely result in adverse economic consequences to such holders. In the unlikely event that holders of a substantial amount of these notes did elect to convert, we might choose to borrow additional amounts and we would be exposed to changes in interest rates. A hypothetical increase of 100 basis points in the interest rates on any refinancing of the convertible notes would not have a material effect on our earnings.
As of September 30, 2006, we had approximately $900 million invested in money market instruments and approximately $200 million invested in auction rate securities. Most cash investments are invested at floating
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rates. As interest rates change, so will the interest income derived from these instruments. Assuming that these investment balances were to remain constant, a hypothetical decrease of 100 basis points in interest rates would not have had a material effect on other income for the nine months ended September 30, 2006.
Off-Balance Sheet Arrangements
There were no substantial changes to our off-balance sheet arrangements or contractual commitments in the nine months ended September 30, 2006, when compared to the disclosures provided in our Annual Report on Form 10-K for the year ended December 31, 2005.
Special Note Regarding Forward-Looking Statements
This Form 10-Q contains or incorporates by reference forward-looking statements about our financial condition, results of operations and business. These statements include, among others:
• | statements concerning the benefits that we expect will result from our business activities and certain transactions we have completed, such as increased revenue, decreased expenses and avoided expenses and expenditures; and |
• | statements of our expectations, beliefs, future plans and strategies, anticipated developments and other matters that are not historical facts. |
These statements may be made expressly in this document or may be incorporated by reference to other documents we have filed or will file with the Securities and Exchange Commission (“SEC”). You can find many of these statements by looking for words such as “may,” “would,” “could,” “should,” “plan,” “believes,” “expects,” “anticipates,” “estimates,” or similar expressions used in this document or documents incorporated by reference in this document.
These forward-looking statements are subject to numerous assumptions, risks and uncertainties that may cause our actual results to be materially different from any future results expressed or implied by us in those statements. Some of these risks are described in “Risk Factors” in Item 1A of Part II of this report. These risk factors should be considered in connection with any subsequent written or oral forward-looking statements that we or persons acting on our behalf may issue. Given these uncertainties, we caution investors not to unduly rely on our forward-looking statements. We do not undertake any obligation to review or confirm analysts’ expectations or estimates or to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date of this document or to reflect the occurrence of unanticipated events. Further, the information about our intentions contained in this document is a statement of our intention as of the date of this document and is based upon, among other things, the existing regulatory environment, industry conditions, market conditions and prices, the economy in general and our assumptions as of such date. We may change our intentions, at any time and without notice, based upon any changes in such factors, in our assumptions or otherwise.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information under the caption “Risk Management” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2 of Part I of this report is incorporated herein by reference.
ITEM 4. CONTROLS AND PROCEDURES
The effectiveness of our or any system of disclosure controls and procedures is subject to certain limitations, including the exercise of judgment in designing, implementing and evaluating the controls and procedures, the assumptions used in identifying the likelihood of future events, and the inability to eliminate misconduct
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completely. As a result, there can be no assurance that our disclosure controls and procedures will detect all errors or fraud. By their nature, our or any system of disclosure controls and procedures can provide only reasonable assurance regarding management’s control objectives.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, or the “Exchange Act”) as of September 30, 2006. On the basis of this review, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures are designed, and are effective, to give reasonable assurance that the information required to be disclosed by us in reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and to ensure that information required to be disclosed in the reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, in a manner that allows timely decisions regarding required disclosure.
There were no changes in our internal control over financial reporting that occurred in the third quarter of 2006 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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The information contained in Note 9—Commitments and Contingencies to our condensed consolidated financial statements in Item 1 of Part I of this report is incorporated herein by reference.
Risks Affecting Our Business
Increasing competition, including product substitution, continues to cause access line losses, which could adversely affect our operating results and financial performance.
We compete in a rapidly evolving and highly competitive market, and we expect competition to continue to intensify. We are facing greater competition in our core local business from cable companies, wireless providers (including ourselves), facilities-based providers using their own networks as well as those leasing parts of our network, and resellers. As a reseller of wireless services, we face risks that facility based wireless providers do not have. In addition, regulatory developments over the past few years have generally increased competitive pressures on our business. Due to these and other factors, we continue to lose access lines and are experiencing pressure on profit margins.
We seek to distinguish ourselves from our competitors by providing new or expanded services such as in-region long-distance, high-speed Internet, wireless, video and VoIP, bundling of expanded feature-rich products and improving the quality of our customer service. However, we may not be successful in these efforts. We may not have sufficient resources to distinguish our service levels from those of our competitors, and we may not be successful in integrating our product offerings, especially products for which we act as a reseller, such as wireless services and satellite video services. Even if we are successful, these initiatives may not be sufficient to offset our continuing loss of access lines. If these initiatives are unsuccessful or insufficient and our revenue declines significantly without corresponding cost reductions, this will cause a significant deterioration to our results of operations and financial condition and adversely affect our ability to service debt and pay other obligations.
Consolidation among participants in the telecommunications industry may allow our competitors to compete more effectively against us, which could adversely affect our operating results and financial performance.
The telecommunications industry is experiencing an ongoing trend towards consolidation, and several of our competitors have consolidated, or have announced plans to consolidate, with other telecommunications providers. This trend will result in competitors that are larger and better financed and will afford our competitors increased resources and greater geographical reach, thereby enabling such competitors to compete more effectively against us. We have begun to experience and expect further increased pressures as a result of this trend and in turn have been and may continue to be forced to respond with lower profit margin product offerings and pricing plans in an effort to retain and attract customers. These pressures could adversely affect our operating results and financial performance.
Rapid changes in technology and markets could require substantial expenditure of financial and other resources in excess of contemplated levels, and any inability to respond to those changes could reduce our market share.
The telecommunications industry is experiencing significant technological changes, and our ability to execute our business plans and compete depends upon our ability to develop and deploy new products and services, such as broadband data, wireless, video and VoIP services. The development and deployment of new products and services could require substantial expenditure of financial and other resources in excess of
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contemplated levels. If we are not able to develop new products and services to keep pace with technological advances, or if such products and services are not widely accepted by customers, our ability to compete could be adversely affected and our market share could decline. Any inability to keep up with changes in technology and markets could also adversely affect the trading price of our securities and our ability to service our debt.
Third parties may claim we infringe upon their intellectual property rights and defending against these claims could adversely affect our profit margins and our ability to conduct business.
From time to time, we receive notices from third parties claiming we have or are infringing upon their intellectual property rights. We may receive similar notices in the future. Responding to these claims may require us to expend significant time and money defending our use of affected technology, may require us to enter into royalty or licensing agreements on less favorable terms than we could otherwise obtain or may require us to pay damages. If we are required to take one or more of these actions, our profit margins may decline. In addition, in responding to these claims, we may be required to stop selling or redesign one or more of our products or services, which could significantly and adversely affect the way we conduct business.
Risks Relating to Legal and Regulatory Matters
Any adverse outcome of the investigation currently being conducted by the DOJ or the material litigation pending against us, including the securities actions, could have a material adverse impact on our financial condition and operating results, on the trading price of our debt and equity securities and on our ability to access the capital markets.
The DOJ investigation and the remaining securities actions described in Note 9—Commitments and Contingencies to our condensed consolidated financial statements in Item 1 of Part I of this report present material and significant risks to us. In the aggregate, the plaintiffs in the remaining securities actions and persons who, at their request, were excluded from the settlement class in the consolidated securities action seek billions of dollars in damages, and the outcome of one or more of these matters or the DOJ investigation could have a negative impact on the outcomes of the other actions. Further, the size, scope and nature of the restatements of our consolidated financial statements for 2001 and 2000, which are described in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2002, affect the risks presented by these actions and the DOJ investigation, as these matters involve, among other things, our prior accounting practices and related disclosures. Plaintiffs in certain of the securities actions have alleged our restatement of items in support of their claims. We continue to defend against the remaining securities actions vigorously and are currently unable to provide any estimate as to the timing of their resolution.
We can give no assurance as to the impacts on our financial results or financial condition that may ultimately result from all of these matters. We have a recorded reserve in our financial statements for the minimum estimated amount of loss we believe is probable with respect to the remaining securities actions described in Note 9—Commitments and Contingencies to our condensed consolidated financial statements in Item 1 of Part I of this report, as well as any additional actions that may be brought by parties who, at their request, were excluded from the settlement class in the consolidated securities action, but who have not yet filed suit. However, the ultimate outcomes of these matters are still uncertain and the amount of loss we ultimately incur could be substantially more than the reserves we have provided. If the recorded reserves are insufficient, we will need to record additional charges to our consolidated statement of operations in future periods. In addition, any settlement of or judgment in one or more of these actions substantially in excess of our recorded reserves could have a significant impact on us, and we can give no assurance that we will have the resources available to pay any such judgment. The magnitude of any settlement or judgment resulting from these matters could materially and adversely affect our financial condition and ability to meet our debt obligations, potentially impacting our credit ratings, our ability to access capital markets and our compliance with debt covenants. In addition, the magnitude of any settlement or judgment may cause us to draw down significantly on our cash balances, which might force us to obtain additional financing or explore other methods to generate cash. Such methods could include issuing additional securities or selling assets.
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Further, there exist other material proceedings pending against us as described in Note 9—Commitments and Contingencies to our condensed consolidated financial statements in Item 1 of Part I of this report that, depending on their outcome, may have a material adverse effect on our financial position. Thus, we can give no assurances as to the impacts on our financial results or financial condition as a result of these matters.
Current or future civil or criminal actions against our former officers and employees could reduce investor confidence and cause the trading price for our securities to decline.
As a result of our past accounting issues, investor confidence in us has suffered and could suffer further. Although we have consummated a settlement with the SEC concerning its investigation of us, in March 2005, the SEC filed suit against our former chief executive officer, Joseph Nacchio, two of our former chief financial officers, Robert Woodruff and Robin Szeliga, and other former officers and employees. In December 2005, a criminal indictment was filed against Mr. Nacchio charging him with 42 counts of insider trading.
Trials could take place in the pending SEC lawsuit against Mr. Nacchio and others or in connection with the criminal charges against Mr. Nacchio. Evidence introduced at such trials and in other matters may result in further scrutiny by governmental authorities and others. The existence of this heightened scrutiny could adversely affect investor confidence and cause the trading price for our securities to decline.
We operate in a highly regulated industry and are therefore exposed to restrictions on our manner of doing business and a variety of claims relating to such regulation.
Our operations are subject to significant federal regulation, including the Communications Act of 1934, as amended, and Federal Communications Commission, or FCC, regulations thereunder. We are also subject to the applicable laws and regulations of various states, including regulation by public utility commissions, or PUCs, and other state agencies. Federal laws and FCC regulations generally apply to regulated interstate telecommunications (including international telecommunications that originate or terminate in the United States), while state regulatory authorities generally have jurisdiction over regulated telecommunications services that are intrastate in nature. The local competition aspects of the Telecommunications Act of 1996 are subject to FCC rulemaking, but the state regulatory authorities play a significant role in implementing those FCC rules. Generally, we must obtain and maintain certificates of authority from regulatory bodies in most states where we offer regulated services and must obtain prior regulatory approval of rates, terms and conditions for our intrastate services, where required. Our businesses are subject to numerous, and often quite detailed, requirements under federal, state and local laws, rules and regulations. Accordingly, we cannot ensure that we are always in compliance with all these requirements at any single point in time. The agencies responsible for the enforcement of these laws, rules and regulations may initiate inquiries or actions based on their own perceptions of our conduct, or based on customer complaints.
Regulation of the telecommunications industry is changing rapidly, and the regulatory environment varies substantially from state to state. Recently a number of state legislatures and state PUCs adopted reduced or modified forms of regulation for retail services. This is generally beneficial to us because it reduces regulatory costs and regulatory filing and reporting requirements. These changes also generally allow more flexibility for new product introduction and enhance our ability to respond to competition. At the same time, some of the changes, occurring at both the state and federal level, may have the potential effect of reducing some regulatory protections, including having FCC-approved tariffs that include rates, terms and conditions. These changes may necessitate the need for customer-specific contracts to address matters previously covered in our tariffs. Despite these regulatory changes, a substantial portion of our local voice services revenue remains subject to FCC and state PUC pricing regulation, which could expose us to unanticipated price declines. There can be no assurance that future regulatory, judicial or legislative activities will not have a material adverse effect on our operations, or that regulators or third parties will not raise material issues with regard to our compliance or noncompliance with applicable regulations.
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All of our operations are also subject to a variety of environmental, safety, health and other governmental regulations. We monitor our compliance with federal, state and local regulations governing the discharge and disposal of hazardous and environmentally sensitive materials, including the emission of electromagnetic radiation. Although we believe that we are in compliance with such regulations, any such discharge, disposal or emission might expose us to claims or actions that could have a material adverse effect on our business, financial condition and operating results.
Risks Affecting Our Liquidity
Our high debt levels pose risks to our viability and may make us more vulnerable to adverse economic and competitive conditions, as well as other adverse developments.
We are highly leveraged. As of September 30, 2006, our total debt was approximately $14.9 billion. Approximately $2.4 billion of our debt obligations comes due over the next three years. In addition, holders of our $1.265 billion 3.50% Convertible Senior Notes due 2025 may elect to convert the principal of their notes into cash during periods when specified, market-based conversion requirements are met. However, we do not anticipate holders will make such an election because we believe it would likely result in adverse economic consequences to such holders. While we currently believe we will have the financial resources to meet our obligations when they come due, we cannot anticipate what our future condition will be. We may have unexpected costs and liabilities and we may have limited access to financing. In addition, on October 4, 2006, our Board of Directors approved a stock repurchase program for up to $2 billion of our common stock over the next two years. Cash used by us in connection with purchases of our common stock would not be available for other purposes including the repayment of debt.
We may periodically need to obtain financing in order to meet our debt obligations as they come due. We may also need to obtain additional financing or investigate other methods to generate cash (such as further cost reductions or the sale of assets) if revenue and cash provided by operations decline, if economic conditions weaken, if competitive pressures increase or if we become subject to significant judgments, settlements and/or tax payments as further discussed in Note 9—Commitments and Contingencies to our condensed consolidated financial statements in Item 1 of Part I of this report and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” in Item 2 of Part I of this report. We can give no assurance that such additional financing will be available on terms that are acceptable. Also, we may be impacted by factors relating to or affecting our liquidity and capital resources due to perception in the market, impacts on our credit ratings or provisions in our financing agreements that may restrict our flexibility under certain conditions.
Our $850 million revolving Credit Facility, which is currently undrawn, has a cross payment default provision, and the Credit Facility and certain of our other debt issues have cross acceleration provisions. When present, such provisions could have a wider impact on liquidity than might otherwise arise from a default or acceleration of a single debt instrument. Any such event could adversely affect our ability to conduct business or access the capital markets and could adversely impact our credit ratings. In addition, the Credit Facility contains various limitations, including a restriction on using any proceeds from the facility to pay settlements or judgments relating to the DOJ investigation and securities actions discussed in Note 9—Commitments and Contingencies to our condensed consolidated financial statements in Item 1 of Part I of this report.
Our high debt levels could adversely impact our credit ratings. Additionally, the degree to which we are leveraged may have other important limiting consequences, including the following:
• | placing us at a competitive disadvantage as compared with our less leveraged competitors; |
• | making us more vulnerable to downturns in general economic conditions or in any of our businesses; |
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• | limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; and |
• | impairing our ability to obtain additional financing in the future for working capital, capital expenditures or general corporate purposes. |
We may be unable to significantly reduce the substantial capital requirements or operating expenses necessary to continue to operate our business, which may in turn affect our operating results.
The industry in which we operate is capital intensive and, as such, we anticipate that our capital requirements will continue to be significant in the coming years. Although we have reduced our capital expenditures and operating expenses over the past few years, we may be unable to further significantly reduce these costs, even if revenue is decreasing. While we believe that our current level of capital expenditures will meet both our maintenance and our core growth requirements going forward, this may not be the case if circumstances underlying our expectations change.
Declines in the value of qualified pension plan assets, or unfavorable changes in laws or regulations that govern pension plan funding, could require us to provide significant amounts of funding for our qualified pension plan.
While we do not expect to be required to make material cash contributions to our qualified defined benefit pension plan in the near term based upon current actuarial analyses and forecasts, a significant decline in the value of qualified pension plan assets in the future or unfavorable changes in laws or regulations that govern pension plan funding could materially change the timing and amount of required pension funding. As a result, we may be required to fund our qualified defined benefit pension plan with cash from operations, perhaps by a material amount.
Our debt agreements allow us to incur significantly more debt, which could exacerbate the other risks described herein.
The terms of our debt instruments permit us to incur additional indebtedness. Such additional debt may be necessary for many reasons, including to adequately respond to competition, to comply with regulatory requirements related to our service obligations or for financial reasons alone. Incremental borrowings or borrowings at maturity on terms that impose additional financial risks to our various efforts to improve our financial condition and results of operations could exacerbate the other risks described herein.
If we pursue and are involved in any business combinations, our financial condition could be adversely affected.
On a regular and ongoing basis, we review and evaluate other businesses and opportunities for business combinations that would be strategically beneficial. As a result, we may be involved in negotiations or discussions that, if they were to result in a transaction, could have a material effect on our financial condition (including short-term or long-term liquidity) or short-term or long-term results of operations.
Should we make an error in judgment when identifying an acquisition candidate, or should we fail to successfully integrate acquired operations, we will likely fail to realize the benefits we intended to derive from the acquisition and may suffer other adverse consequences. Acquisitions involve a number of other risks, including:
• | incurrence of substantial transaction costs; |
• | diversion of management’s attention from operating our existing business; |
• | charges to earnings in the event of any write-down or write-off of goodwill recorded in connection with acquisitions; |
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• | depletion of our cash resources or incurrence of additional indebtedness to fund acquisitions; |
• | an adverse impact on our tax position; and |
• | assumption of liabilities of an acquired business (including unforeseen liabilities). |
We can give no assurance that we will be able to successfully complete and integrate strategic acquisitions.
Other Risks Relating to Qwest
If conditions or assumptions differ from the judgments, assumptions or estimates used in our critical accounting policies, the accuracy of our financial statements and related disclosures could be affected.
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States, or GAAP, requires management to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Our critical accounting policies, which are described in our Annual Report on Form 10-K for the year ended December 31, 2005, describe those significant accounting policies and methods used in the preparation of our consolidated financial statements that are considered “critical” because they require judgments, assumptions and estimates that materially impact our consolidated financial statements and related disclosures. As a result, if future events differ significantly from the judgments, assumptions and estimates in our critical accounting policies, such events or assumptions could have a material impact on our consolidated financial statements and related disclosures.
Taxing authorities may determine we owe additional taxes relating to various matters, which could adversely affect our financial results.
As a significant taxpayer, we are subject to frequent and regular audits from the Internal Revenue Service, or IRS, as well as from state and local tax authorities. These audits could subject us to risks due to adverse positions that may be taken by these tax authorities. Please see Note 9—Commitments and Contingencies to our condensed consolidated financial statements in Item 1 of Part I of this report for examples of legal proceedings involving some of these adverse positions. In addition, for example, in the fourth quarter of 2004, Qwest received notices of proposed adjustments on several significant issues for the 1998-2001 audit cycle. Certain of these proposed adjustments are before the Appeals Office of the IRS. And in June 2006 Qwest received notices of proposed adjustments on several significant issues for the 2002-2003 audit cycle, including a proposed adjustment disallowing a loss recognized by Qwest relating to the sale of its DEX directory publishing business. There is no assurance that we and the IRS will reach settlements on any of these issues or that, if we do reach settlements, the terms will be favorable to us.
Because prior to 1999 Qwest was a member of affiliated groups filing consolidated U.S. federal income tax returns, we could be severally liable for tax examinations and adjustments not directly applicable to current members of the Qwest affiliated group. Tax sharing agreements have been executed between us and previous affiliates, and we believe the liabilities, if any, arising from adjustments to previously filed returns would be borne by the affiliated group member determined to have a deficiency under the terms and conditions of such agreements and applicable tax law. Generally, we have not provided for liabilities of former affiliated members or for claims they have asserted or may assert against us.
While we believe our tax reserves adequately provide for the associated tax contingencies, Qwest’s tax audits and examinations may result in tax liabilities that differ materially from those we have recorded in our consolidated financial statements. Also, the ultimate outcomes of all of these matters are uncertain, and we can give no assurance as to whether an adverse result from one or more of them will have a material effect on our financial results or our net operating loss carryforwards.
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If we fail to extend or renegotiate our collective bargaining agreements with our labor unions as they expire from time to time, or if our unionized employees were to engage in a strike or other work stoppage, our business and operating results could be materially harmed.
We are a party to collective bargaining agreements with our labor unions, which represent a significant number of our employees. In August 2005, we reached agreements with the Communications Workers of America and the International Brotherhood of Electrical Workers on three-year labor agreements. Each of these agreements was ratified by union members and expires on August 16, 2008. Although we believe that our relations with our employees are satisfactory, no assurance can be given that we will be able to successfully extend or renegotiate our collective bargaining agreements as they expire from time to time. The impact of future negotiations, including changes in wages and benefit levels, could have a material impact on our financial results. Also, if we fail to extend or renegotiate our collective bargaining agreements, if disputes with our unions arise, or if our unionized workers engage in a strike or other work stoppage, we could incur higher ongoing labor costs or experience a significant disruption of operations, which could have a material adverse effect on our business.
The trading price of our securities could be volatile.
In recent years, the capital markets have experienced extreme price and volume fluctuations. The overall market and the trading price of our securities may fluctuate greatly. The trading price of our securities may be significantly affected by various factors, including:
• | quarterly fluctuations in our operating results; |
• | changes in investors’ and analysts’ perception of the business risks and conditions of our business; |
• | broader market fluctuations; |
• | general economic or political conditions; |
• | acquisitions and financings including the issuance of substantial number of shares of our common stock as consideration in acquisitions; |
• | sale of a substantial number of shares held by the existing shareholders in the public market, including shares issued upon exercise of outstanding options or upon the conversion of our convertible notes; and |
• | general conditions in the telecommunications industry. |
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Exhibits filed for Qwest through the filing of this Form 10-Q:
Exhibits identified in parentheses below are on file with the SEC and are incorporated herein by reference. All other exhibits are provided as part of this electronic submission.
Exhibit Number | Description | |
(2.1) | Agreement and Plan of Merger, dated as of July 18, 1999 between U S WEST, Inc. and Qwest Communications International Inc. (incorporated by reference to Qwest Communications International Inc.’s Form S-4/A filed on August 13, 1999, File No. 333-81149). | |
(3.1) | Restated Certificate of Incorporation of Qwest Communications International Inc. (incorporated by reference to Qwest Communications International Inc.’s Registration Statement on Form S-4/A, filed September 17, 1999, File No. 333-81149). | |
(3.2) | Certificate of Amendment of Restated Certificate of Incorporation of Qwest Communications International Inc. (incorporated by reference to Qwest Communications International Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, File No. 001-15577). | |
(3.3) | Amended and Restated Bylaws of Qwest Communications International Inc., adopted as of July 1, 2002 and amended as of May 25, 2004 (incorporated by reference to Qwest Communications International Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, File No. 001-15577). | |
(4.1) | Indenture, dated as of April 15, 1990, by and between Mountain States Telephone and Telegraph Company and The First National Bank of Chicago (incorporated by reference to Qwest Corporation’s Annual Report on Form 10-K for the year ended December 31, 2002, File No. 001-03040). | |
(4.2) | First Supplemental Indenture, dated as of April 16, 1991, by and between U S WEST Communications, Inc. and The First National Bank of Chicago (incorporated by reference to Qwest Corporation’s Annual Report on Form 10-K for the year ended December 31, 2002, File No. 001-03040). | |
(4.3) | Indenture, dated as of January 29, 1998, with Bankers Trust Company (including form of Qwest Communications International Inc.’s 8.29% Senior Discount Notes due 2008 and 8.29% Series B Senior Discount Notes due 2008 as an exhibit thereto) (incorporated by reference to Qwest Communications International Inc.’s Annual Report on Form 10-K for the year ended December 31, 1997, File No. 000-22609). | |
(4.4) | Indenture, dated as of November 4, 1998, with Bankers Trust Company (including form of Qwest Communications International Inc.’s 7.50% Senior Discount Notes due 2008 and 7.50% Series B Senior Discount Notes due 2008 as an exhibit thereto) (incorporated by reference to Qwest Communications International Inc.’s Registration Statement on Form S-4, filed February 2, 1999, File No. 333-71603). | |
(4.5) | Indenture, dated as of November 27, 1998, with Bankers Trust Company (including form of Qwest Communications International Inc.’s 7.25% Senior Discount Notes due 2008 and 7.25% Series B Senior Discount Notes due 2008 as an exhibit thereto) (incorporated by reference to Qwest Communications International Inc.’s Registration Statement on Form S-4, filed February 2, 1999, File No. 333-71603). | |
(4.6) | Indenture, dated as of June 23, 1997, between LCI International, Inc. and First Trust National Association, as trustee, providing for the issuance of Senior Debt Securities, including Resolutions of the Pricing Committee of the Board of Directors establishing the terms of the 7.25% Senior Notes due June 15, 2007 (incorporated by reference to LCI’s Current Report on Form 8-K, dated June 23, 1997, File No. 001-12683). |
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Exhibit Number | Description | |
(4.7) | Indenture, dated as of June 29, 1998, by and among U S WEST Capital Funding, Inc., U S WEST, Inc., and The First National Bank of Chicago (now known as Bank One Trust Company, N. A.), as trustee (incorporated by reference to U S WEST’s Current Report on Form 8-K, dated November 18, 1998, File No. 001-14087). | |
(4.8) | Indenture, dated as of October 15, 1999, by and between Qwest Corporation and Bank One Trust Company, N.A., as trustee (incorporated by reference to Qwest Corporation’s Annual Report on Form 10-K for the year ended December 31, 1999, File No. 001-03040). | |
(4.9) | First Supplemental Indenture, dated as of June 30, 2000, by and among U S WEST Capital Funding, Inc., U S WEST, Inc., Qwest Communications International Inc., and Bank One Trust Company, as trustee (incorporated by reference to Qwest Communications International Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, File No. 001-15577). | |
(4.10) | First Supplemental Indenture, dated as of February 16, 2001, to the Indenture, dated as of January 29, 1998, with Bankers Trust Company (including form of Qwest Communications International Inc.’s 8.29% Senior Discount Notes due 2008 and 8.29% Series B Senior Discount Notes due 2008 as an exhibit thereto) (incorporated by reference to Qwest Communications International Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2001, File No. 001-15577). | |
(4.11) | Officer’s Certificate of Qwest Corporation, dated March 12, 2002 (including forms of 8 7/8% notes due March 15, 2012) (incorporated by reference to Qwest Corporation’s Form S-4, File No. 333-115119). | |
(4.12) | Indenture, dated as of December 26, 2002, between Qwest Communications International Inc., Qwest Services Corporation, Qwest Capital Funding, Inc. and Bank One Trust Company, N.A., as trustee (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K filed on January 10, 2003, File No. 001-15577). | |
(4.13) | First Supplemental Indenture, dated as of December 26, 2002, by and among Qwest Communications International Inc., Qwest Services Corporation, Qwest Capital Funding, Inc. and Deutsche Bank Trust Company Americas (formerly known as Bankers Trust Company), supplementing the Indenture, dated as of November 4, 1998, with Bankers Trust Company (incorporated by reference to Qwest Communications International Inc.’s Annual Report on Form 10-K for the year ended December 31, 2003, as originally filed on March 11, 2004, File No. 001-15577). | |
(4.14) | First Supplemental Indenture, dated as of December 26, 2002, by and among Qwest Communications International Inc., Qwest Services Corporation, Qwest Capital Funding, Inc. and Deutsche Bank Trust Company Americas (formerly known as Bankers Trust Company), supplementing the Indenture, dated as of November 27, 1998, with Bankers Trust Company (incorporated by reference to Qwest Communications International Inc.’s Annual Report on Form 10-K for the year ended December 31, 2003, as originally filed on March 11, 2004, File No. 001-15577). | |
(4.15) | Second Supplemental Indenture, dated as of December 4, 2003, by and among Qwest Communications International Inc., Qwest Services Corporation, Qwest Capital Funding, Inc. and Bank One Trust Company, N.A. (as successor in interest to Bankers Trust Company), supplementing the Indenture, dated as of November 4, 1998, with Bankers Trust Company (incorporated by reference to Qwest Communications International Inc.’s Annual Report on Form 10-K for the year ended December 31, 2003, as originally filed on March 11, 2004, File No. 001-15577). | |
(4.16) | Second Supplemental Indenture, dated as of December 4, 2003, by and among Qwest Communications International Inc., Qwest Services Corporation, Qwest Capital Funding, Inc. and Bank One Trust Company, N.A. (as successor in interest to Bankers Trust Company), supplementing the Indenture, dated as of November 27, 1998, with Bankers Trust Company (incorporated by reference to Qwest’s Annual Report on Form 10-K for the year ended December 31, 2003, as originally filed on March 11, 2004, File No. 001-15577). |
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Exhibit Number | Description | |
(4.17) | Indenture, dated as of February 5, 2004, among Qwest Communications International Inc., Qwest Services Corporation, Qwest Capital Funding, Inc. and J.P. Morgan Trust Company (incorporated by reference to Qwest Communications International Inc.’s Annual Report on Form 10-K for the year ended December 31, 2003, as originally filed on March 11, 2004, File No. 001-15577). | |
(4.18) | First Supplemental Indenture, dated as of August 19, 2004, by and between Qwest Corporation and U.S. Bank National Association (incorporated by reference to Qwest Communications International Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, File No. 001-15577). | |
(4.19) | Second Supplemental Indenture, dated November 23, 2004, by and between Qwest Corporation and U.S. Bank National Association (incorporated by reference to Qwest Corporation’s Current Report on Form 8-K filed on November 23, 2004, File No. 001-03040). | |
(4.20) | First Supplemental Indenture, dated June 17, 2005, among Qwest Communications International Inc., Qwest Services Corporation, Qwest Capital Funding, Inc. and U.S. Bank National Association (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K filed on June 23, 2005, File No. 001-15577). | |
(4.21) | Third Supplemental Indenture, dated as of June 17, 2005, by and between Qwest Corporation and U.S. Bank National Association (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K filed on June 23, 2005, File No. 001-15577). | |
(4.22) | Second Supplemental Indenture, dated June 23, 2005, among Qwest Communications International Inc., Qwest Services Corporation, Qwest Capital Funding, Inc. and U.S. Bank National Association (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K filed on June 23, 2005, File No. 001-15577). | |
(4.23) | Indenture, dated as of November 8, 2005, by and between Qwest Communications International Inc. and U.S. Bank National Association (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K filed on November 14, 2005, File No. 001-15577). | |
(4.24) | First Supplemental Indenture, dated as of November 8, 2005, by and between Qwest Communications International Inc. and U.S. Bank National Association (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K filed on November 14, 2005, File No. 001-15577). | |
(4.25) | First Supplemental Indenture, dated as of November 16, 2005, by and among Qwest Services Corporation, Qwest Communications International Inc., Qwest Capital Funding, Inc. and J.P. Morgan Trust Company, N.A. as successor to Bank One Trust Company, N.A. (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K filed on November 21, 2005, File No. 001-15577). | |
(4.26) | Fourth Supplemental Indenture, dated August 8, 2006, by and between Qwest Corporation and U.S. Bank National Association (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K filed on August 8, 2006, File No. 001-15577). | |
(10.1) | Equity Incentive Plan, as amended (incorporated by reference to Qwest Communications International Inc.’s Proxy Statement for the 2006 Annual Meeting of Stockholders, File No. 001-15577).* | |
(10.2) | Forms of option and restricted stock agreements used under Equity Incentive Plan, as amended (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K filed on October 24, 2005, Annual Report on Form 10-K for the year ended December 31, 2005 and Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, File No. 001-15577).* |
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Exhibit Number | Description | |
(10.3) | Employee Stock Purchase Plan (incorporated by reference to Qwest Communications International Inc.’s Proxy Statement for the 2003 Annual Meeting of Stockholders, File No. 001-15577).* | |
(10.4) | Nonqualified Employee Stock Purchase Plan (incorporated by reference to Qwest Communications International Inc.’s Annual Report on Form 10-K for the year ended December 31, 2002, File No. 001-15577).* | |
(10.5) | Deferred Compensation Plan (incorporated by reference to Qwest Communications International Inc.’s Annual Report on Form 10-K for the year ended December 31, 1998, File No. 000-22609).* | |
(10.6) | Equity Compensation Plan for Non-Employee Directors (incorporated by reference to Qwest Communications International Inc.’s Annual Report on Form 10-K for the year ended December 31, 1997, File No. 000-22609).* | |
(10.7) | Deferred Compensation Plan for Non-employee Directors, as amended and restated (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K filed on December 16, 2005, File No. 001-15577).* | |
(10.8) | Qwest Savings & Investment Plan, as amended and restated (incorporated by reference to Qwest Communications International Inc.’s Form S-8 filed on January 15, 2004, File No. 333-11923).* | |
(10.9) | 2006 Qwest Management Bonus Plan Summary (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K, filed December 16, 2005, File No. 001-15577).* | |
(10.10) | Summary Sheet Describing the Compensation Package for Qwest Communications International Inc.’s Non-employee Directors (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K filed on October 24, 2005, File No. 001-15577).* | |
(10.11) | Registration Rights Agreement, dated as of April 18, 1999, with Anschutz Company and Anschutz Family Investment Company LLC (incorporated by reference to Qwest’s Current Report on Form 8-K/A, filed April 28, 1999, File No. 000-22609). | |
(10.12) | Employee Matters Agreement between MediaOne Group and U S WEST, dated June 5, 1998 (incorporated by reference to U S WEST’s Current Report on Form 8-K/A, dated June 26, 1998, File No. 001-14087). | |
(10.13) | Tax Sharing Agreement between MediaOne Group and U S WEST, dated June 5, 1998 (incorporated by reference to U S WEST’s Current Report on Form 8-K/A, dated June 26, 1998, File No. 001-14087). | |
(10.14) | Registration Rights Agreement, dated November 23, 2004, by and among Qwest Corporation and the initial purchasers listed therein (incorporated by reference to Qwest Corporation’s Current Report on Form 8-K dated November 18, 2004, File No. 001-03040). | |
(10.15) | Registration Rights Agreement, dated June 17, 2005, among Qwest Communications International Inc., Qwest Services Corporation, Qwest Capital Funding, Inc. and the initial purchasers listed therein (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K filed on June 23, 2005, File No. 001-15577). | |
(10.16) | Registration Rights Agreement, dated June 17, 2005, by and among Qwest Corporation and the initial purchasers listed therein (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K filed on June 23, 2005, File No. 001-15577). | |
(10.17) | Registration Rights Agreement, dated June 23, 2005, among Qwest Communications International Inc., Qwest Services Corporation, Qwest Capital Funding, Inc. and the initial purchasers listed therein (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K filed on June 23, 2005, File No. 001-15577). |
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Exhibit Number | Description | |
(10.18) | Registration Rights Agreement, dated August 8, 2006, among Qwest Corporation and the initial purchasers listed therein (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K filed on August 8, 2006, File No. 001-15577). | |
(10.19) | Amended and Restated Employment Agreement, dated August 19, 2004, by and between Richard C. Notebaert and Qwest Services Corporation (incorporated by reference to Qwest Communications International Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, File No. 001-15577).* | |
(10.20) | Amendment to Amended and Restated Employment Agreement, dated October 21, 2005, by and between Richard C. Notebaert and Qwest Services Corporation (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K filed on October 24, 2005, File No. 001-15577).* | |
(10.21) | Form of Amendment to Amended and Restated Employment Agreement by and between Qwest Services Corporation and Richard C. Notebaert (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K, filed on December 16, 2005, File No. 001-15577).* | |
(10.22) | Amendment to Amended and Restated Employment Agreement, dated as of February 16, 2006, by and between Richard C. Notebaert and Qwest Services Corporation (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K, filed on February 17, 2006, File No. 001-15577).* | |
(10.23) | Agreement, dated as of February 16, 2006, by and between Richard C. Notebaert and Qwest Communications International Inc. (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K, filed on February 17, 2006, File No. 001-15577).* | |
(10.24) | Aircraft Time Sharing Agreement, dated February 14, 2006, by and between Qwest Business Resources, Inc. and Richard C. Notebaert (incorporated by reference to Qwest Communications International Inc.’s Annual Report on Form 10-K for the year ended December 31, 2005, File No. 001-15577). | |
(10.25) | Amended and Restated Employment Agreement, dated August 19, 2004, by and between Oren G. Shaffer and Qwest Services Corporation (incorporated by reference to Qwest Communications International Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, File No. 001-15577).* | |
(10.26) | Amendment to Amended and Restated Employment Agreement, dated October 21, 2005, by and between Oren G. Shaffer and Qwest Services Corporation (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K filed on October 24, 2005, File No. 001-15577).* | |
(10.27) | Form of Amendment to Amended and Restated Employment Agreement by and between Qwest Services Corporation and Oren G. Shaffer (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K, filed on December 16, 2005, File No. 001-15577).* | |
(10.28) | Amendment to Amended and Restated Employment Agreement, dated as of February 16, 2006, by and between Oren G. Shaffer and Qwest Services Corporation (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K, filed on February 17, 2006, File No. 001-15577).* | |
(10.29) | Agreement, dated as of February 16, 2006, by and between Oren G. Shaffer and Qwest Communications International Inc. (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K, filed on February 17, 2006, File No. 001-15577).* |
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Exhibit Number | Description | |
(10.30) | Aircraft Time Sharing Agreement, dated February 14, 2006, by and between Qwest Business Resources, Inc. and Oren G. Shaffer (incorporated by reference to Qwest Communications International Inc.’s Annual Report on Form 10-K for the year ended December 31, 2005, File No. 001-15577). | |
(10.31) | Retention Agreement, dated May 8, 2002, by and between Qwest Services Corporation and Richard N. Baer (incorporated by reference to Qwest Communications International Inc.’s Annual Report on Form 10-K for the year ended December 31, 2002, File No. 001-15577).* | |
(10.32) | Severance Agreement, dated July 21, 2003, by and between Qwest Services Corporation and Richard N. Baer (incorporated by reference to Qwest Communications International Inc.’s Annual Report on Form 10-K for the year ended December 31, 2002, File No. 001-15577).* | |
(10.33) | Severance Agreement, dated April 4, 2005, by and between Qwest Services Corporation and Thomas E. Richards (incorporated by reference to Qwest Communications International Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005, File No. 001-15577).* | |
(10.34) | Letter Agreement, dated August 20, 2003, by and between Qwest Services Corporation and Paula Kruger (incorporated by reference to Qwest Communications International Inc.’s Annual Report on Form 10-K for the year ended December 31, 2002, File No. 001-15577).* | |
(10.35) | Severance Agreement, dated September 8, 2003, by and between Qwest Services Corporation and Paula Kruger (incorporated by reference to Qwest Communications International Inc.’s Annual Report on Form 10-K for the year ended December 31, 2002, File No. 001-15577).* | |
(10.36) | Letter Agreement, dated August 19, 2004, by and between Qwest Services Corporation and Paula Kruger (incorporated by reference to Qwest’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, File No. 001-15577).* | |
(10.37) | Amended and Restated Employment Agreement, dated August 19, 2004 by and between Barry K. Allen and Qwest Services Corporation (incorporated by reference to Qwest Communications International Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, File No. 001-15577).* | |
(10.38) | Aircraft Time Sharing Agreement, dated February 14, 2006, by and between Qwest Business Resources, Inc. and Barry Allen (incorporated by reference to Qwest Communications International Inc.’s Annual Report on Form 10-K for the year ended December 31, 2005, File No. 001-15577). | |
(10.39) | Letter Agreement, dated March 27, 2003, by and between Qwest Services Corporation and John W. Richardson (incorporated by reference to Qwest Communications International Inc.’s Registration Statement on Form S-4, File No. 333-115115).* | |
(10.40) | Severance Agreement, dated as of July 28, 2003, by and between Qwest Services Corporation and John W. Richardson (incorporated by reference to Qwest Communications International Inc.’s Annual Report on Form 10-K for the year ended December 31, 2004, File No. 001-15577).* | |
(10.41) | Amendment to Severance Agreement, dated as of March 14, 2006, by and between Qwest Services Corporation and John W. Richardson (incorporated by reference to Qwest Communications International Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, File No. 001-15577).* | |
(10.42) | Form of Amendment to Severance Agreement between Qwest Services Corporation and each of Richard N. Baer, Paula Kruger and Thomas E. Richards (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K, filed on December 16, 2005, File No. 001-15577).* | |
(10.43) | Private Label PCS Services Agreement between Sprint Spectrum L.P. and Qwest Wireless LLC dated August 3, 2003 (incorporated by reference to Qwest Communications International Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, File No. 1-15577).† |
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Exhibit Number | Description | |
(10.44) | Stipulation of Partial Settlement, dated as of November 21, 2005, by and among Qwest Communications International Inc., the other settling defendants, and the Lead Plaintiffs inIn re Qwest Communications International Inc. Securities Litigation on behalf of themselves and each of the class members (incorporated by reference to Qwest Communications International Inc.’s Current Report on Form 8-K/A filed on December 6, 2005, File No. 001-15577). | |
12 | Calculation of Ratio of Earnings to Fixed Charges. | |
31.1 | Chief Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Chief Financial Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
99.1 | Quarterly Operating Revenue. | |
99.2 | Quarterly Condensed Consolidated Statement of Operations. | |
(99.3) | Credit Agreement, dated as of October 21, 2005, among Qwest Services Corporation, Qwest Communications International Inc., the Lenders party thereto from time to time, and Wachovia Bank, National Association, as Administrative Agent and Issuing Lender (incorporated by reference to Qwest Communications International Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005, File No. 001-15577). |
( ) | Previously filed. |
* | Executive Compensation Plans and Arrangements. |
† | Confidential treatment has been granted by the SEC for certain provisions. Omitted material for which confidential treatment has been requested has been filed separately with the SEC. |
In accordance with Item 601(b)(4)(iii)(A) of Regulation S-K, copies of certain instruments defining the rights of holders of certain of our long-term debt are not filed herewith. Pursuant to this regulation, we hereby agree to furnish a copy of any such instrument to the SEC upon request.
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
QWEST COMMUNICATIONS INTERNATIONAL INC. | ||
By: | /s/ John W. Richardson | |
John W. Richardson Senior Vice President and Controller (Chief Accounting Officer and Duly Authorized Officer) |
October 31, 2006
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