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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
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 NUMBER 000-22609
QWEST COMMUNICATIONS INTERNATIONAL INC.
(Exact name of registrant as specified in its charter)
<Table>
DELAWARE 84-1339282
(State or other jurisdiction of (I.R.S. Employer
incorporation of organization) Identification No.)
</Table>
1801 CALIFORNIA STREET, DENVER, COLORADO 80202
(Address of principal executive offices and zip code)
TELEPHONE NUMBER (303) 992-1400
(Registrant's telephone number, including area code)
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 [ ]
At October 31, 2001, 1,664,945,725 shares of common stock were outstanding.
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QWEST COMMUNICATIONS INTERNATIONAL INC.
FORM 10-Q
TABLE OF CONTENTS
<Table>
<Caption>
ITEM PAGE
- ---- ----
PART I -- FINANCIAL INFORMATION
1. Financial Statements
Condensed Consolidated Statements of Operations --
Three and nine months ended September 30, 2001 and 2000..... 1
Condensed Consolidated Balance Sheets --
September 30, 2001 and December 31, 2000.................... 2
Condensed Consolidated Statements of Cash Flows --
Nine months ended September 30, 2001 and 2000............... 3
Notes to Condensed Consolidated Financial Statements........ 4
2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 16
3. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 28
PART II -- OTHER INFORMATION
1. Legal Proceedings........................................... II-1
6. Exhibits and Reports on Form 8-K............................ II-2
Signature page.............................................. II-5
</Table>
i
QWEST COMMUNICATIONS INTERNATIONAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
2001 2000 2001 2000
------- ------- ------- -------
Operating revenues:
Commercial services................................... $2,373 $2,421 $ 8,020 $ 4,880
Consumer and small business services.................. 1,752 1,694 5,144 4,666
Directory services.................................... 371 351 1,061 1,029
Switched access services.............................. 270 299 814 1,017
------ ------ ------- -------
Total operating revenues...................... 4,766 4,765 15,039 11,592
------ ------ ------- -------
Operating expenses:
Cost of services...................................... 1,697 1,558 5,343 3,253
Selling, general and administrative................... 1,304 1,343 3,905 3,408
Depreciation.......................................... 996 727 2,693 1,913
Depreciation adjustment for access lines returned to
service............................................ -- -- 222 --
Goodwill and other intangible amortization............ 315 317 1,026 317
Merger-related and other one-time charges............. -- 1,030 624 1,336
------ ------ ------- -------
Total operating expenses...................... 4,312 4,975 13,813 10,227
------ ------ ------- -------
Operating income (loss)................................. 454 (210) 1,226 1,365
Other expense (income) - net:
Interest expense - net................................ 380 314 1,061 732
Investment write-downs................................ -- -- 3,247 447
Decline (increase) in market value of financial
instruments........................................ 7 (58) 7 263
(Gain) loss on sales of rural exchanges and fixed
assets............................................. -- 39 (50) 39
Gain on sales of investments.......................... -- (252) -- (331)
Other expense - net................................... 17 5 51 19
------ ------ ------- -------
Total other expense - net..................... 404 48 4,316 1,169
------ ------ ------- -------
Income (loss) before income taxes and extraordinary
item.................................................. 50 (258) (3,090) 196
Income tax provision (benefit).......................... 192 (10) 339 160
------ ------ ------- -------
(Loss) income before extraordinary item................. (142) (248) (3,429) 36
Extraordinary item - early retirement of debt, net of
tax................................................... -- -- (65) --
------ ------ ------- -------
Net (loss) income....................................... $ (142) $ (248) $(3,494) $ 36
====== ====== ======= =======
Basic (loss) earnings per share:
(Loss) income before extraordinary item............... $(0.09) $(0.15) $ (2.07) $ 0.02
Extraordinary item - early retirement of debt, net of
tax................................................ -- -- (0.03) --
------ ------ ------- -------
Basic (loss) earnings per share......................... $(0.09) $(0.15) $ (2.10) $ 0.02
====== ====== ======= =======
Basic average shares outstanding........................ 1,664 1,662 1,660 1,644
====== ====== ======= =======
Diluted (loss) earnings per share:
(Loss) income before extraordinary item............... $(0.09) $(0.15) $ (2.07) $ 0.02
Extraordinary item - early retirement of debt, net of
tax................................................ -- -- (0.03) --
------ ------ ------- -------
Diluted (loss) earnings per share....................... $(0.09) $(0.15) $ (2.10) $ 0.02
====== ====== ======= =======
Diluted average shares outstanding...................... 1,664 1,662 1,660 1,686
====== ====== ======= =======
Dividends per share..................................... $ -- $ -- $ 0.05 $ 0.31
====== ====== ======= =======
</Table>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
1
QWEST COMMUNICATIONS INTERNATIONAL INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31,
2001 2000
------------- ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 425 $ 154
Accounts receivable - net................................. 4,453 4,235
Inventories and supplies.................................. 357 275
Prepaid and other......................................... 817 535
------- -------
Total current assets........................................ 6,052 5,199
Property, plant and equipment - net......................... 30,117 25,760
Goodwill and other intangible assets - net.................. 34,791 32,327
Investments................................................. 1,533 8,186
Other assets................................................ 2,207 2,029
------- -------
Total assets................................................ $74,700 $73,501
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current borrowings........................................ $ 4,369 $ 3,645
Accounts payable.......................................... 1,938 2,049
Accrued expenses and other current liabilities............ 3,000 3,806
Advance billings and customer deposits.................... 378 393
------- -------
Total current liabilities................................... 9,685 9,893
Long-term borrowings........................................ 20,436 15,421
Post-retirement and other post-employment benefit
obligations............................................... 2,897 2,735
Deferred taxes, credits and other........................... 4,484 4,148
Commitments and contingencies (Note 8)
Stockholders' equity:
Preferred stock - $1.00 par value, 200 million shares
authorized, none issued and outstanding................ -- --
Common stock - $0.01 par value, 5 billion shares
authorized; 1,687 million and 1,672 million issued;
1,665 million and 1,672 million outstanding............ 17 17
Additional paid-in capital................................ 41,733 41,289
Treasury stock, at cost................................... (1,000) --
Retained (deficit) earnings............................... (3,523) 24
Accumulated other comprehensive loss...................... (29) (26)
------- -------
Total stockholders' equity.................................. 37,198 41,304
------- -------
Total liabilities and stockholders' equity.................. $74,700 $73,501
======= =======
</Table>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
QWEST COMMUNICATIONS INTERNATIONAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
2001 2000
------- -------
Cash provided by operating activities..................... $ 3,356 $ 2,804
------- -------
INVESTING ACTIVITIES
Expenditures for property, plant and equipment............ (7,791) (5,006)
Proceeds from sale of equity securities................... -- 1,838
Cash acquired in connection with the Merger............... -- 407
Investment in equity securities........................... -- (250)
Proceeds from sale of access lines........................ 91 --
Other..................................................... (125) (44)
------- -------
Cash used for investing activities........................ (7,825) (3,055)
------- -------
FINANCING ACTIVITIES
Net proceeds (repayments) from current borrowings......... 965 (3,134)
Proceeds from issuance of long-term borrowings - net...... 6,937 4,267
Repayments of long-term borrowings........................ (2,269) (316)
Costs relating to the early retirement of debt............ (106) --
Proceeds from issuance of common stock.................... 296 315
Repurchase of stock....................................... (1,000) --
Dividends paid on common stock............................ (83) (542)
------- -------
Cash provided by financing activities..................... 4,740 590
------- -------
CASH AND CASH EQUIVALENTS
Increase.................................................. 271 339
Beginning balance......................................... 154 78
------- -------
Ending balance............................................ $ 425 $ 417
======= =======
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest.................................... $ 1,019 $ 647
======= =======
Cash paid for income taxes................................ $ 15 $ 127
======= =======
</Table>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001
(UNAUDITED)
NOTE 1: BASIS OF PRESENTATION
The condensed consolidated interim financial statements are unaudited.
Qwest Communications International Inc. ("Qwest" or the "Company" or "we" or
"us" or "our") prepared these financial statements in accordance with the
instructions for Form 10-Q. In compliance with those instructions, certain
information and footnote disclosures normally included in the financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. In management's opinion, all adjustments
(consisting only of normal recurring adjustments) necessary to fairly present
the consolidated results of operations, financial position and cash flows as of
September 30, 2001 and for all periods presented were made. These financial
statements should be read in conjunction with the audited financial statements
incorporated by reference in Qwest's Annual Report on Form 10-K for the year
ended December 31, 2000. The consolidated results of operations for the three
and nine months ended September 30, 2001 are not necessarily indicative of the
results expected for the full year. Certain reclassifications have been made to
previously reported balances to conform with the current year presentation. See
Qwest's Current Report on Form 8-K, filed July 20, 2001, for additional
information.
NOTE 2: MERGER WITH U S WEST
Final purchase price allocation. On June 30, 2000, Qwest completed its
acquisition (the "Merger") of U S WEST, Inc. ("U S WEST"). U S WEST was deemed
the accounting acquirer and its historical financial statements have been
carried forward as those of the combined company. In connection with the Merger,
each outstanding share of U S WEST common stock was converted into the right to
receive 1.72932 shares of Qwest common stock. In addition, all outstanding U S
WEST stock options were converted into options to acquire Qwest common stock.
All share and per share amounts have been restated to give retroactive effect to
the exchange ratio.
The Merger has been accounted for as a reverse acquisition under the
purchase method of accounting with U S WEST being deemed the accounting acquirer
and Qwest (prior to the Merger or "pre-Merger Qwest") the acquired entity. The
total value of the consideration was approximately $40.0 billion, which has been
allocated to the identifiable tangible and intangible assets and liabilities of
pre-Merger Qwest. During the second quarter of 2001, we completed the allocation
of the purchase price to the acquired net assets of pre-Merger Qwest and
adjustments to the preliminary purchase price allocation were recorded as
follows:
<Table>
<Caption>
PRELIMINARY FINAL
PURCHASE PURCHASE
PRICE PRICE
ALLOCATION ADJUSTMENT ALLOCATION
(DOLLARS IN BILLIONS) ----------- ---------- ----------
Identified intangibles............................. $ 4.1 $ -- $ 4.1
Investment in KPNQwest, N.V........................ 7.9 (3.1) 4.8
Tangible assets and liabilities, net............... 0.8 0.3 1.1
Deferred income taxes.............................. (0.7) (0.1) (0.8)
Goodwill........................................... 27.9 2.9 30.8
----- ----- -----
Purchase consideration............................. $40.0 $ -- $40.0
===== ===== =====
</Table>
The identifiable intangibles consist of the following (including related
amortization periods): $2.2 billion in product technology (10 years), $1.2
billion in customer relationships (10 years), $100 million in assembled
workforce (3 years) and $600 million in tradename value (40 years). There was no
change between the preliminary purchase price allocation of identifiable
intangibles and the final independent appraisal.
4
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Prior to the Merger, pre-Merger Qwest's investment in KPNQwest, N.V.
("KPNQwest") was approximately $552 million. The preliminary purchase price
allocation of $7.9 billion was based upon the publicly traded share price at the
date of the Merger and did not consider restrictions related to our investment
in KPNQwest. To properly value the investment, we obtained an independent
appraisal that was completed in June 2001. The appraisal resulted in a final
purchase price allocation of $4.8 billion, requiring an adjustment to the
preliminary purchase price allocation of $3.1 billion. The excess carrying value
of our investment in KPNQwest over our proportionate share of KPNQwest's net
equity will be amortized over 10 years. (See Note 4 for information on other
adjustments made subsequent to the final purchase price allocation relating to
the KPNQwest equity investment.)
At the time of the Merger, pre-Merger Qwest had net tangible assets with a
book value of approximately $3.0 billion. To properly record the fiber optic
network at fair value, we obtained an independent appraisal that was completed
in June 2001. The appraisal resulted in a reduction of property, plant and
equipment of approximately $1.1 billion. The reduction in carrying value was
principally due to declining replacement costs for fiber optic network assets.
There were no significant differences between the preliminary purchase price
allocation and the final appraised values for property, plant and equipment. The
remaining reduction in net tangible assets related principally to increased
liabilities associated with severance costs for pre-Merger Qwest employees,
costs to terminate redundant contracts, adjustments to the fair value of
pre-Merger Qwest's obligations and transaction costs incurred by Qwest (the
legal acquirer) to consummate the Merger. The preliminary allocation of purchase
price to net tangible assets has been adjusted upward by approximately $300
million based upon information obtained subsequent to the preliminary purchase
price allocation.
We recorded deferred income taxes in the purchase price allocation,
resulting from adjustments to the Company's tangible assets and liabilities and
from recording the identifiable intangible assets. Because of the tax-free
nature of the Merger, there was no corresponding increase in the tax basis of
those assets and liabilities.
The final purchase price allocation has resulted in goodwill of
approximately $30.8 billion which will be amortized on a straight-line basis
over 40 years.
The operating results of pre-Merger Qwest have been included in the
consolidated statement of operations from the Merger date (June 30, 2000). The
unaudited results of operations for the three and nine months ended September
30, 2001, the three months ended September 30, 2000 and the unaudited pro forma
results of operations for the nine months ended September 30, 2000 (as though
the Merger had been completed as of the beginning of 2000) are as follows
(dollars in millions, except for per share amounts):
<Table>
<Caption>
NINE MONTHS ENDED
THREE MONTHS ENDED SEPTEMBER 30,
SEPTEMBER 30, --------------------
------------------ PRO FORMA
2001 2000 2001 2000
------- ------- ------- ---------
Revenues..................................... $4,766 $4,765 $15,039 $13,936
Net loss..................................... $ (142) $ (248) $(3,494) $ (414)
Diluted loss per share....................... $(0.09) $(0.15) $ (2.10) $ (0.25)
</Table>
The unaudited pro forma results of operations for the nine-month period
ended September 30, 2000, are not necessarily indicative of what the actual
results of operations might have been if the Merger had been effective at the
beginning of 2000.
5
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Merger-related and other one-time charges. We consider only those costs
that are incremental and directly related to the Merger to be "Merger-related."
For the three- and nine-month periods ended September 30, 2001 and 2000, we
incurred the following Merger-related and other one-time charges:
<Table>
<Caption>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------- --------------
2001 2000 2001 2000
(DOLLARS IN MILLIONS) ---- ------ ---- ------
Contractual settlements and legal contingencies.... $ -- $ 80 $274 $ 80
Severance and headcount-related charges............ -- 161 199 238
Other Merger-related and one-time charges.......... -- 789 151 1,018
---- ------ ---- ------
Total Merger-related and other one-time
charges................................ $ -- $1,030 $624 $1,336
==== ====== ==== ======
</Table>
For the nine months ended September 30, 2001, other Merger-related and
one-time charges include professional fees, asset impairment charges,
re-branding costs and other costs related to the integration of U S WEST and
Qwest. Since the Merger, we have reduced staffing levels by approximately 13,400
employees and contractors.
For the three and nine months ended September 30, 2000, we incurred $1.030
billion and $1.336 billion, respectively in Merger-related costs. These included
severance and headcount charges resulting from payments to employees who left
the business upon the consummation of the Merger and retention bonus payments
that were subject to the successful completion of the Merger. Other
Merger-related and one-time charges included professional fees, re-branding
costs and other costs related to the integration of U S WEST and Qwest. Also
included in the Merger-related costs were asset impairment charges of $324
million for the three and nine months ended September 30, 2000.
A summary, as of September 30, 2001, of Merger-related and other one-time
charges accrued at December 31, 2000 and subsequent provisions and charges
against those accruals and provisions follows:
<Table>
<Caption>
CURRENT CURRENT
DECEMBER 31, YEAR YEAR SEPTEMBER 30,
2000 BALANCE PROVISION UTILIZATION 2001 BALANCE
(DOLLARS IN MILLIONS) ------------- --------- ----------- -------------
Contractual settlements and legal
contingencies...................... $376 $274 $218 $432
Severance and headcount-related
charges............................ 130 199 261 68
Other Merger-related and one-time
charges............................ 17 151 158 10
---- ---- ---- ----
Total Merger-related and
other one-time charges... $523 $624 $637 $510
==== ==== ==== ====
</Table>
We do not foresee any additional Merger-related charges and anticipate that
the majority of the contractual settlements, severance and other Merger-related
and one-time charge accruals will be paid by the end of the current fiscal year.
Legal contingencies will be paid as the related matters are resolved. When
matters are finalized, any differences between amounts accrued and actual
payments will be reflected in results of operations as an adjustment to
Merger-related and other one-time charges.
NOTE 3: ACCESS LINES RETURNED TO SERVICE
During 1999 and 2000, U S WEST committed to sell approximately 800,000
access lines to third-party telecommunications service providers, including
approximately 570,000 access lines to Citizens Communications Company
("Citizens"). Because these access lines were "held for sale," we discontinued
recognizing
6
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
depreciation expense on these assets and recorded them at the lower of their
cost or fair value, less estimated cost to sell.
On July 20, 2001, we terminated our agreement with Citizens under which the
majority of the remaining access lines were to have been sold and ceased
actively marketing the remaining lines. As a result, the remaining access lines
were reclassified as being "held for use" as of June 30, 2001. The access lines
were measured individually at the lower of their (a) carrying value before they
were classified as held for sale, adjusted for any depreciation (amortization)
expense or impairment losses that would have been recognized had the assets been
continuously classified as held for use, or (b) their fair value at June 30,
2001. The required adjustments to the carrying value of the individual access
lines are included in income from continuing operations for the nine months
ended September 30, 2001. This resulted in a charge to depreciation of $222
million.
In April 2001, we sold approximately 38,000 access lines resulting in a
gain for the nine months ended September 30, 2001 of $50 million.
NOTE 4: INVESTMENT WRITE-DOWNS AND DECLINE IN MARKET VALUE OF FINANCIAL
INSTRUMENTS
Investment write-downs. The following is a summary of the investment
write-downs recorded during the nine months ended September 30, 2001 and 2000.
There were no investment write-downs for the three months ended September 30,
2001 or 2000.
<Table>
<Caption>
FOR THE NINE
MONTHS ENDED
SEPTEMBER 30,
--------------
2001 2000
(DOLLARS IN MILLIONS) ------ ----
KPNQwest investment......................................... $3,048 $ --
Lucent Technology, Inc. investment.......................... 36 --
Other investment losses..................................... 163 447
------ ----
Total investment write-downs................................ $3,247 $447
====== ====
</Table>
We review our portfolio of equity securities on a quarterly basis. Many
factors are considered in assessing whether a decline in value is other than
temporary, including, as may be appropriate:
- Earnings trends and asset quality
- Near term prospects and financial condition of the issuer
- Financial condition and prospects of the issuer's region and industry
- The cause and severity of the decline in market price
- Analysts recommendations and stock price projections
- The length of time market value was less than the carrying value
- Stock price volatility and near term potential for recovery
- Qwest's intent and ability to retain the investment
As a result of the review of our portfolio of equity securities for the
three months ended September 30, 2001 and 2000, no charges were recorded to
reduce the carrying values of our investments to their estimated fair values.
For the nine months ended September 30, 2001 and 2000, charges of $3.247 billion
and $447 million, respectively, were recorded to reduce the carrying values of
our investments to their estimated fair values.
7
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
KPNQwest equity investment. In March 1999, KPN Telecom B.V. ("KPN") and
pre-Merger Qwest formed the corporate joint venture, KPNQwest. The carrying
value of Qwest's investment in KPNQwest at the date of the Merger was $552
million. On June 30, 2000, our preliminary estimate of the value of our
investment in KPNQwest was $7.9 billion, based upon the closing price of the 11%
publicly traded minority stake of $39.625 per share on that date. However,
because our investment in KPNQwest is subject to a number of restrictions, the
fair value of our investment was ultimately determined by an independent
appraisal.
As part of the finalization of the purchase price allocation associated
with the Merger, we engaged an independent appraiser to perform a valuation of
our investment in KPNQwest as of June 30, 2000. The appraisal was completed in
June 2001, and indicated a fair value for our investment in KPNQwest of $4.8
billion or $23.775 per share. Accordingly, the carrying value of the KPNQwest
investment was adjusted, in accordance with purchase accounting, to equal the
$4.8 billion fair value.
At June 30, 2001, we evaluated our investment in KPNQwest and concluded
that the decline in fair value from $4.8 billion was other than temporary.
Factors considered in reaching this conclusion included the following, among
others:
1. KPNQwest's stock price had remained at approximately $11 per share
throughout the second quarter. The period of time the market price was
below our carrying value of $23.775 per share and the severity of the
decline indicated that the decline had become other than temporary.
2. Analysts had released new recommendations during the quarter of their
stock price targets for KPNQwest which showed a significant decline from
the first quarter.
3. The European telecom sector had experienced a severe deterioration
during the quarter, including numerous bankruptcies, making the near
term prospects of KPNQwest's stock recovery less certain at June 30,
2001.
As a result of the evaluation of our investment in KPNQwest, we concluded
that the fair value of our investment at June 30, 2001 was $1.3 billion and took
a charge of $3.048 billion to reduce the carrying value to the estimated fair
value of the investment.
Other investments. During the nine months ended September 30, 2001, we
concluded that several other investments in equity securities had experienced
declines in fair value that were other than temporary and we recognized a loss
of $199 million for the nine months ended September 30, 2001.
Included in this charge for the nine months ended September 30, 2001 was a
charge for $36 million relating to our investment in Lucent Technology, Inc.
("Lucent") based on our conclusion at June 30, 2001 detailed below. Although the
market price for Lucent stock had declined below our carrying value as of March
31, 2001, we concluded that insufficient evidence existed to reach a conclusion
that the decline was not temporary. Factors considered in reaching that
conclusion included Lucent's earnings trends, financial health (including debt
and analyst ratings), asset quality, executive management changes, restructuring
plans, large customer contract announcements and actions taken to reduce
headcount, capital and other expenditures. In addition, we considered the
potential acquisition of Lucent by a large European telecommunications equipment
manufacturer.
At June 30, 2001, we again evaluated our investment in Lucent and concluded
that the decline in fair value was other than temporary. Factors considered in
reaching this conclusion included the following:
1. An additional three months of declines in the Lucent stock price.
2. The magnitude by which Lucent did not meet analysts' first quarter 2001
earnings estimates.
8
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. A decline in the number of analysts with buy recommendations.
4. The announced termination of merger discussions with the large European
telecommunications equipment manufacturer.
As a result of the evaluation of our investment in Lucent, we concluded
that the fair value of the investment at June 30, 2001 was $4.2 million and took
a charge of $36 million to reduce the investment from its carrying value to its
fair value.
For the nine months ended September 30, 2000, we recorded charges of $447
million associated with an other than temporary decline in our Global Crossing
Ltd. ("Global Crossing") investment.
Decline in market value of derivatives. On August 22, 2001, we settled
derivative contracts associated with our previously-owned equity investment in
Global Crossing. These derivatives were recorded at market value with any change
in market value taken immediately to income. Due to a decline in the market
value of the derivatives, we recorded a charge of $7 million for the three and
nine months ended September 30, 2001. For the three and nine months ended
September 30, 2000, the increase (decrease) in market value was $58 million and
($263) million, respectively.
NOTE 5: WEIGHTED AVERAGE SHARES
The following table is a reconciliation of basic weighted average shares to
diluted weighted average shares. The 2000 shares have been adjusted to reflect
the conversion of the U S WEST shares into Qwest shares due to the Merger.
<Table>
<Caption>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------- --------------
2001 2000 2001 2000
(SHARES IN MILLIONS) ----- ----- ----- -----
Basic weighted average shares outstanding........... 1,664 1,662 1,660 1,644
Dilutive effect of stock options.................... -- -- -- 42
----- ----- ----- -----
Diluted weighted average shares outstanding......... 1,664 1,662 1,660 1,686
===== ===== ===== =====
</Table>
For the three and nine months ended September 30, 2001, 121 million options
were excluded from the earnings per share computation solely because their
effect was anti-dilutive. For the three and nine months ended September 30,
2000, 128 million and 11 million options, respectively, were excluded because
their effect was also anti-dilutive.
NOTE 6: SEGMENT INFORMATION
We operate in four segments: retail services, wholesale services, network
services and directory services. The retail services segment provides local
telephone and data services, long-distance voice and data services and wireless
services. The wholesale services segment provides exchange access services that
connect customers to the facilities of interexchange carriers ("IXCs") and
interconnection to our local telecommunications network to competitive local
exchange carriers ("CLECs"). The network services segment provides access to our
telecommunications network, including our information technologies, primarily to
our retail services and wholesale services segments. The directory services
segment publishes White and Yellow Pages telephone directories and provides
electronic directory and other information services. We provide the majority of
our services to more than 25 million residential and business customers in
Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North
Dakota, Oregon, South Dakota, Utah, Washington and Wyoming (our "local service
area").
9
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Following is a breakout of our segments. The accounting principles used are
the same as those used in the condensed consolidated financial statements. The
"other" category includes unallocated corporate expenses and revenues. We
internally track, separately, only the assets of our directory services segment
and all remaining assets are included as a reconciling item. The "Reconciling
Items" category also includes other adjustments. The figures presented below for
the three and nine months ended September 30, 2000 have been adjusted to reflect
certain reclassifications to conform with the presentation of the corresponding
periods of 2001.
<Table>
<Caption>
TOTAL
COMMUNICATIONS
RETAIL WHOLESALE NETWORK AND RELATED DIRECTORY RECONCILING CONSOLIDATED
SERVICES SERVICES SERVICES SERVICES SERVICES OTHER ITEMS TOTAL
-------- --------- -------- -------------- --------- ----- ----------- ------------
(DOLLARS IN MILLIONS)
THREE MONTHS ENDED
SEPTEMBER 30,
2001
External revenues..... $3,603 $777 $ 13 $4,393 $ 371 $ 2 $ -- $ 4,766
EBITDA(1)............. 2,718 664 (1,598) 1,784 260 (279) -- 1,765
Assets................ -- -- -- -- 1,819 -- 72,881 74,700
Capital
expenditures........ 287 -- 1,880 2,167 -- 65 -- 2,232
2000
External revenues..... 3,484 823 88 4,395 351 19 -- 4,765
EBITDA(1)............. 2,758 696 (1,341) 2,113 216 (465) -- 1,864
Assets................ -- -- -- -- 1,194 -- 70,894 72,088
Capital
expenditures........ 198 15 1,820 2,033 12 33 -- 2,078
</Table>
<Table>
<Caption>
TOTAL
COMMUNICATIONS
RETAIL WHOLESALE NETWORK AND RELATED DIRECTORY RECONCILING CONSOLIDATED
SERVICES SERVICES SERVICES SERVICES SERVICES OTHER ITEMS TOTAL
-------- --------- -------- -------------- --------- ------- ----------- ------------
(DOLLARS IN MILLIONS)
NINE MONTHS ENDED
SEPTEMBER 30,
2001
External revenues..... $11,558 $2,292 $ 104 $13,954 $1,061 $ 24 $ -- $15,039
EBITDA(1)............. 9,062 1,925 (5,090) 5,897 698 (804) -- 5,791
Assets................ -- -- -- -- 1,819 -- 72,881 74,700
Capital
expenditures........ 655 -- 6,966 7,621 2 168 -- 7,791
2000
External revenues..... 8,154 2,337 113 10,604 1,029 (41) -- 11,592
EBITDA(1)............. 6,336 1,954 (2,945) 5,345 634 (1,048) -- 4,931
Assets................ -- -- -- -- 1,194 -- 70,894 72,088
Capital
expenditures........ 527 97 4,314 4,938 35 33 -- 5,006
</Table>
- ---------------
(1) Earnings before interest, income taxes, depreciation and amortization
("EBITDA") does not include non-recurring and non-operating items such as
Merger-related and other one-time charges, investment write-downs,
gains/losses on the sale of investments, declines in the market value of
financial instruments and gains/losses on sales of rural exchanges and fixed
assets. EBITDA does not represent cash flow for the periods presented and
should not be considered as an alternative to net earnings (loss) as an
indicator of operating performance or as an alternative to cash flows as a
source of liquidity, and may not be comparable with EBITDA as defined by
other companies.
10
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation from Segment EBITDA to earnings (loss) before income taxes
and extraordinary item follows:
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2001 2000 2001 2000
(DOLLARS IN MILLIONS) ------- ------- ------- ------
Segment EBITDA................................ $1,765 $1,864 $ 5,791 $4,931
Less:
Depreciation and amortization............... 1,311 1,044 3,941 2,230
Merger-related and other one-time charges... -- 1,030 624 1,336
Other expense -- net........................ 404 48 4,316 1,169
------ ------ ------- ------
Earnings (loss) before income taxes and
extraordinary item.......................... $ 50 $ (258) $(3,090) $ 196
====== ====== ======= ======
</Table>
NOTE 7: OTHER COMPREHENSIVE INCOME
Comprehensive income (loss) for the three- and nine-month periods ended
September 30, 2001 and 2000 is as follows:
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------
2001 2000 2001 2000
(DOLLARS IN MILLIONS) ------- ------- ------- -----
Net (loss) income............................. $(142) $(248) $(3,494) $ 36
Other comprehensive (loss) income:
Net unrealized gains (losses) on
available-for-sale marketable securities,
net of deferred taxes....................... (5) (72) 16 (132)
Foreign currency translation.................. 36 (83) (19) (83)
----- ----- ------- -----
Comprehensive loss............................ $(111) $(403) $(3,497) $(179)
===== ===== ======= =====
</Table>
Net unrealized losses for the quarters ended September 30, 2001 and 2000
were net of deferred tax benefits of $3 million and $46 million, respectively.
Net unrealized gains and losses for the nine months ended September 30, 2001 and
2000 were net of deferred tax expenses (benefits) of $10 million and ($86)
million, respectively.
Embedded in net unrealized gains and losses on available-for-sale
marketable securities are reclassification adjustments. Reclassification
adjustments are comprised of amounts that have been removed from comprehensive
income and recognized in income or loss from operations in the condensed
consolidated statement of operations during the periods cited below. For the
nine months ended September 30, 2001, unrealized gains and losses on marketable
securities included reclassification adjustments of $36 million of losses (net
of deferred tax benefits of $23 million) pertaining to other than temporary
impairments of our investments in certain marketable equity securities.
For the nine months ended September 30, 2000, net unrealized losses on
marketable securities include reclassification adjustments of $319 million (net
of deferred tax benefits of $128 million) pertaining to an other than temporary
decline in our investment in Global Crossing common stock, offset by realized
gains from the sale of marketable securities.
11
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8: COMMITMENTS AND CONTINGENCIES
COMMITMENTS
Minimum Usage Requirements and Other Commitments. We have agreements with
IXCs and third party vendors that require us to maintain minimum monthly and/or
annual billings based on usage. We believe that we will meet substantially all
minimum usage commitments. We also have certain agreements with third party
vendors that require payments that are unconditional. Where requirements have
not been met, we have recorded appropriate charges. We have reflected in our
financial statements the financial impact of all current, unmet minimum usage
requirements.
CONTINGENCIES
In January 2001, an amended purported class action complaint was filed in
Denver District Court against us and certain current and former officers and
directors on behalf of stockholders of U S WEST. The complaint alleges that we
have a duty to pay a quarterly dividend to U S WEST stockholders of record as of
June 30, 2000. Plaintiffs further claim that the defendants' efforts to close
the Merger in advance of the record date and the defendants' failure to pay the
dividend breaches fiduciary duties owed to stockholders of U S WEST. In June
2000, the court rejected the plaintiffs' motion for a temporary restraining
order attempting to prevent the closing of the Merger. In October 2001, our
motion to dismiss the complaint was denied. Discovery has now commenced.
Through September 2001, seven purported class action complaints had been
filed in various state courts against us and U S WEST on behalf of customers in
the states of Arizona, Colorado, Minnesota, New Mexico, Oregon, Utah and
Washington. The complaints alleged, among other things, that from 1993 to the
present, U S WEST, in violation of alleged statutory and common law obligations,
willfully delayed the provision of local telephone service to the purported
class members. The complaints also alleged that U S WEST misrepresented the date
on which such local telephone service was to be provided to the purported class
members. The complaints sought compensatory damages for purported class members,
disgorgement of profits and punitive damages. The parties have signed agreements
to settle the complaints. As of September 2001, the settlements have been
approved by all of the courts.
In April 1999, CSX Transportation, Inc. filed a complaint in federal
district court in Jacksonville, Florida against us claiming breach of a 1995
contract. Discovery in the case is ongoing, and trial is scheduled to commence
in May 2002.
Through September 2001, several purported class actions have been filed in
various courts against us on behalf of landowners in Alabama, California,
Colorado, Georgia, Illinois, Indiana, Kansas, Louisiana, Mississippi, Missouri,
North Carolina, Oregon, South Carolina, Tennessee and Texas. The complaints
challenge our right to install our fiber optic cable network in railroad
rights-of-way and in California, Colorado, Illinois, South Carolina and Texas,
also challenge our right to install fiber optic cable in utility and pipeline
rights-of-way. In Alabama, the complaint challenges our right to install fiber
optic cable in any right of way, including public highway. The complaints allege
that the railroads, utilities and pipeline companies own a limited property
right-of-way that did not include the right to permit us to install our fiber
optic cable network on the plaintiffs' property. 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 Alabama, California, Colorado,
Georgia, Kansas, Louisiana, Mississippi, Missouri, North Carolina, Oregon,
Tennessee and Texas actions purport to be on behalf of a class of such
landowners in Alabama, California, Colorado, Georgia, Kansas, Louisiana,
Mississippi, Missouri, North Carolina, Oregon, Tennessee and Texas,
respectively. The Illinois action purports to be on behalf of landowners
adjacent to railroad rights-of-way over which our network passes in Illinois,
Iowa, Kentucky, Michigan, Minnesota, Nebraska, Ohio and Wisconsin. The South
Carolina action purports to be on behalf of landowners adjacent to railroad
rights-of-way over which our network passes in Georgia, North Carolina, South
Carolina and Virginia. The complaints seek damages on theories of trespass and
unjust enrichment, as well as punitive damages. None of the complaints have been
12
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
certified by a court as an appropriate state-wide or national class action. In
Tennessee, the court certified a class of a small number of counties, and that
ruling is on appeal. We have received, and may in the future receive, additional
claims and demands that may be based on similar or different legal theories.
From March 2, 2000 to March 9, 2000, five purported class action complaints
were filed against us in state court in Delaware on behalf of our stockholders.
The complaints allege that we and our directors breached our fiduciary duty by
entering into the Merger and by agreeing not to solicit alternative
transactions. Since the filing of the complaints, there has been no discovery or
other activity in the cases.
On March 17, 2000 and March 20, 2000, two class action complaints were
filed in federal district court in Delaware against us and our Chairman and
Chief Executive Officer, Joseph P. Nacchio, on behalf of U S WEST stockholders.
The complaints allege, among other things, that Qwest and Mr. Nacchio made
material false statements regarding our intent to solicit an alternative
transaction to the Merger. Since the filing of the complaints, there has been no
discovery or other activity in the cases.
In 1999, twelve purported class action complaints were filed against U S
WEST and its directors on behalf of U S WEST stockholders. Each of the
complaints allege that the defendants breached their fiduciary duties to the
class members by entering into a merger agreement with Global Crossing thereby
refusing to seek all bona fide offers for U S WEST and refusing to consider an
acquisition proposal from Qwest. Since the filing of the complaints, there has
been no discovery or other activity in the cases.
From time to time we receive complaints and become subject to
investigations regarding tariffs, "slamming" (the practice of changing
long-distance carriers without the customer's consent) and other matters. In
2000, the California Public Utilities Commission opened an investigation
relating to certain slamming complaints. An administrative hearing was held in
May 2001, and we are awaiting a recommendation from the administrative law
judge. A purported class action complaint was filed in federal court in
Connecticut containing slamming allegations. We continue to analyze regulatory
and governmental requirements and may modify our practices as a result. We may
receive complaints or become subject to investigations in the future. Such
complaints or investigations could result in the imposition of certain fines and
other penalties or awards of damages.
On July 23, 2001, we filed a demand for arbitration against Citizens
alleging that it breached Agreements for Purchase and Sale of Telephone
Exchanges dated as of June 16, 1999, between Citizens Utilities Company and U S
WEST Communications, Inc., with respect to the purchase and sale of exchanges in
Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska and Wyoming. The
demand for arbitration was filed after Citizens failed to close the exchange
sales in violation of the terms of the Purchase Agreements. Citizens in turn
filed a demand alleging claims against us in connection with the sale of those
same exchanges. In the arbitration, we seek a determination that Citizens
breached the agreements and, as a result, we are entitled to retain the letters
of credit Citizens provided in connection with the transactions and other
damages. Citizens seeks a determination that we breached the agreements and, as
a result, they are entitled to damages. This dispute is still at a preliminary
stage.
In August 2001, we filed a complaint in state court in Colorado and an
arbitration demand against Touch America, Inc. ("Touch America"). In response,
also in August 2001, Touch America filed a complaint against us in federal
district court in Montana and removed our state court complaint to federal
district court in Colorado. Touch America's complaint was dismissed on November
5, 2001. The disputes between us and Touch America relate to various billing,
reimbursement and other commercial disputes arising under agreements entered
into for the sale of our interLATA (local access transport area) business in our
local service area to Touch America on June 30, 2000. Each party seeks damages
against the other for amounts billed and unpaid and for other disputes. The
maters are in a preliminary stage, discovery has not begun in these cases and no
dates have been set for trial or arbitration.
From July 27, 2001 to October 1, 2001, seven purported class action
complaints were filed in federal district court in Colorado against us, our
Chairman and Chief Executive Officer, Joseph P. Nacchio, and our
13
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Chief Financial Officer, Robin R. Szeliga on behalf of purchasers of our
publicly traded stock between March 22, 2001 and July 23, 2001. One of the seven
complaints has been voluntarily dismissed. The remaining six complaints, which
have been consolidated, allege, among other things, that Qwest, Mr. Nacchio and
Ms. Szeliga made material false statements regarding the results of operations
for the quarter ended March 31, 2001 in violation of sections 10(b) and 20(a) of
the Securities Exchange Act of 1934 and that, during the above period, the
individual defendants sold shares of our common stock. The complaints allege
that our first quarter 2001 results and the statements regarding those results
were false and misleading due to our alleged improper valuation of KPNQwest in
violation of generally accepted accounting principles, and due to the following
alleged facts which the plaintiffs claim were undisclosed: (1) first quarter
earnings were better than expected because of a change in the discount rate used
to calculate our pension obligations; (2) we failed to properly "write-down" the
value of our holdings in KPNQwest; (3) our aggressive use of capitalization to
classify interest and software development costs as assets rather than expenses
increased first quarter earnings; and (4) our selling, general and
administrative expenses were 22% of sales, not due to tight expense controls but
to improper classification of selling, general and administrative expenses as
cost of sales. The complaints seek unspecified compensatory damages and other
relief. Since the filing and consolidation of the actions, the court has
appointed a lead plaintiff and lead counsel; otherwise, there has been no
discovery or other activity in these cases.
We have also been named as a defendant in various other litigation matters.
We intend to vigorously defend these outstanding claims.
We have provided for these matters in our condensed consolidated financial
statements as of September 30, 2001. We do not expect any material adverse
impacts in excess of such provision as a result of the ultimate resolution of
these matters.
NOTE 9: SUBSEQUENT EVENTS
In October 2001, we entered into agreements under which we will purchase
approximately 14 million shares of KPNQwest common stock, and Anschutz Company,
our principal stockholder, will purchase approximately 6 million shares, from
Koninklijke KPN N.V., the Dutch telecommunications company. The agreed upon
purchase price was $4.58 per share. After completion of the purchase, we will
own approximately 47.5% of the voting power of the KPNQwest stock. As part of
the agreement, KPN granted us an option to purchase some or all of KPN's shares
in KPNQwest. The purchase, which is subject to several conditions including
antitrust approval in several European jurisdictions and KPNQwest shareholder
approval of certain amendments to the KPNQwest articles of association, is
expected to be completed before December 31, 2001. We will continue to account
for our proportionate share of KPNQwest's operations under the equity method of
accounting.
On October 31, 2001, we announced a voluntary stock option exchange. Under
the terms of the offer and subject to certain restrictions, Qwest employees may
exchange all or a portion of their stock options with an exercise price of $35
or more. The offer is available only to our full-time, non-union employees
(excluding 15 senior executives), with options granted by Qwest or U S WEST.
Options surrendered by an employee will be cancelled and new options will be
issued no earlier than six months and one day after the termination of the
option exchange offer. The exercise price on the new options will equal the
closing market price on the day the new options are granted. The options will
vest ratably over a four-year period commencing on the new option grant date.
For more information, see Amendment No. 1 to Schedule TO which we filed with the
Securities and Exchange Commission on November 5, 2001.
NOTE 10: NEW ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations." This pronouncement eliminated the use of the "pooling of
interests" method of accounting for all mergers and acquisitions. As a result,
all mergers
14
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and acquisitions will be accounted for using the "purchase" method of
accounting. SFAS No. 141 is effective for all mergers and acquisitions initiated
after June 30, 2001. Adoption of this pronouncement has no impact on our results
from operations or our financial position.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." This statement addresses financial accounting and reporting for
intangible assets (excluding goodwill) acquired individually or with a group of
other assets at the time of their acquisition. It also addresses financial
accounting and reporting for goodwill and other intangible assets subsequent to
their acquisition. Intangible assets (excluding goodwill) acquired outside of a
business combination will be initially recorded at their estimated fair value.
If the intangible asset has a finite useful life, it will be amortized over that
life. Intangible assets with an indefinite life are not amortized. Both types of
intangible assets will be reviewed annually for impairment and a loss recorded
when the asset's carrying value exceeds its estimated fair value. Goodwill will
be treated similar to an intangible asset with an indefinite life. SFAS No. 142
is effective for fiscal years beginning after December 15, 2001. We currently
estimate the adoption of SFAS No. 142 will reduce our amortization expense by
approximately $850-$950 million annually, beginning January 1, 2002. We are
currently evaluating the impact this pronouncement will have on the value of our
intangible assets.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." This statement deals with the costs of closing
facilities and removing assets. SFAS No. 143 requires entities to record the
fair value of a legal liability for an asset retirement obligation in the period
it is incurred. This cost is initially capitalized and amortized over the
remaining life of the underlying asset. Once the obligation is ultimately
settled, any difference between the final cost and the recorded liability is
recognized as a gain or loss on disposition. SFAS No. 143 is effective for years
beginning after June 15, 2002. We are currently evaluating the impact this
pronouncement will have on our future consolidated financial results.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This pronouncement addresses how
to account for and report impairments or disposals of long-lived assets. Under
SFAS No. 144, an impairment loss is to be recorded on long-lived assets being
held or used when the carrying amount of the asset is not recoverable from its
undiscounted cash flows. The impairment loss is equal to the difference between
the asset's carrying amount and estimated fair value. Long-lived assets to be
disposed of by other than a sale for cash are to be accounted for and reported
like assets being held or used except the impairment loss is recognized at the
time of the disposition. Long-lived assets to be disposed of by sale are to be
recorded at the lower of their carrying amount or estimated fair value (less
costs to sell) at the time the plan of disposition has been approved and
committed to by the appropriate company management. In addition, depreciation is
to cease at the same time. SFAS No. 144 is effective for fiscal years beginning
after December 15, 2001. We are currently evaluating the impact this
pronouncement will have on our future consolidated financial results.
On July 19, 2001, the Emerging Issues Task Force ("EITF") issued EITF Issue
00-11, "Meeting the Ownership Transfer Requirements of FASB Statement No. 13 for
Leases of Real Estate." This issue is primarily concerned with ownership
transfer requirements for a sales-type lease of property under SFAS No. 13.
According to EITF 00-11, a nominal purchase option contained in a lease does not
satisfy the transfer of ownership criterion in SFAS No. 13 for transfers of real
property, if the failure to pay the nominal amount results in ownership not
being transferred to the lessee. EITF 00-11 provides, however, that this
criterion will be met in cases involving integral equipment or property
improvements when the lessor agrees, regardless of whether or not the lessee
pays any amount, to execute and deliver to the lessee all documents (including,
if applicable, a bill of sale) that may be required to release the property from
the lease and transfer ownership to the lessee. EITF 00-11 applies to leases
entered into after July 19, 2001 and to certain leases modified after that date.
We are in compliance with SFAS No. 13 with respect to these ownership transfer
requirements.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Form 10-Q contains or incorporates by reference "forward-looking
statements," as that term is used in federal securities laws, about Qwest
Communications International Inc.'s ("Qwest" or the "Company" or "us" or "we" or
"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 revenues, 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 will file with the Securities
and Exchange Commission. You can find many of these statements by looking for
words such as "believes," "expects," "anticipates," "estimates," or similar
expressions used in this report or incorporated by reference in this report.
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.
The most important factors that could prevent us from achieving our stated
goals include, but are not limited to, the following:
- intense competition in the markets in which we compete;
- changes in demand for our products and services;
- the duration and extent of the current economic downturn;
- adverse economic conditions in the markets served by us or by companies
in which we have substantial investments;
- dependence on new product development and acceleration of the deployment
of advanced new services, such as broadband data, wireless and video
services, which could require substantial expenditure of financial and
other resources in excess of contemplated levels;
- higher than anticipated employee levels, capital expenditures and
operating expenses;
- rapid and significant changes in technology and markets;
- adverse changes in the regulatory or legislative environment affecting
Qwest's business;
- delays in Qwest's ability to provide interLATA services within its
14-state local service area;
- failure to maintain rights-of-way; and
- failure to achieve the projected synergies and financial results expected
to result from the acquisition of U S WEST, Inc. ("U S WEST"), by Qwest
on June 30, 2000 (the "Merger"), and difficulties in combining the
operations of the combined company, which could affect our revenues,
levels of expenses and operating results.
Because these statements are subject to risks and uncertainties, actual
results may differ materially from those expressed or implied by the
forward-looking statements. We caution you not to place undue reliance on the
statements, which speak only as of the date of this report.
16
Further, the information contained in this document or in a document
incorporated or deemed to be incorporated by reference herein is a statement of
our present intention and is based upon, among other things, the existing
regulatory environment, industry conditions, market conditions and prices, the
economy in general and our assumptions. We may change our intentions, at any
time and without notice, based upon any changes in such factors, in our
assumptions or otherwise.
The cautionary statements contained or referred to in this section should
be considered in connection with any subsequent written or oral forward-looking
statements that Qwest or persons acting on our behalf may issue. We do not
undertake any obligation to review or confirm analyst's expectations or
estimates or to release publicly any revisions to any forward-looking statements
to reflect events or circumstances after the date of this report or to reflect
the occurrence of unanticipated events. In addition, we make no representation
with respect to any materials available on the Internet, including materials
available on our website.
MERGER WITH U S WEST
The Merger has been accounted for as a reverse acquisition under the
purchase method of accounting. For accounting purposes, U S WEST was deemed the
acquirer and Qwest the acquired entity. As U S WEST was deemed the accounting
acquirer, its historical financial statements have been carried forward as those
of the combined company. In connection with the Merger, each outstanding share
of U S WEST common stock was converted into the right to receive 1.72932 shares
of Qwest common stock. In addition, all outstanding U S WEST stock options were
converted into options to acquire Qwest common stock. All share and per share
amounts have been restated to give retroactive effect to the exchange ratio.
The results of operations for Qwest (the acquired entity for accounting
purposes) before the Merger ("pre-Merger Qwest"), are not reflected in the
accompanying condensed consolidated statements of operations. However, due to
the significance of the Merger, the comparison of 2001 to 2000 results in
Management's Discussion and Analysis of Financial Condition and Results of
Operations will be based upon the 2001 financial statements prepared in
accordance with generally accepted accounting principles ("GAAP") (referred to
as "As Reported"), the As Reported financial statement for the three months
ended September 30, 2000 and the unaudited pro forma financial statement for the
nine months ended September 30, 2000. The unaudited pro forma financial
statement for the nine months ended September 30, 2000 was prepared as if the
Merger occurred on January 1, 2000 and the financial statements of pre-Merger
Qwest and U S WEST were combined as of that date. This pro forma financial
statement has been adjusted to reflect the elimination of pre-Merger Qwest's
in-region long-distance activity, the inclusion of interest expense on pre-
Merger Qwest borrowings and the amortization of intangible assets arising out of
the Merger. The unaudited pro forma results of operations for the nine-month
period ended September 30, 2000, are not necessarily indicative of what the
actual results of operations might have been if the Merger had been effective at
the beginning of 2000.
17
<Table>
<Caption>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------------- ---------------------------------------
2001 2000 2001 2000
AS AS INCREASE AS PRO INCREASE
REPORTED REPORTED (DECREASE) REPORTED FORMA (DECREASE)
(DOLLARS IN MILLIONS) -------- -------- ------------------ -------- ------- ------------------
Operating revenues:
Commercial services........... $2,373 $2,421 $ (48) (2.0)% $ 8,020 $ 6,881 $ 1,139 16.6%
Consumer and small business
services.................... 1,752 1,694 58 3.4% 5,144 5,009 135 2.7%
Directory services............ 371 351 20 5.7% 1,061 1,029 32 3.1%
Switched access services...... 270 299 (29) (9.7)% 814 1,017 (203) (20.0)%
------ ------ ------- -------- ------- ------- ------- --------
Total operating
revenues............. 4,766 4,765 1 0.0% 15,039 13,936 1,103 7.9%
------ ------ ------- -------- ------- ------- ------- --------
Operating expenses:
Cost of services.............. 1,697 1,558 139 8.9% 5,343 4,577 766 16.7%
Selling, general and
administrative.............. 1,304 1,343 (39) (2.9)% 3,905 4,064 (159) (3.9)%
------ ------ ------- -------- ------- ------- ------- --------
EBITDA........................ 1,765 1,864 (99) (5.3)% 5,791 5,295 496 9.4%
Depreciation.................. 996 727 269 37.0% 2,693 2,002 691 34.5%
Depreciation adjustment for
access lines returned to
service..................... -- -- -- N/A 222 -- 222 N/A
Goodwill and other intangible
amortization................ 315 317 (2) (0.6)% 1,026 951 75 7.9%
Merger-related and other
one-time charges............ -- 1,030 (1,030) (100.0)% 624 1,336 (712) (53.3)%
------ ------ ------- -------- ------- ------- ------- --------
Total operating
expenses............. 1,311 2,074 (763) (36.8)% 4,565 4,289 276 6.4%
------ ------ ------- -------- ------- ------- ------- --------
Operating income (loss)......... 454 (210) 664 316.2% 1,226 1,006 220 21.9%
Other expense (income)-net:
Interest expense-net.......... 380 314 66 21.0% 1,061 807 254 31.5%
Investment write-downs........ -- -- -- N/A 3,247 447 2,800 626.4%
Decline (increase) in market
value of financial
instruments................. 7 (58) 65 (112.1)% 7 263 (256) (97.3)%
(Gain) loss on sales of rural
exchanges and fixed
assets...................... -- 39 (39) 100.0% (50) 39 (89) 228.2%
Gain on sales of
investments................. -- (252) 252 (100.0)% -- (375) 375 (100.0)%
Other expense-net............. 17 5 12 240.0% 51 24 27 112.5%
------ ------ ------- -------- ------- ------- ------- --------
Total other
expense-net.......... 404 48 356 741.7% 4,316 1,205 3,111 258.2%
------ ------ ------- -------- ------- ------- ------- --------
Income (loss) before income
taxes and extraordinary
item.......................... 50 (258) 308 119.4% (3,090) (199) (2,891) (1,452.8)%
Income tax provision
(benefit)..................... 192 (10) 202 (2,020.0)% 339 215 124 57.7%
------ ------ ------- -------- ------- ------- ------- --------
Loss before extraordinary
item.......................... (142) (248) 106 42.7% (3,429) (414) (3,015) (728.3)%
Extraordinary item -- early
retirement of debt, net of
tax........................... -- -- -- N/A (65) -- (65) N/A
------ ------ ------- -------- ------- ------- ------- --------
Net loss........................ $ (142) $ (248) $ 106 42.7% $(3,494) $ (414) $(3,080) (744.0)%
====== ====== ======= ======== ======= ======= ======= ========
Diluted loss per share.......... $(0.09) $(0.15) $ 0.06 40.0% $ (2.10) $ (0.25) $ (1.85) (740.0)%
====== ====== ======= ======== ======= ======= ======= ========
</Table>
RESULTS OF OPERATIONS
Three and Nine Months Ended September 30, 2001 Compared with 2000
REVENUES:
Total Revenues. Total revenues for the three months and nine months ended
September 30, 2001 were $4.766 billion and $15.039 billion, respectively. When
compared to the same periods in 2000, revenues were flat for the three months
ended September 30, 2001 while they grew $1.103 billion or 7.9% for the nine
months ended September 30, 2001. Although total revenue did not grow during the
three months ended September 30, 2001, certain areas within the business
continued to generate increasing revenues such as Internet Protocol ("IP"),
which includes, among other things, digital subscriber lines ("DSL"), dedicated
Internet
18
access ("DIA"), virtual private networks ("VPN"), professional services and web
hosting, traditional private lines and wireless products and services. DSL
subscribers grew by 84% over the same period in 2000 to 391,000 customers in
Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North
Dakota, Oregon, South Dakota, Utah, Washington and Wyoming (our "local service
area"). These increases were offset, however, by declines in optical capacity
asset sales, IP equipment sales and local service revenues. The major
contributors to the growth for the nine months ended September 30, 2001 over the
nine months ended September 30, 2000 were sales of optical capacity assets,
traditional private lines, DSL, DIA, VPN, professional services, web hosting and
wireless products and services. Data and IP products and services revenues
represent more than 23% of total revenue for the three months ended September
30, 2001. We believe revenues from data and IP products and services will
account for an increasingly larger portion of our revenues in future periods.
Revenues for the foreseeable future may reflect the continuing impact of a
slowing economy as well as a fundamental shift in the wholesale buying behavior
for optical capacity as customers shift away from network asset purchases to
shorter-term agreements. In addition, our CyberCenters may experience lower than
expected utilization if the current economic conditions persist.
Commercial Services Revenues. Commercial services revenues are derived
from sales of IP, data, voice and wireless products and services provided to
both retail and wholesale business customers. For the three months ended
September 30, 2001, commercial services revenues decreased by $48 million or
2.0% from the comparable period in 2000. While sales of our IP and certain data
services (DSL, DIA, VPN, traditional private line, professional services, web
hosting and dial Internet access) continued to grow, these increases were more
than offset by the reduction in optical capacity asset revenues and IP equipment
sales. Declining optical capacity asset revenue sales were the result of
softening wholesale demand and a shift in customer purchasing behavior away from
network asset purchases to shorter-term agreements. The increase in commercial
services revenues for the nine months ended September 30, 2001 as compared to
the same period last year was $1.139 billion or 16.6%, and was primarily
attributable to growth in our data services and IP (DSL, DIA, VPN, professional
services, web hosting and dial Internet access) and optical capacity asset
sales. During the three-and nine-month periods ended September 30, 2001, we
recognized $133 million and $989 million, respectively, in revenues from optical
capacity asset sales under indefeasible right of use ("IRU") agreements versus
$232 million and $648 million, respectively, for the comparable periods in 2000.
Certain rule-making bodies, such as the Financial Accounting Standards Board
("FASB") and the Emerging Issues Task Force ("EITF"), are currently discussing
matters that may impact the accounting for sales-type leases. We actively
monitor these rule-making activities and evaluate their impact on our current
accounting practices.
Consumer and Small Business Services Revenues. Consumer and small business
services revenues are derived from sales of IP, data, voice and wireless
products and services to the consumer and small business markets. The increases
in consumer and small business services revenues for the three and nine months
ended September 30, 2001 over comparable periods in 2000, were principally
attributable to sales of wireless products and data services such as DSL whose
revenue grew by approximately 80%. Wireless products and services revenue in the
three- and nine-month periods ended September 30, 2001 grew by 68% and 55%,
respectively, over the three- and nine-month periods ended September 30, 2000.
Average revenue per user increased for the second straight quarter, increasing
from $52 in the second quarter of 2001 to $55 in the third quarter as we
continued to focus on high-value customers and exited the low-usage, pre-paid
business. Sales of bundled packages (which include the phone line, calling
features and/or wireless services) to our small business and consumer customers
for these periods also contributed to the revenue growth. Partially offsetting
these increases were declines in local service revenues and intra-LATA toll
revenues in our local service area as a result of the slowing economy,
competitive losses and technology displacement. In addition, the number of
consumer local access lines declined 2.2% from September 30, 2000.
Directory Services Revenues. Directory services revenues are derived
primarily from selling advertising in our published directories. Directory
services revenues increased 5.7% for the three months ended September 30, 2001
and 3.1% for the nine months ended September 30, 2001 primarily due to increased
19
advertising rates and a change in the mix and length of directories published as
compared to the same periods in the prior year.
Switched Access Services Revenues. Switched access services revenues are
derived from inter- and intrastate switched access from interexchange carriers
("IXCs"). The decreases in switched access services revenues for the three and
nine months ended September 30, 2001 as compared to the same periods in 2000
were principally attributable to increased competition and federal access reform
that reduced the rates we are able to collect for switched access services. We
believe revenues from switched access services will continue to be negatively
impacted by federal access reform.
OPERATING EXPENSES
Cost of services. Cost of services, as a percent of revenues, increased to
35.6% for the three months ended September 30, 2001 from 32.7% for the three
months ended September 30, 2000. For the nine months ended September 30, 2001,
cost of services, as a percent of revenues, increased to 35.5% versus 32.8% for
the comparable period in 2000. The increase in cost of services for the three
months ended September 30, 2001 was primarily attributable to an increase in
switched and special access charges associated with increased volumes for our
long-distance voice services and growth in our data and DIA services offered
outside our local service area. Partially offsetting this growth was a decrease
in cost of goods sold associated with declining optical capacity asset sales.
For the nine months ended September 30, 2001 as compared to the same period in
2000, the increase was principally due to increased cost of goods sold
associated with increased optical capacity asset sales and an increase in
switched and special access charges associated with increased volumes for our
long-distance voice services and growth in our data and DIA services offered
outside our local service area. In addition, for both the three- and nine-month
periods, a shift in our product mix to higher growth services, costs associated
with the sales of data and wireless products and services, introduction of new
product platforms (including Qwest's Internet dial and hosting infrastructure),
expenses associated with improving local service and costs related to our
re-entry into the long-distance business in our local service area contributed
to the increases. Partially offsetting these increases were decreases in
employee-related costs due to the reduction in the overall number of employees
and contractors and other savings generated through cost controls and
operational efficiencies since June 30, 2000. Operational efficiencies have been
realized through the consolidation of core operational units that provide common
services and by leveraging our purchasing power throughout the Company.
Selling, general and administrative. Selling, general and administrative
expenses, as a percentage of revenues, decreased from 28.2% for the three months
ended September 30, 2000, to 27.4% for the three months ended September 30,
2001. For the nine months ended September 30, 2001, selling, general and
administrative expenses, as a percentage of revenues, decreased to 26.0% as
compared to 29.2% for the nine months ended September 30, 2000. The percentage
decreases were primarily attributable to the reduction in employee headcount and
the number of contractors, an increase in the pension credit (net of other post-
retirement benefits) and lower taxes (other than income taxes).
Selling, general and administrative expenses for the three months ended
September 30, 2001 decreased $39 million when compared to the same period of
2000. The decrease was primarily due to a higher pension credit (net of other
post-retirement benefits) and lower commissions due to changes in our commission
compensation plan. These lower costs were offset somewhat by higher professional
fees, uncollectible expenses, marketing costs and occupancy costs relating to
the opening of several new CyberCenters. For the nine months ended September 30,
2001, selling, general and administrative expenses decreased $159 million
compared to the same period in 2000. The decrease was primarily attributable to
decreased employee headcount and contractors, a reduction in advertising, lower
taxes (other than income taxes), higher pension credit (net of other
post-retirement benefits) and lower commissions due to changes in our commission
compensation plan. Since June 30, 2000, we have reduced our employee headcount
and contractors by approximately 13,400, a portion of which also impacts cost of
services. Increases in professional fees, uncollectible expenses and occupancy
costs relating to the opening of several new CyberCenters partially offset some
of the cost decreases.
20
For the three months ended September 30, 2001, results include a pension
credit, net of other post-retirement expenses, of $83 million ($52 million
after-tax or $0.03 per diluted share) compared to $71 million ($44 million
after-tax or $0.03 per diluted share) for the three months ended September 30,
2000. For the nine months ended September 30, 2001, results include a pension
credit, net of post-retirement expenses, of $253 million ($157 million after-tax
or $0.09 per diluted share) compared to $212 million ($131 million after-tax or
$0.08 per pro forma diluted share) for the same period in 2000. We anticipate
that our pension credit, net of other post-retirement expenses, will be
negatively impacted by lower interest rates and market conditions in 2002.
However, we do not anticipate a need to make a contribution to the pension plan
in 2002.
Depreciation. The increases in depreciation expense for the three- and
nine-month periods ended September 30, 2001 compared to the same periods in
2000, were primarily attributable to higher overall property, plant and
equipment balances resulting from our capital program. In addition, for the nine
months ended September 30, 2001 there was an increase in depreciation related to
a one-time charge for access lines returned to service. We continue to invest in
our network and service platforms to support re-entry into the long-distance
business in our local service area, meet forecasted customer demand and make
service improvements.
During 1999 and 2000, U S WEST committed to sell approximately 800,000
access lines to third-party telecommunications service providers, including
approximately 570,000 access lines to Citizens Communications Company
("Citizens"). Because these access lines were "held for sale," we discontinued
recognizing depreciation expense on these assets and recorded these assets at
the lower of their cost or fair value less estimated cost to sell.
On July 20, 2001, we terminated our agreement with Citizens under which the
majority of the remaining access lines were to have been sold and ceased
actively marketing the remaining lines. As a result, the remaining access lines
were reclassified as being "held for use" as of June 30, 2001. The access lines
were measured individually at the lower of their (a) carrying value before they
were classified as held for sale, adjusted for any depreciation (amortization)
expense or impairment losses that would have been recognized had the assets been
continuously classified as held for use, or (b) their estimated fair value at
June 30, 2001. The required adjustments to the carrying value of the individual
access lines are included in income from continuing operations for the nine
months ended September 30, 2001. This resulted in a charge to depreciation of
$222 million.
Goodwill and other intangible amortization. Amortization expense is
directly attributable to goodwill and other intangibles recorded as a result of
the Merger. The final purchase price allocation to identifiable intangible
assets and goodwill was $4.1 billion and $30.8 billion, respectively.
Additionally, $4.8 billion was allocated to our investment in KPNQwest, N.V.
("KPNQwest"), which created a preliminary excess carrying value of $4.2 billion
to be amortized over 10 years. For the quarter, amortization was flat as
compared to the same quarter in 2000. For the nine months ended September 30,
2001, amortization decreased by $77 million versus the same period in 2000. The
decrease was primarily associated with the second quarter 2001 KPNQwest
write-down of $3.048 billion. The average amortization period for all
identifiable intangibles, the excess basis in KPNQwest and goodwill is 25 years.
Merger-related and other one-time charges. No Merger-related and other
one-time charges were incurred for the three months ended September 30, 2001.
For the nine months ended September 30, 2001, we incurred Merger-related and
other one-time charges totaling $624 million. We considered only those costs
that were incremental and directly related to the Merger to be Merger-related.
For the nine months ended September 30, 2001, the Merger-related costs include
$274 million of contractual settlements and legal contingencies, $199 million of
severance and headcount-related charges and $151 million of other Merger-
related and one-time charges. Other Merger-related and one-time charges include
professional fees, re-branding costs, other integration-related costs and asset
impairment charges.
We do not foresee any additional Merger-related charges and anticipate that
the majority of the contractual, severance and other Merger-related and one-time
charge accruals will be paid by the end of the current fiscal year. Legal
contingencies will be paid as the related matters are resolved. When matters are
21
finalized, any differences between amounts accrued and actual payments will be
reflected in results of operations as an adjustment to Merger-related and other
one-time charges.
Other expense (income)-net. Interest expense was $380 million and $1.061
billion for the three and nine months ended September 30, 2001, respectively,
compared to $314 million and $807 million for the three and nine months ended
September 30, 2000. The increases in interest expense were primarily
attributable to increased borrowings required to fund the capital improvements
to our network and the repurchase of shares from BellSouth Corporation
("BellSouth").
We follow a process of reviewing our portfolio of equity securities on a
quarterly basis. We evaluate for other than temporary declines when the carrying
value of an investment exceeds its fair value. For a further discussion of the
factors we use to determine the fair value of our equity investments, see Note 4
to the condensed consolidated financial statements.
For the three months ended September 30, 2001, we recorded a write-down of
$7 million for a decline in the fair value of our derivative financial
instruments. The nine-month period ended September 30, 2001 included a $3.048
billion write-down of our KPNQwest investment, $199 million in other unrealized
investment losses and a $7 million write-down for the decline in the fair value
of our derivative financial instruments (as described in Note 4 to the condensed
consolidated financial statements). The $3.2 billion write-down on our
investment in KPNQwest and other marketable equity securities represents a
non-cash charge against earnings. At September 30, 2001, subsequent to the
charge for other than temporary declines in fair value, these investments had a
carrying value of $1.3 billion for KPNQwest and $8 million for our portfolio of
other marketable securities.
An increase of $58 million in the fair value of our derivative financial
instruments was reported in the quarter ended September 30, 2000. For the nine
months ended September 30, 2000, we recorded a $263 million decline in the
market value of our derivative financial instruments and a $447 million
write-down of our Global Crossing Ltd. ("Global Crossing") investment. In
addition, we generated gains on the sales of various marketable equity
securities of $252 million and $375 million for the three and nine months ended
September 30, 2000, respectively. We also incurred a loss of $39 million on the
sale of fixed assets for the three and nine months ended September 30, 2000.
During the nine months ended September 30, 2001, we completed a sale of
approximately 38,000 access lines in Utah resulting in a gain of $50 million.
Other expenses include losses from our investments accounted for under the
equity method and regulatory interest expense, net of interest income on
short-term investments.
Provision for income taxes. The effective tax rates for all periods
presented were impacted by the non-deductible goodwill and KPNQwest excess basis
amortization and foreign losses associated with our investment in KPNQwest. All
periods presented except for the three months ended September 30, 2001 were also
affected by certain non-deductible Merger-related costs. In addition, the nine
months ended September 30, 2001 was impacted by the non-deductible KPNQwest
investment write-down. Excluding the impact of these items, the effective tax
rates for the three months ended September 30, 2001 and 2000 were 61.3% and
36.8%, respectively. The increase in our effective tax rate was due to an
increase in our non-deductible expenses and other permanent differences as a
percentage of our revised estimated 2001 annual pre-tax income. A one-time, $150
million catch-up adjustment to tax expense was recorded in the three-month
period ended September 30, 2001 to reflect the effective tax rate change. For
the nine months ended September 30, 2001 and September 30, 2000, the effective
tax rates after adjustment for the items discussed above, were 42.5% and 38.0%,
respectively. The changes in these adjusted effective tax rates were primarily
due to miscellaneous non-deductible expenses and other permanent differences and
tax credits.
Extraordinary item -- early retirement of debt. During the nine months
ended September 30, 2001, we completed a tender offer to buy back certain
outstanding debt. In the tender offer, we repurchased approximately $995 million
in principal ($1.2 billion in face value) of outstanding debt. As a result of
the repurchase, we incurred a pre-tax charge of $106 million ($65 million after
tax) in premium payments.
22
Net loss. Net loss for the three months ended September 30, 2001 was $142
million compared to a net loss of $248 million in the third quarter of 2000. The
change was primarily due to a decrease in Merger-related expenses combined with
flat revenue growth. This was offset somewhat by a decrease in the gains on sale
of investments and increases in depreciation, interest and higher tax expense
due to a cumulative catch-up adjustment. Our net loss increased from $414
million in the first nine months of 2000 to a $3.494 billion loss during the
same period in 2001. The change was primarily due to the write-down of our
investment in KPNQwest. Other contributors were the one-time depreciation charge
to return access lines to service, higher depreciation driven by the continued
investment in our network, an increase in interest expense and higher tax
expense due to a cumulative adjustment. A reduction in Merger-related costs
helped to reduce the impact of these additional charges.
Diluted loss per share for the three months ended September 30, 2001 and
2000 were $0.09 and $0.15, respectively. The decrease in diluted loss per share
from the quarter ended September 30, 2000 as compared to the same period in 2001
was due to the decrease in Merger-related costs combined with flat revenue
growth. This charge was partially offset by a decrease in the gains on sale of
investments and increases in depreciation, interest and higher tax expense due
to a cumulative catch-up adjustment. For the nine months ended September 30,
2001 and 2000, the diluted loss per share was $2.10 and $0.25, respectively. The
increase in diluted loss per share for the comparable nine-month periods ended
September 30, 2001 and 2000 resulted from the loss generated during 2001
primarily relating to the write-down of our KPNQwest investment, the one-time
depreciation charge to return access lines to service, higher depreciation
driven by the continued investment in our network, an increase in interest
expense and higher tax expense due to a cumulative catch-up adjustment. The
increased loss was partially offset by a reduction in Merger-related costs. The
diluted losses per share for the three and nine months ended September 30, 2001
were impacted by the repurchase of our common stock from BellSouth that offset
some of the increase in shares outstanding at September 30, 2001.
LIQUIDITY AND CAPITAL RESOURCES
The liquidity and capital resources analysis is based upon "As Reported"
results. Consequently, operating, investing and financing activities for the
nine months ended September 30, 2001 as compared to the nine months ended
September 30, 2000 were impacted significantly by the Merger.
Operating Activities. Cash provided by operations increased to $3.356
billion for the nine months ended September 30, 2001 from $2.804 billion for the
same period in 2000. The change was primarily due to the growth in net income
after adjusting for depreciation, amortization, the write-down of our KPNQwest
investment and gains and losses on the sale of investments. In addition, cash
flow from operations was impacted by an increase in net accounts receivable
($217 million), inventories and supplies ($105 million) and a decrease in other
accrued expenses ($1.086 billion). The change in other accrued expenses was due
to higher than anticipated health care payments and a net reduction in our
plant, property and equipment accruals.
On January 16, 2001, we entered into an agreement with BellSouth under
which BellSouth committed to acquire services from us over a five-year period.
The agreement provides that BellSouth will make payment for the services in
Qwest common stock based upon values contained in the agreement. At September
30, 2001, we had invoiced BellSouth for approximately $70 million which, along
with services invoiced prior to the settlement date, will be settled with our
common stock in December 2001.
Due to a net tax loss being generated during the current tax year, we have
made minimal income tax payments in 2001.
Investing Activities. Capital expenditures were $7.791 billion for the
nine months ended September 30, 2001 and $5.006 billion for the nine months
ended September 30, 2000. Capital expenditures have been, and continue to be,
focused on the modernization and expansion of our telecommunications network,
expansion of our wireless, local broadband, Internet and data communications
networks, re-entry into the long-distance business in our local service area and
service improvements. Our capital expenditures through September 30, 2001
represent over 90% of our expected capital spending for the year of
approximately $8.5 billion. The
23
disproportionate capital costs for the first three quarters of the year are
primarily attributable to capital spending associated with our re-entry into the
long-distance business in our local service area, service quality improvements
and infrastructure built to meet forecasted demand at such time. Included in our
expenditures for property, plant and equipment are cash expenditures for optical
capacity purchase agreements. The purchases are principally for capacity outside
the United States. These agreements provide us with the right, among other
things, to network capacity provided by major carriers on specific routes at
current market rates for periods of 20 to 25 years. Several of these carriers
have also acquired optical capacity from us, principally in the United States,
during 2001 in separate cash transactions at market rates. These transactions
are accounted for separately as purchases of property, plant and equipment used
in our operations and as sales of inventory. Property, plant and equipment
increased by approximately $418 million and $868 million due to these purchases
during the three- and nine-month periods ended September 30, 2001, respectively.
Of these purchases during the nine months, $672 million was acquired with cash
and $196 million with a note. With these same vendors, we also entered into
sales contracts valued at $870 million during the nine months ended September
30, 2001. Revenue recognized for optical capacity sold to these vendors was $124
million and $664 million for the three- and nine-month periods ended September
30, 2001, respectively.
During the nine months ended September 30, 2001, we sold approximately
38,000 access lines resulting in a gain of $50 million and generating cash
proceeds of $91 million.
Future cash needs could be impacted by the pursuit of new business
opportunities, including the acceleration of the deployment of additional and/or
advanced new services to customers, such as broadband data, wireless and video
services. In addition, the expansion and upgrades of our network could affect
our future cash requirements. We expect that such cash needs, if any, will be
funded through operations, the sale of assets and, when necessary, the issuance
of debt.
Financing Activities. Cash provided by financing activities was $4.740
billion and $590 million for the nine months ended September 30, 2001 and 2000,
respectively. In 2001, we increased our commercial paper balances to finance the
acquisition of telecommunications equipment for the upgrade and expansion of our
network and to fund general Company operations. Long-term borrowings increased
during 2001 to refinance maturing commercial paper obligations, finance the
acquisition of telecommunications equipment for the upgrade and expansion of our
network and to fund general Company operations. During the nine months ended
September 30, 2001 we reacquired 22.22 million shares of our common stock from
BellSouth for $1.0 billion.
In March 2001, we completed a cash tender offer to buy back certain
outstanding debt. In the tender offer, we repurchased approximately $995 million
in principal ($1.2 billion in face value) of outstanding debt. As a result of
the repurchase, we incurred $106 million ($65 million after tax) in premium
payments.
On May 2, 2001, our Board of Directors approved a dividend of five cents
per share on our common stock which was paid to stockholders of record as of the
close of business on June 1, 2001 in satisfaction of any prior statement by us
in connection with or following the Merger regarding the payment or declaration
of dividends. As a result, dividends of $83 million were paid on common stock
for the nine months ended September 30, 2001 compared to $542 million in the
comparable 2000 period. The decline was due to a change in the dividend policy
after the Merger.
We maintain commercial paper programs to finance purchases of
telecommunications equipment. As of September 30, 2001, we had a $4.0 billion
syndicated credit facility to support our commercial paper programs. The
syndicated credit facility matures on May 3, 2002.
We currently believe that cash flow from operations and available debt
financing will be sufficient to satisfy our anticipated cash requirements for
the next 12 months. Currently, we do not anticipate a need for any additional
equity or debt financing beyond that period. However, depending upon, among
other things, the impact of the current economic slowdown on our future
operating results, changes in the strategic direction of the Company and the
success of our cost cutting initiatives, we may be required to fund some of our
cash requirements with additional equity or debt financing.
24
NEW ACCOUNTING STANDARDS
In June 1998, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities." This statement establishes accounting and reporting standards for
derivative instruments and hedging activities. SFAS No. 133 requires, among
other things, that all derivative instruments be recognized at fair value as
assets or liabilities in the consolidated balance sheets and changes in fair
value generally be recognized currently in earnings unless specific hedge
accounting criteria are met. The adoption of SFAS No. 133 on January 1, 2001 did
not have a material impact on our consolidated financial results.
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities." This
statement provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishment of liabilities. SFAS No. 140
requires that after a transfer of financial assets, an entity continues to
recognize the financial and servicing assets it controls and the liabilities it
has incurred and does not recognize those financial and servicing assets when
control has been surrendered and the liability has been extinguished. SFAS No.
140 is effective for transfers and servicing of financial assets and
extinguishments of liabilities occurring after March 31, 2001. Adoption of SFAS
No. 140 did not have a material impact on our consolidated financial results.
In June 2001, the FASB issued SFAS No. 141, "Business Combinations." This
pronouncement eliminated the use of the "pooling of interests" method of
accounting for all mergers and acquisitions. As a result, all mergers and
acquisitions will be accounted for using the "purchase" method of accounting.
SFAS No. 141 is effective for all mergers and acquisitions initiated after June
30, 2001. Adoption of this pronouncement has no impact on our results from
operations or our financial position.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." This statement addresses financial accounting and reporting for
intangible assets (excluding goodwill) acquired individually or with a group of
other assets at the time of their acquisition. It also addresses financial
accounting and reporting for goodwill and other intangible assets subsequent to
their acquisition. Intangible assets (excluding goodwill) acquired outside of a
business combination will be initially recorded at their estimated fair value.
If the intangible asset has a finite useful life, it will be amortized over that
life. Intangible assets with an indefinite life are not amortized. Both types of
intangible assets will be reviewed annually for impairment and a loss recorded
when the asset's carrying value exceeds its estimated fair value. Goodwill will
be treated similar to an intangible asset with an indefinite life. SFAS No. 142
is effective for fiscal years beginning after December 15, 2001. We currently
estimate the adoption of SFAS No. 142 will reduce our amortization expense by
approximately $850-$950 million annually beginning January 1, 2002. We are
currently evaluating the impact this pronouncement will have on the value of our
intangible assets.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." This statement deals with the costs of closing
facilities and removing assets. SFAS No. 143 requires entities to record the
fair value of a legal liability for an asset retirement obligation in the period
it is incurred. This cost is initially capitalized and amortized over the
remaining life of the underlying asset. Once the obligation is ultimately
settled, any difference between the final cost and the recorded liability is
recognized as a gain or loss on disposition. SFAS No. 143 is effective for years
beginning after June 15, 2002. We are currently evaluating the impact this
pronouncement will have on our future consolidated financial results.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This pronouncement addresses how
to account for and report impairments or disposals of long-lived assets. Under
SFAS No. 144, an impairment loss is to be recorded on long-lived assets being
held or used when the carrying amount of the asset is not recoverable from its
undiscounted cash flows. The impairment loss is equal to the difference between
the asset's carrying amount and estimated fair value. Long-lived assets to be
disposed of by other than a sale for cash are to be accounted for and reported
like assets being held or used except the impairment loss is recognized at the
time of the disposition. Long-lived assets to be disposed of by sale are to be
recorded at the lower of their carrying amount or estimated fair value (less
costs to sell) at the time the plan of disposition has been approved and
committed to by the appropriate company management. In addition, depreciation is
to cease at the same time. SFAS No. 144 is effective for fiscal years
25
beginning after December 15, 2001. We are currently evaluating the impact this
pronouncement will have on our future consolidated financial results.
On July 19, 2001, the EITF issued EITF Issue 00-11, "Meeting the Ownership
Transfer Requirements of FASB Statement No. 13 for Leases of Real Estate." This
issue is primarily concerned with ownership transfer requirements for a
sales-type lease of property under SFAS No. 13. According to EITF 00-11, a
nominal purchase option contained in a lease does not satisfy the transfer of
ownership criterion in SFAS No. 13 for transfers of real property, if the
failure to pay the nominal amount results in ownership not being transferred to
the lessee. EITF 00-11 provides, however, that this criterion will be met in
cases involving integral equipment or property improvements when the lessor
agrees, regardless of whether or not the lessee pays any amount, to execute and
deliver to the lessee all documents (including, if applicable, a bill of sale)
that may be required to release the property from the lease and transfer
ownership to the lessee. EITF 00-11 applies to leases entered into after July
19, 2001 and to certain leases modified after that date. We are in compliance
with SFAS No. 13 with respect to these ownership transfer requirements.
MARKET RISK
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.
As of September 30, 2001 and December 31, 2000, approximately $3.3 billion
and $2.4 billion, respectively, of floating-rate debt was exposed to changes in
interest rates. This exposure is linked to commercial paper rates and London
Interbank Offered Rates ("LIBOR"). A hypothetical increase of one-percentage
point in commercial paper rates and LIBOR would increase annual pre-tax interest
expense by $33 million. As of September 30, 2001 and December 31, 2000, we also
had approximately $1.0 billion and $1.2 billion, respectively, of long-term
fixed rate debt obligations maturing in the following 12 months. Any new debt
obtained to refinance this debt would be exposed to changes in interest rates. A
hypothetical 10% change in the interest rates on this debt would not have had a
material effect on our earnings.
As of September 30, 2001 and December 31, 2000, we had entered into
cross-currency swaps with notional amounts of $133 million. The cross-currency
swaps hedge our exposure to movements in the Swiss Franc to the U.S. dollar
exchange rate. The effect of the cross-currency swap is to synthetically
transform the Swiss Franc borrowings into $93 million of U.S. dollar borrowings
at September 30, 2001 and December 31, 2000, respectively. Any foreign exchange
gains (losses) on the cross-currency swaps would be offset by foreign exchange
losses (gains) on the Swiss Franc debt obligations. The Swiss Franc borrowings
mature in November 2001.
As of December 31, 2000, we had entered into equity swaps with notional
amounts of $761 million relating to the sale of 24 million shares of Global
Crossing common stock we previously owned. Of the 24 million shares subject to
equity swaps, one-third matured in February 2001, one-third matured in May 2001
and the final one-third matured in August 2001. As of September 30, 2001, we no
longer own any equity swaps of shares of Global Crossing common stock.
We currently hold 200 million shares of stock in KPNQwest. At September 30,
2001 and December 31, 2000, the 11% minority stake in KPNQwest was trading at
$4.19 and $18.94 per share, respectively. The carrying value of our KPNQwest
investment was approximately $6.64 per share at September 30, 2001. The decline
in KPNQwest's stock price during the quarter ended September 30, 2001 was
considered temporary as evidenced by its closing stock price of $7.05 on October
25, 2001. The per share value of our investment in KPNQwest may be less than the
publicly traded minority stake because of the restrictions on the marketability
of our shares. Given the foregoing, a hypothetical 10% decline in the public
trading price of KPNQwest at September 30, 2001 could decrease the value of our
investment by approximately $100 million.
Upon the completion of the additional purchase of KPNQwest shares of common
stock as described in Note 9 to the condensed consolidated financial statements,
restrictions on the marketability of all shares of
26
KPNQwest we own will be eliminated. KPN will have certain tag along rights with
respect to any future KPNQwest stock offerings.
Equity investments in other publicly traded companies consists of the
following (dollars in millions):
<Table>
<Caption>
SEPTEMBER 30, 2001 DECEMBER 31, 2000
- ------------------------------------------- -------------------------------------------
UNREALIZED UNREALIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE COST GAINS LOSSES FAIR VALUE
- ---- ---------- ---------- ---------- ---- ---------- ---------- ----------
$112 $ -- $(104) $8 $90 $30 $(62) $58
==== ===== ===== == === === ==== ===
</Table>
The estimated potential loss in fair value resulting from a hypothetical
10% decrease in the September 30, 2001 prices quoted by stock exchanges would
decrease the fair value of our other equity investments by less than $1 million.
RECENT REGULATORY DEVELOPMENTS
As a general matter, we are subject to substantial regulation, including
requirements and restrictions arising under the Telecommunication Act of 1996
(the "Act") and state utility laws, and the rules and policies of the Federal
Communications Commission ("FCC"), state Public Utility Commissions ("PUCs") and
other governmental entities. This regulation, among other matters, currently
prohibits us (with certain exceptions) from providing retail or wholesale
interLATA telecommunications services within our local service area, and governs
the terms and conditions under which we provide services to our customers
(including competitive local exchange carriers ("CLECs") and IXCs in our local
service area).
Interconnection. The FCC is continuing to interpret the obligations of
incumbent local exchange carriers ("ILECs") under the Act to interconnect their
networks with, and make unbundled network elements available to, CLECs. These
decisions establish our obligations in our local service area, and our rights
when we compete outside of our local service area. In addition, the United
States Supreme Court is now considering an appeal from a ruling of the Eighth
Circuit Court of Appeals that the FCC's rules for the pricing of interconnection
and unbundled network elements by ILECs unlawfully preclude ILECs from
recovering their actual costs as required by the Act.
Access Pricing. The FCC has initiated a number of proceedings that
directly affect the rates and charges for access services that we sold or
purchased. It is expected that these proceedings and related implementation of
resulting FCC decisions will continue through 2002.
On May 31, 2000, the FCC adopted the access reform and universal service
plan developed by the Coalition for Affordable Local and Long-Distance Service
("CALLS"). The adoption of the CALLS proposal resolved many outstanding issues
before the FCC including: the court remand of the 6.5% productivity factor; the
treatment of implicit universal service support; the treatment of low-volume
long-distance users; and the next scheduled price cap review. The CALLS plan has
a five-year life and provides for the following: elimination of the residential
presubscribed interexchange carrier charge; increases in subscriber line
charges; reductions in switched access usage rates; the removal of certain
implicit universal service support from access charges and direct recovery from
end users; and commitments from participating IXCs to pass through access charge
reductions to end users. We have opted into the five-year CALLS plan.
Advanced Telecommunications Services. On two separate occasions the FCC
has ruled that advanced services provided by an ILEC are covered by those
provisions of the Act that govern telephone exchange and exchange access
services. We have challenged this finding, contending that advanced services fit
within neither category and are not properly treated as exchange services. On
April 20, 2001, the Court of Appeals vacated and remanded to the FCC its
classification of DS2-based advanced services.
InterLATA Long-Distance Entry. Several Regional Bell Operating Companies
("RBOCs") have filed for entry into the interLATA long-distance business.
Although many of these applications have been supported by state PUCs, the FCC
had rejected all applications until December 1999. As of September 30,
27
2001, long-distance authority has been granted in the states of Connecticut,
Kansas, Massachusetts, New York, Oklahoma, Pennsylvania and Texas.
We filed applications with all of our local service area state PUCs for
support of our planned applications to the FCC for authority to enter the
interLATA long-distance business. Workshops and related proceedings are underway
at the state level to evaluate our satisfaction of requirements under the Act
that must be met in order for an RBOC to obtain long-distance authority. We have
agreed to test operational support systems on a regional basis in thirteen
states, and testing of those systems began in March 2001. Testing in Arizona is
being conducted separately, and began in February 2001. We are on track to
receive FCC approval to provide long-distance service in each of our 14 states
by mid-2002.
Reciprocal Compensation for Internet Service Providers ("ISPs"). On April
27, 2001, the FCC issued an Order with regard to Intercarrier Compensation for
ISP bound traffic. The Order required carriers serving ISP bound traffic to
reduce reciprocal compensation rates over a 36-month period beginning with an
initial reduction to $0.0015 per minute of use and ending with a rate of $0.0007
per minute of use. In addition, a cap was placed on the number of minutes of use
on which the terminating carrier may charge such rates. This reduction will
lower costs that Qwest pays CLECs for delivering such traffic to other carriers.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information relating to market risk is included in Item 2, Management's
Discussion and Analysis of Financial Condition and Results of Operations, in the
section under the caption "Market Risk."
28
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In October 2001, a derivative action was filed in federal district court in
Colorado against Qwest's board of directors. Qwest is also named in the lawsuit,
as a nominal defendant. This complaint alleges, among other things, that the
entire board of directors of Qwest breached fiduciary duties to Qwest by (1)
misusing internal nonpublic information that allowed three directors to profit
by insider trading, (2) failing to oversee the implementation of the securities
laws that prohibit insider trading, and (3) causing Qwest to be sued for
securities fraud in the In re Qwest Communications International Inc. Securities
Litigation. The plaintiffs seek restitution and unspecified damages against each
of the named parties, punitive damages and other relief. We may in the future
receive additional claims and demands that may be based on similar or different
legal theories. There has been no discovery or other activity in this case,
which is still in a preliminary stage.
For a discussion of other claims and proceedings arising in the ordinary
course of business, see Note 8: "Commitments and Contingencies" -- to the
condensed consolidated financial statements.
II-1
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits required by Item 601 of Regulation S-K.
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
(2.1) -- Separation Agreement, dated June 5,1998, between U S
WEST, Inc. (renamed "MediaOne Group, Inc.") ("MediaOne
Group") and USW-C, Inc (renamed U S WEST, Inc.) ("U S
WEST"), (incorporated by reference to U S WEST's Current
Report on Form 8-K/A dated June 26, 1998).
(2.2) -- Amendment to the Separation Agreement between MediaOne
Group and U S WEST dated June 12, 1998 (incorporated by
reference to U S WEST's Annual Report on Form 10-K/A for
the year ended December 31, 1998).
(3.1) -- Amended and Restated Certificate of Incorporation of
Qwest (incorporated by reference to Qwest's Registration
Statement on Form S-4/A, File No. 333-81149, filed
September 17, 1999).
(3.2) -- Amended and Restated Bylaws of Qwest (incorporated by
reference to Qwest's Annual Report on Form 10-K for the
year ended December 31, 2000).
(4.1)*** -- Indenture, dated as of October 15, 1997, with Bankers
Trust Company (including form of Qwest's 9.47% Senior
Discount Notes due 2007 and 9.47% Series B Senior
Discount Notes due 2007 as an exhibit thereto).
(4.2)**** -- Indenture dated, as of August 28, 1997, with Bankers
Trust Company (including form of Qwest's 10 7/8% Series B
Senior Discount Notes due 2007 as an exhibit thereto).
(4.3)**** -- Indenture dated as of January 29, 1998 with Bankers Trust
Company (including form of Qwest's 8.29% Senior Discount
Notes due 2008 and 8.29% Series B Senior Discount Notes
due 2008 as an exhibit thereto).
(4.4) -- Indenture, dated as of November 4, 1998, with Bankers
Trust Company (including form of Qwest'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's Registration
Statement on Form S-4, File No. 333-71603, filed February
2, 1999).
(4.5) -- Indenture, dated as of November 27, 1998, with Bankers
Trust Company (including form of Qwest'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's Registration
Statement on Form S-4, File No. 333-71603, filed February
2, 1999).
(4.6) -- Registration Agreement, dated November 27, 1998, with
Salomon Brothers Inc. relating to Qwest's 7.25% Senior
Discount Notes due 2008 (incorporated by reference to
Qwest's Registration Statement on Form S-4, File No.
333-71603, filed February 2, 1999).
(4.7) -- 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 Exhibit 4(c) in LCI's
Current Report on Form 8-K, dated June 23, 1997).
</Table>
II-2
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
(4.8) -- Registration Rights Agreement, dated August 20, 1999,
between U S WEST Capital Funding, Inc., U S WEST, Inc.,
J.P. Morgan Securities, Inc. and Merrill Lynch, Pierce,
Fenner & Smith Incorporated (incorporated by reference to
U S WEST's Form S-4 Registration Statement, File No.
333-92523, filed December 10, 1999).
(4.9) -- 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, National Association), as Trustee (incorporated
by reference to U S WEST's Current Report on Form 8-K,
dated November 18, 1998).
(4.10) -- 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's quarterly report on Form 10-Q for the quarter
ended June 30, 2000).
(4.11) -- 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'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's quarterly report on
Form 10-Q for the quarter ended March 31, 2001).
(4.12) -- First Supplemental Indenture, dated as of February 16,
2001, to the Indenture dated as of October 15, 1997 with
Bankers Trust Company (including form of Qwest's 9.47%
Senior Discount Notes due 2007 and 9.47% Series B Senior
Discount Notes due 2007 as an exhibit thereto)
(incorporated by reference to Qwest's quarterly report on
Form 10-Q for the quarter ended March 31, 2001).
(4.13) -- First Supplemental Indenture, dated as of February 16,
2001, to the Indenture dated as of August 28, 1997 with
Bankers Trust Company (including form of Qwest's 10 7/8%
Series B Senior Discount Notes due 2007 as an exhibit
thereto) (incorporated by reference to Qwest's quarterly
report on Form 10-Q for the quarter ended March 31,
2001).
10.1 -- Third Amended and Restated Operating Agreement of Qwest
Digital Media, LLC (formerly known as Slingshot Networks,
LLC) entered into as of January 2, 2001 between Anschutz
Digital Media, Inc. and U.S. Telesource, Inc.
</Table>
- ---------------
( ) Previously filed.
*** Incorporated by reference to exhibit 4.1 in Form S-4 as declared effective
on January 5, 1998 (File No. 333-42847).
**** Incorporated by reference to Qwest's Annual Report on Form 10-K for the
year ended December 31, 1997.
(b) Reports on Form 8-K:
(i) On July 20, 2001, Qwest filed a report on Form 8-K to restate its
cost of sales and selling, general and administrative expenses for 2000 and
2001.
(ii) On July 26, 2001, Qwest filed a report on Form 8-K/A, amending
and restating, in its entirety, a report on Form 8-K filed on July 24, 2001
regarding its 2001 second quarter results of operations.
(iii) On August 13, 2001, Qwest filed a report on Form 8-K/A, amending
and restating, in its entirety, a report on Form 8-K filed on August 7,
2001 regarding a speech by its Chief Executive Officer.
II-3
(iv) On September 10, 2001, Qwest filed a report on Form 8-K regarding
an update on its financial guidance for 2001 and 2002.
II-4
SIGNATURE
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/ ROBIN R. SZELIGA
-------------------------------------
Robin R. Szeliga
Executive Vice President -- Finance
and
Chief Financial Officer
November 14, 2001
II-5
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
(2.1) -- Separation Agreement, dated June 5,1998, between U S
WEST, Inc. (renamed "MediaOne Group, Inc.") ("MediaOne
Group") and USW-C, Inc (renamed U S WEST, Inc.) ("U S
WEST"), (incorporated by reference to U S WEST's Current
Report on Form 8-K/A dated June 26, 1998).
(2.2) -- Amendment to the Separation Agreement between MediaOne
Group and U S WEST dated June 12, 1998 (incorporated by
reference to U S WEST's Annual Report on Form 10-K/A for
the year ended December 31, 1998).
(3.1) -- Amended and Restated Certificate of Incorporation of
Qwest (incorporated by reference to Qwest's Registration
Statement on Form S-4/A, File No. 333-81149, filed
September 17, 1999).
(3.2) -- Amended and Restated Bylaws of Qwest (incorporated by
reference to Qwest's Annual Report on Form 10-K for the
year ended December 31, 2000).
(4.1)*** -- Indenture, dated as of October 15, 1997, with Bankers
Trust Company (including form of Qwest's 9.47% Senior
Discount Notes due 2007 and 9.47% Series B Senior
Discount Notes due 2007 as an exhibit thereto).
(4.2)**** -- Indenture dated, as of August 28, 1997, with Bankers
Trust Company (including form of Qwest's 10 7/8% Series B
Senior Discount Notes due 2007 as an exhibit thereto).
(4.3)**** -- Indenture dated as of January 29, 1998 with Bankers Trust
Company (including form of Qwest's 8.29% Senior Discount
Notes due 2008 and 8.29% Series B Senior Discount Notes
due 2008 as an exhibit thereto).
(4.4) -- Indenture, dated as of November 4, 1998, with Bankers
Trust Company (including form of Qwest'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's Registration
Statement on Form S-4, File No. 333-71603, filed February
2, 1999).
(4.5) -- Indenture, dated as of November 27, 1998, with Bankers
Trust Company (including form of Qwest'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's Registration
Statement on Form S-4, File No. 333-71603, filed February
2, 1999).
(4.6) -- Registration Agreement, dated November 27, 1998, with
Salomon Brothers Inc. relating to Qwest's 7.25% Senior
Discount Notes due 2008 (incorporated by reference to
Qwest's Registration Statement on Form S-4, File No.
333-71603, filed February 2, 1999).
(4.7) -- 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 Exhibit 4(c) in LCI's
Current Report on Form 8-K, dated June 23, 1997).
(4.8) -- Registration Rights Agreement, dated August 20, 1999,
between U S WEST Capital Funding, Inc., U S WEST, Inc.,
J.P. Morgan Securities, Inc. and Merrill Lynch, Pierce,
Fenner & Smith Incorporated (incorporated by reference to
U S WEST's Form S-4 Registration Statement, File No.
333-92523, filed December 10, 1999).
</Table>
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
(4.9) -- 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, National Association), as Trustee (incorporated
by reference to U S WEST's Current Report on Form 8-K,
dated November 18, 1998).
(4.10) -- 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's quarterly report on Form 10-Q for the quarter
ended June 30, 2000).
(4.11) -- 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'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's quarterly report on
Form 10-Q for the quarter ended March 31, 2001).
(4.12) -- First Supplemental Indenture, dated as of February 16,
2001, to the Indenture dated as of October 15, 1997 with
Bankers Trust Company (including form of Qwest's 9.47%
Senior Discount Notes due 2007 and 9.47% Series B Senior
Discount Notes due 2007 as an exhibit thereto)
(incorporated by reference to Qwest's quarterly report on
Form 10-Q for the quarter ended March 31, 2001).
(4.13) -- First Supplemental Indenture, dated as of February 16,
2001, to the Indenture dated as of August 28, 1997 with
Bankers Trust Company (including form of Qwest's 10 7/8%
Series B Senior Discount Notes due 2007 as an exhibit
thereto) (incorporated by reference to Qwest's quarterly
report on Form 10-Q for the quarter ended March 31,
2001).
10.1 -- Third Amended and Restated Operating Agreement of Qwest
Digital Media, LLC (formerly known as Slingshot Networks,
LLC) entered into as of January 2, 2001 between Anschutz
Digital Media, Inc. and U.S. Telesource, Inc.
</Table>
- ---------------
( ) Previously filed.
*** Incorporated by reference to exhibit 4.1 in Form S-4 as declared effective
on January 5, 1998 (File No. 333-42847).
**** Incorporated by reference to Qwest's Annual Report on Form 10-K for the
year ended December 31, 1997.