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Qwest Communications International 10-Q 2011 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended September 30, 2011 or
For the transition period from to Commission File No. 1-15577
QWEST COMMUNICATIONS INTERNATIONAL INC. (Exact name of registrant as specified in its charter)
(318) 388-9000 (Registrant’s telephone number, including area code) N/A (Former name and former fiscal year, if changed since last report) 1801 California Street, Denver, Colorado 80202 (Former address, if changed since last report)
THE REGISTRANT, A WHOLLY OWNED SUBSIDIARY OF CENTURYLINK, INC., MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONS H(1) (a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT. Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x As of November 4, 2011, there were 1,000 shares of common stock outstanding.
TABLE OF CONTENTS
* All references to “Notes” in this quarterly report refer to these Notes to Consolidated Financial Statements.
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PART I. FINANCIAL INFORMATION Item 1. Financial Statements Qwest Communications International Inc. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
See accompanying notes to consolidated financial statements.
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Qwest Communications International Inc. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
See accompanying notes to consolidated financial statements.
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Qwest Communications International Inc. CONSOLIDATED BALANCE SHEETS (UNAUDITED)
See accompanying notes to consolidated financial statements.
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Qwest Communications International Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
See accompanying notes to consolidated financial statements.
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Qwest Communications International Inc. CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT) (UNAUDITED)
See accompanying notes to consolidated financial statements.
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Qwest Communications International Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2011 (UNAUDITED) Unless the context requires otherwise, references in this report to “Qwest,” “we,” “us” or “our” refer to Qwest Communications International Inc. and its consolidated subsidiaries, references to “QCII” refer to Qwest Communications International Inc. on an unconsolidated, stand-alone basis and references to “CenturyLink” refer to our direct parent company, CenturyLink, Inc., and its consolidated subsidiaries. (1) Basis of Presentation On April 1, 2011, we became a wholly owned subsidiary of CenturyLink, Inc. in a tax-free, stock-for-stock transaction. Although we continued as a surviving corporation and legal entity after the acquisition, the accompanying consolidated statements of operations, comprehensive income (loss), cash flows and stockholders’ equity (deficit) are presented for two periods: predecessor and successor, which relate to the period preceding the acquisition and the period succeeding the acquisition, respectively. The recognition of assets and liabilities at fair value has been reflected in our financial statements and, therefore, has resulted in a new basis of accounting for the “successor period” beginning on April 1, 2011. This new basis of accounting means that our financial statements for the successor periods are not comparable to our previously reported financial statements, including the predecessor period financial statements in this report. The predecessor consolidated balance sheet as of December 31, 2010, which was derived from our audited financial statements, and our unaudited interim consolidated financial statements provided herein have been prepared in accordance with the instructions for Form 10-Q. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission, or SEC; however, in our opinion, the disclosures made are adequate to make the information presented not misleading. We believe that these consolidated financial statements include all normal recurring adjustments necessary to fairly present the results for the interim periods. The results of operations for the first nine months of the year are not indicative of the results of operations that might be expected for the entire year. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2010. During the first quarter of 2011, we changed the definitions we use to classify expenses as cost of services and products and selling, general and administrative, and as a result, we reclassified previously reported amounts to conform to the current period presentation. We revised our definitions so that our expense classifications are more consistent with the expense classifications used by our new parent company, CenturyLink. These revisions resulted in the reclassification of $306 million and $912 million from selling, general and administrative to cost of services and products for the predecessor three and nine months ended September 30, 2010, respectively. Our current definitions are as follows:
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These expense classifications may not be comparable to those of other companies. We also have reclassified certain other prior period amounts to conform to the current period presentation. These changes had no impact on total operating expenses or net income for any period. We have reclassified certain prior year balance sheet amounts presented in our Annual Report on Form 10-K for the year ended December 31, 2010. We made these changes so that the classifications of our assets and liabilities are more consistent with the asset and liability classifications used by our new parent company, CenturyLink. These reclassifications primarily included: $241 million from accrued expenses and other current liabilities, $109 million from benefit plan obligations, net, $232 million to accounts payable, $118 million to other deferred credits, $63 million to net property, plant and equipment and $59 million from capitalized software, net. We record intercompany charges at the amounts billed to us by our affiliates. Regulatory rules require certain expenses to be recorded at market price or fully distributed cost. Our compliance with regulations is subject to review by regulators. Adjustments to intercompany charges that result from these reviews are recorded in the period they become known. Because of the significance of the services we provide to our affiliates and our other affiliates transactions, the results of operations, financial position, and cash flows presented herein are not necessarily indicative of the results of operations, financial position and cash flows we would have achieved had we operated as a stand-alone entity during the periods presented. We provide to our affiliates telecommunications services that we also provide to external customers. In addition, we provide to our affiliates computer system development and support services. We also purchase services from our affiliates including telecommunications services and marketing and employee-related support services. In the normal course of business, we transfer assets and liabilities to and from CenturyLink and its affiliates based on carrying value. We have recorded $99 million of non-cash dividends associated with asset transfers to CenturyLink during the six months ended September 30, 2011. Recent Accounting Pronouncements.
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(2) Acquisition by CenturyLink On April 1, 2011, we became a wholly owned subsidiary of CenturyLink. Each outstanding share of our common stock immediately prior to the acquisition converted into the right to receive 0.1664 shares of CenturyLink common stock, with cash paid in lieu of fractional shares. The estimated aggregate consideration was approximately $12.273 billion based on:
Since April 1, 2011, our results of operations have been included in the consolidated results of operations of CenturyLink. CenturyLink has accounted for its acquisition of us under the acquisition method of accounting, which resulted in the assignment of the purchase price to the assets acquired and liabilities assumed based on our preliminary estimates of their acquisition date fair values. The determination of the fair values of the acquired assets and assumed liabilities (and the related determination of estimated lives of depreciable tangible and identifiable intangible assets) requires significant judgment. As such, we have not completed our valuation analysis and calculations in sufficient detail necessary to arrive at the final estimates of the fair values of the acquired assets and assumed liabilities, along with the related allocations to goodwill and intangible assets. As such, all information presented is preliminary and subject to revision pending the final fair market valuation analysis. We expect to complete our final fair value determinations no later than the first quarter of 2012. Our final fair value determinations may be significantly different than those reflected in our consolidated financial statements as of September 30, 2011. Based on our preliminary estimate, the aggregate consideration exceeds the aggregate estimated fair value of the acquired assets and assumed liabilities by $10.135 billion, which amount has been recognized as goodwill. This goodwill is attributable to strategic benefits, including enhanced financial and operational scale, market diversification and leveraged combined networks that we expect to realize. None of the goodwill associated with this acquisition is deductible for income tax purposes.
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The following is our preliminary assignment of the aggregate consideration:
We retrospectively adjusted our previously reported preliminary assignment of the aggregate Qwest consideration for changes to our original estimates of the fair value of certain items at the acquisition date. These changes are the result of additional information obtained since the filing of our Form 10-Q for the quarter ended June 30, 2011. Identifiable intangible assets – other decreased $179 million due to a decreased tradename valuation and accounts receivable and other current assets increased by $88 million primarily due to a change in deferred income taxes and an insurance reimbursement related to a litigation settlement. Deferred credits and other liabilities increased by $40 million primarily from a change in deferred income taxes and a revision to our pension and post retirement asset valuation. Goodwill increased by $130 million as an offset to the above mentioned changes. We have recognized $19 million and $146 million of expense associated with the our activities related to the CenturyLink acquisition during the successor three months and six months ended September 30, 2011, respectively. These expenses were comprised of primarily severance, retention bonuses, share-based compensation and system integration consulting. During the predecessor three months ended March 31, 2011, we recognized $3 million of expenses associated with our activities related to the acquisition. As of April 1, 2011, as part of acquisition accounting, we also included in our goodwill $35 million for financial advisory fees, $23 million for certain performance awards and $16 million related to retention bonuses, all of which were contingent on the completion of the acquisition and had no benefit to CenturyLink after the acquisition. CenturyLink has cash management arrangements between certain of its subsidiaries, including us, under which the majority of our cash balance is transferred on a daily basis to CenturyLink as a short-term affiliate loan.
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(3) Goodwill, Customer Relationships and Other Intangible Assets Goodwill, customer relationships and other intangible assets as of September 30, 2011 and December 31, 2010 consisted of the following:
As a result of the adjustment to the tradename valuation and resulting retrospective application of amortization expense, discussed in Note 2—Acquisition by CenturyLink, we recognized amortization expense related to our tradename in the amount of $20 million and $42 million for the successor three months and six months ended September 30, 2011, respectively. At September 30, 2011, the gross carrying amounts of goodwill, customer relationships and other intangible assets were $19.724 billion. These assets were recorded at fair value on April 1, 2011 as a result of CenturyLink’s acquisition of us. We expect to complete the final determination of these acquisition date fair value estimates and related estimated lives for amortizable intangible assets no later than the first quarter of 2012. Total amortization expense for intangible assets was as follows:
We amortize customer relationships primarily over an estimated life of 10 years, using either the sum-of-the-years-digits or straight-line methods, depending on the type of customer. We amortize capitalized software using the straight-line method over estimated lives ranging up to seven years and amortize our other intangible assets predominantly using the sum-of-the-years digits method over an estimated life of four years. We estimate that total successor amortization expense for intangible assets for the three months ending December 31, 2011 and for the successor years ending December 31, 2012 through 2015 will be as follows:
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We periodically review the estimated lives and methods used to amortize our other intangible assets. The actual amounts of amortization expense may differ materially from our estimates, depending on the results of our periodic reviews and our final determinations of acquisition date fair value related to our intangible assets. We are required to review goodwill recorded in business combinations for impairment at least annually, or more frequently if events or a change in circumstances indicate that an impairment may have occurred. Our annual measurement date for testing goodwill impairment is September 30. We are required to write-down the value of goodwill only in periods in which the recorded amount of goodwill exceeds the fair value. The impairment testing is done at the reporting unit level; in reviewing the criteria for reporting units when allocating the goodwill resulting from our acquisition by CenturyLink, it was determined that we are one reportable unit. We early adopted the provisions of ASU 2011-08, Testing Goodwill for Impairment, during the third quarter, which permits us to make a qualitative assessment of whether it is more likely that not that a reporting unit’s fair value is less than its carrying amount before applying the two step goodwill impairment test. If, after completing our qualitative assessment we determine that it is more likely that not that the carrying value exceeds estimated fair value, we compare the fair value to our carrying value (including goodwill). If the estimated fair value is greater than the carrying value, we conclude that no impairment exists. If the estimated fair value of the reporting unit is less than the carrying value, a second calculation is required in which the implied fair value of goodwill is compared to its carrying value. If the implied fair value of goodwill is less than its carrying value, goodwill must be written down to its implied fair value. We elected to early adopt the provisions of ASU 2011-8 and perform a qualitative assessment given the six month proximity of the goodwill impairment date and the acquisition date resulting in the creation of the goodwill. We have accounted for the CentruryLink’s acquisition of us under the acquisition method of accounting, which resulted in the assignment of the aggregate consideration to the assets acquired and liabilities assumed based on- preliminary estimates of their acquisition date fair values. The fair value of the aggregate consideration transferred exceeded the acquisition date fair value of the recorded tangible and intangible assets, and assumed liabilities by an estimated $10.135 billion, which has been recognized as goodwill. The determination of the fair values of the acquired assets and assumed liabilities (and the related determination of estimated lives of depreciable tangible and identifiable intangible assets) requires significant judgment. As such, we have not completed our valuation analysis and calculations in sufficient detail necessary to arrive at the final estimates of the fair values of the acquired assets and assumed liabilities, along with the related allocations to goodwill and intangible assets. The amounts recorded related to the acquisition are preliminary and subject to revision pending the final fair market valuation analysis. We expect to complete our final fair value determinations no later than the first quarter of 2012. Our final fair value determinations may be significantly different than those reflected in our consolidated financial statements as of September 30, 2011. As a result of the acquisition and related acquisition accounting, the carrying value of our assets and liabilities equaled our fair value as of April 1, 2011. A decrease in our fair value in excess of a reduction in our carrying value will result in us having a carrying value in excess of our fair value, which may result in an impairment of our goodwill. There is significant judgment in estimating the fair value of the company. The factors that most significantly impact our estimate of fair value include forecasted cash flows and risk adjusted discount rate. The applicable risk adjusted discount rate is impacted by the market risk free rate of return and our debt risk rating. The qualitative analysis included assessing the impact of changes in certain factors from April 1, 2011 (the acquisition date on which all assets and liabilities were assigned a fair value) to September 30, 2011 (the goodwill impairment testing date), including (i) changes in forecasted operating results and comparing actual results to those utilized in the April 1, 2011 fair value assignment; (ii) changes in our weighted average cost of capital from April 1, 2011 to September 30, 2011; (iii) changes in the industry or our competitive environment since the acquisition date; (iv) changes in the overall economy, our market share, and interest rates since the acquisition date; (v) trends in the stock price of CenturyLink and related market capitalization and enterprise values; (vi) trends; (vi) trends in peer companies total enterprise value metrics; (vii) control premiums paid for
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recent industry transactions; and (viii) additional factors such as management turnover, changes in regulation, and changes in litigation matters. Based on our qualitative assessment, we concluded that it was more likely that not that the estimated fair value of our reporting unit exceeded its carrying value as of September 30, 2011 and thus, determined it was not necessary to perform the two step goodwill impairment test. We believe the more impactful assessments include our actual results compared to those forecasted as of April 1, 2011 and the decline in our weighted average cost of capital since April 1, 2011. To date, our actual operating results have been comparable to those forecasted as of April 1, 2011 and, as of September 30, 2011, we believe the forecasted results of future periods are not materially different than those used as of April 1, 2011. (4) Long-term Debt On September 21, 2011, our wholly owned subsidiary, Qwest Corporation (“QC”), issued $575 million aggregate principal amount of its 7.50% Notes due 2051 in exchange for net proceeds, after deducting underwriting discounts and expenses, of $557 million. The notes are senior unsecured obligations of QC and may be redeemed, in whole or in part, on or after September 15, 2016 at a redemption price equal to 100% of the principal amount redeemed plus accrued and unpaid interest to the redemption date. As described below under “Subsequent Events,” in October 2011, QC used the net proceeds of this issuance, together with net proceeds from a debt issuance on October 4, 2011 and available cash, to redeem the $1.500 billion aggregate principal amount of its 8.875% Notes due 2012. On June 8, 2011, QC issued $661 million aggregate principal amount of its 7.375% Notes due 2051 in exchange for net proceeds, after deducting underwriting discounts and expenses, of $643 million. The notes are unsecured obligations of QC and may be redeemed, in whole or in part, on or after June 1, 2016 at a redemption price equal to 100% of the principal amount redeemed plus accrued and unpaid interest to the redemption date. QC used the net proceeds, together with available cash, to redeem $825 million aggregate principal amount of its 7.875% Notes due 2011, and to pay related fees and expenses. Until April 1, 2011, we had a revolving credit facility, which made available to us $1.035 billion of additional credit subject to certain restrictions. That credit facility was terminated in conjunction with the CenturyLink acquisition. In January 2011, CenturyLink entered into a new four-year revolving credit facility with various lenders (the “Credit Facility”) that allows CenturyLink to borrow up to $1.700 billion for the general corporate purposes of itself and its subsidiaries. Up to $400 million of the Credit Facility can be used for letters of credit, which reduce the amount available for other extensions of credit. Interest is assessed on borrowings using the London Interbank Offered Rate (“LIBOR”) plus an applicable margin between 0.5% and 2.5% per annum depending on the type of loan and CenturyLink’s then-current senior unsecured long-term debt rating. At September 30, 2011, CenturyLink had no borrowings and an immaterial amount of letters of credit outstanding under the Credit Facility. QCII and another one of its wholly owned subsidiaries, Qwest Services Corporation (“QSC”), are guarantors of the Credit Facility. In February 2011, our wholly owned subsidiary, Qwest Capital Funding, Inc. (“QCF”), paid at maturity the $179 million aggregate principal amount of its 7.25% Notes due 2011. At September 30, 2011, we were in compliance with the provisions and covenants contained in our debt agreements. Subsequent Events On October 4, 2011, QC issued $950 million aggregate principal amount of its 6.75% Notes due 2021 in exchange for net proceeds, after deducting underwriting discounts and expenses, of $927 million. The notes are senior unsecured obligations of QC and may be redeemed, in whole or in part, at a redemption price equal to the greater of their principal amount or the present value of the remaining principal and interest payments discounted at a specified U.S. Treasury interest rate plus 50 basis points. In October 2011, QC used the net proceeds from
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this offering, together with the $557 million of net proceeds received on September 21, 2011 from the debt issuance described above and available cash, to redeem the $1.500 billion aggregate principal amount of its 8.875% Notes due 2012 and to pay all related fees and expenses, which resulted in an immaterial loss. (5) Employee Benefits We sponsor defined benefit pension plans, which in the aggregate cover a substantial portion of our employees. In connection with CenturyLink’s acquisition of us on April 1, 2011, we performed a valuation analysis and recognized a $490 million net liability as of April 1, 2011 for the unfunded status of our pension plans, reflecting projected benefit obligations of $8.267 billion in excess of the $7.777 billion fair value of plan assets. Net periodic pension benefit (income) expense for the successor three and six months ended September 30, 2011, predecessor three months ended March 31, 2011 and predecessor three and nine months ended September 30, 2010 consisted of the following components:
We also sponsor plans that provide post-retirement health care and other benefits to qualifying retirees. In connection with CenturyLink’s acquisition of us on April 1, 2011, we performed a valuation analysis and recognized a $2.522 billion liability as of April 1, 2011 for the unfunded status of our post-retirement benefit plans, reflecting estimated accumulated post-retirement benefit obligations of $3.284 billion in excess of the $762 million fair value of the plan assets. Net periodic post-retirement benefit (income) expense for the successor three and six months ended September 30, 2011, predecessor three months ended March 31, 2011 and predecessor three and nine months ended September 30, 2010 consisted of the following components:
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We report net periodic pension benefit (income) expense and net periodic post-retirement benefit (income) expense in cost of services and products and selling, general and administrative expenses. (6) Severance and Leased Real Estate We have announced reductions in our workforce and have accrued liabilities for related severance costs. These workforce reductions resulted primarily from the progression of merger integration plans, increased competitive pressures and the loss of access lines. We report severance liabilities in salaries and benefits within accrued expenses and other liabilities in our consolidated balance sheets and report severance expenses in selling, general and administrative expenses and cost of services and products in our consolidated statements of operations. In periods prior to CenturyLink’s acquisition of us, we had ceased using certain real estate that we were leasing under long-term operating leases. As of the April 1, 2011 acquisition date, we recorded liabilities to reflect our preliminary estimates of the fair values of the existing lease obligations, net of estimated sublease rentals. Our fair value estimates were determined using discounted cash flow methods. Periodically, we recognize expense to reflect accretion of the discounted liabilities and we adjust the expense when our actual experience differs from our initial estimates. We report the current portion of liabilities for ceased-use real estate leases in accrued expenses and other liabilities and report the noncurrent portion in deferred credits and other liabilities in our consolidated balance sheets. We report the related expenses in selling, general and administrative expenses in our consolidated statements of operations. As of September 30, 2011, successor and December 31, 2010, predecessor, the current portion of our leased real estate accrual was $26 million and $28 million, respectively, and the long-term portion was $140 million and $195 million, respectively. The remaining lease terms range from 0.1 to 14.3 years, with a weighted average of 9.1 years. Changes in our accrued liabilities for severance expenses and leased real estate for the successor six months ended September 30, 2011 and the predecessor three months ended March 31, 2011 were as follows:
Our severance expenses for the successor three and six months ended September 30, 2011 also included $1 million and $12 million, respectively, of share-based compensation associated with the accelerated vesting of stock awards that occurred in connection with workforce reductions relating to CenturyLink’s acquisition of us.
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(7) Fair Value Disclosure Our financial instruments consist of cash and cash equivalents, accounts receivable, accounts receivable—affiliates, short-term affiliate loans, accounts payable, accounts payable—affiliates and long-term debt excluding capital lease obligations. The carrying amounts of our cash and cash equivalents, accounts receivable, accounts receivable—affiliates, short-term affiliate loans, accounts payable and accounts payable—affiliates approximate their fair values. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between independent and knowledgeable parties who are willing and able to transact for an asset or liability at the measurement date. We use valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs when determining fair value and then we rank the estimated values based on the reliability of the inputs used following the fair value hierarchy set forth by the FASB. The three input levels in the hierarchy of fair value measurements are defined by the FASB generally as follows:
During the second quarter of 2011, the rights to our auction rate securities were assigned to CenturyLink. Upon assignment, the fair market value of those securities was $79 million. The following table presents the carrying amounts and estimated fair values of our investment securities, which are reported in noncurrent other assets, and long-term debt, excluding capital lease obligations, as well as the input levels used to determine the fair values:
The table below presents a rollforward of our auction rate securities valued using Level 3 inputs for the predecessor three months ended March 31, 2011 and the successor six months ended September 30, 2011:
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(8) Income Taxes In connection with CenturyLink’s acquisition of us on April 1, 2011, we recorded a $2.1 billion deferred tax liability under the acquisition method of accounting. Our preliminary acquisition date assignment of deferred income taxes and the related valuation allowance are subject to adjustment as discussed in Note 2—Acquisition by CenturyLink. The CenturyLink acquisition caused an “ownership change” within the meaning of Section 382 of the Internal Revenue Code. As a result, CenturyLink’s ability to use our accumulated net operating loss carryforwards, or NOLs, and certain other tax attributes to reduce future consolidated federal taxable income is subject to annual limits imposed by Section 382. Despite this, based on our evaluations and current circumstances, CenturyLink and we expect to use substantially all federal NOLs and certain other deferred tax attributes prior to their respective expirations. Thus, we have made no adjustments to our valuation allowances to reflect limitations imposed by virtue of the acquisition. Included in income tax expense for the predecessor nine months ended September 30, 2010 was a $113 million expense related to the change in the tax treatment of the Medicare Part D subsidy as a result of the comprehensive health care reform legislation enacted in March 2010. (9) Products and Services Revenues We are an integrated communications company engaged primarily in providing an array of communications services, including local and long distance, network access, broadband, data, managed hosting and video services. We strive to maintain our customer relationships by, among other things, bundling our service offerings to provide our customers with a complete offering of integrated communications services. We categorize our products and services into the following four categories:
Since the April 1, 2011 closing of CenturyLink’s acquisition of us, our operations are integrated into and reported as part of the segments of CenturyLink. CenturyLink’s chief operating decision maker (“CODM”) has become our CODM, but reviews our financial information on an aggregate basis only in connection with our quarterly and annual reports that we file with the SEC. Consequently, we do not provide our discrete financial information to the CODM on a regular basis.
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Our operating revenues for our products and services consisted of the following categories for the successor three and six months ended September 30, 2011 and predecessor three months ended March 31, 2011 and predecessor three and nine months ended September 30, 2010:
Affiliates and other services revenues include revenue from universal support funds which allows us to recover a portion of our costs under federal and state cost recovery mechanisms and certain surcharges to our customers, including billings for our required contributions to several USF programs. These surcharge billings to our customers are reflected on a gross basis in our statements of operations (included in both operating revenues and expenses). The table below presents the aggregate USF surcharges recognized on a gross basis:
(10) Commitments and Contingencies CenturyLink is involved in several legal proceedings to which we are not a party that, if resolved against CenturyLink, could have a material adverse effect on its business and financial condition. As a wholly owned subsidiary of CenturyLink, our business and financial condition could be similarly affected. You can find descriptions of these legal proceedings in CenturyLink’s quarterly and annual reports filed with the SEC. Because we are not a party to any of these matters, we have not accrued any liabilities for these matters. In this section, when we refer to a class action as “putative” it is because a class has been alleged, but not certified in that matter. Until and unless a class has been certified by the court, it has not been established that the named plaintiffs represent the class of plaintiffs they purport to represent. To the extent appropriate, we have accrued liabilities for the matters described below. The terms and conditions of applicable bylaws, certificates or articles of incorporation, agreements or applicable law may obligate us to indemnify our former directors, officers or employees with respect to certain of the matters described below, and we have been advancing legal fees and costs to certain former directors, officers or employees in connection with certain matters described below. KPNQwest Litigation/Investigation On September 29, 2010, the trustees in the Dutch bankruptcy proceeding for KPNQwest, N.V. (of which we were a major shareholder) filed a lawsuit in district court in Haarlem, the Netherlands, alleging tort and mismanagement claims under Dutch law. We and Koninklijke KPN N.V. (“KPN”) are defendants in this lawsuit
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along with a number of former KPNQwest supervisory board members and a former officer of KPNQwest, some of whom were formerly affiliated with us. Plaintiffs allege, among other things, that defendants’ actions were a cause of the bankruptcy of KPNQwest, and they seek damages for the bankruptcy deficit of KPNQwest, which is claimed to be approximately €4.2 billion (or approximately $5.7 billion based on the exchange rate on September 30, 2011), plus statutory interest. Two lawsuits asserting similar claims were previously filed against Qwest and others in federal courts in New Jersey in 2004 and Colorado in 2009; those courts dismissed the lawsuits without prejudice on the grounds that the claims should not be litigated in the United States. On September 13, 2006, Cargill Financial Markets, Plc and Citibank, N.A. filed a lawsuit in the District Court of Amsterdam, the Netherlands, against us, KPN, KPN Telecom B.V., and other former officers, employees or supervisory board members of KPNQwest, some of whom were formerly affiliated with us. The lawsuit alleges that defendants misrepresented KPNQwest’s financial and business condition in connection with the origination of a credit facility and wrongfully allowed KPNQwest to borrow funds under that facility. Plaintiffs allege damages of approximately €219 million (or approximately $300 million based on the exchange rate on September 30, 2011). We will continue to defend against the pending KPNQwest litigation matters vigorously. Other Matters Several putative class actions relating to the installation of fiber-optic cable in certain rights-of-way were filed against us on behalf of landowners on various dates and in various courts in Alabama, Arizona, California, Colorado, Florida, Georgia, Illinois (where there is a federal and a state court case), Indiana, Kansas, Massachusetts, Michigan, Mississippi, Missouri, Nevada, New Mexico, New York, Oregon, South Carolina, Tennessee, Texas, Utah and Washington. For the most part, the complaints challenge our right to install our fiber-optic cable in railroad rights-of-way. The complaints allege that the railroads own the right-of-way as an easement that did not include the right to permit us to install our fiber-optic cable in the right-of-way without the plaintiffs’ consent. Most of the actions purport to be brought on behalf of state-wide classes in the named plaintiffs’ respective states, although two of the currently pending actions purport to be brought on behalf of multi-state classes. Specifically, the Illinois state court action purports to be on behalf of landowners in Illinois, Iowa, Kentucky, Michigan, Minnesota, Nebraska, Ohio and Wisconsin, and the Indiana state court action purports to be on behalf of a national class of landowners. In general, the complaints seek damages on theories of trespass and unjust enrichment, as well as punitive damages. On July 18, 2008, a federal district court in Massachusetts entered an order preliminarily approving a settlement of all of the actions described above, except the action pending in Tennessee. On September 10, 2009, the court denied final approval of the settlement on grounds that it lacked subject matter jurisdiction. On December 9, 2009, the court issued a revised ruling that, among other things, denied a motion for approval as moot and dismissed the matter for lack of subject matter jurisdiction. The parties are now engaged in negotiating settlements on a state-by-state basis, and have filed and received preliminary approval of a settlement in Alabama federal court, and Tennessee state court. Preliminary and final approval also has been granted in a federal court action in Illinois, to which we are a party, and in a similar action in Idaho, to which we are not a party. One group of plaintiffs filed a motion with the judicial panel on multi-district litigation seeking consolidation of all the federal actions, which we and all other defendants, as well as a second group of plaintiffs, opposed. On August 8, 2012, the multi-district litigation panel denied the motion. (11) Financial Statements of Guarantors QCII and two of its subsidiaries, QCF and QSC, guarantee the payment of certain of each other’s registered debt securities. As of September 30, 2011, each series of QCII’s outstanding notes totaling approximately $2.7 billion in aggregate principal amount is guaranteed on a senior unsecured basis by QCF and QSC (the “QCII Guaranteed Notes). These notes are guaranteed through their respective maturity dates, the latest of which is in April 2018. In addition, each series of QCF’s outstanding notes totaling approximately $1 billion in aggregate principal amount is guaranteed on a senior unsecured basis by QCII (the “QCF Guaranteed Notes”). These notes are guaranteed through their respective maturity dates, the latest of which is in February 2031. The guarantees
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described above are full and unconditional and joint and several. All of the QCF Guaranteed Notes and $1.3 billion of the QCII Guaranteed Notes are registered debt securities. A significant amount of QCII’s and QSC’s income and cash flow are generated by their subsidiaries. As a result, the funds necessary to meet their debt service or guarantee obligations are provided in large part by distributions or advances from their subsidiaries. The following information sets forth our condensed consolidating statements of operations for the three months ended September 30, 2011, six months ended September 30, 2011, three months ended March 31, 2011, three months ended September 30, 2010 and nine months ended September 30, 2010, our condensed consolidating balance sheets as of September 30, 2011 and December 31, 2010, and our condensed consolidating statements of cash flows for the six months ended September 30, 2011, three months ended March 31, 2011 and nine months ended September 30, 2010. The information for QCII is presented on a stand-alone basis, information for QSC and QCF is presented on a combined basis and information for all of our other subsidiaries is presented on a combined basis. Each entity’s investments in its subsidiaries, if any, are presented under the equity method. The consolidating statements of operations and balance sheets include the effects of consolidating adjustments to our subsidiaries’ tax provisions and the related income tax assets and liabilities in the QSC and QCII results. Both QSC and QCF are 100% owned by QCII, and QCF is a finance subsidiary of QCII. Other than as already described in this note, the accounting principles used to determine the amounts reported in this note are the same as those used in our consolidated financial statements. CenturyLink periodically restructures the internal capital structure of its subsidiaries, including QCII and its subsidiaries, based on the needs of its business.
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Qwest Communications International Inc. CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 2011 SUCCESSOR (UNAUDITED)
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Qwest Communications International Inc. CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS SIX MONTHS ENDED SEPTEMBER 30, 2011 SUCCESSOR (UNAUDITED)
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Qwest Communications International Inc. CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS THREE MONTHS ENDED MARCH 31, 2011 PREDECESSOR (UNAUDITED)
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CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 2010 PREDECESSOR (UNAUDITED)
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Qwest Communications International Inc. CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 2010 PREDECESSOR (UNAUDITED)
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Qwest Communications International Inc. CONDENSED CONSOLIDATING BALANCE SHEETS SEPTEMBER 30, 2011 SUCCESSOR (UNAUDITED)
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Qwest Communications International Inc. CONDENSED CONSOLIDATING BALANCE SHEETS DECEMBER 31, 2010 PREDECESSOR (UNAUDITED)
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