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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

Commission File No. 000-22609

Qwest Communications International Inc.
(Exact name of registrant as specified in its charter)

        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 o     No ý.

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý    No o.

        At November 30, 2003, 1,768,301,330 shares of common stock were outstanding.

QWEST COMMUNICATIONS INTERNATIONAL INC.
FORM 10-Q

TABLE OF CONTENTS

PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

QWEST COMMUNICATIONS INTERNATIONAL INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(DOLLARS IN MILLIONS, SHARES IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

(UNAUDITED)

The accompanying notes are an integral part of these condensed consolidated financial statements.

QWEST COMMUNICATIONS INTERNATIONAL INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(DOLLARS IN MILLIONS, SHARES IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

The accompanying notes are an integral part of these condensed consolidated financial statements.

QWEST COMMUNICATIONS INTERNATIONAL INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(DOLLARS IN MILLIONS)

(UNAUDITED)

The accompanying notes are an integral part of these condensed consolidated financial statements.

QWEST COMMUNICATIONS INTERNATIONAL INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

THREE AND SIX MONTHS ENDED JUNE 30, 2003

(UNAUDITED)

Note 1: Basis of Presentation

        The condensed consolidated interim financial statements are unaudited. Qwest Communications International Inc. ("Qwest," "we," "us," the "Company" and "our") prepared these condensed consolidated financial statements in accordance with the instructions for Form 10-Q. In compliance with those instructions, certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States of America ("GAAP") have been condensed or omitted.

        In the third quarter of 2002, we entered into contracts for the sale of our directory publishing business. In November 2002, we closed the sale of our directory publishing business in seven of the 14 states in which we offered these services. In September 2003, we completed the sale of the directory publishing business in the remaining states. As a consequence, the results of operations of our directory publishing business are included in income from discontinued operations in our condensed consolidated statements of operations for all periods presented. See Note 4—Discontinued Operations including Assets Held for Sale.

        We made certain reclassifications to prior balances to conform to the current year presentation. Also, in connection with the preparation of this Form 10-Q, we moved $124 million of tax expense we improperly reflected in our quarter ended June 30, 2002 consolidated financial statements (which are included in our annual report on Form 10-K for the year ended December 31, 2002 (the "2002 Form 10-K")) into our quarter ended September 30, 2002 consolidated financial statements. These statements include all the adjustments necessary to fairly present our condensed consolidated results of operations, financial position and cash flows as of June 30, 2003 and for all periods presented. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in our 2002 Form 10-K. Due to the number of subsequent events and updates that have occurred since the end of the period covered by these condensed consolidated financial statements, for the convenience of the reader we have generally included these items in their related footnotes. The condensed consolidated results of operations for the three and six month periods ended June 30, 2003 and the statement of cash flows for the six month period ended June 30, 2003 are not necessarily indicative of the results or cash flows expected for the full year.

Recently adopted accounting pronouncements and cumulative effects of adoption

        On January 1, 2003, we adopted Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations" ("SFAS No. 143"). This statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs, generally referred to as asset retirement obligations. SFAS No. 143 requires entities to record the fair value of a legal liability for an asset retirement obligation required to be settled under law or written or oral contract. If a reasonable estimate of fair value can be made, the fair value of the liability will be recognized in the period it is incurred, or if not, in the period a reasonable estimate of fair value can be made. This cost is initially capitalized and then amortized over the estimated remaining useful life of the asset. We have determined that we have legal asset retirement obligations associated with the removal of a limited group of long-lived assets and recorded a cumulative effect of a change in accounting principle charge upon adoption of SFAS No. 143 of $28 million (liability of $43 million net of an asset of $15 million) as of January 1, 2003.

        Prior to the adoption of SFAS No. 143, we have included in our group depreciation rates estimated net removal costs (removal costs less salvage). These costs have historically been reflected in the calculation of depreciation expense and therefore recognized in accumulated depreciation. When the assets were actually retired and removal costs were expended, the net removal costs were recorded as a reduction to accumulated depreciation. While SFAS No. 143 requires the recognition of a liability for asset retirement obligations that are legally binding, it precludes the recognition of a liability for asset retirement obligations that are not legally binding. Therefore, upon adoption of SFAS No. 143, we reversed the net removal costs within accumulated depreciation for those fixed assets where the removal costs exceeded the estimated salvage value and we did not have a legal removal obligation. This resulted in income from the cumulative effect of a change in accounting principle of $365 million pretax upon adoption of SFAS No. 143 on January 1, 2003. The net income impact for the six months ended June 30, 2003 is $206 million ($365 million less the $28 million of charges disclosed above, net of income taxes of $131 million).

        On a going forward basis, the net costs of removal related to these assets will be charged to our consolidated statement of operations in the period in which the costs are incurred. As a result, the adoption of SFAS No. 143 is expected to decrease our depreciation expense on an annual basis by approximately $32 million and increase operating expenses related to the accretion of the fair value of our legal asset retirement obligations by approximately $6 million annually beginning January 1, 2003. Based on historical charges and activity through the date of filing of this Form 10-Q, we believe that recurring removal costs will be approximately $35 million to $45 million annually which will be charged to our consolidated statement of operations as incurred.

        In December 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 148, "Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of FASB Statement No. 123," ("SFAS No. 148"), which is effective for financial statements related to periods ending after December 15, 2002. SFAS No. 148 requires the following expanded disclosure regarding stock-based compensation. We account for our stock-based compensation arrangements under the intrinsic-value recognition and measurement principles of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". Under the intrinsic-value method, no compensation expense is recognized for options granted to employees when the strike price of those options equals or exceeds the value of the underlying security on the measurement date. Any excess of the stock price on the measurement date over the exercise price is recorded as deferred compensation and amortized over the service period during which the stock option award vests using the accelerated method described in FASB Interpretation No. 28, "Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans".

        Had compensation cost for our stock-based compensation plans been determined under the fair value method in accordance with the provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"), our net (loss) income and basic and diluted (loss) income per share would have been changed to the pro forma amounts indicated below:

        The pro forma amounts reflected above may not be representative of the effects on our reported net income or loss in future years because the number of future shares to be issued under these plans is not known and the assumptions used to determine the fair value can vary significantly.

Earnings per share

        The weighted average number of shares used for computing basic and diluted (loss) income per share for the three months ended June 30, 2003 and 2002 was 1.734 billion and 1.678 billion, respectively, and for the six months ended June 30, 2003 and 2002 was 1.720 billion and 1.672 billion, respectively. For the periods ended June 30, 2003 and 2002, the effect of approximately 129 million and 127 million, respectively, of outstanding stock options were excluded from the calculation of diluted (loss) income per share because the effect was anti-dilutive.

Note 2: Asset Impairment Charges

        Effective June 30, 2002, pursuant to SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"), a general deterioration of the telecommunications market, downward revisions to our expected future results of operations and other factors indicated that our investments in long-lived assets may have been impaired at that date. In accordance with SFAS No. 144, we performed an evaluation of the recoverability of the carrying value of our long-lived assets using gross undiscounted cash flow projections. For impairment analysis purposes, we grouped our property, plant and equipment and projected cash flows as follows: traditional telephone network, national fiber optic broadband network, international fiber optic broadband network, wireless network, web hosting and application service provider ("ASP") assets, assets held for sale and out-of-region digital subscriber line ("DSL") assets. Based on the gross undiscounted cash flow projections, we determined that all of our asset groups except our traditional telephone network were impaired at June 30, 2002. For those asset groups that were impaired, we then estimated the fair value using a variety of techniques which are presented in the table below. For those asset groups that were impaired, we determined that the fair values were less than our carrying amount by $10.613 billion in the aggregate of which $120 million has been reclassified to income from discontinued operations for certain web hosting centers in our condensed consolidated statement of operations for the three and six months ended June 30, 2002.

        Calculating the estimated fair value of the asset groups as listed above involves significant judgments and a variety of assumptions. For calculating fair value based on discounted cash flows, we forecasted future operating results and future cash flows, which included long-term forecasts of revenue growth, gross margins and capital expenditures. We also used a discount rate based on an estimate of the weighted average cost of capital for the specific asset groups. Comparable market data was obtained by reviewing recent sales of similar asset types in third-party market transactions.

        A brief description of the underlying business purpose of each of the asset groups that were impaired as a result of our analysis as of June 30, 2002 is as follows:

•

Our national fiber optic broadband network ("National Network") provides long-distance voice services, data and Internet services and wholesale services to business, residential and wholesale customers outside of our local service area.



•

Our international fiber optic broadband network ("International Network") provides the same services to the same types of customers, only outside of the United States.



•

Our wireless network provides personal communications service ("PCS") in select markets in our local service area.



•

Our web hosting and ASP assets provide business customers shared and dedicated hosting on our servers as well as application hosting services to help design and manage customers' websites and hosting applications.



•

Assets held for sale primarily consist of excess network supplies. See Note 4—Discontinued Operations including Assets Held for Sale for further information.



•

Our out-of-region DSL assets provide DSL service to customers outside our local service area.

        In accordance with SFAS No. 144, the fair value of the impaired assets becomes the new basis for accounting purposes. As such, approximately $1.9 billion in accumulated depreciation was eliminated in connection with the accounting for the impairments as of June 30, 2002. The impact of the impairments has reduced our annual depreciation and amortization expense by approximately $1.3 billion, effective July 1, 2002.

        In addition, for the six months ended June 30, 2002, we recorded other asset impairment charges of $6 million associated with the write-down of other real estate assets that were held for sale.

Subsequent Event-Asset Impairment

        In August 2003, we entered into a services agreement with a subsidiary of Sprint Corporation ("Sprint") that allows us to resell Sprint wireless services, including access to Sprint's nationwide PCS wireless network, to consumer and business customers, primarily within our local service area. We plan to begin offering these Sprint services under our brand name in early 2004. Our wireless customers who are currently being serviced through our proprietary wireless network will be transitioned at our cost onto Sprint's network. Due to the anticipated decrease in usage of our own wireless network following the transition of our customers onto Sprint's network, in the third quarter of 2003 we performed an evaluation of the recoverability of the carrying value of our long-lived wireless network assets.

        In accordance with SFAS No. 144, we compared gross undiscounted cash flow projections to the carrying value of the long-lived wireless network assets and determined that certain asset groups were not expected to be recovered through future projected cash flows. For those asset groups that were not recoverable, we then estimated the fair value using market prices for similar assets. Cell sites, switches, related tools and equipment inventory and certain information technology systems that support the wireless network were determined to be impaired by $230 million.

        Estimating the fair value of the asset groups involved significant judgment and a variety of assumptions. Comparable market data was obtained by reviewing recent sales of similar asset types.

Note 3: Goodwill and Other Intangible Assets

        On January 1, 2002, we adopted SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"), which requires companies to cease amortizing goodwill and intangible assets which have indefinite useful lives. SFAS No. 142 also requires that goodwill and indefinite-lived intangible assets be reviewed for impairment upon adoption on January 1, 2002 and annually thereafter, or more often if events or circumstances warrant. Under SFAS No. 142, goodwill impairment may exist if the carrying value of the reporting unit to which it is allocated exceeds its estimated fair value.

        Based on the transition provisions of SFAS No. 142, we reclassified the $50 million net carrying value of our assembled workforce intangible asset, which was recognized in connection with the June 30, 2000 acquisition of U S WEST, Inc. (the "Merger"), into goodwill effective January 1, 2002. The assembled workforce intangible asset no longer met the criteria for recognition as a separate intangible asset apart from goodwill. Amortization of goodwill, including the addition to goodwill from the reclassification of the assembled workforce intangible asset, ceased on January 1, 2002. We also ceased amortizing our intangible assets with indefinite lives, including trademarks, trade names and wireless spectrum licenses on January 1, 2002.

        In accordance with SFAS No. 142, we performed a transitional impairment test of goodwill and intangible assets with indefinite lives as of January 1, 2002. The first step of the transitional test of impairment was performed by comparing the fair value of our reporting units to the carrying values of these reporting units to which goodwill was assigned. Because we do not maintain balance sheets at the reporting unit level, we allocated all assets and liabilities to each of the reporting units based on various methodologies that included specific identification and allocations based primarily on revenues, voice grade equivalents (the amount of capacity required to carry one telephone call) and relative number of employees. Goodwill was allocated to reporting units based on the relative fair value of each reporting unit. We did not allocate any goodwill to our wireless and directory publishing reporting units because they were not expected to benefit significantly from the synergies of the Merger and are not considered sources of the goodwill which arose from the Merger.

        Upon implementation of SFAS No. 142, we identified 13 reporting units. Goodwill was allocated to four of these reporting units on a relative fair value basis. Reporting units that were non-revenue producing or that were not expected to benefit significantly from the synergies of the Merger were not allocated goodwill. In addition, insignificant reporting units were not allocated goodwill. As discussed in Note 8—Segment Information, operating segments were changed in the fourth quarter of 2002 after goodwill had already been reduced to zero through impairments discussed in the following paragraphs.

        We estimated the implied fair value of goodwill for each reporting unit by subtracting the fair value of the reporting unit's assets, including any unrecognized intangibles, from the total fair value of the reporting unit. The excess was deemed the implied fair value of goodwill. The implied fair value of the goodwill was then compared to the carrying amount of goodwill for the reporting unit. Based on this analysis, we recorded a charge for the cumulative effect of adopting SFAS No. 142 of $22.8 billion on January 1, 2002. This charge related to the reporting units in the table below:

        Changes in market conditions, downward revisions to our projections of future operating results and other factors indicated that the carrying value of the remaining goodwill should be evaluated for impairment as of June 30, 2002. Based on the results of that impairment analysis, we determined that the remaining goodwill balance of $8.483 billion was impaired and we recorded an impairment charge on June 30, 2002 to write-off the remaining balance.

Note 4: Discontinued Operations including Assets Held for Sale

        The following table presents the summarized results of operations for the periods indicated related to our discontinued operations. These results primarily relate to our directory publishing business. Our previously reported December 31, 2002 consolidated financial statements have been adjusted to reflect changes in the business units that comprise our discontinued operations.

        The following table presents the condensed balance sheets related to our discontinued operations, primarily our directory publishing business, as of the dates presented.

Discontinued directory publishing business

        During the second quarter of 2002, we began actively pursuing the sale of our directory publishing business. On November 8, 2002, we completed the first stage of the sale of our directory publishing business to a new entity formed by the private equity firms of The Carlyle Group and Welsh, Carson, Anderson & Stowe (the "Buyer") (the "Dex Sale"). The sales price for the first stage of the Dex Sale, which involved the sale of Dex operations in the states of Colorado, Iowa, Minnesota, Nebraska, New Mexico, North Dakota and South Dakota (the "Dex East business") was $2.75 billion and was paid in cash. We recognized a gain of $1.6 billion (net of $1.0 billion in income taxes) on the sale of the Dex East business.

        Concurrent with the closing of the sale of the Dex East business, we entered into an advertising and telecommunications commitment agreement with the Buyer. Pursuant to that agreement, we agreed to purchase from the Buyer at least $20 million annually worth of advertising, at fair value, for 15 years and the Buyer agreed to exclusively purchase from us those telecommunication services that it uses from time to time during this same period, at market based rates, subject to availability.

Excess network supplies held for sale

        We periodically review our network supplies against our usage requirements to identify potential excess supplies for disposal. During the second quarter of 2002, we identified $359 million of excess supplies and engaged a third-party broker to conduct a sale of those assets. An impairment charge of $342 million was recorded on June 30, 2002 to reduce the carrying amount of the supplies to their estimated fair value less cost to sell of $17 million. Fair value was based upon market values of similar equipment. The impairment charge of $342 million is included in asset impairment charges in our six months ended June 30, 2002 condensed consolidated statement of operations.

Subsequent Events—Discontinued Operations including Assets Held for Sale

        The sale of our directory publishing business in the remaining states of Arizona, Idaho, Montana, Oregon, Utah, Washington and Wyoming (the "Dex West business") was completed in September 2003. We received approximately $4.3 billion in gross sale proceeds related to the sale. We recognized a gain of $2.5 billion (net of $1.6 billion in income taxes) on the sale of the Dex West business.

Note 5: Investment in KPNQwest

        In April 1999, pre-Merger Qwest and KPN Telecom B.V. ("KPN") formed KPNQwest, a joint venture to create a pan-European Internet Protocol ("IP")-based fiber optic broadband network linked to Qwest's network in North America for data and multimedia services. Because we have never had the ability to designate a majority of the members of the supervisory board or to vote a majority of the voting securities, we accounted for our investment in KPNQwest using the equity method of accounting for all periods presented.

        In May 2002, KPNQwest filed for bankruptcy protection and ceased operations. We do not expect to recover any of our investment in KPNQwest and, as a result, we recorded losses of $576 million and $1.190 billion for the three and six months ended June 30, 2002, respectively, on our remaining investment in KPNQwest which is included in loss from continuing operations.

Note 6: Borrowings

        Our borrowings, net of discounts and premiums, consisted of the following for the dates indicated:

        During the second quarter of 2003, we exchanged approximately 12 million shares of our common stock with an aggregate value of $47 million for $55 million face amount in Qwest Capital Funding ("QCF") notes. The trading prices for our shares at the time the exchange transactions were consummated ranged from $3.53 per share to $4.96 per share. As a result of these transactions, we recorded $8 million of gain on the debt extinguishment during the second quarter of 2003.

        For the six months ended June 30, 2003, we exchanged approximately 31 million shares of our common stock with an aggregate value of $113 million for $142 million face amount in QCF notes. The trading prices for our shares at the time the exchange transactions were consummated ranged from $3.22 per share to $4.96 per share. We recorded $29 million of gain on the debt extinguishment for the above transactions during the six month period ended June 30, 2003.

        During the three months ended June 30, 2003, we exchanged $188 million of new Qwest Services Corporation ("QSC") notes for $255 million face amount of QCF notes. For the six months ended June 30, 2003, we also exchanged $406 million of new QSC notes for $560 million face amount of QCF notes. The new QSC notes have interest rates ranging from 13% to 13.5% while the original QCF notes had interest rates ranging from 6.875% to 7.90%. These debt-for-debt exchanges were accounted for in accordance with the guidance in Emerging Issues Task Force Issue No. 96-19, "Debtor's Accounting for a Modification or Exchange of Debt Instruments". On the date of the exchanges, the present value of the cash flows under the terms of the revised debt instruments were compared to the present value of the remaining cash flows under the original debt instruments. The cash flows were not considered "substantially" different to that of the exchanged debt; therefore, no gain was realized on the exchanges and the differences between the face amount of the new debt and the carrying amount of the exchanged debt of $62 million and $144 million for the three and six months ended June 30, 2003, respectively, are being amortized as credits to interest expense using the effective interest rate method over the life of the new debt.

        On June 9, 2003, we entered into a senior term loan with two tranches for a total of $1.75 billion principal amount of indebtedness. The term loan consists of a $1.25 billion floating rate tranche, due in 2007, and a $500 million fixed rate tranche, due in 2010. The term loan is unsecured and ranks equally with all of our current indebtedness. The floating rate tranche is non-prepayable for two years and thereafter is subject to prepayment premiums through 2006. There are no mandatory prepayment requirements. The covenant and default terms are substantially the same as our other senior indebtedness. The net proceeds were used to refinance our debt due in 2003 and fund or refinance our investment in telecommunications assets. The floating rate tranche bears interest at London Interbank Offered Rates plus 4.75% (with a minimum interest rate of 6.50%) and the fixed rate tranche bears interest at 6.95% per annum. The interest rate on the floating rate tranche was 6.50% at June 30, 2003. The lenders funded the entire principal amount of the loan subject to the original issue discount for the floating rate tranche of 1.00% and for the fixed rate tranche of 1.652%. Also, in connection with this issuance, our obligation under the QSC credit facility ("QSC Credit Facility"), was paid down by $429 million to a balance of $1.57 billion.

Subsequent Events—Debt-Related Matters

        On August 12, 2003, Qwest Dex, Inc. ("Dex"), our directory publishing subsidiary, paid in full the $750 million it owed under a term loan agreement consummated in August 2002.

        On September 9, 2003, we completed the sale of the Dex West business. The gross proceeds from the sale of the Dex West business were $4.3 billion and were received in cash. We used $321 million of the cash proceeds to reduce our QSC Credit Facility obligation to $1.25 billion. We expect to use the balance of the proceeds from the Dex West sale to invest in telecommunications assets and/or to redeem other indebtedness.

        Subsequent to June 30, 2003 and through December 3, 2003, we exchanged, through direct transactions, $312 million face amount of debt issued by QCF and Qwest Communications Corporation for $198 million in cash and for equity with an aggregate value of $89 million. We recorded a gain of $24 million related to these transactions.

        On November 19, 2003, we commenced a tender offer for up to $2.25 billion in aggregate principal amount of our debt securities. The offer is being made for specified series of debt securities of Qwest Communications International, Inc., QCF and QSC. Of the $2.25 billion we are offering to repurchase, up to $625 million is allocated to debt securities maturing in 2005 through 2007, up to $1.3 billion is allocated to debt securities maturing in 2008 through 2011 and up to $325 million is allocated to debt securities maturing in 2014 through 2031. The offer period expires on December 19, 2003, unless our offer is extended or earlier terminated, and the offer includes an early participation incentive for holders who tender on or before December 4, 2003.

Note 7: Restructuring and Merger-Related Charges

Restructuring and other charges

2003 Restructuring

        During the six months ended June 30, 2003, we identified planned employee reductions in various functional areas. As a result, we established a severance reserve and recorded a charge to our condensed consolidated statement of operations of $25 million to cover the costs associated with these actions as more fully described below.

        An analysis of activity associated with our 2003 restructuring reserve for the six months ended June 30, 2003 is as follows:

        The 2003 restructuring includes charges of $25 million for severance benefits and other charges pursuant to established severance policies associated with a reduction in employees. We identified 750 employees from various functional areas to be terminated as part of this reduction. Through June 30, 2003, 300 of the planned reductions had been completed and $9 million of the restructuring reserve had been used for severance payments and enhanced pension benefits.

        Other restructuring-related charges, primarily severance-related, were $4 million and $5 million for the three and six months ended June 30, 2003, respectively.

2002 Restructuring

        During 2002, in response to shortfalls in employee reductions planned as part of the 2001 restructuring plan (as discussed below), and due to continued declines in our revenues and general economic conditions, we identified planned employee reductions in various functional areas and permanently abandoned a number of operating and administrative facilities. As a result, we established a restructuring reserve and recorded a charge to our condensed consolidated statement of operations to cover the costs associated with these actions.

        An analysis of activity associated with our 2002 restructuring plan for the six months ended June 30, 2003 is as follows:

        During 2002, we identified approximately 4,500 employees from various functional areas to be terminated as part of this reduction. At June 30, 2003, 4,100 of the planned reductions had been accomplished and for the six months ended June 30, 2003, $37 million of the restructuring reserve had been used for severance payments and enhanced pension benefits. We expect the remaining employee reductions to be completed by December 31, 2003.

        Also as part of the 2002 restructuring, we permanently abandoned 64 leased facilities and recorded a charge to restructuring and other charges in our consolidated statement of operations. The abandonment costs include rental payments due over the remaining terms of the leases, net of estimated sublease rentals, and estimated costs to terminate the leases. For the six months ended June 30, 2003 we utilized $8 million of the established reserves primarily for payments of amounts due under the leases. We expect the balance of the reserve to be utilized over the remaining terms of the leases, which are up to five years.

2001 Restructuring

        During the fourth quarter of 2001, a plan was approved to reduce employee levels, consolidate and sublease facilities, abandon certain capital projects and terminate certain operating leases. An analysis of activity associated with our 2001 plan for the six months ended June 30, 2003 is as follows:

        In 2001 we identified approximately 10,000 employees from various functional areas to be terminated as part of an employee reduction and accrued a restructuring reserve for severance benefits for those employees. At June 30, 2003, approximately 7,000 employees had been terminated. For the six months ended June 30, 2003, $1 million of the restructuring reserve had been used for severance payments, enhanced pension benefits and other employee-related outlays. In 2002, in response to this shortfall in planned employee terminations, we reviewed our manpower complement in other functional areas and identified employees to be terminated as part of another staffing reduction. These planned reductions are discussed above in connection with our 2002 restructuring activities.

        Due to our staffing reduction and consolidation of our operations, we accrued a restructuring reserve associated with the expected termination of 40 operating lease agreements across the country. For the six months ended June 30, 2003 we utilized $11 million of the established reserve for payments associated with contract termination costs related to exiting these buildings.

        As a result of the slowing economy and the excess capacity that existed for web hosting, we suspended our plans to build web hosting centers where construction had not begun and halted work on those sites that were under construction. We identified 10 web hosting centers that would be permanently abandoned. We expected to sublease the majority of the non-operational web hosting centers at rates less than our lease rates for the facilities. Certain of these leases are for terms of up to 20 years. As a result, in 2001 we established a restructuring reserve to cover the expected sublease losses. For the six months ended June 30, 2003, we utilized $11 million of the established reserve primarily for payments made on the web hosting center leases and contract termination costs.

Merger-related charges

        As of June 30, 2003, total Merger-related accruals of $22 million are included on our condensed consolidated balance sheet. These relate primarily to outstanding legal liabilities. As the matters identified as contractual settlements and legal contingencies are resolved, any amounts due will be paid and charged against our remaining accrual. Any differences between amounts accrued and actual payments made will be reflected in Merger-related charges in our condensed consolidated statement of operations for the period in which the difference is identified.

Note 8: Segment Information

        SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS No. 131") establishes standards for reporting information about operating segments in annual financial statements of public business enterprises and requires that those enterprises report selected information about operating segments in interim and annual financial reports issued to shareholders. Operating segments are components of an enterprise that engage in business activities from which revenues may be earned and expenses may be incurred, and for which discrete financial information is available and regularly evaluated by the chief operating decision maker ("CODM") of an enterprise.

        The CODM of a business represents the highest level of management who is responsible for the overall allocation of resources within the business and assessment of the performance of the business. Our CODM is our Chief Executive Officer. Set forth below is revenue and operating expense information for the three and six months ended June 30, 2003 and 2002 for our three operating segments at June 30, 2003: wireline services, wireless services and other services. Management evaluates the performance of each segment and allocates capital resources based on segment income as defined below. Until September 2003, we also operated a fourth segment, our directory publishing business, which as described in Note 4—Discontinued Operations including Assets Held for Sale, has been classified as discontinued operations in our condensed consolidated statements of operations and accordingly is not presented in our segment results below.

        Segment income consists of each segment's revenues and direct expenses. Segment revenues are based on the types of products and services offered as described below. The network infrastructure is designed to be scalable and flexible to handle multiple products and services. As a result, we do not allocate network infrastructure costs to individual products. Direct administrative costs include sales, customer support, collections and marketing. Indirect administrative costs such as finance, information technology, real estate, legal, marketing services and human resources are included in the other services segment. We manage indirect administrative services costs centrally; consequently, the costs are not allocated to the wireline or wireless services segments. Similarly, depreciation, amortization, interest expense, interest income and other income (expense) are not allocated to either the wireline or wireless segments.

        Our wireline services segment includes revenues from the provision of voice services, access services and data and Internet services. Voice services consist of local voice services (such as basic local exchange services, operator services, public telephone service, enhanced voice services and revenues from the sales of customer premises equipment ("CPE")) and long-distance voice services (such as IntraLATA and InterLATA long-distance services). Access services revenues are generated through our wholesale sales channel from switched-access service revenues (which are revenues generated principally from charges to interexchange carriers ("IXCs"), for use of our local network to connect their customers to their long-distance networks). An IXC is a telecommunications company that provides long-distance services to end-users by handling calls that are made from a phone exchange in one local access transport area ("LATA"), to an exchange in another LATA.

        Data and Internet services include data services (such as traditional private lines, wholesale private lines, frame relay, asynchronous transfer mode ("ATM") and related CPE) and Internet services (such as DSL, dedicated Internet access ("DIA"), virtual private network ("VPN"), Internet dial access, web hosting, professional services and related CPE). Revenues from optical capacity transactions are also included in revenues from data services as is revenue from the provision of wholesale billing services. Depending on the product or service purchased, a customer may pay an up-front fee, a monthly fee, a usage charge or a combination of these fees and charges.

        Our wireless services are provided through our wholly owned subsidiary, Qwest Wireless LLC, which holds 10 Megahertz licenses to provide PCS in most markets in our local service area. We offer wireless services to residential and business customers providing them the ability to use the same telephone number for their wireless phone as for their home or business phone. In August 2003, we entered into a services agreement with a subsidiary of Sprint that allows us to resell Sprint wireless services, including access to Sprint's nationwide PCS wireless network, to consumer and business customers, primarily within our local service area (see Note 2—Asset Impairment Charges).

        Our other services segment consists of revenues and expenses from other operating segments and functional departments that do not meet the quantitative threshold requirements of SFAS No. 131. Other services revenue is predominately derived from subleases of some of our real estate assets, such as space in our office buildings, warehouses and other properties. Our other services segment expenses include unallocated corporate expenses for functions such as finance, information technology, real estate, legal, marketing services and human resources.

        Information for all periods has been conformed to our June 30, 2003 presentation, as described above. Other than as already described herein, the accounting principles used are the same as those used in our condensed consolidated financial statements. The revenues shown below for each segment are derived from transactions with external customers. Internally, we do not separately track the total assets of our wireline or other segments. As such, total asset information for the three segments shown below is not presented.

        The following table reconciles segment income to net (loss) income for the three and six months ended June 30, 2003 and 2002:

        Set forth below is revenue information for the three and six months ended June 30, 2003 and 2002 for revenues derived from external customers for our products and services.

        We provide a variety of telecommunications services on a national and international basis to global and national businesses, small businesses, governmental agencies and residential customers. It is impractical for us to provide revenue information about geographic areas.

        We do not have any single major customer that provides more than 10 percent of the total of our revenues derived from external customers.

Note 9: Non-Cash Activities

        Supplemental disclosures of non-cash investing and financing activities are as follows:

        During the six months ended June 30, 2003, we exchanged debt with a carrying value of $142 million that was issued by QCF. In exchange for the debt, we issued approximately 31 million shares of our common stock with a fair value of $113 million and recorded a $29 million gain on early retirement of debt.

        During the first quarter of 2002, we exchanged debt with a carrying value of $96 million that was issued by QCF. In exchange for the debt, we issued approximately 9.88 million shares of our treasury stock with a fair value of $87 million and recorded a $9 million gain on early retirement of debt.

        During the first quarter of 2002, we received approximately 278,000 shares of our common stock valued at $13 million from BellSouth Corporation in partial satisfaction of a $16 million receivable outstanding at December 31, 2001.

Note 10: Other Comprehensive (Loss) Income

        Other comprehensive (loss) income for the three and six months ended June 30, 2003 and 2002 was as follows:

Note 11: Commitments and Contingencies

Subsequent Events—Commitments

        In September 2003, we terminated our services arrangements with Calpoint, LLC ("Calpoint") and another service provider and settled certain claims of the parties. We agreed to pay $174 million to terminate these arrangements. However, we will continue to make payments to a trustee related to the Calpoint arrangements for 75% of an unconditional purchase obligation, and as a result, we recorded a liability of $346 million. We also recorded a reduction in a pre-existing deferred credit of $127 million in connection with the termination of the Calpoint arrangements. Our third quarter 2003 condensed consolidated financial statements reflect a net $393 million charge related to these terminations.

        In July 2003, we entered into an information technology services agreement with International Business Machines Corporation ("IBM"), under which IBM provides us data center operations and technical support services. The term of the agreement is 10 years. The agreement allows us to terminate at our convenience, but would require us to pay IBM termination fees ranging from $146 million in the first year of the contract to $38 million in the seventh year. We expect to pay IBM approximately $82 million in fees under this agreement in 2003 and approximately $212 million in 2004, although these amounts may vary depending on our actual usage of IBM's services and other factors.

Rights of Way

        We have transferred optical capacity assets on our network primarily to other telecommunications service carriers in the form of indefeasible rights of use ("IRU") transactions involving specific channels on our "lit" network or specific dark fiber strands. These IRUs provide for the exclusive right to use a specified amount of capacity or fiber for a specified period reflecting the estimated useful life of the optical capacity asset, typically 20 years or more. Typically, at or before the end of the IRU term, ownership of the optical capacity asset will have passed to the customer. Our fiber optic broadband network is generally located in real property pursuant to an agreement with the property owner or another person with rights to the property. It is possible that we may lose our rights under one or more of such agreements, due to their termination or their expiration. If we lose any such rights of way and are unable to renew them, we may find it necessary to move or replace the affected portions of the network. However, we do not expect any material adverse impacts as a result of the loss of any such rights.

Investigations

        On April 3, 2002, the Securities and Exchange Commission ("SEC") issued an order of investigation that made formal an informal investigation initiated on March 8, 2002. We are continuing in our efforts to cooperate fully with the SEC in its investigation. The investigation includes, without limitation, inquiry into several specifically identified Qwest accounting practices and transactions and related disclosures that are the subject of the various adjustments and restatements described in our 2002 Form 10-K. The investigation also includes inquiry into disclosure and other issues related to transactions between us and certain of our vendors and certain investments in the securities of those vendors by individuals associated with us.

        On July 9, 2002, we were informed by the U.S. Attorney's Office for the District of Colorado of a criminal investigation of us. We believe the U.S. Attorney's Office is investigating various matters that include the subjects of the investigation by the SEC. We are continuing in our efforts to cooperate fully with the U.S. Attorney's Office in its investigation.

        While we are continuing in our efforts to cooperate fully with the SEC and the U.S. Attorney's Office in each of their respective investigations, we cannot predict the outcome of those investigations. We have engaged in discussions with the SEC staff in an effort to resolve the issues raised in the SEC's investigation of us. Such discussions are preliminary and we cannot predict the likelihood of whether those discussions will result in a settlement and, if so, the terms of such settlement. However, settlements typically involve, among other things, the SEC making claims under the federal securities laws in a complaint filed in United States District Court that, for purposes of the settlement, the defendant neither admits nor denies. We would expect such claims to address many of the accounting practices and transactions and related disclosures that are the subject of the various restatements we have made as well as additional transactions. In addition, any settlement with the SEC may also involve, among other things, the imposition of a civil penalty, the amount of which could be material, and the entry of a court order that would require, among other things, that we and our officers and directors comply with provisions of the federal securities laws as to which there have been allegations of prior violations.

        In addition, as previously reported, the SEC has conducted an investigation concerning our earnings release for the fourth quarter and full year 2000 issued on January 24, 2001. The release provided pro forma normalized earnings information that excluded certain nonrecurring expense and income items resulting primarily from the Merger with U S WEST. On November 21, 2001, the SEC staff informed us of its intent to recommend that the SEC authorize an action against us that would allege we should have included in the earnings release a statement of our earnings in accordance with GAAP. At the date of this filing, no action has been taken by the SEC. However, we expect that if our current discussions with the staff of the SEC result in a settlement, such settlement will include allegations concerning the January 24, 2001 earnings release.

        Also, as previously announced in July 2002 by the General Services Administration ("GSA"), the GSA is conducting a review of all contracts with us for purposes of determining present responsibility. Recently, the Inspector General of the GSA referred to the GSA Suspension/Debarment Official the question of whether Qwest should be considered for debarment. We have been informed that the basis for the referral is last February's indictment against four former employees in connection with a transaction with the Arizona School Facilities Board in June 2001 and a civil complaint filed the same day by the SEC against the same former employees and others relating to the Arizona School Facilities Board transaction and a transaction with Genuity, Inc. ("Genuity") in 2000. We are cooperating fully with the GSA and believe that we will remain a supplier of the government, although we cannot predict the outcome of this referral.

Securities actions and derivative actions

        Since July 27, 2001, 13 putative class action complaints have been filed in federal district court in Colorado against us alleging violations of the federal securities laws. One of those cases has been dismissed. By court order, the remaining actions have been consolidated into a Consolidated Securities Action (the "Consolidated Securities Action"). Plaintiffs in the Consolidated Securities Action name as defendants in the Fourth Consolidated Amended Class Action Complaint ("Fourth Consolidated Complaint"), which was filed on or about August 21, 2002, us, our former Chairman and Chief Executive Officer, Joseph P. Nacchio, our former Chief Financial Officers, Robin R. Szeliga and Robert S. Woodruff, other of our former officers and current directors and Arthur Andersen LLP. The Fourth Consolidated Complaint is purportedly brought on behalf of purchasers of our publicly traded securities between May 24, 1999 and February 14, 2002, and alleges, among other things, that during the putative class period, we and certain of the individual defendants made materially false statements regarding the results of our operations in violation of section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), that certain of the individual defendants are liable as control persons under section 20(a) of the Exchange Act, and that during the putative class period, certain of the individual defendants sold some of their shares of our common stock in violation of section 20A of the Exchange Act. The Fourth Consolidated Complaint also alleges that our financial results during the putative class period and statements regarding those results were false and misleading due to the alleged: (i) overstatement of revenue, (ii) understatement of costs, (iii) manipulation of employee benefits in order to increase profitability and (iv) misstatement of certain assets and liabilities. The Fourth Consolidated Complaint further alleges that we and certain of the individual defendants violated Section 11 of the Securities Act of 1933, as amended (the "1933 Act"), and that certain of the individual defendants are liable as control persons under Section 15 of the 1933 Act by preparing and disseminating false registration statements and prospectuses for: (1) the registration of 897,907,706 shares of our common stock to be issued to U S WEST shareholders dated June 21, 1999, as amended August 13, 1999 and September 17, 1999; (2) the exchange of $3.25 billion of our notes dated July 12, 2001; and (3) the exchange of $3.75 billion of our notes dated October 30, 2001. The Fourth Consolidated Complaint seeks unspecified compensatory damages and other relief. However, lead counsel for the plaintiffs has indicated that plaintiffs will seek damages in the billions of dollars. On September 20, 2002, both we and the individual defendants filed motions to dismiss the Fourth Consolidated Complaint. Those motions are currently pending before the court. On November 4, 2002, lead plaintiffs in the consolidated securities action filed a motion for a temporary restraining order and preliminary injunction seeking to enjoin the Dex Sale or, in the alternative, to place the proceeds of such sale in a constructive trust for the benefit of the plaintiffs. The court denied both motions.

        On October 22, 2001, an alleged derivative lawsuit was filed in the United States District Court for the District of Colorado, naming as defendants each of the then members of our Board of Directors, and naming us as a nominal defendant. The derivative complaint is based upon the allegations made in the consolidated securities action and alleges, among other things, that the Board members intentionally or negligently breached their fiduciary duties to us by failing to oversee implementation of securities laws that prohibit insider trading. The derivative complaint also alleges that the Board members breached their fiduciary duties to us by causing or permitting us to commit alleged securities violations, thus (i) causing us to be sued for such violations, and (ii) subjecting us to adverse publicity, increasing our cost of raising capital and impairing earnings. The derivative complaint further alleges that certain directors sold shares between April 26, 2001 and May 15, 2001 using non-public information about us. On or about October 31, 2001, the court filed an order consolidating this derivative lawsuit with the consolidated securities action. In December 2001, the derivative lawsuit was stayed, pending further order of the court, based on the fact that the merits of the derivative lawsuit are intertwined with the resolution of the consolidated securities action. In March 2002, plaintiffs filed a first amended derivative complaint. The first amended derivative complaint adds allegations relating to the disclosures of our consolidated financial results from April 2000 through February 2002. On or about November 5, 2002, plaintiffs filed a second amended derivative complaint. The second amended complaint adds as defendants to the lawsuit certain former officers, including Robin R. Szeliga, Robert S. Woodruff and others. The second amended complaint contains allegations in addition to those set forth in the prior complaints, stating, among other things that (i) certain officers and/or directors traded our stock while in the possession of inside information, and (ii) certain officers and/or directors caused the restatement of more than $1 billion in revenue by concealing improper accounting practices. Plaintiffs seek, among other remedies, disgorgement of alleged insider trading profits. The lawsuit remains stayed.

        On March 6, 2002, an alleged derivative lawsuit was filed in the District Court for the City and County of Denver, naming as defendants each of the then members of our Board of Directors, certain former officers of ours and Arthur Andersen LLP. We are named as a nominal defendant. The derivative complaint is based upon the allegations made in the consolidated securities action and alleges that the Board members intentionally or recklessly breached their fiduciary duties to us by causing or allowing us to issue financial disclosures that were false or misleading. Plaintiffs seek unspecified damages on our behalf against the defendants. On July 2, 2002, this state court derivative lawsuit was stayed pending further order of the court. On or about August 1, 2003, the plaintiffs filed an amended derivative complaint, which does not contain claims against our former officers and Arthur Andersen, but continues to assert claims against the Board defendants. In the amended complaint, the plaintiffs allege, among other things, that the individual defendants abdicated their duty to implement and maintain an adequate internal accounting control system and thus allegedly violated (i) their fiduciary duties of loyalty and good faith; (ii) GAAP; and (iii) our Audit Committee's charter (which requires, among other things, that our Audit Committee serve as an independent and objective party to monitor our financial reporting and internal control system). The amended complaint also states new claims against Mr. Nacchio for his alleged breach of fiduciary duties. Plaintiffs seek a court order requiring that Mr. Nacchio disgorge to us all of his 2001 compensation, including salary, bonus, long-term incentive payouts and stock options. In addition, the plaintiffs contend that Mr. Nacchio breached his fiduciary duties to us by virtue of his sales of our stock allegedly made using his knowledge of material non-public information. The plaintiffs seek the imposition of a constructive trust on any profits Mr. Nacchio obtained by virtue of these sales.

        Since March 2002, seven putative class action suits were filed in federal district court in Colorado purportedly on behalf of all participants and beneficiaries of the Qwest Savings and Investment Plan and predecessor plans (the "Plan") from March 7, 1999 until the present. By court order, five of these putative class actions have been consolidated, and the claims made by the plaintiff in the sixth case were subsequently included in the Second Amended and Consolidated Complaint described below (the "consolidated ERISA action"). We expect the seventh putative class action to be consolidated with the other cases since it asserts substantially the same claims. The consolidated amended complaint filed on July 5, 2002 names as defendants, among others, us, several former and current directors, officers and employees, Qwest Asset Management, the Plan's Investment Committee and the Plan Administrative Committee of the pre-Merger Qwest Communications 401(k) Savings Plan. Plaintiffs filed a Second Amended and Consolidated Complaint on May 21, 2003, naming as additional defendants a former employee and Qwest's Plan Design Committee. The consolidated ERISA action, which is brought under the Employee Retirement Income Security Act ("ERISA"), alleges, among other things, that the defendants breached fiduciary duties to the Plan members by allegedly excessively concentrating the Plan's assets invested in our stock, requiring certain participants in the Plan to hold the matching contributions received from us in the Qwest Shares Fund, failing to disclose to the participants the alleged accounting improprieties that are the subject of the consolidated securities action, failing to investigate the prudence of investing in our stock, continuing to offer our stock as an investment option under the Plan, failing to investigate the effect of the U S WEST Merger on Plan assets and then failing to vote the Plan's shares against it, preventing plan participants from acquiring our stock during certain periods and, as against some of the individual defendants, capitalizing on their private knowledge of our financial condition to reap profits in stock sales. Plaintiffs seek equitable and declaratory relief, along with attorneys' fees and costs and restitution. Plaintiffs moved for class certification on January 15, 2003, and we have opposed that motion, which is pending before the court. Defendants filed motions to dismiss on August 22, 2002. Those motions are also pending before the court.

        On June 27, 2002, a putative class action was filed in the District Court for the County of Boulder against us, The Anschutz Family Investment Co., Philip Anschutz, Joseph P. Nacchio and Robin R. Szeliga on behalf of purchasers of our stock between June 28, 2000 and June 27, 2002 and owners of U S WEST stock on June 28, 2000. The complaint alleges, among other things, that we and the individual defendants issued false and misleading statements and engaged in improper accounting practices in order to accomplish the U S WEST Merger, to make us appear successful and to inflate the value of our stock. The complaint asserts claims under Sections 11, 12, 15 and 17 of the 1933 Act. The complaint seeks unspecified monetary damages, disgorgement of illegal gains and other relief. On July 31, 2002, the defendants removed this state court action to federal district court in Colorado and subsequently moved to consolidate this action with the consolidated securities action identified above. The plaintiffs have moved to remand the lawsuit back to state court. Defendants have opposed that motion, which is pending before the court.

        On August 9, 2002, an alleged derivative lawsuit was filed in the Court of Chancery of the State of Delaware, naming as defendants each of the then members of our Board of Directors and our current Chief Financial Officer, Oren G. Shaffer, and naming us as a nominal defendant. On or about September 16, 2002, an amended complaint was filed in the action, naming the same defendants except Mr. Shaffer, who is no longer a defendant in the action. A separate alleged derivative lawsuit was filed in the Court of Chancery of the State of Delaware on or about August 28, 2002. That lawsuit names as defendants our former Chairman and Chief Executive Officer, Joseph P. Nacchio, our former Chief Financial Officer, Robert S. Woodruff, former Board member, Marilyn Carlson Nelson, and each of the then members of our Board of Directors and names us as a nominal defendant. On October 30, 2002, these two alleged derivative lawsuits were consolidated, and an Amended Complaint (the "Second Amended Complaint") was later filed on or about January 23, 2003, and names as defendants the current members of our Board of Directors, former Board member Hank Brown, our former Chief Executive Officer, Joseph P. Nacchio, and our former Chief Financial Officer, Robert Woodruff, and names us as a nominal defendant. In the Second Amended Complaint, the plaintiffs allege, among other things, that the individual defendants (i) breached their fiduciary duties by allegedly engaging in illegal insider trading in our stock; (ii) failed to ensure compliance with federal and state disclosure, anti-fraud and insider trading laws within Qwest, resulting in exposure to us; (iii) appropriated corporate opportunities, wasted corporate assets and self-dealt in connection with investments in initial public offering securities through our investment bankers; and (iv) improperly awarded severance payments of $13 million to our former Chief Executive Officer, Mr. Nacchio. The plaintiffs seek recovery of incentive compensation alleged wrongfully paid to certain defendants, all severance payments made to Messrs. Nacchio and Woodruff and all costs including legal and accounting fees. Plaintiffs have also requested, among other things, that the individual defendants compensate us for any insider-trading profits. Plaintiffs likewise allege that we are entitled to contribution and indemnification by each of the individual defendants. Plaintiffs request that the court cancel all unexercised stock options awarded to Messrs. Nacchio and Woodruff to which they were not entitled, that the defendants return to us all salaries and other remuneration paid to them by us during the time they breached their fiduciary duties and that the court order the defendants to enforce policies, practices and procedures on behalf of us designed to detect and prevent illegal conduct by our employees and representatives. On March 17, 2003, defendants moved to dismiss the Second Amended Complaint, or, in the alternative, to stay the action. That motion is pending before the court.

        On November 22, 2002, plaintiff Stephen Weseley IRA Rollover filed a purported derivative lawsuit in Denver District Court, naming as defendants each of the then members of our Board of Directors, certain of our former officers, Anschutz Company and us as a nominal defendant. Plaintiff alleges, among other things, that the director defendants breached their fiduciary duties to us and damaged us by deliberately in bad faith or recklessly (i) implementing a sham system of internal controls completely inadequate to ensure proper recognition of revenue; (ii) causing us to issue false and misleading statements and financial results to the market regarding our earnings, revenues, business and investments; (iii) exposing us to massive liability for securities fraud; (iv) damaging our reputation; and (v) trading our shares while in possession of material, non-public information regarding our true financial condition. The complaint purports to state causes of action for breach of fiduciary duty, gross negligence, unjust enrichment against some of our former officers and breach of contract and breach of the duty of loyalty/insider trader trading against several of our former officers and former and current directors. On or about January 7, 2003, plaintiff's counsel filed a proposed amended complaint which substitutes a new plaintiff, Thomas R. Strauss, and adds another former officer as a defendant. In the amended complaint, plaintiff seeks (i) disgorgement of bonuses and other incentive compensation paid to certain defendants; (ii) disgorgement of any profits that certain defendants made by virtue of their alleged trading on material, inside information; and (iii) other damages. By order dated January 9, 2003, the court permitted the substitution and Strauss became the plaintiff in this lawsuit under the amended complaint.

        On December 10, 2002, the California State Teachers' Retirement System ("CalSTRS") filed suit against us, certain of our former officers and certain of our current directors and several other defendants, including Arthur Andersen LLP and several investment banks, in the Superior Court of the State of California in and for the County of San Francisco. CalSTRS alleges that the defendants engaged in fraudulent conduct that caused CalSTRS to lose in excess of $150 million invested in our equity and debt securities. The complaint alleges, among other things that in press releases and other public statements, defendants represented that we were one of the highest revenue producing telecommunications companies in the world, with highly favorable results and prospects. CalSTRS alleges that defendants were engaged, however, "in a scheme to falsely inflate Qwest's revenues and decrease its expenses so that Qwest would appear more successful than it actually was." The complaint purported to state causes of action against us for (i) violation of California Corporations Code Section 25400 et seq. (securities laws) (seeking, among other damages, the difference between the price at which CalSTRS sold our notes and stock and their true value); (ii) violation of California Corporations Code Section 17200 et seq. (unfair competition); (iii) fraud, deceit and concealment; and (iv) breach of fiduciary duty. Among other requested relief, CalSTRS seeks compensatory, special and punitive damages, restitution, pre-judgment interest and costs. We and the individual defendants filed a demurrer, seeking dismissal of all claims. In response, the plaintiff voluntarily dismissed the unfair competition claim but maintained the balance of the complaint. The court denied the demurrer as to the California securities law and fraud claims, but dismissed the breach of fiduciary duty claim against us with leave to amend. The court also dismissed the claims against Robert S. Woodruff and Robin R. Szeliga on jurisdictional grounds. On or about July 25, 2003, plaintiff filed a First Amended Complaint. The material allegations remain largely the same, but plaintiff no longer alleged claims against Mr. Woodruff and Ms. Szeliga following the court's dismissal of the claims against them, and reasserted its claim against us for breach of fiduciary duty as an allegation of aiding and abetting breach of fiduciary duty. We filed a second demurrer to that claim, and on November 7, 2003, the court dismissed that claim without leave to amend.

        On November 27, 2002, the State of New Jersey (Treasury Department, Division of Investment) ("New Jersey"), filed a lawsuit similar to the CalSTRS action in New Jersey Superior Court, Mercer County. On October 17, 2003, New Jersey filed an amended complaint, alleging, among other things, that we, certain of our former officers and certain current directors and Arthur Andersen LLP caused our stock to trade at artificially inflated prices by employing improper accounting practices, and by issuing false statements about our business, revenues and profits. As a result, New Jersey contends that it incurred tens of millions of dollars in losses. New Jersey's complaint purports to state causes of action against us for: (i) fraud; (ii) negligent misrepresentation; and (iii) civil conspiracy. Among other requested relief, New Jersey seeks from the defendants, jointly and severally, compensatory, consequential, incidental and punitive damages. On November 17, 2003, we filed a motion to dismiss. That motion is pending before the court.

        On January 10, 2003, the State Universities Retirement System of Illinois ("SURSI") filed a lawsuit similar to the CalSTRS and New Jersey lawsuits in the Circuit Court of Cook County, Illinois. SURSI filed suit against us, certain of our former officers and certain current directors and several other defendants, including Arthur Andersen LLP and several investment banks. On October 29, 2003, SURSI filed a second amended complaint, dropping (i) certain individual and corporate defendants, and (ii) its claim under the Illinois Consumer Fraud and Deceptive Business Practice Act. The second amended complaint alleges that defendants engaged in fraudulent conduct that caused it to lose in excess of $12.5 million invested in our common stock and debt and equity securities. The complaint alleges, among other things that in press releases and other public statements, defendants represented that we were one of the highest revenue producing telecommunications companies in the world, with highly favorable results and prospects. SURSI alleges that defendants were engaged, however, in a scheme to falsely inflate our revenues and decrease our expenses by, among other allegations, improper conduct related to transactions with the Arizona School Facilities Board, Genuity, Calpoint, KMC, KPNQwest, and Koninklijke KPN, N.V. The complaint purports to state causes of action against us under: (i) the Illinois Securities Act; (ii) common law fraud; (iii) common law negligent misrepresentation; and (iv) Section 11 of the 1933 Act. SURSI seeks, among other relief, punitive and exemplary damages, costs, equitable relief including an injunction to freeze or prevent disposition of the defendants' assets and disgorgement.

        The consolidated securities action, the consolidated ERISA action, and the CalSTRS, New Jersey and SURSI actions described above present material and significant risk to us. Some of the allegations in these lawsuits include many of the same subjects that the SEC and U.S. Attorney's Office are investigating. Moreover, the size, scope and nature of our recent restatements of our financial statements for fiscal 2001 and 2000 affect the risks presented by these cases. While we intend to defend against these matters vigorously, the ultimate outcomes of these cases are very uncertain, and we can give no assurance as to the impacts on our financial results or financial condition as a result of these matters. Each of these cases is in a preliminary phase. None of the plaintiffs or the defendants has advanced evidence concerning possible recoverable damages, and we have not yet conducted discovery on these and other relevant issues. Thus, we are unable at this time to estimate reasonably a range of loss that we would incur if the plaintiffs in one or more of these lawsuits were to prevail. Any settlement of or judgment on one or more of these claims could be material, and we cannot give any assurance that we would have the resources available to pay such judgments. Also, in the event of an adverse outcome of one or more of these matters, our ability to meet our debt service obligations and our financial condition could be materially and adversely affected.

Regulatory matters

        On February 14, 2002, the Minnesota Department of Commerce filed a formal complaint against us with the Minnesota Public Utilities Commission alleging that we, in contravention of federal and state law, failed to file interconnection agreements with the Minnesota Commission relating to certain of our wholesale customers, and thereby allegedly discriminated against other competitive local exchange carriers ("CLECs"). On October 21, 2002, the Minnesota Commission adopted in full a proposal by an administrative law judge that we committed 26 individual violations of federal law by failing to file, as required under Section 252 of the 1996 Telecommunications Act, 26 distinct provisions found in 12 separate agreements with individual CLECs for regulated services in Minnesota. The order also found that we agreed to provide and did provide to McLeod USA Incorporated ("McLeod") and Eschelon Telecom, Inc. ("Eschelon"), discounts on regulated wholesale services of up to 10% that were not made available to other CLECs, thereby unlawfully discriminating against them. The order found we also violated state law, that the harm caused by our conduct extended to both customers and competitors, and that the damages to CLECs would amount to several million dollars for Minnesota alone.

        On February 28, 2003, the Minnesota Commission issued its initial, written decision imposing fines and penalties, which was later revised on April 8, 2003 to include a fine of nearly $26 million and ordered us to:

•

grant a 10% discount off all intrastate Minnesota wholesale services to all carriers other than Eschelon and McLeod; this discount would be applicable to purchases made by these carriers during the period beginning on November 15, 2000 and ending on May 15, 2002;



•

grant all carriers other than Eschelon and McLeod monthly credits of $13 to $16 per unbundled network element—platform ("UNE-P") line (subject to certain offsets) during the months of November 2000 through February 2001;



•

pay all carriers other than Eschelon and McLeod monthly credits of $2 per access line (subject to certain offsets) during the months of July 2001 through February 2002; and



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allow CLECs to opt-in to agreements the Minnesota Commission determined should have been publicly filed.

        The Minnesota Commission issued its final, written decision setting forth the penalties described above on May 21, 2003. On June 19, 2003, we appealed the Minnesota Commission's orders to the United States District Court for the District of Minnesota. The appeal is pending.

        Arizona, Colorado, New Mexico, Washington, Iowa and South Dakota have also initiated formal proceedings regarding our alleged failure to file required agreements in those states. On July 25, 2003, we entered into a settlement with the staff of the Arizona Corporation Commission to settle this and several other proceedings. The proposed settlement, which must be approved by the Arizona Commission, requires that we provide approximately $21 million in consideration in the form of a voluntary contribution to the Arizona State Treasury, contributions to certain organizations and/or infrastructure investments and refunds in the form of bill credits to CLECs. On December 1, 2003, an administrative law judge issued a recommended decision denying the proposed settlement. The judge also recommended final orders requiring us to pay approximately $11 million in penalties and to issue credits to CLECs for a 24-month period from October 2000 to September 2002 equal to 10% of all wholesale intrastate services performed by us. We plan to file exceptions to the recommended decisions with the full Arizona Commission. New Mexico has issued an order providing its interpretation of the standard for filing these agreements, identified certain of our contracts as coming within that standard and opened a separate docket to consider further proceedings. Colorado has also opened an investigation into these matters. On June 26, 2003, we received from the Federal Communications Commission ("FCC") a letter of inquiry seeking information about these matters. We submitted our initial response to this inquiry on July 31, 2003. The proceedings and investigations in New Mexico, Colorado, Washington and at the FCC could result in the imposition of fines and other penalties against us that could be material. Iowa and South Dakota have concluded their inquiries resulting in no imposition of penalties or obligations to issue credits to CLECs in those states.

        Illuminet, Inc., a traffic aggregator, and several of its customers have filed complaints with regulatory agencies in Idaho, Nebraska, Iowa, North Dakota and New Mexico, alleging that they are entitled to refunds due to our purported improper implementation of tariffs governing certain signaling services we provide in those states. The commissions in Idaho and Nebraska have ruled in favor of Illuminet and awarded it $1.5 million and $4.8 million, respectively. We sought reconsideration in both states, which was denied and subsequently perfected appeals in both states. The proceedings in the other states and in states where Illuminet has not yet filed complaints could result in agency decisions requiring additional refunds.

        As a part of the approval by the FCC of the Merger, the FCC required us to engage an independent auditor to perform an attestation review of our compliance with our divestiture of in-region InterLATA services and our ongoing compliance with Section 271 of the 1996 Telecommunications Act. In 2001, the FCC began an investigation of our compliance with the divestiture of in-region InterLATA services and our ongoing compliance with Section 271 for the audit years 2001 and 2000. In connection with this investigation, we disclosed certain matters to the FCC that occurred in 2003, 2002, 2001 and 2000. These matters were resolved with the issuance of a consent decree on May 7, 2003, by which the investigation was concluded. As part of the consent decree, we made a voluntary payment to the U.S. Treasury in the amount of $6.5 million, and agreed to a compliance plan for certain future activities. Separate from this investigation, we disclosed matters to the FCC in connection with our 2002 compliance audit and otherwise, including a change in traffic flow related to wholesale transport for operator services traffic and certain toll-free traffic, certain bill mis-labeling for commercial credit card bills and certain billing errors for public telephone services originating in South Dakota for toll free services and certain marketing issues related to long-distance services in Arizona. The FCC has not yet instituted an investigation into the latter categories of matters. If it does so, an investigation could result in the imposition of fines and other penalties against us.

        We have other regulatory actions pending in local regulatory jurisdictions which call for price decreases, refunds or both. These actions are generally routine and incidental to our business.

Other matters

        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 attempted to avoid paying the dividend by changing the record date from June 30, 2000 to July 10, 2000. In September 2002, we filed a motion for summary judgment on all claims. Plaintiffs filed a cross-motion for summary judgment on their breach of contract claims only. On July 15, 2003, the court denied both summary judgment motions.

        From time to time, we receive complaints and become subject to investigations regarding "slamming" (the practice of changing long-distance carriers without the customer's consent), "cramming" (the practice of charging a consumer for goods or services that the consumer has not authorized or ordered) and other sales practices. In December 2001, an administrative law judge recommended to the California Public Utilities Commission that we be assessed a $38 million penalty for alleged slamming and cramming violations. On October 24, 2002, the full California Commission issued a decision reducing the fine to $20.3 million. We appealed that decision, and the appeal was unsuccessful. Through August 2003, we resolved allegations and complaints of slamming and cramming with the Attorneys General for the states of Arizona, Colorado, Florida, Idaho, Oregon, Utah and Washington. In each of those states, we agreed to comply with certain terms governing our sales practices and to pay each of the states between $200,000 and $3.75 million. We may become subject to other investigations or complaints in the future, and any such complaints or investigations could result in further legal action and the imposition of fines, penalties or damage awards.

        Several purported class actions were 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. Class certification was denied in the Louisiana proceeding and, subsequently, summary judgment was granted in our favor. A new Louisiana class action complaint has recently been filed. Class certification was also denied in the California proceeding, although plaintiffs have filed a motion for reconsideration. Class certification was granted in the Illinois proceeding. Class certification has not been resolved yet in the other proceedings. The complaints challenge our right to install our fiber optic cable in railroad rights-of-way and in Colorado, Illinois and Texas and 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 highways. 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 on the plaintiff's 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, South Carolina, Tennessee and Texas actions purport to be on behalf of a class of such landowners in those states, 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. Plaintiffs in the Illinois action have filed a motion to expand the class to a nationwide class. The complaints seek damages on theories of trespass and unjust enrichment, as well as punitive damages. Together with some of the other telecommunication carrier defendants, in September 2002, we filed a proposed settlement of all these matters in the United States District Court for the Northern District of Illinois. On July 25, 2003, the court granted preliminary approval of the settlement and entered an order enjoining competing class action claims, except those in Louisiana. The settlement and the court's injunction are opposed by some, but not all, of the plaintiffs' counsel and are on appeal before the Seventh Circuit Court of Appeals. At this time, we cannot determine whether such settlement will be ultimately approved or the final cost of the settlement if it is approved.

        On October 31, 2002, Richard and Marcia Grand, co-trustees of the R.M. Grand Revocable Living Trust, dated January 25, 1991, filed a lawsuit in Arizona Superior Court alleging that the defendants violated state and federal securities laws and engaged in fraudulent behavior in connection with an investment by the plaintiff in securities of KPNQwest. We are a defendant in this lawsuit along with Qwest B.V., Joseph Nacchio and John McMaster, the former President and Chief Executive Officer of KPNQwest. The plaintiff trust claims to have lost $10 million in its investment in KPNQwest.

        We have built our international network outside North America primarily by entering into long-term agreements to acquire optical capacity assets. We have also acquired some capacity from other telecommunications service carriers within North America under similar contracts. Several of the companies from which we have acquired capacity appear to be in financial difficulty or have filed for bankruptcy protection. Bankruptcy courts have wide discretion and could deny us the continued use of the assets under the optical capacity agreements without relieving us of our obligation to make payments or requiring the refund of amounts previously paid. If such an event were to occur, we would be required to write-off the cost of the related optical capacity assets and accrue a loss based on the remaining obligation, if any. We believe that we are taking appropriate actions to protect our investments and maintain on-going use of the acquired optical capacity assets. At this time, it is too early to determine what effect the bankruptcies will have with respect to the acquired capacity or our ability to use this acquired optical capacity.

        The Internal Revenue Service ("IRS") has proposed a tax adjustment for tax years 1994 through 1996. The principal issue involves our allocation of costs between long-term contracts with customers for the installation of conduit or fiber optic cable and additional conduit or fiber optic cable retained by us. The IRS disputes our allocation of the costs between us and third parties for whom we were building similar network assets during the same time period. Similar claims have been asserted against us with respect to 1997 and 1998, and it is possible that claims could be made against us for other periods. We are contesting these claims and do not believe they will be successful. Even if they are, we believe that any significant tax obligations will be substantially offset as a result of available net operating losses and tax sharing arrangements. However, the ultimate effect of these claims is uncertain.

        We intend to defend against these matters vigorously. However, the ultimate outcomes of these matters are uncertain and we can give no assurance as to whether or not they will have a material effect on our financial results.

Intellectual property

        We frequently receive offers to take licenses for patent and other intellectual rights, including rights held by competitors in the telecommunications industry, in exchange for royalties or other substantial consideration. We also regularly are the subject of allegations that our products or services infringe upon various intellectual property rights, and receive demands that we discontinue the alleged infringement. We normally investigate such offers and allegations and respond appropriately, including defending our self vigorously when appropriate. There can be no assurance that, if one or more of these allegations proved to have merit and involved significant rights, damages or royalties, this would not have a material adverse effect on us. Although the ultimate resolution of these claims is uncertain, we do not expect any material adverse impacts as a result of the resolution of these matters.

Note 12: Subsequent Events

        In most cases, we have included subsequent events that arose after the balance sheet date of June 30, 2003 in the applicable footnotes. Some subsequent events that do not fall into the context of any of the above footnotes have been set forth in this Note 12.

        Since August 2001, we have been in several disputes with Touch America, Inc. ("Touch America") relating to, among other things, various billing, reimbursement and other commercial disputes and allegations by Touch America that we violated certain state and federal antitrust and other laws. Touch America and we recently agreed to resolve all of these matters in a settlement agreement that was approved by the United States Bankruptcy Court for the District of Delaware on November 13, 2003, and which became a final order on November 24, 2003. The settlement agreement, as approved by the Bankruptcy Court, provides for: (a) the mutual general release of claims, except for bills for services provided after September 1, 2003; (b) the termination of all proceedings pending before the FCC, and all litigation between Touch America and us; (c) Touch America's forgiveness of a $23 million obligation due from us to Touch America; (d) the adjustment to zero by Touch America and us of all accounts payable and receivable for services delivered from one to the other prior to September 1, 2003; (e) our forgiveness of a $10 million loan to Touch America under a debtor in possession financing agreement; (f) Touch America's agreement to continue to provide or contract for the provisioning of services currently provided to us; (g) our agreement to purchase certain fiber assets necessary to our in-region operations from Touch America for a total price of $8 million; (h) our agreement to purchase certain Frame/ATM assets and customers from Touch America; (i) our agreement to give Touch America $3 million in billing credits; and (j) Touch America's agreement to reject and abandon a lit fiber IRU Qwest sold to Touch America in 2000.

        As disclosed in our 2002 Form 10-K, we have been involved in discussions to resolve disputes with several of our insurance carriers over their attempts to rescind or otherwise deny coverage under our director and officer ("D&O") liability insurance policies and employee benefit plan fiduciary liability insurance policies. The insurance policies that the carriers sought to rescind or otherwise deny coverage comprised: (i) the Qwest D&O Liability Runoff Program (for the policy period June 30, 2000 to June 30, 2006), which otherwise provided coverage of up to $250 million for claims that at least in part involve conduct pre-dating the U S WEST Merger; (ii) the Qwest D&O Liability Ongoing Program (for the policy period June 30, 2000 to June 30, 2003), which otherwise provided coverage of up to $250 million for claims exclusively involving post-Merger conduct; and (iii) the Qwest Fiduciary Liability Program (for the policy period June 12, 1998 to June 30, 2003), which otherwise provided coverage of up to $100 million for claims in connection with Employee Benefit Plans. The insurance carriers sought to rescind these policies and any coverage that these policies could provide for, among other things, the consolidated securities action, the actions by CalSTRS, New Jersey and SURSI, the Colorado (federal and state) and Delaware derivative actions, the consolidated ERISA action, the SEC investigation and the U.S. Attorney's Office investigation, which are described above. These matters involve conduct that could give rise to coverage under policies with collective limits of $350 million.

        We reached a settlement of these disputes with the carriers on November 12, 2003, which involved, among other things, an additional payment by us of $157.5 million, and in return, the carriers paid into trust $350 million. Of the $350 million, $150 million is available to reimburse us for defense costs or other losses incurred by us in connection with, among other matters, the investigations and securities and derivative actions described above. The remaining $200 million is set aside to cover our losses and the losses of current and former directors and officers and others who released the carriers in connection with the settlement.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

        Unless the context requires otherwise, references in this report to "Qwest," "we," "us" and "our" refer to Qwest Communications International Inc. and its consolidated subsidiaries.

Results of Operations

Overview

        Our operating revenues are generated from our wireline, wireless and other segments. We market and sell our products and services to consumer and business customers. In general, our business customers fall into the following categories: (1) small businesses; (2) national and global businesses; (3) governmental entities; and (4) public and private educational institutions. We also provide our products and services to other telecommunications providers on a wholesale basis.

        Our wireline segment includes revenues from the provision of voice services and data and Internet services. Voice services revenue consists of revenues from local voice services, long-distance voice services and access services. Depending on the product or service purchased, a customer may pay an up-front fee, a monthly fee, a usage charge or a combination of these. Please note that we have slightly modified our presentation of wireline revenues as compared to the presentation in our annual report on Form 10-K for the year ended December 31, 2002, or our 2002 Form 10-K. Within each of the revenue categories described below, we now present the channel from which the revenue was received, from consumer, business or wholesale. Also, in this Form 10-Q, we now present our wireline revenues on the basis of the following categories:

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Local voice services revenue.  Local voice services revenue includes revenues from basic local exchange services, switching services, custom calling features, enhanced voice services, operator services, public telephone services and customer premises equipment, or CPE. Local voice services revenue also includes revenue from the provision of wholesale access services.



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Long-distance voice services.  Long-distance voice services revenue includes revenues from IntraLATA and InterLATA long-distance services as well as from international long-distance services. Long-distance voice services revenue also includes revenue from the provision of wholesale long-distance services.



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Access services.  Access services revenue primarily includes revenues from switched-access services.



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Data and Internet services.  Data and Internet services revenue includes revenues from data services (such as traditional private lines, wholesale private lines, frame relay, asynchronous transfer mode and related CPE) and Internet services (such as digital subscriber line, or DSL, dedicated Internet access, or DIA, virtual private network, or VPN, Internet dial access, web hosting, professional services and related CPE). Revenues from optical capacity transactions are also included in revenue from data and Internet services, as is revenue from the provision of wholesale billing services.

        Our wireless services are provided through our wholly owned subsidiary, Qwest Wireless LLC, which holds 10 Megahertz licenses to provide personal communications service, or PCS, in most markets in our local service area. We offer wireless services to residential and business customers, providing them the ability to use the same telephone number for their wireless phone as for their home or business phone.

        In August 2003, we entered into a services agreement with a subsidiary of Sprint Corporation that allows us to resell Sprint wireless services, including access to Sprint's nationwide PCS wireless network, to consumer and business customers, primarily within our local service area. We plan to begin offering these Sprint services under our brand name in early 2004. Our wireless customers who are currently being serviced through our proprietary wireless network will be transitioned at our cost onto Sprint's network. We evaluated both the operational effects of this new wholesale wireless arrangement and the financial effects; and, due to the anticipated decrease in usage of our own wireless network, we recorded a charge related to an impairment of our wireless network of $230 million in the third quarter of 2003.

        Other services revenue is predominately derived from subleases related to our unused real estate assets, such as space in our office buildings, warehouses and other properties.

        Our wholly owned subsidiary, Qwest Dex, Inc., previously published telephone directories in our local service area. Virtually all of Dex's revenues were derived from the sale of advertising in its various directories. During 2002, we entered into an agreement to sell our entire directory publishing business to a third party for approximately $7.05 billion. The sale was divided into two phases, the first of which closed in November 2002. At this closing, we received approximately $2.75 billion of gross proceeds. The second phase closed in September 2003. At this closing, we received approximately $4.3 billion of gross proceeds. The results of operations from our directory publishing business for all periods presented are included in income from discontinued operations in our condensed consolidated statements of operations and, accordingly, the results of operations for all periods discussed below do not include the operating revenues or expenses of Dex. For more information regarding the sale of Dex, see Note 4—Discontinued Operations including Assets Held for Sale to our condensed consolidated financial statements in Item 1 of this report.

Business Trends

        Our results continue to be impacted by a number of factors influencing the telecommunications industry and our local service area. First, the competitive landscape is changing. We continue to face competition from cable telephony and are experiencing greater competition from competitive local exchange carriers, or CLECs. CLECs are increasing their use of unbundled network element-platform, or UNE-P, to gain a relative cost advantage for local voice services. In addition, technology substitution from wireless and DSL continues to erode our local service revenues. As a result of competition and technology substitution, we will continue to lose high margin local service revenues. We expect to partially offset these revenue losses by expanding our DSL coverage and offering new long-distance services, an expanded wireless offering, enhanced data and Internet services and video services. These expanded service offerings provide us the ability to retain and reacquire customers; however, revenues and margins from local services will continue to be pressured as the result of mandated UNE-P pricing. Additionally, industry wide excess capacity and competition have worked to reduce overall operating margins. Finally, our results continue to be impacted by adverse regulatory decisions related to the competitive landscape for both our local and long-distance services. We will continue to manage costs aggressively to help offset these impacts and expect improvement in our in-region long-distance margins as we migrate traffic onto our own proprietary network.

Wireline Trends

        In general, we expect to see a continued decline in wireline related revenues as a result of competition and a decrease in demand for access lines. Our competitors have accelerated their use of UNE-P to deliver wireline voice services. During 2003 and for the foreseeable future, the offering of UNE-P services has and will continue to cause downward pressure on our revenues and will result in incremental retail access line losses. In addition, access lines are expected to continue decreasing primarily because of technology substitution, including wireless and cable substitution for wireline telephony, and cable modem substitution for DIA and dial-up services. The loss of access lines will likely be exacerbated by a recent decision of the Federal Communications Commission, or FCC, requiring the portability of wireline phone numbers to wireless phones. We expect to partially offset these revenue losses by bundling our DSL, long-distance, wireless and video offerings to our customers.

        We have experienced a decrease in wireline revenues associated with long-distance voice services out-of-region (i.e., outside of our local service area) due to competitive pressures, reduced usage by customers and a shift in product mix. Out-of-region competition has expanded from traditional competitors such as AT&T Corp., MCI Communications Corporation and Sprint to other regional bell operating companies. We expect out-of-region long-distance revenue losses to continue due to competition. In addition, we previously shifted our product mix by de-emphasizing certain long-distance products due to margin concerns and the inability to use our proprietary network assets to provide InterLATA services in all states within our local service area.

        We expect to see a continuing decline in wholesale switched-access revenues due primarily to pricing changes and volume declines. Prices declined mainly due to state regulatory actions. Volumes also fell in 2002 and the first six months of 2003 due to UNE-P substitutions by interexchange carriers, competition from wireless and wireline providers and general declines in long-distance usage. We expect that switched-access revenues will continue to decline as a result of these pricing and volume impacts.

        We have also begun to experience and expect increased competitive pressure from telecommunications providers either emerging from bankruptcy protection or reorganizing their capital structure to more effectively compete against us. As a result of these increased competitive pressures, we have been and may continue to be forced to respond with less profitable product offerings and pricing plans in order to retain and attract customers. These pressures could adversely affect our operating results and financial performance.

        In November 2003, we met certain FCC requirements that permitted us to begin providing InterLATA long-distance voice services and certain data and Internet services within our local service area using our own proprietary network assets. Prior to this date, we were allowed to provide these services in our local service area only as a reseller of telecommunications services. As a result, we expect that our costs of providing these services will decrease beginning in the fourth quarter of 2003.

Wireless Trends

        During 2002, we began to experience net subscriber losses due to our decision to de-emphasize marketing of wireless services and changes to customer credit requirements, coupled with intense industry competition and the impact of the economic slowdown. These same factors have continued in 2003, and we expect that the continued loss of subscribers will cause wireless revenues to decline during the remainder of 2003.

        In August 2003, we entered into a services agreement with a subsidiary of Sprint that allows us to resell Sprint wireless services, including access to Sprint's nationwide PCS wireless network, to consumer and business customers, primarily within our local service area. We plan to begin offering these Sprint services under our brand name in early 2004. We expect that this improved offering will make our stand-alone wireless offering and our bundled offerings more attractive and should result in increased customer retention.

Presentation

        The following analysis is organized in a way that provides the information required, while highlighting the information that we believe will be instructive for understanding the relevant trends of our business going forward. We have expanded the presentation of "Operating Revenues" from our 2002 Form 10-K by including revenue results for each of our customer channels: business, consumer and wholesale for the wireline segment. The segment discussions reflect the way we report financial information to our Chief Executive Officer.

Results of Operations