Quarterly Report

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS  

1. Background and Basis for Presentation:

Unless the context requires otherwise, the use of the terms “Windstream,” “we,” “us” and “our” in this Quarterly Report on Form 10-Q refers to Windstream Corporation and its consolidated subsidiaries.

Description of the Business - We are a leading provider of advanced communications and technology solutions, including managed services and cloud computing, to businesses nationwide. In addition to business services, we offer broadband, voice and video services to consumers in primarily rural markets. We have operations in 48 states and the District of Columbia, a local and long-haul fiber network spanning approximately 115,000 miles, a robust business sales division and 22 data centers offering managed services and cloud computing.

Basis of Presentation – The accompanying unaudited consolidated financial statements have been prepared based upon Securities and Exchange Commission (“SEC”) rules that permit reduced disclosure for interim periods. Certain information and footnote disclosures have been condensed or omitted in accordance with those rules and regulations. The accompanying consolidated balance sheet as of December 31, 2011 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States. In our opinion, these financial statements reflect all adjustments that are necessary for a fair presentation of results of operations and financial condition for the interim periods shown including normal recurring accruals and other items. The results for the interim periods are not necessarily indicative of results for the full year. For a more complete discussion of significant accounting policies and certain other information, this report should be read in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2011, which was filed with the SEC on February 22, 2012 .

The preparation of financial statements, in accordance with accounting principles generally accepted in the United States ( “ U.S. GAAP ” ), requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities. The estimates and assumptions used in the accompanying consolidated financial statements are based upon management’s evaluation of the relevant facts and circumstances as of the date of the consolidated financial statements. Actual results may differ from the estimates and assumptions used in preparing the accompanying consolidated financial statements, and such differences could be material.

Effective during the fourth quarter of 2011, we changed our method of recognizing actuarial gains and losses for pension benefits. We have retrospectively adjusted financial information for all prior periods presented to reflect our voluntary change in accounting principle for pension benefits. We elected to revise historical results for certain previously unrecorded immaterial errors. We concluded that the effects, individually and in the aggregate, are immaterial to the unaudited quarterly financial information. See Notes 2 and 8 to the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2011. Additionally, certain prior year amounts have been reclassified to conform to the current year financial statement presentation. These reclassifications did not impact net or comprehensive income.

2. Summary of Significant Accounting Policies and Changes:

Significant Accounting Policies

Assets Held For Sale – On March 30, 2012 and February 22, 2012, we completed the sales of wireless assets acquired from D&E Communications, Inc. ("D&E") and Iowa Telecommunications Services, Inc. ("Iowa Telecom"), respectively, which were previously presented in assets held for sale. As a result of these transactions, we received gross proceeds of approximately $57.0 million and recognized a gain of $5.2 million , net of transaction fees. As of March 31, 2012, we have classified $6.5 million of assets and $3.6 million of liabilities of the energy business acquired in conjunction with the acquisition of PAETEC Holding Corp ("PAETEC") to assets held for sale and liabilities related to assets held for sale, respectively. These amounts are presented in assets held for sale and other current liabilities, respectively, in the accompanying consolidated balance sheet.

Goodwill and Other Intangible Assets – Goodwill represents the excess of cost over the fair value of net identifiable tangible and intangible assets acquired through various business combinations. We have acquired identifiable intangible assets through our acquisitions of interests in various wireline properties and a data center business. The cost of acquired entities at the date of the acquisition is allocated to identifiable assets, and the excess of the total purchase price over the amounts assigned to identifiable assets is recorded as goodwill. In accordance with authoritative guidance, goodwill is to be assigned to a company's reporting units and tested for impairment at least annually using a consistent measurement date, which for us is January 1 ^st of

2. Summary of Significant Accounting Policies and Changes, Continued:

each year. Goodwill is tested at the reporting unit level. A reporting unit is an operating segment or one level below an operating segment, referred to as a component. A component of an operating segment is a reporting unit for which discrete

financial information is available and our executive management team regularly reviews the operating results of that component. Additionally, components of an operating segment can be combined as a single reporting unit if the components have similar economic characteristics. Effective January 1, 2012, we have determined that we have one reporting unit to test for impairment that includes all Windstream operations. We assessed impairment of our goodwill by evaluating the carrying value of our shareholders' equity against the current fair market value of our outstanding equity, where the fair market value of our equity is equal to our current market capitalization plus a control premium estimated to be 20.0 percent . The fair market value of our equity, both including and excluding the control premium, exceed our goodwill carrying value as of January 1, 2012.

During 2011, we determined we had two reporting units for purposes of testing goodwill for impairment: 1) the data center reporting unit representing the Hosted Solutions Acquisitions, LLC ("Hosted Solutions") business acquired on December 2, 2010 and 2) a reporting unit including the remaining Windstream operations.  We integrated our Hosted Solutions operations within twelve months and segment management is no longer reviewing discrete financial information for Hosted Solutions. Therefore, we have determined that the data center operations related to Hosted Solutions no longer meet the criteria of a component for purposes of goodwill impairment testing. See Note 4 for additional information on goodwill.

Change in Accounting Estimate – The calculation of depreciation and amortization expense is based on the estimated economic useful lives of the underlying property, plant and equipment and finite-lived intangible assets. Our regulated operations use a group composite depreciation method. Under this method, when a plant is retired, the original cost, net of salvage value, is charged against accumulated depreciation and no immediate gain or loss is recognized on the disposition of the plant. In accordance with authoritative guidance, we periodically obtain updated depreciation studies to evaluate whether certain useful lives remain appropriate. With the assistance of outside expertise, we completed an analysis of the depreciable lives of assets held for certain subsidiaries in 2012. Based on the results of the analysis, we implemented new depreciation rates beginning in the first quarter of 2012 for those subsidiaries. As a result of this change, depreciation expense increased by $15.7 million and net income decreased $9.7 million or $0.02 per share for the three month period ended March 31, 2012. Additionally, we are conducting an analysis of assets for certain additional subsidiaries and expect to implement new depreciation rates during the second quarter of 2012. Based on our preliminary analysis, we expect a decrease to depreciation expense of approximately $5.0 million for the remainder of 2012.

Recently Adopted Accounting Standards

Testing Goodwill for Impairment – In September 2011, the Financial Accounting Standards Board ("FASB") issued authoritative guidance related to the testing of goodwill for impairment. This guidance allows an entity the option to first assess qualitative factors before calculating the fair value of a reporting unit. The entity may avoid applying the current two-step impairment test to a reporting unit if it determines, based on its assessment of qualitative factors, it is more likely than not that the fair value of the reporting unit is greater than its carrying amount. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. This guidance did not have a material impact on our consolidated financial statements.

Fair Value Measurement – In May 2011, FASB issued authoritative guidance related to fair value measurements. This guidance expands existing disclosure requirements for fair value measurements and makes other amendments. Key additional disclosures include quantitative disclosures about unobservable inputs in Level 3 measures, qualitative information about sensitivity of Level 3 measures and valuation process, and classification within the fair value hierarchy for instruments where fair value is only disclosed in the footnotes but carrying amount is on some other basis. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. We have updated our disclosures accordingly.

Recently Issued Authoritative Guidance

Balance Sheet Offsetting – In December 2011, the FASB issued authoritative guidance related to balance sheet offsetting. This guidance requires enhanced disclosures for financial instruments and derivative instruments that are subject to an enforceable master netting arrangement. This guidance is effective for fiscal years beginning on or after January 1, 2013, including interim periods therein and requires retrospective application. We are currently evaluating the impact this guidance will have on our consolidated financial statements.

2. Summary of Significant Accounting Policies and Changes, Continued:

Comprehensive Income – In June 2011, the FASB issued authoritative guidance requiring reclassification adjustments for items that are reclassified from other comprehensive income to net income be presented on the face of the financial statements where the components of net income and the components of other comprehensive income are presented, which was deferred in December 2011. We will continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before the authoritative guidance issued in June 2011 until further guidance is issued. We do not expect this guidance to have a material impact on our consolidated financial statements.

3. Acquisition:

Acquisition of PAETEC - On November 30, 2011 , we completed the acquisition of PAETEC in an all-stock transaction valued at approximately $2.4 billion . PAETEC shareholders received 0.460 shares of our stock for each PAETEC share owned at closing. We issued 70.0 million shares and assumed equity awards shares for a total transaction value of $842.0 million , based on our closing stock price on November 30, 2011 , and the fair value of the equity awards assumed. We also assumed PAETEC's debt, net of cash acquired, of approximately $1,591.3 million , which included a net premium of $113.9 million based on the fair value of the debt on November 30, 2011 and bank debt of $99.5 million that was repaid on December 1, 2011.

The PAETEC transaction enhances our capabilities in strategic growth areas, including Internet protocol ("IP") based services, cloud computing and managed services. It significantly advances our strategy to drive top-line revenue growth by expanding

our focus on business and fiber transport services.

The purchase price allocation was based on preliminary information regarding the fair value of assets acquired and liabilities

assumed as of the date of acquisition. We are assessing the fair values of the assets acquired and liabilities assumed and the amount of goodwill recognized as of November 30, 2011. This assessment of fair value of assets and liabilities acquired, including property, plant and equipment, intangible assets and deferred taxes requires a significant amount of judgment and we have not completed this analysis as it relates to the valuation of PAETEC. Adjustments to the preliminary purchase price allocation were based on updated information regarding the fair value of assets acquired and liabilities assumed as of the date of acquisition and were primarily associated with changes in accounts receivable, property, plant and equipment, trade names and other, accounts payable and other current liabilities that existed as of the date of acquisition.

The following table summarizes the preliminary fair values of the assets acquired and liabilities assumed for PAETEC:

(Millions)		Preliminary Allocation				Adjusted Allocation
Fair value of assets acquired:
Cash and other current assets		$	247.9			$	248.6
Accounts receivable		273.4				237.9
Property, plant and equipment		880.9				875.0
Goodwill		614.1				669.4
Customer lists (a)		855.0				855.0
Trade names and other (b)		22.0				15.0
Other assets		8.4				8.4
Total assets acquired		2,901.7				2,909.3
Fair value of liabilities assumed:
Current maturities of long-term debt and capital lease obligations		(19.0		)		(19.0		)
Other current liabilities		(453.2		)		(459.6		)
Deferred income taxes on acquired assets		108.6				108.6
Long-term debt and capital lease obligations		(1,643.7		)		(1,643.7		)
Other liabilities		(52.4		)		(53.6		)
Total liabilities assumed		(2,059.7		)		(2,067.3		)
Common stock issued (inclusive of additional paid-in capital)		$	842.0			$	842.0

3. Acquisition, Continued:

The fair values of the assets acquired and liabilities assumed were determined using income, cost, and market approaches. Identified intangible assets, consisting primarily of customer lists, were valued primarily on the basis of the present value of future cash flows, which is an income approach. Significant assumptions utilized in the income approach were based on our

specific information and projections, which are not observable in the market and are thus considered Level 3 measurements as defined by authoritative guidance. The cost approach, which estimates value by determining the current cost of replacing an asset with another of equivalent economic utility, was used as appropriate for property, plant and equipment. The cost to replace a given asset reflects the estimated reproduction or replacement cost for the asset, less an allowance for loss in value due to

depreciation. The fair value of the long-term debt and related interest rate swap agreements assumed were determined based on quoted prices for the repayment of these instruments.

For PAETEC, the credit facility was valued based on the expected redemption cost, while the remaining bonds were valued based on market value. Equity consideration was based on the closing price of our common stock on November 30, 2011. Consideration related to assumed restricted stock units was calculated based on the closing price of our common stock on November 30, 2011, net of the portion of the fair value attributable to future vesting requirements. Consideration related to assumed stock options was calculated based on the fair value of the new Windstream stock options issued as of November 30, 2011, net of the portion of the fair value attributable to future vesting requirements. The fair value of these stock option awards was calculated using the Hull-White II Lattice model based on assumptions determined as of November 30, 2011. The amount

allocated to unearned compensation cost for awards subject to future service requirements was calculated based on the fair

value of such awards at the acquisition date and will be recognized as compensation cost over the remaining future service period.

The accompanying consolidated financial statements reflect our combined operations with PAETEC for the periods following the respective acquisition date. Employee severance and transaction costs incurred by us in conjunction with this acquisition have been expensed to merger and integration expense in the accompanying consolidated statements of income (see Note 9).

The costs of the acquisition were allocated to the assets acquired and liabilities assumed based on their estimated fair values as of the acquisition dates, with amounts exceeding fair value recognized as goodwill. Goodwill associated with the acquired businesses is attributable to the workforce of acquired businesses and expected synergies. Approximately $39.9 million of goodwill associated with the acquisition of PAETEC is expected to be deductible for tax purposes.

Supplemental Pro Forma Information (Unaudited) – PAETEC Acquisition - On November 30, 2011, we completed the acquisition of PAETEC. The amounts of PAETEC's revenue and net loss included in our consolidated statement of income for the three month period ended March 31, 2012 , and the revenue and net income from continuing operations of the combined entity for the three month period ended March 31, 2011 had the acquisition date occurred January 1, 2011, are as follows:

(Millions)			Revenue			Net (Loss) Income from Continuing  Operations
PAETEC actual for three month period ended March 31, 2012 (a)			$	525.1		$	(3.1	)
Supplemental pro forma for the three month period ended March 31, 2011 (b)			$	1,516.0		$	3.7

3. Acquisition, Continued:

The pro forma information presents our combined operating results and PAETEC, with the results prior to the merger closing date adjusted to include the pro forma effect of the elimination of transactions between us and PAETEC, the adjustment to amortization expense associated with the estimated acquired fair value of intangible assets, the impact of merger and

integration expenses related to the acquisition and the impact of tax benefits from PAETEC's loss from operations.

The pro forma results are presented for illustrative purposes only and do not reflect either the realization of potential cost savings or any related integration costs. Certain cost savings may result from the PAETEC merger, although there can be no assurance that cost savings will be achieved. These pro forma results do not purport to be indicative of the results that would have actually been obtained if the merger had occurred as of the date indicated, nor do the pro forma results intend to be a projection of results that may be obtained in the future.

4. Goodwill and Other Intangible Assets:

Goodwill represents the excess of cost over the fair value of net identifiable tangible and intangible assets acquired through various business combinations. The cost of acquired entities at the date of the acquisition is allocated to identifiable assets, and the excess of the total purchase price over the amounts assigned to identifiable assets has been recorded as goodwill.

Changes in the carrying amount of goodwill were as follows:

As of January 1, 2012, we completed our annual impairment review of goodwill in accordance with authoritative guidance and determined that no write-down in carrying value was required. As discussed in Note 2, effective January 1, 2012, we have determined that we have one reporting unit to test for impairment. We assess goodwill impairment by evaluating the carrying value of shareholder’s equity against the current fair market value of outstanding equity, which is determined to be equal to our current market capitalization plus a control premium of 20.0 percent . This premium is estimated through a review of recent market observable transactions involving telecommunication companies.

Intangible assets were as follows at:

 

Amortization expense for intangible assets subject to amortization was $88.1 million and $53.4 million for the three month periods ended March 31, 2012 and 2011 , respectively. Amortization expense for intangible assets is expected to be $270.3 million for the remainder of 2012 . Amortization expense for intangible assets subject to amortization is estimated to be $299.4 million , $259.8 million , $226.2 million , $153.2 million and $124.9 million in 2013 , 2014 , 2015 , 2016 and 2017 , respectively.

 

Senior Secured Credit Facilities

Effective February 23, 2012, we amended and restated $150.4 million of the Tranche A2 senior secured credit facilities outstanding to Tranche A3 and extended the maturity to December 30, 2016. In addition, we incurred new borrowings of $280.0 million of Tranche A3 senior secured credit facilities, which will also be due December 30, 2016.

Revolving line of credit - During the first three months of 2012, we borrowed $225.0 million under the revolving line of credit in our senior secured credit facility and later repaid $465.0 million . On March 18, 2011, we increased the capacity under our senior secured revolving credit facility from $750.0 million to $1,250.0 million . Considering outstanding borrowings and letters of credit of $12.2 million , the amount available for borrowing under the revolving line of credit was $557.8 million at March 31, 2012 .

Letters of credit are deducted in determining the total amount available for borrowing under the revolving line of credit. Accordingly, the total amount outstanding under the letters of credit and the indebtedness incurred under the revolving line of credit may not exceed $1,250.0 million .

5. Long-term Debt and Capital Lease Obligations, Continued:

The variable interest rate on our revolving line of credit ranged from 2.50 percent to 4.50 percent , and the weighted average rate on amounts outstanding was 2.54 percent during the first three months of 2012, as compared to variable interest rates during the first three months of 2011 which ranged from 1.52 percent to 4.50 percent with a weighted average rate on amounts outstanding of 2.54 percent . All $1,250.0 million available under the revolving line of credit will expire December 17, 2015.

Notes Issued by Subsidiaries

PAETEC 2015 Notes - In connection with our acquisition of PAETEC on November 30, 2011 , we assumed the 9.500 percent notes due July 15, 2015 (" PAETEC 2015 Notes") with an aggregate principal amount of $300.0 million .

On January 3, 2012 , we retired $150.0 million of the outstanding PAETEC 2015 Notes, in relation to our call for redemption announced on December 2, 2011 . We paid total consideration of $1,048 per $1,000 aggregate principal amount of PAETEC 2015 Notes, plus accrued and unpaid interest to, but excluding, the redemption date. The PAETEC 2015 Notes were purchased using borrowings on our revolving line of credit.

On February 21, 2012 , we retired the remaining $150.0 million outstanding of the PAETEC 2015 Notes, in relation to our call for redemption announced on January 20, 2012 . We paid total consideration of $1,048 per $1,000 aggregate principal amount of PAETEC 2015 Notes, plus accrued and unpaid interest to, but excluding, the redemption date. The redemption was made using borrowings on our revolving line of credit.

Premium on Long-term Debt, Net of Discounts

The premium on long-term debt, net of discounts is primarily due to the debt issuance premium recorded on the debt acquired in the PAETEC acquisition, partially offset by the net discount recorded on debt in the table above. The premium and discount balances are amortized over the life of the related debt instrument.

Debt Compliance

The terms of our credit facility and indentures include customary covenants that, among other things, require us to maintain certain financial ratios and restrict our ability to incur additional indebtedness. These financial ratios include a maximum leverage ratio of 4.50 to 1.0 and a minimum interest coverage ratio of 2.75 to 1.0 . In addition, the covenants include restrictions on dividend and certain other types of payments. The terms of the indentures assumed in connection with the acquisition of PAETEC include restrictions on the ability of the subsidiary to incur additional indebtedness, including a maximum leverage ratio, with the most restrictive being 4.75 to 1.0 . As of March 31, 2012 , we were in compliance with all of our covenants.

In addition, certain of our debt agreements contain various covenants and restrictions specific to the subsidiary that is the legal counterparty to the agreement. Under our long-term debt agreements, acceleration of principal payments would occur upon payment default, violation of debt covenants not cured within 30 days, a change in control including a person or group obtaining 50 percent or more of our outstanding voting stock, or breach of certain other conditions set forth in the borrowing agreements. We were in compliance with these covenants as of March 31, 2012 .

Maturities for debt outstanding as of March 31, 2012 for each of the twelve month periods ended March 31, 2013 , 2014 , 2015 , 2016 and 2017 were $47.7 million , $1,146.7 million , $53.8 million , $1,741.7 million and $290.5 million , respectively.

(Gain) Loss on Extinguishment of Debt

During the first quarter of 2012, we retired all $300.0 million of the outstanding PAETEC 2015 Notes. The PAETEC 2015 Notes were purchased using borrowings on our revolving line of credit. The retirements were accounted for under the extinguishment method, and as a result we recognized a gain on extinguishment of debt of $1.9 million during the three month period ended March 31, 2012.

During the three month period ended March 31, 2011, we purchased all $1,161.3 million of our 8.625 percent Senior Notes due August 1, 2016 ("2016 Notes") and all $400.0 million of our 7.750 Senior Notes due February 15, 2015. We financed these transactions with proceeds from the issuance of the 7.75 percent senior unsecured notes due October 15, 2020 ( " 2020 Notes"), the 7.750 percent senior unsecured notes due October 1, 2021 (" 2021 Notes"), the 7.500 percent senior unsecured notes due

5. Long-term Debt and Capital Lease Obligations, Continued:

April 1, 2023 (" 2023 Notes") and borrowings from our revolving line of credit. These transactions allowed us to extend our existing debt maturities and lower our interest rates. The retirements were accounted for under the extinguishment method, and as a result we recognized a loss on extinguishment of debt of $101.4 million during the three month period ended March 31, 2011.

The (gain) loss on extinguishment of debt is as follows for the three month periods ended March 31 :

(Millions)				2012				2011
2015 PAETEC Notes:
Premium on early redemption				$	14.3			$	—
Unamortized premium on original issuance				(16.2		)		—
Gain on early extinguishment for 2015 PAETEC Notes				(1.9		)		—
2016 Notes:
Premium on early redemption				—				75.5
Unamortized discount on original issuance				—				18.2
Third-party fees for early redemption				—				2.7
Unamortized debt issuance costs on original issuance				—				0.8
Loss on early extinguishment for 2016 Notes				—				97.2
Valor Notes:
Premium on early redemption				—				10.3
Third-party fees for early redemption				—				0.4
Unamortized premium on original issuance				—				(6.5		)
Loss on early extinguishment for Valor Notes				—				4.2
Total (gain) loss on early extinguishment of debt				$	(1.9	)		$	101.4

Derivatives

We enter into interest rate swap agreements to mitigate the interest rate risk inherent in the variable rate senior secured credit facilities. We account for our derivative instruments using authoritative guidance for disclosures about derivative instruments and hedging activities, including when a derivative or other financial instrument can be designated as a hedge. This guidance requires recognition of all derivative instruments at fair value, and accounting for the changes in fair value depends on whether the derivative has been designated as, qualifies as and is effective as a hedge. Changes in fair value of the effective portions of cash flow hedges should be recorded as a component of other comprehensive income in the current period. Changes in fair values of the derivative instruments not qualifying as hedges, or of any ineffective portion of hedges, should be recognized in earnings in the current period.

In 2006, we entered into four pay fixed, receive variable interest rate swap agreements, designated as a cash flow hedge, with a maturity date of July 17, 2013. The variable rate we received on the swaps was the three-month LIBOR (London-Interbank Offered Rate). We renegotiated the four interest rate swap agreements in December 2010, in a strategy commonly referred to as "blend and extend." The modified swaps will amortize quarterly to a notional value of $900.0 million in 2013, where they will remain until maturity on October 17, 2015 ( $1,000.0 million as of March 31, 2012 ). As a result of the renegotiated agreements, our weighted average fixed rate was lowered to 4.553 percent effective January 17, 2011. The variable rate received resets on the seventeenth day of each quarter to the three-month LIBOR.

Our interest rate swap agreements are designated as cash flow hedges of the interest rate risk created by the variable interest rate paid on Tranche B of the senior secured credit facilities, which has varying maturity dates from July 17, 2013 to December 17, 2015 as a result of an amendment to the credit facility. The variable interest rate paid on Tranche B is based on the three-month LIBOR, and it also resets on the seventeenth day of each quarter. The counterparty for each of the swap agreements is a bank with a current credit rating at or above A .

5. Long-term Debt and Capital Lease Obligations, Continued:

We recognize all derivative instruments at fair value in the accompanying consolidated balance sheets as either assets or liabilities, depending on the rights or obligations under the related contracts. This is included as a component of other comprehensive income and will be reclassified into earnings as the hedged transaction affects earnings.

Set forth below is information related to our interest rate swap agreements: